Contrasts between Islamic and Economic Views of Incentives

Dr. Asad Zaman

1. Introduction
Quran 92:4 Verily, (the ends) ye strive for are diverse.
How does the diversity of human goals impact on the organization of economic activity?
How can we co-ordinate efforts taking this diversity into account? These questions have
been the subject of a deep investigation by economists. Our goal in this article is to
compare these results with Islamic views on the subject.
The vast potential buried within each human being is highlighted in the Quran:
Q95:4,5 Surely We created man of the best stature. Then We reduced him to the lowest of the low,
Man can rise higher than the angels and also be worse than the beasts. The range of
motivations of humans is correspondingly complex and varied, and much better captured
in literature other than economics textbooks. Eschewing heroism, sacrifice, commitment
to higher causes, etc., economists choose to focus on self-interest (greed) as the sole
motive force in economic transactions. It would take us far from the topic of this essay to
explore why economists have accepted this methodology, despite its numerous
limitations and its conflict with our own experience and observations; see Sen (1977) for
an insightful discussion. Instead, we discuss some of the consequences of accepting this
narrow view of human motivation, which creates the framework for contemporary
discussions of incentives by economists.

2. Conflicting Incentives and Consequences.

The problems to be discussed arise when there is a conflict between individual selfinterest and that of the group. Economists ignored these problems for a long time because
they were deceived by the Invisible Hand of Adam Smith (1776): Every individual...
intends only his own gain, (but he is) led by an invisible hand to promote (the public
interest). If individual and public interests are in harmony, there is no problem of
incentives. The voluminous and comprehensive History of Economic Analysis by
Schumpeter (1954) does not mention the word incentives. It was only in the last quarter
of the twentieth century that a theory of incentives emerged from a deeper examination
of a cluster of problems related to conflicting objectives, asymmetric information, and
coordination of group efforts. Modern economists recognize the role of society in shaping
incentives, but argue that economic agents pursue at least to some extent their private
interests is the essential paradigm for the analysis of market behavior by economists;

this quote is from a comprehensive survey by Laffont and Mortimort (2001) which will
be referred to as LM hereafter. We will return to the question of whether it is useful to
study motivation by self-interest in isolation from other social forces on behavior later. In
this section, our goal is to present an overview of the major results from this investigation
within the economists paradigm.
A key insight of the incentive literature is the role of asymmetric information. If
everybody has access to all relevant information, then the problems connected with
conflicting objectives are relatively easy to resolve. In the context of the principal-agent
problem, Arrow noted that by definition the agent has been selected for his specialized
knowledge and the principal can never hope to completely check the agent's
performance." LM write that conflicting goals and differential information characterizes
the incentive problem. Below we provide a list of problems related to incentives which
have been the subject of intensive study by economists.
Information Rent: Cyert and March (1963) studied the changing goals of firms in
response to conflicts of interests of different coalitions within firms. Examining the
structure of a firm leads to the rejection of nave neoclassical views of the firm as a
monolith with a united common goal of profit maximization. Conflicting incentives of
stockholders and managers are studied using principal agent models. In the context of a
firm, the principal delegates a task to an agent who has private information about his
costs. In general, it is not possible to get to the first best outcome, where price equals the
marginal cost of production. The agent can conceal his true costs, and extract an
information rent from the principal. This is called the second best solution.
Free Rider Problem: Deciding on how much public good should be produced requires
evaluation of the aggregated benefits to the public. If people reveal how much they gain,
then the problem is easily solved. However, this is not incentive-compatible since
people have an incentive to conceal the benefits they receive, so as to reduce their taxes.
Foley (1967) formalized an insight of Wicksell that non-strategic behavior and unanimity
can lead to Pareto optimal allocations. However, self interested people will conceal their
true preferences to get an outcome favorable to themselves at the expense of the public.
More recent literature focuses on difficulties arising from this mismatch of private and
public interests and methods of resolving this conflict.
Insurance Markets: Commercial insurance markets create two types of incentive
problems, which are actually pervasive in the literature. The first is called Adverse
Selection. This means that people who have higher risk than average will buy insurance.
Firms which based insurance contracts on the average rates of casualties within the
population will make losses, since clients who buy the insurance will have higher than
average risks. The second problem is Moral Hazard. Those who buy insurance can afford
to do high risk activities, since they are insured against losses. This shift in behavior
towards higher risk activities is an effect of insurance which cannot easily be calculated
or evaluated. The literature shows that these problems cannot be avoided. That is, we can
design contracts which will reduce these to the minimum possible, but the first best
outcome which obtains without these problems cannot be achieved within the

