Inclusive growth with Zakat.
Iqbal, Muhammad Mazhar
Zakat is a religious duty that is imposed annually on idle wealth,
livestock, agricultural produce and commercial assets provided that
their value exceeds a prescribed limit called nisab. Zakat proceeds are
disbursed among the poor. Therefore, being an effective mechanism for
income redistribution, it signifies the role of income distribution for
economic growth in Islamic framework. On the contrary, in classical
economics, supply creates its own demand or the equilibrating variable
for both savings and investment is interest rate. This view minimises
the role of income distribution for economic growth. However, it is not
taken seriously anymore because classical economics failed to explain as
to why saving was persistently not equal to investment during Great
Depression. Then, Keynes emphasised that aggregate demand is more
important for the determination of output and average propensity to
consume falls as income rises. The second point has confusing
implications; on one side, it is argued that a worsening income
inequality may be desirable for a poor agrarian economy to take off
because rich people save more and thus invest more. On the other side,
it is argued that in a country having abject poverty and excess capacity
together; redistribution of income boosts aggregate demand and thus
accelerates economic activity. The first implication has been, so far,
emphasised more. However, recent worsening of income distribution and
sluggish growth in developed countries has drawn attention to the second
point as well. Simulation of this research incorporating two other
realities that marginal productivity of capital falls as capital
concentrates and family size decreases as income increases illustrates
the growth process without and with zakat. The results show that income
redistribution with zakat does not hold back economic growth.
JEL Classification: 015, 049, H23, P46
Keywords: Growth, Inequality, Redistribution, Excess Capacity,
Kuznets Curve, Aggregate Demand
1. INTRODUCTION
Zakat is an annual religious levy that is collected from rich
Muslims and its proceeds are disbursed among poor people of the society.
It has many spiritual and social merits. For example, it purifies the
hearts of zakat-givers as they give away a part of their wealth, one of
the most precious things in their lives, seeking the pleasure of God
without requiring any worldly gains whatsoever. It bridges the social
gap between 'haves' and 'have-nots.' This study
analyses, however, only economic consequences of Zakat for economic
growth. They cannot be appreciated duly unless one understands the
following concepts of modern economics; various theories of consumption,
aggregate demand, stagnation thesis, consumption puzzle, marginal
productivity of capital and Kuznets curve.
In classical economics, consumption is a negative function and
saving is a positive function of interest rate while investment is a
negative function of interest rate. As a result, at equilibrium interest
rate in a closed economy, investment is always equal to saving. In other
words, the issue of persistent deficient aggregate demand does not arise
in classical framework. Therefore, occurrence and longevity of Great
Depression became a puzzle for classical economists as they could not
explain it. At that juncture, Keynes (1936) propounded an alternative
theory that the main determinant of consumption and saving is current
income, not interest rate. An important feature of Keynesian consumption
function known as absolute income hypothesis (AIH) is that average
propensity to consume decreases as income increases. (1)
An important implication of AIH is the 'paradox of
thrift' or stagnation thesis. It states that as an economy grows
over time, its overall average propensity to consume falls and thus the
problem of deficient aggregate demand emerges. (2) Consequently, a
downturn follows every spell of economic growth. It means that income
distribution is relevant for economic growth. For illustration, consider
two economies having exactly the same average per capita GDP but one is
divided into two classes of 'haves' and 'have-nots'
and the other has perfect equality. According to AIH, higher saving rate
of the rich class in the former economy implies greater investment and
economic growth in that economy. Therefore, a natural policy implication
to accelerate economic growth is to create a class of rich businessmen
by granting them investment subsidies, tax holidays and easy credit. As
a matter of fact, many governments of the world actually adopted this
policy. Supporters of this viewpoint contend that accelerated growth of
a country also has the 'trickle down' effect for the poor as
additional investment creates jobs and employment opportunities for
them. As a result, their economic conditions also improve though their
relative position compared with the rich class or income inequality in
the country may worsen over time. However, an adverse consequence of
having a class system in a society is that if richness and hence
investment of upper class keeps on increasing, then excess capacity and
deficient aggregate demand appear simultaneously in the economy which
earmark a downturn in the economy.
