International Trade: Islamic vs. Modern

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

INTRODUCTION

Islamic international trade reflects the trade transaction undertaken between peoples and nations, not between the individuals of the same state. Therefore, the state would undertake export sanctions on certain domestic goods and allow others, and would also license all traders whether belligerent or under covenant. So, the state controls all aspects and the issues of foreign trade.

The Shariah rules related to foreign trade have been revealed with regard to individuals. Accordingly, the rules related to foreign trade are in fact rules related to individuals from a shar’s viewpoint concerning them and their wealth i.e. concerning the rule of Allah on them and the rule of Allah on the wealth they own. Therefore, the shariah rules concerning foreign trade are not related to the traded material or to its place of origin, but to the trader, because the rules concerning wealth follow the owner of wealth, accordingly they apply to both. This would be in contrast to the conventional system, where the rules of foreign trade pertain to the wealth and not to the owner, hence it is the place of origin of the wealth that matters rather than the trader himself.

International trade yields a tremendous benefit due to the high real profits that are generated from it. International trade has a host of distinguishing features, merits and outcomes. The main reason behind the establishment of international trade is the disparity in the proportional costs of commodities between one country and another. It would be therefore in the interest of all Islamic countries to establish international trade between them and with other countries.

International Islamic trade is in fact the management of the Ummah’s commercial affairs from a foreign angle. Such policy should be based on specific fundamentals, and it should adhere to it. We note therefore, that to the socialists, the foreign trade relation is based on their socialistic viewpoint about developing the world. For, although they observe economic gains, they classify the commodities according to the countries they deal with. This in their view would help the progress towards capitalism. If they imported any commodities, they would only import that which improves the production, and that which they need, although this practice is at present, diminishing.

Capitalism in the other hand always looks for material gain, placing the concept of expediency at the heart of her foreign trade policy. They would sell commodities to all people and nations as long as it achieves economic gain. As for the American policy of restricting trading with Russia and china to specific types of commodities and of a total ban on other types.

However, western economists have held different viewpoints about international trade and as a result, various schools of thought have emerged, some of these are the following:

FREE TRADE

The theory of free trade states that trade transactions between countries should be conducted without restrictions, customs duties or any obstacle to imports. The state would no longer be obliged to control imports and exports, because natural forces would achieve the equilibrium between imports and exports.

This theory contradicts Islam, because foreign trade is one of the relations between the state and other states, peoples and nations. These relations are all controlled by the state and it is the state who would organize and directly supervise such relations, whether these were relations between individuals, or economic or trade relations. Therefore it would be totally wrong to adopt such policy for an Islamic state, for the Islamic state prevents the export of certain commodities while permitting others.

PROTECTIONISM

This theory requires that a state interfere in order to achieve equilibrium in foreign trade. The purpose of protectionism is to influence the balance of trade and redress the deficit, because the spontaneous balance between exports and imports would not be able to achieve equilibrium, nor would it be able to redress a deficit. Therefore such policy would be necessary and that is why customs duties as well as export and import restrictions would be imposed.

In Islamic view this theory as it stands is limited, because it restricts the state’s powers to influence merely to achieve a foreign balance of trade or to redress the deficit. This would be wrong because the Islamic state interferes in order to deal with the other states with reciprocity, to provide the country’s needs to generate monetary gains and foreign currencies and, most importantly, to carry the call for Islam.

National Economy

This theory of national economy is linked to the concept of “cultural protection” derived from the theory of heavy industry. The champions of the theory of national economy deem that the economic growth of a nation must aim at providing her with political power as well as economic power. They deem that the growth of any country would undergo three stages: The pastoral/agricultural stage, the agricultural/industrial stage, and then the agricultural/industrial trading stage. A country would not achieve real power unless she acquired a navy, colonies and population with various skills. They also deem that although international economic ties would benefit from free competition, this would depend on all competing countries reaching perfection in developing their powers. This theory imposes the appropriate restrictions and tariffs exclusively on industrial imports and exports, while at the same time, it applies free trade theory on agriculture making it free of any trade restrictions.

