An Islamic Model for Stabilization and Growth [1st ed. 2020] 3030487628, 9783030487621

Table of contents :
Praise for An Islamic Model for Stabilization and Growth
Foreword
Acknowledgments
Contents
Abbreviations
List of Figures
List of Tables
1 Introduction
1.1 Significance of Macroeconomic Adjustment Policy Issues
1.2 Senegal in Brief
1.3 An Islamic Model of Stabilization and Growth
1.4 Chapter Outline
References
2 Overview of Current Macroeconomic Policy Issues and Challenges in Mainstream Economics
2.1 Institutions, Structural Macroeconomic Reforms and Development
2.1.1 Institutions and Development
2.1.2 Institutions and Culture
2.1.3 Institutions and Education
2.1.4 Institutions and Media
2.1.5 Assessment of the Institutions of Change
2.1.6 Public Investment Policy
2.1.7 Inequality and Poverty
2.1.8 Financial Structure and Economic Development
2.1.9 Global Issues on Ethics and Climate Change
2.2 Macroeconomic Financial Stability
2.2.1 Fiscal Policy Design
2.2.2 Monetary Policy
2.3 Conclusion
References
3 Current Economic and Social Challenges and Islam
3.1 Economic Growth Policies from an Islamic Perspective
3.1.1 Islamic Institutions and Economic Growth
3.1.2 Islam and Social Issues
3.1.3 The Environmental Challenge
3.1.4 Islamic Financial Infrastructure Development
3.2 Macroeconomic Stability Policies in an Islamic Economy
3.2.1 The Conduct of Monetary Policy in an Islamic Economy
3.2.2 Islamic Liquidity Management Issues
3.2.2.1 International Cooperation
3.2.3 Islamic Fiscal Policies
3.3 Survey of Islamic Macroeconomic Modeling Literature
3.4 Data and Methodology of Simulation
3.4.1 Data Issues
3.4.2 Methodology Issues
3.5 Conclusion
References
4 Islamic Institutional Policy Framework
4.1 Islamic View of Economic Development
4.1.1 Individual Self-development
4.1.2 Physical Material Progress and Growth
4.1.3 Development of the Human Collective Toward Integration, Cohesion, and Unity
4.2 Islamic Institutional Policy Framework
4.2.1 Fundamental Axioms
4.2.2 Rules Organizing the Legal and Regulatory Economic Environment
4.2.3 The Islamic Concept of Economic Relations
4.3 Conclusion
References
5 Rules of Economic and Financial Operations
5.1 Production Activities
5.2 Expenditure: Consumption and Investment
5.3 Rules of External Economic Relations
5.4 Rules of Public Finance and Banking
5.4.1 Rules of Public Finance
5.4.2 Rules of Banking and Finance
5.5 The Macroeconomic Policy Framework
5.5.1 The Principles of Islamic Economics
5.5.1.1 Decision-Making by the Economic Actors
5.5.1.2 Functioning of the Economy as a Whole
5.5.1.3 Interaction of Economic Actors with Each Other
5.5.2 Design of the Macroeconomic Policy Framework
5.6 Conclusion
References
6 Sustainability of the Senegal Socioeconomic Model
6.1 Real Sector Development
6.1.1 Growth and Inflation
6.1.2 Saving and Investment
6.2 Fiscal Developments
6.3 Money and the Banking Sector
6.4 External Sector
6.4.1 Senegal’s External Current Account Payments
6.4.2 Foreign Debt and Debt Sustainability
6.5 Country and Policy Institutional Assessment
6.6 Social Indicators: Population, Employment, and Poverty
6.7 Current IMF and World Bank Macroeconomic Adjustment Models for Senegal
6.7.1 The International Monetary Fund Analytical Framework
6.7.1.1 Variables of the Model
6.7.1.2 Equations of the Model
6.7.2 The World Bank Analytical Framework
6.7.3 The Integrated Model of the IMF and World Bank Approaches
6.7.4 Critics of IMF and World Bank Analytical Frameworks
6.8 Current Macroeconomic Policies in Senegal and Perspectives
6.8.1 Background: The Emergent Senegal Plan
6.8.2 Macroeconomic Policies and Structural Reforms
6.8.3 Recent Macroeconomic Estimations and Projections
6.8.4 Country Policy Institutional Assessment
6.8.4.1 Overall Islamicity Index Country Score
6.8.4.2 Islamicity Indices Ranking
6.8.4.3 Examination of Changes in the Sub-indices
6.9 Conclusion
References
7 Counterfactual Simulation of the Islamic Model for Senegal
7.1 Synopsis of the Islamic Analytical Macroeconomic Framework
7.1.1 Equations of the Model
7.1.1.1 Equilibrium Condition in the Goods and Services Market
7.1.1.2 Fiscal Balance Constraint
7.1.1.3 The Balance of Payments Constraint
7.1.1.4 Financial Assets market Equilibrium
7.1.1.5 Behavioral Relations
7.1.1.6 Calibration of the Model Parameters
7.2 Counterfactual Simulation of the Islamic Model of Stability and Growth for Senegal
7.3 Conclusion
References
8 Implementation of the Islamic Model for Senegal
8.1 Policy Recommendations
8.1.1 Reforms in Institutions (Rules of Behavior)
8.1.1.1 Role of the State
8.1.1.2 Educational Infrastructure
8.1.2 Reforms in the Real Sector and Trade
8.1.3 Reforms in Public Finance
8.1.4 Reforms of the Money and Banking Sector
8.2 Sequencing of Policy Reforms
8.3 The Financing of the Policy Reforms
8.4 Expected Performances of the Islamic Model in Senegal
8.5 Conclusion
References
9 Conclusion
Appendices
Appendix A. Glossary of Terms
Appendix B
Appendix B (continued): Definition of variables (% of real GDP)
Appendix C
Appendix D. ECM estimation results of ARDL on real economic growth (GYR)
Appendix E. ECM estimation results of ARDL on the Investment Rate of Return (IRR)
Appendix F. Prohibition of Riba from sayings of the Prophet (pbuh). (Source: Sahih al-Bukhari)
Index

Citation preview

POLITICAL ECONOMY OF ISLAM

An Islamic Model for Stabilization and Growth

Adama Dieye

Political Economy of Islam

Series Editors Hossein Askari George Washington University Washington, DC, USA Dariush Zahedi University of California Berkeley, CA, USA

All Middle Eastern countries, with the exception of Israel and Lebanon, profess Islam as their state religion. Islam, whether simply in words or in fact, is woven into the fabric of these societies, affecting everything from the political system, to the social, financial and economic system. Islam is a rules-based system, with the collection of rules constituting its institutions in the quest to establish societies that are just. Allah commands mankind to behave in a fair and just manner to protect the rights of others, to be fair and just with people, to be just in business dealings, to honor agreements and contracts, to help and be fair with the needy and orphans, and to be just even in dealing with enemies. Allah Commands humans to establish just societies, rulers to be just and people to stand up for the oppressed against their oppressors. It is for these reasons that it said that justice is at the heart of Islam. In the same vein, the state (policies) must step in to restore justice whenever and wherever individuals fail to comply with divine rules; government intervention must enhance justice. This series brings together scholarship from around the world focusing on global implications of the intersections between Islam, government, and the economy in Islamic countries.

More information about this series at http://www.palgrave.com/gp/series/14544

Adama Dieye

An Islamic Model for Stabilization and Growth

Adama Dieye Central Bank of the West African Countries Dakar, Senegal

Political Economy of Islam ISBN 978-3-030-48762-1 ISBN 978-3-030-48763-8 (eBook) https://doi.org/10.1007/978-3-030-48763-8 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover image: © Stefano Politi Markovina/Alamy Stock Photo This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Praise for An Islamic Model for Stabilization and Growth

“Every country facing serious economic shocks, before going to the IMF for adjustment and stabilization program, should study the pathbreaking recommendations of this invaluable contribution offering a much-needed alternative to the IMF prescription. A must read for policymakers, macroeconomists, graduate students and IMF Executive Board and staff.” —Hossein Askari is Iran Professor of International Business and International Affairs, George Washington University, USA “The timing of this book could not have been better given the ongoing COVID-19 crisis which is expected to take global economies into recession. This work by Dr. Dieye is result of years of policy experience and deep academic knowledge concerning dealing with economic shocks and attempts to achieve stability through conventional interventions. His observations are very valid and the solutions based on risk-sharing principles are worthy of serious attention. His work makes a valuable contribution to finding viable and alternative solutions to developing long-lasting stabilization programs for which he should be commended.” —Dr. Zamir Iqbal, VP Finance and CFO of the Islamic Development Bank “In this remarkable book, Dr. Adama Dieye adopts an Islamic paradigm that offers far better prospects for macroeconomic growth and social v

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PRAISE FOR AN ISLAMIC MODEL FOR STABILIZATION AND GROWTH

justice. The author fills a gap—the paucity of the investigation of the macroeconomics from an Islamic perspective. He presents clearly the merits of an Islamic model of stabilization and growth and the necessity to start reforms along “Sharia” economic principles. Written in a clear style and an accessible language, this book will be highly useful to scholars, macroeconomists or development economists in Africa and to all economists and policy makers interested in alternative development or macroeconomic approaches. I invite strongly all these actors to read this book. Its reading will contribute-I am sure—to make wealthy the debates and to bring forward research on a subject of major interest for economic and social development, still insufficiently explored.” —Professor Adama Diaw, Université Gaston Berger, Saint -Louis, Senegal

Foreword

Dr. Adama Dieye has written a remarkable and timely book at a juncture of potentially devastating crises. Economies are suffering from instabilities resulting from, inter alia, high indebtedness, forced austerity, supply chain disruptions, massive inequalities of income and wealth, political turmoil and conflicts, heightened levels of risk and uncertainty, and by environmental crisis posing an existential threat to humanity. Materialization of any of these shocks has the potential to destabilize economies. As the book’s review of the history of current adjustment and stabilization paradigm demonstrates, programs designed by the foremost international financial institution and implemented in order to restore stability to economies experiencing shocks have had a dismal track record. The fundamental question addressed in the valuable effort of Dr. Dieye is: Given that the conventional adjustment and stabilization programs have mostly failed, are there effective alternative stabilization models that could restore stability to economies, destabilized by internal and external shocks, more rapidly, sustainably, and at lower costs than the conventional paradigm? His equally essential answer, based on theory and empirics, is to adopt a risk-sharing approach to stabilization rather than the conventional paradigm of shifting or transferring risks of policy adjustments. As the book’s comprehensive review of the history of implementation of the latter approach illustrates, the conventional paradigm of economic policy adjustment has been mostly ineffective if not harmful, even in

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less stressful circumstances. In the present conditions of radical uncertainty of simultaneous materialization of multiple shocks, the conventional approach not only appears severely inadequate, but it also has the potential of enhancing social, political, and economic instabilities rather than alleviating them. To appreciate the unique contribution of the book, one has to have a minimal understanding of the conventional economic adjustment/stabilization programs based on risk transfer or risk-shifting paradigm. Heretofore, developing and emerging market economies have implemented policy adjustment programs, designed by the International Monetary Fund (IMF) when experiencing destabilizing shocks to their economies. Under the provisions of its Articles of Agreement, the IMF is mandated to provide financial and technical assistance to member countries provided the authorities of these countries accept to implement a program designed to induce changes (“reforms”) in the countries’ macroeconomic-policy stance. In exchange, the IMF provides trenched financial assistance tied to the scheduled implementation of IMF’s policy recommendations. Each periodic trench of the overall financial assistance package is released upon the certification of policy implementation, issued by the staff of the IMF. Such an “adjustment program” is designed based on an axiom that fundamental macroeconomic-policy weaknesses make countries “vulnerable” to destabilizing shocks. In the context of IMF thinking, “vulnerability” means that, according to the institution’s assessment, the country is already, or in the process of becoming, unable to service its external debt. This vulnerability reveals itself, so the argument goes, in balance of payments crisis originating in imbalances in fiscal policies supported by wrong monetary policies. Accordingly, the term “adjustment program” means the implementation of a set of policy measures designed to “adjust,” that is change, the authorities policy stance in a way that would “restore external viability”— meaning primarily a combination of policy changes that would restore the external debt-servicing capacity of the country. It is this elemental objective of IMF’s adjustment programs that has prompted some to refer to the institution as “debt collector” for its major shareholder since these are the countries that are, usually, the international creditors. The IMF is known as the “lender of last resort.” This means that developing and emerging markets economies usually turn to this institution for financial assistance when the private international lenders have stopped or severely

FOREWORD

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curtailed lending to these countries. At this point, and in an implicit agreement among the international private lenders, the only path of return to international credit markets suggested to these countries is to have an “agreement” with the IMF to adjust their policies. Considering that often the amounts of financial assistance offered by the IMF, as “the lender of last resort,” is meager–as a percentage of countries’ quota—relative to the usually more substantial needs of countries, it becomes difficult for countries facing economic instability to envision a solution to problems created by instability without a return to the international credit market. And that cannot be done without the IMF’s “seal of good housekeeping,” meaning the institution’s certification that the country’s policies have been “reformed” to make them creditworthy. This “gate-keeping” role gives the IMF enormous power to serve as an effective instrument of transferring or shifting the risks of private or governmental lenders in major shareholder countries to borrower countries’ taxpayers. This riskshifting mechanism creates a self-perpetuating cycle in which repeated adjustment programs–through which risk of lending by major international creditors is minimized at significant costs to the borrowing countries and their people—create a growing class of permanent debt-poor countries. The book presents a useful survey of critiques of IMF’s adjustment programs that have emerged over the last four decades without denting the underlying ideology or the essential features of the institution’s adjustment programs. It has been argued that any substantive and substantial reform of the IMF’s policies toward its developing member countries is not possible without significant governance reform and that, in turn, is not possible without reforming the iniquitous ownership structure of the institution.1 That said, the search for an alternative paradigm that, among other things, provides a different approach to solving problems faced by societies and their economies has begun in earnest. In his book, Dr. Dieye offers one such alternative whose main premise is that an adjustment and stabilization model based on the essential behavioral requirements— rules of the game—of Islamic teachings leads to a more efficient, effective, and longer-lasting stability in economies experiencing internal and

1 See, Abbas Mirakhor and Iqbal Mehdi Zaidi, 2006. “Rethinking the Governance of the International Monetary Fund”, IMF Working Paper No. 06/273.

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external shocks than the conventional adjustment programs, specifically those designed by the IMF. In contrast to the IMF-designed adjustment programs based on risk transfer or shifting, the core engine of the alternative model presented in the book is risk sharing. Once the theoretical risk-sharing model of adjustment is presented, the book illustrates its application to the case of Senegal. In its empirical exercise the book employs counterfactual simulation that asks: What would have been the results had the authorities in Senegal implemented the model it proposes instead of the IMF adjustment programs it actually implemented over the past decades. It employs counterfactual simulation that uses data on the economic performance of Senegal during the period in which the country implemented repeated IMF adjustment programs: 1980–2014. The results of the simulation indicate that the country would have been able to stabilize its economy more rapidly, effectively, efficiently, and sustainably with higher growth had Senegal implemented a risk-sharingbased adjustment program such as the one proposed in the book. In addition to the risk-sharing feature of the model, the focus of the book’s proposed model is on a fundamentally different conception of behavioral rules of the game than the conventional adjustment and stabilization program framework structured on the basis of the so-called “Washington Consensus.” The many interesting and useful theoretical and empirical features make this book a valuable contribution to the field of economic policymaking. In particular, and in contrast to the many critiques and advocates of changes in the IMF approach to adjustment and stabilization, it offers a radically different approach to stabilization. While the book draws on Islamic teachings to inform the structure of its theoretical model, the fabric of the analytics of the model–especially its risk-sharing features– as well as the arguments supporting the proposed approach are general and applicable to non-Muslim economies searching for a more effective, sustainable, and less painful approach to stabilization. The book makes a genuinely fertile scholarly contribution to the growing field that has been attempting to define, design, and analyze Islam’s vision of a just economy. It is among the first successful efforts in investigating the empirical implications of a paradigm whose theoretical consideration began a few decades ago. For all these reasons, policymakers, students of economics and finance, researchers, and analysts would be remiss in not availing themselves of this highly relevant and unique work that proposes

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an effective solution to a serious problem that has been plaguing developing and emerging market economies for decades. Dr. Adama Dieye deserves commendations for producing this book. May his efforts be rewarded by the appreciation of his readers and by the implementation of his recommendations to policymakers in developing and emerging market economies especially Muslim countries. Abbas Mirakhor Retired Professor of Economics and Finance La Junta, CO, USA

Acknowledgments

Praise be to Allah (SWT), Who enabled me to accomplish this research, and peace and infinite blessings be upon His Prophet Muhammad and his family. I express my sincere gratitude to Prof. Dr. Abbas Mirakhor and Prof. Datuk Dr. Syed Othman Alhabshi and Prof. Hossein Askari for their teachings, their wise advice, useful and relentless support. I reserve special mention to my late brother Dr. Noureddine Chrichene and invoke the Mercy of Allah upon him. To my family, I first invoke the Mercy of Allah SWT upon my late father. Then, I express here my deepest gratitude to my mother, to my wife Maty and my children, my grand children, all my brothers and sisters, my relatives, for their prayers, their constant patience, support, and love.

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Contents

1

Introduction 1.1 Significance of Macroeconomic Adjustment Policy Issues 1.2 Senegal in Brief 1.3 An Islamic Model of Stabilization and Growth 1.4 Chapter Outline References

2

Overview of Current Macroeconomic Policy Issues and Challenges in Mainstream Economics 2.1 Institutions, Structural Macroeconomic Reforms and Development 2.1.1 Institutions and Development 2.1.2 Institutions and Culture 2.1.3 Institutions and Education 2.1.4 Institutions and Media 2.1.5 Assessment of the Institutions of Change 2.1.6 Public Investment Policy 2.1.7 Inequality and Poverty 2.1.8 Financial Structure and Economic Development 2.1.9 Global Issues on Ethics and Climate Change 2.2 Macroeconomic Financial Stability 2.2.1 Fiscal Policy Design

1 1 3 4 6 8

11 12 12 15 16 19 20 23 25 30 33 33 34 xv

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3

4

5

CONTENTS

2.2.2 Monetary Policy 2.3 Conclusion References

34 36 37

Current Economic and Social Challenges and Islam 3.1 Economic Growth Policies from an Islamic Perspective 3.1.1 Islamic Institutions and Economic Growth 3.1.2 Islam and Social Issues 3.1.3 The Environmental Challenge 3.1.4 Islamic Financial Infrastructure Development 3.2 Macroeconomic Stability Policies in an Islamic Economy 3.2.1 The Conduct of Monetary Policy in an Islamic Economy 3.2.2 Islamic Liquidity Management Issues 3.2.3 Islamic Fiscal Policies 3.3 Survey of Islamic Macroeconomic Modeling Literature 3.4 Data and Methodology of Simulation 3.4.1 Data Issues 3.4.2 Methodology Issues 3.5 Conclusion References

49 50 50 54 58 60 62

Islamic Institutional Policy Framework 4.1 Islamic View of Economic Development 4.1.1 Individual Self-development 4.1.2 Physical Material Progress and Growth 4.1.3 Development of the Human Collective Toward Integration, Cohesion, and Unity 4.2 Islamic Institutional Policy Framework 4.2.1 Fundamental Axioms 4.2.2 Rules Organizing the Legal and Regulatory Economic Environment 4.2.3 The Islamic Concept of Economic Relations 4.3 Conclusion References

95 96 96 96

105 127 131 131

Rules of Economic and Financial Operations 5.1 Production Activities

133 133

63 66 71 74 76 76 77 83 84

98 100 100

CONTENTS

6

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5.2 5.3 5.4

Expenditure: Consumption and Investment Rules of External Economic Relations Rules of Public Finance and Banking 5.4.1 Rules of Public Finance 5.4.2 Rules of Banking and Finance 5.5 The Macroeconomic Policy Framework 5.5.1 The Principles of Islamic Economics 5.5.2 Design of the Macroeconomic Policy Framework 5.6 Conclusion References

135 137 138 138 139 145 145 147 152 152

Sustainability of the Senegal Socioeconomic Model 6.1 Real Sector Development 6.1.1 Growth and Inflation 6.1.2 Saving and Investment 6.2 Fiscal Developments 6.3 Money and the Banking Sector 6.4 External Sector 6.4.1 Senegal’s External Current Account Payments 6.4.2 Foreign Debt and Debt Sustainability 6.5 Country and Policy Institutional Assessment 6.6 Social Indicators: Population, Employment, and Poverty 6.7 Current IMF and World Bank Macroeconomic Adjustment Models for Senegal 6.7.1 The International Monetary Fund Analytical Framework 6.7.2 The World Bank Analytical Framework 6.7.3 The Integrated Model of the IMF and World Bank Approaches 6.7.4 Critics of IMF and World Bank Analytical Frameworks 6.8 Current Macroeconomic Policies in Senegal and Perspectives 6.8.1 Background: The Emergent Senegal Plan 6.8.2 Macroeconomic Policies and Structural Reforms 6.8.3 Recent Macroeconomic Estimations and Projections 6.8.4 Country Policy Institutional Assessment

157 157 157 159 159 160 162 162 163 164 164 165 165 169 169 170 171 171 173 173 175

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CONTENTS

6.9 Conclusion References 7

Counterfactual Simulation of the Islamic Model for Senegal 7.1 Synopsis of the Islamic Analytical Macroeconomic Framework 7.1.1 Equations of the Model 7.2 Counterfactual Simulation of the Islamic Model of Stability and Growth for Senegal 7.3 Conclusion References

179 180

183 184 185 194 199 200

8

Implementation of the Islamic Model for Senegal 8.1 Policy Recommendations 8.1.1 Reforms in Institutions (Rules of Behavior) 8.1.2 Reforms in the Real Sector and Trade 8.1.3 Reforms in Public Finance 8.1.4 Reforms of the Money and Banking Sector 8.2 Sequencing of Policy Reforms 8.3 The Financing of the Policy Reforms 8.4 Expected Performances of the Islamic Model in Senegal 8.5 Conclusion References

203 203 204 205 207 208 210 215 217 218 219

9

Conclusion

221

Appendices

225

Index

239

Abbreviations

AAOIFI AfDB ANSD BCEAO COMCEC CPIA DP DPEE ECOWAS ESP GCI HDI HIPC ICYF-DC IDB IFI IFSB IMF IRTI ISRA MDRI NGO NIE OIC

The Accounting and Auditing Organization for Islamic Financial Institutions The African Development Bank National Agency for Statistics and Demography Central Bank of the West African States Committee for Economic and Commercial Cooperation of the OIC Country and Policy Institutional Assessment Indicators Directorate Planning Directorate of Forecasting and Economic Studies Economic Community of West African States Emerging Senegal Plan Global Competitiveness Index (World Economic Forum) Human Development Index report Highly Indebted Poor Country Islamic Conference Youth Forum for Dialogue and Cooperation Islamic Development Bank Islamic Financial Institution Islamic Financial Services Board International Monetary Fund (IMF) Islamic Research and Training Institute International Shariah Research Academy for Islamic Finance Multilateral Debt Relief Initiative Non-Governmental Organization New Institutional Economics Organization of Islamic Cooperation xix

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ABBREVIATIONS

PSI SESRIC UNDP WAEMU WDI WEO

Policy Support Instrument Statistical Economic and Social Research and Training Centre United Nations Development Program West-African Economic and Monetary Union World Development Indicators World Economic Outlook

List of Figures

Fig. 3.1

Fig. 6.1 Fig. 6.2 Fig. 6.3 Fig. 6.4 Fig. 6.5

Fig. 6.6 Fig. 6.7 Fig. 7.1

Infrastructure Gap in selected OIC countries—2016–2040 (as % of 2015 GDP) (Source OIC/COMCEC Coordination Office [2019]) Senegal. Real economic growth (GYR) 1980–2014 (%) (Source Government of Senegal/ANSD) Senegal. Total Factor Productivity Index (2001 = 1) (Source Penn World Tables 8.0) Senegal. Fiscal balance financing (billions FCFA) (Source Government of Senegal) Senegal. External account balance/fiscal balance (% GDP) (1994–2014) (Source IMF WEO 2016) Senegal. Government gross debt and external debt (2004–2014) (% GDP) (Source International Monetary Fund 2016) Senegal Overall Index and its components Senegal score compared to the best Group performers score (2018) Senegal real economic growth: Islamic Counterfactuals ex post /actuals/official projections (2015–2019) (Source Dieye [2017, 2020], Government of Senegal/IMF [2017, 2020])

73 158 160 161 163

164 176 176

196

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LIST OF FIGURES

Fig. 7.2

Fig. A.1 Fig. A.2

Counterfactuals economic growth: Islamic scenario/Officials (2019–2024) (Source Author’s calculation. IMF [2020]) Stability test of the coefficients Stability test of the coefficients

198 233 236

List of Tables

Table 2.1 Table 3.1

Table Table Table Table Table Table Table Table

3.2 4.1 5.1 5.2 6.1 8.1 A.1 A.2

Table A.3 Table Table Table Table Table

A.4 A.5 A.6 A.7 A.8

World Bank CPIA criteria Islamicity indices—Main components (Countries are rated on a scale of 0.00 [low] to 10.00 [high]. The overall Islamicity Index has been weighted as follows: Economic Islamicity Index [0.3]; Legal and Governance Islamicity Index [0.3]; Human and Political Rights Islamicity Index [0.3]; International Relations Islamicity Index [0.1]) Inequality metrics in the OIC member countries The GCI Framework: The 12 Pillars of Competitiveness G20 enhanced structural reforms Islamic macroeconomic policy framework Senegal. Savings and investment (% GDP) Sequencing of policy reform recommendations Senegal. Selected macroeconomic indicators (%) Senegal. The Business environment (DTF score): A comparative presentation ECM estimation results of ARDL (3, 2, 3, 2, 1) on real GDP growth Cointegrating form and long-run coefficients Diagnostic tests ECM estimation results of ARDL (1, 4, 0, 4) Cointegrating form and long-run coefficients Diagnostic test

21

52 55 130 148 150 159 211 227 229 230 231 232 234 235 235

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CHAPTER 1

Introduction

Economic activities rise and fall in response to various external and internal shocks, including policy corrections. In severe shocks, the government implements a process of adjustment to stabilize and restore equilibrium to the economy. Since the 1970s, developing countries in particular, have implemented macroeconomic adjustment through financial reform programs, designed and supported by the International Monetary Fund (IMF), the World Bank, and other bilateral and multilateral institutions. The process of macroeconomic adjustment involves implementing macroeconomic policies aimed at managing aggregate demand and structural reform to establish an incentive for macroeconomic stability, poverty reduction and economic growth (Polak 1957; IMF 1987; Mody and Rebucci 2006; Mills and Nallari 1992; Khan and Montiel 1989; Khan et al. 1990; Mikkelsen 1998; Ghosh et al. 2005).

1.1

Significance of Macroeconomic Adjustment Policy Issues

In the mid-1990s, the search for an alternative model to orthodox economic stabilization models emerged, primarily due to the worsening financial, economic, and social conditions in program countries. The 2007/2008 global financial crisis further deepened the need for such reform, spurring debates to rethink macroeconomic policy and more © The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_1

1

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A. DIEYE

recently, rebuild macroeconomic theory, even in developed countries1 (Blanchard et al. 2010; Stiglitz 2011). These debates have exposed the overall ineffectiveness of the IMF and World Bank policies in developing and emerging market economies. Developing countries and, more recently, developed western nations had expressed their reservations about the credibility of the conventional stabilization and growth model. Concerns began to develop about the IMF policy prescriptions that had led to frequent financial crises, economic downturns, excessive fiscal deficits, financial imbalances, rising unemployment and poverty (Edwards 1989; Easterly 1999, 2002, 2003; Agenor 1999, 2002; Barro and Lee 2002; Krugman 2009; Niels and Brigitte 2009). While the IMF policy prescriptions introduce market policies through fiscal and monetary austerity, they seem to lead to financial crises and even debt deflation and depression (Wolfson 2002). Many Muslim countries that implemented orthodox macroeconomic adjustment models did not achieve stabilization and growth as promised in these programs. They still suffer poor growth, declining or nonexistent infrastructure, critical unemployment, and unsustainable external debt (Chapra 1995, 2007, 2008; Ahmed 2002; Mirakhor and Krichene 2009; Askari et al. 2015). The Statistical Economic and Social Research and Training Centre (SESRIC) report published in 2017 pointed out that over the last five to ten years, despite their substantial, diverse resources such as agriculture, energy, mining, and human resources (making up 22.6% of the total world population in 2012), the share of OIC countries in total global production remains stable at 15%. Their contribution to total gross fixed capital formation stood at 8.9% globally, and 17.4% among developing countries. OIC countries also represent 45% of global sovereign wealth funds. In terms of labor productivity, the SESRIC report emphasized that an average worker in OIC countries produced 28.8% of the output produced by an average worker in developed countries. Askari et al. (2012, pp. 227–231) argued, “From a practical standpoint, Muslim countries lack the foundational elements of an efficient economic

1 The IMF organized series of international conferences on the broad theme of “Rethinking macro policy” in 2011, 2013, and 2015. See series of individual contributions published under the title Rebuilding Macroeconomic Theory, Oxford Review of Economic Policy Vol. 34, Nos. 1–2, Spring and Summer 2018, edited by David Vines and Samuel Wills.

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3

and financial system…” and “…have to tackle these glaring shortages in their economic systems.” This book addresses pressing issues on macroeconomic adjustment policies. It posits and investigates the idea that the Islamic economic model prescribed in the Qur’an and applied by the Prophet (SAW) could be the ideal model for Muslim countries and non-Muslim countries. An alternative stability and growth model based on Islamic teachings may be more suitable for countries like Senegal where most of the population are Muslim. Researchers have contended that it is hard to find a contemporary economic system that converges with ideal Islamic principles, and that empirical investigations of the application of an ideal model are not possible. However, Ahmed (2002), unconvinced of this logic, urged researchers to conduct experimental work from an Islamic perspective. To demonstrate the idea, we have put forth Senegal as a case study in the application of an Islamic stabilization and growth model.

1.2

Senegal in Brief

Senegal, located on the West African coast, is a member of the West African Economic and Monetary Union (WAEMU).2 Country members of this Union have a common Central Bank (BCEAO), a common currency—the CFA Franc, pegged at the fixed rate of e1 = FCFA 655.957, and a community structure to supervise regional banking activities. Senegal is also a member of the Economic Community of West African States (ECOWAS).3 Since 1979, Senegal has faced recurrent episodes of instability. In response, the government has embarked on a long economic adjustment program to address deep-rooted fiscal and external imbalances and constraints, and to ensure the economy remains on a path of strong and sustainable growth. The government has completed several IMF macroeconomic adjustment programs,4 supported by the IMF, the World Bank 2 Members of the West African Economic and Monetary Union (also known by its

French acronym, UEMOA) are Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo. 3 15 states: Benin, Burkina Faso, Cape Verde, Cote D’Ivoire, The Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, and Togo. 4 The case of the prolonged use of IMF resources has been under investigation by the IMF Independent Evaluation Office (IMF 2002, 2013).

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and other multi and bilateral partners. Nevertheless, over the period, Senegal has endured volatile economic growth. Macroeconomic instability continues, reflecting persistent constraints—large fiscal and external shortfalls, lack of financial deepening, and limited shallow capital markets, low productivity, and vulnerabilities to exogenous economic and environmental shocks (droughts, disruptions in electricity supply, and adverse terms of trade) (IMF 2013). The country has also not solved its rising social problems, with poverty being the most pressing, and has become more dependent on foreign resources for support. Based on its economic history, Senegal may find it extremely difficult to exit IMF and World Bank programs. Given the fact that successive IMF programs have failed to achieve the promised results, Senegal needs an alternative economic model to its existing conventional one to attain high and sustainable economic growth and improve social justice and human development. As a country, Senegal has rich resources that can be leveraged to address its economic and social challenges, including notable potential in solar energy, river irrigation, offshore oil and gas, and zircon mineral (IDB 2013). Also, as a member of the WAEMU and the ECOWAS, Senegal enjoys a potential regional market with an estimated 378 million consumers. It is therefore not beyond reach to assume that with Quran economic policy more in accord with the values of its population, Senegal should be able to achieve and sustain economic stability and growth.

1.3 An Islamic Model of Stabilization and Growth Senegal’s predominantly Muslim population, exceeding 95% of its total population, bodes well for the implementation of an Islamic economic model in achieving sustainable economic growth. The main point of reference for Islamic economic principles, as with all other Islamic principles, is the Holy Qur’an. The Holy Qur’an is the source of all Islamic paradigms as evidenced by the following verses: “This is the Book about which there is no doubt, a guidance for those conscious of Allah” (2); “Who believe in the unseen, establish prayer, and spend out of what We have provided for them (3)”. (Qur’an, 2:2–3)

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And [mention] the Day when We will resurrect among every nation a witness over them from themselves. And We will bring you, [O Muhammad], as a witness over your nation. And We have sent down to you the Book as clarification for all things and as guidance and mercy and good tidings for the Muslims. (Qur’an, 16:89)

The Qur’an prescribes the rules of behavior—“institutions”—for individuals and societies that cover all facets of life, including economics and finance. In particular, the Qur’an (7:96), stresses the necessary and sufficient condition for a prosperous economy are met through compliance with rules prescribed in it5 (Basmeih 2011): S7 V96: “And if only the people of the cities had believed and feared Allah, We would have opened upon them blessings from the heaven and the earth; but they denied [the messengers], so We seized them for what they were earning.” (Qur’an, 7:96)

These institutions are defined as rules of conduct, and their enforcement characteristics are prescribed in the Qur’an and explained by the Prophet (SAW) (Askari et al. 2015). As the verse assures, compliance with these rules will lead to a resilient, balanced, and prosperous economy. In this book, we propose an Islamic economic model of stabilization and growth by simulating and designing the necessary reforms according to Islamic economic principles in the context of Senegal. The book outlines a macroeconomic policy framework that recommends policies consistent with these principles. The relevance of the Islamic model is simulated using an analytical policy framework, under the assumptions of (i) free markets (ii) no interest rate-based debt instruments. The main proposition is that, when experiencing an economic shock, an Islamic economy moves from a short-term imbalance to a long-term stable equilibrium. To our knowledge, this empirical work has not been done elsewhere despite the availability of a body of relevant conceptual and theoretical research on Islamic macroeconomics. The book addresses this vacuum. The main features of an Islamic macroeconomic model of stabilization and growth for Senegal will be derived from the Qur’an and the Sunnah. For that, the book attempts to answer the following questions: 5 The English translation of verses is from Sahih International.

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1. What is the institutional framework according to the teachings of the Qur’an and Sunnah that, if met, would allow society to achieve stability and sustained economic growth? 2. How does such an institutional framework translate into a set of economic principles and long-term goals that would form the basis of recommended guidelines for economic policies? 3. With Senegal as a case study, how would the economy adjust in response to shocks with the policies designed in accordance with the Islamic model of stabilization and growth? From an empirical point of view, the basic issues to be addressed are: (a) outline an Islamic institutional framework within which the macroeconomic model for stabilization and growth would operate; (b) design an analytical simulation model that enables, along with the requirements of macroeconomic stability, to set up medium-term economic programs consistent with the goal of achieving balanced and sustained growth and to simulate it for the Senegalese economy6 and (c) formulate of a set of policy recommendations that can achieve the desired result for this economy.

1.4

Chapter Outline

The second chapter introduces the actual issues intensively investigated in the conventional economic model, such as the role of institutions in economic growth and development within the “New Institutional Economics” approach. Also, other macroeconomic and sectoral policies are widely discussed, such as fiscal policy and issues on efficiency of public expenditure, crucial social topics inter alia, redistribution of income, financial inclusion and economic development, followed by global issues including climate change and the environment. Chapter 3 analyzes the extent to which issues and challenges raised in the mainstream economy are addressed from an Islamic perspective. It reviews progress in modeling the Islamic economy and methodological

6 Specifically, in the case study of Senegal, economic developments of the country over the past decade suggest that poverty reduction in the country is highly sensitive to growth with elasticity of poverty reduction to per capita income growth estimated around 3.7% in the period 1995–2005.

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issues related to the specification and estimation of an Islamic model of stabilization and growth. Chapter 4 outlines the main features of an Islamic institutional framework. It introduces first the Islamic view of development. Second, it describes some fundamental axioms and a set of rules inferred from the Qur’an which govern the legal and regulatory environment of economic and financial activities. It discusses in depth two core principles derived from the Qur’an that regulate real productive and financial sector operations. Third, these rules are translated into economic principles that allow the design of the features of the Islamic policy framework based on the Qur’an and Sunnah. Chapter 5 focuses on the operational rules for the real and financial sectors. The Islamic economic principles outlined in the previous chapters are considered as general policy guidance towards the objective of macroeconomic stability, sustained growth, and social justice. The chapter infers a macroeconomic policy framework consistent with the objectives of stability and sustained growth. These include the crucial issue of poverty and inequality, which have to be taken into account when looking to achieve sustained growth. Chapter 6 takes a deep dive into the sustainability of Senegal’s economic and social model. The main objective is to identify why Senegal remained under a prolonged adjustment program and to assess the failure of these programs that justify the need for finding an alternative paradigm to the existing conventional economic policy model. The chapter reviews the IMF and World Bank macroeconomic programs from 1980–2014 designed for Senegal, with a presentation of the structure of the analytical framework, the nature of the prescribed macroeconomic adjustment policies and the assessment of their performance, as well as the strength and limits of these macroeconomic models. Finally, the chapter analyzes recent macroeconomic and social trends under a new growth strategy entitled “The Emerging Senegal Plan” (ESP) adopted by the Government of Senegal since 2014 with support from the IMF and World Bank macroeconomic program. Notably, the Senegalese institutional policy is assessed against the benchmark of the Islamicity Index which is based on rules prescribed in the Qur’an and implemented by the Prophet (SAW). Chapter 7 outlines an Islamic analytical framework, relying on the two strong and quantifiable rules of the Islamic economy: prohibition of interest rate-based debt financing and its replacement with risk-sharing finance and the existence of free markets. All other rules of conduct

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are incorporated into qualitative policy recommendations. The chapter presents the results of a counterfactual simulation of this analytical framework performed to assess the relevance of the Islamic model in relation to the Senegalese economy. The empirical results are compared to expected outcomes from the macroeconomic model designed by the IMF and World Bank. Chapter 8 formulates recommendations for the implementation of Islamic macroeconomic adjustment in Senegal in line with rules of the Islamic policy framework. The chapter also proposes the sequencing and phasing of the recommended policy reforms in the main economic and social areas. Chapter 9 draws the main conclusions of the study. It evaluates the performances of the Islamic model of stabilization and growth for Senegal according to the consistency of its properties and expected macroeconomic outcomes as well as policy implications. Finally, it outlines areas of further research to propose a better assessment of the Islamic model of stability and growth of potential outcomes.

References Agenor, Pierre Richard. 1999. Stabilization Policies, Poverty, and the Labour Market: Analytical Issues and Empirical Issues. The World Bank. ———. 2002. Macroeconomic Adjustment and the Poor: Analytical Issues and Cross-Country Evidence. World Bank Working Paper 2788. Ahmed, Adulrahman Yousri. 2002. The Scientific Approach to Islamic Economics: Philosophy, Theoretical Construction and Applicability. In Theoretical Foundation of Islamic Economics, 20–60. Edited by Habib Ahmed. Book of Readings. No. 3. Askari, Hossein, Iqbal, Zamir, Krichene, Noureddine and Abbas Mirakhor. 2012. Risk Sharing in Finance: The Islamic Finance Alternative. Singapore: Wiley. Askari, Hossein, Iqbal Zamir, and Abbas Mirakhor. 2015. Introduction to Islamic Economics: Theory and Application. Singapore: Wiley. Barro, Robert J., and Jong-Wha Lee. 2002. IMF Programs: Who is Chosen and What are the Effects? NBER Working Paper, 8951. Basmeih, Sheikh Abdullah. 2011. Tafsir Ar-Rahman: Interpretation of the Meaning of the Quran: Translation And Commentary. Department of Islamic Development Malaysia, Second printing. Blanchard, Olivier, Dell’Ariccia Giovani, and Mauro Paolo. 2010. Rethinking Macroeconomy Policy. Journal of Money, Credit and Banking 42 (s1): 199– 215.

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Chapra, Muhammad Umer. (1416–1995). Islam and the Economic Challenge. The Islamic Foundation and the International Institute of Islamic Thought Islamic Economics Series, 17. ———. 2007. Islam and Economic Development: A Strategy for development with justice and stability. New Delhi: Adam Publishers. ———. 2008. Muslim Civilization: The Causes of Decline and the Need for Reform. Leicestershire, UK: The Islamic Foundation. Easterly, Williams. 1999. The Ghost of Financing Gap: Testing the Growth Model Used in The International, Financial Institutions. Journal of Development Economics 60 (2): 423–438. ———. 2002. An Identity Crises? Testing IMF Financial Programming. Center for Global Development Working Paper 9. ———. 2003. An IMF and World Bank Structural Adjustment and Poverty. In http://www.nber.org/chapters/c9656NBER. Edwards, Sebastian. 1989. The International Monetary Fund and the Developing Countries: A Critical Evaluation. Carnegie-Rochester Conference Series on Public Policy, 31, 7–68. Ghosh, Atish R., Charalambos Chritophides, Il Kim Jun, Papi Laura, Ramakrishnan Uma, Thomas Alun H., and Juan Zalduendo. 2005. The Design of IMF-Supported Programs. IMF Occasional Paper, 241. International Monetary Fund. 1987. Theoretical Aspects of the Design of FundSupported Adjustment Programs. Occasional Paper No. 55. Washington DC. ———. 2002. Evaluation of the Prolonged Use of Fund Resources. Washington DC: IMF Independent Evaluation Office. ———. 2013. Evaluation of the Prolonged Use of Fund Resources. Washington DC: IMF Independent Evaluation Office. Islamic Development Bank Group. 2013. Senegal: Supporting Competitiveness Enhancement, Increased Agricultural Production and Productivity for an Emergent Nation. Member Country Partnership Strategy. Jeddah: Islamic Development Bank. Khan, Mohsin S., and Montiel, Peter J. 1989. Growth-Oriented Adjustment Programs: A Conceptual Framework. IMF Staff Papers, 36, 279–306. Khan, Mohsin S., Peter J. Montiel, and Nadeem U. Haque. 1990. Adjustment with Growth: Relating the Analytical Approaches of the IMF and the World Bank. Journal of Development Economics, 32: 155–79. Krugman, Paul. 2009. How Did Economists Get It So Wrong? New York Times. In: www.nytimes.com/2009/09/06/magazine/06Economic-t.html. Mikkelsen, Jan. G. 1998. A model For Financing Programming. IMF Working Paper, 98/80. Mills, Cadman Atta, and Raja Nallari. 1992. Analytical Approaches to Stabilization and Adjustment Programs. World Bank Seminar Paper, 44, Washington DC.

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Mirakhor, Abbas, and Noureddine Krichene. 2009. The Recent Crisis: Lessons for Islamic Finance. Second lecture. IFSB, Kuala Lumpur Malaysia. Mody, Ashoka, and Alexandro Rebucci. 2006. IMF Supported Program: Recent Staff Research. Edited by Ashoka Mody and Alessandro Rebucci. Washington DC. Niels, Gilbert, and Unger Brigitte. 2009. Do Loans Harm? The Effect of IMF Programs on Inequality. Utrecht School of Economics Tjalling C. Koopmans Research Institute Discussion Paper Series, 09–26. Polak, Jack Jacobus. 1957. Monetary Analysis of Income Formation and Payments Problems. IMF Staff Papers 6 (1): 1–50. Rehman, Scheherazade S., and Hossein Askari. 2010. An Economic Islamicity Index (EI2 ). Global Economy Journal 10 (3). Stiglitz, Joseph. E. 2011. Rethinking Macroeconomics: What Failed, and How to Repair it. Journal of the European Economic Association 9 (4): 591–645. Wolfson, Martin H. 2002. Minsky’s Theory of Financial Crises in a Global Context. Journal of Economic Issues 36 (2): 393–99.

CHAPTER 2

Overview of Current Macroeconomic Policy Issues and Challenges in Mainstream Economics

From a practical point of view, macroeconomic policies are usually classified into two broad categories: (i) structural policies that cover a wide range of measures designed to tackle obstacles to the fundamental drivers of growth, and to boost the economy’s competitiveness and growth potential in the medium and long run. The structural measures usually have medium and long-term effects; (ii) demand management policies— fiscal and monetary measures—that target short-term macroeconomic stability. Macroeconomic stability refers to a state of the economy that displays internal and external sustainable financial positions, which in turn increase positive prospects for saving, foreign capital inflows, investment, and sustained economic growth. The design of macroeconomic policies remains a controversial issue (IMF 1987, 2006, 2012; Bruno 1988; Rana and Lim 1999; Ghosh et al. 2005; Kentikelenis et al. 2016). The IMF recommends refined theoretical and analytical frameworks to tackle challenges facing its members such as the transition to market economies, poverty reduction, and capital account crises where massive capital outflows have pervasive macroeconomic consequences. However, critics such as Kentikelenis et al. (2016) argue that the policies introduced for ameliorating the social consequences of the IMF advice have been incorporated inadequately into the program design.

© The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_2

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A decade after the outbreak of the global financial crisis, an overview of economic trends points out several sharp interlinked policy challenges, inter alia building sound institutional frameworks, identifying new drivers for sustained inclusive growth (including green growth, knowledge-based assets, and skills), tackling high budget deficits and public debt to ensure macroeconomic stability which is crucial for sustained economic growth. There were also concerns about growing income inequality and other long-term issues related to demographic issues (rapidly growing populations in emerging and developing economies, aging in many developed countries, migration), climate change and the environment, as well as ethics in the economy. The review of the existing literature seeks to assess to what extent the current issues raised in the secular macroeconomic policy practices are empirically addressed, with a major interest in the concept of institutions. The first section deals with institutions and some key issues in macroeconomic structural reforms, and their relationship with development concepts (including social issues). The second section is related to macroeconomic stability, financial policies (including fiscal and monetary policies) and their link with economic growth and financial access. The third section draws the main lessons from this overview.

2.1 Institutions, Structural Macroeconomic Reforms and Development This section addresses in the first instance, the link between institutions and the main subcomponents of development, including economic growth and social issues such as inequality; public investment policies, and their significance to economic and social development. 2.1.1

Institutions and Development

In investigating and assessing the impact of institutions on economic performance, the New Institutional Economics (NIE) proposes an integrated approach that correlates the findings of a broad range of social and behavioral sciences (North 1993; Williamson 1994, 2000; Joskow 2004; Thaler and Sunstaxiein 2008). This is in regard to the theoretical and empirical work related to rules of behavior (institutions) and development (including economic growth). Acemoglu (2009) suggests that institutions

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“refer to rules, regulations, laws, and policies that affect economic incentive and thus the incentives to invest in technology, physical capital, and human capital.” In the same vein, Williamson (2000) identifies four interrelated levels of institutional analysis: social and cultural foundations; basic institutional environment—the formal rules; institutions of governance and short-term resource allocation (neoclassical market economics). At a macroeconomic level, the role of institutions on development particularly, has been investigated under several angles using various variables as proxies for institutions (political and economic), various economic development indicators, primarily Growth Domestic Product (GDP) rates and panel data methodology mainly for quantitative analysis as the data is still scant for individual-country time series analysis. Overall, the empirical results reveal that institutions are indeed important in determining the long-run economic growth.1 However, studies contend that such evidence is more likely to be associated with other key variables such as Institutional quality,2 which is a broad concept that captures high-quality government regulation and service (including the functions of the state), the role of national leadership, the protection of individual rights, the effects of government size on economic growth, the impact of law, the courts and the quality of enforcement (World Bank 2002; Acemoglu and Johnson 2005; Benjamin and Benjamin 2004; Aghion et al. 2007; Acemoglu 2009; Afonso and João 2011; Cristina and Levieuge 2013; Dal Bó and Finan 2016). They claim public goods provision,3 investment, and provision of law and order are essential government functions as taxation for producing a high 1 Durlauf (2018) reviewed widely the empirical evidence on institutions and growth, with methodologies ranging from historical studies to econometric analyses, with different studies making very different theoretical commitments as to what institutions means and how they affect economic development. Finally, Durlauf argues that “this breadth of evidentiary forms has given credibility to empirical institutional economics, allowing for the emergence of robust evidence of the importance of institutions and robust recommendations for policy”. 2 Góes (2015), using the Economic Freedom of the World Index as a proxy for institutions quality, found that on average, a 1% shock in institutional quality leads to a peak 1.7% increase in GDP per capita after six years. The index takes into account five institutions-related subcomponents: legal system reliability, monetary stability, burden of regulation, size of government, and freedom to trade internationally. 3 Public goods are defined as goods and services that are “non-rival” and “nonexcludable.” In other words, no one can be excluded from the benefits and consumption by one person does not diminish consumption by another.

