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MF
34,9
Interrelationship between Zakat,
Islamic bank and the economy
A theoretical exploration
610 Masudul Alam Choudhury
Department of Economics and Finance, Sultan Qaboos University,
Muscat, Oman, and
Sofyan Syafri Harahap
Department of Economics and Finance, Trisakti University, Jakarta, Indonesia
Abstract
Purpose – The purpose of this paper is to formalize a general equilibrium circular causation
relationship model in the Islamic economic framework between wealth tax (Zakat), Islamic bank and
the real economy.
Design/methodology/approach – Mathematical modeling along with explanation.
Findings – The integrative interrelationships can be formalized only under the assumption of unity
of knowledge as derived from the foundation of oneness of the divine law (shari’ah) according to the
Qur’an, Prophetic traditions (Sunnah) and social discourse.
Research limitations/implications – A future work would be to empirically estimate the general
equilibrium model.
Practical implications – A guidance to Islamic banks on the constructive utilization of Zakat fund
for productive transformation in the real economy.
Originality/value – A general equilibrium model guided by the episteme of oneness of the divine
law at work, hence unity of knowledge at work in real problems of ethics and economics according to
the Islamic worldview.
Keywords Banks, Islam, Epistemology, Economic theory, Equilibrium methods, Modeling
Paper type Research paper

Introduction
In this exploratory theoretical paper, we will examine the nature of circular causation
relationships generated by the tripartite flows of resources, namely between Islamic
banks, Zakat at source and the economy at large. Investigation of such a circular
causation interrelationship brings out the dynamic input–output measurement of the
Zakat-economy-institution effects in the context of a framework of relational
epistemology of unity of systemic knowledge (Thayer-Bacon, 2003). This is itself the
foundational groundwork of authentic knowledge and formalism in Islamic issues of
world-system, particularized here to Islamic economy and finance. The complex
relationships in the context of circular flows of resources bring out a valuation model of
the Zakat–economy-institutional interaction that has not been taken up in the Islamic
economic and finance literature. It is hoped that the arguments and formalism
presented here in respect of the Zakat–economy-institution ( Islamic banking)
relationship will shed new conceptual light that can be pursued with data empirically.

Background axiomatization
Managerial Finance The background of all authentic knowledge and formalism in Islamic world-system
Vol. 34 No. 9, 2008
pp. 610-617 issues, particularized here to Islamic economics and finance, is the understanding of
# Emerald Group Publishing Limited
0307-4358
the foundation and functionality of unity of knowledge that emanates from the divine
DOI 10.1108/03074350810890967 source of Tawhid, meaning oneness of God as the complete and absolute in knowledge.
From this epistemological premise are derived the knowledge-flows of the world- Zakat, Islamic
system in studying the pervasively complementary interrelationships between the
entities of these systems. Thus, the episteme of unity of divine knowledge causes
bank and
learning systems to arise from the foundation of Tawhid, and thereby, construct the economy
intra- and inter-systemic unification of knowledge through a discursive process. Such a
discursive process has a number of inherent properties through which it proceeds in a
functional and regimented way to create knowledge-flows and their induced entities in
the world-systems. The totality of these properties along with the epistemological
611
foundation conveys the methodology of Tawhidi String Relation as the configuration of
unity of divine knowledge in world-systems. The Tawhidi methodological formalism to
begin with is explained in Figure 1.
The nature of the Tawhidi string relation (1) is that each process as shown under the
bracketed expression [ ] (except the primal one, which remains exogenous and
permanently effective in driving the whole system) is simulated by learning in the
framework of unity of knowledge as derived from the fundamental epistemology
mapped by Sn on to the world-system. Simulation here involves agent-institution
interaction in terms of the ontology of {}-values that then give rise to interactive (I )
socio-scientific variables {X()}. The objective here is to arrive at an integrative (I )
value of the well-being function, W(, X()), by simulating it over interactive values of
{, X({})} converging to consensual (i.e. integrative values of the same vectors). Each
learning process subsequently evolves into evolutionary (E ) processes of the same
category. Thus, we have the interactive, integrative and evolutionary (IIE)-processes as
the permanent character of the learning world-systems in unity of knowledge.
Circular causation is defined by the circular relationships between the {, X({})}-
vector of variables in the problem of simulating W(, X()). Over a finite number of
interaction the well-being function converges to a value W*(*, X*(*)), for a
convergent interactively integrated value (*, X*(*)), but not an optimal value. Only

