----------------- HES POSTING ----------------- You might be interested in the following review by a Hindu (myself) in the Journal of the Christian Economists (UK) of the book referred to by Elias Khalil in an earlier posting. Perhaps this may provide at least something of a cross-cultural perspective on the subject. Prabhu Guptara, Switzerland (Review Article for The ACE Journal (U.K.), no. 27, 2000, pages 32-43) [NOTE: THE ACE Journal permits further publication of articles published there, and this article is distributed here without violating any copyright laws. - RBE] Islamic Finance: Theory and Practice by Paul S Mills and John R Presley Macmillan Press, UK, 1999, hardback, 171 pages, £45.00 Why should members of ACE be interested in a book on Islamic finance? Because the Islamic financial system is at present the only reasonably well-articulated major contender against the current materialist economic system (capitalism), and because Islamic finance is based on tenets curiously parallel to those in the Old Testaments. Examining the case for and against an Islamic financial system may also help us to consider the case for and against developing a genuinely Biblical economics. Further, one might wish to consider that, as the failure of the Church adequately to address its prophetic duty on the issue of social justice in the nineteenth century led to the creation of Marxism, and as the failure of the Church adequately to tackle the desire for peace and a new world after World War II led to the birth of 'flower power' and the New Age in the Sixties, so the failure of the Church adequately to tackle the challenges of capitalism is leading at the moment certainly to individual conversions to religions or philosophies which are perceived as offering some hope regarding the key issues of global capitalism such as social justice, animal rights and environmental care ('sustainability'); if the Church continues to fail in its prophetic duty to address such issues, we may well see the development of another soul-less and therefore ultimately destructive mass alternative to global capitalism. Mills and Presley observe that "the financial headlines continually bear testimony to the recurring problems of our current approach to banking and finance, (so) it is right to consider whether a more fundamental response than the usual palliatives of more bailouts and regulation is needed" (p. viii, parenthesis mine - here and throughout this article). Islamic Finance is therefore "motivated by the suspicion that there is another way. In particular that the critique of interest-bearing debt finance has more economic cogency than is assumed by mainstream economics. The book begins by setting the Islamic critique of interest and proposals for a non-interest banking system in the context of the Islamic approach to economic analysis. It then develops the theoretical properties of the non-interest model and assesses the recent experience of Islamic banking in practice, before outlining the economic benefits (and costs) of a non-interest financial system....". (p. viii) The salient feature of Islamic finance is its rejection of usury (which, being interpreted into modern English, is the rejection of all interest). Mills and Presley conclude their book with a consideration of the prohibition of interest in the West but, for people who accept the authority of the Qu'ran or of the Bible, this is probably the best point at which to begin. The authors remind us of facts we conveniently choose to forget, if indeed we have ever come across them in the course of our indoctrination into materialist economics. For example, "the Western belief in the benign results of interest-based financial operations is historically relatively novel. More typical has been the attitude of the English Puritan(s) ... to the effect that lending at interest is inherently exploitative" (p 101). Why has the consistent Western tradition of opposition to usury been lost? Due "to the divorce of ethical debate from economic theorizing" (p. 101). When was the historic opposition to usury dropped in the West? The authors date this to the period after Calvin, though this is in my reading historically mistaken, and ought to be traced to the introduction of the distinction between usury and interest by the Roman Catholic Church in the thirteenth century. In any case, the authors argue, "there was far more economic sense in the ...opposition to interest than is currently assumed." (p 101). This case the last chapter sets out to explore. The chapter starts by clarifying that the distinction between 'legitimate' interest payments and 'unjust' usury was originally intended only to indemnify the lender rather than to provide a financial return. (It is worth noting, however, that in the Bible, standing surety is roundly condemned too, from which one might draw the principle that indemnifying the lender is as unsound as is usury). "The number of instances when such payments were deemed legal was gradually increased until most loan charges were legitimized under the guise of 'compensation'. Lenders persisted with the euphemism 'interest' in order to avoid the unwelcome associations of 'usury'". (p. 102) Mills and Presley's summary of the Western opposition to interest begins with the well-known Deuteronomic prohibition of interest, reinforced elsewhere in the Old Testament. The authors seem to think that there is "no explicit rationale for the prohibition given in the texts themselves" (p. 103) - a belief which appears to me to be sustainable only if one