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Middle Eastern Barriers to an Agile Marketplace

Egyptian currency

Tags Global Economy

03/25/2015Salmaan A. Khan

According to economic historian Timur Kuran, “Around roughly the tenth century, the Middle East was an economically advanced region of the world, as measured by standard of living, technology, agricultural productivity, literacy or institutional creativity. Only China might have been more developed.” Today, however, the Middle East is a victim of historical legal impediments that increase time preference among consumers and investors, and which are fraught with failures to restructure Islamic legal code to fit for the numerous changes in the nature of commerce.

Corporate Governance

One of the most critical impediments to Islamic economies has historically been partnership laws. While Europe was building up large corporate enterprises that had hundreds, even thousands of shareholders, businesses in the Islamic world had limited partnerships to no more than six people. The rationale behind this is based on Islamic contract law, whereby if one of the business partners dies, the partner must liquidate the assets of the deceased, and give them to the heirs. However, this did not imply the business must be abolished with the death of a partner, but the added complication — compounded with skewed egalitarian Sharia inheritance laws which stated that two-thirds of any estate are to be distributed amongst relatives, both male and female — made it difficult for companies to achieve economies of scale due to a lack of longevity, specialization, and predictability within companies under Islamic regimes.

Furthermore, families in many areas have tended to be quite large due to the practice of polygamy, so due to many heirs being recipients of the inherited wealth, the business would often just dissolve. As Kuran notes, “Middle Eastern entrepreneurs minimized the risk of premature termination by keeping their partnerships small and ephemeral.” The consequence for Islamic economies has been a long-term game of catch-up once the Industrial Revolution commenced in Europe.

The Legacy of the Waqfs

Some scholars conclude that cultural and religious fatalism has contributed to the inadequacy of Middle Eastern economies, as the idea that "everything is in God’s” hands allows idleness to triumph. But, there is more empirical proof that the underdevelopment of the Middle East today has been heavily affected by the Ottoman Empire’s bureaucratization of special endowments called waqfs.

There were two kinds of waqfs depending on its waqfiyya, or deed, whereby the waqf’s founder would decide what its primary function would be. Either they were charitable waqfs, or family waqfs. Charitable waqfs were established for a social function — for operating a religious center and eventually expanding to take care of the poor, providing health services, schools, libraries, and the overall provision of public goods. Family waqfs, on the other hand, were used to establish property rights for families in need of a safe haven to stash their savings away from the confiscation by the sultan.

Due to the sanctity that waqfs were given, they were theoretically tax exempt. However, according to Murat Cizacka, “Given the authoritarian governments in power, the rulers could expropriate the private property for the sake of the ummah.”

Furthermore, when complications erupted in the case of family waqfs (since charitable waqfs operated under the public radar and its utilization of resources were transparent), they ran into more controversial problems that could not be as easily resolved in court. Moreover, the endowment deeds often were destroyed or damaged by war. Over time, these issues led to more and more expropriation and regulation by the Ottoman government. Meanwhile, Europe was providing similar services through a thriving profit-bearing corporate sector, as well as adopting double-entry bookkeeping and joint-stock companies. According to Kuran, "Westerners had access to commercial banks that could channel capital mobilized from the masses into large-scale productive ventures.”

Essentially, the catalyst of the waqfs’ stagnation was their very strict adherence to religious code. Competition for waqfs from other institutions was not allowed by Sharia Law. Through the legal system, by regulation of the ulama, waqfs attained a monopoly on the provision of public goods, including even the use of school textbooks.

Thus, a correlation can be drawn between the decentralized period of waqfs, in which Islamic countries were at the peak of international trade and prosperity, and the era of centralized control by the Ottoman state which led to a lagging and underdeveloped Middle East economy. As Kuran states, “the waqf was economically inefficient because of its perpetuity, inflexibility, lack of self-governance and absence of separate legal personality.” While once characterized by decentralized and more flexible institutions which brought greater economic prosperity, Middle Eastern economies today look quite different.

In the same way that the Russian people were the victims of totalitarian Russian regimes of the past, the people of the Middle East are today victims of brutal extractive regimes whose main enemies have commonly been their own people. And unfortunately, these regimes can still rely upon restrictive institutions of old to control the marketplace and enrich themselves.

Image source: iStockphoto

Salmaan A. Khan

Salmaan A. Khan is a graduate of Benedictine University with a B.A. in Economics. He currently works for a telecom company and is pursuing a graduate degree in supply chain management.