Figure 1.
Formalism of the Tawhidi
string relation as the
foundational Islamic
epistemology for studying
issues of world-systems
MF satisficing values (Simon, 1960) are acceptable in such continuously learning domains
of processes in unity of knowledge on the epistemological, ontological and ‘‘ontic’’
34,9 (evidential) framework (Sherover, 1972).

Particularization
We particularize the explanation of the Tawhidi string relation (1) to the case of Zakat–
Islamic bank–economy circular causation interrelationship in the light of an objective
612 criterion of the well-being function that interactively integrates these tripartite
interrelationships and causes evolutionary dynamics to occur in a developmental
framework.
Zakat is a levy of 2.5 per cent on net wealth and asset value existing in liquid form.
Let the Zakat variable in monetary units be denoted by Z.
Let Zakat be levied on wealth and asset value at source in the Islamic bank by the
consensus of shareholders. Thereby, Z is mobilized through the Islamic bank into
Shari’ah compliant projects in the economy to generate Gross Domestic Product (GDP)
(Y ) related with those projects and related sectors.
The Islamic bank mobilizes the Zakat at source by participatory forms of
development financing instruments. These are well known in Islamic economics and
finance to be Qard Hasanah (interest-free grants and loans), Mudarabah (shares based
on profit and loss sharing projects in which the poor can participate as shareholders by
mobilizing their portion of Zakat), Trade Financing (in which projects, Zakat can be
made to revolve for the benefit of the Zakat recipients). Let the vector of such
development financing variables be denoted by P.
The economy variable is therefore the GDP. But, this is further disaggregated into C
as consumption expenditure, I as investment expenditure, G as Government expenditure.
The question we face now is whether Z can be linearly added to the national income
and expenditure accounting to explain GDP in an interactive sense between its
components and the Zakat variable. If we accounted for Z in this way, the linearity of
the relationship between the variable will merely be an accounting relation. It would
not explain the circular causation relationships between them. Contrarily, circular
causation between systemic entities in the framework of learning is the essence of
Tawhidi unity of knowledge in world-systems. The interactively generated integration
(consensus by convergence of interaction), followed by further regenerative knowledge
formation and it’s newly cognizing entities in world-systems and in the problems under
attention, form the immutable properties of the IIE-processes.
In other words, in as much as Zakat affects GDP through C, I, G variables and the
development financing instrumental variables (P), so also these latter variables affect
the growth and flow of Zakat. Besides, the variables {Z, C, I, G, P } are themselves
interrelated by circular causation relations in the simulation problem of the well-being
function W ( Z, GDP, P ) ¼ W ( Z, C, I, G, P ). All these variables are knowledge-induced
in reference to the IIE-process generated complementarities (unity of relations) between
the variables, the medium of development financing and resource mobilization
instruments and by the knowledge of such complementarities gained in the
institutional setting of the circular Zakat–Islamic bank-GDP (economy) interrelations.
Such an institutional relationship along with the epistemology and ontology of
knowledge formation is referred to in the Qur’an as the Shura. The IIE-process
underlying this institutional-ontology learning process in the light of the Tawhidi
worldview of unity of knowledge is referred to here as the Shuratic process
(Choudhury, 2003).
 Hence, a linear aggregation of Zakat with the GDP relation is merely an accounting Zakat, Islamic
identity, not the correct way to account for the interactive contributions between the
variables (Z, C, I, G, P ) as generated by IIE-processes.
bank and
economy
The dynamic input-output method of evaluating Zakat-Islamic
bank-economy relationships
We note the following forms of feedback relationships that exist between the
mentioned variables in order to build the dynamic input–output model interconnecting
