The Market Economy and Its Limits

2 May 2009: Draft of Entry for Encylopedia of Islamic Economics Dr. Asad Zaman

1. Introduction By the Market Economy, we mean a method of organizing economic affairs within a society so that an un-regulated market is the means for conducting nearly all material transactions within the economy. In such economies, decisions about production of goods, valuation, trade, distribution, etc. are all settled by individuals or small groups acting with maximum possible freedom, and a minimal set of legal or social constraints. Since this is the dominant mode of organizing economic activity currently, it appears natural, and alternatives are hard to imagine. In fact, as Polanyi (1946) notes, Previously to our time, no society has ever existed that, even in principle, was controlled by markets. To understand the functions and effects of the market economy, it is necessary to delve into the history of its emergence and rise to a global system. The results of this analysis can be summarized as follows: 1. A market economy requires supporting institutions, social structures, political structures, ideologies, and ways of organizing knowledge. Labelling all of these elements combined as a market society, we can say that market economies can only exist within market societies. 2. Social structures required for market economies conflict with traditional social mechanisms. This implies that transitions to market economies are accompanied by violence and destruction of traditional social norms. Recent history is a record of resistance and conflict between traditional society and market society. 3. The global dominance of market economies has led to glorification and praise of their virtues. The tremendous damage inflicted on the world and society by the emergence of market economies has been suppressed A realistic assessment shows that urgent action is needed to rescue man and society from the brink of disaster to which the market economy has brought all of us. Because of the damages caused to society by the market economy, Polanyi (1946) in The Great Transformation forecast its demise following the largest crisis in his time, namely World War 2. The unexpected recovery and rise to global dominance of the unregulated market, and its dreadful consequences have been documented by Klein (2008) in SThe Shock Doctrine: The Rise of Disaster Capitalism . Many of the central elements of the analysis which follows are borrowed from these two sources, referred to simply as Polanyi and Klein hereafter.

2. The Emergence of the Market Economy A confluence of historical forces led to the emergence of a market economy in seventeenth century England. The most important of these are the weakening of the hold of religion, and also the rise in the power of the landed aristocracy in England. Both of these forces are conveniently represented in the brief realm of Oliver Cromwell, who beheaded King Charles I, and also massacred large numbers of Irish Catholics. 2.1: Rise of Secular Thought: The European experience of massacres, violence, and massive social disturbance due to religious conflicts led even religious leaders to agree to the use of secular principles to organize society for the sake of social harmony. Release of the constraints of religion allowed the introduction of values and principles dramatically opposed to traditional values. The most important of a large number of such changes was the replacement of the Biblical idea that The love of money is the root of all evil by Bernard Shaws sentiment that The lack of money is the root of all evil. Traditional society honors those who renounce material possessions, values simplicity over luxury, and considers gluttony, avarice, covetousness, and greed as sinful characteristics. Market societies honor the wealthy, consider poverty as a vice, promotes luxurious lifestyles, and consider greed and selfishness as natural and socially useful. This transition of thought is in accordance with the Quranic verse (2:257) that those who deny God will move from the light into darkness. 2.2: Rise of Landed Aristocracy: In the long standing battle between monarchs and aristocrats, kings had supported commoners against the nobles, to keep a check on their power. Efforts of the aristocracy to gain complete control over their landholdings (the commons, in particular) had been successfully resisted for some time, but Cromwells victory shifted the balance of power permanently in favour of the landed aristocracy. They wasted no time in putting up enclosures, which prevented access of large numbers of the poor to grazing land and other means to eke out a living. The resulting social catastrophe has been described by Polanyi as follows: The lords and nobles were upsetting the social order, breaking down ancient laws and custom, by violence . They were literally robbing the poor of their share in the common, tearing down the houses ( of ) the poor. The fabric of society was being disrupted; desolate villages and the ruins of human dwelling testified to the fierceness with which the revolution raged, endangering the defenses of the country, wasting its towns, decimating its population, turning its overburdened soil into dust, harassing its people and turning them from decent husbandsmen into a mob of beggars and thieves. 3. Consequences of Social Disruption These events in England had far reaching consequences, both temporally and spatially. We list those most important to our current theme, the emergence of the market economy. 3.1: Property Rights: Political tussles frequently led to re-allocation of lands in favour of victors. Utilizing their newly gained power against the monarchs, aristocrats sought to
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prevent this by developing new theories of property. Instead of viewing land as a sacred trust, a gift of God to all humans, the idea of ownership and private property as a natural right was introduced. Philosophers like Locke argued that the right to own property was prior to the social contract, so that governments could not alienate property. The effects of this historical change on modern thought can be seen in the concept of Pareto efficiency. According to this theory, re-allocation of property must command universal support. In a society where a few have all the resources, and the masses have nothing, modern economic theory prohibits us from recommending a redistribution in favour of the poor. Instead of seeing this as an ethical commitment to property rights over the rights of the poor to a decent living, economists view Pareto efficiency as an ethically neutral and value free scientific idea. 3.2 Changing Conception of Poverty: Poverty is an honourable condition in traditional societies. Christian monks take vows of poverty, and the Bible states that it is harder for a rich man to enter paradise, than for a camel to pass through the eye of a needle. Our prophet Muhammad s.a.w., refused riches and wealth, lived with very few possessions, and prayed to Allah to be counted among the poor. Poverty emerged as a social problem for the first time in England, following the first privatization that is, the enclosures. While the poor have always been with us, traditional societies accept and fulfil collective responsibility for feeding the poor. An essential element of a market society is the idea of blaming the poor for their poverty, which was first introduced by Malthus. According to him, it was over-breeding that led to poverty, while poverty led to vice, misery and squalor. To the natural cures of plague, pestilence, and wars for the reduction of population, Malthus added birth control as a means of combating poverty. For reasons to be discussed, the traditional concept of social responsibility for the poor must be destroyed to allow unregulated market economies to function. Malthusian ideas created the possibility not only of blaming the poor for their poverty, but also of arguing that helping the poor would hurt society in the long run. Feeding the poor would lead only to more over-breeding, which would create even larger numbers of poor in the long run. This idea, that helping the poor hurts them in the long run, takes many different shapes in modern economic thought. Reagan and Thatcher reduced taxes on the rich, arguing that this would increase growth because the rich would invest and increase productivity. The poor would only consume the tax cuts, reducing savings, investments and growth this would hurt the poor in the long run. 4. Essential Requirements of a Market Economy The many institutions and ideologies required for self-regulating markets to function are listed below. This section relies fundamentally on the analysis of Polanyi. 4.1 Labour Markets: Production in a market economy depends on the ability to hire labor and a market for labor. Labor is time or the material from which human lives are constructed. It is not normally for sale. England got a fifty year headstart on the industrial revolution because of the surplus pool of labor created by the enclosures. It was the