Subsequent empirical researches mostly using cross-sectional and
household data verified AIH. However, Kuznets' seminal study which
used time series and aggregate data refuted AIH. (3) Kuznets concluded
that ape is constant in the long run. These contradictory findings
presented the consumption puzzle as to why ape of low-income households
is greater than that of high-income households in the short run and as
to why ape remains constant at aggregate level as GDP of a country
increases over time. Friedman (1957) and Modigliani (1966) though
resolved this puzzle to a great extent by propounding permanent income
hypothesis (PIH) and relative income hypothesis (RIH) respectively, yet
the debate on relevance of income distribution for economic growth, at
least in the short run, has not ended.
Currently, on one side are mainstream economists who do not brush
away AIH but still see little relevance of income distribution for
economic growth. They are of the view that any deficiency in aggregate
demand can be made up through alternative methods. Their viewpoint is
generally known as 'Washington Consensus' that particularly
emphasises five key policies; trade linearisation and export-led growth,
financial market liberalisation and financial capital mobility, fiscal
and monetary austerity, privatisation, and labour market flexibility. A
natural consequence of these policies is worsening of income
distribution. (4) On the other side are new Keynesian economists who
still accord much importance to income distribution for economic growth.
(5) In their view, an equitable income distribution is extremely
important to forestall any deficiency in aggregate demand or to avoid
possibility of stagnation thesis in the long run. However, they are not
so strict against an inequitable functional distribution of income that
is between capitalists and wage earners as they are against an
inequitable income distribution within wage earners that is between
managers and production workers or between supervisory and
non-supervisory staff. The reason is that any deterioration in
functional distribution only disturbs the composition of GDP as a
decrease in wages causes a fall in consumption while an increase in
profits causes a rise in investment. On the contrary, any deterioration
in income distribution within workers curtails aggregate consumption
without causing a matching increase in investment. Therefore, they
recommend income redistribution mainly within working class.
In line with classical thinking, another seminal study by Kuznets
(1955) mitigated the importance of any scheme of income redistribution
in a decentralised economy. He explored the historical evolution of
income distribution and per capita 'output. He concluded that
income distribution deteriorates as per capita output of a low-income
country increases but after achieving a certain level of development,
then income inequality starts smoothing out with further increases in
per capita output. That is Kuznets' curve which shows the
relationship between economic growth and income distribution is of
inverse 'U' shape. Various reasons have been offered to
justify this particular shape of Kuznets' curve. For example, one
argument is that a stagnant or slow-growing agrarian economy in which
wages as well as wage differentials are low starts growing fast when a
small fraction of workers move to manufacturing sector in which wages
are usually higher than those in agriculture sector due to greater
capital intensity and wage differential are also higher due to the
requirement of both skilled and unskilled workers. This process of
transformation continues to generate higher growth rate but worsening
income inequality unless majority of workers move to well-paying
manufacturing sector and shortage of skilled workers is also made up
over time. As soon as the economy is transformed from a predominantly
agrarian economy to a predominantly industrial one, then further
increases in per capita output generate equitable distribution of
income. (6)
Aghion and Bolton (1994) gave another explanation. At early stages
of economic growth, capital is owned mostly by the rich. Therefore, they
get richer and richer by appropriating scarcity rent. However, after
achieving a certain level of growth, capital accumulation abounds and
scarcity-rent for capital disappears; then economic growth induces
income equality. Perotti (1993) emphasised the political process for
inverse U shape of Kuznets' curve. In his view, poor workers who
are in majority at early stages of development take some time to mend
the system in favour of subsidised loaning to them, thus promoting
further growth along with a decrease in income inequality. The essence
of all these explanations is that income distribution improves in the
due course of development without requiring any deliberate effort of
income redistribution on the part of government.
However, in the last quarter of twentieth century, it was noticed
that many developing countries particularly Asian tigers experienced
phenomenal growth without damaging their income distribution as
suggested by Kuznets' curve. Moreover, many developed countries
particularly USA which had been experiencing improvement in their income
distribution since the end of World War II, have started experiencing
worsening of their income distribution since 1970s. (7) These anomalies
have casted doubts about universality of Kuznets' theory and thus
have reinvigorated curiosity of academia to reassess the importance of
income redistribution for economic activity at all stages of development
of a country.