613
Zakat (Z ), Islamic bank (policy vector ‘‘P ’’ for generating interaction between the
mentioned variables) and economy (C, I, G ). The input–output model is dynamic in the
sense of its learning coefficients. That is, the I–O coefficients turn out to be dynamic
coefficients under the impact of learning in the IIE-process methodology emanating
from the Tawhidi unity of knowledge as the relational epistemology.
Zakat causes augmentation in consumption through the amelioration of the very
poor and deprived. Investment is enhanced by directing some of the Zakat funds into
grassroots development projects for amelioration of the very poor. Islamic banks direct
Zakat funds into Government-participated projects for the very poor and deprived. In
all such project, financing Islamic banks use a mix of participatory development
financing instruments. The Malaysian Government is known to have used unit trust
called Amanah Saham to build grassroots shareholding. Thus the Zakat expenditure
can be considered to belong to a specific sector of the economy where its activities
abound. We will name the sector that directly uses portion of the Zakat Fund in
servicing current needs as the ZS sector. The rest of the Zakat then goes into the
consumption goods sector (CS), investment goods sector (IS), government sector (GS),
where respective kinds of goods are produced and Zakat funds are used to participate
in such productions.
On a feedback relation, all forms of expenditure, including C, I and G generate
spending in the good things of life according to Shari’ah compliance. Such spending
promotes economic growth and development in dynamic basic needs regimes of
development (Choudhury and Hoque, 2004). Consequently, increasing levels of sector-
specific GDP connected with projects is channeled in turn into more Zakat collection
and disbursement. We will refer to the spending sector separately as the CS, IS and GS.
In each of these sectors waste is avoided by selecting the proper Shari’ah compliant
projects and direction of Zakat funds into dynamic regimes of life-sling goods and
services.
The Islamic policy variables (P) are embedded in all such relations as means of
resource mobilization. The implication is that the poor are capable of and induced into
the productive relationship with others. Projects so chosen are those that complement
the mainstream projects for the ultimate goal of attaining wellbeing through social
and economic complementarities. A good example is the Underprivileged Children
Educational Program in Bangladesh, where the once-panhandlers are taken off the
streets and put in fast-track education and vocational training programs. Students of
this program end up servicing certain technical outlets of mainstream enterprises and
multinational companies.
With the above named sectors the input–output model interrelating the sectoral
flows between them takes the form as shown in Table I.
In Table I, the variables, Xkl denotes the intersectoral flow of resources to generate
intermediate output in the receiving the sector l from the contributing sector k; k,
l ¼ ZS, CS, IS, GS. X’s are the various intersectoral variables as shown in equation (2).
MF V.A. denotes value added for the sectors. z denotes the value added of the direct
34,9 Zakat using sector.
z denotes the residual amount of Zakat after the use of total Z intersectorally in
productive projects for the appropriate recipients of Zakat (Qur’an, 2:177). There are
Shari’ah rulings approving that in certain cases surplus Zakat fund can be transferred
for later use. An example is the case of the use of Zakat proceeds in building Tabung
Haji as a leading charitable institution in Kuala Lumpur, Malaysia.
614 c denotes the residual consumption spending after the intersectoral usage of C. Such
residuals are known to build up stocks for future use. The idea of Takaful in foodstuff
is an example.
i is the residual investment spending after its intersectoral usage in the IS. An
example is of delayed developments of Zakat-related projects.
g denotes the residual government spending. An example is a postponement of G to
future years in the form of foodstuff and insurance.
Now, in terms of the I–O coefficients we write

