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Murat Çizakça

Cross-cultural Borrowing and Comparative Evolution of Institutions


between Islamic World and the West

To be published in S. Cavaciocchi (ed.), Relazioni economiche tra


Europa e mondo Islamico, Secc. XIII-XVIII, (Prato: Istituto di Storia
Economica, F. Datini, Serie II, 38, 2006), forthcoming.

Introduction
The tragic events in our post 9/11 world disguise the fact that Islam and
the West have actually been in a symbiotic relationship over the very long
period. Cross-cultural institutional borrowing has constituted a major
component of this symbiosis. I intend to focus in this paper on the way these
civilizations borrowed important economic institutions from each other.
The paper will start with a brief theoretical model explaining the process
of cross-cultural institutional borrowing. This will then be followed by an
account of the economic institutions actually borrowed. In this context
several institutions come to mind; land ownership, tax-farming,
charitable/philanthropic foundations (- therefore universities, hospitals and
even banks), business partnerships and corporations/joint-stock companies.
Obviously, a thorough analysis of all these institutions cannot be made within
a 20 minutes’ paper. I will therefore concentrate on the business partnerships,
charitable/philanthropic foundations and corporations.
An equally important question pertains to the comparative evolution of
these institutions in both the lending and the borrowing civilization. The crux
of my argument is that institutional borrowing has played an enormously
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important role in the subsequent economic development of the borrowing
civilization through primarily a substantial reduction in the transaction costs. I
will also try to explain why a civilization borrows institutions at a particular
period in history only to become a lender at a subsequent period as well as
the forces that lead to a successful synthesis of the borrowed institutions
with those of the endogenous ones. In short, the paper will also attempt to
develop a theory of cross-cultural borrowing of institutions.
The Model: A Theory of Cross-Cultural Borrowing of Institutions
Assume that, at time T, there are two civilizations, A, the presently more
advanced, and B, the relatively backward, that are in contact. Assume further
that one of these, B, feels the need for a relatively more efficient institution,
which the other civilization A possesses. Cross-cultural borrowing of
institutions would then start.
The relative efficiency of an institution mentioned above refers to the
transaction costs. Efficient institutions significantly reduce these and a
reduction of the transaction costs would have a direct and positive effect on
production.1 In the long run, efficient institutions cannot be monopolized by
a civilization. Such institutions, ceteris paribus, can be, but not inevitably,
borrowed by the more backward civilization. This also implies that
institutional borrowing is not unidirectional, given a sufficiently long time,
what moves from A to B, may well be reversed. This is because B always has
the potential to invent. Indeed, if the institution that B needs does not exist
in A’s institutional portfolio, B may invent it. But institutional invention on B’s
part means that this relatively backward civilization possesses already a certain
degree of internal dynamism. It goes without saying that A too has the
potential to invent.
Borrowed institutions, may or may not, function as efficiently as in the
original civilization. This is because these would be subject to the existing
institutional matrix of the borrower. A lot depends on whether the demand
to borrow originates at the top or the bottom of the society and whether the
borrowed institution is well understood and accepted by the rank and file. If
the demand originates at the bottom and the institution is borrowed through
some sort of a democratic pressure, the “transplant effect”, which impedes
the efficiency of the borrowed institution in the borrowing society, would be
minimized. This is because, for a new law or an institution to be effective,

1 R.H. COASE, The Institutional Structure of Production, Nobel Lecture, reprinted in Handbook
of New Institutional Economics, C. Menard, M.M. Shirley (eds.), Dordrecht 2005 (Springer), p. 35.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
3

local constituencies with a strong interest in them are needed.2 Looked at


from this perspective, elite initiated and imposed institutional borrowing
would be less likely to succeed, unless there is a real need for these
institutions. Of equal importance is the possibility of a synthesis of the
borrowed institution with those that already exist within the institutional
matrix of the borrower, B. The more the “transplant effect” is minimized
through general acceptance caused by widespread need and the better the
synthesis, the greater the potential for success for institutional borrowing.
The relative efficiency of the institutions in A and B would be determined by
the complex interplay of these forces.
We have started this analysis with the assumption that, at time T, the
civilization A was simply more advanced. Let us now focus on the possible
causes of this early advantage. After all, while we are aware that institutions
have a direct impact on the economic performance of a country, our
information about the factors that affect the relative efficiency of the
institutions themselves is limited. North has argued that belief systems, social
values and ideologies, in one word, culture plays a significant role in the
relative efficiency of institutions.3
Religion and the values it imposes affect transaction costs significantly by
creating auto-control systems. Consequently, pious individuals control
themselves and act within a generally expected mode of behaviour, which
leads to a significant reduction in transaction costs.4 Thus the initial advantage
of A may well have been caused by a newly established religion. Furthermore,
if the proponents of this new religion were merchants themselves, they could
write the new rules and design a legal system as well as introduce institutions,
which promote trade.5

2 K. PISTOR, D. BERKOWITZ, J.-F. RICHARD, Economic Development, Legality, and the Transplant
Effect, in “European Economic Review” 47, 2003, 1, pp. 165-195 and K. PISTOR, The Standardi-
zation of Law and Its Effect on Developing Economies, G-24 Discussion Paper No.4, June 2000.
3 D. NORTH, Institutions, Institutional Change and Economic Performance: Political Economy of Insti-
tutions and Decisions, Cambridge 1999 (Cambridge University Press), p. 138; IDEM,. Understanding
the Process of Change, Princeton 2005 (University Press), see particularly chapter three.
4 J. ENSMINGER, Transaction Costs and Islam: Explaining Conversion in Africa, in “Journal of
Institutional and Theoretical Economics”, 153, 1997, pp. 4-39.
5 Reference is made to Islam here. Indeed, it has been estimated that in the ninth and
tenth centuries about 75 percent of all the religious scholars living in Islam’s Arab heartland
earned their living primarily from business. See S.D. GOITEIN, Studies in Islamic History and Insti-
tutions, Leiden 1968 (Brill), pp. 218-219; T. KURAN, The Islamic Commercial Crisis: Institutional Roots
of Economic Underdevelopment in the Middle East, in “Journal of Economic History”, 63, 2003, 2,
pp. 414-446, 418, fn. 13. With the exception of the Qur’an, which according to the Muslim
MURAT ÇIZAKÇA
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Sudden exposure to the accumulated wisdom of earlier civilizations can
also explain why A would have advanced initially.6 B, belonging to an older
religion and having lost contact with the earlier civilizations, would be lacking
these advantages. Consequently, in time T, merchants of B would encounter
higher transaction costs vis a vis their colleagues in A.
Under these circumstances, it would be reasonable to expect that
merchants of B, experiencing higher transaction costs would begin to borrow
A’s institutions. Two things are important here; whether the borrowing is
done, at a relatively slow rate, and by ordinary people, such as merchants, or
after a crushing defeat in panic and imposed by the elite.7 In the former case,
the negative “transplant effect” is minimal.
In time T+1,8 A’s institutions are introduced to B. This institutional
reflection initially appears as a series of newly emerging customs (Law
merchant) practiced by the merchants of B, who were particularly well
exposed to A’s institutions. These new customs, however, may reduce but not
yet minimize the transaction costs of B’s merchants. Relative minimization
occurs when these mercantile customs are first compiled and then
incorporated into the legal system of B. Put differently, transaction costs can
be minimized only after contract enforcement is achieved in T+2.9