With this background knowledge, it may be argued that Islamic
economics not only sides with those economists who favour an equitable
income distribution within wage earners but it also accords even greater
importance to equitable size and functional distributions. Any worsening
of size and functional distributions though may not disturb aggregate
demand in the short run, as argued, yet it certainly holds back economic
growth because marginal productivity of capital falls as capital
concentrates in few hands. Zakat is imposed on a wage earner whose
saving exceeds a certain amount called nisab and also on a capitalist
whose asset holding exceeds nisab. It means that imposition of Zakat,
long before Economics was introduced as a separate discipline of
knowledge, not only endorsed the Keynesian concept of equitable
distribution of income to foreclose any possibility of deficient
aggregate demand but it also visualised the detrimental effect of wealth
concentration in few hands for economic growth of an economy. The
objective of this research is to highlight important features of zakat
and to investigate through a simulation model the major concern of
mainstream economists that any effort to redistribute income at an early
stage of development jeopardises economic growth.
The scheme of this paper is that Section 2 presents theoretical
background to appreciate economic significance of zakat that is normally
interpreted merely a form of worship to God. Section 3 highlights
important features of zakat to qualify it as an ideal tool for income
redistribution. Section 4 presents a simulation model that compares
economic growth with and without zakat. The last section is reserved for
conclusion and policy implications, if any.
2. THEORETICAL BACKGROUND
For a long time after the emergence of Economics as a separate
discipline of knowledge, Say's law remained the dominant theory to
explain aggregate consumption behaviour and output of a country. It can
simply be stated as supply creates its own demand or a "general
glut" (the term used in Say's time for a widespread excess of
supply over demand) cannot occur. If certain goods remain unsold, it is
because other goods which can be sold immediately are not produced in
the country. Technically it implies that the equilibrating variable for
both saving and investment is interest rate. Therefore, it is not
possible in a market economy to have deficient aggregate demand and
unemployment for a long time. Along with Adam Smith's theory of
'invisible hand', Say's law has been the other important
doctrine used to support the laissez-faire belief that a capitalist
economy naturally tends toward full employment without any government
intervention. However, longevity and severity of Great Depression cast
doubts about validity of this view. Classical economists could not offer
any appealing reason to justify Great Depression which created a
theoretical vacuum in this otherwise growing discipline of knowledge.
(8)
At that point, Keynes (1936) conjectured a new consumption theory
that was appealing psychologically but was not tested empirically before
its statement. In his theory known as absolute income hypothesis (AIH),
current income is the main determinant of consumption. Although Keynes
admitted that interest rate can influence consumption as a matter of
theory, yet he concluded on the basis of experience that influence of
interest rate on individual consumption in the short run is secondary
and relatively unimportant. Keynes contemplated a consumption function
based on introspection and casual observations. It has two main
features; marginal propensity to consume (mpc) is less than one and
average propensity to consume falls as income rises. The second feature
which is more relevant for this research can also be interpreted as
consumption is the function of the poor and saving is the function of
the rich.
Subsequently, many empirical researches conducted on
cross-sectional micro data on consumption found that households with
higher income saved a larger fraction of their income which confirmed
Keynes idea that ape falls as income rises. However, two events
discredited Keynes' consumption function a great deal. One was that
due to voluminous increase in defense expenditures of the US government
during World War II, GDP increased significantly. Therefore, assuming a
significant fall in government expenditures after the war and a decrease
in overall ape in the country due to high growth during war years, many
economists predicted secular stagnation or emergence of deficient
aggregate demand after the war. But contrary to this prediction, it did
not happen to occur. The other is that Kuznets (1946) analysed almost a
century-long aggregate data on consumption and concluded that ape was
remarkably stable from decade to decade, despite large increases in per
capita GDP over that period. This contradiction in Keynesian consumption
theory and empirical findings of Kuznets presented the consumption
puzzle which could not be resolved by professional economists for some
time. Finally, Friedman (1957) and Modigliani (1966) gave respectively
permanent income hypothesis (PIH) and life-cycle hypothesis (LCH) which
justified falling ape in the short run and almost constant ape in the
long run. It means that these consumption hypotheses did not discredit
Keynesian consumption theory completely. Therefore, the debate about
relevance of income distribution for economic activity has not ended
yet.
Although AIH affirms the role of income distribution for economic
growth, yet somewhat contradictory policy implications are drawn from
it. On one side, it is argued that economic growth in a developing
country can start only if its government encourages income inequality by
providing investment incentives and tax holidays to business community.