Akl ¼ Xkl =Xl ð2Þ

where k, l ¼ ZS, CS, IS, GSX’s are the various sectors as explained.
An example is of AZC ¼ ZZC/C, denoting the proportion of Z used in the development
of poor projects in the CS to the total spending in the CS pertaining to the projects. An
example is of paddy production by means of Z funds as a proportion of the total in the
grains production sector. This is the case of Malaysia paddy production where Zakat is
used as an ameliorative input to help out poor farmers.
Since all Xkl and Xl, as the X() – vector variables are induced by the knowledge-flow
variable {}, therefore, all respective coefficients Akl are learning coefficients. In
regards to the extensively ameliorative effect of charity (Z ), the Qur’an (2:261) declares:
‘‘The parable of those who spend their substance in the way of Allah is that of a grain
of corn: it grows seven ears, and each ear has a hundred grains. Allah gives a manifold
increase to who He pleases: and Allah cares for all and He knows all things’’.
Yet, the enactment of the learning process by means of {}-values simulated in the
progressive IIE-processes is not automatic. It is partly intrinsic and partly guided.
Learning as the experience of unifying participation and complementarities is embedded
in all things according to the Qur’an. Note the ‘‘paired universes’’ that the Qur’an
mentions about (Qur’an, 13:3). Thus all things learn, just as the human world learns in
unity of knowledge in the good things of life. But there is also the central role of moral
guidance in such a learning system. The policy and development financing variables
denoted by P are careers of the moral transformation through the IIE-processes.

Total output ZS CS IS GS V.A.

Z ZZ,Z ZZ,C ZZ,I ZZ,G z

C CC,Z CC,C CC,I CC,G c
I II,Z II,C II,I II,G i
Table I. G GG,Z GG,C GG,I GG,G g
Input–output table
of Zakat-Islamic bank- Notes: Z þ C þ I þ G ¼ accounting total output; z þ c þ i þ g ¼ national income in the Zakat-related
economy interrelations sectors
Islamic banks thus perform a central role in resource mobilization in ways that the Zakat, Islamic
social and economic objectives of social wellbeing are simultaneously realized by bank and
activating the development financing instruments that are Shari’ah compliant. We also
note that in the above kind of formalization regarding the economy-wide resource economy
mobilization with intersectoral linkages with Zakat, the very nature of project-specific
spending of the Zakat fund linking up with similar spending in the other sectors,
reveals the microeconomic nature of the Zakat-accounting in the Zakat–Islamic bank–
economy interrelationship. We thereby note that the ethical focus of the Islamic
615
economy changes the aggregation basis of the variables into microeconomic forms.

Estimation procedure of the learning input-output coefficients

Take two particular circular causations with Zakat variables, in the forms:

Z ¼ A  C   I   G  P  ð3Þ

z ¼ B  cq  i r  g s  P v ð4Þ

These are readily estimable equations along with their counterpart equations in the
other variables determined by circular causation relations.
For a particular case define,
 
