Introduction
Islam, a religion that encompasses holistically every aspect of life and a complete code of conduct, respects the human’s innate desire to strive for affluence. It does not forbid profit-making, rather encourages its followers to undertake trade as their means of earning and considers the profit as a gift from Almighty Allah. As an innate trait of human nature, profit-making’s pervasiveness can be felt in every avenue. Price theory, one of the conventional economics’ fundamental theories, is also centered by profit maximization. Businesses, merchandising, production, and commerce, every notion is insignificant without profit. Despite the immense significance of profit notion, it is yet not highlighted justly in economic theory and other literatures, except for a piece of work by Frank H. Knight’s Risk, Uncertainty, and Profit (1921). This unfair negligence is even further in Islamic economics literature.
Islamic economic concept and free entrepreneurship are congruent on many grounds, except for few prohibitions in Islam which are indispensable for society’s well-being. The ills of interest, speculation, corruption, and unjust practices, that can lead to grave consequences which today’s world economy is facing due to unhampered materialistic drive, are surely forbidden in Islam. Conventional mercantilism has given enough margin to modern commercialism such that present economic scenario is embodiment of disproportional wealth accumulation, poverty elevations, inequality, monopolized power exploitation, and the like. In the name of capitalism and individual freedom, markets tend to overlook the society’s welfare. Islam does not, in any respect, disregard freedom of entrepreneurship, individual ownership rights, free rivalry among market’s players, and innovativeness. Profit is regarded as pivotal for economic development and wealth generation as in conventional economics.
Many mechanisms and tools have been incorporated into Islamic economic system from past, so as the conception of profit. Therefore, to grasp the Islamic version of profit theory, it would be pertinent to refer the conventional profit theory in a nutshell before elaborating its Islamic form. The later part of the chapter is designed in a manner to well grasp the fundamental arguments pertaining to the conventional concept, afterward forwarding to the issues with respect to the Islamic notion, and finally concluding the subject matter. The aim of the discourse is to well comprehend the Islamic notion of profit and the issues pertain to it.
Profit is not an easy topic to deliberate on. The reason is because profit unlike rent, wages, or interest is not an object in itself. It is simply general category of remaining part of your revenue which if positive will be called profit. As a consequence, discussion on profits raises the range of tricky issues to be addressed.
Issues in Conventional Profit Theory
The exposition of the term “profit” can be expanded into subject areas of its broad definition, how and from where it is derived from, whom it is owned by, and finally how it is accumulated to capital. These issues have been marginally overlooked in the literature body of economics. Therefore, briefly probing into these key queries would be useful to surface the issues pertaining to its Islamic notion.
The conventional economists’ view of profit is overly précised and subjective in nature. Concepts like that of depreciation are surfaced on subjective criteria and hence render it marginally biased in nature. Moreover, the inexplicit components, as opportunity costs that are deducted from net profit to come up with the “normal profit,” make it ambiguous in nature. The residual of both, net profit and normal profit, is referred to as “economic profit” by the economic theorists. The bifurcation is not as simple as it merely sounds. The inexplicit elements are not easily filtered out to come about with the figure of economic profit.
The sources of profit are explained by the economists with the rudimentary model of unrealistic suppositions. Earlier theories on profit were based on the profitless models but they could not come up with anything concrete. Economists like J. B. Clark discussed it as the function of risk (risk of losing capital). As per Knight, profit is a functional return based on uncertainties faced by the owners of the capital. Schumpeter considered profit as a function of innovation. Hence, economist could not come with a unified theory agreeing on the source of profit.
The field of economics has always considered profit as a return to the entrepreneur for his investment and decision making at the time of uncertainty. As per Knight, being an entrepreneur is something exceptional as an entrepreneur is the one who has the confidence in his judgment coupled with the ability to operationalize the ideas. Additionally, he should be willing to take risk and has capital in his possession. Capital becomes an interesting prerequisite because that enables entrepreneur to employ other factors of production. But in the face of modern forms of business like joint-stock companies where many shareholders pool in their funds but not be making the decisions, Knight’s theory does not stand. The decisions are made by specialized functionaries who are salaried individuals. As per Zubair Hasan (1975), the conventional economics couldn’t provide any solid theory on profit. On the other hand, an Islamic dispensation which is instilled with ethical values cannot afford such avoidance. Now, we will shift our discussion on how Islam sees profit and we will inspect the Shariah compliant structure of business surpluses.