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growth rate. Under such an approach, research has found evidence that leaders have a large causative influence on the economic outcomes of their nations. Findings have underscored that property rights institutions, protection of political rights and institutional quality are also conducive to capital accumulation and economic growth (Kerekes and Williamson 2008; Besley and Ghatak 2009). Empirical evidence demonstrates the direct relationship between investor protection and economic growth; i.e., the level of investor protection matters for cross-country differences in economic growth. Meaning, countries with strong investor protection tend to grow faster than countries with poor investor protection (Haidar 2009). Additionally, studies pointed out that incentives and selection forces are important in determining the functioning of the judiciary. Incentives and selection matter in the decisions judges make, just as political pressure (reelection incentives) affects sentencing. The quality of enforcement appears to be tightly related to the functioning of the police, judiciary, inspector and auditor cadres, as well as regulatory authorities. Only a subset of interventions work at improving policing, and how interventions affect the power of implementing bureaucrats is crucial. Evidence emphasizes that higher inspections affect regulated behavior by firms, and who pays the inspectors (regulator versus regulated firm) matters in terms of what they report. In considering the effect of government size on economic growth and using the panel approach, Asimakopoulos (2015) found a significant, non-linear relationship between public expenditure and economic growth, i.e., an inverted “U-shaped” curve, known as the “Barro, Armey, Rahn, and Scully (BARS)” curve. This result suggests that the increase in government spending is promising up to a certain threshold, beyond which the impact on growth would turn negative. Over the recent years, literature review exhibited a shift toward actionoriented research that intends to address the crucial issue on how to achieve effective, accountable, and inclusive institutions for all4 (OECD 2015) or in more practical terms, how institutions matter, how they should be reformed, and how such reforms could be implemented

4 The High-Level Panel Report on the Post-2015 Development Agenda (2013) has made a strong plea for effective institutions, calling for a “fundamental shift” to recognize their significant role in contributing to citizens’ well-being.

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(Bourguignon and Wangwe 2018). Indeed, in spite of a wide acceptance that institutions matter for growth and inclusive development, this issue is not quite sufficiently and rigorously documented. Accordingly, growing empirical work has been launched to investigate the interplay of institutions and other possible causal determinants of material progress and social progress, inter alia culture, education, media, environment, inequality, and infrastructure. Some aspects of these issues are discussed in the following sections. 2.1.2

Institutions and Culture5

In the decades since Douglas North’s seminal work, economists and economic historians have paid increasing interest to the relationship between economics and culture, and how they both influence the development of institutions. Roland (2016) presented a survey of the literature on culture in economics, emphasizing the effects of culture as well as the origins of cultural development. Research finds culture to have a large set of effects on economic behaviors, outcomes, and formal institutions. The main conclusion drawn from the study recommends strongly taking into account the effects of different cultures when designing development policies. One should consider the best development policies given the prevailing culture. Particular policies or institutional reforms must be tailored to fit the existing cultural environment. Policies that promote cultural change can only deliver effects in the long run via elite education, the propagation of role models for young people to emulate, and a slow trickledown process. The literature review exhibits a second body of several conceptual and empirical studies which suggest that culture and institutions are jointly and endogenously determined and thus jointly affect all sort of economic activities. Consequently, studies have investigated these joint

5 Alesina and Giuliano (2015) noted that most of the empirical papers (if not all) follow the definition adopted by Guiso et al. (2005), where culture is defined as “those customary beliefs and values that ethnic, religious, and social groups transmit fairly unchanged from generation to generation.” Empirical papers, therefore, combine values and beliefs in the same definition. In contrast, conceptual papers had often treated values and beliefs differently. In empirical studies, the most common tool for measuring culture is through survey questions. The answers are then aggregated at the country level. (Example of data source: See World Values Survey Database).

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dynamics with the aim to identify conditions under which the interaction of culture and institutions would produce outcomes of interest. Exploring an extensive survey of research papers on the two-way relationship, Alesina and Giuliano (2015) pointed out that this interdependence generates, in all models, multiple stable equilibria, with different sets of self-reinforcing institutions and a variety of cultural norms (including cooperation, trust, family ties, individualism, and fairness). Bisin and Verdier (2015) developed a more general model in which—depending on the economic environment and initial conditions—culture and institutions might complement each other, or might act as substitutes, contrasting each other and limiting their combined ability to promote economic growth. Moreover, they posited that even when studying environments in which the causal effect is indeed from new institutions to economic activity, such effect depends on whether the appropriate cultural traits develop to support the new institutions (Roland 2016). 2.1.3

Institutions and Education

According to the World Bank (2018), education delivers large, consistent returns in terms of income and is the most important factor to ensure equality of opportunities. Spiel et al. (2018) contended that education is the process of learning and expanding culture. Considering the close relationship advocated above, it can be argued that education plays a crucial role in building institutions. Well-educated persons are expected to be informed, responsible and engaged citizens, better able to understand and participate in the broad tasks of creating, maintaining, and improving the complex institutions of contemporary societies. Moreover, education is expected to foster social progress through four different but interrelated purposes: developing individual and collective human virtues to their full extent; enhancing public life and active participation in a democratic society6 ; providing individuals with intellectual and practical skills that make them productive and enhance theirs and society’s living conditions; and fostering social equity and justice. Overall, for societies, education drives long-term economic growth, spurs innovation, strengthens institutions, and fosters social cohesion through teaching, training, or research. Education starts informally with the interaction of

6 See Wubbels et al. (2017).

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children with their parents by learning by doing, and subsequently moves to formal education, such as primary and secondary school and then college and universities. On empirical grounds, over this last decade, higher education has regained prominence in development agenda research. As well as being regarded as important to social and economic development, higher education is also being linked to, inter alia, environmental awareness and sustainability, post-conflict resolution, poverty alleviation, cultural preservation, or change. New research has also focused on the links between higher education, good governance, and developmental leadership. In a study on the experience of Ghana, Jones et al. (2014) reported that quality education played an important role in the formation of developmental leadership and was shown to promote social integration and shared values. Specifically, Oketch et al. (2014) reviewed the literature available on the impact of tertiary education on development, particularly in low and middle-income countries. Tertiary education was found to have an important impact on development. Higher education provides measurable benefits to graduates, relating to health, gender equality, and democracy. It contributes to the strengthening of institutions, and the forming of professionals who are vital for sectors such as education and health. In the same area, the World Bank has investigated the impact of investment in higher education on economic growth and development. However, preliminary conclusions highlighted the need for more analytical work to demonstrate how higher education could also contribute to the reduction of extreme poverty and enabling shared prosperity. A literature review on primary education (Bold and Svenson 2016) shows that, particularly in many low-income countries, an increase in school enrollment has not resulted in a general increase in human capital. Considering these worrisome findings, there has been a growing number of studies addressing the issue, shifting their focus on the quality of education. The evidence highlights important avenues for future research from three perspectives: teacher effort, knowledge, and skills. The improvement of the quality of public primary and higher education is crucial given its larger potential impact on both short-term well-being and longer run economic performance.7 Specifically, for the poorer segment of the 7 Wubbels et al. (2017) argued “Education is crucial in helping people at all age levels to participate fully and responsibly in a democratic society, in its discourse and its institutions. Education… needs to include the competence to participate and deliberate.”

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population in developing countries that cannot afford to buy high-quality education in private markets, increasing the quality of primary education should be high on the research agenda. It is widely agreed that education is of utmost importance, and the initial step in improving the quality of human capital (Burgess 2016). From this angle, the relationship between human capital, institutions, and economic growth has been extensively investigated. It is argued that institutions increase the return to education, thus stimulating human capital accumulation and knowledge creation. Therefore, the amount of human capital available in the economy depends on the quality of institutions (Coe et al. 2008; Seck 2011; Dias and Tebaldi 2012). Empirical evidence supports the view that institutions are the fundamental cause of long-run development, working through physical capital, Total Factors Productivity, and also through human capital (Acemoglu et al. 2005, 2014). It is worth to note that research in education and training has paid particular and growing interest to the rapid technological changes, especially the recent developments in Artificial Intelligence (AI) and its potential impact on economies and societies (Brynjolfsson and McAfee 2018; Tuomi 2018; European Commission 2018; Harkut and Kasat 2019; Baker et al. 2019). Studies suggest that advances in Artificial Intelligence and machine learning will have profound impacts on future labor markets and the demand for skill and competence requirements in learning and teaching practices. Accordingly, educational systems have to adapt to the rapid changes prompted by Artificial Intelligence, primarily in science and computer science. However, it is worth noting that several studies pointed out that substantial research is needed to adequately understand and assess the potential and challenges of Artificial Intelligence in education. Also, the application of Artificial Intelligence in society (including the education system) and the economy raise very challenging ethical issues (Dignum 2018). Tuomi (2018) underscored “as there may be fundamental theoretical and practical limits in designing AI systems that can explain the human behavior and decisions, it is important to keep humans in the decision-making loop.” Considering this perspective, Luckin (2017) argued that context and culture are hugely compounding factors to the way in which Artificial Intelligence will move through society and accordingly suggested an approach of AI articulated around the following lines: (i) engage educators and trainers in working with AI developers to build AI technology that is specifically designed

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for education and training; (ii) educate people about AI, so that they can use it successfully, ethically and knowledgeably and (iii) prioritize the development of human intelligence so that attention focuses on the elements of intelligence that are not (yet) automatable with AI, such as social intelligence and metacognitive intelligence. 2.1.4

Institutions and Media

Media (including social media8 ) can be defined as the main means of mass communication (broadcasting, publishing, and the Internet) regarded collectively.9 ICT with a pace of change that is continuously accelerating, offer increased potential for advancing progress toward economic and social development objectives.10 Universal access to the worldwide spread of mobile telephony and communication systems, fixed and wireless broadband internet, smartphones and tablets, cloud computing, and the availability of big data has undeniably had an increasingly significant impact on every economic and social sector, inter alia institutional change. This very close relation with ICTs suggests that media development could play a prominent role in promoting sound institutional infrastructure. Evidence from the empirical literature review holds out media development as a key part of governance reform (Kalathil 2011; Happer and Philoa 2013; La Ferrara 2016), arguing that a pluralistic, sustainable, editorially independent media sector would: (i) directly support good governance, regarding its potential to contribute to an informed and empowered citizenry, to foster responsive, legitimate and effective government; (ii) promote voice and accountability by providing the system of checks and balances embedded in a democracy to work, ensuring that electoral threat incentivize governments, (iii) complement and reinforce other good governance goals such as corruption-free society, transparency at all levels of society, at the governmental level (including local institutions) in terms of change through policy action, and at the level of the individual, through commitments to behavioral 8 Social media is a tool for giving voice to those excluded from access to the mainstream media. 9 Oxford dictionaries. 10 However, Information and communication technologies (ICTs) expansion raises also

sharp concerns related to digital divide and a gap in broadband access between developed and developing countries, as well as within countries.

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change. Even though Mass media has the potential to induce important changes in people’s beliefs, preferences, and aspirations by providing information on the economic environment and available opportunities, some caveats need to be addressed appropriately (La Ferrara 2016; Tucker et al. 2017). These include Media capture, the crowding effect of media consumption that could lead to people’s isolation and decreased social capital, risk of strategic content manipulation of media contents for propaganda purposes—particularly in the area of Educational Entertainment,11 as well as repression technology used to face online opposition. 2.1.5

Assessment of the Institutions of Change

This endeavor raises very challenging statistical and methodological issues that stem from (i) the multiplicity of institutions that may affect economic development; (ii) the institutions tightly linked with the structure and nature of political power, which has to be considered as a given; (iii) little empirical evidence on how the functioning and evolution of institutions interplay with economic mechanisms and finally economic development12 ; (iv) the content of likely revisions which need to be commensurate with the availability of information; (v) continuity in the criteria to avoid unwarranted changes in scores. Considering the crucial role of institutions for development, research initiatives were undertaken particularly by Multilateral Development Banks (MDBs) (the World Bank, the African Development Bank, the Asian Development Bank) and other public and private research institutions (such as the UK Department for International Development) to set up institutional diagnostic tools that would permit policymakers and researchers to capture the quality of a country’s policies and institutional arrangements, identify weak institutional areas that constrain development and therefore design appropriate directions for reform. Some examples are as follows:

11 La Ferrara (2016), quoting (Singhal and Rogers 2004): “Educational entertainment (EE, or edutainment) is the process of purposely designing and implementing a media message to both entertain and educate, in order to increase audience members’ knowledge about an issue, create favorable attitudes, shift social norms, and change the overt behavior of individuals and communities”. 12 Commander and Nikoloski (2010), (Docquier 2014), Yildirim and Gökalp (2016).

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1. The World Bank Country Policy and Institutional Assessment (CPIA) is a diagnostic tool (Table 2.1) used as a guide in the allocation of the International Development Agency (IDA), lending resources process and several other corporate activities. It focuses on the key elements that are within the country’s control. Specifically, the CPIA measures the extent to which a country’s policy and institutional framework support sustainable growth and poverty reduction, and consequently the effective use of development assistance. The current practice relies on rating actions and policy implementation rather than promises or intentions. The CPIA consists of 16 criteria grouped in four equally weighted clusters: Economic Management, Structural Policies, Policies for Social Inclusion and Equity, and Public Sector Management and Institutions. For each of the 16 criteria, countries are rated on a scale of 1 (low) to 6 (high). The outcome of the exercise yields both an overall score and scores for all of the sixteen criteria that compose the CPIA. Table 2.1 World Bank CPIA criteria A. Economic Management 1. Monetary and Exchange-Rate Policies 2. Fiscal Policy 3. Debt Policy and Management B. Structural Policies 4. Trade 5. Financial Sector 6. Business Regulatory Environment C. Policies for Social Inclusion/Equity 7. Gender Equality 8. Equity of Public Resource Use 9. Building Human Resources 10. Social Protection and Labor 11. Policies and Institutions for Environmental Sustainability D. Public Sector Management and Institutions 12. Property Rights and Rule-based Governance 13. Quality of Budgetary and Financial Management 14. Efficiency of Revenue Mobilization 15. Quality of Public Administration 16. Transparency, Accountability, and Corruption in the Public Sector Source World Bank (2017)

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Recent methodological research has focused particularly on the design of growth-oriented institutional diagnostic tools which would allow: (i) to overcome shortcomings of the former institutional diagnostic tools13 originally inspired by the growth diagnostics approaches14 (Rodrick et al. 2005; Hausman et al. 2008) and, (ii) to identify in practical settings the most important binding economic constraints, the growth policies and effective institutional reforms (including building an appropriate political capacity) that can address dynamically the related issues and benefits from opportunities for inclusive and sustainable growth, in a given political and social environment. In this vein, the Economic Development and Institutions (EDI) research program (initiated by UK Department for International Development), instead of designing an institutional diagnostics tool15 a priori, proposed a heuristic methodological approach based on case studies16 with a focus on policy engagement, in the expectation that some general diagnostic tool will emerge from the juxtaposition of these studies (Bourguignon and Wangwee 2018). This country-centered approach is broken down into four main stages: Stage 1: Identification and justification of institutional areas Stage 2: Deep-dive thematic studies into key restrictive institutional areas Stage 3: Integration of findings and proposals for potential institutional reforms Stage 4: Dissemination of findings

13 See Bourguigon and Wangwe (2018) for a summary of the standard approaches

(features and drawbacks) developed to identify the institutional factors hindering development or ways of remedying specific factors: historical case studies; contemporaneous cross-country analysis; and observable realities evaluated by Randomized Control Trials (RCT) techniques. 14 See Felipe and Usui (2008) for practical assessment of this methodology -features and limitations- and some proposal of directions for further improvements. 15 The EDI methodology uses a definition of “Institutions (are defined) as rules, procedures or other human devices that constrain individual behavior, either explicitly or implicitly, with a view to making individual expectations about others’ behavior converge and allowing individual actions to become coordinated.” 16 The programme has started with Tanzania, Benin, and Bangladesh as country study cases.

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The practical application of the EDI approach follows two steps: (i) collect the view of decision-makers (top policymakers, experts) on institutional obstacles in their country. This can be done by a questionnaire survey and qualitative interviews supported by a review of the related literature. The objective is to set up a complete survey of the economic and development performances and constraints faced by the country and to see whether the most obvious “binding economic constraints” are caused by clearly identified institutional factors and (ii) a thorough analysis of these critical areas in order to understand what it is that does not function on the institutional side, why and how things could be fixed, and what would be at stake in such reforms. 2.1.6

Public Investment Policy

Since the seminal empirical work of Aschauer (1989) that tested the existence of a relationship between aggregate productivity and stock and flow government-spending variables, there has been a growing body of studies using formal analysis to measure the effect of public capital on economic activity, using various methodologies.17 Research on the impact of public investment, particularly public expenditures in infrastructure, shows high returns to private sector productivity, GDP growth, and even a drop in fiscal deficit (Belloc and Vertova 2006; Bivens 2012; Duran-Fernandez and Santo 2014; Estache and Garsous 2012; Creel et al. 2015). Duran-Fernandez and Santo (2014) emphasized positive elasticities of the aggregate output in respect to public infrastructure expenditure that ranges globally between 0.15 and 0.35, close to estimations pointed out by Bivens (2012) (from 15 to 45%). For developing countries, Erden and Holcombe (2006), in a study covering 19 countries found that public investment is complementary to private investment. The results show that in the long run, a one percent increase in public investment will result in an increase in private investment of about 0.54%. The shortrun impact is also positive, but about half as large. The results also show that the interest rate does not have a statistically significant impact on the level of investment, while the credit availability to the private sector has a significant effect. The result suggests that imperfections in the 17 Most of the empirical studies use a broad definition of public capital, which includes public capital stock of roads (motorways and streets), water and sewer systems, schools, hospitals, conservation, and development structures.

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credit market play a significant role in inhibiting private investment in developing economies. The complementarity relationship between public and private investment and a positive effect of public investment on output are also the conclusion reached by Belloc (2006) in a study on a selected group of HIPCs, in six out of seven cases. On base, these results and lessons from other country cases such as the members of West African Economic and Monetary Union, the analysis of the link between macroeconomic adjustment and growth in highly indebted countries should consider carefully and country-by-country, the possibility of crowding-in and output-enhancing effects of public investment. Indeed, in many cases, fiscal adjustment had lower government investment, shrank aggregate investment, and in turn negatively affected output and even hampered adjustments in the long run. In such a case, fiscal stability had been reached only at the high cost of compromising economic performance. Debate on the public investment efficiency is addressed in the study of Cavallo and Daude (2008) related to the impact of public investment on private investment, in a panel of 116 developing countries between 1980 and 2006, using dynamic panel data techniques. The study found a strong and robust crowding-out effect. It also found that this effect is dampened (or even reversed) in countries with better institutions and that are more open to international trade and financial flows. The results suggest that, while public infrastructure may be complementary to private capital in the aggregate production function, there are distortions associated with the public investment process that might render a crowding out of private investment in building public capital stocks. Therefore, the design of public investment should favor policies and actions that would strengthen the structural competitiveness of economic sectors where social returns are the highest and positive externalities are significant. In addition, countries set up efficient institutions that can handle appropriately the process of planning, including cost–benefit analysis and maintenance cost, as well as monitoring the execution and evaluation. These overall results emphasizes the importance of positive externalities of public investment for private investment in developing countries, particularly investment in infrastructure, education, and health. The results underscore also the necessity of better financial infrastructure and regulation to relieve financial constraints that impair private investment in such economies. Estache and Garzous (2012) assessed, by region, the annual infrastructure investment requirements to achieve the growth

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needed to reach the reductions in poverty as outlined by the Millennium Development Goals (MDGs): Sub-Saharan Region: 15% of the region’s GDP’s (including 5% for operation and maintenance) Asia region: 6.5% of GDP Latin America: 4% of GDP Middle East and North Africa (MENA): 3% of GDP 2.1.7

Inequality and Poverty

From a global perspective, Oxfam International (2018) reported that 82% of all growth in global wealth in 2017 went to the top 1%, while the bottom half of humanity saw no increase in wealth at all. During 2018, dollar billionaires (2043 worldwide) increased their combined fortunes by $762bn, an amount that is enough to end extreme poverty seven times over. Similar patterns emerge from the World Inequality Report (2018) showing that income inequality has increased in nearly all world regions in recent decades, but at different speeds. The share of the total national income accounted for by just that nation’s top 10% earners was 37% in Europe, 41% in China, 46% in Russia, 47% in US-Canada, and around 55% in Sub-Saharan Africa, Brazil and India, and 61% in the Middle East. The report emphasized that differences in the inequality levels among countries, even when they share similar levels of development, highlights the important roles that national policies and institutions can play in shaping inequality. In fact, it is widely recognized that if not properly monitored and addressed, rising or excessive inequality could lead to dramatic economic and social political upheavals. Oxfam’s report also cites other social science research, showing significant correlations between inequality and the incidence of social problems such as poorer physical and mental health, higher rates of crime and incarceration, inferior rates of educational attainment, and weaker environmental protection policies. The sharp concern expressed over the persistence at high levels of inequality indicators has been echoed in the intensification of studies with the purpose to analysis in depth and explain the growth of inequality from economic, political, and social perspectives (Orton and Rowlingson 2007; Stiglitz 2015, 2017) and to shape concrete, time-bound targets and policy

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agenda to address the issue of a necessary reduction of inequality, both within nations and worldwide. Stiglitz (2015) advocated the following factors that may have contributed to the increase in inequality: (i) an increase in land rents and land values, and an increase in exploitation rents and an associated increase in wealth that represents the capitalization of those rents; (ii) and changes in public policies which have shaped labor markets and patterns of remuneration. With regard to labor markets specifically, Oxfam International (2018) underscored that over the recent decades, while the value of what workers produce has grown significantly, they have not seen similar progress in their wages or working conditions. Temporary, precarious work is the norm in developing countries and is on the rise in rich nations.18 Temporary employees have lower wages, fewer rights, and less access to social protection. Unfortunately, women and young people are more likely to be in these jobs. Studies proposed several approaches to initiate a reduction in inequality. Empirical evidence (Martínez-Vázquez et al. 2012; OECD 2012; IMF 2017; Mattauch et al. 2018; World Inequality Lab 2018) suggests that public policy can help reduce income inequality through various channels and close opportunities inequalities. These include: (i) progressive direct taxes and transfers (ii) adoption of universal basic income19 or universal basic assets (iii) higher public expenditure derived from GDP, on social welfare for expanding access to quality education and health services, housing, enhancing human capital, productivity and social mobility, ensuring more environmental protection; (iv) welldesigned labor market institutions and policies. Stiglitz (2017) argued

18 The International Labour organization’s report (2018) worried about the fact that, the significant progress achieved in the past in reducing vulnerable employment has essentially stalled since 2012, with the rate remaining above 42%. In 2017, almost 1.4 billion workers are estimated to be in vulnerable forms of employment, and every year an additional 17 million join them. Moreover, many countries still have no minimum wage or collective bargaining and most minimum wages are significantly lower than what is needed to survive or what could be described as a living wage—a wage that is high enough to enable workers and their families to meet their needs for nutritious food and clean water, shelter, clothes, education, healthcare, energy, childcare and transport, as well as allowing for some savings and discretionary income (Oxfam International 2018). 19 Francese and Prady (2018) considered an Universal Basic Income as a benefit regularly (e.g., yearly or monthly) paid out in cash unconditionally to all residents in a country. Under such a program all residents would receive the same amount, with the benefit being benchmarked as a fraction of median equivalent income.

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that policies addressing the inequality issue should focus not just on redistribution, but also on the distribution of income and wealth.20 Specifically, the research explored addressed the issue of the effective income/wealth tax contribution of a given group. In this regard, Hatgioannides et al. (2017) using an indicator of fiscal inequality coefficient suggested that policymakers with a strong social conscience should reevaluate the progressivity of the income tax system and make the richest echelons of the income and wealth distributions pay a fairer and higher tax. Caiani et al. (2016) developed a benchmark model which suggests that taxation would reduce inequality.21 Nevertheless, Stiglitz (2017) underscored that with shifting, capital taxation may not be the solution to inequality and could even make matters worse. Also, recent literature surveys emphasized that the relationship between growth, inequality, and poverty remains intensively investigated,22 particularly from an empirical point of view. Research results (Ostry et al. 2014; Dabla-Norris et al. 2015) suggested: (i) lower net inequality is robustly correlated with faster and more durable growth, for a given level of redistribution (ii) the combined direct and indirect effects of redistribution—including the growth effects of the resulting lower inequality—are on average pro-growth (iii) if the income share of the top 20% (the rich) increases, then GDP growth actually declines over the medium-term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20% (the poor) is associated with higher GDP growth. In the same vein, Marrero and Serven (2018), using a panel dataset covering 158 countries for estimation over the period of 1960–2010, found that a 10 percentage point decrease in the headcount poverty rate is associated with a rise in annual per capita real growth of 0.5–1.8%, depending on the precise specification of the empirical model. Further 20 Oxfam international (2018) called for “reward work, not wealth.” 21 The benchmark model developed is a macroeconomic framework based on the

combination of the Agent Based and Stock Flow Consistent approaches. The proposed framework provides a coherent and exhaustive representation of the inter-linkages between the real and financial sides of the economy viewed by the authors as a pivotal feature of every macroeconomic model. 22 Earlier survey on the issue (Lopez 2011) stressed a consensus among researchers that emphasized: (i) growth is fundamental for poverty reduction; (ii) the brake on poverty alleviation is largely the result of high inequality; and (iii) education, infrastructure, and economic stability promote both growth and shared income.

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analysis reveals that when the level of poverty is low (below the sample median), the growth effect of poverty is not statistically significant. In contrast, when the level of poverty is high, a 10 percentage point decrease in the headcount poverty rate is associated with an increase in growth ranging between 1% and as much as 2%. Holding poverty constant, assessment of the link between inequality and growth shows that the direct effect of inequality on growth is not robust. In contrast, the indirect effect of inequality (through poverty) on growth is found to be robustly negative, especially when the level of poverty is high; e.g., a 10-percentage point decrease in the Gini coefficient is associated with an increase of per capita growth of 0.3% in the full sample, and between 0.7 and 1.1% in the above-median poverty subsample. Controversially, under extremely high poverty, the sign of the correlation turns positive, and a 10-percentage point increase in the Gini coefficient is associated with an increase in per capita growth of about 0.1%. More recently, Aiyar and Ebeke (2019) found that income inequality has a negative impact on growth in those economies characterized by low equality of opportunity, as measured by intergenerational mobility.23 It is interesting to note that the relationship between infrastructure and material progress has again become a trendy topic over this last decade. Empirical studies overall found positive effects of infrastructure development on income growth and, more tentatively, on distributive equity. Still, the precise mechanisms through which these effects accrue, and their full impact on welfare, remain relatively unexplored (Calderon and Serven 2014; Raychaudhuri and Prabir 2010; Odondo and Kalu 2016). Specifically, Hooper et al. (2017) investigated the relationship between infrastructure and inequality, using US state-level panel data infrastructure spending and on per capita income inequality from 1950 to 2010. They found that highways and higher education spending growth in a given decade correlates negatively with Gini indices at the end of the decade. Such a result suggests a causal effect from growth in infrastructure spending and education to a reduction in inequality, through better access to job and education opportunities. This relationship seems stronger with inequality at the bottom 40% of the income distribution. In addition, 23 Aiyar and Ebeke (2019) underscored “that not accounting for inequality of opportunity will tend to bias empirical estimates of the relationship between income inequality and growth. This is likely to be an important factor behind the inconclusive state of this literature.”

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infrastructure expenditures on highways are shown to be more effective at reducing inequality. Taking into account the high volume of financial resources needed to improve infrastructure volume and quality, Hooper et al. (2017) suggest various financial and policy innovations such as the redirection of corporate tax revenues from multinational companies toward infrastructure spending, promotion of Public–Private Partnership contracts, increased contribution from MDBs, multilateral and regional global investment platforms that match long-term investors with long-term infrastructure projects. From the behavioral economics approach, numerous studies have highlighted new insights to queries pertaining to the rising inequality issue and tools with which to address it. For example, Piff et al. (2017) outlined a conceptual inequality maintenance model of social class to show how class-differentiated experiences enhance economic inequality. The authors investigated in detail five social life domains—structural barriers of threat, scarcity, and access to valued networks, social class signaling, the ideology of merit, moral-relational tendencies, and intergroup processes that perpetuate divide class. Scheffer et al. (2017) analyzed similarities in patterns of inequality between species abundance in nature and wealth in society and concluded that in a globalized world, wealth will inevitably be appropriated by a very small fraction of the population unless effective wealth-equalizing institutions emerge at the global level. Côté et al. (2015) explored the issue on the social impact of unequal resource distribution and found that higher-income individuals are only less generous if they reside in a highly unequal area or when inequality is experimentally portrayed as relatively high. Nishi et al. (2015) argued that inducing behavioral changes in rich people might offer an alternative approach to reducing inequality, especially when policy-based resource redistribution is not feasible or acceptable. Lessons from international experiences (Filho and Paiva 2017; World Bank 2015; Kremer et al. 2019; OECD 2017, 2019) underscored that many government policies and programs geared toward overcoming poverty suffer from compromised results and wasted resources due to a misunderstanding on how those involved in the design and implementation of policies and programs, and the beneficiaries of these programs perceive its individual components and policies in the decision-making process. Therefore, in the design, implementation, and evaluation of public policies and social policies, special attention must be given to the complex dimensions of human nature

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and the human condition, such as the impact of cognitive, emotional, and social factors including ethical principles and the decision-making processes of individuals living in poverty, for a better understanding of individual behavior. 2.1.8

Financial Structure and Economic Development

Researchers have conducted critical studies on the financial development– economic growth nexus (Rioja et al. 2004; Demirguc-Kunt et al. 2009, 2011; Levine 2005, 2011; Beck 2012). In a broad survey of theoretical and empirical works, Ross found a positive link between the functioning of the financial system (capital market and banking sector) and long-term growth. Also, studies on finance and economic growth, using the panel threshold technique, have found that financial development is favorable to growth only up to a certain level, beyond which further development of finance turns negative (Law et al. 2013, 2014). Evidences from recent investigations on this relationship (Gambacorta et al. 2014; Langfield and Pagano 2016; Liu and Zhang 2018) confirm the evolving effect of financial structure on economic growth at different stages of economic development. They suggest also that banks and markets differ considerably in their moderating effects on business cycle fluctuations. Banks are more likely to supply loans during a “normal” downturn, thus smoothing the impact of the recession. But their shock-absorbing capacity is impaired when the downturn is associated with a financial crisis. According to Gambacorta et al. (2014), recessions in countries with bank-oriented systems are three times as severe (12.5% of GDP) as in those with a market-oriented financial structure (4.2% of GDP). Recent empirical work highlights the role of securities markets as a buffer, compensating for the collapse in bank lending during crises. Empirical works have placed a growing emphasis on the link between financial access (including “financial inclusion”) and inequality (Demirguc-Kunt et al. 2009, 2011; Stijn and Enrico 2007; World Bank 2014). Honohan (2004) has shown that finance-intensive growth (at least as measured by banking depth) is empirically associated with lower poverty ratios. However, financial depth alone is an insufficient measure of financial development and needs to be supplemented with other important institutional infrastructural dimensions such as legal, regulatory, and ownership. An extensive literature review on the interactions between financial sector and institutional development has showed

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that: (i) given its intertemporal nature, finance is one of the most “institutions-intensive” sectors, and its development has been shown to depend critically on a conducive institutional framework, including effective contractual framework and transparency; (ii) the outreach of the financial system and, ultimately, its impact on economic development, increases in governance and trust, as this will allow to expand the financial system to lower-income population segments and small and medium-sized enterprises, (iii) an effective and competitive financial system can also improve institutions. By increasing competition in the real sector, it can favor new entry and fosters entrepreneurship, which can increase demand for effective and accessible institutions, (iv) a major policy implication, particularly for developing countries, is the imperative need to identify the binding constraints that hold back sustainable financial sector development, but also the political constraints that might prevent addressing these policy constraints. More recently, there has been growing focus on the financial–inclusive growth nexus (Demirguc-Kunt et al. 2017). Empirical evidence from literature suggests that financial inclusion allows people to make many everyday financial transactions more efficiently and safely, which could translate into expansion of investment and financial risk-management options, and ultimately more economic growth. In fact, revolutionary developments in ICT products (including mobile phone development, the falling price of smartphones) supplemented by reforms in the regulatory frameworks have brought formal banking and financial services to billions of people. Empirical evidence from African countries demonstrates that higher mobile penetration can foster economic growth, not only by facilitating financial inclusion, but also by consolidating the impact of financial inclusion on economic growth (Andrianaivo and Kpodar 2011; Okeleke and Sardi24 2019). However, according to Demirguc-Kunt et al. (2017), there needs to be further documentation of the relationship between financial inclusion, inequality, and macroeconomic growth, as well as some related issues such as: (i) the impact of product design, including pricing, on demand and development outcomes for financial inclusion, (ii) the link between the micro-level evidence of

24 According to Okeleke and Sardi, in 2018, mobile technologies and services generated 8.6% of GDP in Sub-Saharan Africa—a contribution that amounted to $144.1 billion of economic value added.

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the benefits of financial inclusion to macro-level goals, inter alia greater economic growth and lower inequality. Considering the specific case of developing countries,25 Beck (2012, 2013, 2016) through wide literature, outlined an agenda of research questions related to financial deepening and policies that remain of crucial significance for these countries: what are the institutions and policies that are most relevant for financial sector deepening and is there an optimal sequencing? Considering the issue on the role of government in financial services, to which extent can the lessons from East Asian experience26 be transferred to other developing regions of the world? Also, Beck’s literature review pertaining to the link between financial structure and the economy raised practical issues, such as: what is the optimal structure of financial systems for different economic structures and income levels, and specifically what financial structures are optimal for agriculturally dominated economies and natural resource-based countries? What kind of financial system allows economies to move from low to middle-income and middle to high-income status? Specifically, considering the Indian and Chinese success stories, what is the relative importance of informal and formal finance for long-term growth? And overall, what can we learn from these experiences across developing countries? From a methodological standpoint, the interaction between institutional infrastructural dimensions with the financial system and their combined impact on growth have suggested an approach to defining a more comprehensive summary statistic. The general recognition among policymakers is that financial inclusion plays a significant role in sustaining employment, economic growth, and financial stability. Therefore, the computation methodology for financial inclusiveness indicators has recorded a significant improvement for a better identification of financial inclusion dimensions and design of consistent related policies (Demirguc-Kunt and Klapper 2012; Amidži´c et al. 2014). Mookerjee and Kalipioni (2010) carried out extensive research that confirmed the proposition that financial development in a broad sense and access to the financial system help to mitigate income inequality. 25 Beck (2013) argued that research methodology on financial deepening and policies in developing countries should mix theory and lessons from historic and present-day experiences in emergent and developed markets. 26 See Bhattarai (2015).

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Global Issues on Ethics and Climate Change

One of the fundamental lessons of worldwide economic trends over the last two decades is a sharp global awareness of the need to appropriately address ethics and climate change issues in designing a new economic policy framework. The demand for ethics in the economy has been of major interest particularly in the aftermath of the global financial crisis 2007–2008. Numerous analysis emphasized, among major generating factors, the failure in corporate ethics, the deficient ethical training of executive managers, systematic speculative conduct, and the abandonment by public policy of the protection of the collective interest in basic issues (Kliksberg 2012; Küng 2012). According to Klisberg, proposals for a new ethical agenda for the economy would have, as a guideline, a renewal of the development paradigm that moves toward social responsibility in public policies, corporate social responsibility, the mobilization of the share capital through the strengthening of volunteerism, and other features such as the enhancement of social commitment in universities and support of faith-based organizations. Climate change affects the basic elements of life for people around the world—access to water, food production, health, and the environment. Scientific evidence shows now that climate change is a serious global threat that requires an urgent global response. The Stern Review (2007) estimated that the dangers could be equivalent to a least 20% of GDP or more. In contrast, the cost of action to reduce greenhouse gas emissions to avoid the worst impacts of climate change could be around 1% of global GDP each year. Accordingly, the international community has undertaken internationally agreed-upon policies, such as the Kyoto Protocol and Paris Accord, to address the problem on a global level. This includes moving to a lower-carbon economy and moreover managing risks and adapting to changes in the climate.

2.2

Macroeconomic Financial Stability

The topic is addressed from two angles: fiscal policy design and the challenges for monetary policy since the onset of the 2007–2008 global financial crisis.

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2.2.1

Fiscal Policy Design

Fiscal policy and related issues—pace, composition, sequence, and timing of reforms—are under extensive debate (Portes and Wren-Lewis 2014; Alesina and Ardagna 2012; Jonung 2014; Blot et al. 2015; Yang et al. 2015). In discussing the composition of fiscal adjustment, Alesina and Ardagna (2012) found that expenditure-based adjustments associate more with smaller recessions or no recessions compared to tax-based adjustments. A policy package comprising pro-growth policies can remove downturns from expenditure-based adjustments. In contrast, Blot et al. (2015) argued that, until the short-term nominal interest rate hits the zero lower bound, spending-based consolidations are less efficient than tax-based ones with regard to public finance sustainability and more costly on economic growth. It is worth noting that, a decade after the eruption of the 2007–2008 global financial crisis, the debate on fiscal adjustment remains deeply unsettled. As an illustration, Ostry et al. (2016) examined the issue of fiscal austerity from two financial policy perspectives: (i) the resorption of fiscal deficits and public debt; (ii) and the removal of restrictions on the mobility of capital across countries. They argued that both of these policies reduce the bargaining power of labor while increasing that of the rich and wealthy; while free capital mobility increases the probability of a financial crisis and of large output declines. These in turn are associated with increased income inequality. Increased inequality in turn hurts the rate and sustainability of growth. In a recent study, Alesina et al. (2019) concluded that during a period of austerity (the most common case) spending cuts have much smaller costs in terms of output losses than tax increases. Spending cuts can sometimes be associated with output gains in the case of expansionary austerity and are much more successful than tax increases in reducing the growth of debt. 2.2.2

Monetary Policy

In an environment where capital flows are global and mobile, taking timely and effective monetary-policy action in response to global financial conditions27 shocks remains a crucial challenge for policymakers. Over the 27 Financial conditions can be defined as the current state of financial variables that influence economic behavior and the future state of the economy. In theory, such financial

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past decades, the limits of monetary policy are often discussed on the basis of the so-called economic trilemma, meaning that an independent monetary policy and free capital movements with a stable exchange rate form an impossible trinity (Khan 2003; Obstfeld 2015).28 However, new evidence put forth a competing view (Rey 2015) suggesting that there are only two choices—free capital mobility or monetary independence; and that they are independent of the exchange-rate regime. In fact, global factors have indeed become important drivers of domestic financial conditions. Empirical results show that: (i) countries’ exposure to the global price of risk29 is related to macroeconomic risks as measured by output, credit, inflation volatility, the magnitude of financial crises, and stock and bond market downside risk (ii) higher exposure to the global price of risk corresponds to both higher output volatility and higher output growth and (iii) macroeconomic and financial stability policies should be considered jointly (Adrian et al. 2016). The effects of monetary policy on financial stability,30 and the roles for macroprudential and monetary policies for reducing risks to financial stability are issues intensively investigated.31 Lessons from current Central Banking practices (Bernanke 2012; Ingves 2017; Marcel 2018) stress that Central Banks can still influence domestic financial conditions, at least to some extent. However, financial globalization with volatile capital flows complicates the use of monetary policy to contain the transmission of global financial shocks in an effective and timely manner. In addition, continued low real interest rates may limit the degree of freedom for the monetary policy when economic activity is weakening

variables may include anything that characterizes the supply or demand of financial instruments relevant for economic activity, a wide array of asset prices and quantities (both stocks and flows), as well as indicators of potential asset supply and demand (Hatzius 2010). 28 According to Khan (2003), adoption on inflation-targeting provides a solution to solve this puzzle. 29 Price risk could be defined as the risk of a decline in the value of a security or a

portfolio. 30 Financial stability reflects a resilient financial system that is less likely to amplify adverse shocks. 31 See Adrian et al. (2016) for an extensive literature on monetary policy transmission and financial stability, macroprudential policies, interaction between macroprudential and monetary policies.

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and inflation is below target. Therefore, it becomes necessary to complement monetary policy with other policies inter alia: (a) macroprudential policies32 that can help to safeguard financial stability by increasing the resilience of the financial sector, reducing the procyclicality of credit growth, increasing an economy’s resilience to capital flows especially during episodes of outflows, by building capital buffers or by reducing the reliance on wholesale funding (b) exchange-rate flexibility viewed to be crucial as a shock absorber and capital flow management measures that can also help in specific circumstances (c) non-traditional tools such as the cost–benefit framework that compares the expected benefits and costs of proposed policy actions (d) clear communication tools, always important in central banking; (e) international cooperation essential to protect nations’ individual economies as well as the interconnected global economy.

2.3

Conclusion

From a mainstream perspective, the literature review on current debates and challenges for macroeconomic policy has highlighted, in an interconnected global economy,33 an increased risk diversity resulting in a rise in new global challenges ranging from economic and financial instability (that current models have failed to foresee) to social inequalities among and within countries, artificial intelligence and automation pressures particularly on market labor, rapid technological breakthroughs, immigration crisis, climate change, and environment threats, and global security issues, to name a few. 32 Macroprudential tools intervene directly in the business activities of financial market players. The toolkit includes: (i) quantitative restrictions on borrowers, instruments or activities; (ii) capital and provisioning requirements; (iii) other quantitative restrictions on financial institutions’ balance sheets; (iv) taxation/levies on activities or balance sheet composition; and (v) other, more institutional-oriented measures, such as accounting changes, changes to compensation, etc. Except for (i), which aims to affect demand for financing, all can be seen as affecting the supply side of financing (Claessens 2014). 33 From a modeling perspective, McKibbin and Stoeckel (2018) underscored that impor-

tant aspects of the world economy that tend to be missing in most macroeconomic models are the importance of global linkages in trade and financial markets, the role of relative prices (sectoral disaggregation), and changes in risk premium that have been important sources of shocks for most countries since 2000 (as an illustration, see McKibbin and Stoeckel 2017).

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Recent studies (Wolfers 2016; Lavoie 2018) contended that the global financial crisis has undermined the fundamental hypotheses and assumptions of modern macroeconomic policy, inter alia the rational expectations; the efficient market hypothesis; the unbiased efficiency hypothesis in international finance; the assumption of perfect asset substitutability; Barro’s Ricardian equivalence theorem; the idea of expansionary fiscal contractions; rational expectations; the Dynamic Stochastic General Equilibrium (DSGE) models; consumption Euler equations and Calvo pricing assumption. Taking into account these limitations of many mainstream economic policy frameworks (including monetary policy), Vines and Wills (2018), exhibited a number of requirements grouped in four main headings for a new core DSGE model: (i) incorporating financial frictions rather than assuming that financial intermediation is costless; (ii) relaxing the requirement of rational expectation; (iii) introducing heterogeneous agents; and (iv) underpinning the model—and each of these three new additions— with more appropriate microfoundations. A debate in the aftermath of the global financial crisis 2007–2008 emphasized clearly the need to move beyond an improvement of the core DSGE model. From then, the design of macroeconomic policies should be part of a broader perspective to address appropriately crucial issues such as social inclusion (meaning improving the ability, opportunity, and dignity of those disadvantaged in the society), ethics, and environmental sustainability. This requirement is particularly pressing in the context of developing countries. Indeed, most of these countries remain confronted with the crucial challenge of structural change seen as a sine qua none condition for sustained economic growth.

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CHAPTER 3

Current Economic and Social Challenges and Islam

An Islamic economy is a rule-based system. Allah (SWT) prescribed in the Qur’an a set of rules of behavior that could be defined as institutions for societies and individuals. These rules were explained and implemented by His Prophet (SAW ) when he was both the temporal and spiritual leader in Medina. According to Ahmed (2002) and Mirakhor (2007), Islamic economics could benefit from secular economic theories by reviewing practical responses developed in response to economic issues and challenges prevailing over time. Particularly, discussion of the relevance of institutions from theoretical and empirical research from the secular economic perspective has been developed widely in the field of “New Institutional Economics” (NIE) over the past four decades. This school of economic thought pointed out that the performance of an economy depends on the rules governing it. Importantly, the approach unlocks challenging methodological prospects for a better understanding of the impact of institutional policies on the economy (Ahmed 2002; Mirakhor and Idriss 2009). Since the objectives of Islam are socioeconomic justice and welfare for all, the discussion raises further key issues and challenges related to growth-oriented structural policies in the long run and, in the short run, macroeconomic stability policies. In the first section, the chapter

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reviews literature on economic growth and queries linked to institutions, economic and social issues, and other crucial global challenges such as climate change and the environment from an Islamic perspective. Section 3.2 reviews research on macroeconomic stability policies in an Islamic economy. Section 3.3 updates results of conceptual and empirical work on Islamic macroeconomic modeling. Section 3.4 addresses issues related to the estimation and simulation methodologies for an Islamic model of stabilization and growth, and discusses their properties. Finally, the fifth section draws the main conclusions of the chapter.

3.1 Economic Growth Policies from an Islamic Perspective 3.1.1

Islamic Institutions and Economic Growth

From an institutional point of view, Shatzmiller (2011) has examined the role of Islamic institutions in economic growth in the early Islamic world, underlining a rational and efficient economic, institutional behavior between the seventh and eleventh century. At the country level, evidence from the Malaysian case study shows a contrasting picture. Wilson (1998) has stressed that while Islam has been an important factor in Malaysian politics, its influence has been marginal on the economy. However, more recently, Mahyudi (2015) has argued that constitutional and legal frameworks of a sovereign State could provide the impetus for introducing a “Sharia”-based Values Infusion Policy (VIP). This policy encourages decision-makers and people in Muslim countries to actualize the societal change needed for running a true Islamic economy. Particularly, the conception of policies needs to be sustained by mass education through intensive communication campaigns as well as education. This will help to promote the internalization of the Islamic values by individuals in the society. Ly et al. (2015), in a study covering OIC member countries, inferred that strong political and economic institutions have positive effects on economic growth. Also, research studies focused on the conception of an Islamic institutional framework based on the teachings of the Qur’an and Sunnah and the translation of the Islamic institutions in economic principles for empirical studies (Mirakhor and Idris 2009; Askari et al. 2015; Mirakhor and Askari 2017; Dieye 2017; Iqbal and Mirakhor 2017).

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Earlier work by Rehman and Askari (2010) conceived an Economic Islamicity Index (EI2) that relies on measurable variables as proxies for Islamic teachings deduced from the Qur’an and its interpretation by Prophet Muhammad (SAW) during his lifetime in the first Muslim community he established in Medina. Using a sample of Muslim countries1 and non-Muslim countries ranked by their compliance with Islamic economic principles, the study concluded, inter alia that Islam is not a deterrent to good economic performance, compared with the macroeconomics results of non-Muslim, wealthy, and developed countries that are compliant with Islamic rules. Further, this original study was deepened and systemized from two angles. The first is improving and updating the original indices, and adopting the Organization of Islamic Cooperation (OIC) as a benchmark for country classification. The set of variables used as proxies for Islamic rules deduced from the Qur’an and Sunnah are divided into four major indices: Economy, Legal and Governance, Human and Political Rights, and International Relations. These elements are then combined into an overall Index. Each of these major components is further broken into subcomponents as per Table 3.1. The second angle is the setting up of an Islamicity Foundation, a nongovernmental organization, to regularly publish results of national index assessments in the form of annual reports. The objective of the program is “to develop an organizational structure in Muslim countries to disseminate the ongoing results of Islamicity Indices (successes and failures of each Muslim country and their institutional shortcomings) and build a vast global community of Muslims who better understand the teachings of the Qur’an and support peaceful reforms and more effective institutions.” Globally, Muslim countries recorded a slight improvement of 1.21% in 2018 relative to 2017 in the Overall Index (OI). This positive pattern reflected mostly an increase of 1% in its Legal & Governance Index (LGI) and of 5% in its Human and Political Rights Index (HPRI). The positive impact of these evolutions has been mitigated by a contraction of 1% in the Economic Index (EI) and of 2% in the International Relations Index (IRI) (Islamicity Foundation 2018). From a comparative perspective, performances of the Muslim countries as a Group, relatively to records of the All Countries and Non-Muslim 1 Muslim countries are defined as member countries of the OIC, where a majority or a large percentage of citizens identify themselves as Muslims.

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Table 3.1 Islamicity indices—Main components (Countries are rated on a scale of 0.00 [low] to 10.00 [high]. The overall Islamicity Index has been weighted as follows: Economic Islamicity Index [0.3]; Legal and Governance Islamicity Index [0.3]; Human and Political Rights Islamicity Index [0.3]; International Relations Islamicity Index [0.1])

Islamicity indices Economic Islamicity Index 1. Economic opportunity and economic freedom 2. Job creation and equal access to employment 3. Property rights and sanctity of contracts 4. Provisions to eradicate poverty, provision of aid and welfare 5. Supportive financial system 6. Adherence to Islamic finance 7. Economic prosperity 8. Economic justice Legal and Governance Islamicity Index 9. Legal integrity 10. Prevention of corruption 11. Safety and security index 12. The management index 13. Government governance Human and Political Rights Islamicity Index 14. Human development 15. Social capital 16. Personal freedom 17. Civil and political rights 18. Women’s rights index 19. Access to education 20. Access to healthcare 21. Democracy International Relations Islamicity Index 22. Globalization index 23. Military/wars global militarization index Source Askari et al. (2017)

Countries Groups, appear less favorable in 2018. Results of overall Islamicity indices and their subcomponents in 2018 for country groups— Muslim countries and non-Muslim countries (including Europe, North America, other OECD members)—were in the wake of the trends highlighted over the period 2000–2016 (Askari et al. 2017) which indicated that: – The top 30 countries that exhibit the best performance, in accordance with the teachings of Qur’an operationalized by the Prophet

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(SAW), have generally been those in Europe (in particular Scandinavian countries), Canada, United States, Japan, Korea, New Zealand, Australia, Hong Kong, and Singapore. The subcomponents of the overall Islamicity Index exhibit strong institutions in economic, legal and governance, human and political rights, and generally avoid conflicts.2 – In contrast, for Muslim countries as a group, the overall Islamicity index and its subcomponents have been below average throughout the period of 2000–2016. Askari et al. (2017) pointed out that only two Muslim countries—Malaysia and the United Arab Emirates (UAE)—rank in the top 50 during 2000–2017. Moreover, Muslim countries lack the most important institutions: an impartial and effective legal system (the rule of law), effective system of governance, guarantees of freedom and basic human rights, and a free and representative political system. Particularly, a look at the trends of two key economic growth drivers— gross fixed capital formation and Foreign Direct Investment (FDI) supports strongly the above overall conclusion. Indeed, available data (SESRIC Report 2017) shows that during the period of 2000–2016: (i) the share of the OIC countries in the global gross fixed capital formation increased from 4.2% in 2000 to 8.6% in 2010, and has since remained relatively stable around that level. Also, the share of OIC countries (as % of developing countries gross fixed capital formation) has contracted from 21.3 to 17.3% and (ii) FDI flows to OIC countries generally remained lower than their potential. Overall, the share of OIC countries in global FDI inflows has declined during the period under consideration and reached its lowest value in 2016 with 5.2%. The relatively poor performance recorded by the OIC countries in accumulating investment capital and attracting FDI, as compared to developing countries, need to be addressed adequately. Accordingly, the OIC countries have to implement effective policies that foster the attractiveness and competitiveness of their economies.

