Islamic Economics A Solution for Environmental Protection

Saeed Mortazavi, Ph.D. Professor of Business and Economics Humboldt State Universit Summer !""#

$%ford Universit &rade, 'ro(th and the Environment Au)ust * + Au)ust ,-, !""#

Islamic Economics A Solution for Environmental Protection Saeed Mortazavi, Ph.D. Professor Humboldt State University Arcata, California USA Abstract Concern over the tragedy of the commons emanates from the fact that estern economics has become a disci!line devoid of values. "#!loitation of the natural environment can be abated $hen individuals consider intergenerational $elfare and %ustice to be im!ortant factors in their economic decisions. &slamic economics, unli'e its estern counter!art, is a value(driven disci!line re!lete $ith moral values that limits individual)s consum!tion, and im!oses significant social and religious res!onsibilities on individuals as guardians of the natural environment for future generations. Introduction History of economic develo!ment bears the truth as to the relationshi! bet$een economic gro$th and environmental decay. *ne can differentiate bet$een economic gro$th and economic develo!ment $ith res!ect to their corres!onding goals. +he ob%ective of economic gro$th is to im!rove the standard of living by increasing the ,DP !er ca!ita, $hile economic develo!ment intends to im!rove !eo!le)s $ell(being. +he conce!t of $ell(being is a much broader conce!t that encom!asses the -uality of life. *ne factor that ma'es the distinction bet$een economic gro$th and economic develo!ment even more !ronounced is the conce!t of negative e#ternalities in economics. "#ternalities are the e#ternal costs .negative e#ternalities/ or benefits .!ositive e#ternalities/ im!osed or conferred on others by the actions of a !roducer or a consumer. Since the !rivate !roducer or the individual consumer do not ta'e these e#ternal costs or benefits into consideration $hen they ma'e their !roduction or consum!tion decisions, conse-uently, mar'ets fail to incor!orate them in !rices charged for these goods. 0igure 1 de!icts mar'et)s inefficient solution for negative e#ternalities.

.i)ure ,. Mar/et .ailure0 1e)ative E%ternalities Price of good 2

Marginal Social Cost

"#ternal Cost

Marginal Private Cost

Ps P!

Marginal Private 3enefit

4s

4!

4uantity of good 2

0igure 1 sho$s the mar'et solution as 4! and P!. Su!!ose the firm)s decision !roduces e#ternal cost for the society, such as $ater !ollution. Conse-uently, the social solution for this case should be 4s and Ps. Mar'et failure to ta'e this additional cost into consideration $ill result in over(!roduction and under !ricing of good 2 by the mar'et. +his !a!er is concerned $ith negative e#ternalities and their im!act on the environment5 air !ollution, $ater !ollution, noise !ollution, climate change, etc. Mar'et failure in such cases $ill im!ose cost on individuals, $ildlife, and future generations. "conomic solution for negative e#ternalities is to convert e#ternal costs into internal costs and correct mar'et decisions either by the reassignment of !rivate !ro!erty rights, government regulation, or !rivate negotiation bet$een interested !arties. Pro2ert 3i)hts +he overe#!loitation of !ublic !ro!erty resources is so $ell documented in economic literature that economists have named it the 6tragedy of the commons.7 &f such resources $ere !rivately held, then the o$ner $ould monitor the use of the !ro!erty to guarantee that marginal benefit of the usage e#ceeds the marginal cost of the usage. Conse-uently, the !rivate o$ner eliminates o!en access to this !ro!erty and eliminates the e#ternal cost to the society.