competitive profit maximizing paradigm. Numerous second best type solutions are
characterized in the literature.
Taxation and Labor: Ideally, a society would like to provide basic needs for all its
members. However, taxation and redistribution distort work incentives and can lead to
many types of inefficiencies. Taxation will reduce incentives for work for the most
productive members, and provision of income to the needy will also reduce their
incentives to provide labor. Both will adversely impact on productivity, and reduce the
total product available for redistribution. The theory of optimal taxation is concerned
with minimizing this distortionary effect, as it is clear that these cannot be eliminated
altogether. Heady (1993) has provided a survey of the optimal taxation literature with
emphasis on practical and policy related aspects.
While incentive problems arise in many other areas, the above collection of examples
provides sufficient variety and highlights the major areas where conflicting incentives
interfere with efficiency of production. In general, the results show that free markets
cannot solve the problems caused by asymmetric information. Private agents motivated
purely by greed will arrive at inefficient outcomes which are inferior for the society as a
whole.

3. Islamic Views on Information

A large number of economic problems arise because agents have private information
which it is in their interest to conceal, even though it would be beneficial to society to
reveal this information. Islam has provided a lot of guidance about such situations, and
the necessity of revealing information, when it is necessary for social benefit. One of the
most striking verses in this regard is the following:
Q4:135 O ye who believe! stand out firmly for justice, as witnesses to Allah, even as
against yourselves, or your parents, or your kin, and whether it be (against) rich or poor:
for Allah can best protect both. Follow not the lusts (of your hearts), lest ye swerve, and if
ye distort (justice) or decline to do justice, verily Allah is well- acquainted with all that ye
do.
Contrary to the idea embodied in the Fifth Amendment of the US Constitution, Allah
Taala asks us to bear witness (provide information) even when it is against our own
interests. This is inconceivable within the economic paradigm based on self-interest
which was discussed in the last section.
There are a large number of Quranic verses and Ahadeeth which direct people to reveal
the truth, to bear witness to the truth, and to not hide the truth. One such which seems
most closely directed towards economic aspects is cited below:
Q4:37 [Allah loves not] those who are niggardly, and bid others to be niggardly, and conceal whatever
God has bestowed upon them out of His bounty.

This verse appears to be directly applicable to the idea of revealing the benefits that one
obtains from public goods, and not being niggardly by entertaining the idea that this
revelation might lead to monetary loss.

4. Ideals Versus Practical Reality

Can we apply such high ideals, seemingly far removed from our daily experience of
human behavior? Answering this question requires recalling three crucial ingredients of
the message of Allah to mankind which have been largely forgotten, even by Muslims
today. Because of this, the message of Islam is as fresh, exciting, inspiring, and
revolutionary today as it was fourteen hundred years ago, when its absorption by ignorant
and unlettered desert Arabs changed the tides of history permanently. It is well
established that the existence of universally admired ideals of excellent behavior exerts a
strong impact on social behavior, even when the ideals are rarely achieved.

4.1 Modeling Excellence

The first ingredient is the life of the Prophet s.a.w himself, who is a role model for us in
all dimensions:
Q33:21 Ye have indeed in the Messenger of Allah a beautiful pattern (of conduct) for any one whose
hope is in Allah and the Final Day, and who engages much in the Praise of Allah.
If we have only seen selfish conduct, and never witnessed noble behavior, then the we
will find it hard to believe that the potential for such conduct exists within the human
being. On the conquest of Mecca, when the Prophet s.a.w. forgave sworn and deadly
enemies who had caused tremendous harm to Muslims in general, he opened the eyes of
the Muslims to the possibility of behaving in this manner. Since then his conduct was
emulated by numerous Muslim commanders who behaved gently towards the conquered,
not following the standard patterns. The most famous example is that of Salahuddin
Ayubi, who did not take revenge for numerous outrages on his re-conquest of Damascus.
More relevant to the economic realm is the unparalleled generosity of the Prophet, one
example of which is cited in the collection of Ahadeeth in Muslim (Fazail 57-58). Safvan
bin Umayya looked with amazement at a valley full of camels, flocks of sheep and goats,
which had become Muslim property following victories after the conquest of Mecca.
Seeing his interest, the Prophet said to him that you can have the valley and everything in
it. Safvan could not help but say: "No one but a prophet could have this generous a
heart." Incidents of Muslims who have followed this role model of being as generous as
the rain are too numerous to recount.
The message of Islam is that we must become role models for the change that we want to
bring about. In the first instance, the message is not about whether or not we can use it to
model or describe economic behavior. The Quran starts by stating that it contains
guidance for those who are God-Fearing. So the relevant question is: Can I live up to the

standards prescribed in the Quran? Since Allah Taala has asked it of us, it follows that
it is possible to do it. If I, and many others, make the effort to act according to the
commands of Allah, we will become role models for others, and bring about the change
that Islam asks for.