2 With the exception of the US, the UK, France, and Australia, according to Askari et al. (2017).

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3.1.2

Islam and Social Issues

Analyzing social equity issues, with reference to Muslim countries, the SESRIC report (2015) underscored that in terms of poverty alleviation, many OIC member countries have made significant progress. As a result, the share of poor in OIC total population was recorded at 22.3% in 2011 compared to 41.1% in 1990. Notwithstanding this progress, the incidence of multidimensional poverty remained high in OIC member countries with 35% of their total population living in multidimensional poverty3 in 2017 (SESRIC 2018). Considering the issue on distribution of income and asset ownership, the SESRIC report (2018) stressed that the share of income held by the poorest households in OIC member countries ranged from 3.2 to 10%. More than one-fifth of the multidimensional poor are deprived of asset ownership in 13 high burden countries. Table 3.2 provides recent estimates of inequality income4 and inequality wealth5 metrics in some OIC member countries extracted from the World Inequality Report 2018, issued by the World Inequality Lab. The sample covered 110 countries (advanced and emerging economies) including 23 OIC member countries. Although the OIC economies of the sample recorded a decline in poverty, their absolute levels of inequality remain much higher. Moreover, available data shows that wealth distribution is significantly less equal to the average income in these countries.

3 The Multidimensional Poverty Index (MPI) in a new tool developed for poverty evaluation. The Index examines deprivations across the same three indicators composing the Human Development Index (HDI)—education, health and standard of living, but consisting of 10 indicators and shows the number of people who are multidimensional poverty, i.e., suffering deprivations in 33% of weighted indicators. 4 Income refers to money received by a person or household over some period of time. Income includes the revenue streams from wages, salaries, interest on a savings account, dividends from shares of stock, rent, and profits from selling something for more than paid for it. Unlike wealth statistics, income figures do not include the value of homes, stock, or other possessions. 5 Wealth refers to the stock of assets held by a person or household at a single point in

time minus liabilities. Assets can include everything from an owned personal residence and cash in savings accounts to investments in stocks and bonds, real estate, and retirement accounts. Liabilities cover what a household owes. In some ways, wealth is more important for understanding social inequality because wealth generates income, so income inequality depends in part on wealth inequality.

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Table 3.2 Inequality metrics in the OIC member countries

Country Albania Algeria Azerbaijan Bangladesh Cameroon Chad Egypt Indonesia Iran, Islamic Rep. Kazakhstan Kyrgyz Republic Malaysia Mali Mauritania Morocco Mozambique Nigeria Pakistan Senegal Sierra Leone Tunisia Turkey Uganda

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Net income gini index

Wealth gini index

Poverty rate (%)

38.60 32.20 38.60 39.50 39.80 38.30 47.00 45.70 38.80

44.80 75.80 51.00 57.90 74.10 69.30 91.70 83.70 67.30

7.70 3.90 2.70 59.20 45.00 66.50 16.10 33.80 2.50

28.80 34.10

92.60 62.90

0.40 23.30

42.80 32.30 30.30 35.70 39.90 39.00 36.20 34.50 32.00 33.30 39.80 37.60

82.00 64.50 62.30 81.40 71.10 69.50 52.60 69.80 58.70 69.10 81.80 68.60

3.10 79.00 23.60 N/A 88.50 77.60 39.70 67.50 81.30 9.10 2.40 66.60

Source The World Economic Forum’s inclusive development index 2018

Considering the complexity of poverty, its highly dramatic extent in Muslim countries and disastrous consequences6 to individuals, societies, and nations, poverty alleviation strategies occupy a central place in Islamic economic and social research. Literature review on contemporary Muslim scholars’ works related to poverty (Salleh 2017) exhibits a multitude of terms to depict the consequences of this social scourge.7 6 The Messenger of Allah [SAW] said: “Seek refuge with Allah from poverty, want and humiliation, and from wronging others or being wronged” (Sunan an-Nasa’i, Book 50, Hadith 37). 7 Particularly, poverty is regarded as social time bomb, a threat to human’s beliefs and to the security and stability of the society as a whole, emerging along with unemployment,

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On empirical grounds, studies found that the promotion of health and education, financial development and strong institutional structure in Islamic countries has a statistically significant negative effect on income inequality and poverty (Meisami et al. 2011; Majeed 2017; Shahabadi et al. 2018). Such studies also investigated deeply the main mechanisms historically used to build social safety nets, such as obligatory Zak¯ ah, voluntary Sadaq¯ a and Waqf (for long-term purposes), the issue of the effective collection and efficient utilization of their proceeds that could address these problems (Atia 2011; Sarif 2013; Amuda and Che Embi 2013; Bachir 2018; Kuzudisli 2017; Zaman 2018; SESRIC 2015a). Another very challenging issue in OIC member countries is higher average unemployment rates compared to non-OIC developing countries during the period 2000–2018. During that period, total unemployment fluctuated between 7.5 and 6.8%, a significant margin over the non-OIC average record (around 2%) during the same period. Additionally, available data indicated sharp concerns about youth unemployment8 in OIC Member States which stagnated at around mostly above 16% between 2000 and 2017 (with a peak close to 20% in 2005). In 2018, the indicator was estimated to reach 15.4% compared to 11.5% in non-OIC developing countries (SESRIC 2018). Also, until 2006, unemployed youth accounted for more than half of all unemployed people in OIC Member States, before decreasing from its level of 53.4% in 2000 to 44.6% in 2016 (SESRIC and ICYF-DC 2017). Research (empirical and conceptual) has documented sufficiently social and economic costs of higher unemployment rate; including youth unemployment (Feldstein 1978; OECD 2011; Hassan and Nassar 2015; Chand et al. 2017; Alrasheedy 2017). These studies emphasized: – Loss of earnings for the unemployed. Prolonged periods of unemployment can push households into debt and increase rates of relative poverty.

indebtedness, unequitable income distribution, leading to crimes and hatred between rich and poor to untold sufferings resulting in begging, leading to incapacity, helplessness, and dependence on others, driving a person close to disbelief, denying to people the freedom of choice and actions that can help them getting rid of deprivation. 8 Youth unemployment is the unemployment of young people, defined by the United Nations as 15–24 years old. An unemployed person is defined as someone who does not have a job but is actively seeking work.

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– Potential homelessness. Loss of income can leave people without sufficient income to meet housing costs and exacerbate the rates of homelessness. – Harms future prospects. Those who are unemployed will find it more difficult to get work in the future (hysteresis effect9 ). – Stress and health problems of being unemployed. Among studies of unemployed men, signs of depression, mental anxiety, and health problems are noticeably higher. – Lost human capital and a decrease in labor productivity. Unemployed people would miss out “on the job training”—a key component of human capital and labor skills. – Increased government borrowing. Higher unemployment will cause a fall in tax revenue. Also, the government will have to spend more on unemployment and related benefits. – Lower GDP for the economy. High unemployment indicates the economy is operating below full capacity and is inefficient. This will lead to lower output and incomes since the unemployed are also unable to purchase as many goods, this will contribute to lower spending and lower output (a negative multiplier effect). – Increase in social problems. Areas of high unemployment (especially youth unemployment) tend to have more crime and vandalism. It can lead to alienation and difficulties in integrating young unemployed people into society. Also, high levels of unemployment can translate into a rise of political instability and social unrest. From a policy perspective, with regard to the current contemporary macroeconomic and social challenges, OIC member countries have developed a first comprehensive action plan, dubbed the “OIC Ten Year Programme of Action (2005–2015)”—followed by another second action plan for cooperation and partnership, the “OIC 2025”10 (2016–2025) in order to “address issues emerging out of political and economic developments in the world as well as to help OIC countries in achieving sustainable development” (SESRIC 2018). From an economic standpoint, the OIC 2025 includes a number of priority areas related to the 9 Hysteresis states that historical rates of unemployment are likely to influence the current and future rates of unemployment. 10 The SESRIC Report 2018 provides a review of the strengths and weaknesses of OIC countries and discussion on the rationale for selection of the priority areas.

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main issues discussed previously: (i) poverty alleviation; (ii) trade, investment and finance; (iii) employment, infrastructure, and industrialization; (iv) agriculture and food security; and (v) other priority areas such as environment, climate change and sustainability, education, science, technology, and institutional reforms. In relation to these priorities, the OIC 25 agenda proposes a number of economic and social policy orientations, of which the effective implementation would allow the countries to strengthen their economies and achieve sustainable development. In fact, these policy orientations in many ways complement the reform recommendations formulated in other studies (Askari et al. 2017) that emphasize the paramount importance of reforms aimed to create a more conducive business environment for entrepreneurs and SMEs, and to promote Islamic finance alongside growing Islamic impact investing.11 From a finance perspective, according to an Islamic Financial Services Board report 2018, the Islamic finance service industry’s total worth across its three main sectors (banking, capital markets, and tak¯aful) is estimated at US$2.05 trillion in 2017 and is estimated to reach US$3.2 trillion in 2020. The numbers suggest that the Islamic finance sector offers a wide opportunity for OIC member countries that could be used to bridge the huge gap in financing investment needs for sustainable development. In terms of Islamic funds, even though the numbers have decreased marginally to 1161 in 2017, assets under management (AuM) increased by 19% to US$67 billion. It is worth noting that 20 of the 34 domiciles of Islamic funds are non-OIC countries, such as Ireland, the United States, or Luxembourg, with a combined AuM of nearly 20% of the total. This underscores the imperative need for Muslim countries to “adopt effective institutional reform and scaffolding as recommended in Islam, recommendations that are also upheld outside of Islam on the base of an agreed political reforms agenda and a realistic timetable for transitioning to representative governments that are accountable” (Askari et al. 2017). 3.1.3

The Environmental Challenge

The threat posed by environmental issues (global warming, depletion of freshwater sources, biodiversity reduction, and ozone thinning) has 11 The term impact investing defines investments that generate a measurable and beneficial social or environmental impact alongside a financial return on investment.

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sparked growing research on the environmental content of the Qur’an, considering the relationship between the core components of the natural world (human beings, water, air, land, plants, animals, and other natural resources), and the relative ethical policy implications (Khalid 2002; Ashtankar 2016; Helfaya et al. 2018). Studies based on the teachings of the Qur’an have highlighted that the Islamic view on the environment relies on the belief that Allah (SWT) is the Creator and Sustainer of the universe. For the sustenance of His creation, Allah (SWT) has placed a measured quantity of the environmental resources. This implies the existence of environmental balance in the natural ecosystem. Al-Jayyousi (2015) analyzed environmental degradation as an indicator of a moral and ethical crisis, arguing that this balance has been disturbed by human choices and behaviors which result in overconsumption, overexploitation, and overuse of natural resources. Hence, the disposal of natural resources should be undertaken responsibly whiletaking into consideration the well-being of every living creature.12 Accordingly, Muslim leaders (including Islamic scholars) endorsed an “Islamic Declaration of Istanbul” addressing climate change (2015) and calling on the people of all nations and their leaders to phase out greenhouse gas emissions as soon as possible in order to stabilize greenhouse gas concentrations in the atmosphere, and to commit themselves 100% to renewable energy and/or a zero-emissions strategy as early as possible. In the same vein, AlJayyousi (2015) proposed: (i) a shift from the secular environment model to a revival of the holistic approach of Islam founded on the concept of sustainability (including environment, social, and economic dimensions) which is founded on the notion of harmony and “natural state” (“fitra”) and in respecting balance (“mizan”) and proportion (“mikdar”) in the systems of the universe and (ii) the revival of the concept of a Green Endowment Fund (“Waqf ”) to support a transition to a sustainable economy by promoting green activism, green innovation inspired by nature and culture, and a green lifestyle. Given the fact that climate change is expected to intensify disaster significantly in many OIC member countries, the OIC 25 agenda advocates the adoption of prudent environmental management practices to reduce disaster risks and the adverse effects of climate change. Considering the crucial issue of increasing water productivity, special emphasis

12 This point will be developed in the next chapter.

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is put on the improvement in technical efficiency of water use and the efficient allocation of available water among competing uses. 3.1.4

Islamic Financial Infrastructure Development

Researchers underscored that Islamic Finance had deepened its tools in practice (Iqbal and Muljawan 2007; Askari et al. 2014). A large volume of research has focused on financial sector development, shifting from issues on the efficiency, production technology and general performance features of Islamic versus conventional banks to competition, SME lending and financial inclusion, and risk-sharing principles that spreads and allocates risk among members of society rather than concentrate it among the borrowing class or needy segment of the population. More precisely, a new discussion that has emerged is the economic benefits of adopting an Islamic system, particularly with regard to macroeconomic stability and growth (Ibrahim and Nafis 2017). Studies stressed that Islamic finance could offer a large spectrum of instruments and unconventional approaches which, if implemented according to Islamic tenets, can lead to reduced poverty and inequality in Muslim countries, promote financial inclusion and provide a significant source of noninterest-rate-based debt financing for capital accumulation (Mohieldin et al. 2012; Mirakhor 2012). However, some empirical studies in OIC countries show weak evidence of the positive impact of an Islamic financial infrastructure on financial inclusion—a weakness that would partially reflect data issues (Demirguc-Kunt et al. 2013; Naceur et al. 2015) as well as deviation from risk-sharing Islamic finance (Alaabed 2016). Recently, the Global Report on Islamic Finance (IDB 2018) investigated in depth the crucial challenge of mobilizing financial resources for long-term investment needed to address appropriately key issues for effective and sustainable development. The report argued that Islamic finance, because of its risk-sharing and equity participation principles, provides an alternative perspective and solution to the underfunding of long-term investment. Accordingly, the Global Report outlined a set of policy recommendations from two angles: (i) strengthen the financial system by developing a supportive legal, administrative, and regulatory environment and (ii) enhance the institutional framework and diversity of instruments for long-term financing. Insight into the current state of the Islamic Financial Services Industry (IFSI) (Islamic Financial Services Board 2019) emphasized that, with the

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exception of Iran and Sudan, the issue of Islamic financial structure development takes place mainly in the context of a dual financial system, in which conventional and Islamic financial institutions work alongside each other. However, conventional banks remain dominant. From a practical point of view, lessons from Malaysia’s country experience (Aziz 2005)13 could provide milestones in a possible roadmap to be considered by other countries in designing and implementing a comprehensive framework for a sound Islamic finance infrastructure and institutional reforms. In fact, the Malaysian financial system has evolved from just a few institutions at inception, to a well-functioning and internationally integrated mixed financial system. To ensure the sustainability of its progress, Malaysian regulators in 2001 implemented reforms in the Islamic financial industry to define long-term strategies. As an illustration, some key features of the Malaysian strategy are highlighted as follows: – The formulation of a Ten-Year Master Plan for the progressive and orderly development of Islamic banking and finance to provide a common vision. It includes strategies and action plans, identifies the milestones that need to be pursued over the medium to long term to develop an Islamic financial system, provides the sequencing of priorities and the speed of the reforms, identifies the key financial infrastructure that needs to be put in place before advancing forward, and finally the speed of the process (sequentially or simultaneously). – The development of an integrated financial system, comprising the Islamic banking industry, the “takaful ” industry, the nonbank financial institutions, and the Islamic interbank and capital markets, deeply rooted in Islamic core values and principles. – The enhancement of institutional capacity and the development of supporting financial infrastructure, inter alia setting up a comprehensive legal infrastructure and Shariah framework (such as a Shariah advisory committee in each institution offering Islamic products and within the Central Bank); creating a robust and effective regulatory and supervisory framework complete with adequate firewalls to ensure the absolute separation of banking operations to

13 See also Solé (2007).

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avoid co-mingling between Islamic and conventional funds in a dual financial system. – The development of financial market infrastructure including: (i) Islamic interbank and foreign exchange markets to facilitate the liquidity operations of Islamic financial institutions, to serve as a transmission channel for monetary policy and strengthen the central banks as a lender of last resort; (ii) a viable payment system for the clearing and settlement of payments; and (iii) other important mechanisms such as mortgage and credit guarantee institutions, rating agencies, deposit insurance mechanisms, auditing, tax, and legal structures. – Other key areas that provide support to the development of Islamic financial institutions are research and development to incorporate core Islamic values into banking products and business models, consumer education and awareness about Islamic banking products and principles, and an overall commitment by the government to develop the industry. With regard to the growing global demand for more social equity and environmental responsibility, new directions of research are currently being investigated in the areas of: (i) the socially responsible investments (Bank Negara Malaysia 2015; UN Alliance for SDG Finance14 in 2017) and (ii) the value-based intermediation that aims “to re-orient Islamic finance business models towards realizing the objectives of Shariah that generate positive and sustainable impact to the economy, community and environment” (Bank Negara Malaysia 2018).

3.2 Macroeconomic Stability Policies in an Islamic Economy This section focuses on the conduct of monetary and fiscal policy, primarily the crucial issue of bank liquidity management.

14 Which brings together the UN Global Compact, the UN Environment Finance Initiative and the Principles for Responsible Investment (PRI) Alliance.

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The Conduct of Monetary Policy in an Islamic Economy

On a conceptual basis, earlier research (Mirakhor and Iqbal 1988; Khan and Mirakhor 1989) investigated the transmission mechanism of monetary policy in an Islamic open economy, with the rate of return to real sector as a benchmark. Askari et al. (2014) argued that the challenge for monetary policy in the Islamic framework is to design instruments that satisfy the requirements of an effective monetary policy while meeting the rule of exchange-based transactions without resorting to interest-based instruments of monetary policy. Also, researchers have contended that in an Islamic economy, the principal goal of monetary policy should remain to ensure macroeconomic stability mainly by price-level stability and viable balance of payments position. The Islamic Central Bank can operate directly through its regulation and powers, or indirectly through its influence on capital market conditions. Direct main instruments would be bank-by-bank credit ceilings, statutory liquidity ratios, and directed credit, reserve requirements, public sector deposits and foreign exchange swap (Choudry and Mirakhor 1997). These direct instruments are mainly aimed at the balance sheets of commercial banks and central banks. Since a 100% depository banking system does not yet exist, central banks continue to impose reserve requirements on deposits and investment accounts. When they involve open market-type operations with equity-based instruments, they provide more flexibility for effective monetary control by the central bank. According to Askari et al. (2014), through trading (buying and selling) risk-sharing securities—i.e., equity or securitized assets in projects and asset-linked “Sukuk’’ (from investment bank type Islamic institutions), monetary authorities have a direct effect on the portfolios of the private sector (households and firms). This also has an indirect effect on bank portfolio and conditions in the capital markets, which in turn affect real economic activity. In practice, in an Islamic economy, the main instruments of monetary policy will be the trading of risk-sharing securities. However, monetary authorities in such an economy can adopt additional monetary tools available in the conventional system with the exception of the discount rate and other policy tools that involve interest rate, such as selling and buying interest-bearing bonds. Therefore, two policy measures are of crucial significance: (i) the promotion of a primary and secondary financial market. This can be

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achieved by having the central bank assume a leading role in the promotion of these markets and (ii) state-level enforcement of Islamic rules on contracts and property rights to enhance financial institutions and financial intermediation. More studies have focused on practical issues related to monetary operations and their transmission mechanism in a dual financial system with coexisting Islamic and conventional institutions, related issues such as Islamic banking operation and current risk management practices, and the principle of lender of last resort (Cevik and Joshua 2011; Basu et al. 2015; Khatat 2016). Lessons from country experiences show that when a central bank has to deal with a dual banking system, it faces new and different challenges in terms of its monetary policy and supervisory and regulatory roles compared to a purely conventional banking sector. For instance, if the objective of the monetary policy is a target money base, and the central bank operates only in the conventional component of the money market, a significant component of the money base will be beyond its control, which may be detrimental to the stability of the financial system. Indeed, monetary policy as well as banking supervision and regulation have to be formulated in an inclusive framework that integrates both conventional and Islamic components of the banking sector for the central bank to have comprehensive monetary policy and supervision oversight. With regard to prudential regulation, both Islamic and conventional banks are subject to Basel III prudential guidelines even though their assets differ. Consequently, the central bank has to specify the types of assets that satisfy the prudential ratios in each type of banking system. Also, in the case of a dual system in which financial assets are issued in both conventional and Islamic capital markets, the pricing mechanism and the risk profile of the assets held by each type of banking differ. Accordingly, the central bank still faces the challenge to develop an integrated interbank money market that enables both conventional and Islamic banks to manage their liquidity. From an operational point of view, the Islamic Research and Training Institute (IRTI/IDB) and the Maldives Center for Islamic Finance conjointly held a research workshop on “Islamic Monetary Economics

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and Institutions: Theory and Practice”15 centered around a broad array of conceptual and operational topics, including: – How to design an interest-free economy and financial system and what would be its optimal monetary and financial structures? – How to design a monetary policy framework in a dual banking system and what would be the optimal setting for monetary policy from an Islamic perspective? – What would be reliable monetary indicators (including the monetary anchor)? – Which tools should be used by the regulators, and should the monetary policy be bounded rules or be carried out on a discretionary system? – What are the roles of the Islamic banks in the monetary transmission and ultimately how would the proposed monetary policy, based on Islamic principles, facilitate the achievement of Islamic goals of economic and social justice? In relation to the Islamic monetary policy, researchers outlined other directions of research that need to be deepened primarily with regard to the regulatory environment. This includes: (i) optimal institutional structures of financial sector supervision, governance, and benchmarks; (ii) experiences and challenges in implementing the IFSB framework capital adequacy requirements for Islamic banking; and (iii) the importance and needs of macroprudential analytical frameworks for Islamic monetary policy. On empirical grounds, evidence from countries that operate in a dual financial system (Malaysia, Indonesia, Pakistan, and Turkey) suggest that credit and financing channels are still relevant for Islamic banking as they are with their conventional counterparts in the monetary transmission mechanism (Zulkhibri 2018; Ibrahim 2017; Fikri 2018; Aysan et al. 2018). Additionally, some studies have documented the tools of monetary policy available to central banks in the absence of the interest rate mechanism, as in the case of Sudan and Iran (Toutounchian 1998; Maysami 1999; Bidabad et al. 2011; Sarker 2016; Alavi et al. 2016). In the case 15 See Zulkhibri et al. (2019).

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of the policy mix in Iran—a full-fledged Islamic economy, the evidence (Razieh and Pooya 2018; Naini et al. 2018) argued that a prolonged period of fiscal sector dominance seems to have inverted the traditional roles of fiscal and monetary policies. This is because inflation is predominantly determined by decisions made in the fiscal domain, while monetary policy dictates economic growth and government solvency. The dominance of the fiscal sector in the case of Iran seems to have substantially undermined the central bank’s control over its monetary policy instruments and objectives. Consequently, both fiscal sector dominance and the lack of proper monetary instruments at the central bank’s disposal had hampered the effectiveness of the monetary policy, leaving the country to experience a high rate of inflation. Lessons from Iran’s experience led to recommendations on macroeconomic policy measures that target fiscal balance, or at the very least a significantly smaller fiscal deficit; the revision of central bank laws to provide operational autonomy to the institution; and the implementation of an exchange rate policy consistent with the requirement for macroeconomic stability and sustained inclusive economic growth. 3.2.2

Islamic Liquidity Management Issues

Findings of recent empirical studies in mainstream economics (Bianchi and Bigio 2017; Van der Ghote 2018) suggests that banks’ liquidity management is paramount to the implementation and transmission of monetary policy. In fact, financial intermediaries provide settlement services to both households and financial intermediary services between households and nonfinancial firms. Because the provision of settlement services exposes financial intermediaries to random withdrawal shocks on their short-term liabilities, there is demand for banks to address this issue of liquidity management via reserves (liquid assets of which supply and demand are dependent on monetary policy). The issue of liquidity management is of major concern to Islamic banks and central banks (IFSB Stability Report 2015). In addition, Islamic banks face a limited availability of lender-of-last-resort facilities and liquid Shariah-compatible money market instruments with desirable characteristics that enable the institution: (i) to gain a return on their capital, while ensuring compliance with Shariah rules and principles and (ii) to meet local statutory or regulatory requirements while also satisfying internal liquidity management needs.

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In practice, Commodity Murabahah interbank placement of funds under various profit-sharing arrangements, and Islamic mutual funds, are the most commonly used liquidity management instruments by IFIs in many jurisdictions (Abdullah 2010). Commodity Murabahah is a form of a short-term finance based on a Murabahah contract and is generally used for the buying and selling of commodities in the international market. However, while it provides Islamic financial institutions the opportunity to invest their short-term funds, it also leads to the inefficient use of these funds due to the low returns. For term maturities such as Sukuk 16 the instruments used in the market are concentrated in real estate. Central banks and governments have a crucial role in addressing issues in liquidity management faced by Islamic banks operating in a dual financial system through the issuance of financial instruments that would be easily tradable and broadly accepted by Shariah Committees of IFIs, and have a high credit rating. In this vein, researchers suggested a number of strategies for central banks to undertake with regard to liquidity management in a dual banking system (Majid 2003; IFSB 2008, 2012; Abdullah 2010; Ali 2013; Karim and Abdel 2016). They involve inter alia: – Enhancing the development of an Islamic interbank market and the information systems related to interbank activities such as the volume of transactions and prices. – Enhancing the availability of Shariah-compliant liquidity management facilities by central banks to Islamic financial institutions, by providing Shariah-compliant deposit facilities, Shariah-compliant discount windows, or refinancing facilities. – Conducting primary market issuance of Shariah-compliant securities for monetary policy purposes. – Developing efficient trading arrangements and infrastructure for active secondary markets. – Adapting Open Market Operations for central banks to accommodate transactions of Islamic financial institutions. – Developing Islamic money markets through regular issuance of Shariah-compliant securities by government and central banks. 16 The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), in its ‘Sharia’ Standard 17 (2), defines investment ‘Sukuk’ (‘Sukuk’ isthimar) as “certificates of equal value representing undivided shares in ownership of tangible assets , usufructs and services, assets of particular projects or special investment activity.”

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– Developing a Shariah-compliant foreign exchange market. – Issuing standards and guidelines for regulation and supervision in liquidity management. – Enhancing standardization of market practices including issuance of master agreements for liquidity management centers. – Facilitating investment of surplus funds of Islamic financial institutions into Shariah-compliant short- and medium-term instruments. – Providing advisory services to facilitate Islamic financial institutions to manage liquidity mismatches through short- and medium-term liquid investments. Taking into account cross-border operations, Abdullah (2010) underscored that one of the major concerns in the future will be to identify suitable assets that can be the basis for the underlying transactions and that are tradable on a cross-border basis with full recourse to the law of the land. Accordingly, the following actions could be considered: (i) to set up a global Shariah supervisory board issuing globally accepted Fatwa; (ii) to build a robust and integrated cross-border liquidity infrastructure; (iii) design and develop globally accepted Shariah-based short-term financial instruments; (iv) ensure global standardization of documentation, product, process, pricing, benchmarking, and accounting; (v) to build a globally accepted payment and settlement system; and (vi) to develop an integrated liquidity monitoring and supervising liquidity risk management framework. The Islamic financial system can also glean insight from different jurisdictions and Islamic financial institutions such as: – Malaysia’s Islamic Interbank Money Market, which was established in 1994, is an example of a well-functioning intermediary that provides Shariah-compliant programs such as Mudarabah Interbank Investment and the Commodity Murabahah Programme. An example of diversifying instruments can be seen in Bahrain, Indonesia, Malaysia, and Sudan’s efforts to use Sukuk issuance programs to integrate Islamic finance into their public expenditure programs. – From the experiences of the Hong Kong Mortgage Corporation (Yam 1996) and Malaysia’s Cagamas (Chung 2015), central banks may consider to establish national mortgage corporations (NMCs)

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in their respective countries to boost the issuance of Islamic securities on a regular basis (as well as to increase the capacity of Islamic financial institutions in providing more financing). This reform will address the limited issuance of Islamic securities on a regular basis in local currency. NMCs acquire Shariah-compliant mortgages from financial institutions and issue financial papers to finance the acquisition of public mortgages through securitization. In addition to boosting regular issuance of Sukuk NMCs would also contribute to increasing the capacity of Islamic financial institutions to provide more financing as they receive new funding from the partial sale of their financing portfolio to NMCs. NMCs are traditionally major issuers of securities especially in local currency. They will boost the issuance of Islamic papers on a regular basis. – Central banks may consider enhancing their respective legal and regulatory frameworks to facilitate the issuance of Shariah-compliant papers, including issuance by governments and central banks. Mandatory rating requirements for Shariah-compliant securities would help to strengthen investors’ confidence. Effective liquidity risk management requires a functioning system of business laws. Countries with Islamic banks (IFIs) or those with ambitions to set up IFIs have to put great emphasis on creating a supportive legal structure for IFIs. – Liquidity infrastructure requires accepted Shariah-compliant shortterm financial instruments, a payment and settlement mechanisms, a global standardization of documentation, product, process, pricing, benchmark, accounting platform for short-term liquidity, an integrated liquidity monitoring and supervising liquidity risk management framework, and an electronic multi currency and multi-commodity trading platform. Malaysia’s Islamic Interbank Money Market, which was established in 1994, is an example of a well-functioning intermediary that provides “Shariah”-compliant programs such as Mudarabah Interbank Investment and the Commodity Murabahah Programme. Bahrain, Indonesia, Malaysia, and Sudan provide other examples of policy diversification of financial instruments in their efforts to use Sukuk issuance programs to integrate Islamic finance into their public expenditure programs (Majid 2003).

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3.2.2.1 International Cooperation – The Basel Committee on Banking Supervision (BCBS) addressed the issue of banking liquidity management, by providing a regulatory response, with the new Basel III principles. The principles aim to improve the liquidity position of banks by: (i) imposing a “stable funding ratio” and (ii) ensuring that over a 30-day period, the banks have a positive daily cash flow; requiring them to hold a quantity of High Quality Liquid Asset (HQLA). The Basel Committee has proposed two new metrics to be used in liquidity risk management: liquidity cover ratio (LCR) and net stable funding ratio (NSFR). However, with the specificity of the Islamic industry, according to Thomas (2013), the recommendations of Basel III on liquidity management need some modifications to take into account the unique characteristics of the IFIs. Particularly, the design of Shariahcompliant financial products “as alternative HQLA applicable to such banks only” is of major significance. – From the experience of the Asian Bond Fund (Chan et al. 2011), central banks in a dual banking system may consider to voluntarily allocate a portion of their international reserves for investment in Sharia-compliant papers of selected countries. Particularly, for the countries member of the West African Economic and Monetary Union who share a common pool of their international reserve, such an initiative provide a valuable alternative to the deposit of 50% of the common pool international reserve into an account at the French Treasury, according to an international monetary cooperation treaty. The pool of the allocated reserves would be managed by reputed professional fund managers to have a bigger impact on international Sukuk market development and an oversight committee may be authorized to review the performance of the fund on a quarterly basis. Cooperation with established institutions (e.g., Bloomberg, Reuters) would be developed to set up multicurrency benchmark indices for global and local currency Sukuk. This reform will deepen and broaden the Sukuk market to promote efficiency of financial intermediation within a group of countries, identify and address market barriers, and to allow central banks to work together and build trust among each other. – Central banks may have to enter into mutual agreements or bilateral basis to recognize Shariah-compliant papers issued by other

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sovereign or central banks as eligible collateral for Islamic financial institutions to access standing facility. This reform will broaden the range of eligible Shariah-compliant collaterals for Islamic financial institutions to access standing facility provided by central banks. It will strengthen collateralized interbank loans between Islamic financial institutions as eligible collaterals for standing facility are commonly accepted for interbank transactions as well. In fact, some central banks in industrial countries, e.g., European Central Bank, Federal Reserve, and Bank of England, have adopted mutual recognition of other countries’ securities as eligible collateral for their standing facilities. Similar mutual recognition was adopted in several Asian countries on a bilateral basis, e.g., Malaysia–Singapore (2011), Japan–Thailand (2012). The availability of a range of eligible Shariah-compliant good collaterals’ assets is one of the most significant challenges in providing Shariah-compliant facility to Islamic financial institutions. – At the level of integration of Islamic money markets, central banks may consider contributing with readily available assets as underlying to facilitate issuance of Sukuk, by the International Islamic Liquidity Management Corporation (IILM). This initiative enables to address the limited supply of high-quality sovereign, sovereign-linked entities, and supranationals’ assets to be used as underlying for IILM Sukuk issuance. The benefit of this initiative is to have a sufficient supply of eligible assets in the pipeline, for continuous issuances of IILM short-term Sukuk which is very critical to the development of Islamic liquidity management internationally. – Central banks may consider to collaborate with established institutions (e.g., Euroclear, Clearstream) to enable international payment, clearing and settlement systems to be facilitative of Islamic liquidity management transactions and instruments. 3.2.3

Islamic Fiscal Policies

The main feature of the contemporary state of public finances for both Muslim and non-Muslim countries is the worsening fiscal deficits.17

17 One can note that principle of fiscal balance was the main characteristic of early Islamic era fiscal policies (Siddiqi 1996; Sadr 2016).

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Solutions to restore sustainable public finance until now has been implementing strong austerity policies (high taxes and lower public expenditures) and increased interest-based public borrowing, which results in a sharp increase in government debt leading to crisis and financial vulnerability. There are also distributional issues involved. External borrowing drains domestic resources and domestic borrowing has an adverse impact on income and wealth distribution. The Islamic fundraising for development projects excludes interestbased debt financing and proposes an alternative to the conventional model that would rely on the development of medium- to long-term risksharing instruments based on the characteristic operational requirements of Islamic finance (Mirakhor 2010, 2012), inter alia: (i) transparency, trust, and faithfulness to terms and conditions of contracts; (ii) close relationship between finance and the real sector activities such that the rate of return to the latter determines that of the former; (iii) better asset-liability management by the Islamic financial institutions; and (iv) limitation on credit expansion and leverage. Accordingly, at the country level, the policy instrument for public borrowing, if needed, must comply with the rule of the prohibition of interest (al-riba) and be based on risk-sharing principle. It worth to note that risk sharing is not only for financing deficits, but for all fiscal items, especially development expenditures as infrastructures using equity or securitized assets in projects (participation papers) and asset-linked securities, Sukuk as means of mobilizing financial resources for public spending. The benefit for the state would be the debt burden reduction while the household sector would enjoy a high rate of return driven by the return to the real sector.18 These instruments should be issued in small denominations for trade on the secondary market, with an appropriate rate of return (ISRA-IRTIDURHAM University 2012; Askari et al. 2015). The benefits for the State are multiple: a mobilization of idle funds for its expenditures while promoting risk-sharing financing, the opportunity for the public to earn a high rate of returns on its savings, a more direct impact on monetary policy. Sadr (2015) stressed that, in the early Islamic State, “the interests 18 Mirakhor (2012) suggested, from a global perspective, to consider the possibility of a macro-market instrument that could be issued jointly by the Multilateral and Regional Financial Institutions with additional resources provided by some members of the G-20, with its rate of return tied to the growth of the debtor country.

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and confidence between the state and the public had create such an advantage, if the state were to declare its deficiencies, the public would have helped as much as they could.” In the contemporary states, these shared interests and confidence remain essential to support private–public partnership for investment. As an illustration of financial issues related to the development of infrastructure projects in the OIC country members, Fig. 3.1 presents the infrastructure gap (as of the GDP 2015) in selected OIC Countries over the period 2016–2040 (OIC/COMCEC Coordination Office/OIC 2019). Globally, for the sample of countries, the gap in financing infrastructure projects would average 49.3%, a relatively higher level. At first analysis, a higher percentage of the gap relative to the GDP as in the case of Senegal (136% of the GDP) could translate in greater difficulty for governments to fill these financing gaps for infrastructure development projects. From this point of view, a private sector contribution would be essential to cover the financing needs. 160.0% 140.0% 120.0% 100.0% 80.0% 60.0% 40.0% 20.0% 0.0%

Fig. 3.1 Infrastructure Gap in selected OIC countries—2016–2040 (as % of 2015 GDP) (Source OIC/COMCEC Coordination Office [2019])

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3.3 Survey of Islamic Macroeconomic Modeling Literature Compared to Islamic finance, Islamic macroeconomics is still in the process of sharpening its theoretical, analytical, and policy framework. Progress has been made in modeling the Islamic economy and in assessing its consistency characteristics (Khan F. 1984; Khan M. 1986; Mirakhor and Iqbal 1988; Mirakhor 1993; Naqvi 1997). Naqvi presented a formal model to prove that an Islamic economic system—with its ethical values, a set of economic objectives, and policy instruments—can represent an “optimum regime” that combines social justice concerns with those of economic growth. Tahir (2009) reviewed some macroeconomic models of the Islamic economy in the earlier conceptual works (Ahmad 1987; Khan M. 1986; Iqbal and Saif 1991; Sattar 1991; Hussain 1994; Khan F. 1996; Anwar 1987; Tahir 2009). The authors of these earlier generations of Islamic economic models used the standard analytical framework IS-LM to analyze the equilibrium conditions of an Islamic economy where interest is replaced by the rate of return to the real sector. Indeed, the main limitations of these Islamic macroeconomic models are: (i) they focus on the case of closed economy; (ii) the lack of study on their long-run dynamic to the steady state and their economic stability; and (iii) for some models, the slope of the I-S curve is negative and suggests a negative relationship between the rate of return and the Investment function. Then, the research was extended to the conception of open economy models. Mirakhor (1993) and Askari et al. (2014) analyzed the equilibrium conditions in both short run and long run for a closed economy, for an open economy which trades in goods only, and finally a general case of complete open Islamic economy with trades in goods and equity shares. Then they demonstrated the long-run stability of the Islamic model. The major conclusions inferred from the model are: (i) the rate of return in the real sector plays a determinant role in the equilibrium conditions of the markets in an Islamic economy and (ii) the economy moves from shortrun equilibrium to a stable long-run equilibrium from any initial point as a result of the absence of interest and debt, and the full flexibility of markets. At the sectorial level, researchers attempted to translate the injunctions prescribed in the Qur’an into the aggregate consumption (Khan 1984; Iqbal 1985; Hasan 1997, 2007) and in the aggregate investment

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function (Sattar 1991). Lastly, the literature review shows that specific works on the components of aggregate demand, mainly consumption and investment functions, remain rare and are still at odds with issues on the impact of Zakah on the consumption and choice of parameters related to expenses for the sake of Allah (SWT) (Iqbal Mahdi 1985; Khan 2013). Another issue relates to the setting of boundaries for “waste of resources.” The fact that similar benchmarks rely on individual perspectives as there are no voiced prohibitions or social norms; makes the task significantly complicated. Overall, the investigation will require a wide survey of detailed microeconomic data, case studies, and new methodologies that can address individual behavior. Researchers have reviewed the financial policies; i.e., fiscal and monetary policies, that apply the fundamental principles of Islamic finance (Othman and Mirakhor 2013; Norhanim et al. 2015). Shaukat et al. (2013) presented a risk-sharing model based on Islamic finance as an alternative to the debt-based model and demonstrated its stable characteristics. There is also a growing investigation of the Islamic finance–economic growth nexus. Studies using the panel approach have shown that development of Islamic banking favors macroeconomic efficiency (Gheeraert and Weill 2014) and economic growth (Gudarzi and Dastan 2013; Imam and Kpodar 2015; Abedifar et al. 2016). Country case studies using a cointegration framework showed contradicting results toward the association between Islamic finance and economic growth (Furqani and Mulyany 2009; Abduh and Chowdhury 2012; Nejib and Amine 2015). Overall, the literature review from an Islamic point of view exhibits a substantial volume of conceptual research work and growing empirical research on current debates and challenges related to current global macroeconomic and social issues. On practical grounds, with a focus on the case of Muslim countries, the OIC 25 Agenda strongly recommends that institutional and societal factors be taken into account in the design and implementation of policy reforms to ensure their success, inter alia: (i) an appropriate follow-up as well as a strong political commitment within the countries and the OIC group and (ii) a social adhesion of the populations that should favor the implementation of sound institutional reforms that guarantee the rule of law, an effective system of governance, basic human needs and political rights, as well as a fair and representative political system. Also crucial are policies that break the cycle of social instability, violence, and conflicts as well as minimize threats of natural

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disasters and climate change, which in combination poses a dramatic humanitarian crisis.19

3.4

Data and Methodology of Simulation

With few exceptions, empirical validation of Islamic macroeconomic models (including simulation methods) had been hitherto rarely attempted. Indeed, the empirical investigation of an Islamic economy model faces two at least formidable challenges: data issues and methodology issues. 3.4.1

Data Issues

Historical data on nearly macroeconomic variables are contaminated with the rate of interest and debt—of which both have to be replaced by substitutes. The rate of return to the real sector has to replace the interest rate as a monetary policy tool, and debt has to be replaced with nondebt investment flows. Historical data on these relationships do not exist to provide inputs for investigations of an Islamic macroeconomic model. In the case of Senegal, monetary, and fiscal data20 is contaminated by the historical presence of interest rates and interest policy of the anchor currency (French Franc and then Euro), governed by the European Monetary Union Authorities. Hence, the available data would give misleading results and would not produce an accurate reading on the use of the rate of return to real sector as a monetary policy tool. One possible alternative methodology for empirical investigation of macroeconomic policy in an Islamic economy is to use counterfactual simulation. A number of economists have applied the counterfactual methodology to analyze the effects of macroeconomic policies in various countries (Bourguignon et al. 1989; Caivano et al. 2011; Orphanides and Williams 2011; Pesaran and Smith 2012, 2014). According to Pesaran and Smith (2012, 2014), counterfactual simulations refer to “what would have occurred if some observed characteristics or aspects of the processes under consideration were different from those 19 According to the SESRIC Report 2018, around 83% of all new internal displacement in the world during the recent past took place in OIC countries. By the end of 2017, 75% off all the refugees in the world (24.8 million refugees) originated from OIC countries. 20 Interest rate-based borrowing dominates Senegal’s fiscal picture.

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prevailing at the time.” Caivano et al. (2011) underline that the use of such methodology is based on the hypothesis that the development of events actually observed in history was not entirely inevitable. The comparison between actual and counterfactual events (and therefore only hypothetical) can aid in the understanding of, which, among the a priori identified factors as possible causes of a given sequence of events, have really contributed to determining it. Counterfactuals are essential to isolate the effects of particular policies and to identify causal relationships between such policies and desired outcomes that can be used for conceptual learning, decision-making, social cognition, and performance evaluation. Studies distinguish between: (i) “ex post ” counterfactual that compares “ex post ” realized outcomes with a counterfactual outcome and (ii) “ex ante” counterfactual simulation that aims to contribute to the decision-making, leading to the adoption of a new policy. In this case, counterfactual predictions are compared with predicted (“ex ante”) values of the outcome variables. However, researchers underscore that counterfactual reasoning, based on the hypothetical reconstruction of facts that have never occurred, intrinsically bears risks of wide arbitrary margins not always easily acceptable. Small differences in initial conditions or inclusion of elements of randomness in the model can produce a large differential impact. 3.4.2

Methodology Issues

Because nearly all the rules are prescribed for internalization by individuals, their formalization and quantification for modeling is constrained by a lack of appropriate methodologies that can handle subjective variables. Nevertheless, it is possible to construct an Islamic economic model relying on the two most important and quantifiable rules of an Islamic economy: prohibition of interest, rate-based debt financing, and its replacement with risk-sharing contracts. All other rules of conduct require policy-legislative actions supplemented by an effective incentive structure to operationalize them. These are incorporated in qualitative policy recommendations. Hence, a key feature of the Islamic macroeconomic framework is the use of the investment rate of return which plays a prominent role in the individual agent decision to invest, instead of the interest rate. According to Askari et al. (2014), an increase in the investment rate of return would raise the investment expenditure, which results in an increase in the aggregate demand, and in turn the desired

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levels of output to be produced. It is worth nothing that, from a secular economic perspective, an interest rate rise negatively impacts investment, which would reduce the demand and therefore the output. The practical application of the counterfactual method is used in this study to simulate the Islamic model of stability and growth and to analyze the outcomes within a financial programming approach with a general objective of sustained growth in macroeconomic stability. The financial program model studies the economic and financial interrelations within the economy and determines the financial balances in each sector. The four economic sectors—real sector, fiscal sector, balance of payments, and monetary sector—are interrelated through real and financial flows. The approach is policy-oriented. It is basically an accounting model that may be applied over the short run, or medium and long run. It explains how the implementation of specific growth, fiscal, monetary, or external sector policies interreact and affect each sector’s financial balances. It ensures consistency of projections (based on assumed behavioral or projection rules) about the main linkages between the macroeconomic accounts and their economic consistency. Also, implications of a change in the assumptions (new projections of exogenous variables and modifications of targets) can be determined rapidly and analyzed. Typically, the financial program tool has wide-ranging applications by the IMF, governments, or central banks. The latter use it in their monetary programming and formulation of policies. Medium- and long-term economic growth considerations are incorporated with a specification and estimation of a long-term relationship that relates the Gross domestic Product (GDP) positively to the investment rate of return in the real sector of the economy. Concerns about macroeconomic stability are addressed assuming appropriate levels of domestic inflation (price stability) and fiscal deficit and external current (financial sustainability). According to Mikkelsen (1998), the growth rate target must remain sustainable over the long term. Thus, fiscal and monetary policies should preserve the short-term fluctuations of the output growth around its long-term trend. From these considerations, the following methodological issues will be addressed: (i) the computation of the investment rate of return at the macroeconomic level as a benchmark for investment, (ii) the specification and estimation of reduced-form models relating the real GDP growth rate and the investment rate of return to the policy variable—in particular the fiscal variables, and (iii) the medium-term simulation.

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1. Estimation of the investment rate of return in the real sector To determine a benchmark as a replacement for the interest rates, Haque and Mirakhor (1999) discussed several calculation methods from simple financial ratios to market indexes. During the last decade, researchers have conducted more studies on the topic at both aggregated and desegregated levels (Canning and Bennathan 2004; Pina and Miguel 2004; Bai Chong-En et al. 2006; Caselli and Feyrer 2007). Following Pina et al. (2004) and Afonso and Aubyn (2008) used the vector autoregressive (VAR) framework in a study that covered 14 European Union countries, Canada, Japan, and the United States. They estimated the macroeconomic rates of return for public and private investment by assessing long-term elasticities of GDP with respect to investment aggregates and the long-term marginal productivity of investment. Using the elasticity of GDP to private investment IP (εIP ) derived from VAR estimation, the marginal productivity of private investment (IP) is given by: MPIP ≡ with εIP =

Y Y = εIP IP IP

(3.1)

 log Y  log IP

Then the rate of return of private investment (r) is obtained from Eq. (3.1): (1 + r )t = MPIP

(3.2)

where t is the average life of a capital good. The weak point of this approach is that the rate of return cannot be computed when the calculated elasticity takes a negative value, as is the case for some countries (Afonso and Aubyn 2008). Also, the choice of an average capital life raises concerns about the vast spectrum of capital goods’ life, for example, from three years for a computer to three decades or more for a dam. Another method would be to estimate the aggregate rate of return based on market index return of capital in well-developed financial markets. However, in the case of Senegal’s economy (Diouf and Ndong 2014) as for many other developing countries, financial markets are not developed enough and do not allow the use of this method.