belief is the word of God, all the other sources of Islamic jurisprudence are man made, which
in view of the above means, made primarily by the merchants.
6 Within the first 20 years of the revelation of Islam, Arabs conquered Roman/Byzantine
Egypt and Syria, thus establishing contact with the wisdom of ancient Greece, Egypt and
Mesopotamia . Conquest of Iran and Islamization of Northern India followed. Soon the first
translations were made from Greek, Arameic, Sanskrit and Persian into Arabic. What the
Greeks lacked, like the concept of zero and trigonometry, were provided by the Indians. By the
ninth century, borrowing reached to a new threshold and Muslims began their own
contributions in astronomy, geography, mathematics and sciences. F. SEZGIN, Kim Demis Islam
Buyuk Bir Medeniyet Degil Diye, in “Zaman”, July 29th, 2005.
7 The Arab invasion of Spain (in 711) though shocking enough, was quickly stopped near
Poitiers in 732. Thereafter although Arabs continued to threaten Southern Italy, we cannot talk
about a panic in Western Europe. By contrast, during the period eighteenth-twentieth centuries
the West inflicted upon the Islamic world a series of crushing defeats and all the three great
Islamic empires, the Mughal, the Safevid and the Ottoman, were destroyed. In this period
panic in the Islamic world was inevitable. With the invasion of Afghanistan and Iraq, panic has
now spread into the twentyfirst century.
8 T+1 does not refer to a specific time. It simply symbolizes sequence and refers to
institutional evolution. Within the context of the very long run considered in this article, T
may be followed by T+1 with a lag of centuries. Arabic numerals are added to T as major
institutional changes occur.
9 Contract enforcement occurred during the 11th-12th centuries when the three most
important compilations were made. These were the Maritime Laws of Rhodes, Oleron and the
Consolato del Mare. It is now definitively established that the first, generally considered to be a
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
5

Following contract enforcement, both A and B end up having similar


institutions. With a common institutional infrastructure, trade between the
two zones would be enhanced.10 Increased trade, on the other hand, leads to
growth in both A and B, time T+3. While this is so, it would be reasonable to
suppose that B’s economy would grow faster than A’s. There are number of
reasons for this. To start with, the initial backwardness of B, prior to time T,
may have been caused also by a great trauma forcing B to a struggle for sheer
survival. If so, the institutions that B has developed during this struggle for
survival combined with the imported institutions from A, in time T+1, may
have generated a dynamic environment.11 Indeed, during the process of
borrowing A’s institutions, a synthesis of the borrowed and the endogenous
institutions is of paramount importance.12 If B has achieved such a synthesis,

derivative of the Roman-Byzantine digests, was in fact based on Al-Mudawwana al-Kubra by


Sahnun Ibn Sa’id al Tanukhi (d. 854). It was reprinted by Ibn Rushd (Averroes d. 1117) and
drafted in Sicily or South Italy, both Muslim territories during the ninth-eleventh centuries. The
second was authored by the Court of the Crusader Kingdom of Jerusalem in order to
harmonise trade relations between the occidental and oriental Christians as well as the
Muslims. This compilation was brought to Europe partly by Eleanor of Aquitaine and partly
by her son Richard the Lion Hearted. The contents of the Oleron compilation are identical to
the Muslim laws of the ninth-tenth centuries. Finally, the Consulato del Mare was written in
Spain. The document originates in the Muslim Middle Eastern texts of eighth-ninth centuries
and was later brought to Andalusia. It was translated during the reign of King Alphonse in
thirteenth century Castille as part of the great works of translation. For all this see; Daniel
Panzac, “Le Contrat d’Affrément maritime en Mediterranée”, Journal of the Economic and Social
History of the Orient, vol. 45, No. 3, pp. 351-358. Also see H.J. BERMAN, Law and Revolution, the
Formation of Western Legal Tradition, Cambridge Mass. 1983 (Harvard University Press).
10 I would propose the following periodization for these developments: The Qur’an was
revealed shortly before the middle of the seventh century. Within a century, time T, Arabs had
established a vast Islamic empire from Spain to the Indian Ocean. By the late eighth-early
ninth centuries this Islamic empire began to trade with the Carolingian Europe: M. MCCOR-
MICK, Origins of the European Economy, Communications and Commerce, A.D. 300-900, Cambridge
2003 (Cambridge University Press). The earliest known evidence for Europeans practicing
commenda is in the tenth century, time T+1: M. ÇIZAKÇA, A Comparative Evolution of Business
Partnerships: The Islamic World and Europe, with Specific Reference to the Ottoman Archives, Leiden 1996
(Brill), p. 11. Contract enforcement occurred during the 11th-12th centuries as described in the
previous footnote D. Panzac, “Le Contrat”, cit.
11 The West went through at least three such traumatic events: the Völkerwanderung, the
shift of the imperial capital from Rome to Constantinople and the collapse of the Western
empire in 476 A.D.. The economic impact of the shift of the capital is now well documented.
See M. MCCORMICK, Origins, cit. These powerful shocks led to the birth of feudalism and
papacy, two institutions, which played a decisive role in the successive development of Europe.
12 Consider for instance the synthesis of the medieval European corporation and, most
likely, the originally Islamic commenda partnership.
MURAT ÇIZAKÇA
6
in time T+3, its economy would indeed grow faster. This would also mean
that the institutions imported from A would evolve faster in B.
Another reason why we should expect faster growth in B is that the units
(institutions) are usually borrowed in their relatively more advanced forms
and that some of the costs of experimentation and introduction will already
have been borne by A. This would save B, the transaction costs that A had
once endured in trying to develop its institutions. Obviously, reference is
made here to the well-known Gerschenkron thesis concerning technology
transfer. I would argue that similar forces would also be relevant for
institutional borrowing. These dynamics play an important role in explaining
North’s argument that institutions are subject to increasing returns.13 In
addition to all these factors explaining the faster rates of growth in B, there
may be powerful endogenous factors working in the opposite direction
inhibiting growth in A itself. Indeed, relatively rich territories often attract
invaders. Such invasions not only devastate the invaded economies but also
may completely transform them into much more centralized, autocratic and
disciplined political structures. Such transformations may be conditio sine qua
non for survival. But while survival may be achieved, this may well occur at
the expense of liberal economic growth.14
The faster rate of growth thus achieved in the once backward B would
force it to invent new institutions. Such institutional inventions, however,
would not emerge everywhere in B, but rather in certain sub-units, i.e.,
countries or regions, leading to a differentiation within B itself.15 Assuming
that there is sufficient interstate rivalry and low cost information, B’s
relatively backward sub-units would begin to imitate its more advanced ones.
Once again, sub-units with high transaction costs would borrow the
institutions of those with low transaction costs.
Under these circumstances, the once backward B would have gained
several types of institutions; those developed endogenously in response to
the earlier crisis, those borrowed from A and synthesized, and finally, those
invented in response to the faster growth rates in B. With such an impressive

13 D. NORTH, Institutions, cit., p. 96.


14 Reference is made here to the double invasion of the Islamic world during the
disastrous eleventh-thirteenth centuries and the emergence of highly centralised and powerful
Turkish empires. For further details see below.
15 Possible causes for initial advantage (between regions within B) may include proximity
to a major world-economy as medieval Italy was to the Islamic world, or early establishment of
democratic institutions, due to endogenous factors, leading to the protection of property rights
and freedoms, as was the case in medieval Flanders. See E. JONES, The European Miracle, Cam-
bridge 2003 (CUP).
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
7

institutional matrix, certain sub-units of B would achieve extra-ordinary rates


of growth and may even begin leapfrogging. Consequently, the once
advanced A begins seriously to fall behind, time T+4.16
The first agents to feel A’s predicament would be its armies and
merchants. The former would be killed or defeated in the battlefields and the
latter would be driven out from the international markets, in either case a
merciless process. Under these new circumstances, the only way for A’s
merchants to survive would be to reduce their own transaction costs. This
means borrowing B’s now more advanced institutions. This is a painful
process for A, and the longer it takes A’s agents to realize the situation, the
more radical would be the process. Indeed A, might even be forced to borrow
not only an institution or two but a whole legal system. Such dramatic
borrowing, in T+5, is known as “jurisprudential shift.”17 This shift would be
wholeheartedly supported by some of A’s merchants, who find themselves in
competition with B’s merchants and might lead to a differentiation amongst
A’s merchants; those that can participate in the jurisprudential shift and those
that cannot, the latter being impeded by certain social and cultural
constraints. If a settlement between these two groups cannot be achieved,
social upheavals, even massacres, may take place. If the group that has
participated in the jurisprudential shift and therefore grown “rich” happens
to be a minority, it may be obliterated. But if the most dynamic elements of
A’s agents are thus eliminated, A’s chances of competing with B, are reduced
even further. This is because, whether violent or non-violent, elimination of
the rich minorities deprives their eliminators of accumulated professional
know-how as well as commercial networks and leads to massive flight, theft,
in short, depletion of capital. Under these circumstances, deprived of a
functioning yet minority dominated private sector, the leaders of A may be
forced to abandon liberal economic policies, to the extent that these existed,