0or instance, if the o$nershi! of a river $ere assigned to an individual o$ner.s/, then !roblems such as over(fishing and $aste dis!osal $ould be resolved automatically. +his suggests that !rivate cost(benefit incentives are the best o!timizing tools for the use of natural resources. 'overnment 3e)ulation Since !rivate !ro!erty assignment is im!ossible in a myriad of cases, government regulation is the most !ervasive method of correcting mar'et failure caused by e#ternalities. &n reference to 0igure 1, government regulation goal is to !roduce 4s and Ps as the o!timal solutions for the society by internalizing the e#ternal cost of !roduction. +his can be accom!lished by either regulating the out!ut of the industry at 4s level and setting standards for the industry or regulating the !rice at Ps level by im!osing fees and ta#es on the industry. +his strategy can be e#em!lified by e#amining government regulation to control !ollution. 8egulatory !olicies to control !ollution have vacillated bet$een setting emission standards and emission charges. An emission standard is the ma#imum level of !ollutants that a firm can emit into the environment. +he enforcement of emission standards re-uires a sizeable government bureaucracy, $hich in turn is !er se costly, intrusive, and often inefficient. Conse-uently, economists favor emission charges in the forms of emission fees, ta#es, or transferable .tradable/ emission !ermits that are less intrusive. "mission fees and ta#es are im!osed on the firm for each unit of !ollutant released into the environment. +hese charges shift the firm)s !rivate marginal cost u!$ard to achieve the social o!timal level of !roduction. +ransferable emission !ermits $ill achieve the same results at a substantially lo$er cost to society $ith minimum intrusion in the firm)s decision(ma'ing !rocess. +he regulatory agency $ill determine the total number of !ermits to guarantee the o!timal level of !ollution for the society. "ach !ermit that is sold to the firm allo$s the release of a certain amount of !ollutant into the environment and, hence, converts the e#ternal cost of !ollution to firm)s internal cost of !roduction. "mission charges are the most efficient method of !ollution control. +hey are mar'et(based !olicies that !rovide incentives for firms to control !ollution $ithout further intervention by the government. Additionally, the government can use the

additional revenue generated by these charges to !rovide other !ublic goods, reduce ta#es in other areas, or reduce government deficits. "ach of these o!tions, rather than use of government resources, !ositively affect the $elfare of the society. 4oase5s theorem Pro!erty rights $ill give the o$ner the right to use his9her !ro!erty in $ays that he9she sees fit. "ven $ith !ro!erty rights defined legally, e#ternalities could be still an issue for the society. 0or instance, in :orthern California, lumber com!anies often face !ublic o!!osition $hen they $ant to cut old(gro$th forest on their o$n !ro!erty. 8onald Coase argued that regardless of initial assignment of !ro!erty rights, $hen the cost of negotiation is minimal, a social o!timal solution could be achieved through negotiation bet$een the t$o !arties ;1<. &n the case of :orthern California lumber com!anies, instead of a costly la$suit= the t$o !arties can negotiate a mutually beneficial outcome. +o end this conflict to the satisfaction of both !arties, either the !rotestors could !ay a fair !rice for the com!any)s !ro!erty and !reserve the forest, or the com!any can com!ensate the !rotestors .or the society/ for the !erceived damages caused. &t is im!ortant to notice that Coase)s theorem is concerned $ith o!timality .efficiency/ of the solution and not $ith e-uity and ethical considerations. &n our e#am!le, the $ell(being of the !arties and the cash transfer bet$een them have drastically different ethical conse-uences. Islamic Economics Political economy $as initially a branch of moral !hiloso!hy. Adam Smith and his follo$ers $ere -uite concerned about moral issues and the norms of good social behavior. &n times, economics became inde!endent from ethics and estern economists declared it as a value(free disci!line. Conse-uently, classical . estern/ economists !rinci!ally focused on 6self interest7 to e#!lain human motivation in social, !olitical, and economic arenas. +he metamor!hosis of modern estern economics $as com!leted $hen economics lost its !olitical side and ado!ted the engineering conce!t of 6efficiency.7 +he efficiency of an economic solution is measured by the !rinci!le of 6Pareto o!timality.7

