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Early Islam and the Birth of Capitalism

By Benedikt Koehler | IslamiCommentary | 01 May 2014

Arabs first made a name for themselves in business; their reputation for religious zeal came later. Arabs earned a reputation as long distance traders and risk investors long before the advent of Islam, and arguably the spread of Islam also was a breakthrough for capitalism and globalization. This is hardly surprising, considering Islam is the only world religion whose founder had a background in business and came from a long line of merchants.

For Muhammad, trade diplomacy ran in the family. His family, the Hashimites, take their name from Muhammad’s great grandfather Hashim, a merchant who became famous because he struck trade agreements with Bedouins that made caravan travel across Arabia’s deserts safer and thus more profitable. Muhammad’s own business career took off when his future wife Khadija bint Khuwaylid backed him with an investment. Khadija, a professional investor, later married Muhammad and became the first convert to Islam. Muhammad, during their twenty-four years of marriage, had insight into the risks and rewards of investing in caravans. He made good use of that knowhow when he established his community in Medina and introduced institutions and guidelines for a society where entrepreneurs would thrive.

In Medina, one of Muhammad’s key initiatives was to set up a market. Moreover, during a food crisis, he showed his support for letting markets develop their own dynamics free from outside interference. A famine had squeezed up the price of food, and Muhammad’s adherents appealed to him to set a price cap but Muhammad refused, saying he had no mandate to set prices because, as he explained: “Prices are in the hand of God.” That pronouncement is akin to Adam Smith’s notion that markets are ruled by an “invisible hand.” However, that is not the only instance where early Islamic approaches to markets anticipate modern economics. According to the economist Friedrich von Hayek, societies that give free rein to entrepreneurial drive create wealth and encourage innovation more widely, and that pattern showed up in early Islamic societies from the first. For example, after Muhammad conquered land around Khaybar, he awarded to his Companions land grants but stipulated they had to distribute harvests to provide for the poor. At that moment, Muhammad in effect introduced into Islamic property law the concept of trusteeship. It did not take long for his successors to find new applications for that innovation.

2EarlyIslamC1 (2)The first caliph, Abu Bakr, vested property to provide for his descendants, and the third caliph, Osman, bought a well in Medina and gave it over to public use free of charge. Over time, many wealthy individuals ring-fenced assets that were dedicated to a wide range of charitable purposes, and these charities came to be known as waqfs. The scale of these endowments was considerable. By the eighteenth century, waqfs in Istanbul provided 30,000 meals a day. Many other waqfs supported educational academies, the madrasas. But the list of economic reforms of early Islam goes on, culminating in the seventh century with the creation of a new currency, the Islamic dinar. The Islamic dinar was based on gold, the first time a gold currency was issued outside Europe.

The dynamism of early Islamic economies could not fail to impress trading partners from Europe. In fact, although the politics of Islam and Christendom in the Middle Ages for the most part were adversarial, in the commercial world there were durable on-going relationships. Trade flows across the Mediterranean stimulated enterprise in cities such as Venice and Genoa, where merchants launched convoys that set out to buy high priced goods to bring home and sell. Convoys and caravans may seem to have nothing in common – but their business model is the same: investors advance money for a venture, and managers earn a bonus tied to performance. The legal frameworks of convoys and caravans were virtually identical.

Crusaders and religious orders settling in Palestine observed other Islamic practices and institutions that proved useful back home. When a certain Walter de Merton in thirteenth-century England vested assets to endow an institution for educating scholars in Oxford, the terms of the legal agreement to all intents and purposes replicated those of a waqf to set up a madrasa. By then, waqfs had been in operation for many centuries in Islamic societies, but in England the concept had never been applied before.

Individuals who had first hand exposure to Islamic societies pioneered many innovations in medieval Europe. In particular, Europe’s brightest mathematicians often were trained by Arabs. Pope Sylvester II as a young man went to study in Muslim Spain and when he came back explained how to calculate using an abacus, a skill Europeans had forgotten after the Roman Empire had collapsed. Leonardo Fibonacci, a seminal mathematician from Pisa, grew up in Algeria where he had an Arab teacher who showed him how to use zeros, an invaluable skill for anyone pursuing a career in business.

But scholars, pilgrims, and intellectuals were not the only Europeans who ventured into the realm of Islam. Merchants were another key group. The tradition of buccaneering businessmen who imported luxury goods from Asia to Europe began long before Islam. Already in ancient Rome, status-conscious consumers were willing to pay high prices for pearls (these came from Bahrain), incense (from Yemen), and pepper (from India). Stopovers for merchants were in place all along major trade routes in the Middle East, and when the Islamic Empire supplanted Byzantine rule, the Greek term for these hostels – pandocheion – morphed into funduq. (Today, the term in Arabic refers to hotels.) Islamic rulers understood long distance trade was a source of tax revenue and actively encouraged the establishment of funduqs across the Islamic Empire. Funduqs were self-contained walled buildings where merchants had lodgings and kept their merchandise under lock and key. Saladin, whose name is usually mentioned in connection with his war against the Crusaders, was a key proponent of trade liberalisation. Saladin licensed many Europeans to open up funduqs in Egypt and elsewhere, and Alexandria once more became what it had been in Antiquity, the leading trade hub in the Eastern Mediterranean. Funduqs also opened up in Cairo, Damascus, and in many other trade centers from Morocco to the coasts along the Black Sea. In many ways, funduqs were forerunners of today’s offshore trade centers – foreign merchants had separate tax codes and every funduq had a general manager who acted as a legal representative in case a merchant had a grievance against local authorities.

The dynamism of Islamic economic policies was key to the success of Islamic societies in the Middle Ages, and knowledge transfers to Europe were a spark for invigorating economic growth in Italy that rippled across Europe. Europeans decoupled from Islamic models once they launched their own gold currencies, and devised frameworks for entities that turned into corporations. From then on, European economies had their own engines of economic growth – and began to overtake Islamic economies. But it still took many centuries, however, until Adam Smith would come forward and re-discover Muhammad’s insight: the guiding principle of a market is an “invisible hand.” Indeed, Islamic societies today looking to invigorate economic dynamism do not need to prop on to their economies institutional templates from abroad: a complete set of policies regarding competition policy, consumer protection, and fair trading is contained in the economic reforms of Muhammad and of his early successors. Arguably, the roots of Chicago economics lie in seventh century Medina.