Supporters of this view further argue that a sustained increase in
investment by rich people of the country has some 'trickle
down' effect for poor people as well. As investment increases, they
get well-paid jobs. As a result, their absolute poverty decreases and
their economic conditions improve though their relative poverty may
worsen over this period. On the other side is the stagnation thesis; as
per capita output in a country grows over time, households consume a
smaller and smaller fraction of their incomes or overall ape in the
country falls. Consequently aggregate consumption may not be sufficient
to absorb all output that is generated from profitable investment
projects. As a result, on one hand, excess capacity on the supply side
of the economy starts increasing and, on the other hand, aggregate
demand on the demand side of the economy starts squeezing that threatens
economic downturn. (9)
Another seminal study by Kuznets (1955) concluded that the
relationship between economic growth and income inequality if plotted on
a graph looks like inverse 'U'. That is, at initial stages of
economic growth, income inequality worsens and after achieving a certain
benchmark of economic growth, income inequality starts improving without
any deliberate effort of income redistribution on the part of
government. Many economists believe that the benchmark growth rate is
achieved when a basically agrarian economy is transformed into an
industrial one. (10) Kuznets' findings, in fact, mitigated the
importance of stagnation thesis and left no room for any deliberate
governmental effort to redistribute income from the rich to the poor.
Although stagnation thesis sounds good theoretically, yet it has
not occurred, so far, in any developed country as feared. Actually there
are various government options and uncontrollable economic events which
can postpone it for a long time. One such option is an increase in
budget deficit either through an increase in government expenditures or
through a cut in taxes. It raises aggregate demand that may counter any
fall in aggregate demand due to falling overall ape in the country.
Another option is an expansionary monetary policy that mostly results in
an increase in bank lending to households, businessmen and corporate
sector that may cover up any deficiency in aggregate consumption due to
falling ape. Yet another option is initiation of an export promotion
scheme as an increase in a country's exports offsets any deficiency
in aggregate demand domestically. One such uncontrollable economic event
is onset of a boom either in stock market or in real estate market or in
both. It raises the value of wealth of ongoing businesses and households
which, in turn, pushes up their investment and consumption demands.
Another such event is that households change their preferences; they
start consuming more and saving less. It also adds to aggregate demand
of a country. (11)
All these options have been exercised and events have occurred, so
far, either one after the other or in some combination or all together
in many countries particularly in USA. Therefore, USA that is the
citadel of capitalism has never experienced the brunt of stagnation
thesis in its true form except in Great Depression. However, two
developments, the widening income inequality in USA in the last three
decades in face of continuous economic growth and sluggish economic
recovery after the global financial crisis in 2007-08 have drawn the
attention of academia again toward stagnation thesis. These developments
have brought home two ideas which Keynesian consumption function
implies; income distribution has serious consequences for economic
growth and income distribution gets worse in a decentralised economy as
it grows over time.
Having understood the relevance of income distribution for economic
growth in conventional economics, one can appreciate that zakat, which
was introduced for a primitive Muslim society fourteen centuries ago,
has economic significance for a well-functioning capitalistic system
like the current one. Zakat not only affirms that equitable distribution
of income is congenial for economic growth but it also gives the details
of an effective scheme of redistribution. That is, it specifies the
period after which a deliberate redistribution scheme by the state has
to be implemented and it also specifies the minimum redistribution rate
for each type of assets. It may also be argued that in Islamic
economics, an equitable income distribution and alleviation of poverty
takes precedence over economic growth as zakat is imposed even if there
is no growth in the economy.
3. BASIC FEATURES OF ZAKAT (12)
(i) State Tax: Zakat is one of the five pillars of Islam. It is
enjoined upon Muslims like an act of worship. However, in economic
terminology, it can be translated as a wealth tax that is collected
annually by the state from the wealth of a Muslim provided that it
exceeds a certain limit called nisab. Zakat proceeds are expended for
the benefit of the poor. If the state does not collect zakat, then a
rich Muslim is obligated to pay it directly to the poor.
(ii) Items Subject to Zakat: Zakat is unanimously levied on gold,
silver, cash or bank deposits, pasturing cattle, agricultural produce,
mines and treasure troves. Regarding business assets and property held
for commercial purposes, there are two opinions. One is that zakat is
levied on their value. The other view which is supported by majority of
Muslim jurists is that it is levied on the income generated from them.
According to majority view, intermediate goods used for production of
final goods like tools and machinery, and animals used for agriculture
are not subject to zakat. Any property and durable goods possessed for
personal use like dwelling houses, furniture and fixture, clothing,
household utensils, books are exempted from zakat irrespective of their
value.