Islam and Profit
Along with the spiritual insightfulness, Islam honors the worldly thrive of its believers with due respect. Striving for one’s livelihood is well acknowledged; rather, trade and business are esteemed when undertaken within the Islamic jurisdictions. The innate human’s lust of wealth, if set unbridled, can lead to hazardous consequences. Hence, Islam confines the materialistic ventures of its followers within moral boundaries, with an aim to avoid deprivation of individuals’ privileges at any cost, prescribing the ways to earn their appropriate stake. Honesty is the most imperative trait of the business dealings. Either be it the promoting and marketing, or it be the selling of the product to the end customer, honesty can never be overlooked. It is important to the degree that the product’s faults also have to be exposed. In Islam, exploiting other’s scarce knowledge or false acclaim of one’s product for marketing purposes is not legitimate, which the present commerce is embodiment of. One has to prioritize the moral virtues over the voracity of wealth and hence has to act within the Islamic boundaries forgoing the superfluous profit on account of honesty.
These virtuous merits are instilled in believers repeatedly in Quran and Sunnah by emphasizing the comparison between short-termed worldly lives with that of eternal bounties of hereafter, hence cognizing the orderly earnings within Islamic boundaries. The benefit of honesty additionally entails the merits of equity and justice in overall society safeguarding each individual’s rights.
One remarkable difference in Islamic economic system from its conventional counterpart is avoiding gharar or speculation. Such activities that include capitalizing on uncertain circumstances entail inherently enormous risk that can trigger devastating consequences cascading to multiple economies around the globe as evidenced from economic crisis. With the strong foundation of justice, equity, honesty, and communal welfare, Islamic economic system disproves the blind hunches for business dealings that can jeopardize the person himself and the counterparties. Hence, the system is indigenously risk mitigating and resilient to deliver a win-win situation for all market players. The inputs to the production process, i.e., land, labor, and capital, are also filtered through Islamic principles to foster Islamic economic system in essence with all its merits and values. Logically, we would further analyze the important issues regarding these factors of production.
Interest in Islam
When Islamic finance or economics is under discussion, the first label it connotes is “interest free.” Despite some contradictions, majority of Muslim intellectuals reach an agreement that “riba” is absolutely and entirely prohibited. The consensus pertains to all of its forms and definitions. Regardless of its types, usage, quality, or the underlying contracts, interest is altogether forbidden unanimously. Therefore, rather than reinventing the wheel by jumping into the extensive argument, it is rational to go with the majority and suffice our decision on complete prohibition of interest. When religiously following the Islamic theology, a believer’s sufficient reason to abstain from interest is its prohibition in Islam, but when it is projected in literature as a substitute system to conventional economics, Islamic economic system has to be assessed critically as to why interest is prohibited, and how business profit, a quite similar value, is approved while interest not.
One answer to modern economists is from their own economics literature itself. Famous General Theory of Keynes exposed lagging nature of interest rates in comparison with the expected profit, demonstrating inverse behavior with growth and stability. When expected profits tend to be higher than interest rates, inclination of earning through debt increases, consequently leading toward inflation-ridden economic behavior. Reciprocally, when profit expectations tend to fall more steeply than interest rates, the economy faces extending recessionary pattern. Hence, interest brought no good for economic development.
The marginal productivity theory while professing to warrant distributive justice could not justify the interest. Capital (funding) is undeniably important factor of production. Nonetheless, a fundamental question arises that how does interest coincide with productivity? Especially where the main determinants of interest are the market forces in bond markets and the monetary policy rates which are generally set by central bank based on their needs. Both of them do not correspond with the productivity of capital employed. Additionally, funds whether they are in the shape of equity or debt are pooled together for investment or day-to-day operations and are prone to same level of risk in the business. Since both are taking same level of risk, the question arises that why the providers of both be rewarded differently, i.e., one with interest and the other with gain or loss?
Talking purely from finance perspective, interest rate is one of the foundational variables in finance; all the financial models are structured on its basis. In general phenomenon of the interaction of market forces, the price of an item (in our case money) is decided ex-post. For instance, price of oranges is established after they are supplied in the market but when it comes to price for money, i.e., interest rates, they are defined ex-ante. They are established beforehand, and then, they are used in different models which are followed by real market activities in the form of supply and demand of financial assets. This makes it a tool to control the time value of money and not to price money.
