Factors of Production in Islam and Factor Markets in Islamic Framework.

Factors of Production in Islam and Factor Markets in Islamic Framework

Summary of the Previous Lecture

In our previous lecture we discussed the following;•we discussed the concept of money in Islam and the conventional economic system.•Watched the animated documentary about the evolution of conventional banking system and role of money as debt. And the implications of having fiat money like;

1.Credit Creation

2.Inflation

3.Unjust wealth appropriation

4.Deposit multiplication

Learning outcomes

After this lecture you will be able to

•Understand the conventional concept of factors of production, i.e. land, labor, capital, and entrepreneur.

•Understand the concept of factors of production in Islamic economic system.

•Role of money as of being a factor of production.

Factors of Production inIslamic Economic Framework

First we see what are the factors of production in conventional economic system:•Factors of production are the Inputs that provide a productive service in a production process.•Conventional economic theory suggests four factors of production, i.e.

1. Land

2. Labor

3. Capital

4. Entrepreneur

Factors of Production in Conventional Economic System


Name of the Factor

Owner of the Factor

Reward of the Factor

Nature of the Factor

Land Landlord Rent Natural resources

Labor Laborer Wages Human factor

Capital Money Lender Interest Man made factors

Entreprise Entrepreneur Profit Man made factor



• Capital is recognized as money and physical capital. • Reward of capital is interest rate which suits the money

capital but it is treated as price of the physical capital too. Logic suggest that physical asset should earn rent per machine or per capital asset.

Factors of Production in Islamic Framework

All productive inputs are grouped into two categories;

1.Factor inputs: those inputs that don’t get consumed in the production process.

2.Consumed inputs: those inputs that are consumed during the production process and lose their original nature and shape, e.g. fuel, raw cotton, plastic, etc.

Factors of Production in Islamic Framework

Money as factor of production:•Money is recognized as “consumed input” and become useful only when converted into consumed input or factor input.

•Money itself is not considered a factor of production but it has the potential to become a factor of production.

Rewards for the Factors of Production

• Hired Factors of Production (HFP): all those factors that earn ujrat (wage or rent), e.g. labor earns wage, land earns rent, machinery earns rent etc.

• Entrepreneurial Factors of Production (EFP): the factors that face risk instead of earning a fixed wage or rent, e.g. entrepreneur, capital assets employed in the production process.

• Factor inputs can become HFP or EFP.

Rewards for the Factors of Production

• For factor inputs that opt to become HFP the reward is ujrat or rent; money not being a factor input can not earn any ujrat or rent (interest). All the consumable inputs can neither be rented nor they can earn any ujrat.

• Those factor inputs that opt to become EFP the reward is profit (or loss) against the risk associated with new business venture.

Entrepreneurial Factors of Production (EFP)

• EFP is the combination of human and non-human resources that are willing to bear risks involved in initiating or participating in a productive economic venture.

• EFP’s are economic resources when confronted with a choice to work for wage or to have their own work, decide in favor of their own work. Sometime economic resource have no choice but to become an EFP, e.g.

1. A person having money can’t earn interest (ujrat) on it.

2. Sometime wage rate or rent rates are so low that the person prefer not to sell the labor or rent out the property.

Entrepreneurial Factors of Production (EFP)

• Decision making and risk bearing are two entrepreneurial functions, where decision making is solely upon human resources while the risk bearing can be done by the human resources and physical or monetary resources as well.

• Entrepreneurship is to visualize an opportunity and decide to initiate a productive activity in an innovative way and face all the associated risk with it.

• An entrepreneur may not be a good manager, so this type of organizational capabilities (managerial, clerical, security etc.) can be hired against an ujrat.

• Organizers earn ujrat while entrepreneurs earn profits (face the risk of loss)

Hired Factors of Production (HFP)

• All the resources that offer productive services for a definite reward known in advance are called HFP’s.

• All factor inputs can become HFP but none of the consumed inputs can become HFP ("Organization" and "managers" as factors of production too are treated as HFPs as long as they are not willing to bear the entrepreneurial risks).

• HFP’s are employed by EFP’s, i.e. employment opportunities will increase with the increase in entrepreneurial activities. Demand and supply of HFP’s will determine the ujrat and rent.

Hired Factors of Production (HFP)

• HFP’s include land, labor, physical capital good and human capital (monetary resources are excluded).

• HFPs are derived from the same resources which can offer themselves as entrepreneurial resources.

• The supply and demand for HFPs thus competes with the supply and demand of EFPs.

• All these resources have to make a choice whether to opt in favor of becoming an HFP and get an Ujrat or to become an EFP to enjoy the profits.

Institutional Framework in Islamic Economic System

Some of the institutional frameworks that explain the nature of factors of production and factor market are as follows:

1.Commodity Market

2.Factor Market for HFP

3.Institution of Participation

4.Institution of Social Insurance

1. Commodity Market

• Islam rates trading activities very high and the institution of commodity market is one of the most important institutions in Islam.

• Islamic laws regulate the commodity market operations and ensure the free market system with restrictions on the bad practices (monopoly) and misallocation of the resources.