confines oneself to the specific verses in question. However, the context of these verses makes it clear that the prohibition of interest was part of a larger spirituo-socio-politico-economic system in which there would be 'long life', 'none of the diseases' which plagued the Egyptians, 'peace and plenty' and 'no poor' people (because, though there would always be some income differences, poorer people would be taken care of by the generosity of those who were richer, by the system of tithes and offerings, by the restriction on collateral, by the prohibition of usury, by the generous provision for freed slaves, times of festival, the cancellation of debt, and so on; see Deut. 4.49; 5.29 & 33; 6.2; 7.14 & 15; 14.22-28; 15.1-18; 16.9-17; 24.8, 12, 14, 17, 19-21; 26.12; 28.11-12 et al). So the creation of a society based on interest, inter alia, militates against these promised benefits. That is the rationale for the prohibition of interest - though of course there is no 'economic' rationale provided in the texts which makes sense in modern economic terms; in other words, the question here is: 'logic' or 'rationale' by whose definition? The authors are right, however, in pointing out that post-prophetic rabbinical teaching explained the prohibition "largely in terms of encouraging charity and community feeling, rather than declaring interest to be inherently unjust. Jewish communities have tended to observe the prohibition of interest amongst themselves but charged interest on loans made to Gentiles (following the brother / foreigner distinction of Deuteronomy)" (p. 103). Among the Greeks, "only Plato and Aristotle voiced outright opposition to the very existence of interest within Greek thought....interest free lending to family and friends was greatly esteemed within ancient Greek societies, (but) interest was regarded as legitimate if charged on an impersonal or business loan - echoing the Old Testament injunction" (p. 103). Roman authorities were "far more interventionist, however, as the perpetual indebtedness of peasant farmers, and the severe penalties for default, resulted in periodic debtor revolts. The maximum interest rate was set at 10 per cent in 450 BC but eventually lowered to zero in 342 BC. This outright prohibition quickly became obsolete in practice, but was periodically revived during debt crises. Sulla eventually adopted the customary rate of 12 per cent as the legal maximum in 88 BC, which continued until the fall of the Western Empire" (p. 103). However, the authors are again on tendentious ground when they declare that the New Testament makes "only passing reference to interest..... Most relevant is Jesus' teaching to his disciples on lending ('If you lend to those from whom you hope to receive, what credit is that to you? Even sinners lend to sinners in order that they may receive in return the equal amount. But love your enemies, and do good and lend, despairing of nobody'). An idiomatic rendering of the final phrase would be 'lend, without hoping for any return'. Whilst Jesus is clearly advocating a radically liberal approach to lending, it is not clear what is to be forgone - interest, principal or the hope of reciprocal favours" (p. 103). The authors' commentary is weak because the text clearly contrasts the usual practice among 'sinners' of lending to others in hope of getting back 'the equal amount' (no expectation of interest, even among sinners!) with the practice, commended by Jesus, of not lending only to those from whom we might hope to receive anything (no reciprocal favours!) - rather of lending even to those from whom we despair of receiving the principal. 'Lending', in other words, is to be done simply as a 'good' in its own right. The believer is to give freely and liberally, expecting back neither interest nor principal - nor indeed reciprocal favours - in contrast to the calculating attitude of unbelievers. (In a similar vein, see also Jesus' teaching on luncheons and dinner parties, Lk 14: 12-14; and on the otherwise easily-declinable appeals of beggars for one's cloak; as well as on the unjust but legal demands by Roman soldiers requiring one to carry their luggage for a mile). Other explicit references to interest, point out the authors, come in the parables of the ten talents or minas. "By implication, these references describe interest as 'reaping where one has not sown'". (pp 103-104). In any case, as a result of the Biblical teachings, interest was formally proscribed within the Church by the Council of Elvira (306 AD) and the Church Fathers were unanimous in condemning usury for greed and uncharitableness. St Augustine went further and declared usury to be a variant of theft and so inherently immoral, though interest was first proscribed for all citizens by a Western legislature under Charlemagne in 789. Until approximately 1050, interest-taking was considered to be a sin of greed and lack of charity. However, the commercial revival of the late eleventh century and the ensuing increase in demand for business loans tempted theologians to reclassify usury as a sin of injustice. This was also the time when the distinction between interest and usury came to be accepted though the harshest anti-usury Church legislation was passed by the Council of Vienna (1317), which called for the excommunication of usurers as well as the excommunication of any ruler who sanctioned usury. In other words, usury was classed along with heresy. The theoretical ban on usury continued till the late eighteenth century in Roman Catholic Europe (Mills and Presley claim