16 To the extent that real wages reflect the performance of an economy, these arguments
are supported by Özmucur and Pamuk, who observed that at the beginning of the sixteenth
century real wages in North-Western Europe (Amsterdam, Antwerp, London) were already
higher than in Istanbul and remained so until the industrial revolution. But it is also revealing
that Valencia, Vienna and Leipzig were also lagging behind confirming the competition among
the sub-units of B. B. S. ÖZMUCUR, S. PAMUK, Real Wages and Standards of Living in the Ottoman
Empire, 1489-1914, in “Journal of Economic History”, 62, 2002, 2, pp. 293-321, 312-314. See
also S. BROADBERRY, B. GUPTA, The Early Modern Great Divergence: Wages, Prices and Economic
Development in Europe and Asia, 1500-1800, in “The Economic History Review”, LIX, 2006, 1,
pp. 2-31, 5.
17 T. KURAN, The Islamic Commercial Crisis, cit. Islamic world went through this process
during the nineteenth and twentieth centuries.
MURAT ÇIZAKÇA
8
and resort to socialism impeding long term growth even further.18 In view of
above, it would be very difficult (but not impossible) for A’s conservative
elements to invent new institutions or to achieve a new synthesis.
Under these circumstances, the once advanced A enters into a path
dependency and panic sets in. Leaders of A begin to feel that getting out of
the path dependency would be possible only by radical reforms and a
complete jurisprudential shift. Thus, denied the potential for a synthesis, the
borrowing process in A suffers from the full “transplant effect” reducing the
probability of success greatly.19
On the other hand, other leaders in the defeated A may believe that
returning to the pristine traditions of the once glorious age, when A was the
leading civilization, is the ultimate solution to escape the path dependency.
An elite conflict between the modernists and the radical conservatives may
follow.20 Such a conflict would spell disaster for the future of democracy in
A.21 If the “modernist” leaders somehow manage to control the state
apparatus in A, or in the various sub-units of A, the reforms and the
jurisprudential shift would be attempted not from the bottom up but from
top down. To the extent that these reforms are imposed from the top and not
shared by the masses, the negative “transplant effect” begins to operate
impeding the overall effectiveness of the reforms as well as the
jurisprudential shift. Of the set of imported institutions and laws, those
accepted by the masses, would be successfully incorporated into the existing

18 Consider here the tragic Armenian incidents in 1915 and the bloodless but almost
equally dramatic population exchange between Greece and Turkey at the beginning of the
twentieth century. The harassment of the “rich” minorities continued in Turkey with the
ruthless “wealth tax” imposed primarily on the remaining minorities in 1942 (A. AKTAR, Varlık
vergisi ve ‘Türkleştirme’ Politikaları, İstanbul 2000 (İletişim)) and the 1955, 1964 events as a result
of which most minorities left the country and out of a multi-ethnic and multi-denominational
empire a “homogenous nation” was created. In post-independence Malaysia, by contrast, the
ruling Malays (Muslims) and the entrepreneurial Chinese (Christians) managed to reach a
settlement. Consequently, Malaysia did not loose its entrepreneurs, their networks and capital
and could pursue relatively liberal economic policies allowing a direct linkage between the pre-
and post colonial enterprises: J. KENNEDY, A History of Malaysia, Kuala Lumpur 1993 (Abdul
Majeed & Co.), pp. 333-336.
19 Consider the massive westernization imposed by the Kemalists in Turkey during the
1920s. After an experimentation of about 60 years, the elites felt the need for a synthesis in the
1980s. See H. YAVUZ, Islamic Political Identity in Turkey, Oxford 2003 (Oxford University Press),
pp. 59-81.
20 Much of the Islamic world during the nineteenth and particularly the twentieth
centuries has been characterised by this conflict, which has spilled into the twentyfirst century.
21 M. BURTON, J. HIGLEY, Elite Settlements, in “American Sociological Review”, 52, 1987, pp.
295-307, where it is stated that an “elite settlement” is a conditio sine qua non for democracy.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
9

legal system of A. Others would be rejected or find no application.


Obviously, the elements that would be accepted would be those that reduce
the transaction costs. On the other hand, if the ruling elite insisted on
implementing certain rules and regulations notwithstanding their rejection by
the masses, negative “transplant effect” would be maximized and the
transaction costs would increase tremendously, impeding production and
growth.22
It is possible that A may progress somewhat with the imported
institutions and laws. But for A to catch B, a much more ambitious
undertaking, it is necessary that the imported institutions and laws be
synthesized with A’s existing institutions and value systems. Such a synthesis,
on the other hand, would only be possible through a settlement between the
rival modernists and the conservative elites representing the masses. To the
extent that the former control the armed forces and the state, the latter would
have no choice but to compromise. Consequently, the conservative elites of
A, in time T+6, may split into radicals, who refuse any accommodation, and
liberals willing to reach a compromise with the modernists. Aided by the
powerful modernists, the liberals may begin to dominate the conservative
camp and may even come to power through a democratic process tolerated
by the modernists. Meanwhile the radicals would be marginalized. These
developments can occur only in the most advanced sub-unit of A, where
democratic process and institutions, though imperfect and borrowed from B,
operate. Thus an elite settlement between the liberal conservatives and
traditional modernists paves the way for further democratization.
Democratization, on the other hand, may lead to a successful synthesis of the
inherent traditional values and the institutions borrowed from B.23 Once this
is achieved, this most advanced sub-unit of A begins to have a common
institutional infrastructure with the more advanced B and lowering its
transaction costs begins to enjoy rapid growth. At this point two, not
necessarily mutually exclusive, possibilities appear. First, other sub-units of A
begin to emulate the most advanced sub-unit and progress towards a

22 Pistor and her colleagues emphasise the importance of the way the law is initially
received. Countries that have developed legal orders internally have more effective legality than
“transplant effect” countries and legality is one third lower in the latter. Meanwhile, they also
calculated that a one percent increase in legality is associated with a 4.75 percent increase in
GNP per capita (K. PISTOR, D. BERKOWITZ, J.-F. RICHARD, Economic Development, cit., pp. 165-
168).
23 The 1967 waqf law in Turkey constitutes an outstanding example for this. See: M. ÇI-
ZAKÇA, A History of Philanthropic Foundations: Islamic World From the Seventh Century to the Present,
Istanbul 2000 (Bogazici University Press), pp. 90-105.
MURAT ÇIZAKÇA
10
common institutional infrastructure with B. Second, the advanced sub-unit
may decide to carry the jurisprudential shift, with which it is already well
acquainted, to a whole new plateau and attempt a complete “civilizational
shift” abandoning A, of which it has been a leading member for centuries,
and opting to join B, the rival civilization.24