(iii) Nisab or Exemption Limit: The nisab is fixed in terms of
gold, 7.5 tola equal to approximately 84 grams, and in terms of silver,
52.5 tola equal to approximately 612 grams. In case of cash and bank
deposits, it is equivalent to the value of 84 grams of gold or the value
of 612 grams of silver whichever is less. The nisab for agricultural
produce is 5 wasaq equal to approximately 948 kilo grams and for
pasturing cattle it depends upon the type of cattle. For example, in
case of goats and sheep, it is 40 heads and in case of cows and
buffalos, it is 30 heads.
(iv) Rate of Zakat: Zakat rate is not the same for all zakatable
items. It is 2.5 percent for gold, silver, cash and bank deposits. It
ranges from 1 to 2.5 percent for pasturing cattle. It is 5 percent on
the produce of irrigated land and 10 percent on the produce of
non-irrigated land. It is 20 percent on treasure troves.
(v) Observable and Non-Observable Wealth: Observable wealth like
pasturing cattle and agricultural produce cannot be easily hidden
whereas non-observable wealth like gold, silver and cash can easily be
hidden from the state to avoid zakat. Therefore, Muslim jurists suggest
that the state should collect zakat on observable wealth compulsorily
even by force, if necessary, whereas state should leave payment of zakat
on non-observable items upon the will of their holders.
(vi) Usage of Zakat Proceeds: Zakat revenue can be spent only on 8
heads mentioned in Quran; poor, needy, state officials appointed for
collection and disbursement of zakat, those whose hearts are to be made
inclined and polite toward Islam, ransoming of captives, debtors, way
farers and in the way of God. Currently fourth and fifth heads are not
much relevant. Regarding the remaining heads except the thirds one,
Muslim jurists have agreed unanimously that the poor should be given
preference.
(vii) Miscellaneous: Zakat is imposed if a Muslim possesses a
zakatable item exceeding its nisab for the whole year. Zakat is
calculated on the average or year-end value irrespective of fluctuations
in its value over the year. If the quantity or number of one zakatable
item possessed by a Muslim falls short of its nisab but their sum
exceeds the nisab, then the person is liable to pay zakat. For
illustration, a Muslim having 20 grams of gold, 20 sheep and 15 cows has
to pay zakat. Zakat may be paid in kind or in equivalent cash on a
single day or over a period of time. It may be spent on a single head or
on some of them or on all of them proportionately or discretionally.
Zakat is preferably given in the possession of its recipient and is not
donated to an institution from which a zakat recipient derives some
benefits. The amount of zakat paid to a recipient should neither be less
than a full day's normal meals, nor be greater than the value of
nisab.
It is evident from basic features of zakat that it is levied on
idle wealth whether inherited or self-accumulated, which has the
potential to grow over time. The rate of zakat on a wealth item depends
on the extent to which its growth depends on nature. For example, rate
of zakat is minimum on pasturing cattle and maximum on non-irrigated
land and treasure troves. Its beneficiaries are mostly down trodden
people of the society. With these characteristics, zakat can be claimed
as an ideal mechanism to discourage concentration of wealth in few hands
and an ideal tool to redistribute income from the rich to the poor.
4. ECONOMIC GROWTH WITH AND WITHOUT ZAKAT
For the following simulation, first of all population has to be
divided into three groups; the rich class in which each member has idle
saving or owns wealth in excess of the nisab, the middle class in which
each member has idle saving or owns wealth that is less than the nisab
and the poor class in which each member has little savings or lives
below the poverty line. Zakat is imposed on the rich and its proceeds
are disbursed among the poor. The middle class neither pays zakat nor
receives it. Then capital stock of each class has to be approximated in
order to determine aggregate supply of output in the country. For this
purpose, Horrod-Domer growth model or a fixed output capital ratio has
been used. (13) However, keeping in line with decreasing marginal
productivity of capital, the output capital ratio for capital stock of
rich class has been assumed the lowest and that for capital stock of the
poor class the highest. With regard to functional distribution of
income, it is assumed that a big part of output generated from capital
stock of each class is retained by it in the form of profits. It is also
assumed that wage earners of a lower class get a part of output
generated from capital stock of a higher class in the form of wages but
not the vice versa. (14) Capital stock of each class has been augmented
by its annual saving and in accordance with AIH, saving rate for the
rich class has been assumed the highest and that for the poor class the
lowest. The simulation has been carried out just for 8 years because the
difference in growth rate of per capita income without and with zakat
becomes quite vivid over this period.
