Robin Matthews is professor at universities in London and Moscow; consultant with international companies; writes on business, economics; and finance: creative imagination techniques in management.
Conventional versus islamic economics ; a spiritual matter
CONVENTIONAL VERSUS ISLAMIC ECONOMICS AND FINANCE; A SPIRITUAL MATTER
I gave a paper just a couple of years ago about the distinctiveness of Islamic economics, with specific reference to Islamic finance. The main contention of the paper was that the real distinctiveness was that Islamic economics does not separate the spiritual and the material aspects of the world. It recognises that two worlds are inseparable.
The remit of the lecture was to address a general audience rather than a group of specialists in Islamic finance. Also, I considered that a lecture involving mathematics might be a burden on specialists in Islamic finance too.
In this paper though I will let some simple mathematics intrude.
Following a background introduction, I went on to consider finance, saying that the real difference between conventional and Islamic finance was operational rather than substantive. Both versions are concerned with interest and risk. Islamic finance emphasises risk sharing from the perspective of economic justice. Conventional finance considers risk sharing from the perspective of systemic risk; unwanted risk sharing through massive interbank global connectivity.
The point made in conventional financial economics about systemic risk is fundamentally that individuals can spread risk through portfolio diversification. But diversification doesn’t make risk disappear. It is stacked up in portfolios considered in aggregate. And a shock to the financial system can cause mayhem, as it did in 2008 and will probably do so again.
It’s a moot point as to whether prohibition of interest reflects the fact that in zero growth primitive economies, as was the case in early Islam, zero interest rates were equilibrium rates. I considered this in the lecture but I leave it aside in this short paper.
Instead, I focused on the operational issue about the distinctiveness of the Islamic and conventional approaches to finance and by implication, to economics generally.
It amounts to the issue about the existence of replicating portfolios; between the portfolios envisaged by conventional finance; consisting of equity and debt portfolios in conventional finance and Islamic all equity portfolios.
The questions are; Are the portfolios replicable? Does a replicating portfolio between the two exist? To this there is a theoretical and practical answer; in theory the answer may be Yes but in practice No.
Consider two sets, the set of all Islamic portfolios and the set of all conventional portfolios. There are three possibilities;
1. Islamic portfolios are a proper subset of conventional portfolios,
2. Islamic portfolios and conventional portfolios are intersecting sets,
3. Islamic portfolios and conventional portfolios are disjoint sets.
The issue about the existence of replicating portfolios between the two hangs on whether the sets are convex or not; or whether an approximate convex set exists between the two portfolios.
Reminding the reader about some mathematics, if a set is convex it means that any linear combination of two portfolios within the set is contained in the set.
A replicating portfolio is a linear combination of two portfolios.
Considering two sets, the set of all conventional portfolios and the set of all Islamic portfolios. Personally I think it is the case that Islamic portfolios are a proper subset of conventional portfolios (as in 1 above). Leave aside for the moment the question as to whether Islamic portfolios are a proper subset or not.
If they are a proper subset, that is, if the set of all Islamic portfolios are contained in the set of all conventional portfolios, then the issue is; Is the set of all conventional portfolios a convex set? If this is so, then in principle, an Islamic portfolio can be constructed as a linear combination of elements of a conventional portfolio that contains no interest-bearing debt.
Suppose on the other hand that Islamic portfolios intersect with conventional portfolios, but they are not a proper subset (as in 2 above). In this case, the issue concerns the possibility of constructing the smallest convex set containing both types of portfolios. The same issue arises if the two portfolios are disjoint (as in 3 above). In both cases, since we have constructed a convex set, however artificially, then in principle a replicating portfolio, exists.
Thus, I maintained in the lecture, that at least in the case of finance, distinctiveness between the Islamic and the conventional approach hinged on an operational issue, of consisting of the question, Are financial portfolios convex sets? If so, the two types of portfolio are interchangeable; one, the Islamic portfolio can be constructed out of the other, the conventional portfolio.
If this is not so and the portfolios in practice are not convex or convexifiable, then one cannot be constructed out of the other. But this is an operational issue about the nature of portfolios.
Coming back to what I said at the outset of the paper about the fundamental distinction between Islamic and conventional finance being essentially that the separation between the spiritual and the material which emerged in Renaissance Europe, influenced conventional economics and finance very fundamentally but that separation does not exist in Islamic economics and finance.
A reservation I have about the teaching of Islamic finance and about textbooks in Islamic finance and economics is that they fail to address this distinction. Instead teachers and textbooks absorb themselves in technicalities and operational, that is, material issues, almost to the total exclusion of the spiritual.
As a footnote to the discussion, I add the observation that a spiritual approach to economics is needed very much at this time and that it should not be limited to an Islamic approach. I prefer a mystical approach. Mystical in this context does not mean fantastical or illusionary. It means beginning from the contention that the material and the spiritual (whatever version of spirituality one prefers) are one.
Reality is Unity
In reality, everything is contained in a Unity that it is impossible to conceive of. Instead, we have to partition reality into distinct parts, considering one part at a time, ignoring the other and considering the parts as separate as a matter of convenience.
But in economics and finance separation between the spiritual and material may be convenient. Consideration of unity can be postponed but to ignore it permanently is a disaster.
Another thought is that the division between the material and the spiritual though necessary at the time; science was dogged not so much by spirituality as by fear of unfamiliar ideas however functional. I noticed this in the section of the audience I mentioned earlier.
References and a full paper available on request from the author