%Z
AZC ¼  C ¼   C ð5Þ
%C


%z
aZC ¼  c ¼ q  c ð6Þ
%c

Rest of the parameters and I–O coefficients can be estimated likewise. These
coefficients describe the dynamic path of sectoral linkages as a sign of unity of
knowledge. It can be seen that the dynamic components of the I–O coefficients are now
readily estimable in terms of the variables {Z, C, I, G, P}. A and B are learning shift-
coefficients.
Since the estimated regression coefficients, even in their random forms (Bayesian
probabilities), would not explain the dynamic nature of such coefficients, it is
recommended to use other statistical methods for the simulation of such coefficients so
as to arrive at desired simulated values vis-à-vis expressions (5) and (6). Every such
desired set of estimated values of the coefficients such as AZC [aZC] and its
counterparts is policy induced by P, though this is not necessary to explicitly exhibit.
Such statistical programs that were used for a similar empirical work (Choudhury et al.,
2003) are Statistical Package for Social Scientists (SPSS) (for estimation of regression
coefficients) combined with spatial domain analysis of Geographical Information
System (GIS) (to simulate a random field of the estimated I–O coefficients similar to
AZC [aZC]). The field of possible estimates of the latter was interpreted as the
domain of policy-induced values of the regression coefficients. Such simulated
estimates reflect interesting policy meanings in the development context.
Once the dynamic versions of the I–O are so estimated we can transform the I–O
Table I into its coefficients form and then re-estimate the dynamic and policy induced
MF values as in Table I. This formalism is not shown here but can be seen elsewhere
(Choudhury and Hossain, 2005).
34,9
The simulated well-being functions
In the end, the well-being function can be estimated as follows. Let the well-being
function be in the form,
Z/GDP ¼ a, a parameter simulated to 2.5 per cent, as the rate of Zakat.
616 Alternatively, this equation can be expressed as,
0 0 0 0
Z ¼ a  C a  I b  Gc  P d ð7Þ

The implication here is that the Islamic economy in dynamic life-fulfilling goods and
services and the endogenous existence of ethical values enjoy increasing returns to
scale in production. This occurs as unit cost of risk and production progressively
decline with enhanced learning in complementarities generating participatory
opportunities. a0 , b0 , c0 , d0 are elasticity coefficients of Z with respect to C, I, G and P,
respectively. ‘‘a’’ is a learning shift-parameter. Other similar coefficients for the circular
causation equations in the other variables can be treated in like manner.
The comprehensive well-being simulation problem interlinking the variables {Z, C,
I, G, P} in respect to their respective sectors as shown in Table I is now given by,
0 0 0 0
Simulate Z ¼ a  C a  I b  Gc  P d ;

with circular causation expressions (3) and (4) along with the remaining similar
relations between the recursive variables {Z, C, I, G, P}.
A given range of simulation stops within a given IIE-process when Z/GDP is
sufficiently near to 2.5 per cent. The nearness of this simulated value is decided by the
institution of Shuratic discourse in development planning.
The above simulation model shows that two dynamics are constantly at work,
namely the setting of the elasticity coefficients, , , , ; q, r, s, v; a0 , b0 , c0 , d0 by virtue
of expressions (5) and (6) using the appropriate statistical methods of dynamic
simulation of these parameters. Secondly, there is continuous institutional guidance
along Shari’ah compliant ways for the Shuratic process to evolve. This requires the
central role of Islamic bank in resource mobilization with positive feedback with the
economy sustaining along life-fulfilling regimes of development.

Conclusion
This paper introduces a new dimension in the measurement of the effects of Zakat and
its related economic variables in the economy-wide sense of general systems of
interrelations. The sheer accounting version of the Zakat variable along with the other
spending variables does not reveal the extensively complementary effects of Zakat on
and between the other variables of the GDP and vice versa. This kind of an
investigation in general systems of relations between Zakat and the other spending
variables in the GDP accounting relations is important to bring out the importance of
Zakat in the total development process.
At the policy level, a general system analysis of Zakat and the other spending
variables in the GDP relation strengthens the meaning of the participatory
development financing instruments in projects that are interlinked across sectors. This
kind of understanding of the participatory development financing instruments
expands the application of the Islamic financing instruments of Mudarabah, Zakat, Islamic
Musharakah, Murabaha and Trade Financing from the narrow limits of specific
projects to all the complementary projects in the consumption goods, the investment
bank and
goods and GSs. economy
The endogenous impact of the participatory policy and instrumental variables on
the potential linkages to be gained between the Zakat and other spending variables in
compliance with the Shari’ah highlight the important role of Islamic banks as direct
resource mobilizing institutions toward attaining the wellbeing of a diversely 617
complemented embedded social and economic system. This is an important point to
observe in development planning.

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Corresponding author
Masudul Alam Choudhury can be contacted at: [email protected]

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