RENT SEEKING IN ISLAM

According to Adam Smith^[1], a rent is money paid for the use of a capital asset, whether land, a building, an office, a car, a bicycle, or whatever someone might want but cannot or does not want to own. The owner who rents out his assets need only worry about (illegal) damage like vandalism, theft, etc. and about (inevitable) depreciation, where the capital value of the asset declines in time through ordinary use. Loaning money is a kind of renting, where the asset may depreciate through inflation and where there is considerable risk that the borrower may default or go bankrupt. The element of risk introduces an element of profit, but a careful lender can see to it that borrowers have the assents to cover any defaults: and the legal right to recover capital distinguishes renting from a straight investment for profit (where the whole capital can be lost without legal, moral, or any other recourse). Like banks in that respect, most renting enterprises mix rents with profits: they invest for profit by running a business where they collect rents.

Since modern economists have generalized the concept of rent to include all factors of production, the supply of any factors may at times fall short of its demand at the current price, thus, selling at a price higher than its production cost – the excess of which is called economic rent. ^[2]

Rent seeking

The phenomenon of rent seeking was first identified in connection with monopolies by Gordon Tullock, in a 1967 paper ^[3], which became the genesis of the rent-seeking literature. The phrase “rent seeking” itself, however, was coined in 1974 by Anne Krueger in another influential paper ^[4], which refers to lose-lose activities in which real resources are expended in an effort to capture money from others. In the modern economy, it takes innumerable forms, such as extortion, civil law cases, manipulation of financial markets, lobbying of politicians etc.

In economics, rent seeking occurs when an individual, organization or firm seeks to make money by manipulating the economic and/or legal environment rather than by trade and production of wealth. Rent seeking is more often associated with government regulation and misuse of governmental authority than with land rents as defined by David Ricardo.^[5] Rent seeking^[6] generally implies the extraction of uncompensated value from others without making any contribution to productivity, such as by gaining control of land and other pre-existing natural resources, or by imposing burdensome regulations or other government decisions that may affect consumers or businesses. While there may be few people in modern industrialized countries who do not gain something, directly or indirectly, through some form or another of rent seeking, rent seeking in the aggregate may impose substantial losses on society.

Rent seeking from Islamic perspective

"Law is in Islam a process of discovery. Just as the physical scientist believes that the laws of physics exist as an absolute, waiting to be discovered rather than invented, so the Muslim legal scholar believes that the shariah has been created by God and his role is to discover and articulate it rather than invent it."

- Imad-ad-Dean Ahmad –

'Rents and rent-seeking are both ubiquitous and inevitable, and as long as there are rights there will be rent-seeking, both between private and public actors and between private actors themselves. There is no single correct definition of waste and the choice of any definition is selective. The real issue is not minimizing rent-seeking, but how to allocate rents.'

- Steven M. Medema -

For the purpose of this article, we will only discuss on the government’s involvement in rent seeking. Rent seeking often involves government because government transfers huge amounts of money for which people can compete. In addition, government can use force in ways that no private citizen or group of citizens can, and that use of force can be made to enrich some at the expense of others ^[7].

The Holy Quran explicitly favours productivity and free trade, but encourages moderation in all matters. Therefore, Islam believes that free markets need the rule of law to operate because they do not operate by commands, but by individual choices made under laws. During the Prophet’s and Abu Bakr’s time, there was protection of property. The few taxes that existed were specifically fixed and non-confiscatory. There was no government intervention into the economy except to expose fraud, punish theft, or nullify riba (the charging of interest). Despite the adoption of tax practices found in newly conquered lands (often at severely reduced rates) and the institution of some regulations made necessary by the administration of those vast territories, the same general pattern was practiced by all the righteous khalifahs.

In Islam, any government policies that create privileged groups are deemed undesirable and this is obvious from the following examples :

a) Prophet Muhammad (s.a.w.) took back land from his companion Abyad b. Hammal when he came to know that it contained a salt mine and its private ownership might cause hardship to the general public.

b) Prophet Muhammad (s.a.w.) donated land to some of his companions with the hope that they would develop it. Later, when it was learned that the donee did not develop the land, it was taken back from him.