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These limitations motivate the use of an alternative method, developed by Chong-En Bai et al. (2006), to estimate a rate of return on capital as a proxy for the investment rate of return to the real sector, based on the Hall and Jorgenson (1967) rental price equation. Considering still the decision of a firm at the margin to purchase a unit of capital for production, and assuming that the firm takes the output price as a given, Chong-En Bai et al. (2006) reformulated the rental price equation as: i(t) =

PY (t)MPK j (t) ÙK (t) − δj + P J PK J

(3.3)

where i is the nominal rate of return, PY the price of the output goods, PKj the price of the capital of type j, δj the depreciation rate of type j ÙK (t) capital, MPKj the marginal physical product of type j capital, and P J the percentage rate of change of the price of type j capital. At the macro level, the rate of return on capital can be calculated from the aggregate output, capital stock, and share of payments to capital income. Since the marginal product of capital cannot be observed, the methodology uses a proxy of capital share of total output α(t) as 1 minus labor share. Consequently, the macroeconomic nominal return is calculated as: i(t) =

α(t) ÙK (t)  − δ(t) + P PK (t)K (t) PY (t)Y (t)

(3.4)

where the denominator represents the capital-output ratio. PY (t) is the price of the aggregate output Y(t ); PK the price of aggregate capital stock; ÙK (t) the average growth rate K (t ) and δ(t ) its average depreciation rate; P of the price of aggregate capital stock. For simplification, in assuming a constant price of capital, the rate of return can be extracted as the ratio of capital share in income to the ratio of capital-output minus the depreciation rate. The real rate of return to capital can be derived from the nominal extraction by subtracting the growth rate of the output price ÙY (t). P The rate of capital depreciation is calculated using the geometric form adopted in most research on asset depreciation (Fraumeni 1997; Baldwin et al. 2005). Per-period depreciation (Dt ) is Dt = δ(1 − δ)t−1

(3.5)

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where δ is the constant (age invariant) rate of depreciation. Following Issoufou et al. (2014), δ is assumed to equal 5% for Senegal. 2. Estimation method of reduced-form models of the real GDP growth rate and investment rate of return This section specifies the reduced-form models of economic growth and investment rate of return and their estimation methodology. • Model specification Based on counterfactual analysis and for the analysis of ad hoc changes in the policy variable, Pesaran and Smith (2012, 2014) argue that: (i) knowledge about structural parameters is unnecessary and that the analysis can be based on the reduced-form policy equation and (ii) the autoregressive distributed lagged approach (ARDL) is preferable to VAR models because it allows efficiency gains by conditioning contemporaneous policy variables. Moreover, the bivariate ARDL may be more robust to structural change than models with many variables, thus reducing predicted uncertainty due to estimation error. Accordingly, the study uses the cointegration approach ARDL to avoid limitations of the existing conventional procedures to estimate the longrun relationship between the real GDP growth and investment rate of return and between the latter and the public investment. Furthermore, a reduced-form equation of the real growth of GDP is specified as an ARDL model in the functional form: GYR = f (IRR, IEV)

(3.6)

where GYR represents the real GDP growth, IRR is the estimated investment rate of return to the real sector. IEV is a variable related to the economic and financial international environment, either net capital inflows, term of trade, or world (or Euro Zone) economic growth rate. The functional form of the reduced equation of the investment rate of return is the following: IRR = f (RIG , IEV)

(3.7)

where RIG is the ratio of public investment to the GDP and IEV a variable proxy of the external environment. The estimated relations would allow

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assessment of the impact of fiscal policy experiments on the investment rate of return and in turn on the GDP growth rate. • Medium-term simulation methodology Medium-term simulation of the Islamic model on Senegal will employ the following three steps: 1. calibration of the model parameters and test for the extent to which the model replicates the historical economic and financial patterns of the economy 2. setting a medium-term baseline scenario (2015–2019 and 2019– 2024 in the Senegal case study), under the assumption that previous macroeconomic policies remain unchanged and there are no fundamental external shocks. The quadratic trend approach will be used for the computation values of the trend for real growth rates and real growth of exports 3. simulation of economic policy experiments on the same period and analysis of the outcomes compared to the baseline scenario projections and the results expected from the IMF macroeconomic model implemented in Senegal The main data sources will be from Senegal’s Government/Ministry of Economics and Finance, the Central Bank of West African States (BCEAO), The International Monetary Fund, the World Bank and the Penn World Tables 8.0 (Feenstra et al. 2013). Also, it is worth noting that the assessment of the degree of Islamicity of the OIC member countries including Senegal, refers other well-known index rankings such as United Nations Human Development Index (UNHDI), Economist Intelligence Unit’s (EIU) Democracy Index, Heritage Foundation’s Index of Economic Freedom, Fraser Institute’s Economic Freedom Index, Transparency International’s Corruption Perceptions Index, the Governance Index and Transformation Index (BTI), the Environmental Performance Index (EPI), United Nations Human Development Report, the Global Militarization Index (GMI), and the Global Peace Index (GPI) (Askari et al. 2017).

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Conclusion

The previous chapter reviewed the current debates and challenges in macroeconomic policy centered around key topics that shape the global economy. It covered the link between financial infrastructure development and economic growth, the significance of the quality of institutions (norms and rules) for economic development, ethics in economics, as well as issues on inequality and climate change. The current chapter investigates to what extent these debates and challenges are addressed from an Islamic point of view. The literature review stressed sustained progress, at a macroeconomic level, in modeling the Islamic economy and assessing its consistency characteristics. Empirically, a growing number of studies paid particular attention to the socioeconomic impact of financial variables (including financial infrastructure development) as well as the importance of institutional variables (the quality of institutions) for economic development. While at a sectorial level, the role of Islamic banking in monetary mechanism transmission was assessed. The results were in line with those obtained in the conventional economy. In particular, evidence from the OIC Member Countries confirm the positive impact of institutions on economic performance. However, from the perspective of macroeconomic policymaking and simulation, the empirical literature on Islamic macroeconomic models remains rather scant. This observation stands in contrast to the growing empirical studies in Islamic finance, which address the relation between theory and practice. It suggests that more work is urgently needed to empirically demonstrate the Islamic model’s bearings on macroeconomic policy (economic stability and economic growth) and economic well-being (social-economic development and ultimately social justice). Considering the methodological and data issues faced when addressing the empirical challenge of Islamic economics, the chapter revisits recent progress in quantitative methods that could be applied to empirical research on nontraditional approaches (including simulation where data is unavailable). Additionally, a reference to consider could be the integrated approach developed in mainstream economics by the “New Institutional Economic” school of thought that shares some ideologies with Islamic economics. The approach that closely interconnects economic theory, practical methods and application, and a broad range of social and behavioral disciplines, could provide new perspectives to unlock the challenging methodological issues in Islamic economic experiments.

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CHAPTER 4

Islamic Institutional Policy Framework

Economic activity takes place within the limits of an economic system that consists of a set of economic entities which operate in an organizational framework in compliance with a set of axioms and other rules. The axioms, regarded as self-evident truth, deal with the worldview society holds and provides legitimacy to the rules that regulate the relationship between economic entities. An important feature of the economic system is its analytical functioning which is shaped according to the rules. The Qur’an has specified rules of behavior prescribed by Allah (SWT) for all individuals and societies. These rules were implemented by the Prophet (SAW) in Medina during his lifetime. These rules are immutable and appropriately formulated to be applied to societies everywhere for all time. In this chapter, the first section presents the Islamic view of economic development. The second section outlines a set of Islamic rules that constitute the institutional framework for the Islamic model of stability and growth for Senegal. The third section infers a macroeconomic policy framework consistent with the objectives of stability and sustained growth and the fourth section concludes the chapter.

© The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_4

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4.1

Islamic View of Economic Development

Islam has a holistic approach to development based on three related and interdependent dimensions (Mirakhor and Hamid 20091 ): 4.1.1

Individual Self-development

Individual self-development is viewed as a process of human evolution from darkness of the state created by their emotions and feelings, to the light of full awareness of their Creator, Allah (SWT), to the point that, with their free will, they choose to submit to the will of their Creator by becoming fully compliant (“Taqwa”2 ) with the rules He prescribed in the Qur’an (Qur’an S2:257, S5:16; S14:1 & 5): S2:257: “Allah is the ally of those who believe. He brings them out from darkness into the light. And those who disbelieve - their allies are Taghut. They take them out of the light into darkness. Those are the companions of the Fire; they will abide eternally therein.” S14:1 & 5: “Alif, Lam, Ra. [This is] a Book which We have revealed to you, [O Muhammad], that you might bring mankind out of darkness into the light by permission of their Lord - to the path of the Exalted in Might, the Praiseworthy (1),” “And We certainly sent Moses with Our signs, [saying], ‘Bring out your people from darkness into the light and remind them of the days of Allah.’ Indeed in that are signs for everyone patient and grateful (5).”

4.1.2

Physical Material Progress and Growth

Physical material progress and growth are emphasized in the Qur’an (S11:61): S11:61: “And to Thamud [We sent] their brother Salih. He said, ‘O my people, worship Allah; you have no deity other than Him. He has produced

1 Mirakhor and Hamid reviewed extensively the evolution of the economic development concept from the mainstream economic thinking. 2 “Taqwa” incorporates consciousness and fear of Allah (swt) as well as piety. Piety

basically can be understood as righteousness that can be only obtained by the obedience of Allah and refrain from His prohibitions. In the Qur’an (S24:55) Allah (SWT) has promised to bestow on those Muslims who have faith and do good deeds: (i) succession and authority over the earth, (ii) establishing the factual religion of Truth everywhere, and (iii) abolishing all the factors that cause fear and insecurity.

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you from the earth and settled you in it, so ask forgiveness of Him and then repent to Him. Indeed, my Lord is near and responsive.”

The Qur’an specifies that, in an exact measure and in a dynamic way, Allah (SWT) has created sufficient resources to satisfy the needs of all His creatures (Qur’an S65:3; S15:20–21). S65:3: “And will provide for him from where he does not expect. And whoever relies upon Allah - then He is sufficient for him. Indeed, Allah will accomplish His purpose. Allah has already set for everything a [decreed] extent.” S15:20: “And We have made for you therein means of living and [for] those for whom you are not providers. (21) And there is not a thing but that with Us are its depositories, and We do not send it down except according to a known measure.”

Everything in the universe is made subservient to all humanity by their Creator. The challenge for human beings is to seek ever more knowledge that helps them to discover, extract, and process these universal bounties (Qur’an S22:65; S31:20; S45:13); to serve their needs, preserve and protect these bounties. S22:65: “Do you not see that Allah has subjected to you whatever is on the earth and the ships which run through the sea by His command? And He restrains the sky from falling upon the earth, unless by His permission. Indeed Allah, to the people, is Kind and Merciful.” S31:20: “Do you not see that Allah has made subject to you whatever is in the heavens and whatever is in the earth and amply bestowed upon you His favors, [both] apparent and unapparent? But of the people is he who disputes about Allah without knowledge or guidance or an enlightening Book [from Him].” S45:13: “And He has subjected to you whatever is in the heavens and whatever is on the earth - all from Him. Indeed in that are signs for a people who give thought.”

Humanity must express gratitude to the Creator (Qur’an S16:78) by sharing the proceeds from these resources with those who are less able (Qur’an S6:141):

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S16:78: “And Allah has extracted you from the wombs of your mothers not knowing a thing, and He made for you hearing and vision and intellect that perhaps you would be grateful.” S6:141: “And He it is who causes gardens to grow, [both] trellised and untrellised, and palm trees and crops of different [kinds of] food and olives and pomegranates, similar and dissimilar. Eat of [each of] its fruit when it yields and give its due [ Zakah] on the day of its harvest. And be not excessive. Indeed, He does not like those who commit excess.”

4.1.3

Development of the Human Collective Toward Integration, Cohesion, and Unity

Islam encourages the free movement of people, free trade, sharing of technology, knowledge, and ideas for the integration of humankind as originally created by Allah (SWT). This is clearly stated in the following verse (Qur’an S49:13) that intrinsically rejects all racial, political, ethnological, tribal, geographical, economic, intellectual, cultural, social differences and places the fear of God as the standard for distinction between virtues and vice: S49:13: “O mankind, indeed We have created you from male and female and made you peoples and tribes that you may know one another. Indeed, the most noble of you in the sight of Allah is the most righteous of you. Indeed, Allah is Knowing and Acquainted.”

There is an organic link between changes in individuals’ consciousness and changes in society. Rule compliance by individuals induces a dynamic and positive change in society. Essential to this process is the operationalization of one the most important ordinance of the Qur’an: it is the duty of individuals and collectivities to invite rule compliance and dissuades rule violation or noncompliance (Qur’an S9:71; S9:112). S9:71: “The believing men and believing women are allies of one another. They enjoin what is right and forbid what is wrong and establish prayer and give Zakah and obey Allah and His Messenger. Those - Allah will have mercy upon them. Indeed, Allah is Exalted in Might and Wise.” S9:112: “[Such believers are] the repentant, the worshippers, the praisers [of Allah], the travelers [for His cause], those who bow and prostrate [in prayer], those who enjoin what is right and forbid what is wrong, and those who observe the limits [set by] Allah. And give good tidings to the believers.”

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The above two verses could be related to Verse 96 chapter 7 to highlight the interdependence between people’s moral attitude and external circumstances. The following verses of the Qur’an (S8:53; S13:11) indicate explicitly the relentless sanctions of Allah (SWT) for rules and violations which lead to social, economic, and political decay. S8:53: “That is because Allah would not change a favor which He had bestowed upon a people until they change what is within themselves. And indeed, Allah is Hearing and Knowing.” S13:11: “For each one are successive [angels] before and behind him who protect him by the decree of Allah. Indeed, Allah will not change the condition of a people until they change what is in themselves. And when Allah intends for a people ill, there is no repelling it. And there is not for them besides Him any patron.” S16:112: “And Allah presents an example: a city which was safe and secure, its provision coming to it in abundance from every location, but it denied the favors of Allah. So Allah made it taste the envelopment of hunger and fear for what they had been doing.”

To facilitate performance of this duty, Allah (SWT) has endowed humans with the faculty of the mind “Aql ” to process deep, careful reasoning that helps them become rule compliant. “Aql ” operates through cognition by the heart and articulation by the mind at every decision point. The process of rationalizing (reasoning) begins with full consideration of the decision to be made or action to be taken (Ta’aqul ), buttressed by deep contemplation (tafakur) on the decision or action and its consequences (taddabur). From an economic perspective, rule compliance, reinforced with a suitable mechanism, reduces uncertainty for individuals. The network of rules that orders human life into a pattern intended by Allah (SWT) is called “Shariah”—(Law). The word etymologically is derived from a root meaning “the road.” “Shariah” rules are derived based on the Qur’an and operationalization by the Prophet (SAW ) through a rigorous process of investigation and thinking across time and geographical regions, based on consensus in the community, analogical reasoning, and independent human reasoning of those (Mujtahid) who

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specialize in Islamic law.3 These processes give “Shariah” great flexibility to handle problems in diverse situations, customs, and societies.

4.2

Islamic Institutional Policy Framework

In designing the Islamic institutional policy framework, the chapter will describe the rules of behavior prescribed in the Qur’an (such as property rights, faithfulness to the terms and conditions of contracts, trust, cooperation, and the rule of law) and assumes these rules provide the basis for the policy-oriented macroeconomic model and the resulting policy recommendations. Economic implication of the rules will be configured consistently to present an alternative Islamic framework of economic policies and prospects for achieving the ideal Islamic economic system. Hence, the Islamic institutional framework defined as an organizational framework for economic activities can be represented by: (i) fundamental axioms—rules regarded as self-evident truth; (ii) set of rules of behavior organizing the legal and regulatory framework; and (iii) rules regulating specifically real economic and financial activities. These second set of rules will be specifically analyzed in the next chapter. 4.2.1

Fundamental Axioms

The Qur’an in chapter 2, verse 177 allows to derive three core axioms that support the rules of the institutional policy framework: S2:177: “Righteousness is not that you turn your faces toward the east or the west, but [true] righteousness is [in] one who believes in Allah, the Last Day, the angels, the Book, and the prophets and gives wealth, in spite of love for it, to relatives, orphans, the needy, the traveler, those who ask [for help], and for freeing slaves; [and who] establishes prayer and gives Zakah; [those who] fulfill their promise when they promise; and [those who] are patient in poverty and hardship and during battle. Those are the ones who have been true, and it is those who are the righteous.”

These three axioms are the following: 3 A ‘mujtahid’ is a scholar who has the knowledge of the Qur’an, Sunnah, and the previous consensus, has the ability to deduce a rule from the “Sharia” sources, has sufficient knowledge of the Arabic language to enable him to have an accurate knowledge of the text, and has a comprehensive knowledge of the current issues (Kamali 1991).

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• Belief in the Oneness and the Uniqueness of the Creator (“Tawheed”) and its corollary: the unity of the creation. The Qur’an (S21:16, 38:27) emphasizes that all things in the universe created by Allah (SWT) have a just purpose and therefore are complementary to one another in an integrated whole. S21:16: them S38:27: them

“And We did not create the heaven and earth and that between in play.” “And We did not create the heaven and the earth and that between aimlessly…”

Also, the Qur’an mentions another fundamental function which other creatures perform and which Man may not perceive, worshipping Allah (SWT) (Qur’an S16:48; S24:41; S55:6–7 & 10). S16:48: “Have they not considered what things Allah has created? Their shadows incline to the right and to the left, prostrating to Allah, while they are humble.” S24:41: “Do you not see that Allah is exalted by whomever is within the heavens and the earth and [by] the birds with wings spread [in flight]? Each [of them] has known his [means of] prayer and exalting [Him], and Allah is Knowing of what they do.” S55:6–7 & 10: “And the stars and trees prostrate (6)” “And the heaven He raised and imposed the balance (7)”… “And the earth He laid [out] for the creatures (10).”

One could infer from this axiom that the human relation with the universe is a relationship of sustainable utilization for man’s benefit and a relationship of care and nurture for man’s good works to extend the interests of nature and all creatures (Alhabshi and Syed 1987). Indeed, while the primary relationship is of that between the Creator and the rest of His creation, the Creator Himself outlined the relationship between Man and the rest of His creation (Qur’an S2:28; S21:16; S38:26; S5:48). The Qur’an stressed numerous rules prescribed and implemented by The Prophet (SAW ), compliance with which would have curtailed considerable environmental damage in pursuit of economic activity. Allah (SWT) has created everything in this universe in due proportion and measured both quantitatively and qualitatively (Qur’an 54:49; 25:2). Man is appointed as the agent-trustee of Allah (SWT) on earth (Qur’an

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S2:30; S6:165; S35:9), and has to manage the earth in accordance with the purposes intended by its Creator, for his own benefit and the benefit of other created beings, within the limits dictated by his Trust (Qur’an S7: S31:56, S 17:26–27) since Allah (SWT) considers the animals as sentient beings living in communities like Man (Qur’an S6:38): S6:38: “There is not a moving (living) creature on earth, nor a bird that flies with its two wings, but are communities like you. We have neglected nothing in the Book, then unto their Lord they (all) shall be gathered.”

The divinely appointed measurement and distribution of all elements and creatures, each performing its ordained role and all of them valuable, makes up the dynamic equilibrium by which the divine creation is maintained. The Qur’an (S55:5–8) expresses the perfect equilibrium and absolute justice of creation, which humans as successors are obliged to help perpetuate: S55:5–8: “The sun and moon revolve to a reckoning (5) and the grasses and trees bow in adoration (6) He raised the sky and set the balance (7) so that none may transgress against the balance (8).”

Overexploitation, abuse, misuse, destruction, and pollution of natural resources are all transgressions against the divine scheme. Moreover, the use of resources created by Allah (SWT) would not lead to negative externalities which would be harmful to third parties even for next generations. Mirakhor and Idris (2009) argued: “It is important to note that any attempt at divisiveness – instead of enhancing and strengthening the recognition and actualization of unity – is a serious transgression.” The conservation of natural resources is a religious duty as well as a social obligation,4 and exploitation of a particular natural resource is directly related to accountability and maintenance of the resource (Qur’an

4 The Prophet (SAW) gave high degree of importance toward sustainable cultivation of land, waste minimization, humane treatment of animals, preservation of natural resources, and protection of wildlife. As example, the Prophet (SAW) said: “The world is beautiful and verdant, and verily God, be He exalted, has made you His stewards in it, and He sees how you acquit yourselves.” (Hadith related by Sahih Muslim on the authority of Abu Sa’id al Khudri). “If any Muslim plants a tree or sows a field, and a human, bird or animal eats from it, it shall be reckoned as charity from him” (S.ah.¯ih. al-Bukh¯ar¯i 2195).

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S7:85). In the following, some examples of such principle of natural resources preservation: • Water. The resource is the basis and origin of life (Qur’an S21:30; S2:164; S6:99; S22:5; S25:48–49): S21:30: “Have those who disbelieved not considered that the heavens and the earth were a joined entity, and We separated them and made from water every living thing? Then will they not believe”

Allah (SWT) has made its use the common right of all being without monopoly, usurpation, despoilment, wastage, or abuse (Qur’an S54:28) S54:28: “And inform them that the water is shared between them, each [day of] drink attended [by turn].”

And also, the Prophet (SAW ) has reaffirmed: “Muslims are to share in these three things: water, pasture, and fire.”5 • Air. Regarding its biological and social functions, its conservation, pure and unpolluted, is a crucial dimension of the conservation of life (S15:22; S2:164; S7:57). • Land, soil. It is crucial to preserve and enhance their fertility for the perpetuation of human lives and the lives of other creatures (Qur’an 55:10): S55:10: “And the earth He laid [out] for the creatures.”

• Plants and animals. As a living genetic resource, each species and variety is unique and irreplaceable. Plants by their unique function of producing food from the energy of the sun, constitute the basic source of sustenance for animal and human life on earth (Qur’an 80:24–32; 56:71–73). Consequently, to preserve the genetic diversity of living beings and other resources, nor should any be exploited at a rate in excess of their natural regeneration. 5 Reference: Sunan Ibn Majah Vol. 3, Book of Chapters on Rulings, Hadith 2340.

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Overall, Man must help maintain the cosmic balance by acting justly toward nature as well as toward each other. The built environment and the natural environment should be in perfect harmony. In fact, the Qur’an holds that Man will be tested (S5:48) and accordingly stands a clear warning on the consequences of the abuse of creation (S10:30): S5:48: “… He wanted to test you regarding what has come to you…” S10:30: “There! Every person will know (exactly) what (all) he had earned before, and they will be brought back to Allah, their rightful Lord (Maula), and their invented false deities will vanish from them.”

Mirakhor and Samawi Hamid (2009) argued “the stronger the feeling of oneness with humanity and the rest of the creation, and closer convergence of the interests of ‘one’ with that of the ‘other’ and with that of ‘all’.” Another corollary that can be inferred from the axiom is the concept of unity of human knowledge. It has practical applications particularly in economics since Islamic economics could benefit from the methodology, the analytical and empirical tools developed in the secular economic to address relevant issues, as long as they do not contradict Islamic values. • Belief in the appointment and delegation from the Creator. Messengers and prophets convey and operationalize His commands (Qur’an S2:136–137). S2:136–137: “Say, [O believers], ‘We have believed in Allah and what has been revealed to us and what has been revealed to Abraham and Ishmael and Isaac and Jacob and the Descendants and what was given to Moses and Jesus and what was given to the prophets from their Lord. We make no distinction between any of them, and we are Muslims [in submission] to Him (136)’ ‘o if they believe in the same as you believe in, then they have been [rightly] guided; but if they turn away, they are only in dissension, and Allah will be sufficient for you against them. And He is the Hearing, the Knowing (137).”

• Belief in the return to the Creator and accountability of each human for actions and behaviors toward their Creator, humanity, and the rest of the creation during lifetime (Qur’an S84:6; S4:86; S99:7–8; S35:18; S2:284).

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S84: “O mankind, indeed you are labouring toward your Lord with [great] exertion and will meet it.” S4:86: “And when you are greeted with a greeting, greet [in return] with one better than it or [at least] return it [in a like manner]. Indeed, Allah is ever, over all things, an Accountant.” S99:7–8: “ So whoever does an atom’s weight of good will see it (7),” “And whoever does an atom’s weight of evil will see it” (8). S2:284: “To Allah belongs whatever is in the heavens and whatever is in the earth. Whether you show what is within yourselves or conceal it, Allah will bring you to account for it. Then He will forgive whom He wills and punish whom He wills, and Allah is over all things competent.”

The Prophet (SAW ) manifested the relevance of accountability to man’s life: Every one of you is a liable guardian. The ruler who has authority over people is their guardian and liable for them. A man is the custodian of his family and liable for them. A woman is the guardian of her husband’s household and children and liable for them. A slave (Abd) is a guardian of his master’s property and liable for it. So all of you are guardians and are liable for your charges.

Therefore, belief in accountability on earth has strong implications in every Muslim’s life. 4.2.2

Rules Organizing the Legal and Regulatory Economic Environment

The following set of rules of behavior organizes the legal and regulatory framework and regulates the economic environment. • Human Agency (“Khilafa”). Allah (SWT) appointed humans as agent-trustees on earth (Qur’an S2:30; S6:165; S35:9). S2:30: “And [mention, O Muhammad], when your Lord said to the angels, ‘Indeed, I will make upon the earth a successive authority.’ They said, ‘Will You place upon it one who causes corruption therein and sheds blood, while we declare Your praise and sanctify You?’ Allah said, ‘Indeed, I know that which you do not know.’”

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S6:165: “And it is He who has made you successors upon the earth and has raised some of you above others in degrees [of rank] that He may try you through what He has given you. Indeed, your Lord is swift in penalty; but indeed, He is Forgiving and Merciful.” S35:9: “And it is Allah who sends the winds, and they stir the clouds, and We drive them to a dead land and give life thereby to the earth after its lifelessness. Thus is the resurrection.”

Humans are accountable and liable for the use of resources created by Allah (SWT) and for externalities from economic activities harmful to third parties (environmental damage, depletion of natural resources, and intergenerational equity). A saying of The Prophet (SAW) that is often quoted reads: There should be neither harming nor reprisal.

• Rule of human unity. The rule derives from the “Tawheed” axiom. Particularly, chapter 49 of the Qur’an (composed of 18 verses) teaches what to do for praiseworthy manners and matters to be avoided in relationships between individuals and Allah (SWT) and His Prophet (SAW), as well as in relationships between Muslims and all mankind. The characters of believers are as follows: i. Relationship between individuals and Allah (SWT) and His Prophet (SAW) (S49:1–5). These verses teach to not say anything that contradicts the Qur’an and Sunnah, in other words, to follow the lead of the Prophet (SAW) in all matters, to observe good manners with Allah’s Messenger, particularly respect, honor, esteem, to lower voices in the presence of Allah’s Messenger,6 to be patient (a virtue). Full compliance of the rules set by Allah (SWT) is synonymous with “Taqwa.” The verses also address the issue of the behavior of members of Muslim communities with respect to the leader—it is forbidden to raise voices above the leaders. More explicitly, verse 59 of chapter 4 of the Qur’an enjoins to the believers: 6 In fact, raising voices in normal conversation is considered ill-mannered (S31:19).

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S4:59: “O you who believe! Obey Allah and obey the Messenger (Muhammad SAW), and those of you (Muslims) who are in authority. (And) if you differ in anything amongst yourselves, refer it to Allah and His Messenger (SAW), if you believe in Allah and in the Last Day. That is better and more suitable for final determination.”

It is worth to note that the aforementioned verse includes the three axioms of the Islamic economic system: ii. Relationship between Muslim and in fine all mankind (S49:6–13) These verses forbid acts that will destroy the Islamic brotherhood and emphasizes those which enhance it, and explicitly enjoins to community members: – – – – –

to verify the reliability of the news conveyed by wicked people; to follow the decision of the Prophet (SAW) which is the better; to prohibit mocking and ridiculing one another; to prohibit unfounded suspicion; to prohibit spying or backbiting each other (honor is sacred in Islam as blood and wealth); – to make peace between disputing Muslims (and also establish security for both persons and their wealth) (Qur’an S49:9). S49:9: “And if two factions among the believers should fight, then make settlement between the two. But if one of them oppresses the other, then fight against the one that oppresses until it returns to the ordinance of Allah. And if it returns, then make settlement between them in justice and act justly. Indeed, Allah loves those who act justly.”

– to promote cooperation between all mankind because all are children of Adam and Hawwa and “the believers are nothing else than brothers…” (S49:10); – to forbid discrimination among humans, to earn honor through “Taqwa” since the only basis of superiority and excellence between

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man and man is that of moral excellence, as prescribed in the Qur’an (S49:13; S3:1037 ). S49:13: “O mankind, indeed We have created you from male and female and made you peoples and tribes that you may know one another. Indeed, the most noble of you in the sight of Allah is the most righteous of you. Indeed, Allah is Knowing and Acquainted.”

iii. The verses (S49:14–15) highlighted also what would be the characters of believers. Particularly the Qur’an (S49:15) enjoins to Man: S49:15: “The believers are only the ones who have believed in Allah and His Messenger and then doubt not but strive with their properties and their lives in the cause of Allah.8 It is those who are the truthful.”

It can be argued that if adhered to, Chapter 49 in and of itself alone can establish a healthy, dynamic, prosperous, and just society built around cardinal values. Taqwa, which is the synonym of compliance (with rules), brotherhood which means mutual respect and preservation of the honor of brothers, cooperation between the individuals (by sharing with others, enjoining what is just and forbid what is evil), and peace between believers. By implication, all humans have an equal opportunity of access to natural resources created by Allah (SWT). Considering the aforementioned rules, a landscape of the present state of Muslim societies taken as a whole demonstrates a long process of evident violation of fundamental rules of Islam as prescribed in Chapter 49 (“Al-Hujurat ”). These, among others include:

7 S3:103:“ And hold firmly to the rope of Allah all together and do not become divided. And remember the favor of Allah upon you - when you were enemies and He brought your hearts together and you became, by His favor, brothers. And you were on the edge of a pit of the Fire, and He saved you from it. Thus does Allah make clear to you His verses that you may be guided.” 8 Qur’an (S2:261) emphasizes the “Baraka” attached to the expenditure for the cause of Allah (SWT).

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– Oppression and violating political powers—particularly bloody and costly revolutions against repressive order; conquests and/or preservation of power by dictators (and their clan) as a way to accumulate wealth by any means (even against morals and at high social cost); waste of public resources in nonproductive expenditures or the interests of a few to gain political support, security and military forces; bureaucracy, in blatant contradiction with the rules of consumption stated in the Qur’anic verses (25:67; 17:27; 6:141); – The massacre of innocent civilians by religious sects and so-called “brothers of Islam,” and an increase in anti-immigration laws particularly against foreign workers in wealthy Muslim countries; – Rising tensions between Muslim countries (such as recent political tensions amongst GCC countries) for objectives which are far from the Islamic goals of enhancing economic growth and social welfare; – Weakness of cooperation and social solidarity inside the Muslim world as illustrated by the situation of the OIC-LDC’s or OICHIPC (21 countries) which are faced with severe poverty and external indebtedness which bears interest (in violation of the prohibition of Riba). At the same time, the total reserves—including gold—of the OIC countries as a whole, totaled US$1.6 trillion in 2018 (representing 13.2% of World total monetary reserves). Additionally, OIC-HIPC countries are financially constrained by the high burden of energy import bills despite possessing more than 70% of the world’s energy resources. – High levels of income disparity among OIC countries. As an illustration, the per capita GDP of Qatar was 5.5 times higher than the average OIC country (SESRIC report 2018). In fact, increasing inequality in and across countries, in a context of moral decay, leads to indignity for people at the bottom of the wealth pyramid and exacerbates economic and social instability. The rules within Chapter 49 (Al-Hujurat) correlate with the following rules to strengthen and preserve global peace and social order: • Rule of dignity “Karamah” (Qur’an S17:70); S17:70: “And We have certainly honored the children of Adam and carried them on the land and sea and provided for them of the good things

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and preferred them over much of what We have created, with [definite] preference.”

• Rules of competition and cooperation in useful and righteous deeds (Qur’an S5:2; S23:61; S3:200); S5:2: “O you who have believed, do not violate the rites of Allah or [the sanctity of] the sacred month or [neglect the marking of] the sacrificial animals and garlanding [them] or [violate the safety of] those coming to the Sacred House seeking bounty from their Lord and [His] approval. But when you come out of iúram, then [you may] hunt. And do not let the hatred of a people for having obstructed you from al-Masjid al-haram lead you to transgress. And cooperate in righteousness and piety, but do not cooperate in sin and aggression. And fear Allah; indeed, Allah is severe in penalty;” S23:61: “It is those who hasten to good deeds, and they outstrip [others] therein.” S3:200: “O you who have believed, persevere and endure and remain stationed and fear Allah that you may be successful.”

There are also many texts of the Sunnah in this regard, including the following: “There should be no envy except in two [cases]: [towards] a person whom Allah has given [knowledge of] the Qur’an and he recites it throughout the night and day, and thus a neighbor of his hears him and says, ‘I wish I was given like so-and-so, and could do what he is doing.’ The second is [towards] a person whom Allah has given wealth and he spends it for the sake of Allah. A man says, ‘I wish I was given like so-and-so to do what he is doing.’” (Sahih Muslim. Book 4. Hadith 1779).

• Rule of reciprocity in good to improve solidarity among humans (Qur’an S55:60) S55:60: “Is the reward for good [anything] but good?”

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• Rule of consultation (Qur’an S42:38; S3:159) which imposes the duty of taking part in the community affairs for all members of the society. S42:38: “And those who have responded to their lord and established prayer and whose affair is [determined by] consultation among themselves, and from what We have provided them, they spend.” S3:159: “So by mercy from Allah, [O Muhammad], you were lenient with them. And if you had been rude [in speech] and harsh in heart, they would have disbanded from about you. So pardon them and ask forgiveness for them and consult them in the matter. And when you have decided, then rely upon Allah. Indeed, Allah loves those who rely [upon Him].”

• Rule of resolution of dispute by reference to Qur’an and Sunnah (Qur’an S4:59, S42:10). S4:59: “O you who have believed, obey Allah and obey the Messenger and those in authority among you. And if you disagree over anything, refer it to Allah and the Messenger, if you should believe in Allah and the Last Day. That is the best [way] and best in result.” S42:10: And in anything over which you disagree - its ruling is [to be referred] to Allah. [Say], “That is Allah, my Lord; upon Him I have relied, and to Him I turn back.”

• Property rights.9 Allah (SWT) has permanent full ownership of all property, whether natural or man-made (Qur’an S4:126 & 134; S16:52; S43:85; S5:120): S4:126: “And to Allah belongs whatever is in the heavens and whatever is on the earth. And ever is Allah, of all things, encompassing (126).” S16:52: “And to Him belongs whatever is in the heavens and the earth, and to Him is [due] worship constantly. Then is it other than Allah that you fear?” S43:85: “And blessed is He to whom belongs the dominion of the heavens and the earth and whatever is between them and with whom is knowledge of the Hour and to whom you will be returned.” 9 Referring to Askari et al. (2015) the concept of “property” could be defined “as a bundle of rights, duties, powers, and liabilities with respect to an assets.”

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S5:120: “To Allah belongs the dominion of the heavens and the earth and whatever is within them. And He is over all things competent.”

Man has the right of possession and property ownership as trust. (Qur’an S2:255; S37:96; S42:12). S2:255: “Allah - there is no deity except Him, the Ever-Living, the Sustainer of [all] existence. Neither drowsiness overtakes Him nor sleep. To Him belongs whatever is in the heavens and whatever is on the earth. Who is it that can intercede with Him except by His permission? He knows what is [presently] before them and what will be after them, and they encompass not a thing of His knowledge except for what He wills. His Kursi extends over the heavens and the earth, and their preservation tires Him not. And He is the Most High, the Most Great.” S37:96: “While Allah created you and that which you do?” S42:12: “To Him belong the keys of the heavens and the earth. He extends provision for whom He wills and restricts [it]. Indeed He is, of all things, Knowing.”

The disposal of property (“Al-Mâl ”) is a test of faith since the owner has to use it consistently with God’s revealed wisdom. Islam recognizes two ways of accruing property rights: through creative labor and transfer (exchange, contract, grant, and inheritance) (Qur’an S9:105; S4:11; S70:24/25; S51:19; S4:92). S9:105: “And say: Work (righteousness): Soon will Allah observe your work, and His Messenger, and the Believers: Soon will ye be brought back to the knower of what is hidden and what is open: then will He show you the truth of all that ye did.” S70:24–25: “And those within whose wealth is a known right (24)” “For the petitioner and the deprived (25).” S4:92: “And never is it for a believer to kill a believer except by mistake. And whoever kills a believer by mistake - then the freeing of a believing slave and a compensation payment presented to the deceased’s family [is required] unless they give [up their right as] charity. But if the deceased was from a people at war with you and he was a believer - then [only] the freeing of a believing slave; and if he was from a people with whom you have a treaty - then a compensation payment presented to his family and the freeing of a believing slave. And whoever does not find [one or cannot afford to buy one] - then [instead], a fast for two months consecutively,

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[seeking] acceptance of repentance from Allah. And Allah is ever Knowing and Wise.”

Once obtained, humans are responsible for the safekeeping of these rights (Qur’an S4:21; S5:38; S26:183). S4:21: “And how could you take it while you have gone in unto each other and they have taken from you a solemn covenant?” S5:38: “[As for] the thief, the male and the female, amputate their hands in recompense for what they committed as a deterrent [punishment] from Allah. And Allah is Exalted in Might and Wise” S26:183: “And do not deprive people of their due and do not commit abuse on earth, spreading corruption.”

This rule has further important implications regarding limitation of the rights of disposition of property, distribution, and redistribution of wealth—mainly sharing income or wealth proceedings from sale according to ordained duties, redeeming the rights of the unable and less able in revenue and wealth of the more able (S51:19; S70:24–25)10 : S51:19: “And from their properties was [given] the right of the [needy] petitioner and the deprived.” S70:24–25: “And those within whose wealth is a known right (24)”…“ For the petitioner and the deprived.”

Askari et al. (2015) stressed that in the evolution of western economies, with the emergence of the market economy, “of the two earlier property rights principles- the right to exclude the others and the right to be not excluded by the others-the latter was abandoned, and the new conception of property rights was narrowed to cover only the right to exclude others. In Islam, however, this right is retained without diminishing the role of the market as a mechanism for resource allocation and impulse transmission.”

10 See also verses S17:26 and S30:38 related to the relative and traveler right.

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• Work and work ethics.11 Work is a right, duty, and obligation. Islam raises hard work to the level of worship (Qur’an S11:61; S23:51; S9:105; S62:10). S23:51: “[Allah said], ‘O messengers, eat from the good foods and work righteousness. Indeed, I, of what you do, am Knowing.” S9:105: “And say, ‘Do [as you will], for Allah will see your deeds, and [so, will] His Messenger and the believers. And you will be returned to the Knower of the unseen and the witnessed, and He will inform you of what you used to do.” S62:10: “And when the prayer has been concluded, disperse within the land and seek from the bounty of Allah, and remember Allah often that you may succeed.”

Idleness, laziness, and squandering time in unproductive activities suggest a lack of faith or nonbelief. Rewards or retributions underline peoples’ actions (Qur’an S16:97; 99:6–8; S53:39–41). S16:97: “Whoever does righteousness, whether male or female, while he is a believer - We will surely cause him to live a good life, and We will surely give them their reward [in the Hereafter] according to the best of what they used to do.” S99:6–8: “That Day, the people will depart separated [into categories] to be shown [the result of] their deeds (6),” “So whoever does an atom’s weight of good will see it (7),” “And whoever does an atom’s weight of evil will see it (8).” S53:39–41: “And that there is not for man except that [good] for which he strives (39), ‘And that his effort is going to be seen (40),’ ‘Then he will be recompensed for it with the fullest recompense (41)’.”

As mentioned above, work is also central to ownership. Men are ordered to perform rule-compliant activities.12 They may also combine their physical and intellectual abilities with the created resources to sustain

11 Study on the concept of Islamic Work Ethic and its impact on workers performance has received a growing interest from researchers (Ali and Al-Owaihan 2008; Siswanto and Syakur 2019). 12 The Prophet (SAW) said: “How fine is rightly acquired wealth in the possession of an upright man.” Musnad Ahmad, 29:299, Hadith no. 17763 (in al-Maktabah al-ShÉmilah).

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themselves and their families while bearing in mind the needs of other members of society. The Islamic perspective settles the employer–employee relationship based on fair contracts. The remuneration a person receives for his labor must correspond to his effort (Qur’an S53:39, S4:32, S7:85; S83:1–3). S53:39: “That man can have nothing but what he strives for.” S4:32: “And do not wish for that by which Allah has made some of you exceed others. For men is a share of what they have earned, and for women is a share of what they have earned. And ask Allah of his bounty. Indeed Allah is ever, of all things, Knowing.” S83:1–3: “Woe to those that deal in fraud (1),” “Who, when they take a measure from people, take in full” (2), “But when they have to give by measure or weight to men, give less than due (3).”

Labor pricing from an Islamic perspective goes beyond the common reference of the market forces. It further considers employer–employee brotherhood relationship, the workload and working conditions should be humanely acceptable.13 The contract must safeguard the minimum requirements that fulfill the basic needs of workers. Related to work is human capital development. This principle aims at improving personal knowledge, skills, and attitudes (including spiritual) to help humanity achieve the basic status of trusteeship. The Qur’an and sayings of the Prophet (SAW ) stress strongly seeking and sharing knowledge (Box 4.1) and realizing distinction in performance14 (Qur’an S2:148). S2:148: “For each [religious following] is a direction toward which it faces. So race to [all that is] good. Wherever you may be, Allah will bring you forth [for judgement] all together. Indeed, Allah is over all things competent.”

13 The Prophet (SAW) said: “Your slaves are your brothers and Allah has put them under your command. So whoever has a brother under his command, should feed him of that which he eats and dress him of that which he wears. Do not ask them (slaves) to do things beyond their capacity (power) and if you do so, then help them.” (Sahih al-Bukhari, Book 2, Hadith 23). 14 Allah’s apostle said: “Verily Allah (s.w.t) has prescribed perfection in everything.” (Muslim, no. 3614).

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As Sadr (2015) has pointed out: “The basis for the development and growth of the economy of the earliest period of Islam was the training and guidance of human abilities and their productivity. The only resource available to the Prophet (SAAS) to build the new community was the potential human capital of the Muslims.”

Box 4.1. Importance of seeking and teaching knowledge in Islam

• Islam gives high importance on seeking knowledge, making it necessary for all Muslims as stated in the Holy Qur’an (S 96:1–5; S20:114; S58:11, S39:9). S96:1–5: “Read! In the Name of your Lord Who has created (all that exists) (1). He has created man from a clot (2). Read! And your Lord is the Most Generous (3). Who has taught (the writing) by the pen (1). He has taught man that which he knew not (5).” S20:114: “So high [above all] is Allah, the Sovereign, the Truth. And, [O Muhammad], do not hasten with [recitation of] the Qur’an before its revelation is completed to you, and say, My Lord, increase me in knowledge.”

Also, Allah (SWT) will grant him/her high ranks to whoever seeks knowledge, (Qur’an S58:11; S39:9): S58:11: “Allah raises of those who believe and those who have been given knowledge many levels.” S39:9: “Is one who is devoutly obedient during periods of the night, prostrating and standing [in prayer], fearing the Hereafter and hoping for the mercy of his Lord, [like one who does not]? Say, Are those who know equal to those who do not know? Only they will remember [who are] people of understanding”

• Also, the sayings of the Prophet (SAW).emphasize the great importance of acquiring knowledge and its teaching: – “Seeking knowledge is an obligation upon every Muslim.” (Al-Tirmidhi).

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– “Acquire knowledge and impart it to the people.” (AlTirmidhi, no 107). – “When a man dies all his deeds come to an end except for three: an ongoing charity, beneficial knowledge and a righteous son who prays for him.” (Al-Bukhari). – “The excellence of a scholar over another (ordinary) worshipper is like the excellence of the full moon over the rest of the heavenly bodies.” (Abu Dawood). – “Whoever treads a path in seeking knowledge, Allah will make easy for him the path to Paradise.” (Al-Tirmidhi). Ultimately, seeking knowledge must be linked to values and goals.

• Rule of justice (interpersonal, economic, and societal). Justice is an obligation, injustice an offense (Qur’an S16:90). S16:90: “Indeed, Allah orders justice and good conduct and giving to relatives and forbids immorality and bad conduct and oppression. He admonishes you that perhaps you will be reminded.”

Its centrality in the Islamic system is stressed in the mission of Prophets. S57:25: “We have already sent Our messengers with clear evidences and sent down with them the Scripture and the balance that the people may maintain [their affairs] in justice. And We sent down iron, wherein is great military might and benefits for the people, and so that Allah may make evident those who support Him and His messengers unseen. Indeed, Allah is Powerful and Exalted in Might.”

Believers may observe constant conflict between passion and justice and find resolution in the Qur’an (S4:135, S55:9):

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S4:135: “O you who have believed, be persistently standing firm in justice, witnesses for Allah, even if it be against yourselves or parents and relatives. Whether one is rich or poor, Allah is more worthy of both. So follow not [personal] inclination, lest you not be just. And if you distort [your testimony] or refuse [to give it], then indeed Allah is ever, with what you do, Acquainted.”

From an Islamic economic perspective, justice hinges on three parts (Askari et al. 2015): (i) equality of liberty and opportunity about the use of natural resources; (ii) justice in market exchange governed by ethical and moral rules; and (iii) distributive justice through the transfer of property and inheritance. • Rule of distribution–redistribution: Distribution takes place after production and sales and remuneration of all factors of production. Redistribution occurs when charges due to the less able are levied (Askari et al. 2015). The operating mechanism for the redemption of the rights for the less able in the more able person’s wealth and income is either: – Payment of Zakah (Qur’an S9 V 60; S92 V 18; S2:110/177) which cleanses property, wealth, and income accrued from revenues and assets. Payout occurs after receipt of compensation for resources used in production or for the monetized value of the sale of products or resources (labor, land, capital, and entrepreneurship). S2:110: “And establish prayer and give Zakah, and whatever good you put forward for yourselves - you will find it with Allah. Indeed, Allah of what you do, is Seeing.”

The Qur’an (S9 V 60) mentions the specific people to whom Zakah can be given: S9:60: “ Zakah expenditures are only for the poor and for the needy and for those employed to collect [Zakah] and for bringing hearts together [for Islam] and for freeing captives [or slaves] and for those in debt and for the cause of Allah and for the [stranded] traveler - an obligation [imposed] by Allah. And Allah is Knowing and Wise.”

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– Payment of “Sadaqah” (Qur’an S9:103–104; S2:271–273) to voluntarily give part of one’s wealth to Allah (SWT). Particularly verse 271 of chapter 2 recommends that payment has to be made in secret to preserve the dignity of the poor. S9:103–104: “Take, [O, Muhammad], from their wealth a charity by which you purify them and cause them increase, and invoke [Allah’s blessings] upon them. Indeed, your invocations are reassurance for them. And Allah is Hearing and Knowing (103),” “Do they not know that it is Allah who accepts repentance from His servants and receives charities and that it is Allah who is the Accepting of repentance, the Merciful? (104).” S2:271–273: “If you disclose your charitable expenditures , they are good; but if you conceal them and give them to the poor, it is better for you, and He will remove from you some of your misdeeds [thereby]. And Allah, with what you do, is [fully] Acquainted (271),” “Not upon you, [O Muhammad], is [responsibility for] their guidance, but Allah guides whom He wills. And whatever good you [believers] spend is for yourselves, and you do not spend except seeking the countenance of Allah. And whatever you spend of good - it will be fully repaid to you, and you will not be wronged (272),” “[Charity is] for the poor who have been restricted for the cause of Allah, unable to move about in the land. An ignorant [person] would think them self -sufficient because of their restraint, but you will know them by their [characteristic] sign. They do not ask people persistently [or at all]. And whatever you spend of good - indeed, Allah is Knowing of it.”

– Expenditure, “Infaq” (Qur’an S92:18–20; S2:261), to seek the countenance of Allah (SWT) by helping the deprived. The Qur’an (S2:261) highlights the blessings (“Baraka”15 ) accredited to the expense for the cause of Allah (SWT). S92:18–20: “[He] who gives [from] his wealth to purify himself (18),” “And not [giving] for anyone who has [done him] a favor to be rewarded (19),” “But only seeking the countenance of his Lord, Most High (20).”

15 “Baraka” is defined as a nonlinear dynamic return to rule compliance, i.e., the magnitude of the return is not linearly related to amount of the expense, as emphasized in the verse above mentioned with the parable of the grain of corn which brings seven ears, each bearing hundred grains.

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S2:261: “The example of those who spend their wealth in the way of Allah is like a seed [of grain] which grows seven spikes; in each spike is a hundred grains. And Allah multiplies [His reward] for whom He wills. And Allah is all-Encompassing and Knowing.”

– Loan “Qardh Hasan” made to Allah (SWT) (Qur’an S64:17) without expectation of return on the capital. S64:17: “If you loan Allah a goodly loan, He will multiply it for you and forgive you. And Allah is Most Appreciative and Forbearing.”

– Endowment “Waqf ”: A “Waqf ” is a trust established when a contributor endows the stream of revenue in income accrued to a property for charitable purpose in perpetuity. The Waqf assets which are donated, bequeathed, or purchased remain in the permanent trust for constant charity or for a general or specific cause that Islam regards as worthwhile. – Inheritance rules (Qur’an S4:11–12; S4:176) specify clearly and in detail how to divide the wealth of the deceased among present and future inheritors. S4:11: “Allah instructs you concerning your children: for the male, what is equal to the share of two females. But if there are [only] daughters, two or more, for them is two thirds of one’s estate. And if there is only one, for her is half. And for one’s parents, to each one of them is a sixth of his estate if he left children. But if he had no children and the parents [alone] inherit from him, then for his mother is one third. And if he had brothers [or sisters], for his mother is a sixth, after any bequest he [may have] made or debt. Your parents or your children - you know not which of them are nearest to you in benefit. [These shares are] an obligation [imposed] by Allah. Indeed, Allah is ever Knowing and Wise (11).” S4:12: “And for you is half of what your wives leave if they have no child. But if they have a child, for you is one fourth of what they leave, after any bequest they [may have] made or debt. And for the wives is one fourth if you leave no child. But if you leave a child, then for them is an eighth of what you leave, after any bequest you [may have] made or debt. And if a man or woman leaves neither ascendants nor descendants but has a brother or a sister, then for each one of them is a sixth. But if they are

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more than two, they share a third, after any bequest which was made or debt , as long as there is no detriment [caused]. [This is] an ordinance from Allah, and Allah is Knowing and Forbearing (12).” S4:176: “They request from you a [legal] ruling. Say, ‘ Allah gives you a ruling concerning one having neither descendants nor ascendants [as heirs].’ If a man dies, leaving no child but [only] a sister, she will have half of what he left. And he inherits from her if she [dies and] has no child. But if there are two sisters [or more], they will have two-thirds of what he left. If there are both brothers and sisters, the male will have the share of two females. Allah makes clear to you [His law], lest you go astray. And Allah is Knowing of all things.”

Compliance with the rules of distribution and redistribution of wealth and income would create a stable society without extremes of wealth and poverty in and across countries. • Rules of market behavior. Before entering the market, all participants must internalize the rules of behavior mentioned either in the form of market norms or in the form of prohibitions. These include16 : – Prohibition of hoarding17 wealth. Based on the injunction of the Qur’an, the Prophet (SAW )18 judged hoarding a sin, strictly punishable in the afterlife (Qur’an S9:34–35, S3:180). S9:34–35: “O you who have believed, indeed many of the scholars and the monks devour the wealth of people unjustly and avert [them] from the way of Allah. And those who hoard gold and silver and spend it not in the way of Allah - give them tidings of a painful punishment (34).”