The Evidence: Islamic Finance


The most important characteristic of Islamic finance is the stringent
prohibition imposed on interest bearing transactions. It is unusual for a
cultural constraint to remain so constant over the very long term, having a
continuous impact on institutional evolution, ergo, transaction costs and
economic performance. This is not to say that Muslims throughout history
obeyed the prohibition strictly. While, at all times, there were certainly those
who violated the law, this was done at higher transaction costs. Higher
transaction costs, on the other hand, mean that the pertinent activity would
be mitigated.25 Moreover, it was one thing for an individual entrepreneur to
disregard the law and quite another for an institution that violated the law to
emerge. Thus the prohibition certainly had a significant impact on the
structure of financial institutions. The structure of Islamic finance from its
very origins until today has been affected by this constraint. This situation led
classical Muslim jurists to develop or perfect ingenious new financial
instruments.
But is it safe to deduce from all this that these instruments overcame any
negative effect that the prohibition might have had on the economy? The
well-known work of Avram Udovitch, who so implied, does not help here as
it merely looks into the Islamic world and does not compare Islamic finance
with the developments that took place in the West.26 In what follows a long-
term comparison of Islamic finance with that of the West will be provided.

Evolution of Islamic Finance, Business Partnerships


First, let us view how Islamic finance actually functioned while observing
the interest prohibition. Muslims during the seventh and eighth centuries
24H. YAVUZ, Islamic Political Identity, cit.; S. HUNTINGTON, The Clash of Civilizations and the
Remaking of World Order, New York 1996 (Simon & Schuster); M. HEPER, The Justice and Devel-
opment Party, Government and the Military in Turkey, paper submitted at the workshop Religion and
Politics in Turkey, Istanbul; July 2-3, 2004.
25 R.H. COASE, The Institutional Structure, cit., p. 35.
26 A. UDOVITCH, Partnership and Profit in Medieval Islam, Princeton 1970 (Princeton Univer-
sity Press).
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
11

developed various business partnerships that obeyed the prohibition. The


most important was the mudaraba and the rest are considered as derivatives of
it. A thorough understanding of this financial instrument is therefore
essential.
Mudaraba was basically a partnership that brought together a capitalist and
an entrepreneur. The entire capital in this association was provided by the
capitalist and it was entrusted to the entrepreneur, who traded with it. Profits
generated were divided between the two partners according to a
predetermined percentage. In most cases a ratio of 3/4th to 1/4th was
applied, with the principal receiving the larger share, but these ratios were not
fixed and there was room for flexibility.
This flexibility was due to the general principle that in Islamic
partnerships profit follows mutual agreement, and loss follows the capital
invested. That is to say, profit is distributed between the partners according to
a mutually agreed and predetermined ratio, while if the venture ends with a
loss, this would be distributed in proportion to the capital contributed by
each partner. Since in the mudaraba partnership the entire capital was provided
by the capitalist, it follows that he suffers the entire pecuniary loss. But the
nature of this loss has an added dimension because the entrepreneur also
suffers a loss in the form of unpaid effort. It must be emphasized that even
with the entire pecuniary loss accruing to the capitalist, mudaraba is a limited
liability partnership. For, even if the worse comes to the worst, the capitalist
looses only the capital he has invested in the partnership. The losses incurred
by the agent over and above the capital invested by the principal accrue to the
agent.
Another area, where one observes great flexibility, concerns the freedom
of the agent or the entrepreneur. The principal could restrict the agent’s
freedom. But in an age of difficult communications and with the agent
travelling overseas, granting the maximum freedom to an entrusted agent was
the rational thing to do. Most importantly, the agent could pool the resources
of many other principals, with that of the original one and even transfer this
accumulated capital to a multitude of agents in another city.27 Thus, Islamic
law paved the way for the expansion of capital entrusted to an agent and
made it possible for a multitude of capitalists to hand capital to an agent,
buying shares in the venture, according to their means. This joint-stock like
structure was a highly advanced financial arrangement. But, even so, genuine
joint-stock companies as those in the West have not been observed in the
Islamic world. Although it was legally possible to combine the capital of
27 Ibidem.
MURAT ÇIZAKÇA
12
many principals and mobilize this accumulated capital for a major project,
this was either exceptional or did not take place in the Islamic world at all.28
What then impeded the Muslims? The answer will be given after the
European evolution has been considered.
As stated above, other partnership forms were derived from mudaraba.
Each of these partnerships was approved by Islamic law. Consequently they
could freely spread all over the Islamic world. There is evidence that from
Morocco to the Malay world they were well known and found widespread
application.29
In addition to being so widespread, these partnerships were also
remarkably resilient. There is substantial evidence that they have survived
from the seventh to the twentieth century. It is also remarkable that in this
long time span, with the exception of the twentieth century, they have not
substantially changed in the Islamic world. Thanks to the Ottoman archives, it
is possible to follow these partnership forms from the fifteenth to the early
twentieth century. In this period, archival evidence has yielded a picture of
continuity rather than major evolutionary changes.30
In the middle of the twentieth century, however, a major evolutionary
step was taken in Egypt with the foundation of Islamic banks. Established as
sophisticated mudaraba partnerships by Ahmed El-Naggar, Islamic banks
successfully synthesised the European corporation with this ancient Islamic
institution. Thanks to this synthesis, Islamic banks have succeeded, for the
first time in Islamic financial history, in mobilizing the savings of the masses
for investment.31 There follows a look at the evolution of another Islamic
financial institution, cash waqfs.

Cash Waqfs
Cash waqfs are charitable endowments established with cash capital.
What distinguishes these from the standard real estate endowments is the
nature of their capital, corpus, which is in cash. Thus, whereas a well to do
Muslim normally endows his real estate and channels its rent revenue into
charity, in the case of a cash waqf, not real estate but cash is endowed and the

28 M. ÇIZAKÇA, Comparative Evolution, cit.


29 Ibid., pp. 18-21.
30 Ibid., pp. 84, 130, 209.
31 To be sure, Western style banks mobilizing savings had been introduced to the Islamic
world well before the El-Naggar experiment but they were institutional transplants and do not
represent an indigenous evolution within Islamic financial history.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
13

revenue generated goes to charity.32 Imam Zufar, who had approved of the
cash waqfs for the first time during the eighth century, had envisaged that the
corpus would be invested through the mudaraba partnership.
The origins of cash waqfs are obscure. In the Roman Empire cash gifts
were made to finance games.33 Possible linkages to Mesopotamia, ancient
Greece and pre-Islamic Arabia have also been mentioned. But their full
development and maturity had to wait until the sixteenth century, when they
became the most popular form of philanthropy among the Ottomans. This
popularity was probably both due to religious and economic reasons.
Concerning the former, Muslims believe that perpetual charities, sadaqah
jariya, would enable them to obtain merits even after death, sawab bad al-wafat
(Çizakça, 2000: 5-6). As for the latter, in a society where interest prohibition
prevailed, cash waqfs provided an excellent means for investing one’s capital
or generating much needed cash from an illiquid real estate. Moreover, the
profits generated by cash waqfs were spent on essential services, like health
and education.
The popularity of the Ottoman cash waqfs did not fail to trigger
opposition among the learned circles. The argument of those, who opposed
the cash waqfs was based on a seemingly powerful point that once endowed,
the corpus of a waqf belongs to Allah. But while investing the corpus of a cash
waqf, whether in the form of a mudaraba or simple loaning, the cash endowed
is inevitably distributed to the borrowers. What belongs to God, the
opposition argued, cannot be distributed to third persons!
It should be noted, however, that only the right to use the waqf capital
was distributed to the borrowers, not the ownership. The latter was protected
by a hefty collateral, which was usually in the form of the borrower’s house.
In this arrangement, known as istiglal, borrowers from a cash waqf used its
capital for a limited period, usually a year. During the period that the
borrower kept the cash, he was permitted to continue using his house, which
he had given to the waqf as collateral. In return, the borrower paid a rent to
the waqf. It was this rent, which constituted the “extra” paid to the waqf over
and above the amount borrowed. When the borrower paid back his debt, the
collateral, i.e. the ownership of his house, was returned to him. Whether the
capital of the endowment was lent as credit to the borrowers and the return

