Unemployment and Inflation

 

Since 1960s the economies of the free world have been facing the twin problems of inflation and unemployment. Earlier, it was believed that the two problems had an inverse relationship. If we were to control inflation, we would get higher unemployment, and vice versa. But the experience of the recent past has been particularly perplexing to economists. So far no recipe has succeeded. The formulas tried so far include the management of fiscal deficit, incomes policy, control of money supply, manipulation of exchange rates, supply side economic package, etc. The problem has survived all attempts at its solution because , none of the policies has struck at the root cause of the problem. The main cause of unemployment is interest on capital which retards the level of investment, leaving physical and human resources unemployed. At the going rate of interest there will always remain some investment proposals which will not be able to convince the potential investors that they would be able to earn enough to pay the interest. Therefore, some projects would be set aside as nonviable.

 

Thus, the solution of involuntary unemployment lies in reducing the rate of interest to zero.The question as to how this can be done does not concern us at the moment. Perhaps, this can be left as a c))allenge to human ingenuity, once it is recognised that the root cause of unemployment is interest on finance and our first priority is to eradicate it. Incidentally, Keynes also analysed this problem along these lines and recommended reduction of the rate of interest to its technical minimum. (He thought it to be 2 % at that time). This he termed as the ‘euthanasia of the rentier’. He prescribed deficit financing or expansionary spending after the rate of interest had been reduced to its technical minimum. Unfortunately, the Keynesian advice was not properly heeded.

Its first part, which pertained to the reduction of the rate of interest to its technical minimum, was discarded and the policy of expansionary spending by way of Beveridge’s social insurance package was adopted. The result was that, on the one hand, brakes on investment (in the form of interest) kept on being applied, and on the other, the accelerator of public ~pending on social insurance was continuously pressed. The economy started giving serious jerks. The unemployment caused by high rates of interest was obstinate. It simply refused to go down while inflation was striding as a result of deficit financing. The social security system visualised by the new welfare economics (and now deeply institutionalised) had left only two options before the governments: to raise funds through taxes or to borrow on interest. The first solution dampened the economy further. The second not only increased the fiscal deficit and thus inflation but also distributed income in favour of the rentier class and led to economic injustice.

 

The Islamic position is quite simple: abolish interest on capital in all its forms and allow the investment to rise to its maximum. It will increase employment levels, reducing the need for social security spending. Second, from an Islamic viewpoint deficit financing does not appear to be a ‘desirable policy. The once golden rule of balanced budget is closer to the ethos of Islam. 2 Once this is accepted, the only problem and of course, a formidable one – would be to develop an institutional arrangement for providing interest-free finance. To our mind, human efforts should have been focused on this question instead of elaborating the rather easier course of providing social securit)’. benefits. So far as the problem of inflation is concerned, the Islamic policy takes care of that also.

First, one of the causes of inflation is interest itself, since the latter enters into the cost of production and thus becomes a part of the price of the products. This point might not have appeared plausible under the assumption of perfect competition. But now when we know that corporations wield enormous economic power and are almost autonomous in fixing the price of their products, it is accepted that interest enters into the price level and causes inflation.3 Once we abolish interest, prices would come down to the extent the interest entered in the cost of production.

Second, the abolition of interest would lead to higher investment and to greater supply of goods and services. This, too, will become an element in bringing down the price level.

Third, zakah is a tax on financial wealth and agricultural income and is collected and distributed at the local level to provide assistance to those who need it for one reason or the other. The community at the local level and the family at the micro level are responsible for looking after the poor and the indigent. The government only takes up the residual needs of the poor and that too through taxation and other revenues rather than through deficit financing.

