Salman Ahmed Shaikh
In this issue of newsletter, we discuss three aspects of Urban Economics.
1) Urban Home Ownership & Role of IFIs.
2) Financing Public Goods & Infrastructure.
3) Internalizing Externalities & Conserving Environment.
1) Urban Home Ownership & Role of IFIs
In the practiced Islamic banking, Diminishing Musharakah (DM) is usually used to provide financing for buying new homes and undertaking construction and renovation of homes. In DM, the bank and the client purchase property jointly and simultaneously also enter into a leasing arrangement where bank is the Lessor and client is the Lessee. In periodic installments, the client pays rent for the use of part of property owned by the bank and with other part of the installment payment, the client purchases the share of the bank and eventually with these installments, the client becomes the sole owner of the property.
However, taking an ‘undertaking to lease’ enables the bank to avoid market and price risk. The bank only buys the property when it has obtained a unilateral undertaking from the client which is legally enforceable and which allows the bank to lock the second leg of sale and charge a stipulated price before committing any of its funds. This results in avoidance of market and price risk which is a distinguishing line between trade for profit and lending for interest.
In this brief write-up, an alternative proposal is presented which will make the transaction look much more transparent, realistic and conform to not only legal standards, but reflect and be based on the general way such leasing transactions are done normally.
The alternative would work as follows:
a) The bank buys the property paying the asset owner the full amount of the asset. The bank is now the sole owner of the asset.
b) It leases the property to the client and the bank also enters into an option contract as the call option writer. Then, as option writer, the bank is obliged to sell the asset if the call buyer (client) decides to exercise the contract.
c) If the call buyer does not exercise, the option contract expires and the bank is in a position to lease the property on rent again.
d) If the call buyer exercises the contract, the bank gets the asset price plus the rental income for the period before the expiration of the contract.
2) Financing Public Goods & Infrastructure
In public sector management, the real problem arises in funding operations of non-revenue generating activities like the operations of courts and police and in the provision of public goods. Public goods are goods which are non-excludable and non-rival. To solve this problem, first, we must note that certain quasi public goods can be made excludable.
- Toll Tax can also be levied to fund the development of roads and infrastructure.
- Stamp duty can be levied which is a tax on documents before they become legally effective.
- In developing industrial zones, export processing zones and developing necessary infrastructure, the government can charge a licensing fee from the industrialists to fund expenditure on development in particular area benefiting particular segments. Such a tax/fee or charge is not against the Islamic injunctions as it is directly linked with provision of services and performance and taken from identified beneficiaries using the ‘benefits principle’ of taxation.
In an Islamic economy, direct tax in the form of wealth tax (2.5%) and lenient production/income tax (Khums, i.e. 5% & Ushr, i.e. 10%) will encourage more circulation of wealth, reduce dependence on government’s subsidies and support programs and it will also help in boosting investment, employment and engender competitive markets without necessarily requiring a planned economy.
3) Internalizing Externalities & Conserving Environment
With the concept of afterlife accountability, Islam immensely influences intertemporal choice and behavior. It helps in private economic agents (consumers, producers etc.) modifying their actions in such a way that takes the externalities into consideration and also their own welfare, both in this world and afterwards. Afterlife accountability stimulate positive change in behavior in a much more comprehensive and permanent manner than any regulation or material incentive could possibly do.