A solution is Pareto o!timal if im!rovement is no longer !ossible, i.e., mutually beneficial o!!ortunities have been e#hausted. +here seems to be a trade(off bet$een Pareto o!timality .efficiency/ and e-uity, fairness, and other distribution issues as the follo$ing !assage sho$s. A state can be Pareto o!timal $ith some !eo!le in e#treme misery and others rolling in lu#ury, so long as the miserable cannot be made better off $ithout cutting into the lu#ury of the rich. Pareto o!timality can, li'e >Caesar)s s!irit), >come hot from hell) ;?<. +his transformation of economics $as res!onsible for the rise of !ositive economics .analysis of the facts and e#!lanation of ho$ mar'ets do o!erate/ at the e#!ense of normative economics .$hich is concerned about conce!ts such as rights, e-uity, and other desirable social(!olitical values that e#amine ho$ mar'ets ought to o!erate./ &n contrast to estern economics, &slamic economics is a value(driven disci!line. &ndividual Muslim)s choices are subordinate to the collective interests of a larger &slamic community. Accordingly, the collectivist social and religious norms of &slam guide the economic behavior of individual Muslims. Hence, homo &slamicus, unli'e its counter!art homo economicus, must be a !aragon of values. +able 1 de!icts homo &slamicus as the antithesis of homo economicus. &able ,0 &(o $22osite Models

Homo Economicus 1. Assum!tions a. @imited resources .scarcity/ b. Unlimited needs ?. 3ehavioral :orms a. &ndividualism b. Self(interest c. Com!etition d. Amoralism

Homo Islamicus 1. Assum!tions a. Abundant resources b. @imited needs ?. 3ehavioral :orms a. Collectivism b. Common interest c. Coo!eration d. Moralism

estern classical economics is based on the idea of unlimited needs of individuals $ho face limited resources. +he classical homo economicus is a rational and calculating !erson $ho see's to ma#imize his ha!!iness .utility/. &ndividuals) search for ha!!iness is re!resented by an emotionless cost(benefit analysis of their decisions. More im!ortantly, ha!!iness is usually measured by material means. 0urthermore, due to a scarcity of resources, individuals must com!ete $ith each other to secure ha!!iness. Conse-uently, homo economicus is a com!etitive and ac-uisitive !erson $ho is interested in his o$n self(interest. Additionally, due to inde!endence of economics from moral !hiloso!hy, the rational and materialistic homo economicus)s behavior has turned into a value(free calculation. &n contrast to classical economics, &slamic economics begins $ith the abundance of resources and assumes the limited needs of individuals. Accordingly, the !roblem of scarcity in classical economics is due to unnatural assum!tion of unlimited needs created by artificial means such as advertising. &slam, li'e other religions, im!oses legal and moral restrictions on totality of human behavior, including individuals) needs. &slam, as a com!rehensive $ay of life, embraces the totality of Muslims) conducts, including their economic transactions. &ndividual Muslim)s freedom is al$ays bounded by his9her social and religious res!onsibilities. Muslims are free, but they are res!onsible to ,od and other Muslims for their actions. As a result, freedom and res!onsibility are the t$o sides of one coin in &slam. Social and religious res!onsibilities are the constraints im!osed on Muslims) behavior, including their economic behavior. &slamic norms of behavior such as %ustice .4uran, A5B/, moderation .4uran, 1C5?D/, charity .4uran, AC5C/, and $aste avoidance .4uran, C5E1/ are the restrictions that are meant to change the innate selfish nature of man to altruistic and com!assionate economic behavior. Islam and $(nershi2 &n the absence of an ecumenical &slamic economics model, $e introduce the !ieces of the model as de!icted in 0igure ?.

.i)ure !0 Islamic Economic S stem Social Fustice G &slamic :orms &slamic State 8edistribution System Private *$nershi! Production Consum!tion

Mar'et

0igure 1 !laces the institution of !rivate !ro!erty at the center of &slamic economics system. Understanding this institution is essential for the develo!ment of a true economic theory of &slam. &n &slam, o$nershi! in an absolute sense belongs to ,od. +he earth and its natural resources are ,od)s blessings that He has mercifully made available to man'ind for his9her sustenance. +o Allah belongs al that the heavens and earth contain. .4uran, ?5?BH/ Do you not see ho$ He has subdued to you all that is in the earthI .4uran, ??5JA/ He has sub%ected to you $hat the heavens and the earth contain= all is from Him. .4uran, HA51E/ +he 4uran also indicates that ,od has created man as His de!uty on earth to en%oy and !rotect ,od)s creation. 3ohold, thy @ord said to the angels= 6& $ill create a vicegerent on earth.7 .4uran, ?5EK/ &t is He $ho hath made you the inheritors of the earth. .4uran, J51JA/ &t is im!ortant to remember that &slamic economics is of a normative form. +hus, the use of these resources is sub%ect to &slamic norms of moderation and avoidance of $astefulness. +he earth and its resources must be !rotected for all generations to come.