Islam is averse to such a theory, because leaving the foreign agricultural trade free of control means that the state would not control the foreign trade of agricultural products. This is forbidden, for the state organizes all agricultural, industrial, or any other commodity that enters or leaves the country. She could ban the export of some commodities, while permitting the export of others. In short, such theory contradicts Islam due to the total freedom given to agriculture.

Policy of Self-Sufficiency

This policy means that a country aims towards being self-sufficient and to form a closed economic unit that could survive on its own. This country would not import nor export any commodities. Her aim would, in this instance, go beyond the protectionists’ theory, differ from the theory of national economy and contradicts the free trade theory.

The theory of self-sufficiency, which has been implemented between the last two world wars, has been highlighted in two forms: Nazi Germany represented a model of a country that adopted such policy.

Although the policy of self-sufficiency represented in fact a host of measures which had political aims, the champions of such policy deem that it represents a fundamental economic basis, which is summarized in the fact that a country that possess raw material, chemicals, machines and manpower, should be able to survive. The point at hand would be organization. The government should be prepared to manage without many of its needs; because this policy would make a country unable to fulfill all her needs, except basic needs of individuals, the nations and the state.

If one were to look closer at the policy of self-sufficiency, one would realize that it doesn’t rise to the level of being commercial or economic solutions. It is merely a temporary preventive measure that the state would undertake against a potential foreign economic or commercial siege. Therefore it is not a remedy for foreign trade, but a reactive measure that a country may undertake if she was subjected to a foreign economic or commercial embargo. It would be wrong to ask what the shariah rule is concerning this policy, for it is merely a style that might be adopted. This policy would not be adopted if it had no reality and it was impossible to be self-sufficient regarding the basic needs of the state, the ummah and the individuals.

Development of Islamic Trade System

The relationship between Islam and trade is not well appreciated in the West. The Prophet Muhammad (peace be upon him) and his wife Khadija were both merchants. The Qur’an, the Muslim scripture, is filled with parables using the language of trade. It was merchants, not soldiers, who were mainly responsible for the spread of Islam throughout the world.

Conversely, the rise of the Islamic civilization contributed to the progress of economic development and economic theory. The rising tide of Islam today is in part a reaction against the Arab socialism that has destroyed the markets of the Muslim world. That the rejection of secularism and of socialism should come hand-in-hand should not be surprising. One cannot be a Muslim and opposed to freedom of enterprise, as we shall show.

Opposition to free trade and market can come from a number of directions. It may be rooted in an ideological objection to private property (socialism), in a disdain for material prosperity itself (asceticism), in an antipathy to the variations in wealth that must accompany market mechanisms (economic egalitarianism), or in a mistaken belief that a command economy can better provide economic benefits (authoritarianism). Islam refutes all of these.

In contrast to socialism, Islam enshrines private property as a sacred trust. Everything belongs to God, and it is Man that God has created as His khalîfah, or His agent on earth (Qur’ân 2:30). Each person is individually responsible directly to the Almighty for the faithful execution of this awesome trust (36:54). Therefore that concept of private property well established among the Semitic peoples is taken as a given by the Qur’an. Rather than modify the concept of property, the Qur’an specifies the terms for its wholesome and just enjoyment and employment. It should neither be used wastefully nor in a way that will deprive others of their justly acquired property (2:188). When one holds the property of others in trust, for example for orphans, one should not divert it to one’s personal benefit (2:2; 4:10), but one should not turn over one’s own property to those incapable of managing it (2:5). When orphans mature they should be given control of their own property (2:6). Inheritance rights are not only respected (4:33), but expanded to include women (4:7). Property rights of women are as sacred as those of men in other cases as well (4:24, 4:32) and the treatment of women as chattel is prohibited (4:19).

Islam rejects both monastic asceticism that glorifies poverty and suffering and the Calvinistic variety discussed by Max Weber that esteems the accumulation of wealth at the expense of its enjoyment. Neither poverty nor wealth are proofs of virtue. Rather both are trials of one’s commitment to the higher spiritual order. The Islamic view of the material world is as a neutral stage in which the individual demonstrates submission to the will of God by his choices, including the lawful acquisition and use of God’s bounties. Profit may be pursued even on the day of congregational prayer (62:10).