32 Actually the boundaries between the two types of waqfs were not always so clear cut.
Often waqfs with mixed capital were also endowed. There were excellent legal reasons for this.
For more details see M. ÇIZAKÇA, Philanthropic Foundations, cit.
33 R. DUNCAN-JONES, The Economy of the Roman Empire, Cambridge 1982 (Cambridge Uni-
versity Press), pp. 133-138.
MURAT ÇIZAKÇA
14
was, in fact, simply interest, and whether the whole investment process was
perfectly legal, constitutes a debate.34 In short, the cash waqf was a useful
financial instrument, which allowed house owners to obtain the credit they
needed in an economic system that normally avoided interest.
The cash waqf controversy lasted throughout the sixteenth and
seventeenth centuries without conclusion. Meanwhile, thousands of cash
waqfs continued to be endowed. In Istanbul, of the 2,517 waqfs established
in the period 1456-1551, 1,161, that is 46 percent, were cash waqfs and in the
smaller city of Bursa, there were 761 cash waqfs during the eighteenth
century.35 Apparently, notwithstanding the controversy, based upon
Ebussuud’s fatwa and supported by the sultans’ orders, these waqfs continued
to flourish.
Although ultimately the endowed cash was earning cash, i.e., a cash-cash
transaction and therefore constituted a potentially usurious transaction, the
fact that the cash earned by the waqf was in the form of rent for pawned real
estate, transformed the whole process into a perfectly legal transaction. In
short, cash waqfs obeyed the letter of the interest prohibition. But since the
endowed cash yielded a fixed return, which hardly changed over the long
term, the yield was very close to ordinary interest. Islamic finance, particularly
in the Ottoman Empire, was dominated by cash waqfs until the nineteenth
century, when western banks were introduced. Meanwhile, Muslims colonized
by western powers, particularly Indian Muslims looking for alternative Islamic
instruments of finance, borrowed Ottoman cash waqfs and introduced them
to India, which became a source of further diffusion itself.36

The European Evolution


There is no doubt that during the eighth and ninth centuries (time T), the
Islamic world was more advanced than the West. From the tenth to the
thirteenth century much of the wisdom of the Islamic world from
philosophy to science, astronomy and medicine was borrowed by the
Europeans.37 In the field of finance, there is a high probability that the
34 J.E. MANDAVILLE, Usurious Piety: The Cash Waqf Controversy in the Ottoman Empire, in “In-
ternational Journal of Middle Eastern Studies”, 10, 1979, 3, pp. 289-308 and M. ÇIZAKÇA, Risk
Sermayesi, Özel Finans Kurumları ve Para Vakıfları, Istanbul 1993 (ISAV) (Venture Capital).
35 Ö.L. BARKAN, E.H. AYVERDI, Istanbul Vakıfları Tahrir Defteri, Istanbul 1970 (Istanbul
Fetih Cemiyeti), p. xxx; M. ÇIZAKÇA, Comparative Evolution, cit., p. 132 and IDEM, Philanthropic
Foundations, cit..
36 Ibid., pp. 28-38.
37F. SEZGIN, Einfuehrung in die Geschichte des Arabisch-Islamischen Wissenschaften, Frankfurt n.d.
(J. W. Goethe Universität)
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
15

concept of Islamic business partnerships was borrowed during the tenth


century. The most important business partnership in medieval Europe, the
commenda appears to have drawn heavily on the mudaraba.
Borrowing of the mudaraba by medieval Europeans has been the subject
of a major debate between those, who argue that the commenda, like all other
medieval European institutions, originated in Roman law, and others,
particularly Udovitch,38 who argue that it had its origin in the Islamic
mudaraba. Actually any possible link between the commenda and Roman law
was rejected long ago.39 Sayous wrote the following: “The Muslims had,
during the tenth-eleventh centuries incontestably more perfect commercial
methods than those of the Europeans. From the time of Muhammed... the
contract consisting in the return of money and the participation in the profit
to be earned by it, existed under a form nearly identical to that of commenda,
which appeared a little later in the Christian states... The Christians of Europe
could not improve upon them”.40 I might add here that what Sayous calls “a
little later” was actually about three centuries. Confirmation of the superior
financial methods of the Arabs is provided by Herman Van Der Wee. He
explains the considerably more advanced financial instruments of the
Genoese in comparison to the Venetians, with the closer contact enjoyed by
the Genoese with the Islamic world, despite the fact that commerce had
begun to flourish in Venice at a very early date.41
The Udovitch thesis has been thoroughly scrutinized by Pryor. While he
insists on the plausibility of the Roman/Byzantine link, he has not been able
to reject the Islamic origins either. Consider his statement: “of the three
contracts, which Udovitch examined, the qirad (mudaraba) was undoubtedly
more similar to the commenda than were the Chreokoinonia and the Isqa. Even
taking into account the qualifications... similarities both in economic structure
and juridical conception between the mudaraba and commenda were far too
striking”.42 I have concluded from these sources that the mudaraba was
38A. UDOVITCH, At the Origins of the Western Commenda: Islam, Israel, Byzantium?, in “Specu-
lum”, 37, 1962, pp. 198-207.
39M. WEBER, Zur Geschichte der Handelsgesellchaften im Mittelalter, Stuttgart 1889, p. 2; G.
LASTIG, Die Accomendatio, die Grundform der heutigen Komanditgesellschaften in Ihrer Gestaltung vom XII
bis XIX Jahrhundert, Halle 1907 (Waisenhaus), p. xix; W.J. ASHLEY, An Introduction to English
Economic History and Theory. I-II, New York 1893 (Longmans Green), Introduction, II, p. 412.
40 A. SAYOUS, Le Commerce des Europeens a Tunis depuis le XIIe siécle jusqua a la fin de XVIe,
Paris 1929 (L’Academie de des Sciences Coloniales), pp. 132-133.
41 H. VAN DER WEE, European Banking in the Middle Ages and Early Modern Times, in A His-
tory of European Banking, R. BOGAERT, G. KURGAN-VAN HERTENRYK, H. VAN DER WEE eds.,
Antwerp 1994 (Fonds Mercator), pp. 71-254, 85.
42 J.H. PRYOR, The Origins of the Commenda Contract, in “Speculum”, 52, 1977, pp. 33, 37.
MURAT ÇIZAKÇA
16
borrowed by the West (time T+1). This is not to say that Europe could not
have invented commenda endogenously. It certainly could have, but that is
unlikely because, the existence of a relatively efficient institution somewhere
in the world and the low cost information about the performance of that
institution would constitute a powerful incentive for the more backward
civilization to borrow.43 This is because, if a particular cultural regime
generates a relatively inefficient economy, the opportunity cost of not
engaging in some form of cultural (ex)change that is more conducive to
increasing the economy’s level of efficiency, is simply impoverishment.44
Meanwhile, there is more solid evidence that waqfs were borrowed during
the Crusades. First, in view of the known connection of the Franciscans with
the development of the use device, consider the fact that St. Francis spent
parts of the years 1219/1220 in Islamic territory and that the use device
became common after the Franciscan Friars reached England in 1224.45
Second, Monica Gaudiosi, a comparative historian of law, has proved that
Merton College of Oxford was designed in the form of an Islamic waqf.
That is to say, it was initiated with an endowment, which generated income in
perpetuity earmarked for education. Herein lies the similarity to the waqf. In
addition to this it was incorporated, a western institution. Thus Oxford
constitutes an excellent synthesis of Islamic and western forms. This Oxford
model was then emulated by many other colleges in medieval Europe.46
Cash waqfs, were also known in Europe and were called in Italy Monti di
Pieta.47 These foundations were originally established by the well-to-do in
order to lend to the poor at low rates of interest, to rescue them from
usurers. Up to this point they were nearly identical to the Islamic cash waqfs,
which, despite the Islamic prohibition, also lent to the poor at reasonable
rates of interest disguised as the rent of pawned real estates. The two
institutions began to differ when the managers of the Monti di Pieta realized