&n a fe$ $ords, &slamic social %ustice demands intergenerational e-uity as $ell. +his suggests that $hile $e are allo$ed to use these resources for our o$n benefits, $e must also !rotect them for our !rogeny. Conse-uently, &slamic economics could resolve a ma%or !roblem that has !reoccu!ied estern economists for a long time, namely, the !roblem of negative e#ternalities and its im!act on the environment. &n &slam, the earth and its resources belong to ,od and Muslims are obligated to !rotect these resources for future generations. Conse-uently, &slamic norms $ill not allo$ one to benefit from these resources and im!ose cost on others. A com!lete a!!lication of &slamic norms $ill eliminate the !roblem of negative e#ternalities and !rovide a safeguard for environmental !rotection. e have already established that absolute o$nershi! belongs to ,od and human beings are His trustees and care ta'ers $ho have the right to use and en%oy the earth and its resources and yet they must !rotect and !reserve it for future generations. +herefore, one can argue that &slam has !ragmatically established the limited right of !rivate o$nershi! as a system of re$ards and incentives to motivate individuals in their trusteeshi! function. +hen, !rivate o$nershi! is ,od)s re$ard for those $ho fulfill their obligations. Islam and Mar/ets Having discussed the institution of o$nershi! in &slam, $e no$ direct our attention to the economic conce!t of mar'ets. Mar'ets !lay a 'ey role in ca!italism .or mar'et economies/. +hey determine the mar'et(clearing !rice at $hich buyers and sellers voluntarily e#change goods and services $ith each other to !ursue their o$n satisfaction as declared by Adam Smith in his ealth of :ations ;E<. &t is not from the benevolence of the butcher, the bre$er or the ba'er that $e e#!ect our dinner, but from their regard to their o$n interest. e address ourselves not to their humanity, but to their self(love. &t is the invisible hand of the mar'et that controls and coordinates these individuals) actions to create the unintended $ealth of nations. e have already alluded to differences bet$een the t$o economic systems. &slamic collective norms, values, and in%unctions have !ut limitations on individuals) freedom, o$nershi! right, and !ursuit of self(interest. Additionally, the &slamic state has

a very visible !resence in &slamic economics and regulation of mar'ets, as $ell as, individuals) e#changes. Mar'ets have al$ays e#isted in the &slamic $orld, but so have mar'et regulators .mhutasibs/. +he follo$ing !assage from Ayatollah +ale-ani)s Islam and Ownership sho$s the irreconcilable differences bet$een &slamic economics and ca!italism ;H<. ,iven the limits on freedom of trade and the government)s su!ervision of commodities in &slam the la$ of su!!ly and demand in the ca!italist sense does not a!!ly. Demand in common ca!italist usage and in its reality is determined by !urchasing !o$er and $ealth $hereas demand based on &slamic %uris!rudence .fe-h/ arises out of need. &n &slam the su!!ly and !rovision of commodities $ill be to the e#tent of satisfying .'amali/;morally elevating< necessities. &n &slamic economics the mar'et cannot become the toy of ca!italist greed $hich may o!en the $ay to 6eat in vanity.7 &slamic social %ustice demands regulation of mar'et to guarantee that !rices remain fair in the mar'et!lace. +herefore, the invisible hand of the ca!italist mar'et is su!!lanted by the visible hand of mar'et regulators in &slamic economics. Ca!italism strives for com!etitive outcomes5 com!etitive mar'ets and com!etitive mar'et !rices. Such outcomes are considered desirable and hence are not sub%ect to government control. &n contrast, &slamic economics does not rely on mar'et !rices, but strives for fairness in the mar'et!lace. +o guarantee the fairness of !rices, &slam !rohibits hoarding, blac' mar'ets, and the concentration of mar'et !o$er in any form and fashion. +here is no room for mono!olies, oligo!olies, and cartels in &slamic economics. &ndividual e#changes and trade, in general, must also be legal, fair, and based on honesty and mutual consent. +herefore, the e#ertion of force and economic !o$er in business transactions are totally banned in &slam. Islam and 'overnment +he role of government in economics is another discernible difference bet$een ca!italism and &slamic economics. ,overnments have a very limited role in classical economics. +hey !rovide national defense and enforce rules and la$s to guarantee

