Interest and its Role in Economy and Life 5-8
INTEREST AND ITS ROLE IN ECONOMY AND LIFE : THE ILLS OF INTEREST I
Description: The various ways in which interest has harmed society.
The Ills of Interest
Economists can attempt to come up with numerous justifications for the payment of interest but the real test is to study the affects that interest has. It is important to note that when something is prohibited by God, this does not mean that there is absolutely nothing beneficial in the prohibited item or practice. Indeed, one may be able to find something beneficial even in prohibited items. For example, God says in the Quran about alcohol:
“They ask you [O Muhammad] concerning wine and gambling. Say: ‘In them is great sin, and some benefit for people; but the sin of them is greater than the benefit…’” (Quran 2:219)
Thus, the essential point is not whether there is anything beneficial in something but whether the harm of something outweighs its benefit. Thus, economists may be able to find a hint of a justification for paying interest but this definitely would not outweigh the harms that interest can be shown to cause, as shall be discussed in this section.
Even if interest is considered some kind of payment to a factor of production, it has some unique characteristics that set it apart from payments to any other factor of production. Due to its unique nature, it leads to some very disturbing results.
First, interest leads to an inequitable distribution of income. This can be seen by taking an example of three people. Suppose there are three people who consume of all of their income in a given year yet one of them starts with $1,000 in savings, a second with $100 and a third with zero. At 10% interest per annum, by the end of the year, the first person will have $1,100, the second $110 and the third person zero in their accounts. If the same scenario follows in the next year, the first person will have $1,210, the second $121 and the third will have zero. Already, one can see how the distribution between them grows every year, even between the one who has some savings of his own. This scenario will be made even worse if the richest person will also to be able to add savings. Suppose he adds one thousand at the end of each year. He will have 1,100 at the end of the first year, he adds $1,000 and continues with his 10% interest and he will have $2,310 at the end of the second year, and so on. Now it is one thing if this money paid was actually due to some positive factor of production but in reality one cannot make that argument in this case. The money that the people are making via interest may have been squandered, lost or even stolen by the people who borrowed it, but one still has to be pay the interest. It may have been invested in a completely losing project and therefore it actually did not produce anything. But all of that does not matter, it has to be paid regardless of whether that “factor of production” produces anything or not. This is simply one of the unique aspects of money and payments to money. No one can argue that this is just and therefore its results are an inequitable distribution of money.
Furthermore, the distribution of income becomes more and more skewed over time. One can imagine some individuals dealing in millions while others are dealing in hundreds or thousands. The disparity in their interest incomes will indeed be great and growing every year. In other words, as one hears often, it will lead to a situation where the rich keep getting richer while the poor keep getting relatively poorer. Note that those in debt, paying interest that grows every year, have not been added to the equation. In their case, as interest continues to grow, more and more of their overall income is consumed by interest, further exacerbating the skewed distribution of income.
Someone could ask as to whether an inequitable distribution of income should be considered a major issue. Besides the psychological effects on the poor, especially given mass media advertising that emphasizes the good life and the need to consume, there are very important effects on the market as a whole. In a market economy, production will be geared towards those who have the money to pay for the output, regardless of how necessary other goods may be for society. If the rich desire, demand and are willing to pay a lot of money for SUVs and gas-guzzling vehicles, those will be produced (regardless of how much conservationists may complain). As the income distribution becomes more and more skewed, more and more resources will be devoted to the demands of the richer classes. Since resources are somewhat “fixed,” this means that less and less will be devoted to the needs of the poorer classes. Furthermore, the lesser resources devoted to the goods that the poor consume reduces supply and drives up the prices of those goods, further harming the poor people’s overall economic situation. For example, one can find numerous medical clinics catering to the rich (those who can afford such treatments), even if they are far from necessary, such as numerous places for cosmetic surgery and the like. At the same time, one may find it very difficult to find clinics catering to the poor and meeting their basic needs. If they could pay more for those essential services, in a market driven economy, one would definitely find more of those types of clinics, more resources devoted to those needs and a cheaper price in the long-run for what they need. (In addition, this skewed distribution also has strong implications for the health of democracy; however, that discussion is beyond the scope of this paper.)