The rejection of asceticism is not an invitation to hedonistic consumption, however. Moderate in all things, Islam emphasizes the importance of trade, commerce and productivity: "O ye who believe! Eat not up your property among yourselves in vanities: but let there be amongst you traffic and trade by mutual good-will: nor kill (or destroy) yourselves: for verily God hath been to you Most Merciful." (4:29)

The zakat, as this obligatory charity is called, basically set at 2.5% of accumulated wealth beyond the subsistence level which would qualify one to be a recipient, tools of the trade and current inventories of stock in trade exempted. It is thus an assessment against wealth, not an income tax (although farmers and miners pay a portion of their gross product instead of a percentage of their capital). Insofar as it is not an assessment against income, it does not discourage productivity, but rather discourages idle wealth. Further, the levels of the assessment are not confiscatory, so while it provides a safety net for the poor, it in no way "levels" the wealth nor penalizes the rich.

The fallacy that the command economy can better provide for the material needs of a society has suffered a severe setback with the fall of the Soviet Union. But the command economy was unpopular with Muslim economists from the beginning. There are numerous traditions that demonstrate that the Prophet Muhammad turned to the marketplace to determine the just price of commodities. On learning that his companion Bilal had traded poor quality dates for high quality dates, the Prophet advised him that buying and selling at market prices over barter avoided the dangers of overcharging (ribâ) inherent in barter.

The Islamic analysis of markets reached the level of economic science by the time of the great fourteenth century historian Ibn Khaldun. He rejected the utopianism of the Greek-influenced philosophers. To him, the fact that the policies mandated by God could be scientifically demonstrated as the best social policies was the natural consequence of the fact that the laws of economics and the laws of good living had the same Creator. His understanding of the harmfulness of the command economy can be seen from the titles of the section headings in his magnum opus, the Muqaddamah (Introduction to History), e.g., "Commercial activity on the part of the ruler is harmful to his subjects and ruinous to the tax revenue."

Markets antedate the mission of Muhammad. They are especially strong in the Semitic world. Like their cousins, the Jews, the early Arabs had a strong commitment to trade and bargaining. The rise of Islam did not change, nor did it seek to change, the centrality of trade and commerce to the Arab way of life. On the contrary, the establishment of commercial law, the expansion of property rights for women, the prohibition of fraud, the call for the establishment of clear standards of weights and measures, and the uncompromising defense of property rights (even while calling for a greater responsibility for alleviating the plight of the poor and needy) pushed the Islamic civilization to the front of the world’s economic stage and made the Muslim world the defining force in international trade for over 800 years. The Islamic activists throughout the Muslim world can help to usher in a new Renaissance if they avoid the temptation to yield to political pragmatism and hold fast to the pro-market principles of Islam.

ISLAMIC FINANCE VERSES CONVENTIONAL FINANCE

Riba’

The Qur’an commands Muslims not to take riba’ the most widely accepted interpretation is that any interest, irrespective of the level of interest rate and the purpose of the credit, is prohibited. Riba then, is defined as a positive, predetermined return on capital. The conventional financing system relies heavily on the taking of interest – riba’.

In the Islamic perspective, however, does not mean that a provider of capital should not participate in the financial results of a venture financed, or co-financed, by him. Participation is legally permissible where his returns are not predetermined in the venture’s results, which may be positive but also could become negative. In short, interest financing should be replaced by Profit and Loss (PLS) arrangements.

PLS PARTNERSHIP PRINCIPLES

Musharaka

This is where a bank and an entrepreneur jointly contribute to the capital of a company or a particular project. The bank receives an agreed percentage of the expected profit. Should the final result be a loss, the bank has to share the loss in proportion to its contribution to the total capital of the financed venture. Both the bank and the entrepreneur have a right to manage the venture, though the bank may decide not to exercise this right.

