In my book, Muslim Mechanics, I have maintained that Islam encourages a free market system for conducting business. Muhammad was a trader who worked caravans, as were some of the caliphs who followed him. Umar ibn al-Khattab, the second caliph, is reputed to have said, "Death can come upon me nowhere more pleasantly than where I am engaged in business in the market, buying and selling on behalf of my family."
However, Islamic business is based on a distributive justice system. Distributive justice is concerned with the norms of resource allocation and the perception of fairness of the recipients. It discourages any discrimination among people and promotes equal distribution among the people. Islam does encourage profit, but it must be a "halal" profit. In other words, there are ways and things that a business person can do to make a profit, but there are also things they cannot. The profit is unacceptable if the gain is made by violating Islam's tenets.
One Islamic rule that guides how Muslims conduct business is their perception of money. Islamic companies are based on the belief that money shouldn't have any value. It's just a way to exchange products and services that do have value. Linked to this way of thinking about money is the idea that you shouldn't make money from money. This way of thinking means getting involved in interest by either paying or receiving it should be avoided wherever possible. Another important idea that underpins Islamic finance is that it shouldn't cause harm. Therefore, Islamic financial services should not invest in things like alcohol, tobacco, and gambling. Islamic finance also encourages partnership. This viewpoint means that, where possible, both profit and risks should be shared.
There seem to be three sources of the rules that guide Muslim business practices. Scriptures and rulings from the holy Qur'an, hadith, and fatwas are plentiful and somewhat overwhelming. A remarkable fact about Islam is that the Qur'an's most extended verse (2:282) deals with debt transactions and related issues. As for hadith, there are probably several hundred sayings of the Prophet that deal with rules and regulations about business. As for fatwas, the legal rulings by the ulema, the Islamic literature is loaded with directives about trade and commerce.
Primary Conditions to Conduct Business
A free market. Things sold must not be stolen goods and goods acquired fraudulently. Money paid must not be coerced or forced. Information about the product and the payment must be available to both sides of the transaction. Islam does not support a "Caveat emptor" (let the buyer beware or sold as is) mentality.
Goods and commodities are not to be sold before obtaining their possession. Forward transactions lead to speculation and risk.
No trade and traffic in things prohibited by Islam. For example, there can be no trade in wine, swine, or dead bodies of animals and idols.
Prohibited Forms of Business
Monopoly business. Monopoly means the concentration of supply, which can lead to the exploitation of consumers and workers. Gigantic trusts, cartels, and monopolies should not exist in Islamic society. Consequently, Muslims are comfortable with government control over monopolies.
Speculative business. Speculation means buying something cheap in bulk at a time and selling it for an excessive profit later when the product is needed. It is thought that speculation might drive artificial scarcity or an artificial demand for a given product. This scarcity would border on creating a forced demand for a product, destroying a free market with multiple buyers and sellers.
Products that have interest transactions. Capital invested in business brings an excess called profit; investment in banking brings interest. Business involves a systemic risk of loss. Also, in its case, it is not only the capital invested that brings profit, which is equally the result of the initiative, enterprise, and efficiency of the entrepreneur. Hence its rate cannot be predetermined and fixed.
Trade is productive. A person reaps a benefit after undergoing labor and hardship. It creates conditions of full employment and economic growth. It will also be noted that trade is one of the dominant factors in building civilization through cooperation and the mutual exchange of ideas. Interest has no redeeming feature at all. The fixed rate of profit that a person gets from a financial investment without any risk of loss and without augmenting it with human labor creates in man the undesirable weakness of miserliness, selfishness, and lack of sympathy.
Transactions similar (in nature) to gambling. Any monetary gain which comes too easily, so much so that one does not have to work for it, is unlawful.
Up to this point, we have discussed the top part of the income statement, i.e., the what, where, and how money comes into the business. Let's shift our review to the part where the money comes out on the bottom line, i.e., the profit
Profit Maximation
My research in this area alluded to one hadith in which Muhammad said, "One-third is enough." I found two articles that suggested this line of thought had merit, but I could not find any specific hadith that supported this finding. If anyone knows of this source, please use the comment section to keep me up to date.
Most Islamic scholars believe Islam does not restrict the profit margin in a transaction or business. Two hadith are frequently repeated, showing profit margins of 100 percent or better. The first hadith, mentioned by ulema scholars Bukhari, Ahmad, Tirmizi, and Abu Dawud, tells the story of Muhammad and the goat. Muhammad gave one of his companions one dinar to buy a goat for him. The companion went to the market, bought two goats with the dinar from one herdsman, sold one of the goats to another farmer for one dinar, and returned to Muhammad with a goat and a dinar. When the Prophet came to understand the transaction, he was delighted with it and prayed for the companion. This one transaction indicates that earning 100 percent profit has been approved by the Prophet himself.
There is another tradition in Bukhari which gives details of a transaction between companions of the Prophet. The Prophet's cousin bought a piece of land in Medina. Many years later, the cousin's son sold the parcel for almost ten times more than it cost. This transaction shows that earning this profit is allowed under Islamic law.
For Muslims, sharia is the guiding light for ethical business. Sharia focuses on the ethical acquisition of revenues on the top line and the honest generation of profits on the bottom line. If the gain is earned through deception, it is referred to as excessive profiteering. While ethics are sound, capitalist companies underwent this phase in the 1980s. Remember when the book In Search of Excellence was a best seller in 1982? Peters and Waterman related how major American companies became enamored with ethical behavior, doing the right thing for the customer and the society to which they belonged.
Capitalism versus Islamic Finance
Muslims have defined capitalism as an outlaw branch of financial operations. For example, capitalism takes advantage of interest, arbitrage, speculation, risk, uncertainty, derivatives, insurance, profit maximization, marginal productivity, and innovation. Capitalism pushes the envelope. While Islamic finance has found ways to compete with capitalism, it would be like a prop airplane competing with a jet. While Islamic finance and capitalism can work in a free market system, I maintain that capitalism is the better allocation of resources. Capitalism needs a more unrestrained market to work best, whereas Islamic finance can work in socialist markets.