that the Vatican formally recognised the legitimacy of interest only in 1917 though this is debatable) and it would be useful to know to what extent it applied in practice in Roman Catholic Europe. In Protestant Europe, the ban on usury continued only till the sixteenth century, when Calvin's grudging acceptance of it when applied to borrowings by rich people opened the door to the legitimisation of interest. >From 1600 onwards, the debate in fact shifted from whether to proscribe interest altogether to which rate was most expedient to have as the legal maximum. Ultimately, the debate shifted to whether a legal maximum could be justified at all, for instance in the writings of Jeremy Bentham, which carried the day, resulting in the 1854 Moneylender's Act that abolished the 5% usury law and allowed lenders to charge at any rate. A limit of 48% was reimposed in 1927 in an attempt to protect vulnerable borrowers. However, since the passage of the Consumer Credit Act (1974), even that restriction was removed - borrowers must instead demonstrate exploitation to a court given their circumstances. There is no definition of exploitation in the legislation, and I understand that there is no case law on the subject. Briefly, we may say that there is a strong case against the taking of interest through the centuries of Western thought and that the theoretical and spiritual grounds for the ban on interest have never been countered. These grounds focus on the Biblical attitude to charity, justice, social divisions and societal health, to relationships, to work, to risk, to money and to time: "Eventually, the whole usury debate turns on our attitude towards time. The justification of interest entails the claim that, quite literally, 'time is money'. Since the mere passage of time supposedly alters the value of assets, money and satisfaction automatically, their forfeiture over time (through a loan) automatically justifies interest as compensation. The opponents of interest would dissent. Since nothing is certain in time, we ought not to act as though it is. Contingent profit-share and rental contracts allow for positive returns to be made, and the services of durables to be enjoyed, over time. But they do not presume that the mere passage of time necessarily affects anything. Hence, it is unwarranted to justify discounting through positive time preference" (p 110-111). I am not sure that rental contracts are Biblical either, but let that pass, for the moment. After piling up the case against interest on ethical, legal and economic grounds, the authors conclude lamely: "While this accumulation of evidence against interest might seem compelling to some, unfortunately the case for the prosecution has one major flaw. Most of its arguments are predicated upon initial premises - be they religious, ethical or legal - that are not unanimously held. If usury could easily be equated with an obviously immoral act, such as theft, then the case for prohibition would be clear" (p. 112). The problem with this position is that, in our pluralistic world, there is no act which is "obviously immoral" - or at least there is no act whose immorality is obvious to everyone. Robin Hood did not consider theft immoral. Nor is theft necessarily considered immoral by certain socialists on the one hand, or on the other by muggers and street louts. In fact, the prohibition of theft has no adequate moral basis outside the Semitic religions, since it is sanctioned at best by tradition, rather than being rooted in the character of God and of the universe as it is in the case of the Bible. Internationally-accepted moral standards in relation to murder, monogamy, work and most other matters originate within the Semitic religions and certainly have no unarguable validity in materialist humanism. So I do not understand why the authors abandon for perceived political correctness the case which they develop with such intellectual rigour. The authors go on to argue that "the practical drawbacks to interest ....must be weighed against the pragmatic disadvantages of its prohibition. In particular, the proscription of interest in a society uncommitted to the underlying requisite religious or ethical ethos will merely result in a thriving black-market for loans - with suitably adjusted risk premie - and the proliferation of contractual devices that disguise interest as profit, rent or unconnected favours. ...While compelling grounds can be given for the rationalization of the Biblical prohibition of interest, their acceptance depends on prior commitment to particular religious or ethical norms....Without moral pre-commitments, the usury debate becomes a pragmatic one. Whilst there are many practical disadvantages to a free market in interest-bearing loans....Western countries have been stripped of the religious and ethical presuppositions conducive to the proscription of interest. (p 112-113). This is surely going too far. While it is true that there appear to be fewer and fewer people in the West with an a priori commitment to particular religious practices, it is also true that there are more and more people with an a priori commitment to ethical norms which are coming to be seen as universal, such as human rights, honesty, transparency, and so on - though it probably ought to be added that such commitment in many instances may be much weaker than among those with specifically religious beliefs. In any case, the authors conclude that "if the legitimacy of interest is to be seriously questioned again, the debate must hinge on the feasibility and