43 D. NORTH, Institutions, cit., p. 137.


44 M. ALTMAN, Culture, Human Agency and Economic Theory: Culture as a Determinant of Mate-
rial Welfare, in “Journal of Socio-Economics”, 30, 2001, 5, pp. 379-391, 385. For evidence on
the low cost of information about Islamic institutions, refer to the birth of trade contacts
between medieval Europe and the Islamic world during the eighth and ninth centuries,
MCCORMICK, Origins, cit.
45 W.F. FRATCHER, Trust, in International Encyclopedia of Comparative Law, VI, pp. 1-141.
46 M. GAUDIOSI, The Influence of the Islamic Law of Waqf on the Development of the Trust in
England: The Case of Merton College, in “University of Pennsylvania Law Review”, 136, 1988, 4,
pp. 1231-1261 and M. ÇIZAKÇA, Philanthropic Foundations, cit.
47 The origins of the Monti di Pietà are not yet clear: they too may have been borrowed
from the Islamic world or may have been independently invented in response to the local
needs.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
17

that they could enhance the capital at their disposal: that is to say, they could
attract capital from the general population by rewarding the depositors with
low rates of interest. Thus, there would be two different rates of interest in
the system. The lending rate to the poor would be higher than the borrowing
rate from the savers, and the difference would constitute the profit of the
Monti di Pieta.48 This profit increased the capital available so that ever greater
numbers of poor could be rescued from the iron hand of the usurers.49 There
is no doubt that the Monti di Pieta played an important role in the revival of
private deposit banking in the sixteenth century50 These institutions originally
established in Italy, rapidly spread to the rest of Europe and became popular
even in Poland and Russia. There is no doubt that abundant capital made
possible by the Monti di Pieta also reduced the prevailing rate of interest in
Europe and consequently encouraged private investment and growth. All of
this was made possible thanks to the relatively relaxed prohibition of interest
transactions in the West.
To sum up, it is true that the prohibition of interest forced Muslims to
develop highly ingenious alternative financial instruments like the mudaraba
and its derivatives as well as the cash waqfs. In the classical age of Islam, as
Udovitch has argued, these instruments sufficed to provide enough
dynamism to the economy. In the later centuries, however, the picture
changed dramatically. While in Italy the Monti di Pieta successfully evolved into
modern deposit banking during the fifteenth/sixteenth centuries, the
Ottoman cash waqfs, although they had a nearly identical organizational
structure, could not evolve in the same direction due to the stringent
application of the interest prohibition on the liability side. Unable to collect
cash from a multitude of savers and relying therefore nearly exclusively upon
the original endowment, Ottoman cash waqfs remained until the twentieth
century small scale financial institutions with limited cash to lend. This
implies that the loanable funds available in the Ottoman economy must have
been considerably less than those available in the West. Consequently, in
practice, the prevailing borrowing rates in the Ottoman Empire were always
higher than in Europe, making private investment costly and impeding
growth. Thus, although it did not matter in the early centuries of Islam,
stringent prohibition of interest proved to be a serious impediment to
48 Savers, who contributed to the capital of the Monti di pietà by depositing their savings
were paid 6.25 percent interest while the borrowers had to pay 15 percent interest to the Monti.
H. VAN DER WEE, European Banking, cit., p. 123.
49 P. AVALLONE, The Utilization of Human Resources in Banking, in “Financial History Re-
view”, 6, 1999, 2, pp. 111-125.
50 Van Der Wee, ibid., 131.
MURAT ÇIZAKÇA
18
economic growth in the later centuries because Christian Europe gradually
relaxed the prohibition, thereby increasing the loanable funds available and
reducing its transaction costs. In the model these developments pertain to
T+3 and T+4, when the Islamic world began to fall behind the rapidly
developing West. This is revealed by the discrepancy in the prevailing rates of
interest in both civilizations. The effect on private investment and growth will
be examined later.
So far, an explanation of why the Ottoman cash waqfs could not evolve
in similar fashion to the Italian Monti di Pieta has been posited. Now attention
is turned, once again, to the partnerships. For, whereas Islamic business
partnerships provided much needed dynamism to the Islamic world in the
period from the seventh to the twelfth centuries, they failed to evolve in the
subsequent ones. Research shows that the mudaraba partnership whether
observed in the seventh or, a millennium later in the seventeenth century,
remained essentially the same. By contrast, commenda, the European version
of mudaraba, evolved into the massive incorporated joint-stock companies
with hundreds of share holders, each, may be investing modest amounts, but
in total, huge sums.51 Why then did joint-stock companies emerge in the West
but not in the Islamic world52, despite the fact that the mudaraba embodied the
most important characteristics of them?
The answer lies in the concept of incorporation, a unique contribution of
Europe to the history of finance. Origins of this concept can be traced back
to the Roman law. A corporation is a community of individuals considered as
a fictitious person that has its own distinct legal personality independent of
its members. The members may die, or voluntarily withdraw from the
partnership by selling their shares, and new members may enter the
community, but the corporation continues its independent existence. The
debts of the individual members are not the debt of the corporation and the
debt of the corporation is not the debt of the members. Third party debts
are owed to the corporation not to its members. A person can be a member
of various corporations. Corporations enjoy perpetuity and independence,

51 M. ÇIZAKÇA, Comparative Evolution, cit. To be sure, this evolution was not direct but
passed through the corporation. But the seeds of it were provided by commenda, which
allowed a multitude of passive partners to finance an agent with shares.
52 Joint-stock companies did not emerge indigenously but were introduced into the Otto-
man Empire as a Western invention during the middle of the nineteenth century. By contrast
the earliest such companies emerged in Europe during the sixteenth century. The famous Le-
vant and the English and Dutch East India companies were established at the end of the 16th
and beginning of the 17th centuries.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
19

that is to say, when a member or shareholder dies, the corporation continues


its independent existence.
The earliest corporations did not emerge in the world of finance. The
church was probably the very first corporation of medieval Europe. By the
fourteenth century, jurists known as the Commentators, began to envisage a city
or even a kingdom as a corporation. These cities or kingdoms were immortal
and had their own independent lives as distinct from their individual
members/citizens.53 These developments were followed by the application of
the Roman law concept Quod omnes tangit ab omnibus approbetur54 to the
corporations. The next step in the evolution was the realization that the
corporation did not need to reach decisions by unanimous voting. Difficulties
involved in getting such decisions gradually paved the way for majority voting.
Reflection of majority voting on business had far reaching consequences.
Consider that in a simple partnership even the member contributing the least
to the joint resources enjoys veto power; he may block a policy change
unilaterally. Likewise any partner can terminate the enterprise by pulling out.
In reaching decisions by majority vote, or concentrating authority in the
hands of large shareholders, thirteenth and fourteenth century Italian
enterprises deprived their lesser members of unilateral power. This must have
eliminated unexpected surprises and enhanced governability. Consequently,
they could now grow in size.55
Although, there is no precise information as to when the idea of
corporation was applied for the first time in business, we do know that
Flemish merchants had organized themselves in corporate guilds as early as
the eleventh century.56 It is very likely that the thirteenth century Flemish
capitalists had operated in London through the Hanse of the Flemish towns,
i.e., a corporation. The magnates of Cologne had similarly established
themselves in England. These hanses primarily tried to ensure the safety of
trade between cities.57 If the thirteenth century origins and the corporate

