Paper Title: The Approach of Islamic Economists to the Prohibition of Interest in the Context of Böhm-Bawerk’s Time Preference Theory of Interest
Author: Cem Eyerci
Publisher: International Journal of Islamic and Middle Eastern Finance and Management, 15(1), 18 – 31.
This paper discusses the theory of interest espoused by Böhm-Bawerk. He described time preference as the origin of the legitimacy of the existence of interest. Time preference is defined as people’s attribution of more value to present goods than future goods with the same quality and quantity. Future goods can be consumed only in the future, whereas present goods can be consumed both now and in the future.
A capital owner enjoys a recurring revenue from capital without making any effort, and Böhm-Bawerk asserted that defining the reason for such an income would help to find the cause of the existence of interest.
The main theoretical problem was the answer to the question: Why is there interest? The social and political factors such as the necessity, justice, fairness, usefulness and goodness of interest were secondary issues. The conditions that require permitting or controlling interest and the formation mechanism of the interest rate are not relevant to the cause of the existence of interest. These are about its effects. Böhm-Bawerk tried to disentangle the positive and normative aspects in the discussion.
The author reviews the works of some Muslim economists who think that since time preference is valid in Islam, so is time value of money.
For instance, the author thinks that Al-Masri showed quite a distinctive approach to the concept of the time value of money. He pointed out that the difference between the spot and forward prices in a deferred sale is the time value and is allowed in Islamic economics. According to him, the origin of time value and interest are the same and both are legitimate in Islamic law.
He highlighted a problem caused by the approach of Islamic economists. Although they are the same, he claims, the time value is called profit in deferred sale and interest in loan transactions. In both Islamic and conventional economics, usually, profit is not controlled, but interest is limited either by administrative arrangements or by the use of financial instruments. Thus, neglecting the importance and usefulness of time value and considering the revenue from uncontrolled deferred sales as profit causes practicing an implicit interest at very high, usurious rates.
Likewise, El-Gamal stated that the existence of instruments based on the difference between spot and forward prices validate the positive time value of money.
However, the author did not delve much into reviewing Islamic sources of knowledge on guidance regarding this issue. Qur’an mentions that humans are generally hasty (Al-Isrā 17: 11), miserly (Al-Isrā 17: 100), impatient (Al-Ma’arij 70: 19) and have love of wealth (Al-ādiyat 100: 8). Thus, humans have impatience, positive time preference, tendency to economize on expenditure and desire for material resources.
In Islamic finance literature, there is largely a consensus that time value of money is not valid, but the time value of commodity is acceptable.
Time value of money is the basis of interest. As per Islamic principles, time value of money is the problem for the investor to avoid keeping his/her money idle and to avoid forgoing the use of money that may bring positive value to his/her investment. However, it does not mean that the investor can demand an arbitrary increase as the cost of using money without taking the risk of a productive enterprise. As per Islamic principles, a financial investor has to undertake risk of productive enterprise by becoming self-entrepreneur or an investing entrepreneur as equity partner in others’ business to have any justifiable compensation out of the production process.