More specifically, to divide population into three classes, data on
idle savings and capital stock is required that is not reported as such
in any data source. Therefore, data from HIES 2011-12 reproduced in
Table 1 and estimates of poverty line have been used for this purpose.
The estimated poverty line on the basis of average calorie
consumption per adult is taken from Jamal (2013) this is Rs 2013 per
month for the year 2010-11. The estimated inflation rate for 2011-12 is
taken from economic Pakistan Economic Survey 2011-12 that is 10.8
percent. Hence, the poverty line for 2011-12 comes out Rs 2230 per month
that is very close to average monthly per capita income of second
quintile in table 1 above. Therefore the bottom and second quintiles
have been assumed to represent the poor class in our simulation. The
nisab for cash holdings and bank deposits is the price of 84 gm gold or
514 gm silver whichever is less. It comes out very close to annual
household saving of the top quintile. Therefore, the top quintile of
population represents the rich class in our simulation. Capital stock
for each class has been approximated from household saving as given in
Table 1; it is 12 times the annual saving of each class. As a result,
five quintiles in Table 1 are reduced to three classes in Table 2.
To reflect the fact that marginal productivity of capital falls and
excess capacity increases as capital accumulation of a class increases,
the output capital ratios for capital stocks of the poor, middle and
rich classes in the first year of simulation have been assumed as 0.7,
0.55 and 0.45 respectively. In every subsequent year, the output capital
ratio of a class falls by the formula:
[a.sub.p](t+1) = [a.sub.pt] + [([a.sub.mt
-[a.sub.pt])([hy.sub.p(t+1)] - [hy.sub.p1])/([hy.sub.mt] - [hy.sub.p1]))
where a denotes output capital ratio and hy denotes household
income; the first subscript denotes the class such as p for the poor and
m for the middle class and the second subscript t denotes the current
period and t+1 denotes the subsequent period.
Regarding the distribution of output produced, it is assumed that
the poor class receives all the output generated from its capital stock
in the form of wages and profits. In addition, the poor class receives
20 percent and 12 percent of the outputs of middle and rich classes as
wages. The middle class retains 80 percent of its output as wages and
profits and also receives 6 percent of the output generated from the
capital stock of rich class as wages. The proportion of wages from the
output of rich class going to the poor class has been kept higher than
that going to the middle class because capital stock of middle class is
good enough to absorb most of the wage earners of its class. The rich
class retains 82 percent of its output as wages and profits. These
figures have been chosen though arbitrarily, yet the resulting growth
rate in per capita income comes out very close to the actual one that is
in the range of 4 to 6 percent without zakat. The initial capital stock
of each class increases in every subsequent year by its annual savings.
Since it is evident from Table 2 that average family size of a
household falls as its income rises and average saving rate of a
household rises as its income rises, therefore the family size of a
class in our simulation decreases yearly by the formula:
[fs.sub.p](i+1) = [fs.sub.pt] + [([fs.sub.mt] -
[fs.sub.pt])([hy.sub.p(t+1)] - [hy.sub.p1]) / ([hy.sub.mt] -
[hy.sub.p1])
where [f.sub.s] denotes family size and hy denotes household
income; the first subscript denotes the class and the second subscript
denotes the period. For the first year of our simulation, family size of
each class is exactly the one given in Table 1. For the rich class, the
minimum household size has been assumed to be 4 and annual maximum
household income to be Rs 800000. Similarly the saving rate of a class
denoted by hs increases yearly by the formula:
[hs.sub.p(t+1) = [hs.sub.pt] + [([hs.sub.mt] -
[hs.sub.pt])([hy.sub.p(t+1)] - [hy.sub.p1]) / ([hy.sub.mt] -
[hy.sub.p1])]
For the first year of our simulation, saving rate of the poor,
middle and rich class is 1.9, 8.6 and 22.8 percent respectively as
calculated from the data on household income and expenditures in Table
2. The maximum saving rate for the rich class has been assumed to be 30
percent arbitrarily.
The results of our simulation are presented in Table 3. The upper
part of the table shows per capita income for each class in a
conventional economy in which zakat is not introduced, whereas the lower
part shows the results when 2.5 percent of household income of the rich
class is transferred to that of the poor class. (15)
As the comparison of the last row of each portion in Table 3 shows
that growth rate with zakat for each year of simulation is slightly
greater than that without zakat. The reason is that the pronounced
negative effect of zakat in the form of reduction in overall saving rate
is offset by two least discussed positive effects; an increase in
overall productivity of capital and a fall in overall household size.