Therefore, from the above two examples, we can observe the following principles that could be used to assist the government to regulate rent seeking activities in the society :

1) The Islamic concept of rights accompanies obligations indicates that there are no rights that do not entail obligations. Therefore, the government should not create any right that does not specify the obligations of the beneficiaries.

2) To protect the interest of the general public, government donations should not be for the purpose of creating monopolies.

3) Donations should not allow some individuals to reap vast profits without the investment of labour or capital. Based on the example above, the salt mine on the land given to Abyad b. Hammal was on the surface and would not have required any development effort to extract salt from it.

4) In Islam, the discretion to donate property to individuals should be decided by the society collectively on the principle of Shura (consultation). This is because government officials (including the president or prime minister), are only trustees of public resources.

5) Governments may create some rents as an incentive for a higher social objective like industrialization or technology development. However, rent seeking becomes objectionable when the vast profits generated in this process are not deployed productively for the benefit of the Ummah.

6) The government must enforce a code of conduct on public servants, politicians, and businessmen, restraining them from seeking to influence the government for their own personal benefits.

Conclusion

It would be too simplistic to presume that there is no special interest groups in today’s Islamic society as there will always be one. However, it is not necessary that these groups act against social interests in each case. In some cases, they may play a positive role by providing information on specific problems. The government should accommodate them on the basis of the general principle of maslahah (welfare).

The Islamic government cannot remain passive to the ethical conditions of the people since, to a large extent, it depends on the voluntary ethical behaviour of its people. In fact, the Holy Quran obliges an Islamic government to enforce proper behaviour and to restrain people from improper behaviour. An Islamic society is responsible for creating institutions that inculcate each citizen with Islamic norms. People should learn and strive to sacrifice their short term personal interests for the greater good of the society. The belief in the hereafter should be embedded in the minds of all so that everyone abides by the rules of social conduct.

In essence, while there may be few people in modern industrialized countries who do not gain something either directly or indirectly through some form or another of rent seeking, rent seeking in the aggregate may impose substantial losses on society, thus the need to have government’s intervention to regulate such activities.

Notes :

1. Kelley L. Ross. "Rent-Seeking, Public Choice, and The Prisoner's Dilemma. Retrieved on November 25, 2008 from http://www.friesian.com/rent.htm

2. Economic rent is defined as the price paid for the use of land including all natural resources that God has provided to mankind as a whole, free of charge (Hasan, 2007, p. 303)

Economic rent is defined in conventional neoclassical theory as the return in excess of opportunity cost. Since opportunity cost is subjective and profits are created through entrepreneurial activity, there is no way for an outside observer to objectively identify economic rent which, in practice, is taken to mean "excessive profits" or "unearned returns." As in the case of the distinction between profits and profiteering, the identification of economic rent depends on judgments of value (von Mises, 1974, p. 129).

3. Gordon Tullock: (1967) The Welfare Costs of Tariffs, Monopolies and Theft, Western Economic Journal (Issue 5) pp.224-232

4. Anne Kreuger: (1974) The Political Economy of the Rent-Seeking Society, American Economic Review (Issue 64) pp.291-303

5. David Ricardo defined rent as the payment made to the landlord for the original and indestructible qualities of land. He argued that rent arises because land is of different quality.