Mudharabah

The bank is the sole provider of capital. The partner contributes his entrepreneurial efforts. The bank receives a share of the profits determined only as a percentage, but not in absolute amounts. Losses have to be borne exclusively by the bank, while the work of the partner goes unrewarded. Only the entrepreneurial partner has the right to manage this venture.

The principles of these PLS partnerships are not only applicable to the financing business of Islamic banks. The relations between the bank and the holder of savings and investment accounts are based on an analogical construction. Depositors no longer receive fixed interest payments on their deposits, but participate in the financial results, the profits or losses, of the bank. As the returns of the provided capital are not predetermined, but unknown in absolute terms at the outset and because the bank is required to share losses when occurring, the bank is said to share economic risk with the entrepreneur, thus relieving some of the financial burden of the active partner. This is considered more than interest-based financing.

Profitability

While depositors of conventional finances receive fixed payments, those of Islamic finance do not receive fixed payments, but rather, participate in the profits of the finance (bank). Very often the net profits in the balance sheets of Islamic banks comprise both the profit shares due to depositors and to shareholders. In the balances of conventional banks, however, the net profits comprise of only the shareholders. Corresponding with the depositors’ profit shares, are the conventional banks’ interest payments to depositors. These can be found as a profit-reducing cost in most income statement. This means that the net profits of Islamic banks, which include the depositors’ shares, cannot be compared meaningfully with the net profit of conventional banks, albeit this is what often happens.

Mobilization of Funds and Employment of Funds

Mobilization of funds has to do with the acceptance of deposits. Islamic banks in this sense are not that different from that of conventional banks. They accept depositors’ funds and the recording of those deposits from an accounting point of view does not differ that much from conventional banks. There’s a current account, then there’s savings accounts that can be of different types, A and B depending on the item and if they are short term or long term. There’s also investment account that are used for specific investment. Finally, there are joint accounts, where discretion is given to the bank to use those funds wherever they want, in any type of investments.

Clearly, the recording of the accounting transactions is not that different from that used by the conventional banking. The only difference is that Islamic banks are required to keep certain transactions separate because there will be a problem at the end as to how to share the profit between the shareholders and the depositors. This is not a problem for conventional banks, as the rate is known. For Islamic banks, it is different. The financial institutions have to wait until the transaction is complete then decide at the end of the year how much each of the group will receive as a profit.

Mudharabah and Musharakah

Mudharabah and Musharakah do not differ much from the joint ventures in conventional banking. These are for a certain types of operation, and it is agreed in advance between two parties that the bank and the customer will contribute certain capital assets as well as technical managerial experience, but in varying proportions. They share the realized profit in an agreed upon ration, sometimes at the beginning and sometimes they wait until the transaction is completed. Normally, the bank does not interfere in the management but periodically can ask for an audit or some financial reporting details. Profit and loss are shared on the basis of capital contribution, after allowing for the costs incurred in running the day-to-day business.

Conventional Bank Instruments Forbidden Under Islamic Law

Interest

The main principle here is that all interest remunerated in purely financial transactions whether connected or not with other banking services are not allowed. Fixed deposits, whether taking the form of certificates or deposits and bonds, prefixed interest, floating interest, convertible to shares, whether denominated in a specified currency or a basket of currencies, are not allowed.

Zero coupon bonds too are prohibited, as they are both at discount and the difference between the purchase value and the face value represents the accumulated interest on the purchase price. Consequently, all dealings in interest bearing securities, whether on primary or secondary markets and stock exchanges are not allowed. Any related activities such as syndication of interest-bearing bonds, managements of such loans and underwriting them, are not allowed. Loans, overdrafts and other facilities are also not allowed.

Discounting Commercial Paper

There is no controversy over the acceptance of commercial paper, or collecting them by Islamic banks. The problem is only buying or selling them at discount, as commercial paper represents a debt, a transfer of debts, and though acceptable by Islamic law should be at par value with no discount or premium.