desperate condition of the large numbers of people evicted from their homes and barred from their conventional means of livelihoods, that led to the possibility of a labor market. Under normal social conditions, people would not submit to the indignity of a labor market requiring them to sell their labor for money. Massive disruption of the social fabric created the conditions required for large scale production in factories to come into existence. A similar catastrophe did not take place in Europe, which caused it to lag behind. 4.2 The Market for Land: Traditional societies value a harmonious relationship between man and nature, treating land and all that lives on it as a sacred trust, a gift of God to humankind. Yet a market economy must separate the man from the land, and turn both into commodities freely available for sale and purchase. Strengthening of property rights and large scale enclosures created the possibility of agricultural capitalism, and the production of large amounts of surplus food as well as industrial raw materials like cotton. This coincided with the industrial needs for raw materials as well as the need for food for large numbers of laborers not engaged in agriculture. The remoteness of the owner from the land allowed him to view it as merely an input to a production process, a means for producing wealth. In a traditional society, a labourer invests his life energies and efforts, and enjoys the reward of bringing valuable products out of dead land. In a market society, economic necessity compels the labourer to sell his time for money. He is alienated from the land and the produce, both of which belong to his employer. It is the loss of this sense of mother earth as an organic entity with an intimate relationship to man that has led to the global environmental catastrophes that threated to destroy us all. 4.3 Money and Financial Markets: The strength of the market economy lies in its ability to produce far beyond the minimal requirements of society. This surplus production creates its own inexorable demands on the structure of market societies. Subsistence economies have small self-sufficient subgroups with minimal trading requirements and hence little use for money. Demand for surplus must be created by promotion and marketing of luxurious lifestyles. Having large amounts of surplus necessitates trade and hence also the use of money for trading purposes. Commodity money functions adequately in non-market societies where trading is marginal and peripheral. Commodity money is not flexible enough to be adequate for market economies which engage nearly everyone in monetary transactions and have large and fluctuating amounts of trade, conducted over long distances in geography and time, and with unfamiliar trading partners. This accounts for the rapid introduction of token monies in market economies. Since token money is directly of no use, the best way to understand it is as a government guaranteed financial instrument it allows trade based on promises to pay which are flexible, backed by the government, and (hence) obligatory on all members of the society. Fluctuations in the quantities of money as well as the needs of trade can lead to fluctuations in price levels these have been the bane of market economies which require stable prices to function smoothly. Many mechanisms, including the introduction of central banks and other government policies have been tried to smooth out the business cycle without success. Problems are substantially exacerbated by international trade,