6. Definitions of rent seeking :

· Rent-seeking is the expenditure of resources and effort in creating, maintaining, or transferring rents. These expenditures can be legal, as with most forms of lobbying, queuing, or contributions to political parties. However, they can also be illegal, as in the case of bribes, illegal political contributions, expenditures on private mafias, and so on (Khan)

· Rent seeking consists of legitimate, non-voting actions that are intended to change laws or administration of laws such that one individual and/or group gains at the same or greater expense to another individual or group. He further distinguishes between two kinds of rent seeking, i.e., market privilege rent seeking and redistribution rent seeking. The first type grants special market privileges to some people while taking privileges away from others. By interfering with free enterprise, the granting of such privileges reduce the market economy’s wealth generating capacity and economic efficiency. The second type of rent seeking does not interfere with free enterprise, although it affects incentives to produce wealth (Gunning, 2004)

7. Other interesting examples are theft and civil suits in the legal system (which does involve the government to some extent). The concept of rent seeking has also been applied to corruption by bureaucrats who solicit and extract ‘bribe’ or ‘rent’ for applying their legal but discretionary authority for awarding legitimate or illegitimate benefits to clients - for example, many tax officials take bribes for lessening the tax burden of the tax payers

CONCEPT OF AL-QARD UL-HASAN

Introduction

The word “qard” is derived from Arabic “qirad” which means to cut. It is called qard as it cuts certain part of the lender’s property by giving loan to the borrower. Hasan is also an Arabic word which originates from “ihsan”, which means kindness. Hasan is an act which benefits persons other than those from whom the act proceeds without any obligation. Perhaps the word hasan, understood in the context of ihsan, is meant to imply that the transaction is possible only when a person is fully aware that he or she is making a loan to someone in need without expecting anything in return from him, but only in order to please Allah s.w.t.

Therefore, the term “al-qard ul-hasan” means beneficial loan or benevolent loan or gratuitous loan. Chapra has defined al-qard ul-hasan as a loan which is returned at the end of the agreed period without any interest or share in the profit or loss of the business.

The difference between al-qard ul-hasan and sadaqah (charity), is that al-qard ul-hasan has to be repaid, although the borrower specifies the time of repayment, while sadaqah is pure charity. It is reported from the Prophet s.a.w. that the reward by Allah s.w.t. for sadaqah is ten times and that of al-qard ul-hasan is eighteen times, thus underlining the importance of al-qard ul-hasan.

Objectives of Al-Qard Ul-Hasan

Islam emphasizes on brotherhood among the Muslims and since al-qard ul-hasan being a gratuitous loan can help the fellow Muslims who need money, we can deduce the objectives of al-qard ul-hasan as the following :

a) To help the needy fellow people

b) To establish better relationship among the poor and the rich people

c) To mobilize wealth among people in the society

d) To perform a good deed that is encouraged and appreciated by Allah s.w.t. and Prophet Muhammad s.a.w.

e) To strengthen the national economy

f) To facilitate the poor to create new job market and business venture by using their merits, skills and expertise

g) To establish a caring society

h) To eradicate unemployment problem from the society

i) To remove social and economical discrimination in the society

Rules regarding Al-Qard Ul-Hasan

Al-qard ul-hasan, being a contract (aqd) between two parties requires the same principles that apply for other Islamic transactions, which are as follows :

a) Both parties should be legally capable to enter into the qard contract

To enter into a contract, parties must be baligh, aqil and rashid (major with sound mind). The Quran (Surah Al Nisa 4:6) states :

“Prove orphans till they reach the marriageable age; then, if ye find them of sound judgment, deliver over unto them their fortune; and devour it not by squandering and in haste lest they should grow up Whoso (of the guardians) is rich, let him abstain generously (from taking of the property of orphans); and whoso is poor let him take thereof in reason (for his guardianship). And when ye deliver up their fortune unto orphans, have (the transaction) witnessed in t heir presence. Allah sufficeth as a Reckoner.”

This verse specifies that the age of marriage and the sound judgement is the age of majority, which means that a major person is capable to enter into any transaction validly.

In a hadith, the Prophet (s.a.w) said, “The pen is raised for three groups (of people) that is, they will not be responsible for their actions : the insane until they become sane, those who are sleeping until they are awaken, and the youth until they reach puberty.” [Ahmad, Abu Daud and al-Tirmidhi].