Indeed, overall saving rate falls as income of the rich class which has
the highest saving rate is transferred to the poor class which has the
lowest saving rate in the economy but overall productivity of the
capital in the country increases because, after payment of zakat, saving
and thus addition to existing capital stock of the rich class which has
the lowest output capital ratio and which is usually subject to excess
capacity decreases whereas, after receiving zakat, saving and thus
addition to existing capital stock of the poor class which has the
highest output capital ratio and which is hardly subject to excess
capacity increases. The negative relationship between household income
and family size as is evident from HIES data given in table 1 further
enhances economic relevance of zakat. An increase in family income of
the poor class due to zakat helps them control their family size and
thus raise their per capita income. Consequently saving and capital
formation of the poor class also increases.
5. CONCLUSION
In Economics, the original view about functioning of markets was
that supply creates its own demand or persistent unemployment cannot
exist in a country. This view, however, could not explain severe
unemployment during Great Depression and thus lost its allure. Keynes
gave the alternative view that aggregate demand plays the dominant role
in determination of a country's output and the main determinant of
consumption is current income. The main feature of Keynes'
consumption function, AIH, is that ape falls or aps rises as income
rises. It indicated that income distribution is relevant for aggregate
economic activity in an economy. However, contradictory policy
implications are drawn from AIH. One is that a developing country can
grow fast if its income distribution is tilted toward the business
class. This policy ultimately helps the poor too; the channel is that an
increase in investment by the rich creates jobs for the poor. The other
is that worsening income inequality leads the economy to stagnate
because of falling aggregate demand and increasing excess capacity. Many
researchers on the basis of cross-sectional household data confirmed
AIH. However, Kuznets on the basis of time series aggregate data
concluded that ape remains constant as GDP of a country increases year
after year. Indirectly, it revived the classical view that income
distribution does not matter for economic activity and growth in the
long run.
The subsequent theories of consumption, particularly PIH and LCH,
reconciled findings of both cross-sectional micro data and time series
aggregate data implying that Keynesian consumption function better
explains short term consumption behaviour and classical view better
explains long term consumption behaviour of individuals.
Meanwhile, Kuznets discovered in his later study that income
distribution worsens at initial stages of economic development but
improves automatically at later stages without requiring any deliberate
income redistribution scheme from the government. This finding further
minimized the Keynesian stance that income distribution matters for
economic growth.
After these theories, one implication of Keynesian Economics that
aggregate demand matters more in determination of equilibrium output was
remembered very well but its other implication that an equitable income
distribution is inevitable to ensure sustainable growth in aggregate
demand was almost forgotten by academia in general and by policy makers
in particular. Since then, many governments of market economies have
used extensive demand management policies both fiscal and monetary and
implemented export-promotion schemes to boost aggregate demand. On the
contrary, they have hardly introduced any income redistribution scheme
in their respective countries. Therefore, stagnation thesis with all its
theoretical elegance has not been taken seriously so far.
However, incidence of recent global financial crisis, sluggish
growth since its ending and worsening income distribution in last few
decades in many market economies along with rising per capita income
particularly in USA have brought the debate about stagnation thesis to
limelight again. The attitude is, however, cautious as currently only
inequitable income distribution within wage earners is targeted and no
issue is taken with worsening of functional income distribution that is
between capitalists and wage earners. In other words, the issue of
excess capacity that is most probably an outcome of worsening size and
functional distributions of income has not been paid due attention yet.
After browsing the main arguments regarding the logic of income
distribution for economic activity in conventional economics, one can
understand very well the theory behind the institution of zakat in
Islamic framework. It endorses Keynesian standpoint that an equitable
income distribution is a prerequisite for smooth expansion of aggregate
demand and thus for sustainable economic growth in an economy.
Furthermore, zakat being a tax on idle savings and capital assets
highlights the fact that marginal productivity of capital decreases as
it concentrates in few hands. Zakat also lays down the details of an
effective mechanism of income redistribution. To investigate
implications of zakat for economic growth, a simulation model about
functioning of a market economy has been carried out. It incorporates
three important functions of income. One is that aps increases as income
rises; it is verified by HIES data used for this simulation. The other
is that aps or capital concentration increases as income increases
which, in turn, causes a decrease in marginal productivity of capital;
it is not supported by the data used for this simulation but having
similarity with the law of diminishing marginal utility of a commodity
and being vivid from excess capacity in big firms, it sounds good. The
last one is that family size is a negative function of income; it is
also evident from the data used for this simulation. In literature, the
first of these three functions is given more attention whereas the last
two are neglected somewhat.