16 Sadr (2016) made a detailed presentation of these rules and their application in the early Islamic period. 17 Ibrahim et al. (2014) presented a wide discussion on hoarding versus circulation of wealth. Hoarding in the article is defined narrowly as “the act of accumulating assets, especially goods or money, over and above that needed for immediate use based on the fear or expectation of future shortages and higher prices.” 18 The Prophet said: “He who hoards is a sinner.” (‘Sahih’ Muslim 3910). Hoarding is necessary to plan for old age, sickness, etc., provided Zakah is fully paid. If “Zakha” is not paid, then it is a sin.)

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S3:180: “And let not those who [greedily] withhold what Allah has given them of His bounty ever think that it is better for them. Rather, it is worse for them. Their necks will be encircled by what they withheld on the Day of Resurrection. And to Allah belongs the heritage of the heavens and the earth. And Allah, with what you do, is [fully] Acquainted.”

– Prohibition of corruption, bribery, fraud, and false testimony (Qur’an S2:188; S2:282; S83:1). Corruption is one of the worst predicaments affecting many countries across the world. It is a global concern that exists in innumerable forms and consequently defies comprehensive definition. It operates in the private as well as the public sector, occurs in rich countries and poor. On International Anti-Corruption Day (December 9, 2017), the SecretaryGeneral of the United Nations, António Guterres said, “The annual costs of international corruption amount to a staggering US$3.6 trillion in the form of bribes and stolen money.” Particularly, empirical studies had shown that corruption has a disproportionate impact on the poor and most vulnerable, increasing costs and reducing access to services such as health, education, and justice. Also, corruption erodes trust in government, distorts justice, violates public interest, and undermines the social contract. It impedes investment, with consequent adverse effects on growth and jobs. Ultimately, the scourge of corruption represents undoubtedly a serious threat to economic, social, and ecological balance. The Qur’an condemns corruption and bribery several times.19 Verses (S7:85; S2:188) state: S7:85: “And O my people, give full measure and weight in justice and do not deprive the people of their due and do not commit abuse on the earth, spreading corruption.” S2:188: “And do not consume one another’s wealth unjustly or send it [in bribery] to the rulers in order that [they might aid] you [to] consume a portion of the wealth of the people in sin, while you know [it is unlawful].”

19 Arafa (2012) stressed that the Sunnah confirms the above prohibition through a general sanction referring to Sunan Abu Dawood Book 25, Hadith 3573: “it was said by ‘Abdullah Ibn ‘Amr Ibn al-‘as that The Apostle of Allah (PBUH) cursed the one who offers bribe as well as the one who accepts bribe”.

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The Qur’an also condemns those in authority who spread corruption and mischief among people, bestowing favors on some and oppressing others (S28:4; S89:11–12). – Prohibition of “Gharar” (asymmetric information) (Qur’an S2:188; S4:29) and all form of manipulating market conditions, collusion or coalition among buyers or sellers, bidding up for goods with no intent to purchase.20 S4:29: “O you who have believed, do not consume one another’s wealth unjustly but only [in lawful] business by mutual consent. And do not kill yourselves [or one another]. Indeed, Allah is to you ever Merciful.”

– Prohibition of price setting of private goods by public authorities21 despite their responsibility for market supervision. – Full disclosure of information about products and prices leading to transparency about quality, quantity, product sale prices, and mode and duration of payments. Ambiguity in any element may cause the transaction to be null and void. – No barriers to market entry or exit, no restrictions on international trade.22 • Enforcement of contracts. Contracts are binding and their terms and conditions protected by Islamic law (Qur’an S5:1 & 89; S16:91– 92; S17:34; S61:2–3).

20 “Najash” and “Talaqqi al-rukban” (practice of going out of the city to meet caravan and purchase their goods before they reach the market place) were prohibited by Prophet (SAW ): “do not go out to meet caravans before they reach the market, do not try to cut in on one another’s sales; do not bid in an auction to drive up price without any intention of purchase; a townsman should not sell on the behalf of a Bedouin; and do not refrain from milking a sheep before selling it to make it seem like it produces more mil than it really does ” (Al-Bukhari, Hadith no 2150). 21 The Prophet (SAW) said: “It is but Allah Who makes the prices low and high. I hope that when I meet Allah, none of you has any claim on me for doing wrong regarding blood or property.” (Sunan Abu Dawud 3443). 22 Askari et al. (2015), Sadr (2016).

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S5:1: “O you who have believed, fulfill [all] contracts. Lawful for you are the animals of grazing livestock except for that which is recited to you [in this Qur’an] - hunting not being permitted while you are in the state of ihram. Indeed, Allah ordains what He intends.” S5:89: “Allah will not impose blame upon you for what is meaningless in your oaths, but He will impose blame upon you for [breaking] what you intended of oaths. So its expiation is the feeding of ten needy people from the average of that which you feed your [own] families or clothing them or the freeing of a slave. But whoever cannot find [or afford it] – then a fast of three days [is required]. That is the expiation for oaths when you have sworn. But guard your oaths. Thus does Allah make clear to you His verses that you may be grateful (89).” S16:91–92: “And fulfill the covenant of Allah when you have taken it, [O believers], and do not break oaths after their confirmation while you have made Allah, over you, a witness. Indeed, Allah knows what you do (91),” “And do not be like she who untwisted her spun thread after it was strong [by] taking your oaths as [means of] deceit between you because one community is more plentiful [in number or wealth] than another community. Allah only tries you thereby. And He will surely make clear to you on the Day of Resurrection that over which you used to differ (92).” S17:34: “And do not approach the property of an orphan, except in the way that is best, until he reaches maturity. And fulfill [every] commitment. Indeed, the commitment is ever [that about which one will be] questioned.”

Habachy (1962) argued that the binding nature of the contract covers private and public law contracts as well as international treaties and moreover every public office in Islam. • “Amanah” (trusteeship). Amanah is an all-embracing concept, considered as the core of belief and the cornerstone of individuals’ relationship with Allah (SWT), his environment, and others in the society. The Qur’an cites “Amanah” or trust in many verses, as the following: S33:72: “Indeed, we offered the Trust to the heavens and the earth and the mountains, and they declined to bear it and feared it; but man [undertook to] bear it. Indeed, he was unjust and ignorant.”

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The trustee has to fulfill the Amanah under the obligations prescribed by Allah (SWT) to keep justice in society [(Askari et al. (2015); Hasan (2015)]. The rule of “Amanah” involves a set of business ethics and social responsibility dynamics. “Amanah” (trustworthiness)—staying faithful to the terms and conditions of contracts and keeping promises—is sacred (S9:4; S23:8, S61:2 & 3) and constitutes the compulsory characteristics of the true believer (Qur’an S23:8; S8:27; S70:32). S9:4: “Excepted are those with whom you made a treaty among the polytheists and then they have not been deficient toward you in anything or supported anyone against you; so complete for them their treaty until their term [has ended]. Indeed, Allah loves the righteous [who fear Him.” S23:8: “And they who are to their trusts and their promises attentive.” S8:27: “O you who have believed, do not betray Allah and the Messenger or betray your trusts while you know [the consequence].”

The rule strengthens the social solidarity (Qur’an S4:36), respect of the right of possession, moderation in gaining wealth (Qur’an S5:106) and circulation of wealth (Qur’an S59:7). S5:106: “O you who have believed, testimony [should be taken] among you when death approaches one of you at the time of bequest - [that of] two just men from among you or two others from outside if you are traveling through the land and the disaster of death should strike you. Detain them after the prayer and let them both swear by Allah if you doubt [their testimony, saying], ‘We will not exchange our oath for a price, even if he should be a near relative, and we will not withhold the testimony of Allah. Indeed, we would then be of the sinful’.” S59:7: “And what Allah restored to His Messenger from the people of the towns - it is for Allah and for the Messenger and for [his] near relatives and orphans and the [stranded] traveler - so that it will not be a perpetual distribution among the rich from among you. And whatever the Messenger has given you - take; and what he has forbidden you - refrain from. And fear Allah; indeed, Allah is severe in penalty.”

In particular, the rule prohibits acquisition of wealth through embezzlement of public money or individual’s property regarding the injunctions of the Qur’an (S3:161; S2:283; S3:75; S4:58).

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S3:161: “It is not [attributable] to any prophet that he would act unfaithfully [in regard to war booty]. And whoever betrays, [taking unlawfully], will come with what he took on the Day of Resurrection. Then will every soul be [fully] compensated for what it earned, and they will not be wronged.” S2:283: “And if you are on a journey and cannot find a scribe, then a security deposit [should be] taken. And if one of you entrusts another, then let him who is entrusted discharge his trust [faithfully] and let him fear Allah, his Lord. And do not conceal testimony, for whoever conceals it his heart is indeed sinful, and Allah is Knowing of what you do.” S4:58: “Indeed, Allah commands you to render trusts to whom they are due and when you judge between people to judge with justice. Excellent is that which Allah instructs you. Indeed, Allah is ever Hearing and Seeing.”

Importantly, “Amanah” relates to respect for the social contract between the ruled and their rulers and requires strong commitments. The ruled have to follow and obey the legitimate ruler so long as they are rule compliant. Considering the first five verses of Chapter 49 of the Qur’an (al-Hujurat ), one can address the issue of the behavior of members of the Muslim community in respect to the leader—it is forbidden to raise voices above Muslim leaders—and more explicitly by reference to verse 59 of chapter 4 of the Qur’an (S4:59): S4:59: “O you who have believed, obey Allah and obey the Messenger and those in authority among you. And if you disagree over anything, refer it to Allah and the Messenger, if you should believe in Allah and the Last Day. That is the best [way] and best in result.”

As counterparty of respect and allegiance of Community, the leader must be Muslim and righteous (mature, wise, and superior in character), and ultimately rule compliant (Qur’an S2:44): S2:44: “Do you order righteousness of the people and forget yourselves while you recite the Scripture? Then will you not reason?”

Overall, the members of the society must truthfully perform their duty of commanding rule compliance and forbidding rule violation “Amr bil Ma’ruf wa Nahy ‘an il Munkar,” as enjoined in the Qur’an (S31:17).

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S31:17: “O my son, establish prayer, enjoin what is right , forbid what is wrong, and be patient over what befalls you. Indeed, [all] that is of the matters [requiring] determination.”

Moreover, compliance with this capstone rule promises the success of the society (Qur’an S3:104). S3:104: “ And let there be [arising] from you a nation inviting to [all that is] good, enjoining what is right and forbidding what is wrong, and those will be the successful.”

Coupled with the prescribed rule of consultation, this duty gives every member of society the right, and imposes on him or her, the duty of participating in community affairs, including elections. Regarding particularly elective appointments, the Prophet (SAW ) consistently refused to make any administrative appointment whenever the person concerned asked for it: We do not assign the authority of ruling to those who ask for it, nor to those who are keen to have it. (Sahih al-Bukhari 7149)

Following this hadith, only a person enjoying a strong sense of self among the electorate would have a real chance of success. 4.2.3

The Islamic Concept of Economic Relations

Verse 2:275 of the Qur’an, considered as a cornerstone in the Islamic concept of economic relations, involves two core principles that regulate real productive and financial activities: (i) permissibility of contract “albay” and prohibition of “al-riba,” and (ii) the principle of risk sharing. S2:275: “Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, ‘Trade is [just] like interest.’ But Allah has permitted trade and has forbidden interest. So whoever has received an admonition from his Lord and desists may have what is past, and his affair rests with Allah. But whoever returns to [dealing in interest or usury] - those are the companions of the Fire; they will abide eternally therein.”

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• Permissibility of contract “al-bay” and prohibition of “al-riba” – Permissibility of contract “al-bay.” From a discussion on the epistemology of Islamic finance, Mirakhor and Smolo (2014) inferred that: (i) a contract is permissible if it meets the requirements of “al-bay” and sufficient condition (no-riba) and (ii) there are two types of contracts involving time: (a) “al tijara” focusing on the trade of already produced commodities with expectation of gain; and (b) “al-bay,” for the exchange of property right claims in the future with the expectation of gain or loss. The latter covers income and employment in the long term, an essential element to future economic growth. – Prohibition of “al-riba”. From a literal definition, “al-riba” means excess, increase, expansion, growth. However, the Qur’an does not define “riba” as one type of transaction or another. The Qur’an condemns in clear terms the practice of “al-riba.” (See Box 4.2 thereafter). Particularly, the practice of “al-riba” is tantamount to waging war with Allah (SWT) and his Prophet (SAW ) (Qur’an S2:279). Also, various sayings of the Prophet (SAW) relate also to “riba,” its forms, and severity of its sin (see Appendix G).

Box 4.2. Prohibition du riba from the Qur’an

• Qur’an: S30:39; S4:161; S3:130; and S2:275–279. S30:39: “And whatever you give for interest to increase within the wealth of people will not increase with Allah. But what you give in Zakah, desiring the countenance of Allah - those are the multipliers.” S4:161: “And [for] their taking of usury while they had been forbidden from it, and their consuming of the people’s wealth unjustly. And we have prepared for the disbelievers among them a painful punishment.” S3:130: “O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful.”

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S2:276: “Allah destroys interest and gives increase for charities. And Allah does not like every sinning disbeliever.” S2:278: “O you who have believed, fear Allah and give up what remains [due to you] of interest , if you should be believers.” S2:V 279: “And if you do not, then be informed of a war [against you] from Allah and His Messenger. But if you repent, you may have your principal - [thus] you do no wrong, nor are you wronged.”

• Principles of risk sharing Referring to Askari et al. (2015), risk sharing can be defined as “a contract or societal arrangement whereby the outcome of a random event is borne collectively by a group of individuals or entities involved in a contract or by individuals or entities in a community.” The principle of risk sharing maintains that entitlement to profit correlates with the liability or risk for loss bearing in compliance with the saying of the Prophet (SAW ), “profit follows responsibility” (Sunan Abi Dawud No. 2493). With the exception of spot exchange or cash sales, Islamic contracts involve time, thus uncertainty, and ultimately risk. Prohibition of “al-riba” , considered as a contract of risk transfer and/or risk shifting, orients economic relations toward risk-taking and risk-sharing schemes. Islam ordains risk sharing through three main venues (Mirakhor 2012): (i) contracts of exchange which allow spreading risk among the participants rather concentrate it on one class of participants; (ii) redistributions and transfer payment programs that favor the more able of the society to share the risk facing the vulnerable of the population; and (iii) risk sharing with the future generation: inheritance rules are specified in the Qur’an through which the wealth of a deceased is distributed among the inheritors). Risk sharing serves the unity of humankind, one of the core Islamic principles referred to in the earlier sections of this chapter. A major economic principle stemming from the risk-return sharing concept is that the rate of return to finance is determined ex post by the rate of return on real activity. Askari et al. (2015) argue that “this follows from the fact that the source of profit in an Islamic economy is the addition to total output. Once the labour is paid its distributive share, the residual is then divided between the entrepreneur and the investor (saver). Since this residual is an ex post facto variable, it follows that the return to investors

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cannot be determined ex ante.” An important result for monetary policy is that the risk-return finance would reinforce the link between evolution in the finance sector and the real economy, and impact the price–quantity relation. Recent research highlights the crucial role attached to the concept of rate of return to investment in Islamic economics that shows how the rate of return determines the macroeconomic equilibrium in the economy without the need for a fixed rate of interest. The emphasis put on the rate of return to investment in Islamic economics also has further significant economic implications since the concept refers to structural competitiveness. At the macroeconomic level, the World Economic Forum (2015) defines competitiveness as the “set of institutions , policies, and factors that determine the level of productivity of a country. The level of productivity, in turn, determines the rates of return acquired by investments in an economy, which are the fundamental drivers of its growth rates.” Table 4.1 presents competitiveness components across 12 pillars in the Global Competitiveness Index (GCI) as estimated by the World Economic Forum. Table 4.1 The GCI Framework: The 12 Pillars of Competitiveness Institutions: public and private —Property rights —Efficiency and transparency of public administration Innovation: Capacity for and commitment to technology innovation Business sophistication Efficiency and sophistication of business processes Market size Size of the domestic and exports markets Technological readiness Adoption of the technology by individuals and businesses Infrastructure Quality and availability of transport, electricity, and communication infrastructures Source World Economic Forum

Financial Market development Efficiency, stability, and trustworthiness of the financial and banking system Macroeconomic environment Fiscal and monetary aggregates, savings rates, and sovereign debt rating Health and Primary education State of public health, quality, and quantity of basic education Higher education and training Quality and quantity of higher education and availability of on-the-job training Goods marketefficiency Competition and quality of demand conditions Labor marketefficiency Efficiency and flexibility, meritocracy, and gender parity in the workspace

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From an economic policy perspective, competitiveness requires the integrated implementation of multiple structural economic policies; i.e., investment in physical capital and infrastructure, education and training, technological progress, macroeconomic environment, good governance, market efficiency, and financial development.

4.3

Conclusion

The collection of rules from the Qur’an outlined in this chapter provides the foundation for an institutional structure essential for sustained economic growth and prosperity. As noted in Chapter 2, empirical studies in secular economics emphasizes the significance of institutions for economic growth and social development such as rule compliance, trust and trustworthiness, fulfillment of terms and conditions of contracts, covenants, and respect of property rights. On the basis of these considerations, it is safe to assume that an economic policy implementation of the Islamic institutional infrastructure is growth oriented. The cornerstone in operationalizing these views is to induce rule compliance and discourage rule violation or noncompliance of the rules as prescribed in the Qur’an and implemented by the Prophet (SAW). Importantly, that compliance with rules of behavior assures the emergence of justice and a just social and political system as an essential outcome of the system.23 Thus, the macroeconomic policy framework is a condition reinforced by a transparent legal infrastructure to ensure the enforceability of the rules. The next chapter will examine the operational rules in real economic and financial activities.

References Alhabshi, Datuk, and Othman Syed. 1987. The Role of Ethics in Economic and Business. IIUM Journal of Islamic Economics 1 (1), August–September. Ali, Abbas J., and Abdullah Al-Owaihan. 2008. Islamic Work Ethic: A Critical Review. Cross Cultural Management: An International Journal 15 (1): 5–19. https://doi.org/10.1108/13527600810848791. Arafa, Mohamed A. 2012. Corruption and Bribery in Islamic Law: Are Islamic Ideals Being Met in Practice? Annual Survey of International & Comparative Law 18 (1), Article 9.

23 Mirakhor and Askari (2017) p. 199.

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Askari, Hossein, Iqbal Zamir, and Abbas Mirakhor. 2015. Introduction to Islamic Economics: Theory and Application. Singapore: Wiley. Habachy, Saba. 1962. Property, Right and Contract in Muslim Law. Columbia Law Review 62 (30): 450–473. Hasan, Zubair. 2015. Economics with Islamic Orientation. Oxford, UK: Oxford University Press. Ibrahim, Ahmad Assad, Radwan Jawal Elatrash, and Farooq Mohammad Omar. 2014. Hoarding versus Circulation of Wealth from the Perspective of Maqasid Al-Shari’ah. International Journal of Islamic and Middle Eastern Finance and Management 7 (1): 6–21. Kamali, Mohammad Hashim. 1991. Principles of Islamic Jurisprudence, 1st ed. Kuala Lumpur: Ilmiah Publishers. Mirakhor, Abbas. 2012. Islamic Finance, Risk Sharing and Macroeconomic Policies. MPRA Paper, 56338. Mirakhor, Abbas, and Askari, Hossein. 2017. Ideal Islamic Economy: An Introduction. London: Palgrave Macmillan. Mirakhor, Abbas, and Edib Smolo. 2014. Epistemological Foundation of Finance: Islamic and Conventional. Islamic Banking and Finance Review I (1): 01–24. https://doi.org/10.32350/ibfr.2014.01.0. Mirakhor, Abbas and Idris, Samawi Hamid. 2009. Islam and Development: The Institutional Framework. New York: Global Scholarly Publications. Sadr, Seyed Kazem. 2015. The Role of Human Capital in Economic Development of The Earliest Islamic Period. International Journal of Islamic and Middle Eastern Finance and Management 8 (4): 398–417. Sadr, Seyed Kazem. 2016. The Economic System of the Early Islamic Period: Institutions and Policies. London: Palgrave-Macmillan. Statistical, Economic and Social Research and Training Centre for Islamic Countries (SESRIC). 2018. Challenges and Opportunities Towards Achieving the OIC-2025. OIC Economic Outlook 2018. Publication Department of SESRIC. Ankara–Turkey. Siswanto, Setiani and Syakur, Ahmad. 2019. The Influence of Islamic Work Ethic and Job Satisfaction on Organizational Commitment: Islamic Educational Institution Evidence. Etikonomi: Jurnal Ekonomi 18 (1): 73–82. World Economic Forum. 2015. 12 Pillars—Global Competitiveness Report 2014–2015. Report.

CHAPTER 5

Rules of Economic and Financial Operations

Further elaborating upon the institutional rules organizing the legal and regulatory economic policy framework as discussed in the previous chapter, this chapter begins by describing a set of operational rules in the main economic sectors; including production and consumption, investment, and external exchange, and financial operations (public finance and banking). The second section infers a macroeconomic policy framework consistent with the objectives of stability and sustained growth, and we conclude this chapter in the third section.

5.1

Production Activities

An analysis of production activities raises three major questions: How to produce? What to produce? For whom to produce and distribute? From this perspective, the Qur’an urges Man to be active and productive and to enjoy the resources Allah (SWT) has made available to them (Qur’an S2:29; S45:12–13; S67:15): S2:29: “It is He who created for you all of that which is on the earth. Then He directed Himself to the heaven, [His being above all creation], and made them seven heavens, and He is Knowing of all things.” S45:12: “It is Allah who subjected to you the sea so that ships may sail upon it by His command and that you may seek of His bounty; and perhaps you will be grateful.” © The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_5

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S45:13: “And He has subjected to you whatever is in the heavens and whatever is on the earth - all from Him. Indeed in that are signs for a people who give thought (13).” S67:15: “It is He who made the earth tame for you - so walk among its slopes and eat of His provision - and to Him is the resurrection.”

In a commentary of verse 60 of Chapter 8, Biraima (1991) argues that the call upon the Muslim “Ummah” to obtain all the means of power it can muster—particularly armament, fundamentally means maximum economic and technological advancement in a contemporary context. However, income and wealth must originate from permissible1 “halal ” economic activities (Qur’an S2:267, S61:10–11). S2:267: “O you who have believed, spend from the good things which you have earned and from that which We have produced for you from the earth. And do not aim toward the defective therefrom, spending [from that] while you would not take it [yourself] except with closed eyes. And know that Allah is Free of need and Praiseworthy.” S61:10–11: “O you who have believed, shall I guide you to a transaction that will save you from a painful punishment?”(10), “[It is that] you believe in Allah and His Messenger and strive in the cause of Allah with your wealth and your lives. That is best for you, if you should know (11).”

Permissibility is an open concept that applies to goods and services not declared forbidden.2 The Qur’an (S7:85; S28:77) specifies a wellbalanced production, not harmful to the self or others. S28:77: “But seek, through that which Allah has given you, the home of the Hereafter; and [yet], do not forget your share of the world. And do good as Allah has done good to you. And desire not corruption in the land. Indeed, Allah does not like corrupters.”

1 Kamali (1991): “The norm in regard to things is that of permissibility,” meaning that permissibility is the natural state and will therefore prevail until there is evidence to warrant a departure from that position. 2 Thomson Reuters in collaboration with Dinar Standard (2016) pointed out: “The Islamic global economy is estimated to be worth around US$ 1.9 trillion (excluding Islamic finance) in 2015 and projected to US$3 trillion in 2021, corresponding to 8% compound annual growth rate (CAGR)”.

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Preservation of biodiversity and ecological equilibrium from overexploitation is as important as worship and social obligation (intergenerational justice). Social aspects of production interrelate with the manufacturing process. To warrant the highest level of social equity, enough goods and services must be provided to allow every individual to “fulfil his basic needs3 ” in food, healthcare, clothing, education, and shelter.

5.2

Expenditure: Consumption and Investment

Consumption. According to the Qur’an, consumption is governed by the following principles: – Principle of permissibility (Qur’an S2:168; S5:88; S16:114): S2:168: “O mankind, eat from whatever is on earth [that is] lawful and good and do not follow the footsteps of Satan. Indeed, he is to you a clear enemy.” S5:88: “And eat of what Allah has provided for you [which is] lawful and good. And fear Allah, in whom you are believers.” S16:114: “Then eat of what Allah has provided for you [which is] lawful and good. And be grateful for the favor of Allah, if it is [indeed] Him that you worship.”

– Principle of moderation. Consumption must be rational—not excessive or scanty: S7:31–32: “O children of Adam, take your adornment at every masjid, and eat and drink, but be not excessive. Indeed, He likes not those who commit excess.”

3 Human wants are usually classified in three mains categories: necessities or essentials basic needs items (‘daruriyyat ’), comforts (‘hajiyyat ’) and luxuries (‘tahsiniyat ’). For practical reasons (measurement, policymaking), in the current circumstances where poverty and inequalities are widely spread in and across countries, the concept of basic necessities fulfillment is related to level of revenue, and the living standards of societies, countries.

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S25:67: “And [they are] those who, when they spend, do so not excessively or sparingly but are ever, between that, [justly] moderate.” S47:12: “Indeed, Allah will admit those who have believed and done righteous deeds to gardens beneath which rivers flow, but those who disbelieve enjoy themselves and eat as grazing livestock eat, and the Fire will be a residence for them.”

– Prohibition of stinginess (Qur’an S4: 37) S4:37: “Who are stingy and enjoin upon [other] people stinginess and conceal what Allah has given them of His bounty - and We have prepared for the disbelievers a humiliating punishment.”

– Prohibition of squandering resources (‘Israf ’), destruction of resources (‘Itlaf ’) and opulence (‘Itraf ’) (Qur’an S17:26–27). S17:26–27: “And give the relative his right , and [also] the poor and the traveler, and do not spend wastefully (26),” “Indeed, the wasteful are brothers of the devils, and ever has Satan been to his Lord ungrateful (27).”

As for production, consumption of goods and services should not be harmful to the self or others. Investment: Islam stands for circulation of wealth in the economy and discourages its concentration in the hands of the few (Qur’an S59:7). It espouses compliance with the principles of risk and return sharing, rules about prohibiting wealth hoarding, moderation in spending, avoidance of waste of resources and opulent consumption, the rule of banking to operate without interest-based debt and to promote risk-sharing financing of real productive activities would provide strong incentives for savings, as well as investment and expenditures in the way of Allah (SWT).

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Rules of External Economic Relations

The rules of unity of humankind and cooperation,4 justice and fairness in transaction5 supports strongly international trade6 and economic integration that favor: (i) freedom of trade including movements of goods and services, labor and capital, knowledge and technology, information (Qur’an, S2:275; S62:10; S16:14), and (ii) mutual understanding which in turn would reduce disputes and conflicts between nations. S62:10: “And when the prayer has been concluded, disperse within the land and seek from the bounty of Allah, and remember Allah often that you may succeed.” S16:14: “And it is He who subjected the sea for you to eat from it tender meat and to extract from it ornaments which you wear. And you see the ships plowing through it, and [He subjected it] that you may seek of His bounty; and perhaps you will be grateful.”

Siddiqi (1992) argued that the pursuit of both national and international economic interest must be in conformity of the “Shariah” principles of fair transactions (Qur’an, 60 V8). S60:8: “Allah does not forbid you from those who do not fight you because of religion and do not expel you from your homes - from being righteous toward them and acting justly toward them. Indeed, Allah loves those who act justly.”

Moreover, the Shariah rules which cover inter-personal economic relations do also rule over international relations, such as the prohibition of riba, rules of market behavior (outlined in Chapter 3, pp. 59–60), and enforcement of contracts (in this case, international agreements).

4 Qur’an (S21; 92). 5 Qur’an (S4; 58; S7; 55–56; S57:25). 6 Potential benefits of international trade: increased commercial opportunities and invest-

ment, enhanced competitiveness, export diversification, diversification of supply sources of goods and services and strengthening competition, exchange of know-how and technology that boost in turn innovation, competition and exchange of best practices between trade partners.

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5.4

Rules of Public Finance and Banking

Macroeconomic stability is critical for stable growth. The idea suggests an economic state that displays stability of prices and internal and external balanced financial positions, which may promote savings, foreign capital inflows, investment and sustained economic growth. Consistent macroeconomic measures rely on fiscal, monetary and exchange-rate policies. The following section will focus on the rules of public finance and banking. 5.4.1

Rules of Public Finance

The rules of public finance are addressed from three angles: government spending, the source of public revenue, and the fiscal balance and its financing model. • Spending of public resources follows the criteria for enhancing social welfare and economic growth (Chapra 1995; Siddiqi 1996). Public expenditures are divided into: – Expenditure for defense (Qur’an S8:60); internal security (by enforcement of law and order, justice); civil administration; individual needs fulfillment; endorsement of Islam and call (Da’wah) for rule compliance. S8:60: “And prepare against them whatever you are able of power and of steeds of war by which you may terrify the enemy of Allah and your enemy and others besides them whom you do not know [but] whom Allah knows. And whatever you spend in the cause of Allah will be fully repaid to you, and you will not be wronged.”

– Expenditure for environmental protection against adverse externalities from industrialization and urbanization of societies, production of public goods as infrastructure, research, and development networks, and stabilization policies.

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• Sources of public revenue include Zakah,7 royalties from natural resources, cost recovery fees, users’ fees, taxation of products, such as fuel products (for road construction and maintenance), taxation of pollutant industries to protect the environment from pollution damage, and voluntary public contributions.8 Moreover, most scholars agree that legitimate governments have the duty and responsibility to structure government financing in such a way to ensure efficient operations and implementation of its policies. Accordingly, studies (Othman and Mirakhor 2013; Askari et al. 2015), underscore that rules of taxation would combine simplicity, revenue efficiency, and fairness. From this point of view, the studies suggest a tax structure that could combine a tax income (20%) and a wealth tax (2.5%). Studies on public finance stress that regional priorities in spending taxes strengthen tax compliance (Sadr 2016). 5.4.2

Rules of Banking and Finance

Studies have argued that the prohibition of interest-based borrowing, promotion of risk-sharing principles and a 100% reserve banking system create strong features that ensure the stability of the Islamic financial system (bank and non-bank institutions, capital markets). Banking institutions : The system of 100% reserve banking was proposed by a number of authors, including the authors of the Chicago Plan (1933),9 Fisher (1936),10 Simons (1948), Rothbard (2008), and de Soto (2006), as a remedy for numerous of defects of the fractional reserve 7 Khoms (tax on income), Zakah (tax on wealth) and Kharaj (land tax) are propor-

tional taxes which, through their proportionalities favor the stabilization of economy (Sadr 2016). 8 See Askari et al. (2015) and Sadr (2016) for detailed discussions on Islamic fiscal taxation. 9 The authors of the Chicago Plan were: Henry Simons, Frank Knight, Aaron Director, Garfield Cox, Lloyd Mints, Henry Schultz, Paul Douglas, and A. G. Hart. 10 The major advantages of the system of 100% reserve banking commonly advocated

are: (i) preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions; (ii) eliminating occurrence of bank runs; (iii) allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest; and (iv) reducing of government debt and private debt levels.

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that include: (i) frequent bank failures and losses suffered by depositors; (ii) wide expansion and contraction of the money supply that created speculative bubbles, crashes, sending the economy into deep recession and loss of output and employment; (iii) unjust wealth redistribution via fictitious credit in favor of borrowers and speculators; and (iv) debt money was too costly to use, since interest has to be paid on outstanding debt and debt money falls if interest cannot be paid. The fact is that, in this system, loans created deposits and not deposits creating loans, as Tobin (1963) underscored. When a bank makes a loan, the loan instantly becomes a deposit. A bank did not wait until savers deposited money to issue loans. A bank issued a loan when it deemed the loan was profitable and the credit risk was tolerable. Most of the deposits at a bank came from its loan issuance as well as the loan issuances of other banks. The expansion of bank credit was far in excess of bank reserves that led to recurrent bank runs and financial failures. The typical model of deposit multiplication is that of the credit multiplier. This system is inherently unstable (Mirakhor and Krichene 2009; Mirakhor et al. 2012) since banks have the power to create money out of thin air and earn an income on a real capital that is not possessed by themselves or by the depositors. Fractional reserve money, called debt money, can only keep rising through credit multiplication to validate new price and wage increases and to pay for the interest rate. It cannot stabilize or decline; and in such event, interest cannot be paid, and the whole banking system collapses. The fractional reserve system cannot survive on its own and needs a central bank to provide it with constant liquidity. The system of 100% reserve banking removes the ability of banks to create money. To establish a stable banking system, the proponents of the Chicago Plan recommended that Federal Reserve Banks should liquidate the assets of all member banks, pay off liabilities, and dissolve all existing banks. New institutions should be created—accepting only demand deposits subject to a 100% reserve requirement in lawful money and/or deposits with the Reserve Banks. Saving of investment deposits would be handled through the incorporation of investment trusts. Present banking institutions would continue deposit and lending functions under Federal Reserve supervision until the new institutions can be put into place (Phillips 1992). Simons (1948, pp. 64–65) stated that: The proposals with reference to banking contemplate displacement of existing deposit banks by a least two distinct types of institutions. First,

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there would be deposits banks, which maintaining 100 per cent reserves, simply could not fail, so far as depositors are concerned, and could not create or destroy money. These institutions would accept deposits just as warehouses accept goods. Their income would be derived exclusively from service charges, perhaps merely from moderate charges for the transfer of funds by check or draft. The second type of institution, substantially in the form of investment trust, would perform the lending functions of existing banks. Such companies would obtain funds for lending by the sale of their own stock; and their ability to make loans would be limited by the amounts of funds so obtained. Various types of agencies, for bringing together would-be borrowers and lenders, would of course appear, In other words, short-term lending would be managed in much the same way as long-term lending; and the creation and destruction of effective circulation medium by private institutions would be impossible.

Ultimately, a 100% reserve banking system separates money from debt obligations. A bank can no longer emit banknotes or deposits and money would be independent of fluctuations in debt. Benes and Michaels (2012) revisited and simulated the Chicago Plan for the US financial system. They found that the Chicago Plan could significantly reduce business cycle volatility caused by rapid changes in banks’ attitudes toward credit risk, it would eliminate bank runs, and it would lead to an instantaneous and large reduction in the levels of both government and private debt. It would accomplish the latter by making government-issued money, which represents equity in the commonwealth rather than debt, the central liquid asset of the economy, while banks concentrate on their strength, the extension of credit to investment projects that require monitoring and risk management expertise. Risk-sharing investment banking is another main component of Islamic banking. Investment banks do not emit or destroy money. They only collect domestic and foreign savings, which they invest in productive projects or financial securities such as stocks or capital market funds. Depositors hold these investment accounts. The principal of the deposits in these accounts is not guaranteed. Depositors share in the profits and losses as well as in capital gains and losses. The investment banking complies with the Islamic law of financing such as “Murabahah,” “Mudarabah,” “Ijara,” Bai Salam, “Istisna,” or other risk-sharing modes. The investment bank finances investments of different maturities such as short-term, medium-term, and long-term investment with funds

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that match the maturities of assets. Commercial credit can also be financed through Islamic contracts. From a practical point of view, it is worth underscoring the Malaysian experience of legal recognition of investment accounts with the Islamic Financial Services Act 2013 (IFSA) that came into effect on the 30th June 2015. The new regulation provides a differentiation between the deposit account and the investment account11 that offers a new investment avenue that caters to a wider range of investor risk-return preferences. In contrast to the deposit account, these funds are being channeled directly to finance entrepreneurship in productive activities. Additionally, the Investment Account Platform (IAP) is currently being developed and will provide a centralized multi-bank platform as a new financing option for entrepreneurs with viable projects as well as an opportunity for the investing public to finance these projects (Aziz 2016). Capital Markets: (Bacha and Mirakhor 2013; Krichene 2013; ISRA 2015). The development of Islamic finance emphasizes, besides the promotion of investment banking, the development of capital markets. Capital markets offer both savers and entrepreneurs the appropriate channels for satisfying their respective needs for diversified investment opportunities and for long-term capital to be fixed in real assets such as buildings, machinery, infrastructure, etc. Large projects require fixed capital and are financed through the capital markets. Stock markets, the main component of capital markets, essentially involve non-interest-based financing and should constitute a priority area in the strategy for developing Islamic finance. They offer the most sophisticated market-based risk-sharing mechanism (Brav et al. 2002). Conditions for wider participation in the stock market have been analyzed in the literature. Allen and Gale (2007) suggest that a successful, deep, and active stock market requires that information, enforcement, and governance costs to be eliminated or at least minimized. Regarding the gap between what Islam teaches and the actual behavior in the market, Mirakhor (2010) recommends a set of policies, actions, and institutions that would elicit market participants to behave in compliance with Islamic rules. The policies would include, inter alia: (i) creating a

11 Banks have to migrate their “Mudaraba” deposit accounts into either “Wadiah” deposit accounts or ‘Qardh’ accounts and convert them into “Mudaraba” Investment Account.

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level playing field for equities to compete fairly with debt-based instruments. It requires to remove all legal, administrative, economic, financial, and regulatory biases that favor debt12 ; (ii) creating positive incentives for risk sharing via the stock market; (iii) limiting leverage (including margin operations) of non-bank financial institutions and the creditcreation ability of banks; (iv) developing strong and dynamic regulatory and supervisory systems for the stock exchanges; (v) regulating and supervising reputational intermediaries; (vi) ensuring completely transparent and accurate reporting of the day’s trade by all exchanges; and (vii) instituting legal requirements for the protection of the rights of minority shareholders.13 These policies should be supplemented by a strong capacity building program through investment in (i) capacity building to produce competent, well-educated and trained human resource, such as lawyers, accountants, financial journalists, Shariah scholars; and (ii) massive public education campaign to familiarize the population with the benefits of stock market participation. The development of the Interbank Money Market as an institution of liquidity management is crucial to the functioning of the Islamic banking system in (i) providing the Islamic financial institutions with the facility for funding and adjusting portfolios over the short term; and (ii) serving as a channel for the transmission of monetary policy. The underlying philosophy of the Islamic Money Market is to further strengthen the institutional structure of Islamic banking operations, through channeling surplus liquid resources for investment, and to meet short-term liquidity needs. Wealth Funds are another key component of capital markets. Funds are entities that intermediate between savers and investors. Islamic investment funds have risen in terms of demand and supply. Almost 41% of the world sovereign wealth funds (45% of shares) are established by Muslim countries (Habib et al. 2014; SESRIC 2015). However, Habib et al. (2014)

12 de Mooij et al. (2013) stressed that most corporate tax systems favor debt over equity finance. The fact is now widely recognized as, potentially, amplifying risks to financial stability. In investigating empirically the link between this tax bias and the probability of financial crisis, they found that greater tax bias is associated with significantly higher aggregate bank leverage, and that this in turn is associated with a significantly greater chance of crisis. 13 One of the key indicators used in the World Bank report “Doing Business”.

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found that many of the sovereign wealth funds in Muslim countries are among the least compliant with the Santiago Principles—a comprehensive set of voluntary codes which can serve as a framework of international best practices for Sovereign Wealth Funds and a landmark achievement in the area of their governance. Accordingly, the study suggests that the sovereign wealth funds in Muslim countries should endeavor to improve their governance structures, public disclosures, transparency, and accountability framework. Microfinance: Microfinance has been recognized worldwide as an important policy instrument to improve access of the poor to financial services for the success of market-based and sustainable poverty alleviation programs. The performances of Islamic microfinance in general are promising. Evidence from impact studies provides positive results on how Islamic microfinance can improve income and income-generating activities of the clients. However, there is still room for improvement, with regard to the improvement of regulation and provision of training in social development both for the institution’s employees and borrowers (Rijwanti 2013; Islamic Research and Training Institute-IRTI 2008; Ali and Al-Owaihan 2008; Ahamad et al. 2016). Literature shows that microfinance empowers women especially, in terms of involvement in income-generating activities, the capability to spend on family, asset ownership and decision-making ability (Hashemi et al. 1996, Cheston and Kunh 2002; Nader 2008). Deposit Takaful (Insurance) (International Centre for Education in Islamic Finance—INCEIF 2012). Deposit insurance is a powerful means to build and maintain public confidence in deposit-taking institutions. Countries, where these institutions are emerging, should consider setting up protection schemes for Islamic depositors. In addition to its potential to provide financial stability, a deposit Takaful (DT) may also have several advantages from a developmental perspective. This is particularly relevant in low-income countries, where there is typically a lack of public trust in the banking system. A well-designed deposit Takaful scheme would encourage participation in the banking system and improve financial inclusion. The deposit Takaful will have to be designed in a way that complies with the Islamic Law. Several important issues need to be addressed, including: (i) the scheme’s coverage; (ii) the funding and investing policies; (iii) the resolution process for dealing with bank failure.

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The Macroeconomic Policy Framework 5.5.1

The Principles of Islamic Economics

An economic principle (economic law) is defined as a statement of an order or relation of phenomena that appears to hold under given conditions (Fetter 1915). Economic principles refer to how the economy works (or should work) or to economic actors. Based on this definition, Islamic economic principles are inferred from the institutional framework in answering the following three questions: How do economic actors make a decision? How does the economy work as a whole? How do economic actors interact with each other? 5.5.1.1 Decision-Making by the Economic Actors It is worth reiterating that the Qur’an in verse 96 of Chapter 7 stresses the necessary condition (‘iman’) and sufficient condition (‘taqwa’) for a prosperous economy. Therefore, individual economic decisions and actions in an Islamic economy must be governed by the capstone rule of inducing rule compliance and discouraging rule violation.14 In discussing the significance of rule compliance, Askari et al. (2015) emphasize that “compliance with the rules prescribed by the Lawgiver prevents distortions. The rules constitute a network that regulates all dimensions of the human experience, individually and collectively.” Particularly, this compliance would ensure lower corruption and other negative behavior that cause inefficiencies in the economy. Such behavior, if persists in an Islamic economy, may also lead to failures in the functioning of the economy. 5.5.1.2 Functioning of the Economy as a Whole – Price mechanism and competition in the market of products and services. Compliance with the rules of market behavior internalized by the participants such as full disclosure of information, trustworthiness, truthfulness and faithfulness to the terms and conditions of contracts based on mutual consent, trust, and non-interference with the working of markets and price mechanism contribute to reducing uncertainty and cost of transactions, ensure fairness and justice in 14 Biraima (1991) argued that “the economic actions of a Muslim must be governed by the principle of thankfulness. This means that he will be guided in all his economic activities by the desire to maximize an ‘Iman’ function, the arguments of which consist of good economic deeds.”

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the transactions, minimize the probability of asymmetric information and finally ensure the determination of just price by the market. Production factors pricing . The principle of justice requires each factor to receive the full value of its contribution to production and the profit-sharing arrangement ensures that excess profit is shared between factors of production. Specifically, the rule of work and work ethics sustains the provision of a humane work environment, a continued enhancement of human capital development (personal knowledge, skills, performance). Growth and price stability. Compliance with principles of risk and return sharing, rules about prohibiting wealth hoarding, moderation in spending, avoidance of waste of resources and opulent consumption, the rule of banking to operate without interest-based debt and to promote risk-sharing financing of real productive activities would provide strong incentives for savings and investment, which in turn sustains growth output. On the demand side, rules of balanced consumption for both private and public sectors, the prohibition of extravagant and opulent expenditures, the anchorage of investment decisions to the real rate of return instead of volatile interest rates, would smooth out fluctuations of the aggregate demand. In case of economic disequilibrium in the economy, the state performs appropriate fiscal and monetary policies to maintain output and employment close to their natural level in the long term and ultimately to ensure economic equilibrium. Fiscal sustainability. The state should set out efficient institutions for the supervision and regulation of the economic activities to preserve public interest and the enforcement of the rules of behavior as prescribed in the Qur’an and Sunnah to achieve social justice (Siddiqi 1996; Askari et al. 2015). The public finance rules also delimit the scope of public expenditures which will target development project, and public revenue, particularly the taxation structure consistent with prescription of the Qur’an. In the case of a deficit, the policy instrument of public borrowing which should comply with the prohibition of the interest rate and are based on risk-sharing principles. Financing the productive sector. The financial system should perform to support real sector activities and promote economic growth without inflation pressures. The institutional framework must also promote vibrant capital markets while preserving the stability of the

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financial system, enhancing financial inclusion to promote growth and reduce poverty and inequality. Improving access to finance for the poor would enable them to finance their human and physical capital accumulation. – Enabling business environment. Rule of property rights and their protection, justice for all and enforcement of laws sustained by an enforced incentive structure of rewarding rules compliance and punishing rule violation, provides a legal and regulatory framework that ultimately create a secure business environment for investment, production and exchange activities. – Social safety nets . Rules of unity and justice, supplemented by distribution/redistribution rules of revenue and wealth, rule of inheritance, if sustained by the appropriate enforcement structures, will favor poverty alleviation, ensure equality of opportunity for all, efficient management of depletable resources for the benefit of present and future generations. It is worth noting that the major portion of social safety nets is the responsibility of individual Muslims, while governments only pick up the shortfall. – Environmental care and preservation of resources. The principle stems from the concept of unity of the creation as a corollary of the core Islamic axiom of Oneness and Uniqueness of the Creator. Man’s relation with the universe is a relationship of sustainable utilization taking into account the interests of nature and all others creatures. 5.5.1.3 Interaction of Economic Actors with Each Other – Social order and economic integration. Compliance with the rules of unity, consultation, cooperation and competition in “good,” the negation of harmful externalities and reprisal favor a responsible and active participation of individuals in the economic affairs of society, enhance community solidarity, mitigate the emergence of collective problems and ultimately strengthen and preserve social order.

5.5.2

Design of the Macroeconomic Policy Framework

From an operational point of view, design of a policy-oriented macroeconomic model involves identifying a set of targets (values of certain endogenous variables which the policymaker would like to achieve),

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Table 5.1 G20 enhanced structural reforms

Enhanced structural reforms Promoting trade, foreign exchange, and investment openness Advancing labor market reform, educational attainment and skills Encouraging innovation Improving infrastructure Promoting fiscal reform Promoting competition and an enabling environment Improving and strengthening the financial system Enhancing environmental sustainability Promoting inclusive growth Source G20 Framework Working Group (2016)

instruments (policy variables controlled by the policymaker) required to reach given targets, an analytical framework which links policies to chosen targets, and finally the timeframe of reforms. From an operational point of view, unlike the common practice in mainstream economics which has come under intense criticism—particularly because its core focus remains the macroeconomic stabilization dimension in the short term15 —it can be argued that the adoption of the Islamic rules and objectives presented and the formulation of economic policy from an Islamic perspective will be more focused on its structural dimension. A similar conclusion could be inferred from Askari et al. (2014, pp. 237–238) who pointed out, in addressing policy challenges from an Islamic perspective, that “ the central goals of Islam for society are the welfare of all its members and socioeconomic justice” and also from a policy perspective “… one would expect a higher rate of growth as higher investment rate, higher educational expenditures, high social awareness, better functioning markets, higher level of trust, and institutions that have been shown to be critical for growth.” For comparison, Table 5.1 presents the enhanced structural reform adopted by the G-20 Finance Ministers and Central Bank Governors Meeting in Shanghai (26–27 February 2016). The set of structural reform is a priority for the G20 to achieve its goal of strong, sustainable and balanced growth. 15 This issue will developed in the next chapter.