The above hadith makes it clear that a person, who has not attained the age of puberty, may not be a responsible party to a qard transaction.

b) Ijab (offer) and qabul (acceptance) of the qard must be clearly made before entering into the loan contract

In the loan agreement, there should be clear expression, collation and conjunction of the ijab and qabul between the parties so as to prevent dispute in future.

c) The date of payment must be specified

The date of payment of the loan should be mentioned in the loan agreement. If no such date is specified, the transaction may lead to ambiguity and dispute among the lender and the borrower.

When Prophet (s.a.w) migrated to Madinah, he was informed that contracts of salam were made without specifying the amount or date, in which he says, “ Whoever enters into a contract of salam should specify the date of delivery and the amount of the subject matter.”

d) The contract should be in writing

Allah s.w.t says in Surah Al Baqarah (2:282) :

“O ye who believe! When ye contract a debt for a fixed term, record it in writing. Let a scribe record it in writing between you in (terms of) equity. No scribe should refuse to write as Allah hath taught him, so let him write, and let him who incurreth the debt dictate, and let him observe his duty to Allah his Lord, and diminish naught thereof. But if he who oweth the debt is of low understanding, or weak, or unable himself to dictate, then let the guardian of his interests dictate in (terms of) equity. And call to witness, from among your men, two witnesses. And if two men be not (at hand) then a man and two women, of such as ye approve as witnesses, so that if one of the two erreth (through forgetfulness) the one of them will remind. And the witnesses must not refuse when they are summoned. Be not averse to writing down (the contract) whether it be small or great, with (record of) the term thereof. That is more equitable in the sight of Allah and more sure for testimony, and the best way of avoiding doubt between you; save only in the case when it is actual merchandise which ye transfer among yourselves from hand to hand. In that case it is no sin for you if ye write it not. And have witnesses when ye sell one to another, and let no harm be done to scribe or witness. If ye do (harm to them) lo! it is a sin in you. Observe your duty to Allah. Allah is teaching you. And Allah is knower of all things.”

Here, the Muslim jurists have differing opinions. The majority of the jurists opined that it is not obligatory but strongly recommended to put the contract in writing. This is because they feel that if the parties decided not to put the contract on paper, there is no longer an obligation upon them to write it down. However, minority jurists are of the opinion that it is obligatory upon the parties to put the contract in writing, in accordance with the verse above.

e) Existence of two witnesses

The Quran verse above (Al Baqarah 2:282) also stresses on the need to have two male witnesses, and if two men are not available, then one man and two women must stand as witness. It is essential that the loan agreement comply with the Quranic injunction to avoid future dispute.

Characteristics of Al-Qard Ul-Hasan fund

An al-qard ul-hasan fund has the following characteristics :

a) It is flexible with respect to collateral.

b) Documentary procedures are usually very simple

c) Loans are usually small in size, approval procedures rapid and disbursement quick

d) There are no interest charges involved

e) The fund has easy access to capital contributors and borrowers because of its local base

f) The fund managers, who are drawn from capital contributors, are fully accountable

Examples of usage of Al-Qard Ul-Hasan in the world

1. United Arab Emirates

Dubai Islamic Bank offers al-qard ul-hasan (an interest free loan) to assist customers overcomes their financial problems so as to save them from undesirable circumstances and exploitation.

The fund aims at promoting a healthy Islamic social structure by facilitating social needs like marriage, education and situations beyond the control of the applicant like prolonged delay in salaries or wages. The facility promotes the concept of takaful (mutual benevolence) amongst Muslims.

This facility is made available through varied financial assistance (through donations or interest free loan) from the bank or other benefactors including individuals, financial corporations, business organizations and even the government.

The facility granted shall be repaid in one calendar year with repayment starting within one month from the date of receiving the al-qard ul-hasan.

2. Islamic Republic of Iran

The al-qard ul-hasan funds provides small consumer and producer loans and, in some cases, engage in profit sharing activities with small producers and firms, thus supplementing the fund’s capital. These funds are usually associated with local mosques or other religious organizations and sometimes with guilds or professional associations. The capital is contributed by the more well-to-do who are at liberty to withdraw their funds at any time. These funds operate with reasonably low administrative costs since most are managed on a voluntary basis by the people within the group.