which cannot be conducted in terms of token money for obvious reasons. Polanyi (1946) discusses the mechanisms for price stabilization at the international level, and how their breakdown led to both world wars. He also suggests that the market economy is inherently unstable, inflicts tremendous damage on man, society and environment, and must be replaced by alternative mechanisms for productions and distribution of goods. 5. Market Ideologies and Consequences: The Quran (104:2) condemns those who gather wealth, and count it, instead of encouraging the pursuit of wealth. Furthermore, wealth in excess of needs should be spent for Allah that is, on socially useful projects, and on other needy people. In direct contrast, market economies encourage the pursuit of wealth to the point of being absolutely irrational, according to Max Weber. Excess wealth is to be spent on personal luxuries, or to be used to multiply wealth even further, but not on social welfare or on the poor and needy! Spending on the poor and needy undercuts the labor market, strengthens the laborers against the capitalists, and results in reduced profits for investment and growth. Classical economist Ricardo wrote that The principle of gravitation is not more certain than the tendency of (laws providing relief for the poor) to change wealth and vigor into misery and weakness (and) universal poverty. Similar sentiments can be found in contemporary writings of economists. Milton Friedman argued that firms should exclusively pursue profits and should not engage in socially beneficial activities. The relentless demand for profits, the production of surplus goods, the legitimization of the pursuit of wealth, and greed and selfishness, has led many disasters and crises both local and global. Polanyi has documented how the demands of the market economy led to world wars 1 and 2. Naomi Klein has picked up the story of capitalism from the 70s to the recent times, and documented the sequence of disasters generated by the market economy. In the three major dimensions (Land, Labor, Money), replacement of traditional values by market society based values has resulted in catastrophe: 5.1 The Market for Human Beings: The Collapse of Values Traditional social transactions are based on a mutuality, and partnership in the service of community and humanity. The market society replaced these by anonymous arms length trades of money for services. The gradual erosion of the sense of community, which accelerated in the post world war 2 era, has resulted in the destruction of family, in ethics of cooperation, generosity and trust. The family is the most fundamental unit of society, where children learn the rules governing social interactions. If the wife cannot trust the husband and the Clinton-Lewinsky affair demonstrates that this is true from the top to the bottom in western societies then no one can trust anyone else. This erosion of trust has been documented in many studies. For example, a report on Fractured Families put out by the Social Justice Foundation(2006) in the UK states that We now have one of the highest divorce rates in the Western world and the fabric of family life has been stripped away in the past thirty years. Some effects of this breakdown are documented by Josephson Institute survey (2008) which shows that more than 30% of the 30,000 USA high school students admitted to

having stolen from a store, parents or friends. According to the Center for Disease Control, USA also has the highest teen pregnancy rate in the world. The vast majority of approximately a million such pregnancies per year are unintended and have devastating social, economic and health consequences for both the unwed mother and the offspring. Promotion of the Invisible Hand idea that individuals pursuing selfish goals will produce socially beneficial results has led widespread corruption. Leaders like Madoff pursue Ponzi schemes, and the greed and dishonesty of followers in the finance industry has led to worldwide financial chaos and collapse. Many sources document massive corruption in post-Katrina, Iraq war, and recent bailout payments following financial meltdown. All of these developments can be directly traced to promotion of the core idea at the heart of market societies: all is fair in the pursuit of wealth. 5.2. The Market for Land: Environmental Disaster By treating land, its products, and all that lives on it, as merely inputs into the process of the production of wealth, the market economy has done large scale environmental damage, destruction and depletion of forests and other natural resources, and created a looming catastrophe due to global warming. The idea that the market is self-regulating leads to the delusion that we dont need to worry about these problems; if they matter, the market will automatically take care of it. The recent financial collapse should be a warning to those who believe this core belief of a market society. Barack Obama states that All across the world, in every kind of environment and region known to man, increasingly dangerous weather patterns and devastating storms are abruptly putting an end to the long-running debate over whether or not climate change is real. Environmentalist Daniel Quinn writes that Upwards of two hundred species.. mostly of the large, slow-breeding variety.. are becoming extinct here every day These species are being burnt out, starved out, and squeezed out of existence. The endless production of radioactive wastes and other poisons are hazardous to the future of life on this planet. For the first time in the history of the world, every human being is now subjected to contact with dangerous chemicals, from the moment of conception until death. With great difficulty, consensus has been reached on global warming and how it threatens human life on the planet. Market societies have prevented a solution, which requires shared sacrifice and cooperation. Leading capitalist countries put self-interest and profits above cooperation for survival. Instead of proportionately sharing the burden of environmental cleanup and costs of anti-pollution measure, they attempt to put all the blame and the cost of adjustments on the poor and powerless countries. 5.3 The Market for Money: Financial Crisis and Collapse As discussed earlier, commodity monies impose discipline and constraint which unregulated market economies cannot cope with. Token monies are able to adjust to changing market conditions and keep prices stable. However, use of token monies involves a crucial element of trust. Even when backed by gold or other commodities, no one is in a position to detect over-issuance of paper. For a large number of different reasons betrayals of this trust are common, and result in financial crises which have been