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Islamic economic principles encompass strengthening market incentives, raising economic efficiency that favors a sustainable rate of potential growth, human capital development, enhancing economic resilience to shocks (domestic and external and environment sustainability. They differ from the G20 framework policy guidelines; in that in an Islamic economy, emphasis is placed on: • The objective of Islamic institutions and related policies to realize social economy and social justice. • Market role in the Islamic economy is an instrument, not an overarching, comprehensive, independent organism as in the conventional economic system. • For labor market and work ethics, principle of justice requires the labor factor to receive the full value of its contribution to production, and according to the profit-sharing arrangement, part of the excess of profit; contracts must safeguard the minimum requirements that fulfill the basic needs of workers. • Financing of the real economy and fiscal balance excludes interestbearing financial contracts and promotes risk-sharing principles. • Rules of property (right of possession) and rules of distribution and redistribution of income and wealth. The Islamic institutional framework anchors macroeconomic policies and guides them toward objectives of stability and sustained and inclusive growth. Policy design extends to both policy goals and policy tools, as well as structural reforms alongside fiscal policy and monetary policy. Based on current practice, an Islamic macroeconomic policy framework could be summarized as follows (Table 5.2). The Islamic economic principles outlined in the previous section must be considered as general policy guidance that should be detailed according to the proper characteristics of economies. The benchmark for sustained growth takes into account the crucial issue of poverty. It is determined on base consultations with the IMF and World Bank staff teams and our experience at the Central Bank BCEAO. It also refers to findings of studies on the relationship between economic growth, inequality and poverty that shows on average, a 10% increase in economic growth (measured by survey mean income) will produce a 25.9% decrease in the proportion of people living in poverty—poverty elasticity to rate

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Table 5.2 Islamic macroeconomic policy framework Goals

Policies and Instruments

Medium to long Run

1. Sustained economic growth (>7%)

Short run

2. Macroeconomic stability – Price stability – Sustainable fiscal balance: >−3% in the medium-run and fiscal balance in the long run – Sustainable external current account >−5% – Foreign reserves: a coverage of at least three months of imports

– Implementation of Islamic economic principles – Set up a legal infrastructure to ensure the enforcement of the rules of behavior Monetary policy – Primary market (open market-type operations of central bank papers and government securities), secondary market operations – Other indirect instruments as reserve requirements, public sector deposit, foreign exchange swaps Fiscal policy – Flat tax comprising income tax component (20%) and wealth tax component (2.5%) based on the Qur’an – Spending-based adjustment – Financing of fiscal deficit with non interest-based debt or issuance of equity participation shares Foreign exchange – Export diversification (markets and products): foreign reserves accumulation

Source Dieye (2017)

of growth of 2.59 (Adams 2003). As for growth, the benchmarks for macroeconomic stability (fiscal balance and external current account balance norms) refer to convergence criteria adopted in the European Union (EU) and in the West African Economic and Monetary Union (WAEMU). Also, they encompass conclusions of consultations with the IMF and World Bank staff teams and our experience at the Central Bank BCEAO on the issue. The reserve coverage ratio refers to the “rules of thumb” that have been used to guide reserve adequacy suggest that

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countries should hold reserves covering 100% of short-term debt or the equivalent of three months’ worth of imports (IMF 2011). The legal infrastructure to enforce the rules should provide clear incentives of rewarding rule compliance and punishment of rule violation. It could be supplemented by enforcers (courts, police, ombudsmen, etc.). Askari et al. (2015, p. 52) underscore that “the stronger the rule compliance by individuals in the society, the more self-sustaining and self-enforcing the rules become. For this outcome to be attained, the rules must be internalized by individuals as endogenous elements of their own mind …” From this point of view, the education of individuals according to Islamic values at every stage of the social ladder should be of the highest priority. From an empirical standpoint, some key issues require attention: • Impact of the sequence16 and pace (speed) of economic policies implementation and the available financing to sustain fiscal consolidation (Zalduendo 2005; Feltenstein and Nsouli 2001; Fan and Woo 2009). Results show that trade and financial liberalization have a positive effect on growth, but more so if they follow economic stability17 and fiscal sustainability (Zalduendo 2005). • Speed of fiscal adjustment and fiscal discipline. Stehn (2011) suggested a “speed limit” of around 2% of GDP and lower in countries with fixed exchange rates. Ljungman (2008) has argued that expenditure ceilings, supported by political commitment, are effective in promoting fiscal discipline and sustainability. However, a number of trade-offs have to be made when setting up a fiscal framework that will survive in a politically charged environment. • Country policy and institutional assessment. A Country Policy and Institutional Assessment is a diagnostic tool developed by some International Financial Institutions (World Bank 2010; African Development Bank 2016) that assesses regularly, for every determined period, the conduciveness of policies and the performance of institutional frameworks. From an Islamic perspective, Askari et al. (2017) conceived an Islamicity Index in order to provide a 16 Reforms implemented simultaneously = big bang, and if implemented sequentially, after uncertainty resolution on the first reform = gradualism. 17 In the context of Global economy, the requirement of macroeconomic stability stands also for an Islamic economy to increase savings, investment, foreign capital inflows—all of which are central to the growth process.

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benchmark for measuring the degree to which a country follows the practices and rules prescribed in Islam. Rules of the institutional framework derived from the Qur’an are grouped in four clusters: economics, legal and governance, human and political rights and international relations. These key dimensions are broken down further into sub-elements that were built to provide the characteristics of a rule-abiding Muslim community.

5.6

Conclusion

The Islamic policy framework outlined in Chapters 4 and 5 comprise a set of rules gained from the Qur’an and the Sunnah that provides sound grounds for the design of macroeconomic policies consistent with the principles of social welfare and social justice in Islam. Recent conceptual works in Islamic economics have investigated the adjustment process and establish the stability of the Islamic economic system in response to shocks. For Islamic finance, in particular, the assumption of 100% reserve bank and the prohibition of interest-based financial transactions eliminate the ability of the financial system to create money out of thin air and limits the ability to leverage an asset base into much larger liabilities, two sources of instability associated with conventional interest-based fractional reserve banking. Moreover, the replacement of an interest-based debt financing with a risk-return sharing principle translates into a closer relationship between the financial and the real sectors of the economy. From a methodological point of view, researchers have developed a set of indicators that allows for a performance assessment of the economies (Muslim and non-Muslim) based on institutions prescribed in the Qur’an and implemented by the Prophet (SAW ). This foundational research, coupled with methodological developments derived from mainstream economics would provide a framework for economic diagnostic and formulation of policies according to the Islamic rules of behavior.

References Adams, R.H., Jr. 2003. Economic Growth, Inequality, and Poverty: Findings from a New Data Set. World Bank Policy Research WP, 2972. African Development Bank. 2016. Country Policy and Institutional Assessment Methodology. African Development Bank.

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Ahamad, S., B. Rosni, and Z. Lubis. 2016. Islamic Microfinance and Its Impacts on Borrowers: A Systematic Review from 1995–2015. Mediterranean Journal of Social Sciences 7 (6): 113. Ali, Abbas J., and Al-Owaihan, Abdullah. 2008. Islamic Work Ethic: A Critical Review. Cross Cultural Management: An International Journal 15 (1): 5–19. https://doi.org/10.1108/13527600810848791. Askari, Hossein, Hossein Mohammadkhan, and Liza Mydin. 2017. Reformation and Development in the Muslim World: Islamicity Indices as Benchmark. Springer. Askari, Hossein, Iqbal Zamir, and Mirakhor Abbas. 2014. Fiscal and Monetary Policy in Islam. In Challenges in Economic and Financial Policy Formulation. Palgrave Studies in Islamic Banking, Finance, and Economics. Palgrave Macmillan, New York. ———. 2015. Introduction to Islamic Economics: Theory and Application. Singapore: Wiley. Aziz, Zeti Akhtar. 2016. Opening at the IFSB Industry Engagement Session. Kuala Lumpur. Bacha, Obiyathulla Ismath, and Abbas Mirakhor. 2013. Islamic Capital Markets: A Comparative Approach. Hoboken, NJ: Wiley. Benes, Jaromir, and Michael Kumhof. 2012. The Chicago Plan Revisited. IMF Working Paper 202/12. Biraima, Mohammad E. 1411 A.H./1991 A.D. A Quranic Model for a Universal Economic Theory. Department of Economics, JKAU: Islamic Economics 3: 3– 41. Brav, Alon, George M. Constantinides, and Christopher C. Geczy. 2002. Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence. Journal of Political Economy 110 (4): 793–824. Chapra, Muhammad Umer. 1416–1995. Islam and the Economic Challenge. The Islamic Foundation and the International Institute of Islamic Thought Islamic Economics Series, 17. Cheston, Susy, and Lisa Kuhn. 2002. Empowering Women Through Microfinance. Opportunity International. de Mooij, Ruud, Michael Keen, and Masanori Orihara. 2013. Taxation, Bank Leverage and Financial Crises. IMF Working Paper 13/48. de Soto, Jesús Huerta. 2006. Money, Bank Credit, and Economic Cycles. First English edition. Auburn, AL: Ludwig von Mises Institute. Dieye, Adama. 2017. Riba-Free Model of Stabilization and Growth: Application to Senegal. International Centre for Education in Islamic Finance PhD, Kuala Lumpur. Fan, Gang, and Wing Thye Woo. 2009. The Parallel Partial Progression (PPP) Approach to Institutional Transformation in Transition Economies: Optimize Economic Coherence Notpolicy Sequence. Modern China 35 (4): 352–369.

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Feltenstein, Andrew, and Saleh M. Nsouli. 2001. Big Bang Versus Gradualism in Economic Reforms: An Intertemporal Analysis with an Application to China. IMF Working Paper 01(98). Fetter, Frank Albert. 1915. Economic Principles, vol. 1. New York: The Century Co. Fisher, Irwing. 1936. 100% Money. New York: Macmillan. Franklin, Allen, and Douglas Gale. 2007. Understanding Financial Crises. Oxford: Oxford University Press. G20 Framework Working Group. 2016. G20 Enhanced Structural Reform Agenda. www.mofa.go.jp/files/000185875.pdf. Habib, Farrukh, Sairally Salma, and Mirakhor Abbas. 2014. Governance, Transparency and Accountability of Sovereign Wealth Funds in Muslim Countries. Journal of Islamic Business and Management 4 (2): 127–142. Hashemi, Syed M., Sidney Ruth Schuler, and Ann P. Riley. 1996. Rural Credit Programs and Women’s Empowerment in Bangladesh. World Development 24 (4): 635–653. IEG-World Bank. 2010. The World Bank’s Country Policy and Institutional Assessment: An IEG Evaluation. Washington, DC: The World Bank. International Centre for Education in Islamic Finance (INCEIF). 2012. Takaful: Realities & Challenges. Kuala Lumpur: Pearson Malaysia. International Monetary Fund. 2011. Assessing Reserve Adequacy. IMF Policy Papers, Washington, DC. International Shar’iah Research Academy for Islamic Finance (ISRA). 2015. Islamic Capital Market: Principles & Practices. Pearson Malaysia. Islamic Research and Training Institute (IRTI). 2008. Islamic Microfinance Development: Challenges and Initiatives. Policy Dialogue Paper. 2. Kamali, Mohammad Hashim. 1991. Principles of Islamic Jurisprudence, 1st ed. Kuala Lumpur: Ilmiah Publishers. Krichene, Noureddine. 2013. Islamic Capital Markets: Theory and Practice. Singapore: Wiley. Ljungman, Gosta. 2008. Expenditure Ceilings—A Survey. IMF Working Paper 08/282. Mirakhor, Abbas. 2010. Whither Islamic Finance? Risk Sharing in an Age of Crises. Paper presented at the Inaugural Securities Commission Malaysia (SC) — Oxford Centre for Islamic Studies (OCIS) Roundtable, March. Mirakhor, Abbas, and Noureddine Krichene. 2009. The Recent Crisis: Lessons for Islamic Finance. Second lecture. Kuala Lumpur, Malaysia: IFSB. Mirakhor, Abbas, Noureddine Krichene, and Mughees Shaukat. 2012. Unsustainability of the Regime of Interest-Based Debt Financing. ISRA International Journal of Islamic Finance 4 (2): 25–52.

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Nader, Yasmine F. 2008. Microcredit and the Socio-Economic Wellbeing of Women and Their Families in Cairo. The Journal of Socio-Economics 37 (2): 644–656. Othman, Azura, and Abbas Mirakhor. 2013. An Islamic Solution to the Present Policy Dilemma. New Horizon, January. Phillips, Ronnie J. 1992. The ‘Chicago Plan’ and New Deal Banking Reform. The Jerome Levy Economics Institute of Bard College Working Paper, 76. Rijwanti, Nur Indah. 2013. Islamic Microfinance as an Alternative for Poverty Alleviation: A Survey. Afro Eurasian Studies 2 (1–2): 254–271. Rothbard, Murray N. 2008. The Mystery of Banking, 2nd ed. Auburn, AL: Ludwig von Mises Institute. Sadr, Seyed Kazem. 2016. The Economic System of the Early Islamic Period: Institutions and Policies. New York: Palgrave Macmillan. Siddiqi, Mohammad Nejatullah. 1996. Role of the State in the Economy: An Islamic Perspective. Islamic Economic Series 20. The Islamic Foundation. Simons, Henry Calvert. 1948. Economic Policy for a Free Society. Chicago, IL: University of Chicago Press. Statistical, Economic and Social Research and Training Centre for Islamic Countries (SESRIC). 2015. OIC Economic Outlook: Promoting Investment for Development. Organization of Islamic Cooperation (OIC). Stehn, Sven Jari, Jan Hatzius, Dominic Wilson, and Stacy Carlson. 2011. The Speed Limit of Fiscal Consolidation. Global Economics Paper, 207. Gs Global Economic Website. Tobin, James. 1963. Commercial Banks as Creators of ‘Money’. Cowles Foundation for Research in Economics Discussion Paper 159, Yale University. World Bank (2002). 2017. Country Policy and Institutional Assessment CPIA 2017 . The World Bank. Zalduendo, Juan. 2005. Pace and Sequencing of Economic Policies. IMF Working Paper 05/118.

CHAPTER 6

Sustainability of the Senegal Socioeconomic Model

This chapter analyzes Senegal’s economic and social performance over the period between 1980 and 2014, as well as recent developments since the government introduced its growth strategy, “The Emerging Senegal Plan” (ESP) in 2015. The chapter diagnoses the country’s disequilibrium under the IMF and the World Bank programs, and seeks to clarify why Senegal remained under a prolonged adjustment program. We also look to assess the failure of these programs that justify the need for finding an alternative to the existing conventional economic policy model. The new paradigm to be developed is intended to help authorities achieve sustainable economic growth, to improve human development and ultimately social justice.

6.1

Real Sector Development

This section analyzes: (i) the growth and inflation performance of the Senegalese economy, (ii) the evolution of the savings-investment balance, and (iii) the dynamic of the factor productivity indicator. 6.1.1

Growth and Inflation

Under macroeconomic adjustment policies, real GDP growth in the country was weak and produced volatile results (Fig. 6.1). In the short © The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_6

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10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0

-6.0

Fig. 6.1 Senegal. Real economic growth (GYR) 1980–2014 (%) (Source Government of Senegal/ANSD)

run, the terms of trade shock had formed an important part of cyclical fluctuations. Over the long-term, low domestic productivity, in the agriculture and energy sectors, explains around 65% business cycle variation in the output. Also, the preponderance of an informal economy underscored a slow structural economic change1 (Diop and Fame 2007). Considering the demographic growth rate, averaging 2.5% during 1988–2013, real GDP per capita showed low progress when assessed against the average per capita GDP growth of the middle-income countries group between 2004 and 2014. Inflation in Senegal was contained at low levels compared to rates recorded by the middle-income countries group, except during the first two years following the CFA Franc devaluation by 50% in 1994 and during 2007–2008 when inflation increased due to the sharp rise in energy and food prices globally. However, from 2004 to 2014, the inflation rate averaged 2.3%.

1 In 2011, the non-agricultural informal sector concentrated 48.8% of the active population and its share in the GDP and produced 41.6% of the GDP (Government of Senegal/ANDS 2014).

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6.1.2

159

Saving and Investment

During the 2000s, Senegal recorded a significant rise in investment, mostly the public sector. However, due to the moderate growth of national savings, this increase has widened the resource gap (savings minus investment), thus triggering a persistent dependency on external financing resources (Table 6.1). Results of investigation on the impact of investment suggest that the growth rate of GDP remained inelastic to high investment in the economy, including the rising private investment. For the public investment program, relevant research (Diop and Fame 2007; Estache and Muñoz 2007; Diagne et al. 2014) found low efficiency in government spending, translated in high capital ratio output, excessive cost, delays in execution, and low recurrent maintenance expenditure. The downward trend of the Total Factor Productivity indicator since the mid-2000s (Fig. 6.2) provides evidence of low productivity identified as one of the major constraints to economic growth (Diop 2012; Kireyev and Mansoor 2015). Recent research (Maurel and Seghir 2014; Issoufou et al. 2013) emphasized that the deterioration of Senegal’s doing business (Appendix C) and governance indicators, which could have affected the productivity of both public and private investment.

6.2

Fiscal Developments

Considering the impact of the country’s fiscal situation on the economy, fiscal balance is a major concern of macroeconomic adjustment policies. The dominant trend in the public finance sector has been the pronounced widening of the fiscal deficit (around 8% on average over the last six years). Table 6.1 Senegal. Savings and investment (% GDP)

Gross national savings Total investment Resource gap

1994–2003

2004–2008

2009

2010

2011

2012

2013

2014

13.1

16.4

15.6

17.6

17.4

18.3

17.5

19.1

17.8

26.3

22.4

22.0

25.6

29.1

27.9

27.9

4.7

9.9

6.8

4.4

8.2

10.4

10.4

8.8

Source IMF WEO Database

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1.10

1.05

1.00

0.95

0.90

0.85

Fig. 6.2 Senegal. Total Factor Productivity Index (2001 = 1) (Source Penn World Tables 8.0)

The deficit was at a sustainable level below 4% of GDP in the 1990s through to the beginning of the 2000s. This evolution reflects a growth of expenditures that outpaced revenue collection, with tax receipt to GDP ratio around 20%, above the regional convergence norm of 17%. Pressures on government spending revealed the combined effects of several policies in response to various exogenous shocks and social and developmental needs while implementing structural reforms. Due to these huge slippages, debt relief did not improve as expected. Therefore, internal sources and more recourse to external financing covered the growing borrowing requirements of the public sector in the period from 2004 to 2014 (Fig. 6.3).

6.3

Money and the Banking Sector

Senegal’s financial system is quasi-conventional bank-based (89% of total assets), with only one bank offering Islamic financial products and services. The rest of the financial system is composed of microfinance institutions (7% of total assets) and insurance companies (4% of total assets). Outside of the government, regional securities, and the equity market, there is a limited source of funding. An overview of financial soundness indicators suggests that banks in Senegal meet capital adequacy standards (Imam and Kolerus 2013; IMF 2017). The banking sector

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500.0 400.0 300.0 200.0 100.0 0.0 -100.0 -200.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 FIN. EXT

FIN.INT

Fig. 6.3 Senegal. Fiscal balance financing (billions FCFA) (Source Government of Senegal)

has strengthened significantly in recent years, with the ratios of credit and deposits to GDP amounting to 34 and 33.1%, respectively. Banks in Senegal finance mainly prime borrowers, such as trade finance, with short-term credit (around 50% of the total domestic credit to the private sector). Key risks represent lending concentration and asset quality (nonperforming loans amount to 9.2% of the total domestic credit to the private sector). Microfinance Institutions (MFIs) represent a small, but rising share of the Senegalese financial sector. They focus on basic services such as savings accounts and microcredit. According to a survey by Imam and Kolerus (2013), more people have accounts at MFIs than at banks, which helps raise overall access to the financial system to about 20% of the population. MFI loans amount to about 10% of bank credit. Larger MFIs cooperate with various commercial institutions in transferring money and increasingly use banks to finance operations as they do not have access to BCEAO refinancing. The largest MFI in the country had experienced governance issues in the past, but this was swiftly addressed by the authorities. The main obstacles to further financial development underscored significant informational asymmetries, limited development of risk-sharing and capital markets, a poor business and judicial environment, a low tax regime, regulatory and supervisory issues, and modest skills.

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6.4

External Sector

This section reviews the global pattern of external current account payments. The analysis also focuses on the evolution of net FDI inflows and the net inflows of Senegalese workers’ remittances. 6.4.1

Senegal’s External Current Account Payments

Persistent and high deficits of the external current account constitute one of the main macroeconomic challenges of the Senegalese government (Sy and Sy 2013; Kireyev and Mansoor 2015). The structural deficit of the trade balance, mitigated by large inflows of official transfers, and especially workers’ remittances of 11.3% of GDP in 2014, has caused the negative pattern of the external current account. Due to its favorable geographic location, Senegal has a high potential for export (Dieye 1996), notably total free access to a large regional market,2 and easy access to the European, North American, and Asian markets.3 However, while the exchange rate shows no significant signs of misalignment, Senegal has failed to expand its exports significantly by using these opportunities. Grants, government borrowing—including non-concessional commercial loans have funded the current external account deficit. Senegal has been struggling to attract foreign direct investment (FDI). Yet, its net inflows (FDI) of about 2% of GDP in 2014, is far below the ratio of 8% of GDP recorded in Ghana (a competitor of Senegal among the Sub-Saharan middle-income countries) or the net inflow of Senegalese workers’ remittances. It is important to note that these remittances have increased significantly since the beginning of the 2000s, representing 11% of GDP in 2014 compared with 5% of GDP in 2000, and 2.6% in average for the period between 1980 and 1999. Research on the structural deficit of the trade balance has underscored the deep structural problems of the primary and secondary sectors (weak productivity, lack of financing, and energy dependence). The limited

2 West African Economic and Monetary Union (WAEMU), Economic Community of West African States (ECOWAS). 3 For example Senegal is signatory of international agreements for preferential access to these markets, the ‘Everything But Arms’ initiative from the Quad countries (Canada, the European Union, Japan and the United States), the African Growth and Opportunity Act (AGOA).

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10.0 5.0 0.0 -5.0 -10.0

-20.0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-15.0

Fiscal balance (% GDP)

External current account balance (% GDP)

Fig. 6.4 Senegal. External account balance/fiscal balance (% GDP) (1994– 2014) (Source IMF WEO 2016)

export capacity of local firms impedes the supply of competitive and higher value-added products and lead to a rise in imports to cover shortfalls in domestic production (Kireyev and Mansoor 2015; Diouf and Ndong 2014; Sy and Sy 2013). A graphic presentation of fiscal and current account balance patterns (Fig. 6.4) shows, the two aggregates moving in the same direction since 2006. From a policy perspective, the fact supports the view that makes the reduction of fiscal imbalances a key part of the strategies addressing the deficit of current accounts recorded by the Senegalese economy. 6.4.2

Foreign Debt and Debt Sustainability

Since 2011, Senegal’s debt outlook has deteriorated. Recent data shows that the ratio of gross debt to GDP amounted to 57% at the end of 2016 (Fig. 6.5). The ratio of external public debt to GDP rose to 41%; far above the 19% that prevailed in 2006 when Senegal enjoyed debt relief under the Highly Indebted Poor Countries Initiative (HIPIC) and the Multilateral Debt Relief Initiative (MDRI).

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60.0 50.0 40.0 30.0 20.0 10.0 0.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 GOVERNEMENT EXTERNAL DEBT

GOVERNEMENT GROSS DEBT

Fig. 6.5 Senegal. Government gross debt and external debt (2004–2014) (% GDP) (Source International Monetary Fund 2016)

6.5

Country and Policy Institutional Assessment

From the World Bank data, the country and policy institutional assessment indicators (CPIA) show real progress in economic management, but mixed results in public sector management and institutions (transparency, accountability, and corruption), and policies for social inclusion and equity. Assessment of the quality of the business environment exhibits many concerns related to the enforcement of contracts, registering of property, resolution of insolvency, availability of electricity, and credit (World Bank 2016).4

6.6

Social Indicators: Population, Employment, and Poverty

The 2015 Human Development Index report (HDI) ranked Senegal 163 out of 187 countries. Despite a clear poverty reduction of around 23 percentage points in 1994–1995, the latest estimations show 47.6% of the population were living below of the international poverty line $1.25 4 Cf. Appendix E.

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(in purchasing power parity terms) a day. The overall unemployment rate of the labor force is estimated at 15.7% and is significantly higher among young people aged 20–29 years (20%) and women (23.3%) (Government of Senegal/ANSD 2018). A review of the past Senegalese performances reveals unsolved unsustainable external current account and structural economic disequilibrium in spite of the prolonged and repeated adjustment programs supported by the IMF and the/World Bank. As explained earlier, the causes pertain to: • the structural transformation of the economy; • the productivity of the factors and consequently, Senegal’s structural competitiveness; • the efficiency of public expense; • the financing of economic activities; • the large segment of people living below the poverty line, particularly in rural zones, and the very challenging issue of unemployment among youth that would perpetuate generational cycles of poverty and break down in social cohesion. From these findings, it is worth analyzing the government’s strategies to solve impediments and disequilibria.

6.7 Current IMF and World Bank Macroeconomic Adjustment Models for Senegal In practice, increasing collabouration exists between the IMF and the World Bank in the form of joint missions to countries facing severe economic problems. The two institutions examine Senegal’s current adjustment from two angles: (i) analytical framework and (ii) macroeconomic policies. 6.7.1

The International Monetary Fund Analytical Framework

One of the fundamental objectives of the IMF Articles of Agreement is to grant members temporary access to its resources to help them adjust their balance of payments problems without resorting to measures that are “destructive of national or international prosperity” (Ghosh et al. 2005).

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The IMF’s analytical framework is mainly a demand-side approach. The targets are key macroeconomic variables (national output, price level, current account balance, fiscal balance, consumption, and investment). Its instruments are fiscal and monetary policies. The framework focuses attention on the perspective of external financing to restore the viability of the country’s external payments position. A flows-of-funds framework—financial programming5 —safeguards consistency of the intermediate policy targets (such as domestic credit, fiscal balance) and the selected set of objectives (growth, inflation, external current account) to help resolve the country’s economic difficulties. Long-term growth projections take full account of debt-sustainability assessments and systemic stress testing to the baseline scenario for debt dynamics. Current practices suggest the basic IMF analytical framework for Senegal remains in line with the Polak-Robichek model of adjustment—a monetary model of an open economy with a fixed exchange rate. The basic structure of the model (Khan et al. 1990) is as follows. 6.7.1.1 Variables of the Model Y is nominal GDP and y the real GDP; P is the price level; C p is nominal private consumption; C G is government nominal consumption; KP and KG are, respectively, changes in private and public investment; P D is an index of domestic prices; P z is the price of imports measured in foreign currency; T is the government current revenue; Z domestic imports; X domestic exports; F P private foreign assets; F G government foreign assets; e is the exchange rate—the domestic currency price of a unit of foreign currency; DC is the flow of total domestic credit; DP and DG are net private and government borrowings from the banking system; R is change in foreign reserves R; M D is the demand for nominal ˆ P and DC ˆ G, money balances; M S is the supply of money; and DC are the credit flows and are policy variables controlled by the monetary authorities.

5 The financial programming analysis is supplemented by a balance sheet approach (BSA) that focus on shocks to stocks of assets and liabilities, which can trigger large adjustments in capital flows (Ghosh et al. 2005).

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6.7.1.2 Equations of the Model National income accounting identity Y −(CP + K P )−(CG + K G )−X + Z ≡ 0 Public sector budget constraint T − CG − K G ≡ FG + DG Balance of payments constraint R = (X − Z ) + (FP + FG ) Monetary balance sheet constraint M ≡ R + DC Flow equilibrium of money market M S = M D M D = υ. Y Fundamental equation of the monetary approach to the balance of payments,   ˆ P + DC ˆ G R = υ. Y¯ − DC Assuming the expected GDP growth, the financial program aims at restoring price inflation, net foreign assets and the fiscal balance, the monetary equilibrium. From the sought value of foreign reserves R, the targeted expansion of domestic credit is set as the ceiling, often with a sub-ceiling, on expanding credit to the nonfinancial public sector. Further adaptation of the framework emphasized the relationship between the fiscal balance, the balance sheet of the banking system, and the balance of payments (Ghosh et al. 2005). The framework “provides a direct link between policies (the fiscal deficit, monetary policy) and the reserves target while requiring only central bank (or banking system) balance sheet data.” This presentation highlighted the balance sheet of the central bank, and in turn the basic monetary relationship between

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the total supply of money (M S ) and the base money6 (H ) through the money multiplier (m). It is assumed that the money multiplier is stable and predictable, thus, the balance sheet relationship of the banking system can be expressed as following: M S = m(R + DCCB ) where DCCB is the change of the Central Bank domestic assets (public and private), R variation of the international reserves. In this framework, a change in net foreign asset leads to a change in reserve money. Consequently, changes in the net domestic assets of the central bank rather than growth in total credit expansion, would be the policy variable. A basic formulation of the link between the three accounts could derived from the following equations (Ghosh et al. 2005): M S ≡ DCCBG + DCCBP + e¯∗ R

(6.1)

(balance sheet of the Central Bank) where e¯ is a fixed or given exchange rate. The government finances its deficit (D f ) by borrowing from the central bank, the domestic bond market B G or (in foreign currency) from the international capital markets ∗: BG ∗ Df = DCBG + BG + BG

(6.2)

With the following assumptions: real output growth is projected, y =  y¯ , the inflation target is given, π = π¯ , and velocity, v, is predictable, money demand is predictable: M =  M¯ = M( y¯ + π¯ + υ) ¯

(6.3)

Substituting Eqs. (6.1) and (6.3) into (6.2) yield to the level of the financeable budget deficit:   ∗ ¯ Def = eB ¯ ¯ (6.4) G + BG +  M−DCp −e

6 Base money (called also reserve money, high powered money) is defined from the Central Bank balance sheet as the sum of currency in circulation, banks’ deposits and ‘other’ deposits.

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Hypothesis on a reserves target, R =  R˜ at a given exchange rate e, ¯ and on a required minimum expansion of credit to the private sector, DCp = DCp , gives a limit on the financeable deficit. 6.7.2

The World Bank Analytical Framework

By mandate, the World Bank’s mission is to help finance growth and development over the medium term for its member countries. Thus, their framework focuses on economic variables, especially estimating the level of investment, imports, and external finance needed to achieve the targeted real GDP growth rate (supply side approach). An illustration, Khan et al. (1990) outlined a model of economic growth approach by the following equation: Y R∗ = ρ −1 K With ρ = ICOR = incremental capital output ratio, YR∗ is the real GDP targeted; K is the domestic investment. The policy tools in this model are public consumption and tax receipts. If foreign capital is available, Y ∗ can be reconciled with a balance of payments target R ∗ to derive the net of foreign capital needed:  Fˆ = aY R∗ + R ∗ − X¯ In case foreign borrowing is regulated, the model becomes one version of the two-gap growth models (savings gap and foreign exchange gap). The import function adapts to include the exchange rate effect on imports. The equation of net inflow of foreign capital becomes:  Fˆ = aY R∗ − beˆ + R ∗ − X¯

6.7.3

The Integrated Model of the IMF and World Bank Approaches

The macroeconomic approaches of the IMF and the World Bank have been merged into one “hybrid” model of adjustment and growth (Khan et al. 1990; Everaert et al. 1990; Agenor 2004). With the same notations as above, the merged model can be solved in a programming mode. Therefore, Y R∗ (real growth rate) becomes a target policy rather than exogenous and can be a function of savings, taxes and government

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spending, exchange rate, foreign borrowing, and private credit (DC = DCP + DCG ). Y R∗ =

(s − ϑ)Y + (1 − s)Tˆ − Cˆ G + sY−1 − F + D P−1 + P

In the merged model, pre-eminence continues to be given monetary policy (D P , D G or e) or fiscal policy (T and G). Consequently, in the short run, stabilization content of the model is still dominant. External borrowing remains the only alternative to cover the financing gaps. 6.7.4

Critics of IMF and World Bank Analytical Frameworks

One major criticism of the IMF and World Bank stabilization and growth policies is a failure to assess their long-term impact on growth and the many short-term deflationary outcomes (Minsky 1986, 1992; Wolfson 2002). Critics also note the theoretical underpinnings of the analytical frameworks (Mills and Nallari 1992; Agenor 2004; Nowak 2013). These criticisms can be summarized as follows: a. Even though IMF Authorities officially state concern about structural constraint, the core focus of the IMF financial programming framework remains the balance of payment disequilibrium. From a policy perspective, a major assumption underlying the design of IMF programs is that the balance of payments is monetary in nature. Also, the framework emphasizes the relationship between the government fiscal balance, the monetary accounts, and the balance of payments. A fiscal deficit, often associated with excessive credit creation and excessive spending, can result in large external imbalances. Consequently, despite their wider involvement, in the short run, stabilization policies remain dominant in IMF financial program operations which therefore concentrate on a limited number of financial variables such as the external current account and the government fiscal balance, inflation, monetary aggregates and debt. The stabilization programs are usually brought about by a restriction of the aggregate demand (consumption and investment), ensured by the tightening of the monetary policy (credit ceiling, interest rates increase, currency devaluation) and the fiscal policy

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(restrictions on public sector credit to control the government fiscal deficit).7 b. Models do not incorporate important features of developing countries. For example, the effect of debt financing of fiscal deficit on domestic interest rates, the endogeneity of private capital flows, and the short-run link between production and bank credit. Also for developing countries, a major drawback of the IMF financial programming model is that it focuses on the short-term financial cost of public investment without considering its medium-term growth payoffs8 (Estache and Muñoz 2007). c. The supply side of the merged model does not reflect the relation between public investment and private investment (complementary in infrastructure). d. The assumption of fixed-coefficient production (the ICOR relationship) raises many analytical and practical difficulties. It also rules out capital-labor substitutability. e. The equilibrating role of the relative prices is underestimated. Also, the models entail no specific function for expectations in the labor market.

6.8 Current Macroeconomic Policies in Senegal and Perspectives 6.8.1

Background: The Emergent Senegal Plan

In early 2014, the Government of Senegal decided to adopt a new growth strategy entitled “The Emerging Senegal Plan” (ESP). The plan aims at transforming Senegal to an emerging economy by 2035. The Plan rests on three pillars:

7 Considering issues on the reforms of the institutional functioning of the IMF and its conditionality, Metinsoy (2019) argued that “We can speculate that a new monetary fund reflecting the changing realities of the international system’s power balance is a greater possibility than an IMF where the U.S. dominance and the Washington Consensus are replaced with a more egalitarian structure and a non-neoliberal macroeconomic philosophy”. See also, Reinhart and Trebesch (2016). 8 In practice, if fiscal adjustment is needed, investments are treated in the same way as current expenditure with targets for budget cuts, irrespective of their impact on future growth potential.

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i. Higher sustainable growth and structural transformation of the economy through better infrastructure, private investment, and development of new sectors (agriculture, agribusiness, mining, and tourism) to create wealth, jobs, and social inclusion. This pillar is based on a more balanced approach to development, with promoting regions and economic poles to stimulate the potential for development of the entire territory. ii. Human development, with a focus on some social sectors and expansion of the social safety net. iii. Reinforcement of governance, peace, stability, and protection of rights. Through their synergies and cumulative effects, the Senegalese government expects that these three pillars will enable the creation of the conditions for transformation of Senegal into an emerging market country. The ESP is carried out through a five-year Priority Plan with strategic pillars, sectorial objectives, and the Strategy’s lines of action. The priority action plan comprises of 17 major reforms and 27 major projects for implementation over 2014–2018, for a total cost of $19 billion (about 125% of the 2013 GDP). These projects envisage real GDP growth to upsurge, and to reach 7–8% over the medium term. In an optimistic scenario, the ESP financing is estimated at US$18.75 billion. The government will bear a large part of the investment. However, the private sector will contribute to funding and implementation of the plan through public–private partnerships (PPPs).9 The projected funding scheme emphasizes a financing gap of US$7.6 billion (41% of the required financing), to collect from traditional donors— multilateral and regional banks,10 the European Union, the United States, 9 Many countries have adopted the Public-Private Partnership (PPP) approach in developing their infrastructure. The World Bank and many other Development Banks are promoting the PPP mode of infrastructure construction. Senegal experienced Public– Private Partnership transactions in the water subsector (SDE in 1996), rail transport sector (TRANSRAIL in 2003), toll road Dakar-Diamniadio (SENAC SA in 2009, 2014). The Government of Senegal has put in place a legislative and institutional framework including Decree 2014/09 of February the 20th (amended by the Decree 2015-03 of February the 20th) on Partnership Agreements and other Institutions such Ministry in charge of Investment Promotion and Partnership, a national PPP Committee and a PPP Unit. 10 World Bank, African Development Bank, Islamic Development Bank, and West African Development Bank.

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and China. A part of this financing may be secured on non-concessional terms (IMF 2015). In June 2015, the authorities signed with the IMF a new three-year Policy Support Instrument (PSI). This instrument supports a three-year program of macroeconomic reforms to advance the “Emerging Senegal Plan.” The PSI reaffirms the need to preserve fiscal sustainability and strives to keep the fiscal deficit on a downward trend. The institutional framework enabling the implementation of the PES comprises of a Strategic Orientation Committee (SOC) placed under the authority of the President of the Republic, a Steering Committee (SC) chaired by the Prime Minister, and an Operational Office in charge of tracking the Plan for an Emerging Senegal (OOM). 6.8.2

Macroeconomic Policies and Structural Reforms

The government intends to complete a package of policies in the short and medium terms to: • Foster macroeconomic stability with measures supported by the ESP. Key structural reforms aim to create the fiscal space for investment related to the national plan, making delivery of public services more efficient, adjusting government spending through public financial management reforms, and containing public consumption to create the fiscal space for investment in human capital and public infrastructure. • Speed up structural reforms supported by the World Bank and other development partners. The goal is to foster a better business environment to attract FDI and to promote the development of the private sector. Interest is expressed in the reform of the energy sector, the labor market, and the investment regime that stresses ex post confirmation over ex ante approval. Another main policy is performing a comprehensive land reform to improve the property rights, strengthen social safety nets, and encourage private investment in the agricultural sector. 6.8.3

Recent Macroeconomic Estimations and Projections

An overview of recent macroeconomic estimations pointed out a real GDP growth of 6.5% in average on the period 2015–2017, below the

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target set at least 7–8% over the medium term while the estimated inflation rate remained below the target of 2%. From a macroeconomic financial sustainability perspective, estimations, and medium-term targets show a persistent unsustainable financial situation since the estimations and outlook for both the ratio to GDP of overall fiscal balance deficit (excluding grants) and the external current account deficit (excluding official transfers) have worsened above 5%. Particularly the estimations and projections for the external current account deficit show an increase of the ratio to GDP from 4% by 2016 to nearly 9.0% by 2018 and 9.4% 2019 (projection), meaning a persistent need to external resources to fill this macroeconomic financial gap. In December 2018, at the end of the PSE Phase I (2015–2018), the government of Senegal had organized, with the support of the World Bank and the United Nations Development Program (UNDP), a Consultative Group with a view to mobilizing additional resources to finance the PSE Phase II over the 2019–2023 period. The promised investment resources by the institutional donors amounted 12 billion euros and will be used to develop priority sectors such as agriculture, agribusiness, infrastructure, energy, digital economy, tourism, and finance. On January 10, 2020, the Executive Board of the International Monetary Fund (IMF) approved a new three-year Policy Coordination Instrument (PCI).11 From policy perspective, the program to be supported by the new PCI, in the context of the second phase of the authorities’ PSE is articulated around three main pillars: (i) achieving high, sustainable, and inclusive growth; (ii) consolidating macroeconomic stability through prudent fiscal policy, including through increasing revenues and spending efficiency, and sound debt management; and (iii) managing the oil and gas sector in a sustainable and transparent manner (IMF 2020). It is worth noting that the recourse to external debt to cover the financing gap remains a crucial unaddressed issue. Numerous studies have highlighted the volatility of the Official Development Assistance (ODA) disbursements and their negative impact on macroeconomic management (Lensink and Olivier 2000; Homi 2008). This instability may have increased in recent years, with program assistance and government aid being the most unstable (Hudson 2015). Moreover, many critical views 11 PCI involves no use of IMF resources. It is designed for countries seeking to demonstrate commitment to a reform agenda or to unlock and coordinate financing from other official creditors or private investors.

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that emerged from the post-global finance crisis 2007–2008 diagnostics pointed out that “the leverage-led growth model - a combination of excessive leverage in the financial system, over-indebtedness of households and governments, low interest rates and global imbalances - was at the heart of the great financial crisis ” (Hannoun and Dittus 2017).12 Recently, sharp concerns about the imminence of a new global financial crisis are expressed with a major emphasis on the high level of global debt and a rise in downside risk from both the global and internal environment. Mbaye and Badia (2019), warned that global debt has reached an all-time high of US$184 trillion in nominal terms, the equivalent of 225% of GDP in 2017. On average, the world’s debt now exceeds US$86,000 in per capita terms, which is more than 2½ times the average income per capita. For developing countries particularly, alarm bells signal the occurrence of a boom-bust cycle in capital inflows that could induce disruption in these capital flows. 6.8.4

Country Policy Institutional Assessment

The institutional evolution of Senegal is carried out on the basis of recent estimates of the Islamicity Indices 2017–2018 issued by the Islamicity Foundation (2018), which refer to the rules prescribed by the Qur’an and implemented by the Prophet Muhammad (SAW ). 6.8.4.1 Overall Islamicity Index Country Score Globally, the Senegal Overall Index (OI) recorded a deterioration of 3.2% in 2018 relative to 2017, reversing the positive 2017 trendline. As evidenced in Fig. 6.6, this negative pattern reflected mostly contractions of 9.5% in its Economic Index (EI) and 15.8% in its Human and Political Rights Index (HPRI). However, the impact of this adverse evolution has been mitigated by improvements of 3.9% in the Legal and Governance Index (LGI) and of nearly 22% in the International Relations Index (IRI). From a regional perspective, the Senegal Overall Indices (OI) score was slightly below the group average for all countries. By contrast, it emerged clearly superior to the average of the OIC countries. Performances are

12 Reinhart and Rogoff (2009) argued that all the financial crisis on the past have been debt crisis. Iqbal and Mirakhor (2017) underscored that a debt-based system is a risk transfer system. Financial and economic systems based on risk transfer are basically unstable and are prone to generate this chain of causation repeatedly: Fractional Reserve system → Credit → Debt → Leverage → Fragility → Crisis.

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8 6 4 2 0 2016

2017 OI

2018 EI

LGI

HPRI

IRI

Fig. 6.6 Senegal Overall Index and its components 12.00 10.00

9.20

9.07

9.07

9.38

9.93

8.00 6.00 4.00 2.00 0.00 OI

EI

All countries

LGI

OIC countries

HPRI

IR

Senegal

Fig. 6.7 Senegal score compared to the best Group performers score (2018)

noteworthy for the Legal and Governance Indice (LGI) and the International Relation (IR) Indices which were above All Countries and OIC Countries group averages. Performances were contrasted for the other two sub-indices, with its Economic Indices (EI) lagged behind All countries and OIC countries averages and the Human and Political Rights (HPRI) Indices ranged between the two group averages. Figure 6.7 highlights the extent of Senegal’s performance lag compared to those of the All countries and OIC countries best

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performers. Evidence suggests the need for steadfast implementation of a comprehensive institutional reform strategy in the country, to significantly upgrade the country results to the level of those of the best competitors. 6.8.4.2 Islamicity Indices Ranking Senegal’s Islamicity Indices ranking reflects the country Islamicity scores pattern. The OI rank, (83 in 2018) fell by 5 compared to 2017, reversing the 2015–2017 positive trendline. This overall negative evolution reflected mainly the sharp declines in EI rankings (9 spots) and HPRI (18 spots). In fact, LGI and IRI improved by 3 spots and 24 spots, respectively, thereby attenuating the negative impact of evolutions in EI and HPRI indices on the overall rank. Overall, in 2018, the country did best in its international relations, scoring and ranking highest in IRI among the indices. In contrast, evolution of the EI score and HPRI score raise sharp concerns. Particularly, for the HPRI, Senegal is ranked among the top 10 declines in rank spots. 6.8.4.3 Examination of Changes in the Sub-indices Economic Islamicity Senegal’s economic performance has been generally positive in 2018. The real sector remained robust at 6.2% and inflation stood around 2%. The fiscal deficit is estimated to be at 3.5% of GDP while current account deficit remained significantly high above 7% of GDP. The country also implemented numerous reforms with mirrored improvement in strengthening fiscal sustainability, bank lending to private sector, economic regulation and economic freedom, ease of doing business. Despite these significant positive macroeconomic developments, the Economic Islamicity index remained on the whole negatively affected by the deterioration of some key social indicators such as high levels of unemployment (particularly for youth), relatively high levels of the human inequality coefficient which is above the sub-Saharan mean, and persistence of systemic weaknesses in the rule of law, slowing implementation on reforms to improve the business environment and stimulate private investment. Also, the steady rise in ratio of the total public debt to GDP from 60.6% in 2017 to 64.5% in 2018 suggests a weak adherence to Islamic finance.

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Legal and Governance Senegal recorded a slight improvement of 3.9% in its Legal and Governance Index. The improvement is attributed to progress in indicators related to its Legal System and Property Rights, Government management, political stability, and the absence of violence/terrorism. In fact, the country has regressed on a number of other crucial issues such as security and safety, corruption perception, government integrity, governance (including government effectiveness, voice and accountability, regulatory quality, rule of law, control of corruption). Human and Political Rights The country has achieved convincing results in a number of vital sectors such as social capital, access to education and healthcare, democracy. However, the impact of these positive evolutions has been more than offset by setbacks in all the other areas, inter alia in human development and human development inequality (for which, Senegal is classified among the low human development Group), personal freedom, civil and political rights. Particularly, Senegal’s 2017 Human inequality coefficient (including income inequality) is 31.7%, above the average of 30.7 for countries in the Sub-Saharan Africa and 30.9 for countries in the low human development Group. International Relations The noteworthy performance of the Senegal IRI was attributed to a decrease of its Global Militarization Index (which reflects the relative weight and importance of the country’s military apparatus in relation to the whole society) and an increase of country level of peacefulness. An analysis of the overall evolution of the indices of Islamicity highlights the imperative need to strengthen the institutional framework of economic and social development, notably to improve the entrepreneurial climate, to boost private investment and revenues considering the acuity of social issues aforementioned. Senegal needs more government governance and government effectiveness, an effective enforcement of anticorruption measures and rule of law, more transparency in the management of extractive industries and other natural resources. The fight against human inequality would represent a high priority that could fully benefit from the distribution and redistribution mechanisms derived from the Qur’an and Sunnah.

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The government may consider the increasing cost of public borrowing, and accordingly enhance its adherence to Islamic finance. In this vain, to finance budget deficits, the government should use only non-debt creating flows by: (i) shifting away from interest-based systems toward enhanced risk-sharing systems and (ii) issuing macro market instruments to furnish the Treasury with a significant source of non-interest, rate-based financing while promoting risk sharing. And finally, it is interesting to take a look at the results of the evaluation of the institutional evolution of the country referring to the World Bank Country Policy Institutional Assessment (CPIA) criteria. The overall score for the Senegal recorded a drop of 0.1 point in 2018 compared to 2017 which reflected declines in all the sub-components of the indicator, except for the sub-component “Social inclusion and equity” criteria, that remained stable.

6.9

Conclusion

The Plan Senegal Emergent (PSE) undeniably represents a decent effort by the Senegalese Government toward an appropriation of the process of conception, implementation, monitoring, and evaluation of the economic and social reforms.13 However, surveillance of the PSE remains contingent on the quantitative assessment criteria (AC) and benchmarks of the Policy Support Instrument Program and since 2020, the Policy Coordination Instrument. Moreover, the strategy for mobilizing financial resources constrains recourse to external debt borrowing. It is widely recognized that externally funded government borrowing may run the risk of debt unsustainability as has occurred previously in Senegal which requires debt relief by donors. The search is still on for an alternative paradigm that allows macroeconomic policies and performance within a model that conforms to the populace values and aspirations such as welfare for all and economic and 13 It is worth to note the organization of a widely inclusive national conference “Les Assises Nationales du Senegal” which gathered, between June 1, 2008 and May 24, 2009, more than 140 representatives of political parties, of the civil society and various other independent personalities. The conclusions were signed by almost all the opposition leaders, including the current head of state, as a strong commitment to work towards effective citizen participation in the management of public affairs. However, the main document issued, the “Charter of Democratic Governance” were never adopted and implemented by the government so far.

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social justice, higher ethical standards—particularly trust in all economic and social contracts, poverty alleviation, distributive justice, better social infrastructure, and the provision of high standard social services (inter alia food, shelter, education, healthcare, security) essential to the development of human capacities, higher degree of environmental preservation, a supportive business environment, and the promotion of risk-sharing contracts instead of debt-based contracts. We argue that full compliance to Islamic Institutional rules prescribed the Qur’an and implemented by the Prophet (SAW ) would provide the desired socioeconomic environment. In the proposed Institutional framework and with the accumulated experience in managing public finances and external debt, the government would be better equipped to achieve its goal of fiscal balance and to break the cycle of inherently volatile debt and financial instability.

References Agenor, Pierre Richard. 2004. The Economics of Adjustment and Growth, 2nd ed. Cambridge, MA: Harvard University Press. Diagne, Youssoupha Sakrya, Hamat Sy, and Dame Thiam. 2014. Efficience des dépenses publiques au Sénégal (Senegalese Government spending efficiency). Government of Senegal/DPEE Study Paper 28. Dieye, Adama. 1996. La Compétitivité De L’économie Sénégalaise (The Competitiveness of the Senegalese Economy). University of Auvergne thesis, Clermont Ferrand, France. Diop, Mouhamadou Bamba. 2012. Quels Secteurs Pour Quelle Croissance Au Sénégal (Which Sectors for Which Economic Growth IN Senegal). Government of Senegal/DPEE Study Paper 4. Diop, Mouhamadou Bamba, and Abdoulaye Fame. 2007. Les sources des fluctuations économiques au Sénégal (Sources of economic fluctuations in Senegal). Government of Senegal/ DPEE Study Paper 4. Diouf, Maurice Ngor, and Ndong, Benjamin. 2014. Real Effective Exchange Rate Changes and Trade Balance in Senegal: Twenty Years after CFA Franc Devaluation. 17th Annual Conference on Global Economic Analysis On: “New Challenges in Food Policy, Trade and Economy Vulnerability”. Dakar/ Senegal, June 18–20. Estache, Antonio, and Rafael Muñoz. 2007. Building Sector Concerns into Macroeconomic Financial Programming: Lessons from Senegal and Uganda. World Bank Africa Region, Working Paper Series 108.

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Everaert, Luc, Fernando Garcia-Pinto, and Ventura Jaume. 1990. A RMSM-X Model for Turkey. Country Economics Department. The World Bank, WPS 486. Ghosh, Atish R., Charalambos Chritophides, Jun Il Kim, Laura Papi, Uma Ramakrishnan, Alun H. Thomas, and Juan Zalduendo. 2005. The Design of IMF-Supported Programs. IMF Occasional Paper, 241. Government of Senegal/ Ministry of Economy and Finance. 2014. Emergent Senegal Plan 2014–2018. Government of Senegal. Government of Senegal/ Ministry of Economy and Finance/Agence Nationale de la Statistique et de la Démographie. 2018. Population of Senegal 2017 Report. Government of Senegal. Hannoun, Herve, and Peter Dittus. 2017. Revolution Required—The Ticking Time Bombs of the G7 Model. Independently published. Homi, Kharas. 2008. Measuring the Cost of Aid Volatility. Wolfensohn Center for Development Working Paper, 3. Hudson, John. 2015. Consequences of Aid Volatility for Macroeconomic Management and Aid Effectiveness. World Development 69: 62–74. Imam, Patrick, and Kolerus Christina. 2013. Senegal: Financial Depth and Macro-Stability. IMF/African Department Series paper, 13/05. International Monetary Fund. 2015. Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund. Washington, DC: IMF. ———. 2016. World Economic Outlook. IMF Data Mapper. ———. 2017. Senegal: Staff Report for the Article IV Consultation and Third Review Under the Policy Support Instrument-Press Release, and Staff Report. IMF Staff Country Reports 17 (1): 1. ———. 2020. Request for a Three-Year Policy Coordination, Instrument—Press Release; Staff Report; And Statement By The Executive Director For Senegal. IMF Country Report No. 20/11. Washington, DC. Iqbal, Zamir, and Abbas Mirakhor. 2017. Ethical Dimensions of Islamic Finance. Theory and Practices. Cham: Palgrave Macmillan. Islamicity Foundation. 2018. Annual Report on the Islamicity Indices Program. Report. Issoufou, Salifou, Andrew Jewell, Alexi Kireyev, and Gaston Mpatswe. 2013. Senegal: Achieving High and Inclusive Growth While Preserving Fiscal Sustainability. Washington, DC: IMF. Khan, Mohsin S., Peter J. Montiel, and Nadeem U. Haque. 1990. Adjustment with Growth: Relating the Analytical Approaches of the IMF and the World Bank. Journal of Development Economics 32: 155–179. Kireyev, Alexei, and Ali Mansoor. 2015. Making Senegal a Hub for West Africa. Washington, DC: IMF African Department.