Critical issues in Al-Qard Ul-Hasan

1. Misinterpretation of the al-qard ul-hasan concept

Al-qard ul-hasan is a benevolent loan, therefore, it is interpreted to mean that the borrower cannot be forced to make repayment under this principle. In the event the borrower is unable to repay the capital amount, the lender must accept this transaction as a charitable act. The borrower can however decide to reward the lender for his timely assistance, and can decide (at his sole discretion) on the quantum of the reward as well.

Therefore, in view of its non-commercial nature, Islamic banks seldom participate in this form of venture. Although banks are seen as social institutions in Islam, they nevertheless need to maintain their business sense for they too have their shareholders and depositors who must be kept satisfied in terms of returns and economic feasibilities.

2. Administrative cost/management fee for loan granted

Many parties have introduced Islamic financing products in the name of al-qard ul- hasan, however, their implementation seem to contravene its benevolent objective, which is meant for welfare service. It now has profit taking purpose behind the label of administrative cost/management fee so as to make it lawful in the eyes of the public.

According to Shariah standard of AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions), all kinds of benefit or additions (from the borrowed amount) agreed to by both borrower and lender, or it is made conditional in the contract upfront, or it is charged upon the late payment, in the type of money, things or any benefit, are strictly prohibited which is considered as riba. It is further stated that the charging of service cost is allowable, provided that it is the actual cost.

The Resolution of International Fiqh (3^rd assembly in year 1986) has stipulated that the charge in excess of the actual cost is strictly prohibited and the formula used to calculate the cost must be appropriate, exact and accurate. Indirect costs such as employment expenditure, office rental and expenses, and other liabilities, are not inclusive in the actual cost of financing.

Therefore, the service and administrative cost in the amount of percentages of 1 percent or 2 percent from the principal amount in not acceptable, as the International Shariah Advisors of AAOIFI has clearly decided that it is not permitted to link the charge to the amount given. The rational for this view is to avoid the percentage from being tied up to the cost amount according to financing amount and leads to the service charge becoming a changeable amount. By right, the charge should be the same amount irrespective of the amounts disbursed to borrower. It is concluded that the service charge based on percentage is actually riba hiding behind the label of service/administrative cost under al-qard ul-hasan.

3. Inflation

Although Islam urges justice to the borrower, it does not approve of injustice to the lender. Inflation undoubtedly does injustice to the interest-free lender by eroding the real value of al-qard ul-hasan.

Socio-economic justice requires the indexation of income and monetary assets by the use of not one universal index but of several indices based on different expenditure patterns. Indexation of al-qard ul-hasan has so far been rejected by the fuqaha because they generally consider it similar to riba in its essence. Their opposition to indexation of interest-free loans is also defensible on economic grounds because even though it is proposed with the innocent objective of doing justice to the interest-free lender, it has the potential of initiating gross injustice to the borrower.

Conclusion

Al-qard ul-hasan is for the benefit of the individuals and the society at large. To safeguard the interest of depositors/investors, these types of loans, as a matter of policy, do not constitute a significant source of financing by Islamic banks. Mirakhor observes, “perhaps the most challenging issue facing the implementation of an Islamic financial system is the development of risk-bearing instruments that can provide the investors with a sufficient degree of liquidity, security and profitability to encourage their holding.’

It is important to appreciate that the requisites for total implementation and success of Islamic banking in a country, include reshaping the society, restructuring of the economic system and reframing of the laws according to the dictates of Islam.

As highlighted above, the issues surrounding al-qard ul-hasan need to be addressed and acted on before a pure al-qard ul-hasan principle can be adopted and used for new product development and innovation.

Lastly, everyone especially the Muslims, need to change their priorities and at least as much emphasis should be laid on improving the ethics, honesty and values of the society as is being done for expansion of interest-free banking.