2. Factor market for HFP

• Only those goods/resources can be rented or hired which are not "consumed“ while they are used.

• Renting or hire is the sale or purchase of the benefits/services of physical assets or resources including human resources.

• The assets or resources that generate benefits in the form of real goods (like tree giving fruits or animals giving milk) can not be rented for such benefits.

• Financial resources can not be rented because they can not generate any service without being "consumed".

Renting of land for agricultural purposes:•There is some difference of opinion about renting land for agricultural purposes. A minority of Islamic scholars disallow renting of land for agricultural purpose. The majority of Islamic scholars allow renting of land for agricultural purpose within the general principle of renting, which is, that any physical resource that is capable of generating a productive service is capable of being rented or hired.

•Land is supposed to be just like a machinery which provides the service of being productive when the inputs are used.



• Rented goods should generate permitted economic benefits which are known and certain otherwise the goods can’t be rented out.

• Those goods which are prohibited to rent or generate prohibited services can’t be rented.

• Any loss or damage to the property not willfully caused by the tenant is to be borne by the owner.

• Ujrat is to be determined by the supply and demand forces.

• Ujrat, by definition, is fixed and known-in-advance. Ujrat should be definite and known in advance.

• If Ujrat is uncertain it will be treated as profit and the resources rented on such an Ujrat will be called entrepreneurial resources.

• Ujrat can’t be in terms of same or similar benefits/services, e.g. ujrat of a machine can’t be in terms of allowing the use of a similar machine. It is, however, allowed to pay Ujrat of a machine by allowing the use of a building, or by allowing the use of a different kind of machinery.


The resources that have been allowed to be rented or hired include:

1.Land for (cultivation, or construction, or plantation etc.)

2.Animals (for transportation or for help in cultivation)

3.Human Resources: This includes manual labor such as loader, unskilled worker, servants etc., as well as such skills and professions as doctors, lawyers, professors, organizers, managers etc.

4.Buildings (such as houses, shops, factories, stores etc.)

5.All such other goods that are capable of rendering services without being consumed in a production process (machinery, tools, dresses, tents, jewelry, etc.)


Factor markets for HFP’s are almost similar to conventional factor market for land, labor, and capital, however, there are some differences:

1.Monetary resources can’t become HFP which is not so in conventional framework.

2.The supply of HFP factors particularly of labor results in the process of a choice whether to be a hired factor or an entrepreneurial factor whereas in the conventional theory, their supply results in the process of a choice whether to get employed or not to get employed.


3. Institution of Participation

• In Islam entrepreneurial resources are encouraged to participate and bear the risk to earn profits (loss). Participation will be on profit and loss sharing basis, e.g. Musharakah and Mudarabah.

• There is a profit and loss sharing mechanism in a participation, i.e. profits can be shared at any agreed rate whereas losses should be shared according the proportion of investment. The relative productive worth of the resources invested will determine the profit ratio.

3. Institution of ParticipationIn a capitalist system •All productive resources are rentable. In an economy with high business risks, all productive resources will prefer to be on Ujrat rather than to be entrepreneurial resource. Scarce factors obviously will have high Ujrat so there will be no compelling reason to opt for participation in an economy with high entrepreneurial risks are very high.

•In labor abundant developing countries wage rates are so low that people prefer to sit idle. The surplus labor fails to get participation from the physical and financial capital because of high risk.

Islamic economic system encourage participation in many ways:

1.Monetary resources are prohibited to earn rent but they can participate in entrepreneurial activities.

2.Obligatory taxes like Zakat is applied on idle monetary resources. This will encourage the resources to be invested or participate with someone else.



In capitalistic system monetary resources are available on interest (rent) but are subject to the credibility of the entrepreneur. Only the bigger businesses and wealthy individuals have easy access to monetary resources. Thus the system make the richer the richest and the bigger corporations even bigger.

In Islam the institution of participation creates demand for entrepreneurial resources by:

a)creating new entrepreneurs to come into the market to avail entrepreneurial opportunities;

b)promoting participation of scarce resources with abundant resources hence causing abundant entrepreneurial resources to come into the market as EFP;

c)promoting participation of big entrepreneurs with small entrepreneurs and hence creating demand for small entrepreneurs;

d)reducing risk in the economy by distributing risk fairly among the entrepreneurs and hence making the potential entrepreneurs to come forward to take up entrepreneurial activities.


4. Institution of Social Insurance

Islam ensures the well being and livelihood of the people. The institution of social insurance consists of the following factors:

a.And in their wealth the beggar and the outcast had due share. (51:19)

b.The institution of Zakat, Sadaqat and charity.

c.The system ensure minimum living needs for everyone so the entrepreneurial factors would be encourage to take risks the demand for EFP would increase which means welfare of the people.

Summary of the Lecture

In this lecture we discussed the following concepts.

• Factors of production in conventional economic system

• Factors of production in Islamic economic system.

Factors of Production in Islam and Factor Markets in Islamic Framework.

Documents

factor factors of production

factor of production

production process

money capital

consumed inputs

conventional economic

concept of money

factor markets