53 J.P. CANNING, Law, Sovereignty and Corporation Theory, 1300-1450, in The Cambridge History
of Medieval Political Thought, ed. J.H. BURNS, Cambridge 1988 (Cambridge University Press), p.
474.
54 “What touches all must be approved by all”. B. TIERNEY, Religion, Law and the Growth of
Constitutional Thought, Cambridge 1982 (Cambridge University Press), pp. 21, 24.
55 T. KURAN, The Enduring Individualism of Islamic Law, forthcoming, 2004.
56 H. PIRENNE, The Early Democracies in the Low Countries, New York reprint 1963 (Harper
Torch Books), pp. 22-23.
57 W.P. BLOCKMANS, Voracious States and Obstructing Cities: An Aspect of State Formation in Pre-
industrial Europe, in Cities and the Rise of States in Europe, A.D. 1000 to 1800, CH. TILLY, W.P.
BLOCKMANS eds., Boulder 1994 (West View Press), pp. 218-245, p. 228.
MURAT ÇIZAKÇA
20
structure of the Hanse are rather obscure, we have definitive information
about the structure of the fifteenth and sixteenth century joint-stock
companies.58 They became a distinct legal entity through a state-issued
charter, hence the term, “chartered companies”. At the Levant Company’s
founding, a share in this chartered trading company entitled the bearer to the
returns from a specific commercial voyage.
Originally, the accounting system of these companies was voyage based.
But eventually, this system led to confusion and mistrust and, in response, the
companies began to issue terminable stock, which provided a claim not on
the returns from a specific voyage but from those obtained during a
designated period. The next logical step was the issuance of permanent stock,
which entitled the owner to returns over an indefinite period, until the stock
passed to a new owner. At this point the joint-stock company differed from a
corporation only in lacking legal personhood.59 This deficiency was overcome
when the company obtained a charter from the state. Some, but not all, joint-
stock companies did undergo this transformation.
Application of the idea of incorporation to business life had far reaching
consequences. The fact that the corporation had a life independent of its
members or founders contrasts sharply with Islamic enterprises. According to
Islamic law, when a partner dies, the whole partnership has to be liquidated
and distributed among the heirs. This had several negative consequences:
first, enterprises subject to Islamic law had, by definition, short life spans.
For, their duration was limited to the life spans of the partners. An untimely
death of any of the partners brought with it the death of the enterprise as
well. By contrast, western corporations enjoyed perpetual existence.60 Second,
the independent existence of a corporation led to massive accumulation of
capital in the western firm. This is because the partners could feel secure.
Third, theoretically the perpetual existence of the firm facilitated the inflow

58 M. POSTAN, The Trade of Medieval Europe: the North, in The Cambridge Economic History of
Europe, 2, Trade and Industry in the Middle Ages, M. POSTAN, E.E. RICH eds., Cambridge 1952 (At
the University Press), p. 220; and J. VAN DILLEN, G. Van Rijkdom en Regenten Handboek tot de
Economische en Sociale Geschiedenis van Nederland Tijdens de Republiek (Wealth and Rulers, A Handbook
on the Economic and Social History of the Netherlands During the Republican Era.), ‘s-Gravenhage 1970
(Martinus Nijhoff).
59 T. KURAN, Enduring Individualism, cit.
60 There is only a slight exaggeration here. The V.O.C., the Dutch East India Company,
lived almost 200 years. Established in 1602 it was only liquidated when Napoleon occupied
Holland. The Hudson Bay Company established as a chartered (incorporated) joint-stock
company on May 2, 1670, though substantially transformed, is still alive and well today. See J.
VAN DILLEN, Rijkdom en Regenten, cit., and P. MILGROM, J. ROBERTS, Economics, Organization and
Management, London N.J 1992 (Prentice-Hall International), p. 6.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
21

of capital from third parties as well because there was no fear that the firm
would suffer an untimely liquidation. Fourth, thanks to the incorporation, the
third parties entered into legally binding contracts only with the corporation
whereas under Islamic law they had to enter into such contracts with each
and every partner, a situation, which obviously increased the transaction
costs. This proved to be a great impediment when outside parties were asked
to lend to the company. In the West, loans from them went directly to the
corporations but under Islamic law, lenders had to sign contracts with each
partner. Consequently, the loan would not exceed the repayment capability of
the weakest partner. To sum up, corporate structure and the resulting
perpetual and independent existence of the western company directly led to
massive accumulation of capital in the firm, contributed both by the founders
and outside parties (Kuran, 2003) so that not only the firm but also its capital
was perpetuated. 61
Meanwhile, the judicial personality concept was extended in the West to
the foundations (waqfs) as well. With both the foundations and the firms
enjoying corporate structure, the two institutions came ever closer.
Foundations’ trustees were granted new rights and approached to the
position of company directors. New foundations were established to manage
financial portfolios. The directors of such portfolio companies were regarded
as foundation trustees. This was a new business corporation acting as a
trustee for its shareholders. Most eighteenth and nineteenth century
institutions established to manage the investments of shareholders of canals
and railways were corporate trusts.
The Islamic world failed to follow these developments. Islamic
enterprises certainly did not have corporate structure. Only the waqfs and
possibly the guilds came close. But the jurists are not in agreement whether
the Islamic waqfs were truly corporate structures. As a result, the cash waqfs
and the mudaraba partnerships could not evolve into modern banking and
giant firms. Deposit banking simply did not emerge due to the interest
prohibition. Both cash waqfs and mudaraba partnerships remained small
institutions with limited capital.62 Moreover, while cash waqfs enjoyed a
relatively long life span, Islamic partnerships had a short one. Due to lack of
corporate structure the mudaraba partnerships were short lived and had
limited capital, while the stringent prohibition of interest on the liability side

61T. KURAN, The Islamic Commercial Crisis, cit.; J. VAN DILLEN, Rijkdom en Regenten, cit., ch. 6.
62Kuran has explained this small size through the Islamic law of inheritance: T. KURAN,
Why the Middle East is Economically Underdeveloped: Historical Mechanisms of Institutional Stagnation, in
“Journal of Economic Perspectives”, 18, 2004, pp. 71-90, 78-79.
MURAT ÇIZAKÇA
22
meant that cash waqfs could not expand their capital as Monti di pieta were
able to do. These are the reasons why notwithstanding their advanced
partnership law, Muslims could not channel the savings of the masses for
major projects which enjoyed longevity and their firms remained small and
ephemeral.
If modern Islamic banks today have achieved what they have failed to do
in the past and now function as sophisticated mudaraba partnerships attracting
the savings of thousands of depositors, this is due to the fact that these
institutions now have borrowed the Western concept of incorporation.
Thanks to this imported concept investor/depositors in Islamic banks do not
have to fear sudden liquidation of the bank due to the unexpected death of a
bank partner. Moreover, the capital of the Islamic bank achieves permanency:
individual partners who are unsatisfied with the performance of the bank
may simply sell their shares and exit and be replaced by others but, unless
they are in a majority, they cannot demand the liquidation of the company.
What the Islamic world provided to the West and to the world of finance
in general were the concepts of limited liability, ability of the passive partners
to merge their capital, transfer of the thus merged capital to the agent, the
arrangement of the sophisticated relations between the passive partners and
the third parties, principles and details of profit and loss sharing,
enhancement of entrepreneurship and shares. But in Europe these
sophisticated financial techniques borrowed from the Islamic world were then
granted, thanks to judicial personality and incorporations, with perpetual life
and capital; concepts borne in the complicated and fascinating historical
circumstances of the medieval West.