In addition, the burden of interest upon the poor who fall into debt puts them into a situation where they cannot advance socially or economically, widening the gap between the rich and the poor. Debt itself is a difficult situation for any individual. However, it is interest payments that make one’s debt a moving target, many times one that an individual simply cannot keep up with. Again, it is a bogus factor of production but it works to allow the rich to get richer while putting a great burden upon those who fall into debt. Perhaps all the readers are familiar with how much of a debtor society the United States, the richest country in the world, has become. This has afflicted not only the lower classes but many of the middle class as well. Some sorry individuals do not realize that if they pay only the minimum on their credit card bills, for example, they will virtually never clear their balance. But, of course, it is the poorest that are hardest hit. In fact, the system is stacked against them as the poorer an individual is, the worst his credit rating and the higher the interest rate he will be forced to pay. Mirza Shahjahan’s Income, Debt and the Quest for Rich America: The Economic Tale of Small and Mid-Sized US Citiesis a study of how debt and its corresponding interest burden has afflicted much of “middle America.” The plight of small-scale farmers forced to borrow due to dropping prices on their output has been well-documented. Many of them have pawned their precious belongings or lost their farms that have been in their families for generations simply due to interest payments that they could not keep up with. Shahjahan found that some of the poor pay over 15% of their yearly income on interest payments alone (with most paying between 8% and 12%)—not to mention the burden of calls and threats from creditors that the poor often receive. In Shahjahan’s conclusions, he states:
Both the monetary and real burdens of debt have kept many debtors in a lifelong struggle to service their debts. The average size of the debt of indebted households for the 1990-1993 period was $32,493, equaling almost 100% of these households’ income. Our estimate of per capita household debt for 1990-1993 amounts to $12,571. Debt of this magnitude, combined with a temporary job and low income, can be depressing and produce overwhelming psychological conditions…
Some households’ interest payments exceed 15% of their income. This high interest cost has been a source of significant erosion of household income…
Most households – millions in number – in mid-sized cities struggle day in and day out to meet their basic needs of life. Thousands of them fail to provide a decent life for their families or support the higher education of their children. They live in debt and die in debt. This situation makes them feel that they live less than a full life…
These households are caught in a situation of economic servitude where the most obvious escape routes are blocked by institutional forces. Acquiring skills or higher education could be the key that opens the way to real opportunity, but higher education is expensive and beyond the reach of most of the households in these cities. These households have no opportunity to excel and find themselves passed over for the positions they had hoped for. This is the nature of the plight of the working class families in the small and mid-sized cities of our nation.
Shahjahan notes, “Most households are not really aware of the degree of erosion of their income which results from high interest payments on outstanding debts.” Mirza Shahjahan, Income, Debt and the Quest for Rich America: The Economic Tale of Small and Mid-Sized US Cities (Beltsville, MD: Writers’ Inc. International, 2000), p. 103.
Shahjahan, pp. 224-236.
INTEREST AND ITS ROLE IN ECONOMY AND LIFE (PART 7 OF 8): THE ILLS OF INTEREST II
Description: The various ways in which interest has harmed society. Part 2: The devastating ills of interest on an international level.
On an international level, the situation is much more devastating and dangerous. There is no question that when looked at from an international perspective, interest kills people. The debt servicing of lesser developed countries today is so great that they must sacrifice essential health and nutritional needs. It is dumbfounding to think that untold numbers of children are dying daily in lesser-developed countries due to the “tool” of modern capitalism: interest. Some African governments are forced to spend more on debt servicing than they spend on health or education.
In this context, the UNDP (1998) predicted that if the external debt of the 20 poorest countries of the world was written off, it could save the lives of 20 million people before the year 2000. In other words, it means that uncancelled debt was responsible for the deaths of 130,000 children a week up until the year 2000.
Ken Livingston, Mayor of London, claimed that global capitalism kills more people each year then were killed by Adolf Hitler. He blamed the IMF and World Bank for deaths of millions due to their refusal to ease the debt burden. Susan George stated that every year since 1981 between 15 and 20 million people died unnecessarily due to debt burden “because Third World governments have had to cut back on clean water and health programs to meet their repayments.”
Debt, with its increasing amount of interest compounded upon it, is dangerous for any nation because it means loss of sovereignty and control.This aspect, incidentally, is no accident. Lesser developed countries—especially their elites and corrupt rulers—are not free of guilt when it comes to the issue of the debt that they have accumulated. At the same time, if they did not borrow and get in debt, pressure would definitely be put on them to do so. Caufield noted:
Thus it has been with the World Bank; refunding operations have become more and more of the total of its lending. The result has been an accumulation of debt by the Bank’s borrowers—and a gradual loss of sovereignty as well. No creditor is willing to keep refunding forever without asserting some control over the way the debtor conducts business. In earlier times, the great powers did not hesitate to use military force to bend recalcitrant debtors to their will. In his classic essay, “Public Debts,” published in 1887, the American economist Henry Carter Adams wrote that “the granting of foreign credits is the first step toward the establishment of an aggressive foreign policy, and under certain conditions, leads inevitably to conquest and occupation.”