Fourth, Islam extols simple living which leads to a consumer behaviour sharply distinct from the consumerism prevalent in the Western society. Nor is this feasible in an environment where interest-bearing finance is not available. Islam also does not approve that people should live beyond their means. Thus the cultural pattern prescribed by Islam keeps the inflationary forces in check. Fifth, Islam visualizes an economy wherein the production sector is preferably organized on a profit-sharing basis so that labour has a stake in the well-being of the industry. As a result, the chances of wage~push inflation are reduced to a minimum.4 In brief, Islam follows a straightforward approach in tackling the twin problems of unemployment and inflation. The foremost measures · are abolition of interest, balanced budget, effective collection ‘and disbursement of zakiih and a consumer behavior based on the values of Islam. The neoclassical approach to solve. these problems is topsy turvy. It does not seek to abolish interest which is the main cause of unemployment. It tends, on the contrary, to have recourse to deficit financing to provide for social insurance and debt-servicing measures which generate inflation. Thus the said approach would lead the economy to disasters of the worst kind. 2.2 Economic development 2.2.1 Concept Almost all the countries of the world profess their commitment to achieve economic development. This is obvious for the developing countries since they have a keen desire to catch up with the developed countries of the world. The developed countries also want to sustain their development, and would like to do so ad infinitum. With slight variation, the models for development being followed by the developing countries are those of the prosperous industrial countries. All the recipes for development are attempts to replicate the development processes of those countries. The objective is to increase the stock of physical goods and services for the population as a whole and thus a higher per capita share of goods and services. The experience of over half a century of development, however, does not provide a very rosy picture. The income differentials between the poor countries and the rich countries are.

greater now than they were half a century ago. Despite all the efforts to increase capital formation, deepening of capital stock and industrialization and urbanization the developing countries are nowhere even near the Western models they are trying to follow. 5 The position in advanced countries is also no less worrisome. Amidst affluence , there is poverty. Environment and ecology are under continuous threat. The waste of non-renewable resources, especially of energy, is depleting the reserves that would be available to posterity. The Western nations are worried about sustaining the present standards of living. With calls for a new international economic order the anxiety of the advanced countries has only increased as the known resources of. the earth do not seem to be  sufficient to allow a similar lifestyle for everyone. This fact has necessitated that a fresh look be cast on the conventional approaches to development.

The Islamic concept of development is distinct from the conventional Western approach. First, the ultimate objective of human society is to achieve falii!J and not merely material prosperity.

Second, Islam emphasizes economic justice in distribution of income and wealth. If a society moves from state A to state B in such a manner that its distributional inequalities are reduced, in Islamic parlance it is development even though there might be no increase in the absolute size of the resources. Third, Islam conceives of a development philosophy which builds on the local cultural and social traditions, relies on local talent and physical resources, and involves the entire population of the area concerned in the process.

 

Strategy

 

Islam seeks to transform the society from its state of initial endowment to a state of falii!J. Since the initial conditions differ from region to region, we shall take up two extreme cases to illustrate the development strategy of Islam. In the first case, let us imagine a poor country in sub-Sahara Africa or South Asia with dense population and a low level of income. The Islamic development strategy for this type of country will be to rely mainly on its own physical, human and technological resources.

The development objective will be to achieve a state of falii!J. The objective will be translated basically to fulfil the basic needs of the population with a degree of austerity. The development effort will concentrate on development of human resources, construction of necessary infrastructure like roads or ports, and development of appropriate technologies. As far as possible, local raw material and local talent will be used. This effort will be supplemented with a programme for the spiritual development of the people through persuasion, formal education, public policies, institutionalization of moral values.

Welfare of the population will be conceived as an end by itself. There will be no ambition to introduce high technology. As far as possible, recourse will not be made to procurement of finance abroad except that which comes as donation or the loan made available on an interest-free basis. Public policy will be devoted to improving distribution of wealth and income, providing preferential treatment to those who are handicapped, and creating the conditions that would involve the common people in development activities. In such a country, per capita income might be far below what we find in some of the industrially advanced countries today.

From an Islamic point of view, however, this country’ will be closer to the state of fala!J, and thus treated as developed second case might be that of a rich countey like some OPEC states. The development strategy for such countries will still have the same objective of achieving falah. They will have a high stock of capital. They will focus on , industrial deve(~pment, introduction of high technology, providing a materially prosperous lifestyle for their people. But the overall considerations of economic justice, spiritual growth, participation of local population in decision-making, and developing local talent will remain the dominantconsiderations. Such countries can set aside some resources either by way of interest-free loans or grants to other countries or for the development of defence industries. Such countries will face the serious risk of drifting into a . consumerist society of the Wes tern kind.

Therefore, a sizable chunk of resources should be spent by them on the spiritual training. of the people through persuasion, formal education, sound and wholesome public··· policies, and institutionalization of the moral values of Islam. These measures will help material prosperity to become the means of promoting fala!J, rather than to a high consumption permissive society. From an Islamic point of view these countries will be closer to fala!J, and thus more developed than the countries following the model of the contemporary Western societies.