As the current practice of conventional banks is to deal with commercial paper by discounting, Islamic banks avoid it. The same applies to forfeiting business as the only difference besides having longer maturity periods is that forfeiting paper does not allow recourse to the drawer, which is not relevant to the question of whether it is according to the Syariah or not.

Documentary Credits

The finance of documentary credits offered from banks to clients on the basis of interest is, for the time of finance, prohibited under Islamic law. Alternatives used by Islamic banks are either purchased and sale of goods with mark up on murabahah basis, in which the bank keeps title of goods as long as it handles the documents representing them and which should be the order of bearer; or the bank shares with its client his profit on sale of goods in accordance with a predetermined formula, taking into account the amount and the term.

Factoring

Factoring is allowed under Islamic law if it is just the collection of invoices on behalf and for the account of the bank’s customer. The bank is only allowed the usual charges for such a service. The same applies in the case of the bank using receivables as collateral for the finance given to the customer, as long as this finance is one of the forms allowed by Islamic law.

However, as is usually the case, factoring is a sale by the customer of its trade debts to the bank or the factoring company against a discount if the bank pays on maturity of the invoices or if the bank is paying ahead of the maturity dates of invoices. Both sale of debts for a different price other than its face value and discount for early payment of debts are prohibited under Islamic law.

Instruments Used by Conventional Banks and Doubtful or Subject to Controversy under Islamic Law

Letters of Guarantee

These are banking transactions that are the subject of controversy among Islamic jurists, or are at least doubtful and subject to continuous debate and discussions among Islamic bankers and jurists. The first one is fees for letters of guarantee. This issuance of banking letters of guarantee is not the subject of any controversy among Islamic jurists. The fees charged by the banks to cover their expenses that are not related to the amount of letter of guarantee are not he subject of any controversy. They are actually considered due fees for services rendered. However, the question arises as to the fees and commissions related to the amount of the letter of guarantee.

The legal aspect behind this controversy is not that the letter of guarantee is considered as finance, and that these fees are considered as interest, but the point is that according to traditional Islamic jurisprudence, the guarantee is classified under “non-lucrative contracts” and such it is assumed to be rendered under human service, free of charge. Therefore, those jurists, allowing with this traditional jurisprudence to be practiced, do not allow Islamic banks to take such proportional fees. As a result Islamic banks are prevented from rendering this service as it involves risks that are not remunerated.

On the other hand, if the letter of guarantee is partially or totally covered by the customer, jurists considered that the main service rendered by the bank in such a case is to pay out of the cover, upon instructions from the customer, as such the bank is entitled to take fees and commission whether in a lump sum or in proportion to the amount involved. The contract resulting from this opinion is that the bank is allowed commission from the customer who is covering the letter of guarantee, and consequently securing the bank’s position, while it is not allowed to take commission when it is taking the risk and giving the letter of guarantee without cover.

Bonuses Paid on Current and Savings Account

The payment of a fixed yield on any deposit is pure interest, and prohibited by Islamic law, whether it is in fixed deposits, current accounts or savings account. The principle in Islamic law is that a deposit, secured to risk any loss, is not allowed to receive either prefixed interest or any portion of the profit. It is allowed that the debtor, when paying back his debt, gives the creditor a bonus whether expressed in increasing the amount of the loan or any other privileges or services and this is even recommended and expected from a pious debtor, provided that there is no previous condition or undertaking in this subject.

Inflation

Another point is the compensation for erosion of the value of money due to inflation. Some conventional banks open savings accounts to be remunerated according to the inflation index, with a minimum and maximum limit. Such a scheme is under consideration from the Islamic point of view, provided that the agreement between bank and depositor, between creditor and debtor in general, clearly stipulates that the scheme applies whether the index is positive or negative and provided that there are no maximum and minimum limits.

Such a scheme applied would entail similar arrangements with users of funds in order not to leave the Islamic bank taking the risk of indexation on the one hand and another type of risk on the other hand. One way of doing this could be to lend the money to users of funds with similar indexation clause and to keep a margin for the bank, for example, by receiving deposits on index rate minus 0.25% and lending at index rate plus 0.25%.