To conclude, interest with its indigenous flaws has contributed more inefficiencies than its superficial benefits. It has proved detrimental to overall well-being of the society. Among many, widening societal gap is the prominent adversity it has inherited to the economies. The income disproportionalities and capital inefficiencies are amplified with the increased contribution of interest in economies. To alleviate financial distress, poor rely on borrowings, which have ultimately driven the concentration of wealth skewed toward the rich, hence rendering the poor even more financially crippled. The time has gone when interest can be fancied as a bridge between savers and borrowers to boost capital efficiency. Currently, the notion of justice is mercilessly defied when the toiled money of the small savers is being utilized by giant business industrialists, rewarding them back with as minimum as possible and piling the rest into their and banks’ pockets, snowballing the disproportional wealth distribution. Conventional banks, deemed integral to the economy to the extent that often titled as “backbone of the economy,” often play their part negligently, as they pass on the burden of increased interest rates to the borrowers, while depositors are left unrewarded for that surge. Conversely, when the interest rates are lowered, that does not relieve the borrowers from their financial cost. On the whole, banks use interest as a tool to exploit the interest rate movement giving least value to the society. Hence, the fabricated benefits of interest are no more a hidden story to even those who surfaced their intellectual economic theories on it. Artificial money creation, cascading inherent risk, and injustice are the outcomes of interest economies have experienced so far. Hence, Islamic prevention of interest is lucid and logical to safeguard the economy from such injuries.
Rent Related Issues
The worth probing issue, pertaining to land as a factor of production, is dealing with agriculture land. Unlike the industrial land, agriculture land has its unique property of fertility, which can be used by the ones who have the expertise; otherwise, the agriculture land resource would not be justifiably and efficiently used. But in some cases, the one who owns this resource is often incapable or uninterested to cultivate the land, so leaving him the option to lend the land to the party who can use it in resourceful manner. The issue arises when the compensation has to be given to the owner. As the ownership rights are still with the owner, but the effort and resources are participated by the agriculturalist, the profit of the crop has to justifiably portion to both parties. The compensation, according to some scholars, can be taken as cash, and according to others is share in crops, while some regard both of the forms.
The crop output cannot be ascertained at the time of contract, and imposing a flat preset amount would be the same as “riba.” Hence, the landowner would be playing the same role to that of a bank, regardless of the crop end product; the landowner stays unconcerned to take his predefined share. A fixed quantity would be inequitable for both of the parties, depending upon the consequences. This can simply be evaded to preset the “proportion” of crop output rather than fixing the amount.
Islamic economic principles do not allow the preset owner’s compensation as it can lead to injustice, hence favor the derived amount instead.
Let us consider two scenarios, i.e., (1) the owner of the land presets a flat amount before the crop has yielded any output let us say $20,000; (2) the owner agrees to take 40% of the share in the profits from the crop output. In first case, it would be unfair with both the parties as it is impossible to ascertain the exact crop output, especially when there are chances of the occurrence of natural calamities exist. The second scenario is fairer to both the parties as it is ex-post, i.e., based on the actual yield of crops.
Labor-Related Issues
Many remarkable theories of economics have extensively discussed the topic of labor, yet very few highlighted the question of compensating the labor justly. Labor though considered equally vital as other factors of production in Smith, Ricardo, Marx, and others’ theories is often neglected in terms of how reasonably it should be remunerated. Islam emphasizes on pegging the wages of labor to the contribution it adds to the output. This logically avoids any injustice at both ends: labor and entrepreneur.
Issues arise when labor has to be remunerated before the output is finally processed. Had the wages be variable to the output of the production, the issues would be simpler, but pragmatically it is not that trivial to implement smoothly. It is quite impractical to peg the variable wage system altogether to output, especially when the business incurs losses. Moreover, the floor rate of wages also imposes another challenge to fix the wages to output.
Issues Related to Wages
Labor law entails the minimum floor to wages, below which recruiting labor is unlawful. Economic course books have generally disregarded the notion of flooring the wages, as it can lead to unemployment in the economy, hence detrimental for labor force. Though theoretically comprehensible, the minimum wage law cannot be ignored practically, as protecting labor rights has precedence over hypothetically assumed economic models. Islamic persistence on human rights of basic provisions can be one of the forms. The indefinite output dilemma can be simplified by sharing the profit. Profit can be a yardstick for pegged wages rather than market trend, to demonstrate more equitable treatment.
Conclusion
To conclude, in order to construct a well-integrated theory of profit, profit shall be as defined revenue minus cost. Second, the focal point of the theory shall be a firm instead of an entrepreneur. Additionally, it should be considered as the function of dynamic changes in business environment. Lastly, the profit may be shared between labor and capital in order to endorse fairness, growth, and peace in society. This type of profit theory will be acceptable in both conventional and Islamic trading frameworks.