The results of our simulation that gives equal importance to all
three functions clearly indicate that zakat is not detrimental but
congenial for economic growth. They confirm that an expected decrease in
aggregate savings and thus in capital stock due to any income
redistribution scheme has been exaggerated whereas its positive effects
on productivity of capital and on family size have been ignored to a
great extent. Our results therefore suggest that proper implementation
of zakat, on one side, may minimise the need of discretionary demand
management policies without ruling them out completely and, on the other
side, may take care of the problem of excess capacity in an economy.
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Muhammad Mazhar Iqbal <mmiqbal@qau.edu.pk> is Assistant
Professor in School of Economics, Quaid-i-Azam University, Islamabad.
Author's Note: He acknowledges valuable comments of the
discussant of this paper, Dr Anwar Shah, and chair of the session, Dr
Hafiz Muhammad Yasin.
(1) See Keynes (1936), Schifferes (2008) and Mankiw (2006).
(2) See Schifferes (2008).
(3) See Kuznets (1946) and Mankiw (2006).
(4) See Pal ley (2002b).
(5) SeePalley (2001, 2002a, 2002b).
(6) See Ahluwalia, et al. (1979).
(7) See Piketty and Saez (2003), and Saez and Zucman (2014).
(8) See Mankiw (2006).
(9) See Wikipedia (not dated) for excess capacity.
(10) See Acemoglu and Robinson (2002).
(11) See Palley (2002a, 2002b).
(12) See Moududi (1990) and Shafi (1963).
(13) For more details, see Ahluwalia, el al. (1979), Arif (1979),
Chenery and Ahluwalia (1975) and Dagdeviren, el al. (2000).
(14) It is assumed to keep the simulation simple; otherwise there
is no theoretical support in its favour.
(15) As mentioned above in section 3(ii) that there is difference
of opinion about application of zakat on business assets or capital
stock of a person. One view is that it is levied on the value of capital
stock and the other view is that it is levied on the income generated
from the capital stock. We have adopted the second view which is
supported by majority of Muslim jurists.
Table 1
Household Size and Saving, and Monthly Per Capita Income by Quintiles
2011-12
Income Expenditures Per Capita
Quintile (Rs) (Rs) Size Income (Rs) Saving (Rs)
Bottom 13307 13123 8.16 1631 184
2nd 16815 16413 7.40 2272 402
3rd 19928 18901 6.77 2944 1027
4th 24531 21741 5.96 4116 2790
Top 43858 34774 4.84 9062 9984
Source: HIES 2011-12; Tables 2.2 and 12.
Table 2
Household Size and Saving, and Annual Per Capita Income by Class
2011-12
Income Expenditures Per Capita
Class (Rs) (Rs) Size Income (Rs) Saving (Rs)
Poor 180732 177216 7.78 23418 3516
Middle 266754 243852 6.365 42360 22902
Rich 526296 417288 4.84 108744 119808
Source: HIES 2011-12; Tables 2.2 and 12 and calculations by the author.
Table 3
Per Capita Annual Income Without and With Zakat
Class
\Year 1 2 3 4
Without Poor 23418 26255 28278 30456
Zakat Middle 42360 44668 47149 49773
Rich 108744 109903 122096 130705
Average 48060 50350 54590 58232
Growth 4.76 8.42 6.67
With Poor 23418 28859 31304 34031
Zakat Middle 42360 44668 47215 49798
Rich 108744 106260 119173 126747
Average 48060 50663 55242 58881
Growth 5.42 9.04 7.59
Class
\Year 5 6 7 8
Without Poor 33304 36537 40505 45195
Zakat Middle 52836 56194 60017 64311
Rich 142237 153602 166503 179987
Average 62903 67813 73509 79800
Growth 8.02 7.80 8.40 8.36
With Poor 37730 41887 47069 53186
Zakat Middle 52879 56226 60053 64345
Rich 137898 148503 160735 173417
Average 63823 68946 74995.8 81695.9
Growth 8.39 8.03 8.78 8.93
Source: Calculations by the author.
