Equitable Distribution of Income with Growth in an Islamic Economy

In classical and neoclassical growth theory, it is argued that inequality is necessary to kick-start economic growth. In the Lewis model (1954), the capitalist class is expected to instigate economic growth through production in modern manufacturing sector. Kuznets (1955) argues that economic growth will trickle down to the masses once economic growth is sustained and allowed to mature. Solow (1956), Romer (1986), Lucas (1988) and Romer (1990) had emphasized on capital formation, technical progress, human capital, ideas and strong public and social infrastructure to achieve economic growth. Later on, economists like Meadows et al (1974) cautioned on the limits to growth amidst finite resources. However, since the policy direction did not take much notice of these concerns, the rapid growth in monetization and international trade has now put the future economic growth in serious jeopardy. An even bigger challenge is to ameliorate the great gap between rich and poor countries that has happened in the course of twentieth century economic growth program. In this study, we identify specific institutions in Islam that can help in achieving egalitarian distribution of income along with continued growth. We discuss that the principle of risk based productive enterprise can foster capital formation and entrepreneurship in an Islamic economy that disallows fixed return on money capital in the form of interest. We discuss that interest free financial intermediation can stabilize the economy from credit default shocks by ensuring broad risk sharing and linking monetary payments to factors of production with the result of productive enterprise. We discuss that a uniform Zakat levy on wealth and produce can result in tax rate smoothing, automatic stabilization of business cycle and encourage long term investments and decision making without leaving the long term planner in private sector to worry about fiscal policy reversals (i.e. Ricardian equivalence). In this paper, we also highlight the effects of inheritance laws of Islam on intergenerational redistribution of endowments. We argue that endowment redistribution in every generation in each family unit will automatically keep the inequitable distribution of resources in check without depending on the pace, nature and distribution of economic growth. We use mathematical modeling to show the effects of these institutions on economic outcomes.