4.2 Islam is Transformative not Descriptive

When the Prophet s.a.w. arrived in the world, the culture of the Arabs was appropriately
described as the Jahiliyyah the culture of ignorance. The classical description of the
economists would have suited this world quite well, where people pursued self-interest
without regard for others. A tremendous effort by him and his followers led to a radical
transformation in this society. The Quran praises those who feed others while being
themselves hungry:
(Q59:9) 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.
The second caliph of Islam, Umar Farooq R.A., ate coarse bread, because he felt ashamed
to eat refined bread when not all of the public could do so. This shows the tremendous
social change brought about by the message of Islam. These types of sentiments and
actions are outside the scope of those contemplated by economic theorists.
The resemblance between society today and that of the Jahiliyyah is striking, even to the
extent of parents burying their own living children; looking up Mothers who kill their
children will turn up many references in addition to Meyer et. al.(2001). It is the wrong
question to ask if Islamic ideals can be used to understand or describe the Jahiliyya.
Islamic ideals are meant as the goals to direct us in our struggle to change the Jahiliyya in
the directions desired by Allah.

4.3 Islam focuses on the Process, not on the Outcomes

The third ingredient in understanding Islamic views on these issues is to realize that Islam
focuses exclusively on the process of change and not at all on the outcomes. The Prophet
s.a.w. was given the responsibility to preach the message of Islam to the whole world, but
he was told that guidance was exclusively in the hands of God. Similarly, it is our
responsibility to struggle to bring about change, but we are not responsible for success or
failure. The outcome of our struggle is exclusively in the hands of Allah. This
understanding creates two major contrasts with western understandings of how the
discipline of economics is to be approached.
The economist seeks to be a neutral and detached observer, to understand the laws of
economic behavior, and to describe how the economic systems of the world operate.

Islam recognizes natural tendencies towards selfishness and base actions, but also
recognized the existence of higher motives within the human soul:
Q90:10 (Have We not) shown him the two highways [of good and evil]?
Islam seeks to challenge and inspire people to achieve the highest potential contained
within each one. It is the process of changing human beings from lower than the beasts to
higher than the angels which is the concern of Islam. The Quran and the Hadeeth are full
of exhortations to do good, and to act unselfishly, and describe various methods to
achieve these goals.
The second contrast is that economists judge the consequences of interventions by the
outcomes achieved. For example, the incentive problem can be solved by a lie-detector
which would force people to reveal the truth; then an efficient outcome would be
achieved. If there continues to be dishonesty within the hearts of the people, then nothing
has been achieved by Islamic standards. Islam asks us to change the hearts of people so
that they are inclined towards telling the truth for the sake of Allah. If some people
change in this way, then we have achieved something, even if there is no perceptible
impact on the outcomes.

5. Creating Communities
As clarified in the previous sections, the Islamic approach to incentives is radically
different from that of the economists. LM (2001) justify ignoring social dimensions of
human behavior as follows: How do private incentives interact with cultural norms of
behavior might be the next important step of research needed to be able to offer sensible
advice on the design of institutions. It is our conviction nevertheless that for such a goal
the mastering of incentive theory is a must. We argue that this is not so. Many authors
have studied the conflict between market norms and social norms, and shown that these
are mutually exclusive; use of one drives out the other see for example Chapter 4 of
Predictably Irrational by Ariely. This means that the market analysis is not of value in
studying situations governed by social norms. Furthermore, those who have done the
comparisons have found that material incentives are very weak as motivation factors
compared to social norms. For example, Barnard (cited in LM 2001) writes that even in
purely commercial organizations, material incentives are so weak as to be almost
negligible except when reinforced by other incentives."
Islam approaches the coordination of incentives by creating love among the hearts of
Muslims and creating community and fostering cooperation.
(Q3:103) And hold fast, all together, by the rope which Allah (stretches out for you),
and be not divided among yourselves; and remember with gratitude Allah's favour on
you; for ye were enemies and He joined your hearts in love, so that by His Grace, ye
became brethren;