practical benefits of a non-interest financial system, which have been examined in the preceding chapters" (pp 112-113). There is much merit in such an approach, though in our day one ought to add the consideration that any usurious economic system is also a high-growth system since it minimises risk for the lender, guaranteeing returns and making capital accumulation possible. In a non-usurious economic system, the only way of accumulating wealth is by hard work (which has its limits), by risk-sharing methods of wealth-generation, or by looting, theft and other immoral means (all of which also have their limits). In historic or traditional non-usurious economic systems, group cultures generally further militated against high growth rates by encouraging conspicuous consumption usually of a public sort (monuments, feasts) while conspicuous consumption of a personal sort was not discouraged. The Protestant contribution to reversing these cultural attitudes is well perceived historically, a la Weber and Tawney, though its precise role in so doing is hotly contested academically (was it the sole cause? was it the sufficient cause? did or do such reversals happen elsewhere? and so on). The merit of a usurious high-growth economy is progress in the supply of material goods. The demerits of a usurious high-growth economy are that it inevitably increases the gap between the poor and the rich, does not necessarily or by itself contribute to the alleviation of poverty (and can in fact increase poverty), and has in any case since the eighteenth century contributed to global environmental degradation (even though it has contributed also to "local" environmental improvement). There is an open question about whether a high-growth economy by its very nature grows faster and faster and whether, when it becomes a global high-growth economy (as it has since more or less the last ten years), it becomes cancerously uncontrollable from an environmental point of view. There are "believers" and "sceptics" on both sides of this debate but I mention it here only to place it on the table as the authors do not seem to me to take sufficient cognisance of this issue, which must also be placed in the balance when one considers whether to press or to abandon the case against usury. We come now to the rest of the book. As the chequered history of usury in the West shows that there was a gulf fixed between theory and practice for most of the time that usury was banned, so the experience of the Islamic opposition to usury too reveals that the theory and the practice of Islamic finance have a large gulf fixed between them. What is the reason for these gaps? The general impression is that this is because the idea of Islamic finance is inherently unsound, just as the idea of an Islamic society is backward-looking. (Compare the fact that if the notion of "a Christian society" still appeals to some people, the notion of "a Biblical financial system" usually seems strange - even though there is general agreement that neither capitalism nor socialism are inherently Biblical.) The authors structure their work as follows: Chapter 1: The Background to Islamic Economics and Banking (and a brief discussion of its guiding principles) Chapter 2: the Islamic Critique of Interest (with the relevant textual evidence and subsequent casuistry, as well as Islam's legal, ethical and economic critique of interest, examining especially Islamic definitions of money and capital) Chapter 3: The Interest-Free Financial System (elaborated by Islamic theoreticians) Chapter 4: Modelling Profit-and-Loss Sharing Chapter 5: Non-interest Banking in Practice Chapter 6: Non-interest Finance and Macroeconomic Stability Chapter 7: Key Issues in the Islamic Financial System. It is not possible to describe and discuss each chapter in detail; I will mention, describe or discuss matters according to the degree to which they appear to me to be of possible interest to readers of ACE. 1. "The devout Muslim with disposable wealth has always faced a dilemma. Qu'ranic opposition to interest is clear, but so too is the condemnation of hoarding and wasteful consumption. The impasse is that of having wealth to save but few legitimate financial instruments with which to do so" (p 15). However, the dilemma arises only because of human fear and greed - in the Qu'ran as well as in the Bible, excess wealth is meant for hospitality, support for the poor, and so on. An Islamic society (as also a society governed by Old Testament or New Testament values and beliefs) is a society in which there is equality of opportunity for everyone to develop and apply their talents to the fullest possible extent, the rewards of which are not meant to be hoarded or loaned on interest but are meant to be enjoyed along with others, though not in a wasteful manner. So what is one to do with excess wealth? It is intended to be given away. This requires supernatural reliance on God in order to counter the fear and greed which naturally attends the accumulation of wealth - a fundamentally different attitude from that of the worldling who is concerned with the accumulation of wealth for its own sake or as a means of keeping uncertainty and mortality at bay for as long as possible. If Islamic society hoards in spite of clear Qu'ranic teaching to the contrary, this is because there is no supernatural life there, just as evidence of this and other sins in Christian communities is evidence of lack of experience of God's power there. 