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© 2012 Sanjeev Sabhlok's revolutionary blog
This is a quick note in response to Timur Kuran’s comment on BBC the other day (here) in which he reminded us that the corporation was the distinguishing institution that underpinned European economic growth and allowed it to overtake the Islamic Ottoman Empire (Islamic law did not encourage such unlimited liability concepts).
This innovation allowed large infrastructure to be established which was no longer tied to a particular individual’s wealth, and could carry on for generations. But then he also seems to partially agree with opponents in that debate about a “tension” between the otherwise successful model of the corporation and societal risk created by corporations that are “too big to fail”. He referred in particular to the banking sector.
I would like to refine this debate by pointing out that there are no societal risks from large companies like Walmart or large railway companies. Should they go bust, someone will always come by and pick up the ruins if there is any value left in them. Consumers don’t lose anything either, since they aren’t buying the services any longer. A few jobs are lost but that’s the natural part of creative destruction (what I call creative replacement in BFN – see online notes).
On the other hand, and here is the key, there is a big difference between banks and typical service providers like Walmart. A few weeks ago I discovered that banks had unlimited liability till the early 20th century when I suspect the Keynesians, the likely ‘do-gooders’, allowed them to avail the limited liability provisions applicable to ordinary corporations.
Till then they were constrained in growing "excessively" large or taking unnecessary risks because owners were directly and entirely responsible for consequences of bad decisions. Today, the owners (ordinary shareholders) may lose a bit of their "skin" but ordinary customers lose a lot, while those who take bad decisions (CEOs, etc.) flourish and receive even fatter salaries. The banking system is simply not suitable for getting access to corporation law.
It appears to be absolutely necessary to revert banking to the unlimited liability model of the past, when it worked without creating the huge societal risks it now does. It is NOT possible to prudentially regulate banking beyond a point. The best remedy is to have the owners increase their "skin in the game" and take unlimited liability for their bad decisions. That way small investors will shun banks or demand a higher risk premium for equity. Either way, that will shrink the bank size and encourage good decisions.
Once this is done, there will no longer remain any tension between the successful institution of corporation and banks that are "too big to fail".
This article by Chris Berg, published in yesterday's The Age, touches upon Timur Kuran's book which I've already highlighted earlier. It is a worthy addition to the literature that shows that Islam is held back not by its scriptures but by itself.
Selling out the Koran
There's nothing in Islam that says people shouldn't be rich, peaceful and free.
FIRST Tunisia, then Egypt, and now Libya: Muammar Gaddafi looks set to join the cohort of fallen Middle East dictators. And about time too. Under Gaddafi's tribe-centric Stalinism, Libya has consistently ranked in the bottom 10 countries for economic, social, political, and press freedom.
Libya is not alone. The Arab world fills the lower ranks of all these indexes.
The causes of the region's discontent are obvious. It has escaped nobody's notice that the Arab world is almost uniformly undemocratic and illiberal. And poor – the 22 member states of the Arab League have a per capita income less than a third of that in the Western world.
Those truths colour the developed world's view not just of the region, but of its 360 million people. And, just as importantly, their majority religion.
But how did the Arab world get that way?
A ground-breaking book released last year by the Turkish economist Timur Kuran, The Long Divergence: How Islamic Law Held Back the Middle East, couldn't be more timely. Kuran is a professor of economics and political science at Duke University in North Carolina.
The title of his book is very specific: Islamic law limited economic growth in the Arab world. Not Islam per se, but the legal framework which built up over centuries in Islamic societies.
After all, the Koran is pretty good on economic growth: it encourages entrepreneurship; it promotes commerce; it praises the acquisition of wealth, instructing Muslims to ''seek the bounty of Allah''; it endorses private property.
Muslims were once some of the world's greatest entrepreneurs. When bandits captured the Chinese city of Guangzhou in 878, they found more than 100,000 Middle Eastern traders there.
So if 1000 years ago you were to wager what religion would dominate the next millennium, Islam would have seemed fairly safe money. Christian Europe was far behind. A European touring the Middle East would have met people who had much higher incomes. So what happened?