The Bank’s approach to its debtors is not so crude. Instead of sending in the Marines, it offers advice on how countries should manage their finances, make their laws, provide services to their people, and conduct themselves in the international market. Its powers of persuasion are great, due to the universal conviction that, should it decide to ostracize a borrower, all other major national and international powers will follow its lead. Thus, by the excessive lending—born of an underlying inconsistency its mission—the Bank has added to its own power and depleted that of its borrowers.
John Perkins’ now famous Confessions of an Economic Hit Man]details contemporary economic intrigues. While describing his job of evaluating projects, he wrote:
The unspoken aspect of every one of these projects was that they were intended to create large profits for the contractors, and to make a handful of wealthy and influential families in the receiving countries very happy, while assuring the long-term financial dependence and therefore the political loyalty of governments around the world. The larger the loan, the better. The fact that the debt burden placed on a country would deprive its poorest citizens of health, education, and other social services for decades to come was not taken into consideration.
Perkins’ work has now been followed up by A Game as Old as Empire: The Secret World of Economic Hit Men and the Web of Global Corruption edited by Steven Hiatt. Hiatt writes,
Debt keeps Third World countries under control. Dependent on aid, loan reschedulings, and debt rollovers to survive—never mind actually develop— they have been forced to restructure their economies and rewrite their laws to meet conditions laid down in IMF structural adjustment programs and World Bank conditionalities.
The current debt situation, with the major role that interest is playing in it, is potentially very devastating for the world as a whole. In Global Trends 2015, the Central Intelligence Agency (CIA) recognized:
The rising tide of the global economy will create many economic winners, but it will not lift all boats. [It will] spawn conflicts at home and abroad ensuring an ever-wider gap between regional winners and losers than exists today. [Globalization’s] evolution will be rocky, marked by chronic financial volatility and a widening economic divide. Regions, countries and groups feeling left behind will face deepening economic stagnation, political instability and cultural alienation. They will foster political, ethnic, ideological and religious extremism, along with the violence that often accompanies it.
Noreena Hertz has an excellent chapter in her work, The Debt Threat: How debt is destroying the developing world… and threatening us all, delineating many of the dangers that the massive debt—and, again, which would not be as massive without the ever-growing aspect of interest—poses for the world today. She details the dangers of extremism, terrorism, depletion of the world’s natural resources, and more. To cite just one aspect, she writes:
Debt’s ugly progeny—poverty, inequality, and injustice—are also called upon to justify, and even legitimize, acts of the greatest violence. Only a few weeks after the World Trade Center was attacked, leading African commentator Michael Fortin wrote: “We have to recognize that this deplorable act of aggression may have been, at least in part, an act of revenge on the part of desperate and humiliated people, crushed by the weight of the economic oppression practiced by the peoples of the West.” Fortin’s language—“crushed,” “oppression,” “desperate,” “humiliated”—is deliberately evocative. And it is manifestly clear that there is an audience with whom such words powerfully resonate.
In reality, there are yet other ills related to interest that could be discussed but the above should suffice for the purposes here.
Cf., Noreena Hertz. The Debt Threat (New York: HarperBusiness, 2004), p. 3.
Ali Mohammadi and Muhammad Ahsan, Globalisation or Reconolisation? The Muslim World in the 21st Century (London: Ta-Ha Publishers, Ltd. 2002), p. 38.
Mohammadi and Muhammad Ahsan, p. 43.
Again, simply the removal of interest from such debts would work wonders to alleviate the position of the world’s poorest. The amount of interest paid by these poor countries is astronomical. Caufield noted, “By 1978, one-quarter of all the money borrowed by non-OPEC Third World countries was used to pay interest on existing debt. The situation was particularly bad in Latin America, where borrowing doubled between 1976 and 1982, and 70 percent of new loans went to pay interest on old debt… By 1982, the situation had become truly absurd. Latin America was owing hundreds of billions of dollars a year, and spending all of it— more—on keeping up payments on its past debts.” Catherine Caufield, Masters of Illusion: The World Bank and the Poverty of Nations (London, England: Pan Books, 1996), p. 137. Even when “debt relief” is granted, payments are delayed but it is demanded that the interest still accumulates on it. According to Gwynne, “Even though the banks may allow a country such as Poland to ‘reschedule’ its debt—allowing it twenty years instead of ten to repay, for example—the interest payments keep coming. And it is interest that shores up the bottom line of a bank’s profit-and-loss statement.” S. C. Gwynne, “Selling Money-and Dependency: Setting the Debt Trap,” in Steven Hiatt, ed. A Game as Old as Empire: The Secret World of Economic Hit Men and the Web of Global Corruption (San Francisco: Berrett-Koehler Publishers, Inc., 2007), p. 35. Payer noted this phenomenon all the way back in 1974, but virtually nothing has been done to correct it. See Cheryl Payer, The Debt Trap: The International Monetary Fund and the Third World (New York: Monthly Review Press, 1974), p 46.