2. The problem for "devout Muslims" (with financial hoards estimated to be of the order of $80 billion in Muslim countries in the early 1980s) therefore became that of how to devise financial intermediaries that operate without resorting to interest but which still yield a return to depositors. "The achievement of Islamic economists and bankers has been the conception and elaboration of such a structure" (p 15). Undeniably, this is an achievement but, much as the development may delight economists theoretically, the achievement is a sort of Pyrrhic victory: Islamic theoreticians have created what neither the Qu'ran nor the Old Testament nor indeed the New Testament ever intended to be devised. That is why it leads Islamic scholars into the sorts of difficulties and disagreements in which they find themselves and it is also why it leads Islamising societies into the practical difficulties their economic systems face as a result. Those who find this saying too hard will naturally commit themselves to something along the lines of current theories of Islamic finance which are, I agree, an achievement which centres round the elaboration of the theory of "interest-free banks" or structures for profit- and loss-sharing (PLS). The authors go on to discuss issues in the theory of interest-free finance specifically in relation to trade and consumer credit as well as government borrowing and monetary policy. 3. "The framing of a theoretical Islamic model society (is) relatively easy. However, like other theocratic ethical systems, Islam can diagnose what is currently wrong and describe the "perfect" society, but is less certain about what to do if people refuse to conform to Islamic moral standards....Islamic economics also includes the evaluation of the government initiatives and legal reforms needed to transform current institutions and modes of behaviour in Muslim societies into those which conform to Islamic norms....building bridges between the "is" and the "ought" ....This leaves ample scope for divergence of opinion because scant guidance is given in Islamic law on such pragmatic questions" (p. 2). This is not quite true; both Biblical and Qu'ranic guidance is available: those who do not obey must be appropriately punished and, depending on the severity of their disobedience, even killed - but our times do not cope with the logic or the necessity of this, regarding this sort of thing as primitive and barbarian when the problem may be our own social and spiritual blindness. 4. The debate regarding interest-free banking "has remained entirely theoretical, however, primarily because the existing private Islamic banks which have to hold 100 per cent demand deposit reserves are enormously disadvantaged in free market competition against conventional banks" today (p 18) which can leverage their deposits with international legitimation by 850% and indeed by more than this in some parts of the world. "The jury is still out on PLS banking because ... countries (which) have abolished "interest" without committing themselves to a full-blown PLS system....remain open to the charge that non-interest banking has been instituted merely to salve the consciences of pious depositors rather than to make a radical impact on how the financial system operates" (p 57) 5. While the authors are right in noting similarities and correspondences between Islamic, Hebrew and New Testament thinking, they seem to think that these similarities are fewer than is in fact the case. For example, it is not only the Qu'ran but also the Old and New Testaments which are primarily theocratic (other rulers are regarded as being instituted by God and therefore worthy of respect and even obedience only so long as these rulers act in consonance with God's revealed ways). Again, it is not only Islamic social thought, but also Old Testament and New Testament social thought, which is organised by the principle that "the spiritual and moral takes precedence over the material and pragmatic, based on the assumption that human happiness is ultimately to be found in moral obedience rather than material ease" (p.2). This is also the case, mutatis mutandis, with belief in a life beyond that of this earth; with the teaching that God rewards and punishes us in that life on the basis of the principles on which we have acted in this life; with the rejection of the notion of inalienable property rights in favour of the status of trusteeship of all that is justly acquired by us; the condemnation of hoarding, squandering and denying to the poor; the duty and indeed importance to God of our work; belief in justice, equality of opportunity, and so on. 6. "What distinguishes Islamic thought from Judaism, Christianity and even Muslim pietism is that the jump from individual obedience to the transformation of society is automatic" (p.2). This is debatable. Consider that the Mosaic laws were given before the Hebrews went in to occupy the promised land specifically in order that an ideal state and an ideal society might be built there. Their society was to be a righteous one, in contrast to the sinful societies which at that time occupied the land (the Hebrews had earlier been told that they could not occupy the land for four generations because the iniquity of the Amorites had not yet reached the depth which would justify God bringing them judgement in the form of the entire elimination of those people by the Hebrews; see Gen. 15.16). In other words, Jewish ethics starts specifically in the context of the founding of a righteous state, and there is as little distinction between individual and "national" matters in original Judaism