There is stress on forming a community, removing enmities and joining our hearts in
love. This is in dramatic contrast to individualistic pursuit of self-interest which has the
effect of dissolving communities and creating enmities, as has been documented in many
sources. We discuss below how creation of social norms for cooperation, and collective
striving for common goals changes the analysis of the problems of conflicting incentives.
Employees Shirking or Concealing Information: An employee under contract is required
to be honest and make reasonable efforts to fulfill his contractual obligations. Not doing
this would make his earnings unlawful under Islamic law. Practice of this Islamic ideal
would substantially reduce firm level incentive compatibility problems discussed in
economic theory. There is substantial historical evidence that these social norms were
widely practiced in Islamic societies. Social approval is a very strong incentive much
stronger than monetary incentives and widespread disapproval of shirking, dishonesty,
and other unethical practices leads to substantial reduction in such practices.
Free Rider Problem: Just as stealing from an orphanage is widely regarded as worse than
stealing from the rich, Islam considers stealing from public funds as equivalent to stealing
from the Ummah as a whole. We have also indicated earlier that people are expected to
reveal accurately the benefits they receive from public goods. If these Islamic principles
are brought out from the books into the lives of Muslims, these would resolve the issues
discussed by economists under this heading. Our job as Muslims is to struggle to bring
about this change. Whether or not efficient provision of public goods results as a
consequence is only of secondary importance.
Insurance: Muslim scholars have on the whole rejected commercial insurance models
prevalent in the west as incompatible with Islam. Islamic alternatives, known as Takaful,
are based on mutual cooperation. The underlying concept is for a group of people to help
each other in times of need, which has a spirit far different from that of a commercial
transaction. Some more details, and further references are provided in Zaman (2008).
Moral Hazard and Adverse Selection problems do not arise if the problem is structured in
this way.
Labor Renumeration and Taxation: Islam sees employer and employee as engaged in a
cooperative enterprise, doing different types of work but being accorded equal respect
that is, entrepreneurial skills receive due recognition in Islam, but are not given primacy.
The firm is seen as an organization which provides a service to the community, rather
than as a profit making machine. According to a Hadeeth 2236 from Ibne-Majah, those
who bring in goods from the outside (to relieve scarcity in a given location) are given
blessings, while those who hoard to earn profits from scarcity are accursed. Blessings
accrue from the intention to benefit to the people, while the intention to benefit from the
distress of the people is accursed. This Islamic view is in dramatic contrast with Adam
Smith, who writes that individuals motivated purely by greed promote the public interest
without having any intention of doing so. Islamic framework for conducting business is
that employees and employers are engaged in a cooperative venture to serve the
community. This completely changes the adversarial relationship between the two which
exists in capitalist societies. The idea that I sell my labor in return for money is

demeaning and creates anomie, a sense of alienation from society. It is coming to be

recognized that jobs provide meaning to lives, and substantially greater life satisfaction
will occur if workers participate, take ownership of and responsibility for their products,
and firms are oriented towards socially beneficial goals. This type of radical change in
social norms would entirely change the nature of the problems considered under this
heading by economists.

6. References
Cyert, Richard and March, James (1963) A Behavioral Theory of the Firm, Prentice Hall,
New Jersey.
Foley, D., (1967), Resource Allocation and the Public Sector, Yale Economic
Essays, 7: 45-98.
Heady, Christopher (1993) Optimal Taxation as a Guide to Tax Policy: A Survey
Fiscal Studies Volume 14 Issue 1, Pages 15 - 3
Laffont, Jean-Jacques and Martimort, David (2001) The Theory of Incentives: The
Principal-Agent Model, Princeton University Press, Princeton, USA.
Schumpeter, Joseph A. (1954) The History of Economic Analysis, George Allen and
Unwin, London.
Meyer, Cheryl et. al. (2001) Mothers Who Kill Their Children, NYU Press, NY.
Sen, Amartya (1977) Rational Fools: A Critique of the Behavioral Foundations of
Economic Theory, Philosophy and Public Affairs, Vol. 6, No. 4, pp. 317-344
Smith, Adam (1776) The Wealth of Nations. Book IV, Chapter II.
Zaman, Asad (2008) Islamic Economics: A Survey of the Literature, Religion and
Development Research Programme Working Paper 22, University of Birmingham.