Kuran argues Islamic law primarily failed to develop the concept of a corporation: an economic and legal construct, separated from family and tribal loyalty, designed to encourage investment and profit sharing.
Islam's early strength – shared faith to unite warring tribes – became a weakness, as it manifested itself in hostility towards smaller, corporate, capitalist forms of organisation.
As corporations multiplied in Europe from the 17th century, the Arab world's relative success disappeared. It needn't have been so. There's nothing particularly un-Islamic about the corporation – the organisation was embraced by Muslims in the 20th century. Kuran shows Islamic law is flexible enough to change, but a failure to encourage economic growth meant Arab nations slipped behind the West.
Today, the other economic positions taken by the Koran – the importance of commerce, the defence of private property, and the freedom to seek wealth uncompromised by state action – are notably absent in the Arab world.
A rich country tends to be a liberal country. Wealth and freedom progress together. So too does social development. Women and minorities in the First World have respect and rights that are the envy of those in the Third World.
Conversely, poverty feeds social backwardness, which reinforces that poverty.
The relative economic decline of the Arab world in the 20th century caused its political decline. The political vanguard in the Middle East has careened from assertive nationalism, to Soviet client socialism, to Islamism.
Islam's critics focus on the obviously archaic and often brutal views held by Islamists. They blame them for the problems of the Arab world. Fundamentalist Islam seeks not only to restore premodern social relations, but premodern economic structures as well. The future caliphate will shield itself from the dynamism of contemporary capitalism.
But it was defective legal institutions that originally put the Arab world behind, not culture or religion. Hence reasons for optimism.
Institutional failures have institutional solutions. An Arab nation that adopts the very best political, economic and legal structures of the developed world could be just as rich, successful, and liberal.
And the pro-market Koran won't need to be discarded to do so. Timur Kuran's findings suggest Islamic faith is perfectly compatible with modernity.
Research published in February in the journal Public Choice, ''Economic freedom, culture and growth'', backs this up.
Using the World Values Survey, the most comprehensive database we have on global beliefs, two economists empirically answer the question of whether culture is a barrier to development. It is – up to a point.
If a country's economy is not free – if it labours under the burden of an overbearing government, high taxes, and high regulation – then culture matters a lot.
But the importance of culture disappears as a country becomes economically free. Once a nation has the ''peace, easy taxes, and a tolerable administration of justice'' Adam Smith described, it will grow rich. Regardless of religious or cultural baggage.
That's a lesson the revolutionaries trying to liberate the Middle East will need to quickly understand.
Right now, in Egypt, Tunisia, Libya and Bahrain, the revolt has a liberal character. A lot of time has passed since the Iranian revolution in 1979. Today, even radical Islamists in those countries are agitating for democracy above all else – not theocracy.
Whether the revolutions remain liberal is far from certain.
But if the citizens in the Middle East wish not to just discard tyranny, but grow rich and prosperous too, they'll need to enact not just political but institutional change. A free, capitalist economy is the foundation of a free society.
Chris Berg is a research fellow with the Institute of Public Affairs. Follow him at twitter.com/chrisberg
Addendum
GUY SORMAN: Is Islam Compatible with Capitalism? – The Middle East’s future depends on the answer.
It is somewhat surprising that Islamic cultures, which generated a scientific attitude and thereby blossomed into great wealth, suddenly collapsed over the past few hundred years.
This seems to have happened due to ossification of its 'laws' which nipped all freedom and innovation in the bud. It would appear that a few but simple laws are better than excessive detail which allows priests (mullahs) to muzzle the minds of the people.
For the first five hundred years of Islam, its leaders promoted learning and innovation. ALL the learnings from across the world were brought together in Baghdad and carefully documented, studied, and expanded upon. Great was that era of Islam – the greatest in human history up to that point in time. But somewhere down the line (and from my limited readings on this topic it appears that Muhammad al-Ghazali [1058-1111] was one of the major Islamic thinkers responsible for this), Islam stopped absorbing innovations that were occurring across the world, particularly in the West.