as there is in Islam. And, insofar as the religion of Jesus is predicated on the failure of the "gathered" Jews to maintain the Mosaic law, the new community of the followers of Jesus is intended to be a "scattered" community, doing its work like yeast in "all the world". Further, insofar as the instructions for the followers of Jesus are a stronger version of the instructions given to the Hebrews, it is clear that the followers of Jesus were meant to influence the world as yeast influences the rising of bread-dough rather than be a national model to the world as in the case of the Hebrews. In whichever part of the world the followers of Jesus were in greater concentrations, it is clear that their influence would go beyond the merely individual to the structural, creating relatively more model societies everywhere rather than an absolutely model society in the promised land - till, that is, the perfect society is directly introduced by God through the radical structural transformation of the heavens and the earth at the completion of the "end times" which were inaugurated by Jesus the Lord. 7. "At the outset there appears to be no fundamental difference between the accepted economic objectives in the West and those of a truly Islamic economy. The underlying feature of any economy must be the desire to achieve social and economic justice." (p. 3). This is an astonishing statement, unlikely to command agreement from Friedmanians and others who are much more concerned about having instead a high-growth economy and who believe that minor matters such as social and economic justice look after themselves by the operation of Adam Smith's invisible hand. 8. "Islamic opposition to interest is primarily inspired by religious adherence to the teachings of the Qu'ran. However, this has not prevented the theoretical analysis and justification of a PLS (profit- and loss-sharing) financial system in order to convince sceptics of the efficacy of Shari'ah (God's laws). In their turn, the sceptics have countered with various theoretical objections that are believed to render a non-interest system impractical or inefficient." (pp 21-22). The authors present both sides of the argument by outlining the theoretical implications of a PLS financial system and assessing its feasibility in the light of conventional economic theory and historical experience - coming out broadly in favour of a PLS system. 9. Mills and Presley present a highly concise discussion (less than six pages) regarding the principal agent problems in financial contracting, covering the background, the case for debt finance with asymmetric information (and its limitations), and the implications thereof for interest-free banking and finance. The case for the defence of non-interest banking is similarly concise (just over 4 pages), before the authors move to their assessment: they acknowledge that financial contract theory poses a prima facie case against non-interest banking. "However, the case against a non-interest financial system is far from overwhelming. In practice, debt finance copes inadequately with risk-sharing in an uncertain world and imposes its own significant agency costs. Also, the practical difficulties associated with non-interest finance are not insuperable. Monitoring costs can be reduced by randomized checking and the handling of borrowers' transactions, whilst their incentive to cheat can be restrained by intertemporal contracts which tie lower PLS ratios in the future to satisfactory performance in the present. In particular, financial contract theory and conventional banking experience suggest that PLS finance will be far more feasible if placed within the context of long-term banking relationships. " (p 32) Having mentioned some ways in which a non-interest banking system might indeed be superior, their overall conclusion is: "By stressing the intertemporal nature of the financial terms on offer, a non-interest banking system should at least prove workable" (p 33). 10. "The theoretical benefits and limitations of a non-interest financial system bear a close resemblance to those of (M.L.) Weitzman's proposal to replace flat-rate wages with profit- or revenue-sharing labour remuneration arrangements....Weitzman predicts a robust economy with a cycle of diminished amplitude and a tendency to full employment (because of) the stabilizing consequences of introducing flexibility into the labour remuneration mechanism" (p 34). 11. In a non-interest contractual system "the manager is left free to choose the individually optimal level of investment in each state contingent on his contractually specified level of effort. Such a contract permits a mean-variance improvement in capital investment - average investment is increased whilst inefficiently large fluctuations around this level are reduced." (p 45) 12. "Conventional economics has neglected the role interest plays in fostering wealth inequalities (and a) non-interest financial system would retain substantial scope for inegalitarian flows of property income, but these should be lessened by the absence of compound interest and the widespread sharing of profits and losses with savers" (pp. 45-46). 