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Lensink, Robert, and Morrisey Olivier. 2000. Aid Instability as a Measure of Uncertainty and the Positive Impact of Aid on Growth. Journal of Development Studies 36: 31–49. Maurel, Matilde, and Majda Seghir. 2014. The Main Obstacles to Firms’ Growth in Senegal, Implications for the Long-Run. African Development Bank Working Paper, 208. Mbaye, Samba, and Marialuz Moreno Badia. 2019. New Data on Global Debt. IMF Blog. https://blogs.imf.org/2019/01/02/new-data-on-global-debt/. Metinsoy, Saliha. 2019. Unending Reform Attempts at the IMF: Organized Hypocrisy or Bricolage? Mills, Cadman Atta, and Raja Nallari. 1992. Analytical Approaches to Stabilization and Adjustment Programs. World Bank Seminar Paper, 44, Washington, DC. Minsky, Hyman P. 1986. Stabilizing an Unstable Economy, a Twentieth Century Fund Report. New Haven and London: Yale University Press. ———. 1992. The Financial Instability Hypothesis. Levy Economics Institute of Bard College Working Paper, 74. Nowak, Wioletta. 2013. The World Bank Revised Minimum Standard Model: Concepts and limitations. Wroclaw economic revue, 19/2, University of Wroclaw. Reinhart, Carmen M., and Kenneth S. Rogoff. 2009. The Aftermath of Financial Crisis. NBER Working Paper, 14656. Reinhart, Carmen M., and Christoph Trebesch. 2016. The International Monetary Fund: 70 Years of Reinvention. Journal of Economic Perspectives 30 (1): 3–28. Sy, Demba and Sy, Hamat. 2013. Causes of the Structural Deficit of the Senegal’s External Account (Les Causes du Déficit Structurel du Compte Courant du Sénégal). Government of Senegal /ANSD study. Wolfson, M.H. 2002. Minsky’s Theory of Financial Crises in a Global Context. Journal of Economic Issues 36 (2): 393–399. World Bank. 2016. Doing Business 2017/Senegal. The World Bank.

CHAPTER 7

Counterfactual Simulation of the Islamic Model for Senegal

Considering the actual data set (available till 2019) and the context of the Phase II of the Plan Senegal Emergent (PSE) (2019–2023), this chapter proposes a counterfactual simulation of the Islamic model for Senegal over the sample period (2019–2024).1 The chapter refers to a policy framework replacing the traditional variables of macroeconomic adjustment policy with their Islamic proxies. It is worth to note that in terms of macroeconomic shocks, the proposed model is well within traditionally modeled adjustment policies in which adjustment to shocks takes place with variables under the control of policymakers such as fiscal policy tools (taxing and spending) and monetary policy tools. The econometric methodology—counterfactual simulation—to simulate the Islamic model of stabilization and growth is one which is widely used with valid and tested intellectual and empirical pedigree. The chapter prospects insights about the modeling approach—in term of counterfactual analysis—and new evidence, from two perspectives: (i) the comparison of ex post realized macroeconomic outcomes with

1 An earlier version of this chapter will appear in: Dieye, Adama. 2020. An Alternative Model of Economic Stabilization and Growth for Developing Countries. In Handbook of Analytical Studies in Islamic Finance and Economics, edited by Nabil Maghrebi, Tarık Akın, Zamir Iqbal, and Abbas Mirakhor. Berlin: Walter de Gruyter GmbH. Deutschland (Forthcoming).

© The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_7

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counterfactual outcomes that could have obtained under certain assumptions regarding the policy variable used in the model and (ii) an ex ante counterfactual simulation of the model over the sample period 2019–2024. Section 7.1 presents a synopsis of the core features of the Islamic macroeconomic framework used to simulate the Islamic model of stabilization and growth for Senegal and results of the economic experiments over the sample period 2015–2019. Section 7.2 is concerned with the counterfactuals in ex post macroeconomic policy evaluation of the impact of fiscal policy on the real economic growth2 in the context of Plan Senegal Emergent Phase I (2015–2019). Then, still with a focus on the real economic growth aggregate, the section presents the model simulation results of the fiscal policy shock and their comparison with the official projections, over the period 2020–2024 covering the Plan Senegal Emergent Phase II. Section 7.3 suggests possible extensions of the model discussions in conclusion.

7.1 Synopsis of the Islamic Analytical Macroeconomic Framework The used Islamic analytical framework is based on an Islamic model of a small open economy with fixed exchange rate (such as Senegal). Macroeconomic policy does not have flexibility on a range of macro and micro variables. Essentially, the policy variables are: the fiscal policy tools (taxing and spending) and monetary policy tools (interest rates, exchange rates and money supply). In the Islamic simulation model, the return on capital and risk-sharing contracts replace the interest rate and the interest-based debt financing, respectively. The Islamic macroeconomic framework refers to a standard macroeconomic model of adjustment and growth with full pedigree dating back to the 1980s and in wide use in macroeconomics (Bourguignon et al. 1989; Ghosh et al. 2005; Mirakhor 1993; Askari et al. 2014). Basically, the structure of the Islamic simulation model is adapted from the Askari et al. (2014) macroeconomic model of open economy extended to the Public finance sector. Two main conclusions of this model are: equilibrium in the

2 For a detailled simulation of the Islamic model for the main macroeconomic sectors (real sector, public finance, financial sector and external sector), see Dieye (2020).

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absence of interest-bearing assets and system stability against debt shocks; the IS line of an open Islamic economy has a positive slope. The result has important macroeconomic policy implications since an increase of the rate of return to investment would translate to an increase in investment. 7.1.1

Equations of the Model

With all macroeconomic variables expressed in real terms, the model equations are: 7.1.1.1

Equilibrium Condition in the Goods and Services Market Y = C + I + (X − M)

(7.1)

C = CP + CG

(7.2)

I = IP + IG

(7.3)

where Y is the real gross domestic product (GDP), C represents total consumption (C P and C G are private and government consumption, respectively), I being the value of the total gross investment (with I P representing a gross private investment, and I G gross government investment), while (X −M ) estimates net exports of goods and nonfactor services. The medium- and long-term rate of output growth will be assumed as an exogenous target, determined according to the investment rate of return to the real economy. The estimated investment rate of return computed for Senegal (Appendix B) during the period 2004–2012 averaged 19%—a high rate compared to the bank-lending rate of return and the interest rate on deposit amounting to, respectively, 9% and 2% on average. Based on the above, the econometric investigation is conducted to identify a long relationship that correlates real economic growth rates (GYR), as the dependent variable, to the computed investment rate of return (IRR), considered as a focal explanatory variable. Regarding the specific conditions of the Senegalese economy, there exists set of controlling variables: the Net Official Development Assistance (NODA—as ratio to the Gross formation capital; the Term of Trade Index (TTR)—to

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proxy the external shocks to the economy; and a dummy variable (DUM) to take into account the effects of the sharp currency spending of the common currency CFA in 1994 of 50% in relation to French Franc. According to the methodology referred to in Chapter 3, a reduced functional form to estimate is specified as follows: GYR =∝0 + ∝1 IRR+ ∝2 NODA+ ∝3 TTR+ ∝4 DUM

(7.4)

Real GDP (Y ) in each period is: Y = Y (−1)(1 + GYR)

(7.5)

The variable IRR is expected to influence GYR favorably. The effects of Net Official Development Assistance and the term of trade (TTR) are controversial issues in the case of developing countries. Specifically the term of trade, according to Blattman et al. (2003) and Fosu and Gyapong (2010), both trend and increased volatility regarding trade adversely affect growth. In contrast, studies of Mendoza (1997) and Barro and Lee (2002) found that advantageous terms of trade had a positive impact on growth. The investment rate of return is raised by the implementation of structural policies that boost competitiveness and increase the attractiveness of the economy. The findings of the Islamic economic model in Senegal are consistent with earlier findings of Diop (2007). The long-term dominance of domestic productivity shocks explains the business cycle variation in aggregate output. The long-term real GDP growth rate determined from Eq. (7.4) translates into the expected growth rate over the long term at which the actual growth rate tends to fluctuate. Therefore, the forecast values of economic growth from the long-term equation may become the reference from which policymakers assume the economic growth rate targets. The economic growth targets should remain sustainable over the long run. An upward growth trend would converge to an equilibrium where capital is preserved, with the ratio of capital output is either constant or decreasing (Mikkelsen 1998). The short-term output converges to the long-term output through changes in prices. The inflation forecast refers to a standard formula of the expectations-augmented Phillips Curve for small open economies with determinants including expected inflation, output gap as well as supply shocks (oil price, food price, power supply). Recent studies suggest inflation expectations anchor price variation targets that refer to price stability

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(Ball and Mazumder 2015). The Monetary Policy Committee, BCEAO, defined price stability in Senegal as an annual rate of inflation between 1 and 3% while the inflation target is equal to 2% of the medium-term forecast. 7.1.1.2

Fiscal Balance Constraint T − CG − IG = FB

(7.6)

where T represents fiscal revenues, C G is current public expenditures, and I G representing public capital expenses, FB the fiscal balance. Public sector consumption and investment arise from autonomous decisions of public administrations. Thus, they cannot follow the same behavioral financial rules of the private sector. With the prohibition of financial contracts based on the ex ante promise of return, it is assumed that the government would issue sovereign risk-sharing securities to finance its development expenditure and fiscal deficit. Regarding the design of these securities, Haque et al. (1999) proposed a National Participation Paper (NPP) to mobilize resources for the government development projects. Diaw et al. (2011) designed a model of GDP-Linked ‘S.ukuk’ (GLS) for infrastructure projects financing. From a policy viewpoint, to design and complete effective fiscal policies for stability and economic growth, a better assessment of the impact of public investment on economic performance is indispensable. Economic and social institutions (infrastructure, macroeconomic stability, education and training, health, and efficient financial system) could encourage private decisions to invest in essential services to the production system to strengthen the total factor productivity and reduce production costs and increase aggregate demand. Public investment can give rise to higher profit and sales expectations and, in fine, spur private decisions to more investment. In the Islamic economic framework, given the significant role of the investment rate of return in the macroeconomic equilibrium determination, a better assessment of the impact of fiscal policy on this variable is needed to design and implement effective policies that support macroeconomic stability and growth. For the Senegalese economy, to assess the impact of fiscal policy on the investment rate of return to the real sector, a reduced form equation

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estimated as follow: IRR = β0 + β1 RIG + β2 TTR + β3 DUM

(7.7)

where RIG represents the ratio of public investment to real GDP, TTR is the index term of trade to proxy the external shocks, and DUM represents the dummy variable. 7.1.1.3

The Balance of Payments Constraint Z + FCA = R

(7.8)

The balance of payments constraint may be stated as: current account balance + capital account balance = change in foreign reserves = change in supply of money Z = (X − M + NCT)

(7.9)

where Z is the external current account, FCA the external financial and capital account, NCT represents the net current transfers (including net foreign income payments).3 From relations (7.1), (7.2), (7.3) and (7.6), the following macroeconomic interrelation is inferred:   (7.10) (X − M + NCTF ) = (T − CG − IG ) + Sp − Ip The relation points to an external current account deficit when investment expense exceeds national savings. It further reflects the effect of fiscal consolidation on sustained external account balance, analyzed through the ratio pattern of the external current account to GDP. In the last decade, interest grew in the concept of “twin deficit”—a mix of weakened fiscal balance and external current account. Recent studies on the subject emphasized that a country’s “twin deficit” can be a differentiating factor for investors, as it would raise the overall risk and place 3 Net Current foreign Transfers could be represented by the following relation: NCT = F e.i ∗ .SF , where i* represents the world market rate of return to investment and, S F the value of Islamic equities held by foreigners, e the fixed exchange rate.

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high upward pressures on sovereign risk (Del Granado and Daal 2014; Ben Salem and Castelletti-Font 2016). Empirical results also suggest that a tightly balanced budget and debt rules would reduce the impact of fiscal balance on the external current account (Badinger et al. 2015). Adequacy of international reserves (R) remains an important parameter in gauging a country’s ability to absorb external shocks. A traditional indicator of reserve adequacy is the import cover of reserves (r). 7.1.1.4 Financial Assets market Equilibrium4 A general formula of the balance in the financial assets market would be (Askari et al. 2014):   a = l r, i ∗ q K where a represents composite financial wealth (sum of real money and real domestic and foreign securities). The right–hand side of the equation reflects the demand for financial assets with r as the rate of return on domestic equities, i* the world market rate of return on investment, and qK representing the real domestic securities. Regarding the financial market weaknesses in most developing countries, as in Senegal,5 the analysis is restricted to supply and demand of money at the aggregation level of M2.6 Relation (7.11) reformulates the flow equilibrium of money market M S = M D

(7.11)

With M S representing the flow of money supply, and M D the flow of money demand.

4 A disaggregated formulation of the demand for financial assets is presented by Mirakhor and Iqbal (1988) in a general equilibrium model with three financial assets and one real asset. 5 Diouf and Boutin-Dufresne, 2012: “The WAEMU regional bond market has succeeded in providing sufficient short-term financing to governments. However, the paper also found that the market fell short in providing long-term financing for both member countries and the private sector”. 6 Money (M2) comprises narrow money (M1) and, in addition, deposits with a maturity of up to two years and deposits redeemable at a period of notice of up to three months.

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7.1.1.5 Behavioral Relations Private Consumption C p = c (Y − T )

(7.12)

where (Y −T ) is viewed as the level of disposable income, Y represents the GDP and T the fiscal. From an Islamic perspective, Askari et al. (2014) introduce the concept of Islamic disposable income. They modify Eq. (7.12) by taking into account the direct Islamic-mandated payments (IP) such as Zakah, khums,7 and kharaj (land taxes and rent): C p = c (Y − T − I P). However, due to the lack of statistics on direct Islamic-mandated payments, the level of private sector could be computed from the basic Eq. 7.12. Demand for Imports

M = λ1 Y + λ2 RPM

(7.13)

where M is the demand function of imports of goods and nonfactor services. Y is the real Gross Domestic Product. RPM represents the relative price of imports. It is expected that a rise of the real Gross Domestic Product would translate in an increase of imports (λ1 > 0). In contrast, an increase of the relative price of imports would induce a contraction of imports (λ2 < 0). From a practical point of view, for less developing countries as Senegal, macroeconomic empirical works use the following reduced form: M = mY Growth Rate of Real Exports Supply GXR = δ1 GYR + δ2 REER

(7.14)

where GXR represents the growth rate of real exports supply of good and nonfactor services and GYR the country real economic growth rate. 7 Khums: one-fifth of charge levied on war booty during the earliest period in Islamic history given to the Prophet (SAW) or his legitimate successor for expenditure and transfer payments (Qur’an, S8:41).

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The relation accounts for a supply exports equation with δ1 and δ2 signify in Eq. (7.14) income and price elasticities of exports. REER the real effective exchange rate, considered as a proxy of relative exports price. In fact, the real effective exchange rate represents an indicator of the overall competitiveness of the economy relative to foreign partners in trade (competitiveness effect). Therefore, the volume of exports results from the relation (7.16):

Money Demand

X = X (−1)(1 + GXR)

(7.15)

M D = k Y

(7.16)

where k represents the coefficient in the Cambridge money demand equation. It is the inverse of money velocity, k = 1/v, where v is money velocity. Equation (7.16) can be written as:

Fiscal Revenue

M D = (1/v) Y

(7.16)

T = tY

(7.17)

Macroeconomic sustainability may integrate into the Islamic economic model by adopting macroeconomic secondary targets: Fiscal secondary targets: the fiscal position should be consistent with the concern for financial viability and Islamic principle of moderation in consumption for both private agents and public sector. Therefore, constraints should be put on: (i) the ratio (f ) of fiscal balance to GDP to address issues about fiscal sustainability and, (ii) the ratio (RI G ) of public investment to GDP reflecting policy orientation to improve the economic competitiveness by raising the capacity of public investment and improving efficiency. Levels of fiscal balance (FB) and public investment (I G ) are: FB = f.Y

(7.18)

IG = R IG .Y

(7.19)

From relations (7.6), (7.18) and (7.19), CG becomes endogenous, determined as: CG = T − IG − FB

(7.20)

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Or [CG = (t − R IG − f ).Y ]

(7.20)

According to Alesina and Ardagna (2012), a design of the fiscal policy more based on the spending side would be less likely to upturn. From relations (7.1), (7.5), (7.6), (7.8), the needed investment, consistent with the long-term economic growth rate, would be: I =Y −C − X + M

(7.21)

[I = (1 − C + M)Y − X ]

(7.21)

Or

The volume of private Investment (I P ) would be: IP = I − IG

(7.22)

External exchange: the ratio (z) of external current account to GDP must be sustainable and the level of international reserve coverage (in term of the month) of imports appropriate.8 Following equations address these considerations: Z = zY  R=r

M 12

(7.23)  (7.24)

The net current transfers (NCT), the financial and capital account (FCA), and the variation of the international reserve (R)—which links the overall balance of payment account to the variation of monetary net foreign assets—are calculated as follow: NCT = Z − (X − M)

(7.25)

8 For example, 3 months in this research. In fact, in the West African Economic Monetary Union, the Central Bank (BCEAO) centralizes the cash international reserves earned by the country members in a common pool of international reserve. A thumb rule assigns to each the country a surplus (or at least an equilibrium) target of the global balance of payments when designing the yearly monetary programs.

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FCA = R − Z

(7.26)

R = R − R(−1)

(7.27)

From practicle standpoint of view, the financial program tool is used to simulate an Islamic model of Senegal in the medium-run according to: (i) a baseline scenario (continuation of the current policies and economic trends) and (ii) a scenario program that simulates economic policy shocks. In the case of the scenario program, it involves the following steps: – specify the real economic growth and price stability targets9 at the horizon of the simulation period; – specify the values of the policy instrument i.e., ratio of public investment to GDP (autonomous decisions of the public administrations) during the simulation period; – design the fiscal and external speed of adjustment regarding the requirement of macroeconomic stability; – generate forecasts for the exogenous variables including the investment rate of return and then the real economic growth, the real GDP and the exportations at a determined horizon; – infer consumption, imports, money demand and fiscal revenue from the estimated behavioral parameters and the total investment using Eqs. (7.1) and (7.16); – generate the fiscal balance and the external current account according to their speed of adjustment. This step has important policy implications: (i) from the public sector’s budget constraint, the public current expenditure become an adjustment variable and (ii) constraint on the external current account and the level of international reserve coverage requires appropriate policies to promote exports, to mobilize remittances and Foreign Direct Investment.

9 In the WAEMU, as the local currency (FCFA) is pegged at fixed rate to the euro, the authorities have only two instruments policies: the monetary policy managed at regional level to target the price stability and the fiscal policy performed at the national level in compliance with the regional convergence criteria.

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7.1.1.6 Calibration of the Model Parameters The model parameters could be calibrated using the following estimates10 : – ∝0 , ∝1 , ∝2 , ∝3 , ∝4 are the long-run coefficients of the ECM estimation of ARDL on real economic growth (GYR) (Appendix D for illustration); – c is the average of the ratio of consumption (C ) to the real GDP Y over the period 1980–2014; the same procedure of approximation is used to compute k (inverse of the money velocity); m ratio of imports (M ) to GDP; t ratio of the fiscal revenue (T ) to GDP; – δ1 and δ2, the benchmarks can be extracted from the literature on low-income countries (Senhadji and Montenegro 1999; Olifin and Babatunde 2007); – the baseline values of the external current account could be computed from the observed ratio of the aggregate to GDP, applied to simulated values of the GDP. The same method of computation can be used to simulate the values of the baseline fiscal balance.

7.2 Counterfactual Simulation of the Islamic Model of Stability and Growth for Senegal From ex post analysis perspective, it is useful reminding the main findings of the earlier counterfactuals simulation version of the Islamic model of stabilization and growth for Senegal (2015–2019). – Evidence from economic policy experiments (2015–2019)11 that target the resorption of the macroeconomic financial deficits (the fiscal balance and the external current account) and address the high propensities to consume and to import suggests. – Globally, the Islamic model of stability and growth would display positive prospects for macroeconomic stability and growth compared to the baseline scenario.

10 For illustration see Dieye (2017). 11 For detailed presentation, see Dieye (2017, 2020).

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– Particularly, the real sector would react positively to an economic shock in the form of a sustained increase in public investment, and a significant upturn in the investment rate of return to the real sector (from 20 to 31%). The increase in the volume of investment aggregate would cause real output growth, meaning that the Government goal to attain constant growth rates of over 7% could be within reach around 2019. Further simulations suggest implementation of policies consistent with Islamic rules of moderate consumption that lower the average propensity to consume (everything else remaining constant or equal) under 80%. In such a case, these would induce a significant rise in the total investment ratio of around 30% to the GDP. – Economic growth performance would translate into an increase in real fiscal revenues that in turn, combined with the adjustment of the current public consumption would establish the fiscal balance sustainability. – With regard to the external current account, in the Islamic model of stability and growth, the prohibition of interest rates and interestbased debt financing improve de facto the fiscal balance and current account balance (since there are interest payments) and therefore would speed their adjustment to sustainable levels, compared to the actual data. In addition, due to these prohibitions on interest rates, the current account financing relies on the risk-sharing principle that favors public–private partnership and foreign direct investment. Particularly for developing countries, leveraging, and securitizing remittances have recorded a notable growth during this last decade (Ratha et al. 2011). The potential favorable effects of remittances on the economic stability and growth have stemmed from two mechanisms: (i) in easing financial constraints, remittances sustain consumption and investment, thus, economic growth and (ii) remittances can help lower the poverty level through direct income transfers to poor recipients or increase in employment and wages. After all, an effective policy implementation to improve the export competitiveness and promotes attractiveness of the business environment remains crucial. – From an evaluation policy perspective, Fig. 7.1 shows ever better prospects compared to real data and official projections, with an

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10 8 6 4 2 0 2015

2016

2017

2018

2019

Real economic growth rate % (Actual) Real economic growth (official projecons) Real economic growth % (Islamic scenario) Fig. 7.1 Senegal real economic growth: Islamic Counterfactuals ex post /actuals/official projections (2015–2019) (Source Dieye [2017, 2020], Government of Senegal/IMF [2017, 2020])

increasing trend which contrasts with the slowdown of the Senegalese economy observed in the last three years.12 Counterfactual simulations of the Islamic model over the sample period 2019–2024, focus on the real economic growth as illustration. The updating of the macroeconomic data made it possible to lengthen the sample period and to perform new estimations of the reduced equations coefficient for both the investment rate of return and the economic growth, key parameters when starting a financial programming exercise. The estimated reduced equation form of the real economic growth which follows presented the most robust statistical properties in consideration of the usual tests (Table 12 Appendix E): GYR = 0.32 ∗ IRR − 0.029 ∗ TTR + 0.41 ∗ NODA + 2.62 ∗ DUM − 2.32 The results of the statistic tests of the estimation of the ARDL Error Correction Model (ECM) exhibit a robust long-run relationship between the real economic growth (GYR) considered as endogenous variable, 12 For details, see IMF (2020).

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the investment rate of return (IRR) the focus explanatory variable, Net financial Official Development Assistance (NODA) and term of trade index (TTR) controlling variables. The estimated long-run coefficients and coefficient of the Error correction term, the results of the robustness and stability test (Appendix E) suggest that: (i) the investment rate of return would have a significant and positive impact on the real GDP growth in the long run whereas the impact on the real GDP growth of the Net Official Development Assistance and Term of Trade seems not significant and (ii) the value of the estimated coefficient of the Error Correction term (−0.82) negative (between −1 and 0) and highly significant would reflect a strong stability of the long-run equilibrium between the selected variables. Also, it suggests that the Senegalese economy would correct its previous period disequilibrium at a speed of 82% annually to reach at the steady state after a policy economic shock. Following the same methodology, Appendix F investigates a long run reduced form relationship that relates the investment rate of return (IRR) considered as dependent variable to the public investment expressed as ratio to the real GDP (RI G ) and considered as focus explanatory variables, two controlling variables: the term of trade index (TTR) and a dummy variable (DUM). The results of the statistic tests point out a robust and stable long-run relationship between the investment rate of return considered as endogenous variable, and the explanatory variables introduced in the specification. The empirical results emphasize a high positive impact of the public investment policy on the investment rate of return whereas long-run effect of the term of trade variable is not significant. The likely high impact of public expenditure on the investment rate of return in the case study of Senegal is consistent with empirical results pointed by the literature review showing high return to public investment. Evidence suggests a design of the fiscal policy expenditure that favors public capital expenditures to sustain economic growth. However, further in-depth investigations are required in order to assess the likely impact of factor productivity indicators (such as total factor productivity, quality of human resources and institutions) on the rate of return on investment. From a policy perspective, the likely high sensitivity of return on investment to public investment supports a design of the fiscal policy that favors more capital public expense. Improving the efficiency of public capital should be a matter of high concern for getting maximum effects of public policies. In this regard, it is worth to

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note that Diop et al. (2016) assessed the impact of the public expenditure composition and externalities associated with public capital on growth using an intertemporal model of endogenous growth. According to policy experiments—assuming significant improvement of the public capital expenditure—Diop et al. (2016). show that with a similar public investment as in the baseline scenario, improving the effectiveness of public spending would induce twice as high gains in growth, compared to the likely results of a mere increase of the public investment volume. Everything else remaining the same, a policy experiment is performed over the period 2019–2024. The target is a resorption of the fiscal deficit (expressed as ratio to GDP) to sustainable level (a ratio to GDP under 5%) combined with reallocation of public expenditures that would increase (1% annually) the ratio of public investment to GDP from 11% in 2020 to 15% in 2024. Figure 7.2 illustrates the economic growth responses to the fiscal and external policy shocks, compared to official projections. Evidence points out a steady and sustained double-digit growth by 2023. 16 14 12 10 8 6 4 2 0 2019

2020

2021

Islamic scenario

2022

2023

2024

Official projecons

Fig. 7.2 Counterfactuals economic growth: Islamic scenario/Officials (2019– 2024) (Source Author’s calculation. IMF [2020])

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Economic policy experiments could be extended to the other macroeconomic aggregates as part of a financial flow table to ensure macroeconomic consistency of the outcomes.13

7.3

Conclusion

Rules from the Qur’an translated in economic principles allow for the setting up of a consistent Islamic policy framework and an analytical model of stability and sustained growth with no interest ratebased debt instruments. All financial transactions center on sharing risk and return principles. Implementation of the Islamic rules of behavior offers a supportive institutional environment that ensures macroeconomic stability. Such an environment is a precondition for encouraging national savings and raising foreign capital at levels that fulfill the investment capacity; thus, sustaining economic growth and social justice. It is worth to note that the simulation model does not incorporate these rules since they have to be internalized by individuals. A basic concept of the Islamic economic model is the investment rate of return to the real sector. A case study on Senegal has tested the relevance of the concept for economic growth and public investment policy. The findings demonstrate a robust long-run relationship between the investment rate of return and the public investment. The Islamic model simulation offers methods to set up a medium-term, growth-oriented program and guidelines for fiscal and external policies that satisfy the requirements for macroeconomic stability. Its distinguishing characteristic is its ability to capture the short and long-run effects of Islamic economic policies on the main macroeconomic variables. The model presents real prospects for increased growth, investment, and exports—the primary drivers of higher employment and wages. The basic structure of the model forms a starting point that extends and adapts other countries’ specific conditions. The Islamic analytical framework can be strengthened in areas such as: (i) impact of the human capital and/or total factor productivity on the investment rate of return, (ii) significance of the investment rate of return for monetary and financial market policy, (iii) behavioral equation for private investment from an Islamic perspective, (iv) behavioral equation of consumption from an

13 See Dieye (2017, 2020).

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Islamic view, determination of the boundaries for “moderate consumption” that requires detailed microeconomic data, case studies and survey, (v) studies on the optimal government size, (vi) legislation to promote the Islamic financial markets and institutions and enhance their attractiveness, and (vii) the determination of national account statistics taking into account the environment concerns (negative externalities), the depletion of nonrenewable resources and the prohibited goods, according to the Islamic tenets.

References Alesina Alberto, and Silvia Ardagna. 2012. The Design of Fiscal Adjustments. NBER Working Paper 18423. Askari, Hossein, Noureddine Krichene, and Abbas Mirakhor. 2014. On the Stability of an Islamic Financial System. PSL Quarterly Review 67 (269): 131–167. Badinger, Harald, Aurelien Fichet de Clairfontaine, and Wolf Heinrich Reuter. 2015. Fiscal Rules and Twin Deficits: The Link between Fiscal and External Balances. Vienna University of Economics and Business Working Paper, 196. Ball, Laurence, and Sandeep Mazumder. 2015. A Phillips Curve with Anchored Expectations and Short-Term Unemployment. IMF Working Paper, 15 (39). Barro, Robert J., and Jong-Wha Lee. 2002. IMF Programs: Who Is Chosen and What Are the Effects? NBER Working Paper, 8951. Ben Salem, Melika, and Barbara Castelletti-Font. 2016. Which Combination of Fiscal and External Imbalances to Determine the Long-Run Dynamics of Sovereign Bond Yields? Banque de France Working Paper 606. Blattman, Christofer, Jason Hwang, and Jeffrey G. Williamson. 2003. The Terms of Trade and Economic Growth in the Periphery 1870–1983. NBER Working Paper, 9940. Bourguignon, Francois, William H. Branson, and Jaime de Melo. 1989. Adjustment and Income Distribution: A Counterfactual Analysis. NBER Working Paper, 2943. Del Granado, Francisco Javier Arze, and Wendell Daal. 2014. High Twin Deficits Pose Risks to Ghana’s Growth Outlook. IMF Survey/IMF African Department. Diaw, Abdou, Obiyathulla Ismath Bacha, and Ahcene Lahsasna. 2011. Public Sector Funding and Debt Management: A Case for GDP-Linked ‘Sukuk’. MPRA Paper 46008. Dieye, Adama. 2017. Riba-Free Model of Stabilization and Growth: Application to Senegal. International Centre for Education in Islamic Finance PhD, Kuala Lumpur.

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———. 2020. An Alternative Model of Economic Stabilization and Growth for Developing Countries. In Handbook of Analytical Studies in Islamic Finance and Economics, edited by Nabil Maghrebi, Tarık Akın, Zamir Iqbal, and Abbas Mirakhor. Berlin: Walter de Gruyter GmbH. Deutschland (Forthcoming). Diop, Mouhamadou Bamba, and Abdoulaye Fame. 2007. Les sources des fluctuations économiques au Sénégal (Sources of Economic Fluctuations in Senegal). Government of Senegal/DPEE Study Paper 4. Diop, Mouhamadou Bamba, Bocar Sall Hamidou, and Samba Diakhite. 2016. Composition of Public Spending, Structural Reforms and Growth in Senegal: An Intertemporal Model for Low-Income Economies. Government of Senegal/DP Planning Paper 9. Diouf, Mame Astou, and Francois Boutin-Dufresne. 2012. Financing Growth in the WAEMU Through the Regional Securities Market: Past Successes and Current Challenges. IMF Working Paper 12(249). Fosu, Augustin Kwasi, and Anthony Gyapong. 2010. Terms of Trade and Growth of Resource Economies: A Tale of Two Countries. IMF Institute High Level Seminar on ‘Natural Resources, Finance, and Development: Confronting Old and New Challenges. Algiers/Algeria, November 4–5. Ghosh, Atish R., Charalambos Chritophides, Jun Il Kim, Laura Papi, Uma Ramakrishnan, Alun H. Thomas, and Juan Zalduendo. 2005. The Design of IMF-Supported Programs. IMF Occasional Paper, 241. Haque, Nadeem U., and Abbas Mirakhor. 1999. The Design of Instruments for Government Finance in an Islamic Economy. Economic Studies 6 (2). International Monetary Fund. 2017. Fiscal Monitor: Tackling Inequality. Washington, DC: International Monetary Fund. ———. 2020. Request for a Three-Year Policy Coordination, Instrument—Press Release; Staff Report; and Statement by the Executive Director For Senegal. IMF Country Report No. 20/11. Washington, DC. Mendoza, Enrique G. 1997. Terms of Trade Uncertainty and Economic Growth. Journal of Development Economics 54 (1997): 323–356. Mikkelsen, Jan. G. 1998. A Model For Financing Programming. IMF Working Paper, 98/80. Mirakhor, Abbas. 1993. Equilibrium in a Non-Interest Open Economy. Jeddah King Abdulaziz University: Islamic Economics 5: 3–23. Mirakhor, Abbas, and Iqbal Zaidi. 1988. Stabilization and Growth in an Open Islamic Economy. IMF Working Paper, 22. Olofin, Sam, and Musibau Adetunji Babatunde. 2007. Estimating Price and Income Elasticities of Sub-Saharan African Exports. African Journal of Economic Policy 16 (2). Ratha, Dilip K., Sanket Mohapatra, Caglar Özden, Sonia Plaza, William Shaw, and Abebe Shimeles. 2011. Leveraging Migration for Africa: Remittances, Skills, and Investments, ed. Dilip Ratha. Washington, DC: The World Bank. Senhadji, Abdelhak S., and Claudio E. Montenegro. 1999. Time Series Analysis of Export Demand Equations: A Cross-Country Analysis. IMF Staff Papers, 46 (3).

CHAPTER 8

Implementation of the Islamic Model for Senegal

Implementing the operational rules of behavior would offer stability and a positive institutional environment for sustained economic growth and social justice. Lessons from case studies on introducing Islamic finance in a conventional financial system suggest common conditions necessary for implementing the Islamic model of stability and growth. The conditions comprise of: (i) political determination and commitment to implement reforms, (ii) credible initiators, communicators, and awareness campaigns for the envisaged Islamic economic reforms, (iii) a supportive legal-judiciary infrastructure and (iv) gradual, prudent introduction of the reforms to allow time for developing a broad consensus for the process, thus rendering it politically and socially more sustainable. Section 8.1 discusses a set of reform recommendations related to institutions (rules of behavior) and economic and financial sectors. Section 8.2 proposes sequencing and phasing of the recommended policy reforms. Section 8.4 outlines the expected performances of the Islamic model of stability and growth in Senegal.

8.1

Policy Recommendations

The policy recommendations conform to Islamic principles. They suggest a set of flexible reforms for countries to apply according to their specific conditions to build an institutional environment for their economic and financial activities. © The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_8

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8.1.1

Reforms in Institutions (Rules of Behavior)

8.1.1.1 Role of the State The success of the Islamic model obliges the State to have a strong participatory political determination and commitment in fulfilling its responsibilities aimed at effective governance, regulation, supervision of economic activity and setting up an institutional framework and incentive structure for rule compliance, conforming to the teachings of Qur’an and Sunnah. Effective public governance by Islamic rules of behavior improves morals, thus changing the behavior of individuals and society by the Islamic rules. Free, fair, and inclusive elections is a prerequisite for establishing a legislature that represents the entire community. This governing body determines the society’s attitude toward the design and implementation of the social contract. The state is duty-bound to prevent market failure, promote social justice and ensure an efficient and transparent management of the country’s natural resources and revenues gained from their exploitation. Since 2014, Senegal has embarked on a new legal and regulatory framework to support Public–Private Partnerships (PPPs) for developing infrastructure projects. To date, Senegal has acquired a consistent PPP experience that needs to be revisited in order to identify the limits of the current legal and regulatory framework and to bring the needed amendments, inter alia: (i) designing future PPP projects in a sustainable development strategy program and (ii) ensuring appropriate consideration of the social aspects of PPP contracts, particularly in terms of employment policy, real transfer of technology, and know-how (including training of nationals) from the contact-awarding private entity to the national enterprises in order to encourage their increased participation in these types of projects. In the same vein, it is essential to implement a capacity building program within the Senegalese government for better management of the PPP process and to provide better support to the discussions, conclusion, monitoring, and evaluation steps of PPP contracts. Regarding the redistribution of wealth and social safety net provision, lessons from case studies of some Muslim countries such as Pakistan, Indonesia, Malaysia (Sarif 2013) emphasize that cooperation among governments, religious scholars and academics can help to institutionalize the main Islamic redistributive institutions, such as ‘Zakah’ and ‘Waqf ,’ to ease poverty. The Senegal parliament has passed in April 2015 a ‘Waqf ’

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law. Following the same process, the authorities should take action to institutionalize ‘Zakah’ which hitherto is administrated at the individual level. 8.1.1.2 Educational Infrastructure The shortage of skilled human resource in Islamic Economic and finance and other related areas, such as Islamic Shariah, is one of the fundamental challenges facing the industry. If not addressed through constant investment in human capital, it can impede the growth of the Islamic economy. The authorities should introduce the modules of Islamic economy and finance at the secondary school level. They also should establish Islamic business and law schools and research institutions at the university level. In this respect, the authorities as private structures should offer incentives to college students, such as scholarships and internships. For the development and implementation of legal and regulatory rules consistent with the Islamic rules in a common environment, special skill training programs for the legal staff in the industry are necessary to help them to become experts in regulation of the economic and financial activities. In the incipient stage of the Islamic model implementation, a firm association with credible, well-established Islamic education and training institutions is necessary to ensure high-quality learning and to enhance the quality and performance of human resources. Also, ongoing awareness campaigns—involving government, institutions, regulators, and scholars—should explain the Islamic economic system (insight, general principles, operational rules) and elaborate the opportunities of the envisaged framework. 8.1.2

Reforms in the Real Sector and Trade

Recent economic trends and the medium-term outlook for Senegal, raise two interrelated major issues: (i) ensuring a steady positive economic growth that stimulates job opportunities and offers better prospects for the restless unemployed youth; and (ii) enhancing the structural competitiveness of the economy. In this context, the following policy recommendations should be noted: a. design and implement competitiveness strategy to improve economic flexibility and resilience commensurate with the changing conditions of the global economy (Dieye 1996);

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b. setting up a competitiveness observatory for assessing economic successes and providing relevant data analyzes and references for the government and the private sector to allow strategies and policies to adapt to changes in the economic and the financial environment; c. addressing the challenges of poverty and unemployment through appropriate structural transformation policies encouraging, for the economic sectors, a shift toward labor-absorbing growth paths1 underpinned by productivity enhancements and value chain approach processes. Particularly, we expect that breaking away from the underutilization of rural labor will offer real opportunities for youth job creation,2 enlargement of the spectrum of tradable products for both domestic and regional markets,3 when undertaking in addition, measures to modernize this sector4 ; d. improving the available factors,5 such as energy and financing resources,6 at competitive prices; e. providing adequate education and training of human resources with the skills they need for jobs the enterprises need to create and fill, especially the youth so that the young people will become a valuable asset to the workforce. Also, the design and implementation of concrete programs for employment-based poverty reduction programs require improving poor’s people access to productive 1 According to African Development Bank estimations (2018), a desirable employment elasticity for developing countries is about 0.7. With output growth of at least 5%, this elasticity should be sufficient to achieve employment growth of at least 3.5%, in excess of the growth in the labor force in most African countries. 2 In 2014, the contribution of the rural sector (52.3% of the potential workforce) to the GDP ratio reached barely 0.5% (Appendix C). 3 Senegal’s membership in the Economic Community of West African States (ECOWAS)

offers a potential regional market estimated to 300 million consumers. 4 Diallo (2018). 5 The World Bank report (2019) “Doing business 2019” indicates for the Senegalese

economy, on a scale from 0 to 100, significant positive distance to frontier scores for starting business (89.94), getting electricity (61.37), trading across border (60.85), dealing with construction permits (59.60) and registering property (57.47). Nonetheless, the report exhibits worrying distance to frontier scores indicators related to getting electricity (44.51) and getting credit (30.0), protecting minority investors (41.67), resolving insolvency, paying taxes (48.08), enforcing contracts (48.15). 6 Maurel and Seghir (2014) found that in the long run, a 1% increase in access to electricity increases total factor productivity by 29% (PMG) and by 12% (PMG) in the short run (PMG meaning Pooled Mean Group).

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resources and investing in their human capital by giving them access to better health systems and school to enable them to share in the benefits of growth. Overall, reforming the education system would require a strong commitment to funding research, educational programs, and employment programs; f. providing access to information and capital at an affordable cost. Regarding the market code of conduct, the major requirements are: (i) effective supervision and enforcement of legal structure on prices adopted after consultation with the private sector; (ii) enforcement of contracts and contractual obligations; (iii) registration and protection of property rights; (iv) development and monitoring of high standards of disclosure and transparency for institutions offering Islamic products and services (including Islamic financial products); and (v) removal of all price and institutional distortions in the labor market. Implementing wage structure requires taking into account labor productivity according to the competitiveness imposed by globalization. Reforms of foreign trade and capital movements are of major interest. ‘Shariah’ principles advocate free foreign trade, capital flows, and an open economy. Applying these principles in Senegal can develop the export sector alongside similar considerations and a significant technical expertise transfer. Tax incentives, free labor market, free capital mobility, and a safe and supportive business environment will encourage foreign direct investment. 8.1.3

Reforms in Public Finance

From a macroeconomic perspective, the state should conduct credible and sustainable public policies that reduce unproductive spending, prioritize productive expenditure in education, healthcare, and infrastructure to enhance factor productivity and improve prospects for economic growth and employment. The prescribed rules of expenditure and consumption at the microeconomic level (prohibition of resource waste and balanced consumption) should function for the public sector in line with the principles of long-term balanced consumption and fiscal balance. Government revenues should be compliant with Islamic rules. Current spending should remain in line with revenue to generate a current budgetary surplus that supports the financing capital expenditure. It is recommended to introduce current expenditure ceilings in the Finance

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Act to strengthen the legislative fiscal commitments and create an independent fiscal policy council to control the ongoing expenses.7 The Finance Act will assess whether the fiscal policy is consistent with the long-run sustainable public finances and budgetary targets. With the budget deficit, the government should use only non-debt creating flows. Commitment to consistent implementation of the Kuala Lumpur Declaration (ISRA et al. 2012) provides three major policy orientations: i. shifting away from interest-based systems toward enhanced risksharing systems; ii. the use of fiscal and monetary policies based on risk sharing; and iii. issuing macro market instruments to furnish the Treasury with a significant source of non-interest, rate-based financing while promoting risk sharing, provided these securities meet three conditions: (a) they are of the low denomination, (b) they are traded on the retail market, and (c) they come with strong governance oversight. For practical application, government securities are expendable for public finance development and monetary policy.8 As Senegal has gained extensive experience in managing public finance and external debt the Government became more capable of reaching the goal of fiscal balance in the medium or long run and breaking the cycle of volatile debt, an unpredictable source of financial instability. 8.1.4

Reforms of the Money and Banking Sector

Recommendations in money and banking should take into account Senegal’s membership in the WAEMU (a Union for designing and implementing regional monetary and exchange rate policies, institutional financial regulation, and supervision). The growing demand for Islamic financial products voiced by broad segments of the population is worth 7 Lars Jonung (2014), Ljungman (2008), The World Bank (2013), and Dorotinsky and Watkins (2013) provide a number of case studies. 8 According to Haque and Mirakhor (1999), the NPP securities can be issued and traded on equity markets that promise on maturity to pay a rate of return approximated by the rate of return observed in the private sector adjusted for any reduction in risk due to the government’s backing.

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noting. Also, the authorities’ determination at a national and regional level to promote the Islamic finance industry while creating strong opportunities for developing the sector and implementing the Islamic model of stability and growth.9 The Central Bank BCEAO established a new regulatory and supervisory framework for Islamic financial institutions in the first quarter of 2017, following a broad consultation with representatives of the Fiscal Administration Department and the Finance Industry in the WAEMU. This approach entails taking into account the unique characteristics of the Islamic paradigm and provides a level playing field with the conventional system so as to ensure that economic and financial transactions are not at a comparative disadvantage. Further measure to consider is to set up an Islamic rules-based macroprudential surveillance consistent with the framework established in 2015 by the Islamic Financial Services Board (IFSB). Other challenges relate to developing the financial institutions in their different forms: Islamic windows, full-fledged Islamic banking, equity-based investment banking, Takaful companies, non-banking institutions, microfinance institutions, and the Islamic markets. For Islamic financial institutions, the high financial resources needed to maintain capital formation process consistent with economic growth targets suggests supporting investment banking for new licenses based on risk-sharing principles. The regional stock market should promote issuing ‘Sukuk’—an alternative investment instrument to the debt-based fundraising for longterm development projects (infrastructure) and greater diversification of financial risk. In October 2016, the Regional Stock Exchange (BRVM) acknowledged that Côte d’Ivoire, Senegal, and Togo (WAEMU members) had issued ‘Sukuk’ on the regional financial market. The trade of ‘Sukuk’ on the regional stock market should create an incentive to boost liquidity of the Islamic market while ensuring the success of future issuance of Islamic Sovereign securities. Regular ‘Sukuk’ issuance programs by the Government and the Central Bank10 with different 9 Islamic finance subsector in the WAEMU zone comprises only two Islamic banks functioning in Senegal, and Niger and belonging to the same bank group which counts the Islamic Development Bank (IDB) as a majority shareholder. 10 Central bank may opt to securitize some of its assets (for example, the Central bank’s building), as in Sudan. However, the value of the Central bank’s assets may limit the

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maturities are recommended for strengthening the market, setting out a benchmark for corporate ‘Sukuk,’ and providing an instrument for a more efficient monetary policy for the private sector portfolio, capital market conditions, and the real economic activity. Developing a comprehensive ‘Shariah’ framework is a crucial challenge. Each institution offering Islamic products should establish a ‘Shariah’ advisory committee to ensure total transparency and ‘Shariah’-compliance of all Islamic transactions, products, and operations. Promoting Islamic microfinance and strengthening its linkages with Islamic banking and capital markets offer more efficient tools for improving financial inclusion and producing full growth and better prospects for job creation for small and medium size enterprises (SMEs) as well as micro-enterprises. Addressing the paucity of ‘Shariah’ scholars and skilled staff in Islamic economics and finance requires international cooperation and exchange of experience with leading countries such as Malaysia. Also, international Islamic institutions for management, regulation, and promotion of Islamic expertise are crucial instruments for expanding the Islamic economic capacity building program with best practices and standards.

8.2

Sequencing of Policy Reforms

Phases implementing policy recommendations may overlap during the process of ensuring flexibility in the sequence of policy reforms (Table 8.1). The numerical benchmarks for the policy reform recommendations are provided by the World Bank “Doing Business Indicators ”11 which allows international comparison. For each indicator, the proposed target in the mid-term is the highest performance among the African competitors and, in the long-term the record of Malaysia.

potential issuance size of these securities. Diaw et al. (2011) designed commodity-linked ‘Sukuk’ models which could be usefully explored as an alternative approach. 11 The benchmarks refer to distance to frontier score with respect to regulatory practice, showing the absolute distance to the best performance in each Doing Business indicator. An economy’s distance to frontier score is indicated on a scale from 0 to 100, where 0 represents the worst performance and 100 the frontier.