orderly o!eration of mar'ets. +heir augmented economic res!onsibilities can be %ustified $hen mar'ets fail to generate efficient solutions. &slamic government is the guardian of &slamic social and economic %ustice. &slamic la$ .shariah/ is the main instrument for the achievement of social and economic %ustice. +herefore, the !rimary res!onsibility of &slamic government is the reinforcement of &slamic la$ and the &slamic value system. As $as mentioned, &slam recognizes the limited freedom of individuals in social, !olitical, and economic arenas. 0reedom is al$ays accom!anied by certain res!onsibilities in &slam. Muslims have res!onsibilities to ,od, to His creation, and to each other. +herefore, Muslims) economic transactions .!roduction and or consum!tion decisions/ are sub%ect to &slamic norms, values, and in%unctions. +his is the reason $hy &slamic normative economics is culturally, not mar'et, driven. +herefore, in &slamic economics the government is the !redominant institution rather than mar'et. &slam also recognizes the necessity of mar'et mechanism, though the visible hand of &slamic government corrects mar'et solutions to guarantee social %ustice and e-uity. +herefore, &slamic government)s regulation of mar'et is not limited to those res!onsibilities dictated by mar'et failure. &slamic social and economic %ustice re-uires the closure of all means of e#!loitation. Conse-uently, mar'et regulation !ut an end to firms) e#!loitation of natural resources and !roduction of negative e#ternalities. &t also !revents individuals to ta'e advantage of each other. Mar'et regulators must guarantee the fairness of mar'et outcomes. 6e)al .ormulas So far $e have sho$n that &slamic economics could control negative e#ternalities through the institution of o$nershi! and the 4uranic in%unctions. +he &slamic government can also interfere $ith the right of o$nershi! in !ursuit of social %ustice. &slamic government could levy ne$ ta#es, and could nationalize natural resources and land for variety of reasons. Additionally, Muslim %urists have develo!ed a set of formulas from the 4uran, Pro!hetic +radition, rules of logic, and urf .custom/ that !rovide additional fle#ibility in

managing environmental issues. Here is a list of some im!ortant legal !rinci!les and formulas that can be used for this !ur!ose. 1. Princi!le of @a Larar .Do no harm/ Muslim scholars believe that &slam has established an order for the use of human and natural resources to eliminate the !ossibility of e#!loitation of these resources. According to 3ani Sadr, the use of these resources for !roduction and consum!tion is allo$ed based on the follo$ing criteria ;A<5 a. &slam !rohibits any destructive use of human and natural resources. b. +he !rinci!le of @a Larar .do no harm/ must be observed by all Muslims to guarantee that their actions $ill not harm others. c. Conservation of these resources is an obligation for all Muslims since $astefulness is a sinful act in &slam. * children of AdamM ear your beautiful a!!arel at every time and !lace of !rayer= eat and drin'5 3ut $aste not by e#cess, for Allah loveth not the $asters. .4uran, C5E1/ ,od has blessed man'ind $ith everything that is needed for his9her sustenance. asteful behavior is a sign of ungratefulness. Conse-uently, conservation is an im!ortant economic norm in &slam. Muslims are custodians of ,od)s resources on earth. +hey should use them for their o$n benefit and !reserve them for future generation)s use as $ell. Muslims are commanded not to $aste these resources. ?. 8e!elling the harmful should be !rior to obtaining the useful +his legal formula that is cited by "nayat ;J< clearly sho$s that must be sto!!ed regardless of !otential benefits. E. &ndividual losses should be borne for the sa'e of !reventing collective losses 8onald Coase argued that e#ternalities are reci!rocal in nature as the follo$ing -uotation indicates. estern cost(benefit analysis is of no use in the case of serious negative e#ternalities. +he harmful act