13. "The quest to find workable (and beneficial) alternatives to interest has strong implications for agricultural finance, particularly in developing economies. The potential for rural moneylenders to exploit and enslave smallholders through high rates of interest and input prices is well-documented. Consequently, there is great scope for PLS development banks specializing in agricultural finance and input supply" (p. 46) 14. "Rulers came to see Shari'ah as applicable to individual conscience but not to social legislation" (p 49) - paralleling what happened in the West. 15. "The most frequently posited advantage of profit-and-loss sharing (PLS) is its contribution to (economic) stability. Whereas conventional finance supposedly amplifies the business cycle, PLS finance is predicted to dampen it" (p 58). The case is examined by setting out the supporting monetary and financial theories of the cycle and the ways in which non-interest banking could alter matters. Wicksell, Hayek, Fisher, Minsky, as well as financial cycle theories dependent on asymmetric information (the equity-rationing approach and the agency cost approach) are all examined to consider non-interest contributions to cyclical dampening (including the destabilizing movements in the cost of capital, fractional reserve banks and credit volatility, bank failures in depressions, speculative lending and borrowing, non-contingent liabilities and debt deflation). The authors conclude: "Debt finance has long been accused of contributing to cyclical instability....However, this is one of the commonsense propositions that economics has delighted in contradicting. (These theoretical rebuttals of the impact of debt finance have been undermined by) the application of asymmetric information considerations to financial relationships (which) has shown ways in which financial structure can have an effect on the real economy. Secondly, the increase in private sector indebtedness in the 1980s resulted in financial fragility ... (which) contributed to the length and depth of the subsequent recession. Two implications can be drawn...(First, it) is illogical that the corporate tax systems of developed economies invariably favour debt over equity finance. Interest payments are tax deductible whilst dividends and retentions are considered as taxable profit. This reduces the cost of debt finance, relative to the equity equivalent, by a company's marginal tax rate. This bias needs to be eliminated not only on efficiency grounds, but also to encourage greater resilience to financial shocks. Indeed, the externality costs of debt financing indicate that the tax incentive should be reversed rather than eliminated. (Second, the) growth in aggregate demand in Anglo-Saxon economies is now closely tied to the private sector's willingness and ability to borrow. That such debts are rarely indexed introduces an inflationary bias to the output:inflation trade-off facing the monetary policy-maker, particularly on the downswing of the cycle". (pp 70-72). 16. Clearly, interest-based finance may not be the only cause of instability within capitalist economies. Equally clearly, a non-interest economy may not be without cycles. But, the authors conclude: "a non-interest economy would be more stable than its debt-financed counterpart. The benefits, in terms of a lower cost of capital and a more advantageous output:inflation trade-off would be considerable" (p 72). 17. In chapter 7 ("Key Issues in the Islamic Financial System"), though the authors acknowledge that the issue of equity deserves full consideration because it is in some ways an even more significant, they choose to focus on only four issues: savings behaviour, the allocation of loanable funds, bank stability and public finance, and government borrowing. "A potential theoretical weakness of proposals for a non-interest financial system that is often alleged is their possible impact upon savings behaviour" but, on the basis of considering the insignificance of return-related savings, the reaction of savers to greater return variance and the riskiness of PLS deposits, they conclude: "careful weighing of the arguments suggests that the introduction of a PLS banking system would have an indeterminate effect on aggregate savings behaviour and might even raise the average propensity to save and the bank-intermediated supply of loanable funds" (p 73). They then discuss one "fundamental concern of critics of a PLS financial system (which) is that the elimination of interest removes the one price signal that efficiently allocates loanable funds between competing demands, and the equilibration of planned saving and investment. An inefficient allocation of loanable funds and lower productivity are predicted. This outcome relies on the assumption that there is no alternative to the rate of interest as an allocator of loanable funds, and that it does the job efficiently at present. Both assumptions are open to dispute" (p 77). "Intermediating finance through interest-bearing contracts biases the supply to borrowers and projects with collateral and secure cash-flow. There can be no presumption that these projects have the highest net present value of those on offer. The resulting allocation of credit discriminates against small firms with little capital, entrenches the status quo and increases the amplitude of the lending cycle. (While interest-based) finance circumscribes short-term agency and monitoring costs, leading to a lower cost of capital, (these) advantages are offset by longer-term inefficiencies in project selection and inappropriate risk-taking (resulting in insufficient) monitoring of borrowers....Few non-interest proponents claim that their system would achieve the "first-best" allocation of investible resources, and macroeconomic equilibrium at a high level of activity in theory, let alone in practice. However, there are sufficient grounds for questioning the allocative efficiency of