Caufield, p. 336
John Perkins, Confessions of an Economic Hit Man (San Francisco: Berrett-Koehler Publishers Inc., 2004), passim.
Perkins, p. 15.
Steven Hiatt, ed. A Game as Old as Empire: The Secret World of Economic Hit Men and the Web of Global Corruption (San Francisco: Berrett-Koehler Publishers, Inc., 2007)
Hiatt, p. 23.
Quoted from Hertz, p. 156.
Hertz, p. 161.
INTEREST AND ITS ROLE IN ECONOMY AND LIFE (PART 8 OF 8): THE ISLAMIC SOLUTION
Description: An Islamic solution to the interest model, and how economy can still thrive without interest.
The Islamic Solution
The Islamic solution to the issue of interest rests upon two basic principles:
(1) If an individual wishes to lend money to another in order to help the latter, this act must be based on “brotherly principles” and it is absolutely unacceptable to charge any interest in such a case. It is not helping another individual to put him into a cycle of debt where he has to pay more than what they borrowed. This principle applies as well to Islamic international relations. If this important principle were applied today, countries would truly give “aid” and assistance to other countries, rather than sucking them into a pattern of dependency and debt burden.
(2) If an individual wishes to use his money to make more money, then he must be willing to put his money at risk. In other words, he cannot guarantee for himself a fixed return (whose amount keeps growing over time) regardless of the result of the investment that his money is used for. If he puts his money at risk, he is deserving of some share of the profits. However, this also means that he must accept losses if losses occur. This is a system that is based on justice. It also has numerous benefits to it. The one who invests becomes concerned about the results of his investment and cannot demand his “pound of flesh” regardless of what may occur to the debtor.
This Islamic solution works for individuals as well as for society as a whole. Banks are essentially financial intermediaries. They take money from those who have excess money (savings) and turn it over to those who need money for investment purposes. Interest is not necessary for such a system to work. The bank and its depositors (shareholders) invest, rather than simply loan, their holdings. The money is put at risk and the return to the depositors will be based on the amount of profits made in the respective investments. Under normal circumstances of a growing economy, if the bank is big enough and it diversifies its portfolio, the bank is virtually “guaranteed” a positive return on its total investments. Thus, those who invest their money with the bank will also receive a positive return on their money without it being guaranteed or fixed ahead of time.
Numerous “Islamic” financial institutions have been set up throughout the world today. They have been established on the principle of avoiding interest and some of them have flourished.
For the most part, “modern civilization” has decided to turn its back on Divine Guidance (mostly due to the experience in the West with Christianity) and have attempted to construct their own economic systems, political systems, international laws and so on. When doing so, though, they have to admit that they are attempting something that is beyond their means. The social sciences are very different from the physical sciences. There are no labs in which humans can be entered to determine what may be the best results under different scenarios (and even that would have to assume that humans will always react the same under the same circumstances).
In the realm of economics, the first thing that may come to mind is the collapse of the theories of socialism and communism. One should, though, also take a closer look at capitalism and how far its reality is from what it is supposed to be. The early capitalist theorists envisioned a theory that would lead to “the best of all possible worlds.” However, their theories were based on assumptions that never were and will never be fulfilled. They assumed perfect competition, perfect knowledge, free trade and so forth. Once these assumptions are violated, which they inevitably are, they do not lead to the “best of all possible worlds.” Instead, they easily lead to a world of exploitation, wherein the rich get richer and the poor get poorer. One of the diving forces behind this system is the institutionalization of interest.
God has blessed humans with the guidance of the Quran—a book that has been minutely preserved since its revelation. This book contains the guidance that humankind needs to lead a successful life in both this world and the Hereafter. It is therefore no surprise that this book absolutely prohibits and condemns interest in the strongest fashion.
For more details on the theoretical and practical workings of such institutions, see El-Gousi, pp. 199-247; Frank E. Vogel and Samuel L. Hayes III, Islamic Law and Finance: Religion, Risk, and Return (The Hague: Kluwer Law International, 1998), pp. 181-295.