From about 1200 AD its leaders started DICTATING to the people. Without an ability to either absorb innovation or to innovate internally, Islam started sliding back rapidly from the technical frontier. As a result, today, except for a few oil-rich parts of the world, the Muslims are among the poorest and most illiterate; and constantly fighting with each other and with everyone else [e.g. in Somalia, Iran, Iraq, Afghanistan, Pakistan]. An entire religion, an entire culture is now on the back foot, frustrated, not capable of understanding what has gone wrong.
Timur Kuran's analysis
Timur Kuran, my erstwhile Professor, and an Islamic scholar of great eminence, has presented an excellent analysis of the causes of this decline (divergence) in his book: The Long Divergence: How Islamic Law Held Back the Middle East.
I introduced readers of this blog to this book in November 2010, but I recently came across another excellent review of the book in The Economist, which is useful to briefly discuss.
In this book Kuran identifies the company with limited liability as the KEY innovation that pushed the West firmly ahead.
My analysis
No doubt this point that Kuran makes is perfectly true. Company structures enabled far greater risk taking and allowed agglomeration and economies of scale. The limited liability company is therefore a great institutional innovation. And this is consistent with my summary analysis of growth (here). Institutions are embedded in opportunity and governance: they form the technology of a society. The better the institutions, the more the opportunity.
All of these are however, underpinned by the level of freedom in society. Thus, the corporation is merely one example of the many things that arise from free societies. Not just the invention of the corporation but printing, the modern cannon, the modern ship, and many other inventions and innovations were crucial to the leap made by the West from about the time of the Renaissance.
The package of modern economic growth is best attributed to increased FREEDOM in the West, not to one or two selected innovations.
Muslim societies, however, consciously put a blindfold over their eyes from around 1200 AD. This did not prevent them from conquering even more backward places like India – that had ossified much earlier (e.g. by around 1 AD, India was mentally dead; a mere fossil), but it kept reducing Islam's competitive advantage, both commercial and mlitary, over the West – till finally it fizzled out, and political power went to the West.
Islam has deteriorated today into a SLAVE culture. No one is permitted to think. Instead of being servants of God, these people have become the slaves of dictators.
As can be seen from the actions of people like Gaddafi, everyone is muzzled. Its people are not allowed to think!!! How can they possibly succeed in life??
Islam, FREE YOURSELF, if you want to recover your vitality. Else it is inevitable that Islamic culture will die out – out of sheer ignorance and incompetence.
The more I read about Mohammed the more I begin to believe that he was a great political strategist. He DID NOT want to create a slave race. But that is what Islamic cultures have become. Its incompetent teachers and petty 'mullahs' have lost the way. There is no intellectual leadership of any calibre from within Islam today (except a few academics like Timur Kuran who don't have mass following).
Unfortunately, without the use of our brains, we must necessarily become beasts. That is what many Islamic terrorists have become. The dénouement of once great culture is nigh. I'm sure Mohammed must be tossing about, deeply disturbed by what is going on, in his grave.
As I wrote a few weeks ago, there is an urgent need to recover the strategic and vital Islam that Mohammed brought to mankind: something created for the welfare of everyone. No, I'm not religious, and I'm not preaching Islam, but I'm definitely suggesting that Islamic intellectuals are now obliged to reverse this decline of thought leadership. Timur Kuran is a bright light – that I hope will shine the way forward for Islam.
EXCTRACTS from the review of Kuran's book
"Europeans inherited the idea of the corporation from Roman law. Using it as a base, they also experimented with ever more complicated partnerships. By 1470 the house of the Medicis had a permanent staff of 57 spread across eight European cities. The Islamic world failed to produce similar innovations. Under the prevailing “law of partnerships”, businesses could be dissolved at the whim of a single partner. The combination of generous inheritance laws and the practice of polygamy meant that wealth was dispersed among numerous claimants.
