Islamic Economics: The Emergence of a New Paradigm

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.We illustrate the potential impact of the Islamic doctrine on western economic relationships by focusing on the prohibition of interest (riba) in Islamic economics. We show that the alternative method of financier remuneration (i.e. mudarabah profit-and-loss sharing) will, under certain conditions, enhance capital investment on account of its ability to act as an efficient revelation device. By applying ideas developed in the western contract literature, we show that a mudarabah contract between the manager of a project and a syndicate of investors may permit a more efficient revelation of any informational asymmetries between the two. * This work has benefited from discussions with Saul Estrin, Hussein Sharif Hussein and Umer Chapra. Helpful comments were also received from two anonymous referees. We should like to express a particular debt of gratitude to Haitham Kabbara for his inspiration and guidance in this area. The usual disclaimer applies.[ 584 ] THE ECONOMIC JOURNAL [MAY II. THE PROHIBITION OF INTEREST THE ECONOMIC JOURNAL [MAY efficiency in production. Since c2 = cl = A(xl) -because (i I b) will obviously bind at the optimum (see Hart and Holmstrom, I987) -the trade-off boils down to the choice of A(xl). It is apparent that A(xl) > A(x*) is not optimal, since, by increasing the gap between c2 and cl, it would imply losses in both productive and allocative efficiency. It must be the case then that A(xl) < A (x*), which implies that (I I a) is not an effective constraint such that x2 = x.We now look at the optimal second best contracts under riba and mudarabah financing in turn. Second Best: RibaThe optimal second best solution under riba financing, fr = {Si, Ii}, is detailed in Appendix Bi. The salient features are summarised in the following proposition:

Sharing contracts' marginalisation, adverse selection and markup calculation

“…Even if the entrepreneur's effort is not observable by the bank, entrepreneur has no interest in reducing it. This is due to the linking of his remuneration to the project's income (e.g., Al-Suwailem, 2003;Presley & Sessions, 1994). 4 This is consistent with financial theory findings concerning adverse selection (e.g., Bester, 1985;Leland & Pyle, 1977).…”

“…• information asymmetries inherent in sharing contracts are of a similar nature compared to those of markup contracts (Al-Suwailem, 2003;Presley & Sessions, 1994;Stiglitz, 1974) and can be mitigated with the same tools; AMRANI | 739…”

La finance islamique : fondements, théorie et réalité

“…Ce paradigme, bien que fondé sur la sMri r a, était né au milieu du XX e siècle et est formulé dans un langage économique qui se veut moderne (Ahmad, 1952;Kurshid, 1980;Nazeer, 1981;Awan, 1983;Almisry, 1985;Presley et Sessions, 1994).…”

Islamic Banking: An Introduction and Overview

“…Incentive compatibility relates to the in-built inducements that exist for the transacting parties to honour the terms of the contract. This is an area in which there are conflicting views (Khan, 1985(Khan, , 1987Ahmed, 1989;Presley and Sessions, 1994). Dar argues that the benefits of improved productivity from the variable-return modes of financing are likely to be outweighed by the moral hazard and adverse selection problems vis-à-vis the fixed-return contracts, perhaps explaining the dominance of the latter in bank portfolios.…”