Reforms in institutions The role the state • Promote good governance: enforcement of the Law on Declaration of wealth for public managers and against corruption (continued process). Benchmark: 100% • Observance of the electoral calendar and conduct of free, fair and inclusive elections (continue the process) • Implementation of a legal and transparent fiscal framework to manage depletable natural resources and resource revenues (continue the process) • Adoption and implementation of law on Zakah

Reforms in institutions The role of the state • Promote good governance: enforcement of the Law on Declaration of wealth for public managers and against corruption (continue the process). Benchmark: 100% of declarations (continued) • Observance of the electoral calendar and conduct of free, fair and inclusive elections (continue the process) • Adoption of a legal and fiscal transparent framework to manage depletable natural resources and its implementation (continue the process) • Adoption and implementation of law on Zakah

Reforms in institutions The role of the state • Promote good governance: enforcement of the Law on Declaration of wealth for public managers and against corruption • Benchmark: 100% of declarations • Observance of the electoral calendar and conduct of free, fair and inclusive elections (continue the process) • Study on a legal and transparent fiscal framework to manage depletable natural resources • Study on the institutionalization of Zakah

(continued)

Phase 3 (5–10 ans) Long-term priorities

Phase 2 (2–5 ans) Medium-term priorities

Sequencing of policy reform recommendations

Phase 1(0–2 ans) Early priorities

Table 8.1

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Phase 2 (2–5 ans) Medium-term priorities Educational infrastructure • Training program for trainers in Islamic economics (including Islamic finance)(continued) • Executive programs in Islamic economic (continue the process) • Awareness campaign program on Islamic economic (continue the process) • Implementation a of master plan for capacity building in Islamic economic and finance • Creation of business Schools, departments of Islamic economics at the level of University • Creation of an Academy of Islamic economics (including center of research in Islamic economic) • International cooperation to support implementing the master plan

Educational infrastructure • Training program for trainers in Islamic economics (including Islamic finance) • Executive programs in Islamic economic (including ‘Shariah’ scholars) • Introducing Islamic economic modules in the Universities and Business Schools teaching programs • Conception of awareness campaign program on Islamic economic (including Islamic finance) • A global master plan for capacity building in Islamic economic (shared vision and chart for promoting Islamic economic knowledge) • International cooperation to support the conception and implementation of the blueprint (exchange of experience; partnership; human resources)

(continued)

Phase 1(0–2 ans) Early priorities

Table 8.1

Educational infrastructure • Training program for trainers in Islamic economics (continue the process) • Executive programs in Islamic economic (continue the process) • Awareness campaign program on Islamic economic (continue the process) • Monitoring of the master plan for capacity building in Islamic economic through annual periodical review • International cooperation to support implementing the master plan

Phase 3 (5–10 ans) Long-term priorities

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(continued)

Reform of the real sector • Annual assessment of the competitiveness of the national economy (continue the process) • Improve access to electricity. Distance to frontier target: 100% • Improve financing to the private sector. Benchmark: 80% • Enforcement of contracts. Benchmark: 90 • Resolving insolvency: benchmark 80% • Registering property: 80% Reforms in public finance • Study on fiscal framework including fiscal expenditure ceilings and creating an independent fiscal policy council, its legislative status • Preserve fiscal sustainability • Promotion of public–private partnership more inclusive and with effective transfer of technology (continue the process)

Reform of the real sector • Annual assessment of the competitiveness of the national economy (continue the process) • Improve access to electricity. Benchmark: 80% • Improve financing to the private sector. Benchmark: 70% • Enforcement of contracts. Benchmark: 70% • Resolving insolvency: benchmark 70% • Registering property: 70% Reforms in public finance • Adoption by the Parliament of the fiscal framework (including fiscal expenditure ceilings and creating an independent fiscal policy council) and its inclusion in the Financial Act • Enhance fiscal sustainability by reducing fiscal deficits (continue the process) • Increase deficit financing by non-interest rate-based securities (continue the process) • Promotion of public–private partnership with effective transfer of technology (continue the process)

Reform of the real sector • Create a competitiveness observatory • Improve access to electricity. Benchmark: 50% • Improve private sector financing. Benchmark: 50% • Enforce contracts. Benchmark: 50% • Resolve insolvency: benchmark 50% • Register property: 60% • Study labor market constraints and challenges

Reforms in public finance • Study on the fiscal framework (including fiscal expenditure ceilings and an independent fiscal policy council) and its legislative status • Enhance fiscal sustainability by reducing budget deficits (continue the process) • Increase deficit financing by equity participation shares in small enough denomination and traded on the secondary markets (continue the process) • Promotion of public–private partnership more inclusive for the national private sector and with effective transfer of technology

Phase 3 (5–10 ans) Long-term priorities

Phase 2 (2–5 ans) Medium-term priorities

Phase 1(0–2 ans) Early priorities

8

213

Reforms of the money and banking sector • Critical appraisal of the master plan. Further steps required • Deepening of Islamic financial infrastructure: increase number of Islamic institutions, general openness to foreign institutions, and Takaful institutions, enhance the microfinance sector • Strengthening human resources capacity-building (continue the process) • International cooperation for exchange of experience (continue process)

Reforms of the money and banking sector • Implantation of the master plan focusing on the available human resources • Extension of the existent institution in branches • The increase in the number of participants: one investment bank, one microfinance institution, one Takaful company, Islamic windows • Enhance the ‘Shariah’ infrastructure • Enhance the regional Islamic capital market • Amendment of the Central Bank Statutes and operational rules to allow the Institution to trade Islamic securities papers • International cooperation for exchange of experience, partnership, technical assistance (continue the process)

Reforms of the money and banking sector • Devise a master plan for developing the Islamic financial sector, as a segment of the plan for Islamic economic knowledge development • Ensure the ‘Shariah’ and regulatory compliance of the existent Islamic institutions (including branches) operations • Guarantee the leveling playing field for the financial system • Focus on the capacity building program (continue the process) and awareness campaign on Islamic institutions and products • International cooperation for exchange of experience, partnership, technical assistance (continue the process)

Source Author

Phase 3 (5–10 ans) Long-term priorities

Phase 2 (2–5 ans) Medium-term priorities

(continued)

Phase 1(0–2 ans) Early priorities

Table 8.1

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The Financing of the Policy Reforms

An important issue is related to the financing of the aforementioned program of reforms. Considering the eminently structural nature of the challenges facing the Senegalese economy (including the urgent need to lessen the heavy reliance to external debt and development aid), the country need to develop a different approach in shifting the financing perspective from short-term to longer-term investment. The issue could be addressed from the following main angles: • Enhancing collection of national resources through: (i) better tax revenue and remittances mobilization.12 These include, inter alia, reform of the tax system to make it fairer, more transparent and effective, sustained by institutional measures to strengthen their enforcement characteristics, to tackle appropriately the detrimental effects of counterproductive barriers such as corruption, weak institutional capacities, narrow tax base, and pervasive tax avoidance and evasion by wealthy individuals and multinational corporations on the on future economic and social development patterns; • leveraging the significant potentialities in gas and other mineral resources (iron ore, zircon, phosphate). Lessons from country experiences and empirical studies13 suggest that improvement of laws and standards and enhancement of their enforcement characteristics sustained by strong institutions (including the financial sector) are essential to prevent rent-seeking and corruption, leonine contracts with multinational companies, to give the right incentives to players in the resource natural sector, all things that would the country to draw new revenues from natural resources into outcomes that matter for the population: access to quality social services (such as education and healthcare, transportation, sanitation infrastructure) better jobs and business opportunities. Particularly, the fiscal

12 From policy perspective, Shirazi et al. (2018) investigated the remittances–growth– poverty nexus for seven African OIC member countries (including Senegal) over the period 1992–2010. The findings suggest that remittance inflows enhance economic growth and reduce poverty in the selected countries. 13 See Williams and Dupuy (2016), Beck and Poelhekke (2017), African Development Bank and Bill & Melinda Gates Foundation (2015), and International Monetary Fund (2016).

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public management should play a key role for a sustainable management of natural resources14 wealth in many ways, notably: (i) buffering the economy from excessive short-term revenue volatility, (ii) refraining from any temptation to bridge forward anticipated revenues through borrowing, (iii) establishing strong socioeconomic institutions for economic and revenue-base diversification to protect some crucial sectors (particularly the rural sector) from the Dutch disease effects, to take into account the long-term decline of revenue related to the likely depletion of resources, and to ensure ultimately inter-generational justice. • Increasing the contribution of the Islamic finance industry to fund sustainable development needs. The total worth of the Islamic Financial Services Industry is estimated at US$2.19 trillion as at 2018. Recent study (Alawode 2017) posits that, with a steady growth of around 9.9%, Islamic finance industry assets could exceed 3 trillion in a few years. Particularly, the Islamic Capital Market sector recorded the major improvements, with a still predominance of “Sukuk” issuances. Studies evidenced that increasing the contribution of the Islamic finance industry for sustainable development would require laws and regulations that can encourage private sector financing Private Public Partnership and promote the Islamic Finance Industry (banks, nonbank financial institutions, capital markets). • An untapped source that has the potential for providing social infrastructure services is the Islamic social sector constituting zakat, waqf and sadaqat. For example, estimates of zakat collection in the Muslim world show that it can potentially be between US$114.34 billion and US$304.9 billion annually. Similarly, according the World Bank Group et al. (2019), estimates of the value of waqf assets in the world range from US$100 billion to US$1 trillion while waqf lands comprise more than one-third of the cultivable lands. More importantly, literature review emphasized growing studies that suggest an institutionalized approach to zakat and waqf that would help to identify new areas of interventions that go beyond the issue of poverty reduction to embrace other economic and social development issues.

14 See Eriksen and Soreides (2017) for the Norway’s case study.

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8.4 Expected Performances of the Islamic Model in Senegal Acceptance of the recommended Islamic economic, financial, and social reforms can be attained if the objectives are framed and well-explained along with effective governance. The latter would enhance private ethics, thus inducing a change in the behavior of individuals and society. Implementing an effective and sustained public policy consistent with the Islamic principles of fiscal balance and risk-sharing finance mechanism would help to overcome high budget deficits and foreign indebtedness of the public sector. A shift of public expenses toward more infrastructures, education, and other public goods can improve global economic competitiveness and create better economic growth prospects. In the financial sector, a regular and sound promotion of investment banking based on risk-sharing principles and a vibrant regional stock market that supports this banking system would be necessary. Also, the Islamic financial structure, underpinned by an effective ‘Shariah’ regulation and supervision, will ensure capital mobilization, promote investment and capital formation and facilitate risk-sharing operations in the public and private sectors. Constant investment in human capital, effective international cooperation among countries and recognized Islamic education and training institutions could address the shortage of skilled human resources. Applying the risk-sharing principles in transactions and undertaking equity-based finance models would restore a close link between evolution in the finance sector and the real economy. Risk-sharing finance and crowdfunding in microfinance activities would improve financial access for small to medium enterprises, thus improve financial inclusion for a more inclusive economic growth that enhances the prospect of job creation. In the real sector, production and trade will enjoy the expected positive effects of many policies and enforcement of market rules of conduct such as faithfulness to contracts and contractual obligations, transparency of the transactions, noninterference with working of the market (including labor market) and price mechanism, protection of property rights, enforcement of justice, measures for raising the economic structural competitiveness and appropriate risk-sharing based finance instruments. These rules could establish a conducive business environment for more sustainable and inclusive economic growth. Risk-sharing financing tools complement redistributive instruments, such as mandatory payments

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(Zakah), voluntary payments to redeem the rights of the less able in the wealth and income of the more able (Sadaqat ), voluntary loans with no creditor’s expectations of return on the principal (Qardh Hasan), voluntary endowment (Waqf ) and the law of inheritance. This set of instruments presents a comprehensive approach to addressing poverty, promote social justice, and increase the potential for a more balanced economic growth.

8.5

Conclusion

The Islamic paradigm presented in this study proposes an alternative policy framework to address these challenges. Unlike the present IMF and World Bank supported programs, the strength of the proposed stability and growth framework offers significant prospects for sustained growth performance, price stability, high employment, efficient financing, enhanced financial inclusion, more wealth, and income equality through risk-sharing, without adverse economic and social consequences. The Islamic framework also promotes international trade and economic integration among countries and unrestricted freedom of movement of labor capital and other factors, according to the Islamic tenets. With a firm political commitment backed by strong social support, Senegal would be better off if it could implement the policy recommendations of the Islamic model since the proposed economic framework uses the technique of financial programming model used by the IMF and World Bank throughout its experience of macroeconomic adjustment, but it does it so within an Islamic framework.

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References African Development Bank. 2018. Chapter 2: Growth, jobs, and poverty in Africa. African Economic Outlook 2018. African Development Bank and Bill & Melinda Gates Foundation. 2015. Delivering on the promise/Leveraging natural resources to accelerate human development in Africa. Report. Alawode, Abayomi A. 2017. The OIC Member States’ Stock Exchanges Forum. 11th Annual Meeting, Istambul. The World Bank. Beck, Thorsten, and Steven Poelhekke. 2017. Follow the Money: Does the Financial Sector Intermediate Natural Resource Windfalls. CEPR Discussion Paper 11872. Diallo, Boubacar. 2018. Secteur agropastoral, infrastructures publiques et croissance économique au Sénégal (Agropastoral sector, public infrastructures and economic growth in Senegal). Cheikh Anta Diop University Thesis, Dakar/Senegal. Diaw, Abdou. 2017. Exploring the Potentials of Diaspora Sukuk for OIC member Countries. Islamic Economic Studies 25 (Special Issue): 1–22. Diaw, Abdou, Bacha Obiyathulla Ismath, and Lahsasna Ahcene. 2011. Public Sector Funding and Debt Management: A Case for GDP-Linked ‘Sukuk’. MPRA Paper 46008. Dieye, Adama. 1996. La Compétitivité de l’économie sénégalaise (The Competitiveness of the Senegalese Economy). University of Auvergne Thesis, Clermont Ferrand/France. Dorotinsky, Williams, and Joana Watkins. 2013. Common Practices in Setting Expenditure Ceilings Within National Budgets. The World Bank “Recently Asked Questions” Series, 98813. Eriksen, Birthe, and Tina Soreide. 2016. Zero-Tolerance to Corruption? Norway’s Role in Petroleum-Related Corruption Internationally. In Philippe Le Billon and Aled Williams: Corruption, Natural Resources and Development: From Resource Curse to Political Ecology. Edw. Elgar 2017 . Haque, Nadeem U., and Abbas Mirakhor. 1999. The Design of Instruments for Government Finance in an Islamic Economy. Economic Studies 6 (2). International Monetary Fund. 2016. World Economic Outlook. IMF DataMapper. ISRA, IRTI, DURHAM UNIVERSITY. 2012. Kuala Lumpur Declaration. Strategic Roundtable Discussion, 20th September. Jonung, Lars. 2014. Reforming the Fiscal Framework: The Case of Sweden 1973–2013. Knut Wicksell Centre for Financial Studies Working Paper 26. Ljungman, Gosta. 2008. Expenditure Ceilings—A Survey. IMF Working Paper 08/282.

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Maurel, Matilde, and Majda Seghir. 2014. The Main Obstacles to Firms’ Growth in Senegal, Implications for the Long-Run. African Development Bank WP, 208. Sarif, Suhaili Bin. 2013. Income Generation Through Zakat: The Islamization Impact on Malaysian Religious Institution. The University of Edinburgh PhD. Shirazi, Nazim Shah, Sajid Amin Javed, and Dawood Ashraf. 2018. Remittances, Economic Growth and Poverty: A Case of African OIC Member Countries. The Pakistan Development Review 57 (2): 121–143. Williams, Aled, and Kedra Dupuy. 2016. At the extremes: Corruption in Natural Resource Management Revisited. U4 BRIEF, No. 6. World Bank. 2013. OECD Beyond the Annual Budget Global Experience with Medium-Term Expenditure Frameworks. The World Bank. ———. 2019. Doing Business 2019: Training for Reform—Senegal (English). Doing Business 2019. World Bank Group, Washington, DC. World Bank Group, INCEIF and ISRA. 2019. Maximizing Social Impact Through Waqf Solutions. Report.

CHAPTER 9

Conclusion

The recent global economic outlook identifies worrisome economic and financial trends with rising downside risks exacerbated by increased restrictions on world trade, hurting productivity and income; coupled with high global debt at US$247 trillion in the first quarter of 2018—or 225% of global GDP. This, combined with declining profitability, weak bank balance sheets and increased risk from climate change have exposed most economies to tighter global financial conditions and capital flow reversals. From a social prospect, the number of people living in extreme poverty remains high. According to recent estimates, 10.7% of the world population live on less than US$ 1.90 a day. Also, the world continues to suffer from substantial inequality between and within countries, faces a daunting refugee crisis and more recently a dramatic global COVID19 pandemic. These developments illustrate the growing diversity of risks which requires to adopt a more multidisciplinary approach for their appropriate management. The book argues that conventional standard economic policies based on monetary and fiscal solutions implemented in many developing and emergent countries have not been effective since they tend to perpetuate the cycles of indebtedness and austerity. In fact, current macroeconomic policy adjustment models follow an unsustainable economic model that has always been under strong criticism. Its policy prescriptions have failed © The Author(s) 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8_9

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to realize stabilization and growth in program countries. Notwithstanding intense research to find a new paradigm that could better address current global economic and social challenges, recent literature has stressed that the reconsideration of many dogmas in macroeconomic and monetary theories in the mainstream economy are still highly topical. In this context, we put forth the idea that the Islamic economic model prescribed in the Qur’an and applied at the time of the Prophet (SAW) could be the ideal model for Muslim countries and non–Muslim countries. The book suggests that an adjustment and growth in the macroeconomic model can be designed based on Islamic precepts, providing a superior alternative to the failed adjustment and growth programs of the Bretton Woods Institutions or debt driven economic models. In this context, Senegal represents the perfect petri dish for the application of an Islamic stabilization and growth model, as the country has completed several IMF-World Bank programs without achieving the promised macroeconomic stability and sustained growth. Accordingly, the study describes the institutional framework of an Islamic economy based on the teachings of the Qur’an and Sunnah and argues that if mobilized, it would allow society to achieve sustained, stable economic growth. Indeed, the Qur’an (S7:96) emphasizes the necessary and sufficient conditions for the existence of a steady and prosperous economy, in compliance with prescribed rules. Translating these rules in economic principles allows the setting up of an Islamic policy framework consistent with the social welfare and social justice principles of Islam. The Islamic policy framework encompasses strengthening market incentives, raising economic efficiency that favors a sustainable rate of potential growth, human capital development, enhancing economic resilience to shocks (domestic and external), and promoting environmental sustainability. Referring to lessons from country experiences, the research points out the necessary requirements to develop an institutional environment for economic and financial activities that conform to Islamic principles, mainly: (i) political will and commitment to implementation of reforms, (ii) credible initiators, communicators and awareness campaigns to induce public acceptability of the envisaged Islamic economic reforms, (iii) supportive legal, judiciary and educational infrastructure, and (iv) the prudent, gradual introduction of reforms to allow for enough time to develop a broad consensus for the process, thereby rendering it more

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politically and socially sustainable. The research argues then that implementation of the Islamic rules of behavior would offer a supportive institutional environment that ensures macroeconomic stability, encourages national savings and strengthens the attractiveness of the national economy for foreign capital at levels that fulfill the investment needs and thus, sustains economic growth and ultimately social justice. From an empirical point of view, while there has been ample research on Islamic finance, there is a paucity of empirical research in Islamic economics. This book aims to make a contribution in filling the vacuum and draw the attention of policymakers to the merits of an Islamic model through the case of Senegal, including initiation of the reforms consistent with Islamic principles. Accordingly, the research performs an analytical Islamic model simulation to set up a medium-term, growthoriented economic, and social program and guidelines for the design of external and fiscal policies that satisfy the requirements for macroeconomic stability. Its distinguishing characteristic is its ability to capture the short and long-run effects of Islamic economic policies on the main macroeconomic variables. Findings of the Islamic simulation model in the Senegal study case exhibit a positive and statistically robust impact of public investment on the rate of return to real sector, consistent with the results of conceptual and empirical studies on the design of fiscal policy. Also, simulation results show a positive and significant effect of the rate of return to real sector on economic growth, consistent with results of conceptual research in Islamic Economics. The book proposes for Senegal, the adoption of an Islamic model of economic stabilization and growth to break the vicious circle of weak and volatile economic growth, financial imbalances, and poverty and inequality. It argues that the proposed Islamic macroeconomic stability and growth framework is in the position to offer a great outlook for sustained growth, investments, and exports—the primary drivers of higher employment and wages. It would promote efficient financing and enhance financial inclusion, more wealth and income equality through risk-sharing mechanism and social safety nets. The Islamic framework would favor international trade and economic integration among countries and unrestricted freedom of movement of labor, capital and other factors, according to the Islamic tenets. Overall, the research acknowledges that institutions (including social values as culture) are important economic tools, as empirically well established by the New Institutional Economics (NIE) contribution on the importance of institutional

224

A. DIEYE

structure in economic performance. Non-alignment of these factors can undermine the motivation and benefits of moving from the present interest rate-based macroeconomic model to the Islamic model which proposes a holistic approach of macroeconomic adjustment policies. The basic structure of the Islamic model proposed in this research forms a starting point that extends and adapts other countries’ specific conditions, particularly developing countries. The potential of the Islamic model to offer a more comprehensive alternative to the conventional model can be strengthened, inter alia, by developing, in parallel with new econometric quantitative techniques, new methodologies for modeling and evaluating the societal implications of individual behavior, market behavior and performances, effects of public policies on social welfare. Current works on the conception and elaboration of Islamicity indices also opens new opportunities to “enhance the understanding of Islam from its fountainhead—the Qur’an, to serve as a benchmark and reference point for countries to build effective institutions for thriving communities, to enable countries to assess their year-onyear performance in designing and implementing of effective institutions (rules, their supervision, and enforcement characteristics)”.

Appendices

Appendix A. Glossary of Terms Market

Investment

Stable macroeconomic equilibrium

a place or institution in which buyers and sellers of a good or asset meet. Nowadays, in many cases, the market is a network of dealers linked physically by telephone and computer networks, and linked institutionally bu trading rules and convention. action or process of making deposits in economic proposals, shares, property, or a commercial venture for profit. In Islamic economics, this concept refers to Al Bay’ (Qur’an, Chapter 2, Verse 275) defined as the exchange of property that covers long-term investment contracts. a stable economic condition after disturbance—restoration of government financial balances, the private sector, and the balance of payments. At

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8

225

226

APPENDICES

The Design of a macroeconomic policy

Rate of return to investment Capital

Capital output ratio Counterfactual simulation

equilibrium, the economy suffers no fiscal deficits and no inflation. identification of targets (values of certain endogenous variables that policymakers would like to achieve), the instruments (policy variables controlled by the policymaker) implied by the given target, an analytic framework linking policies to chosen targets, and, finally, the time frame of reforms. signifies the ratio of profits to physical capital valued at replacement cost. refers in economics, to factors of production that are used to create goods or services and are not themselves in the process. is the amount of capital required to produce output worth. “what would have occurred if some observed characteristics or aspects of the process under consideration differed from those prevailing at the time.”

Appendix B See Table A.1. Appendix B (continued): Definition of variables (% of real GDP) GYR RIG TTR NODA FDEPTH CC FB IRR

real economic growth rate ratio public investment to GDP (real terms); term of trade (Index) Net Official Development Assistance financial depth = ratio of domestic credit to the GDP external current account Fiscal balance Investment rate of return

APPENDICES

227

Table A.1 Senegal. Selected macroeconomic indicators (%)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

GYR

RIG

TTR

FDEPTH

NODA

CC

FB

IRR

−3.1 5.1 7.8 −5.3 3.7 3.3 3.1 6.1 −0.6 4.0 −0.7 2.6 1.2 1.3 0.0 5.4 2.0 3.1 5.9 6.3 3.2 4.6 0.7 6.7 5.9 5.6 2.5 4.9 3.7 2.4 4.2 1.8 4.4 3.5 4.3

4.7 3.2 3.0 3.2 3.4 4.0 4.3 4.2 4.3 4.2 4.2 4.3 4.9 3.8 2.9 4.0 4.2 4.9 4.8 6.0 4.4 4.9 5.2 5.0 5.4 5.8 6.5 6.7 6.7 7.0 7.0 6.3 6.3 6.5 7.0

89.7 88.4 76.6 74.5 85.6 99.5 105.3 104.1 107.2 95.0 107.0 107.1 110.6 112.1 88.0 90.1 90.0 95.3 95.9 100.0 99.4 100.0 96.1 95.4 89.6 90.5 88.2 90.3 83.1 89.1 83.8 80.8 79.4 82.4 83.0

36 37 34 34 30 30 28 27 30 28 27 25 27 27 16 15 16 15 15 15 19 18 18 20 20 23 23 23 24 25 26 29 29 33 34

7.5 12.4 9.2 11.8 13.4 9.8 13.8 13.2 12.0 14.5 14.2 11.2 11.0 8.7 16.4 13.4 11.3 9.1 10.0 10.4 9.2 8.9 8.3 6.7 13.3 8.0 9.2 7.7 8.0 7.9 7.2 7.3 7.7 6.6 6.3

−11.0 −14.5 −8.5 −11.0 −10.1 −12.1 −8.8 −8.5 −8.1 −7.1 −6.4 −6.6 −6.7 −7.6 −4.8 −5.0 −4.0 −4.0 −4.9 −6.2 −7.1 −5.0 −5.9 −6.4 −6.4 −7.8 −9.2 −11.6 −14.1 −6.7 −4.4 −8.1 −10.8 −10.4 −8.9

−4.8 −8.5 −4.7 −5.9 −7.0 −3.8 −2.5 −2.3 −3.2 −2.1 −3.0 1.2 0.6 −3.1 1.5 0.7 2.1 0.4 −0.3 −1.4 −0.2 −1.9 −0.1 −1.3 −3.4 −3.0 −5.7 −3.5 −4.6 −4.9 −6.1 −.2 −5.5 −4.8 −4.2

3.4 2.5 2.8 2.1 1.5 1.4 2.7 3.5 4.2 4.4 5.5 6.3 7.4 8.4 10.4 12.7 16.0 14.7 14.8 16.5 15.4 15.6 14.3 16.7 18.1 16.5 17.5 18.4 18.8 18.6 19.2 19.4 20.7 19.2 19.1

Source Government of Senegal/ANSD/DPEE, Author’s calculation

228

APPENDICES

Appendix C See Table A.2. Appendix D. ECM estimation results of ARDL on real economic growth (GYR) Appendix E explores a long run reduced form relationship that relates real economic growth rate (GYR) as dependent variable to the computed investment rate of return (IRR) considered as focus explanatory and a set of controlling variables, related to the specific conditions of the Senegalese economy: the Net official Development Assistance (N O D A) expressed as ratio to the real GDP, the term of trade index (T T R) to proxy the external shocks to the economy and a dummy variable (DUM)1 to take into account the effects of the sharp currency devaluation of the common currency CFA in 1994 for 50% in relation to French Franc. The reduced functional form to estimate is specified as follows: GY R =∝0 + ∝1 I R R + ∝2 N O D A + ∝3 T T R + ∝4 DU M A general specification of the ARDL Unrestricted Error Correction Model (ECM) to be estimated is the following: DGY Rt = ∝0 + ∝1 GY Rt−1 + ∝2 I R Rt−1 + ∝3 N O D At−1 p + ∝4 T T Rt−1 + ∝5 DU Mt−1 + βi ∗ (GY Rt−i ) i=1 p p + γ 1 ∗ (I R Rt−i ) + γ 2 ∗ (N O D At−1 ) i=0 t−i i=0 t−i p p 3 4 + γt−i ∗ (T T Rt−i ) + γt−i ∗ (DU Mt−i ) + μt i=0

i=0

Where: μt are disturbances,  first difference operator; p maximum lag to be used and determined using information criteria such as the Akaike Information Criterion (AIC), the Schwarz Bayesian Criterion (SBC); ∝0 is the intercept of the model; ∝ i ,1,…,5 are the corresponding long-run coefficients of the underlying ARDL model, whereas β j j=1,…,p and γ is s=1,…,4 and i=1,…, p are the short-run dynamic coefficients.

1 This variable takes the value zero throughout the period, except in 1994, 1995,1996, 2002/2003.

15.99 41.76 36.63

60.85

48.15

40.74

35.8

35.00

30.00

43.47

37.33

49.60

41.67

70.28

44.51

41.67

61.18

61.47

Source World Bank “Doing Business” (2017)

Trading across Borders Enforcing Contracts Resolving Insolvency

Protecting Minority Investors Paying taxes

76.99

Cameroun

86.07

Senegal DB 2017

49.13

55.74

54.15

43.35

40.00

30.00

57.24

57.78

44.36

91.38

Cote d’Ivoire

25.27

54.00

52.32

62.91

53.33

65.00

65.99

60.30

65.34

83.73

Ghana

38.84

53.87

46.24

24.28

40.00

30.00

49.81

44.81

54.26

80.20

Guinea

41.46

43.73

70.79

57.50

40.00

30.00

50.37

50.60

61.02

84.12

Mali

44.69

40.10

63.66

48.22

40.00

30.00

31.40

52.78

45.09

81.71

Togo

Senegal. The Business environment (DTF score): A comparative presentation

Starting a Business Dealing with construction permits Getting electricity Registering Property Getting credit

Indicators

Table A.2

62.49

66.61

82.38

79.20

80.00

75.00

76.29

94.34

81.10

83.67

Malaysia

94.44 (United Arab Emirates) 100 (10 Economies) 84.15 (Korea Rep.) 93.89 (Finland)

99.88 (Korea, Rep.) 94.46 (New Zealand) 100.00 (New Zealand) 83.33 (New Zealand)

96.96 (New Zealand) 87.40 (New Zealand)

Best Performer Globally

APPENDICES

229

230

APPENDICES

The reduced functional form to estimate is specified as : GY R =∝0 + ∝1 I R R+ ∝2 N O D A+ ∝3 T T R+ ∝4 DU M The selected ARDL model optimal according to the AIC criteria is an ARDL (3, 2, 3, 2, 1). Table A.3 presents the results of its estimation: The validity of the estimated reduced model of growth is assessed under two angles: • the bound test of the “null hypothesis of no cointegration (H0: ∝1 =∝2 = ∝3 = ∝4 = ∝5 = 0) against the alternative hypothesis that there exists cointegration (H1: ∝1 = 0, ∝2 = 0, ∝3 = 0, ∝4 = 0, ∝5 = 0) between all variables by using F-statistic; Table A.3 ECM estimation results of ARDL (3, 2, 3, 2, 1) on real GDP growth Dependent Variable: GYR Dynamic regressors (4 lags, automatic): IRR TTR NODA DUM Fixed regressors: C Selected Model: ARDL (3, 2, 3, 2, 1) Variable

Coefficient

GYR(−1) GYR(−2) GYR(−3) IRR IRR(−1) IRR(−2) TTR TTR(−1) TTR(−2) TTR(−3) NODA NODA(−1) NODA(−2) DUM DUM(−1) C R-squared Adjusted R-squared

−0.141884 0.146211 0.091750 0.516294 −1.031032 0.807868 −0.027027 0.258116 −0.158828 −0.098383 0.252940 0.746238 −0.624812 −1.990321 4.366066 −2.098919 0.908542 0.822800

Std. Error 0.092334 0.105531 0.089123 0.242976 0.275132 0.281315 0.051958 0.052488 0.043617 0.041552 0.143599 0.149733 0.125679 0.834711 0.871499 3.741926 F-statistic Prob (F-statistic)

(* ) significant at 1%, (** ) significant at 5%, (*** ) significant at 10%

t-Statistic

Prob.*

−1.536642 1.385482 1.029474 2.124874 −3.747404 2.871761 −0.520180 4.917645 −3.641464 −2.367715 1.761427 4.983805 −4.971507 −2.384444 5.009836 −0.560919

0.1439 0.1849 0.3186 0.0495** 0.0018* 0.0111** 0.6101 0.0002* 0.0022* 0.0308** 0.0973*** 0.0001* 0.0001* 0.0298** 0.0001* 0.5826 10.59625 0.000013

APPENDICES

231

For n=32 and k=4, the calculated F-statistic value of 8.29 is higher than the upper bound critical value of 4.37 at the 1% significance level. Therefore, the null hypothesis of no cointegrating long-run relationship can be rejected, meaning that a long-run relationship exists between the real GDP growth rate and the explicative variables (the investment rate of return, the ratio of Net Official Development Assistance to the real GDP, the term of trade and the dummy variable (DUM). • the robustness tests of the estimated long-run relationship. See Table A.4. Table A.4 Cointegrating form and long-run coefficients Dependent variable : GYR Cointegrating Form Variable

Coefficient

Std. Error

t-Statistic

D(GYR(−1)) −0.237961 0.093676 −2.540268 D(GYR(−2)) −0.091750 0.062810 −1.460760 D(IRR) 0.516294 0.148840 3.468778 D(IRR(−1)) −0.807868 0.167666 −4.818319 D(TTR) −0.027027 0.033958 −0.795911 D(TTR(−1)) 0.257211 0.027330 9.411154 D(TTR(−2)) 0.098383 0.026394 3.727442 D(NODA) 0.252940 0.094211 2.684835 D(NODA(−1)) 0.624812 0.088759 7.039427 D(DUM) −1.990321 0.605176 −3.288829 CointEq(−1) −0.903923 0.111859 −8.080896 Cointeq = GYR−(0.3243*IRR−0.0289*TTR + 0.4142*NODA + 2.6283*DUM−2.3220) Long-Run Coefficients Variable Coefficient Std. Error t-Statistic IRR 0.324287 0.087685 3.698314 TTR −0.028899 0.045291 −0.638073 NODA 0.414157 0.264842 1.563788 DUM 2.628261 1.251430 2.100205 C −2.322011 4.084260 −0.568527 (* ) Significant at 1%, (** ) Significant at 5%, (*** ), Significant at 10%

Prob. 0.0218** 0.1634 0.0032* 0.0002* 0.4377 0.0000* 0.0018* 0.0163** 0.0000* 0.0046* 0.0000*

Prob. 0.0019* 0.5325 0.1374 0.0519*** 0.5776

232

APPENDICES

Table A.5 Diagnostic tests

Jarque–Bera Normality test of the Error term F-stat JB = 0.28

P-value = 0.87

Breusch-Godfrey Serial Correlation LM Test: F-statistic = 2.18 Prob. F(3, 13) = 0.14 Obs*R2-squared= 10.7 Prob. Chi-Square(3) = 0.0135* Heteroskedasticity Test: Breusch-Pagan-Godfrey F-statistic = 0.6 Prob. F(15,16) = 0.84 Obs*R-squared= 11.5 Prob. Chi-Square(15) = 0.71 Ramsey test of mis-specification F-statistic (1,19)= 0.04 Probability= 0.84 (* ) significant at 1%

Table A.5 shows that the model passed diagnostic tests for normality, auto-correlation (at the critical value of 1%), heteroscedasticity, specification. The CUSUM and CUSUMSQ plots (Fig. A.1) lie within the 5% critical bound, thus suggesting that the parameters of the model do not suffer from any structural instability over the sample period. Appendix E. ECM estimation results of ARDL on the Investment Rate of Return (IRR) Following the same methodology used in Appendix D, this Appendix E investigates a long run reduced form relationship that relates the investmentrate of return (IRR) considered as dependent variable to the public investment expressed as ratio to the real GDP (RIG) and considered as focus explanatory variables, two controlling variables: the term of trade index (T T R) and a dummy variable (DUM), the same variables used in Appendix E. The reduced functional form to estimate is specified as follows: I R R =∝0 + ∝1 R I G + ∝2 T T R+ ∝3 DU M The selected ARDL model optimal according to the AIC criteria is an ARDL (1, 4, 0, 4). • Results of the estimation:

2006

Figure A.1

2008

2010

5% Significance

Stability test of the coefficients

CUSUM

2012

2014

-8 -12

-12

2004

-4

-8

2002

0

0

-4

2000

4

8

12

4

8

12

2000

2002

2006

CUSUM

2004

2010

5% Significance

2008

2012

2014

APPENDICES

233

234

APPENDICES

See Table A.6. • ARDL bound tests For n=31 and k=3, the calculated F-statistic value of 6.69 is higher than the upper bound critical value of 4.66 at the 1% significance level. Therefore, the null hypothesis of no cointegrating long-run relationship can be rejected. Hence, a long-run relationship exists between the investment rate return to real sector (IRR), public capital expenses expressed as ratio to real GDP; the term of trade index (TTR) and a dummy variable (DUM) to take into account the modification of the parity of the regional common currency relative to the French Franc in 1994 (Table A.7). • Model robustness diagnostic test Table A.6 ECM estimation results of ARDL (1, 4, 0, 4) Dependent Variable: IRR Dynamic regressors (4 lags, automatic): RIG TTR DUMMY Fixed regressors: C Selected Model: ARDL(1, 4, 0, 4) Variable

Coefficient

IRR(−1) RIG RIG(−1) RIG(−2) RIG(−3) RIG(−4) TTR DUMMY DUMMY(−1) DUMMY(−2) DUMMY(−3) DUMMY(−4) C R-squared Adjusted R-squared

0.586856 0.570932 −0.415078 1.735903 −0.174662 0.666028 0.037651 2.544142 1.613655 2.373056 −0.699664 2.860718 −11.00209 0.991354 0.985590

Std. Error 0.090656 0.324230 0.386496 0.397282 0.393280 0.328829 0.024700 0.641472 0.716165 0.841723 0.707623 0.677790 3.689911 F-statistic Prob(F-statistic)

(* ) significant at 1%; (** ) significant at 5%; (*** ) significant at 10%

t-Statistic

Prob.*

6.473416 1.760886 −1.073950 4.369443 −0.444115 2.025453 1.524332 3.966100 2.253188 2.819284 −0.988753 4.220655 −2.981667

0.0000* 0.0952*** 0.2970 0.0004* 0.6623 0.0579*** 0.1448 0.0009* 0.0370** 0.0114** 0.3359 0.0005* 0.0080* 171.9900 0.000000*

APPENDICES

235

Table A.7 Cointegrating form and long-run coefficients Dependent Variable: IRR Cointegrating Form Variable

Coefficient

Std. Error

t-Statistic

Prob.

D(RIG) 0.621028 0.285644 2.174130 0.0433** D(RIG(−1)) −2.168759 0.526442 −4.119654 0.0006* D(RIG(−2)) −0.503326 0.395711 −1.271955 0.2196 D(RIG(−3)) −0.689942 0.276158 −2.498358 0.0224** D(TTR) 0.025630 0.025537 1.003627 0.3289 D(DUMMY) 2.438061 0.548180 4.447554 0.0003* D(DUMMY(−1)) −4.476218 1.110016 −4.032569 0.0008* D(DUMMY(−2)) −2.156055 0.735425 −2.931712 0.0089* D(DUMMY(−3)) −2.873786 0.609219 −4.717166 0.0002* CointEq(−1) −0.406702 0.066558 −6.110469 0.0000* Cointeq = IRR−(5.7683*RIG + 0.0911*TTR + 21.0385*DUMMY−26.6302) Long-Run Coefficients Variable Coefficient Std. Error t-Statistic Prob. RIG 5.768269 0.498647 11.567837 0.0000 TTR 0.091133 0.061209 1.488867 0.1538 DUMMY 21.038469 2.215448 9.496259 0.0000 C −26.630179 7.852456 −3.391318 0.0033 (* ) significant at 1%; (** ) significant at 5%

Table A.8 shows that the model passed the diagnostic tests for normality, auto-correlation, heteroskedasticity, specification. The plots of CUSUM and CUSUMSQ (Fig. A.2) lie within the 5% Table A.8 Diagnostic test

Jarque–Bera Normality test of the Error term F-stat_JB = 3.32

P-value = 0.190

Breusch-Godfrey Serial Correlation LM Test: F-statistic = 0.09 Prob. F(2,16) = 0.91 Obs*R2-squared= 0.38 Prob. Chi-Square(2) = 0.83 Heteroskedasticity Test: Breusch-Pagan-Godfrey F-statistic = 0.48 Prob. F(12,18) = 0.90 Obs*R-squared= 7.57 Prob. Chi-Square(11) = 0.99 Ramsey test of mis-specification F-statistic= 1.04 Probability= 0.32

5% Significance

Stability test of the coefficients

CUSUM

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Figure A.2

-12

-8

-4

0

4

8

12

-0.4

0.0

0.4

0.8

1.2

1.6

99

00

01

02

04

05

06

07 CUSUM of Squares

03

09

10

11 5% Significance

08

12

13

14

236 APPENDICES

APPENDICES

237

critical bound thus suggesting that the parameters of the model do not suffer from any structural instability over the sample period. Appendix F. Prohibition of Riba from sayings of the Prophet (pbuh). (Source: Sahih al-Bukhari) From Jabir (Gbpwh): “The Prophet (pbuh) cursed the receiver and the payer of interest, the one who records it and the witnesses to the transaction and said: ‘They are all alike [in guilt].’” From Anas ibn Malik (Gbpwh): “The Prophet (pbuh) said: ‘When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually.’” Zaid B. Aslam reported that interest in pagan times was of this nature: “When a person owed money to another man for a certain period and the period expired, the creditor would ask: ‘you pay me the amount or pay the extra’. If he paid the amount, it was well and good, otherwise the creditor increased the loan amount and extended the period for payment again.” The Prophet (SAW ) announced the prohibition of Riba in express terms at the occasion of his last Hajj: “Every form of Riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting Riba. I start with the amount of Riba which people owe to my uncle Abbas and declare it all cancelled”. He then, on behalf of his uncle, cancelled the total amount of Riba due on his loan capital from his debtors.” The Prophet (SAW ) said: “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt – like for like, equal for equal, and hand to hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand to hand.” Bilal (Gbpwh) once visited the Messenger of Allah (pbuh) with some high-quality dates, the Prophet (SAW ) inquired about their source. Bilal

238

APPENDICES

explained that he traded two volumes of lower quality dates for one volume of that of the higher quality. The Prophet (SAW ) said: “This is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the others.”

Index

A accountability, 104, 105, 144, 164 agency, 105 a short-term imbalance, 5 assets, 67, 72, 111, 118, 120, 121, 140, 142, 144, 160, 166–168, 189, 192, 209 asymmetric information, 123, 146 attractiveness, 186, 195, 200, 223 axioms, 100 B banking, 3, 130, 133, 136, 138–144, 146, 152, 166, 167, 208, 209, 214, 217 C calibration of the model parameters, 82 capital accumulation, 147 capital share, 80 cointegration approach ARDL, 81

competition, 110, 137, 145, 147, 148 competitiveness, 24, 130, 131, 137, 165, 186, 191, 195, 205–207, 213, 217 compliance, 5, 51, 98, 99, 119, 121, 129, 131, 136, 142, 145, 147, 193, 210, 214, 222 consultation, 111, 127, 147, 207, 209 consumption, 13, 133, 135, 136, 146, 166, 169, 170, 173, 187, 190, 191, 193–195, 199, 207 cooperation, 100, 110, 137, 147, 204, 210, 212, 214, 217 counterfactual simulation, 8, 76, 77 credit multiplier, 140 crowding-out effect, 24

D data, 76, 179 debt, 121, 141, 180 debt sustainability, 163 depletable resources, 147

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2020 A. Dieye, An Islamic Model for Stabilization and Growth, Political Economy of Islam, https://doi.org/10.1007/978-3-030-48763-8

239

240

INDEX

depletion, 106, 200 depreciation rate, 80 developing countries, 1, 23, 24, 79, 171, 175, 186, 189, 190, 195 dignity, 109, 119 dispute, 111 distribution, 72, 113, 118, 121, 125, 147, 149

E economic activities, 100, 106, 134, 145, 146, 165 economic development, 95, 96 economic environment, 105 economic growth, 4, 6, 13, 50, 78, 81, 128, 131, 138, 149, 150, 157–159, 169, 185–187, 190, 192–197, 199, 203, 205, 207, 209, 217, 222, 223, 226, 228 economic policy experiments, 82 economic policy shocks, 184, 193 economic principle, 129, 145 embezzlement, 125 Emerging Senegal Plan, 7, 157, 171, 173, 179 endowment, 120 enforcement of contracts, 123, 213 equity market, 160 ethics, 114, 125, 146, 149, 217 expenditure(s), 23, 72, 118, 119, 135, 136, 138, 146, 160, 187, 197 external current account, 150, 162, 165, 166, 170, 188, 192–194, 226 external debt, 2, 174, 179, 180, 208

F faithfulness, 100 financial access, 217 financial assets, 189

financial inclusion, 6, 144, 147, 210, 217, 218, 223 financial market, 189, 209 financial programming, 78, 166, 170, 171, 218 fiscal adjustment, 24, 171 fiscal deficit(s), 2, 23, 71, 78, 150, 159, 167, 170, 171, 173, 187, 194, 213, 226 fiscal sustainability, 146 foreign direct investment, 195

G gross domestic product, 78 growth model, 2, 3, 222

H hoarding, 121, 136, 146 human development, 172 Human Development Index, 164

I IMF programs, 4, 170 inequality, 147, 149 inflation, 78, 146, 157, 158, 166–168, 170, 174, 186, 226 information, 123, 137, 142, 145, 207 inheritance rules, 129 institutional assessment indicators, 164 institutional policy framework, 100 institutions, 1, 5, 6, 12, 24, 50, 51, 83, 130, 131, 139, 140, 142–144, 146, 149, 160, 164, 165, 187, 200, 203, 204, 209, 210, 214, 217, 223 integration, 98, 137, 147, 218, 223 interest, 5, 7, 23, 72, 76, 77, 127–130, 136, 137, 139, 140, 142, 146, 149, 150, 152, 170,

INDEX

171, 175, 184, 185, 195, 199, 207, 208, 213, 224, 237 interest rates, 79, 146, 171, 184, 195 intergenerational, 106, 135 international environment, 81 International Monetary Fund, 1, 82, 165, 201 investment, 13, 23, 24, 67, 73, 76–82, 130, 131, 133, 135–138, 140–143, 146–148, 151, 157, 159, 162, 166, 169, 170, 172, 173, 185–189, 191–193, 195, 197–199, 205, 207, 209, 214, 217, 223, 225, 226, 231, 232, 234 investment bank, 141, 214 Islamic analytical framework, 7, 184, 199 Islamic banking, 141, 143, 209, 210 Islamic economic model, 3, 77, 186, 191, 199 Islamic institutional framework, 6, 100, 149 Islamic paradigms, 4 Islamic principles, 3, 129, 203, 217, 222

J justice, 117, 118, 125, 126, 131, 135, 137, 138, 145–147, 149, 217, 223

L labor, 112, 115, 118, 129, 137, 149, 165, 171, 173, 207, 213, 217, 218, 223 labor share, 80 loan, 120 long-term stable equilibrium, 5

241

M macroeconomic adjustment, 1–3, 7, 8, 24, 157, 159, 183, 218, 224 macroeconomic equilibrium, 130, 187, 225 macroeconomic instability, 4 macroeconomic policy, 5, 76, 95, 131, 133, 147, 149, 150, 185, 226 macroeconomic stability, 138, 150 market, 2, 4, 13, 24, 72, 79, 113, 115, 118, 121, 123, 130, 131, 137, 141–145, 148–150, 162, 167, 168, 171–173, 185, 188, 189, 199, 206, 207, 209, 213, 214, 217, 222, 224 market failure, 204 medium and long run, 78 methodology, 76, 77, 80–82, 104, 183, 186, 197, 232 monetary policy, 72, 76, 130, 143, 149, 167, 170, 183, 184, 193, 208, 210

N National Participation Paper, 187 natural resources, 106, 108, 118, 139, 204, 211 New Institutional Economics, 6, 12, 223

O Oneness, 101, 147 open economy, 166, 207

P paradigm, 7, 157, 179, 209, 218 permissibility, 128, 134 permissibility of contract, 128 policy experiments, 198

242

INDEX

poverty, 1, 2, 4, 6, 25, 100, 121, 135, 144, 147, 149, 164, 165, 195, 204, 218, 223 price mechanism, 145 price stability, 78, 146, 150, 186, 193, 218 private investment, 23, 24, 79, 159, 171–173, 185, 199 production factors pricing, 146 productivity, 2, 4, 23, 79, 116, 130, 157–159, 162, 165, 186, 187, 206, 207 prohibition of ‘al-riba’, 128, 129 property rights, 14, 100, 111–113, 131, 173, 207, 217 public–private partnership, 195, 213 public finance, 72, 133, 138, 146, 159, 207, 208, 213 public investment, 23, 24, 81, 159, 166, 171, 187, 188, 191, 193, 195, 197–199, 223, 226, 232 Q Qardh Hasan, 120, 218 Quran, 3–7, 51, 95–101, 104, 105, 109–115, 117–125, 127, 128, 131, 133–138, 145, 146, 150, 152, 190, 199, 204, 222, 225 R rate of capital depreciation, 80 rate of return, 72, 76–82, 129, 130, 185–189, 193, 195, 197, 199, 208, 223, 231, 232 rate of return on capital, 80 ratio of capital-output, 80 real GDP growth, 78, 81, 157, 169, 172, 173, 186, 197, 230, 231 real sector, 72, 76, 78–81, 146, 187, 195, 199, 205, 206, 213, 217, 234

reciprocity, 110 redemption, 118 redistribution, 118 reduced equation, 81 reforms, 8, 51, 148, 149, 172, 173, 203, 210, 217, 222, 223, 226 remittances, 162, 193, 195 rental price equation, 80 reserve banking, 140, 141 reserve coverage ratio, 150 resource gap, 159 rewards, 114 right(s), 14, 98, 101, 111–114, 118, 125, 127, 128, 130, 136, 143, 152, 172, 189, 218 rights of possession, 112 risk-sharing, 72, 127, 129, 139, 141, 142, 146, 149, 161, 187, 195, 208, 209, 217, 218, 223 rule compliance, 126, 138, 145, 151, 204 rules of behavior, 5, 12, 199, 203, 204 rule violation, 98, 126, 131, 145, 147, 151

S Sharia, 50, 67, 99, 100, 137, 207, 210, 212, 214, 217 short-run, 23, 78, 171 simulation model, 6, 184, 199, 223 small open economy, 184 social justice, 4, 146, 149, 152, 157, 199, 203, 204, 218, 222 social order, 109, 147 social safety nets, 147 structural policies, 186 structural reforms, 160, 173 Sukuk, 67, 72, 200, 209, 210 Sunnah, 5–7, 100, 110, 111, 146, 152, 204, 222

INDEX

sustainable, 3, 4, 72, 78, 101, 144, 147–150, 157, 160, 172, 186, 192, 195, 203, 207, 208, 217, 222, 223 T Takaful , 144, 209, 214 the fractional reserve system, 140 the investment rate of return, 77, 78, 80, 197, 199 Total Factor Productivity indicator, 159 trusteeship, 115, 124 trustworthiness, 125, 130, 131, 145 twin deficit, 188 U uncertainty, 81, 99, 129, 145, 151 unicity, 104 Uniqueness, 101, 147

243

unity of the creation, 101, 147

W Waqf , 120, 204, 218 wealth, 72, 100, 110, 112–114, 118–125, 128, 129, 134, 136, 139, 140, 143, 146, 147, 149, 150, 172, 189, 204, 211, 218, 223 work, 112, 114 World Bank, 1–3, 7, 8, 82, 143, 149, 151, 155, 157, 164, 165, 169, 170, 172, 173, 201, 206, 208, 210, 218, 229 World Bank programs, 4, 157, 222

Z Zakah, 98, 100, 118, 121, 128, 139, 190, 204, 211, 218