"None of this mattered when business was simple. But the West’s advantage grew as it became more complicated. Whereas business institutions in the Islamic world remained atomised, the West developed ever more resilient corporations—limited liability became widely available in the mid-19th century—as well as a penumbra of technologies such as double-entry book-keeping and stockmarkets."
I don't usually copy articles form other blogs without advance permission, but I've done so for this one! (directly taken from Marginal Revolution - I trust they won't object to a little bit of extra publicity both for their blog, which I subscribe to and recommend that you do, too, and for Timur Kuran).
Timur Kuran was one of my favourite professors at USC, perhaps the one whose views most closely aligned with mine. He has been a supporter of my work for reforms in India (moral support, which is sufficient). He currently works in the Duke University. I thoroughly recommend his work.
Why Timur Kuran is one of our most important thinkers
Timur is well-known as an economist, but his true importance remains neglected. What follows is my view of "what he achieves," not "what he intends."
Timur grew up in Ankara and Istanbul and he brings economics, rational choice, public choice theory, law and economics, and a strong knowledge of history to bear on the history and current dilemma of the Middle East.
I view Timur as our most important apologist for the history of Islam, and I mean that word apologist in the classical sense, not cynically. I am not claiming he is a Muslim (I have no idea), but rather that he has insight into Islam. He is telling us: "this stuff isn't as screwed up as it might seem to some of you. It is more like you than you probably think." Yet, like so many good apologists, you get mostly biting criticism of what he is apologizing for; he is seeking to reform the world he cherishes.
His first book Private Truth, Public Lies: The Social Consequences of Preference Falsification (one of the best economics books of the last twenty years) is about how societies can stick with screwed up beliefs and defend them publicly, yet without everyone being evil or stupid, even if they sometimes sound as such. It has major implications for the theory of revolution, and sudden flips of opinion, yet I read it as a defense of [fill in the blank] society. His work with Sunstein on availability cascades extends the basic point of how falsehoods spread in otherwise normal environments; it applies directly to U.S. regulation also global religion.
Timur has written a great deal on how "Islamic economics," as the formal movement is known, has not done Islamic economies any great favors. It is precisely when he seems most critical of Islamic doctrines that he is doing the most repair work, by indicating another path forward.
He now has a new book out – The Long Divergence: How Islamic Law Held Back the Middle East. The book explains a large part of why the Middle East and Turkey fell behind the West and law and economics has a lot to do with it. Various laws in Islamic societies were not conducive to large-scale economic structures, at precisely the time when such structures were becoming profitable and indeed essential as drivers of economic growth. This is not a book of handwaving but rather he nails the detail, whether it is on inheritance law, contracts, forming corporations, or any number of other topics.
Timur writes clearly but his understated prose doesn't hop off the page at you, no matter how good the content. He sometimes sounds small when he is in fact writing on a very large canvas. Yet the relevant unit of labor here is his career's work, not any single article or even book. I wonder if the economics profession forces on him too specialized a voice or an ill-fitting conception of what Wertfreiheit means.
Here is the final paragraph of the new book and it is one place where the larger vision peeps through more explicitly:
The good news is that the region borrowed the key economic institutions of modern capitalism sufficiently long ago to make them seem un-foreign, and thus culturally acceptable, even to a self-consciously anti-modern Islamist. These institutions can be improved, recombined, and applied to new domains creatively without opposing Islam as a religion, or even dealing with it. They can be debated essentially in isolation from public controversies over what Islam represents and its relevance to the present. Furthermore, Islamic economic history offers abundant precedents for promoting free enterprise and limiting the government's economic role. In no period has private enterprise been lacking. Widely admired empires had shallow governments that left to waqfs the provision of social welfare, education, and urban amenities. A predominantly Muslim society is not inherently incompatible, then, with an economy based on free competition, openness to borrowing, and innovation, and a government eager to support, rather than stifle, private enterprise.
Here is Timur's home page. You can buy the new book — which I strongly recommend – here. Here is the book's home page. Here is a related podcast. Here is a video of Timur.
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