the rate of interest as a price signal, and for claiming that a profit-related allocator may do better" (p 85). Regarding bank stability, the authors argue that, in effect, banks gamble on the "law of large numbers" and on depositor confidence in order to remain solvent and liquid. Banking history is "littered with occasions" when the gamble did not pay off. "Hence governmental regulation and under-writing of banks is a universal phenomenon.... the safety net provided to private sector banks goes unchallenged...and yet bank collapses and runs are still with us. The fundamental problem cannot be solved by treating its symptoms with better regulatory medicine because the ultimate cause of bank instability lies in contracting on an interest basis": "Banks and other deposit-taking financial intermediaries exist to transform the maturity and liquidity of financial assets. Yet. by issuing interest-bearing liabilities, whose nominal (par) value is guaranteed and potentially recallable on demand, conventional banks pretend that they are not transforming asset maturity and liquidity" (p85)...."Thus far, state intervention has largely succeeded in preventing system-wide bank collapses at the expense of subsidising banks to take risks; favouring large banks over small, and banks in general over other financial intermediaries; incurring high costs to taxpayers through bank rescues and nationalisations; adding to the inflationary bias of capitalist economies; and perpetuating a banking system that amplifies the economic cycle. Interest-based banking has survived thus far by persuading the monetary authorities to underwrite many of its liabilities. The options facing monetary authorities are either to "paper over the cracks" (e.g. by tinkering with DI liabilities) and risk the costly support or collapse of the edifice in the future; or to rebuild the financial structure on firmer foundations, rendering external support unnecessary. If some preconditions are met, a non-interest banking system should not only be feasible, but also more stable and less costly to the rest of the economy" (p 98). Finally, on government borrowing, the authors argue that while the elimination of interest-bearing government debt has serious welfare disadvantages, the long-term economic and moral advantages should outweigh these costs: "The most widely-felt impact of a non-interest financial system would be the elimination of interest-bearing mortgage and consumer debt ....high levels of household indebtedness can prove economically divisive - as the well-off enjoy better terms and access to credit - and socially destructive. Further detrimental consequences can include depressed aggregate savings propensities and more volatile consumer durables demand. High levels of household leverage yield a more fragile macroeconomy, vulnerable to rises in real interest rates. These effects are amplified by a housing sector dependent on mortgage finance to fund house purchases....Clearly, the current reliance upon interest-bearing mortgage and consumer credit is one without its costs. Consequently, there are practical reasons for advocating its replacement ....(and though there are difficulties in a non-interest financial system such as) the provision of credit needed for immediate consumption or liquidity (there are feasible substitutes such as) charitable or state-run interest-free loans funds...non-interest mutual credit arrangements and time-multiple overdraft facilities" (pp 99-100). Conclusion Our authors are cautious and systematic, making little reference to Jubilee, to tithing and wider gift-giving, to the economic value of living a sober life and to "Protestant ethics" generally, or to the contemporary need for a "slow-growth economy". It is interesting that Abraham and his descendants were withdrawn from "high-growth economies" or at least "high" economies in Ur, Egypt, Babylon and Persia and sent to build the "low-growth economic system" outlined in the Old Testament. However, as the Hebrews and the Christians are, at the same time, promised "prosperity" it may be worth drawing a contrast between "pagan" prosperity and "Godly" prosperity. "Magical" sacrifices and unjust systems were replaced with a "rational" system of tithes, rest for the land every seventh year, sabbath rest for people every seventh day, numerous festival seasons and feast days, and so on. While Mills and Presley have some reservations about Islamic finance itself, the book more or less thoroughly endorses the Islamic (and Biblical) case against the ungodly usurious system which pervades the world as a result of the current domination of universities and senates by materialist humanism. It is delightful to have this serious evaluation of the contribution of Islamic finance. What is needed now is similar evaluations of contemporary Jewish economic thinking as well as of the radical alternatives represented by The Other Economic Summit. Similar evaluations of the "relatively high-growth economies" of Egypt, for example in the Early Dynastic Period (3100-2686BC), of China, for example during the Zhou dynasty (1066-221BC), of the Mayans from 325-925AD, of the Incas say from 1200-1530AD, of the Aztecs under Montezuma I and II (1440-1519AD), of the Songhai Empire between 1464 and 1591AD, and of India during the Gupta period (300-500AD) as well as during the Mughal period (specifically 1527-1605AD) would be fascinating as well as useful. Prabhu Guptara ------------ FOOTER TO HES POSTING ------------ For information, send the message "info HES" to [log in to unmask]