extremely common in the twentieth century. Among the big ones, Taleb (2007) in The Black Swan writes that In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American bankingeverything. Can we trust the invisible hand which guides selfish profit seekers to produce socially beneficial outcomes? The deep financial crisis currently enveloping the globe suggests otherwise. Even if the global economy recovers, which many pundits doubt, should we continue with a system which delivers shocks disrupting lives and livelihoods of vast numbers of people on a regular basis? There is ample evidence to suggest that alternatives which provide more comfortable lives for all human beings can readily be devised. 6. The Islamic Alternative The market economy is a western experiment with an alternative method of organizing society. Instead of intrinsic values of cooperation, trust, generosity, and other social virtues, many of which go against the natural grain of man, they sought to built a society with maximum freedom. Everyone is allowed to do whatever he desires, with a minimum of rules and regulations. The outcome of this experiment has been a complete failure on all fronts. Lane (2005) in The Loss of Happiness in Market Economies documents the fact that this freedom has not resulted in happiness. Numerous studies in the emerging field of well-being studies provide evidence for this. At the same time, crucial social structures like family, communities, as well as social values like cooperation, generosity and trust have been substantially depleted more so in the heartland of the market economy, but also, to a lesser extent in the periphery. In addition to eating up social capital, the natural resources of the planet have also been depleted at an astonishing rate by the market society. Many have noted that a sure recipe for complete collapse and disaster is to simply continue in our present ways. Fundamental and radical change is an imperative at this time. Islamic economics provides a radically different system which remedies the fundamental difficulties of market economies. A detailed analysis of the differences between the two, and how Islamic economics can deal with problems generated by market economy concepts is provided in Zaman (2008) Islamic Economics: A Survey of the Literature. One essential aspect of the solution is the concept of Hisbah or market regulation. This was institutionalized from the earliest of times (though it is now forgotten even in Islamic societies) and serves to curb the excesses of markets while benefiting from their benefits. Some other crucial ingredients of the more general changes required to transform market societies are discussed below. The first step is to change the hearts of people, in accordance with the Quranic prescription: 8:53 "Because Allah will never change the grace which He hath bestowed on a people until they change what is in their (own) souls: and verily Allah is He Who heareth and knoweth (all things)."

This was the first step taken by the prophet Mohammad s.a.w. to transform a society in which people buried their own daughters alive, killed each other over trifles, and had blood feuds running for generations. The message of Islam changed these people so that they would give to others even when they themselves were in great need, as the Quran testifies: (59:9) who love all that come to them in search of refuge, and who harbour in their hearts no grudge for whatever the others may have been given, but rather give them preference over themselves, even though poverty be their own lot. In stark contrast to market societies, this change from a selfish attitude to a generosity and caring for others at the individual level is building block of an Islamic society. The Quran testifies to the deep love that our prophet Mohammad s.a.w. bore for all human beings, Muslims and non-Muslims alike, by giving him the title of (Q21:107) Mercy for all mankind and mentions his deep compassion and sorrow for the potential fate of those who reject this mercy of Allah in (Q18:6). Individuals with love and compassion for each other form the building blocks of a society which runs on the basis of cooperation, instead of the competition characteristic of market societies. All the wealth on the earth cannot purchase the treasure which is the love between all members of the society: (Q8:63) And (moreover) He hath put affection between their hearts: not if thou hadst spent all that is in the earth, couldst thou have produced that affection, but Allah hath done it: for He is Exalted in might, Wise. This cooperation, respect for others, and the message of equality before God of all human beings the red and the black, poor and rich, powerful and weak creates a society which accepts the responsibility for food, cloth, housing, and education of all members. Islamic laws in the economic realm prohibit the creation of situations where some members are tremendously wealthy while others are hungry. This is a common feature of market societies; for example, latest reports from the USDA show 36 million people felt hunger in 2008, when at the same time trillions was spent on wars and on bailout payments to billionaires. In Islam, worship is not acceptable from a rich man when his neighbour is hungry. As Islam assures us, and empirical evidence shows, far more than enough in the way of resources is available to feed, clothe and educate all human beings on the entire planet. Nonetheless, by elevating greed and competition to be the main driving forces for human behaviour, the market society has created a situation where all are living under different kinds of threats hunger, job insecurity, loss of homes, loss of treasured social relationships, violence, injustice, and oppression. The guiding light of Islam provides a clear path out of our current difficulties, created by the collective rejection of Islamic principles for organizing social, political and economic affairs: 30:41 Mischief has appeared on land and sea because of (the meed) that the hands of men have earned, that ((Allah)) may give them a taste of some of their deeds: in order that they may turn back

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