+he traditional a!!roach has tended to obscure the nature of the choice that has to be made. +he -uestion is commonly thought of as one in $hich A inflicts harm on 3 and $hat has to be decided is5 ho$ should $e restrain AI 3ut this is $rong. e are dealing $ith a !roblem of a reci!rocal nature. +o avoid the harm to 3 $ould inflict harm on A. +he real -uestion that has to be decided is5 should A be allo$ed to harm 3 or should 3 be allo$ed to harm AI +he !roblem is to avoid the more serious harm. ;C< +he &slamic legal !rinci!le that is cited by "nayat ;B< sho$s &slamic ob%ection to Coase)s argument that e#ternalities have reci!rocal inter!retation. &slam is not concerned about the less serious harm. &slam intends to eliminate harms in the first !lace. 4onclusion +he !rotection of the environment seems to be indis!ensable to sustainable economic develo!ment as it is defined in the follo$ing !assage. Sustainable develo!ment is develo!ment $hich meets the needs for the !resent $ithout com!romising the ability of future generations to meet their o$n needs ;D<. +he cost(benefit model of estern economics has a built(in bias against future costs and

benefits. +he model considers a decision to be $orth$hile if the !resent value of its benefits e#ceeds the !resent value of its cost. +he !resent value is inversely related to the discount rate and the time !eriod involved. As a result, the !resent value of distant benefit and costs $ill have minimum bearing on !resent decisions. 0urthermore, the economic model of cost(benefit analysis ignores social values, and other cultural issues and considers them irrelevant as to the selection of the best o!tion for the society. +his is !erha!s the most im!ortant reason for the negative relationshi! bet$een economic gro$th and the environmental decay. +he environmental crisis seems to be the by(!roduct of estern civilization and its economic and scientific vie$ of the nature that !ut man in control of nature instead of being controlled by it. Ancient cultures believed in the sacredness of the earth and a life style based on the right harmony bet$een human needs and nature.

&slamic economics is a normative and cultural system as $ell. &slamic norm of moderation and $aste avoidance are environmentally friendly. 0urthermore, &slam)s vie$ of intergenerational %ustice and social and religious res!onsibilities $ill motivate Muslim to establish the right balance bet$een human needs and nature. More im!ortantly, the fundamental belief that the true o$nershi! belongs to ,od is the 'ey to environmental !rotection. hat Muslims o$n is in fact entrusted to him9her by ,od for usufruct. She9he can en%oy the use of the !ro!erty on the condition that she9he does not harm or $aste it. +his is formula is a viable safeguard for !rotection of the environment. :otes 1. 8onald Coase, 6+he Problem of Social Cost,7 Journal of Law and Economics, E.1DJK/5 !!.1 NHH. ?. Amartya Sen, On Ethics and Economics, :e$ Oor'5 3asil 3lac'$ell, 1DBC, !. E?. E. Adam Smith, An Inquiry into the Nature and Cause of the Wealth of Nations, Chicago5 the University of Chicago Press, 1DCJ, !. 1B. H. Seyyed Mahmood +ale-ani, Islam and Ownership, +rans. Ahmad Fabbari and 0arhang 8a%aee, @e#ington, Pentuc'y5 Mazda Publishers, 1DBE, !. 1EA. A. Abul(Hassan 3ani Sadr, Iqtesad-e Tawhidi Economics !ased on Tawhid oneness of "od#, &n Persian. :ashr(e Ha%r, 1EAC .1DCB/, !. ?CH. J. Hamid "nayat, $odern Islamic %olitical Thou&ht, Austin5 University of +e#as Press, 1DB?, !. 1HD. C. 8onald Coase, !.1. B. Hamid "nayat, !. 1HD. D. Fonathan Harris, et al, ed. A 'ur(ey of 'ustaina!le )e(elopment* 'ocial and Economic )imensions, ashington5 &sland Press, ?KK1, !. ##i#.