Causes of Stagnation in the Islamic World


The comparative evolution presented above, suggests that the great
Western achievements leading to massive capital accumulation reached the
Islamic world only in the middle of the nineteenth and twentieth centuries, a
delay of three or four hundred years. Thus the Islamic world, which had once
lent institutions to the medieval West became a borrower of institutions, with
a substantial lag, in modern times. The medieval and early modern era, when
corporations were introduced to European business can be analysed in two
segments for the Islamic world: preceding and following the establishment of
the Ottoman Empire. The problem as to why the European inventions were
not introduced in the earlier period may be explained by the disastrous
eleventh-thirteenth centuries when the Islamic world was hit by two powerful
enemies; the crusaders from the West and the Mongols from the East.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
23

Engaged in a fierce struggle for their very survival, it is not surprising that the
Muslims failed to reform their financial institutions. This is the period, when
the Islamic world was unified under the Turkish empires.
The emergence of these empires, first the Selçuks and Mamluks and then
the Ottomans, and their domination of the Islamic world can be explained
within the context of our model. In time T+3 Turks constituted a subgroup
within civilization A. Due to their special circumstances they had contact with
a third civilization C63 and they were able to borrow C’s institutions. The
“transplant effect” here must have been minimal as the Turks were
implementing institutions with which they had long been familiar. As they
accepted Islam, the need arose to make a synthesis between their new religion
and the pre-Islamic institutions of C. It was Ibn Sina (Avicenna), a great
Central Asian philosopher from Bukhara, who achieved this synthesis. Ibn
Sina accepted laws laid down by human authority as an element of
government. Toward the end of the eleventh century, some fifty years after
his death, his theory appeared almost simultaneously in all the most
important political classics: the Siyasetname of the Selçuk vizier Nizam ül-Mülk
(1092); the Kutadgu Bilik (1070) and the Kabus Name (1082). In this way, the
idea of having secular laws, in addition to the Islamic law, Shariat, spread to
the Islamic Turkish empires.64 Moreover, the idea of the rule of law, i.e,
secular rules and principles binding all rulers, Törü, was provided by the
Kutadgu Bilik.65 While space restrictions do not permit us to compare these
vitally important institutions with their Western counter parts, suffice it to say
that thanks to these borrowed institutions from C and Ibn Sina’s synthesis,
these Turkish empires excelled above the older Arab empires. These highly
centralized and autocratic Turkish empires were now able to mobilize massive

63 C comprised of Iran, India and Central Asia.


64 Ibn Sina was also influenced by Plato. Here we have a link between ancient Greece and
medieval Islam, which although very important, remains outside of our analysis. S. MARDIN,
The Genesis of Young Ottoman Thought. A Study in the Modernization of Turkish Political Ideas, Prince-
ton 1962 (Princeton University Press), pp. 95-97. The secularism of the Turkic states
apparently reached a zenith with the Ottomans. Consider the following statement this author
has been consulted about by the forthcoming Bank Negara Museum in Kuala Lumpur: “The
design of the first Ottoman gold coin, minted in 1478, was different from any other
contemporary Muslim coin in one extra ordinary respect: it was unabashedly secular in nature.
On the side, which usually carried the kalima, a standard Islamic expression, there appeared a
formula glorifying the ruler”. Thus the secular nature of the Turkic states which can be traced
back to Ibn Sina and Kudatgu Bilig, appears to have reached an apogee under Mehmet II.
65 H. INALCIK, Turk Tarihinde Ture ve Yasa Gelenegi, in “H. Inalcik, Dogu Bati, Makaleler”, I,
2005, pp. 66-69, 72-73; C. BROCKELMANN, History of the Islamic Peoples, New York 19604 (Capri-
corn Books), p. 164.
MURAT ÇIZAKÇA
24
and well disciplined armies organized according to Central Asian traditions to
meet the challenge of the crusades head on, and even under the Ottomans,
roll them back to the gates of Vienna. While the military organization of
these Turkish empires and states is well known, we have very little
information about their economic policies and institutions.66 Such
information becomes available only with the Ottomans.
To answer the question as to why the European financial institutions
could not be introduced into the Ottoman Empire during the 15th-18th
centuries, we need to have a closer look at its economic philosophy. What was
it in the Ottoman economic doctrine, which impeded the introduction of
European achievements into the Islamic world?
Ottoman economic doctrine has been said to rest on three “pillars”:
fiscalism, provisionism and traditionalism.67 Although research into the pre-
Ottoman origins of this doctrine is still in its infancy, some historians
inadvertently have provided evidence that early traces of it can be found in
the Roman/Byzantine and Islamic empires. Indeed some evidence exists on
the importance of these policies for those empires as well, but whether they
constituted “pillars” for them is not yet clear.68
According to traditionalism, harmony between the social classes was
desired and the expansion of a certain class at the expense of another was
deemed undesirable. It is possible that the idea may have been inspired by the
Qur’an.69 It is also possible that the aim was to entrench the existing system
for the benefit of existing power holders. In any case, whatever the
underlying causes, the business class, the social group with the greatest
potential for expansion, was carefully contained. This was done by a strict and
deliberate policy of price and profit controls. Indeed, in determining the level
of administrative prices, the entrepreneurial and commercial profits were
taken into consideration: these profit rates were to oscillate between 5 and 15
percent and were not allowed to go beyond 15 percent. Prices were then
determined accordingly. Meanwhile, the prevailing rates of interest in the

66 W. BARTHOLD, Turkestan Down to the Mongol Invasion, London 19774 (Gibb Memorial
Trust), Ch.2; O. TURAN, Selçuklular Tarihi ve Türk-Islam Medeniyeti, Istanbul 1993 (Bogazici Yay-
inlari), p. 376-384. Apparently, while these empires provided security, they impeded business
(S.D. GOITEIN, Studies, cit., p. 351).
67 M. GENÇ, Osmanlı İmparatorluğu’nda Devlet ve Ekonomi, İstanbul 2000 (Ötüken), pp. 43-52.
68 M. MCCORMICK, Origins, cit., pp. 87-91; ROSTOVTZEFF (ROSTOWZEW), Gesellschaft und
Wirtschaft im Römischen Kaiserreich, Leipzig 1929 (Quelle und Meyer), I, p. 165; D. NICOL, Byzan-
tine Political Thought, in Medieval Political Thought, cit., p. 62.
69 2: 143.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
25

unofficial capital markets were between 15 to 25 percent.70 This is in sharp


contradiction of Adam Smith’s argument that the interest rate should be half
as much as the “ordinary rate of clear profit”. In the Ottoman Empire
roughly the reverse was true. Among the contemporaries, it was Montesquieu,
who noticed the higher rates of interest prevailing in Islamic countries. But
he attributed it to the prohibition of interest and the consequent increase in
transaction costs associated with the evading of the Islamic law.71 It is clear
that the deliberate Ottoman economic policy was also an important factor
behind these relative rates.
Under these conditions of very narrow margins in the private sector, or
even negative rates of real profits, available liquid capital in the economy,
naturally, did not flow into the commercial sector. It went instead to the state
sector.72 This is because, profit limitations that prevailed in the private sector,
were not applied to government finance. Indeed, in the tax-farming (iltizam)
system, with the so-called “frozen tax-farms”, the state settled for a fixed
revenue and allowed the tax-farmers to reap whatever profits they could make
over and above this amount 73. These arguments have been indirectly
confirmed by an analysis of the relative paths of institutional evolution in the
Ottoman private and state sectors. Research has revealed that whereas

70 M. GENÇ, Devlet ve Ekonomi, cit., p. 51. But cash waqfs lent at around 11 to 12 percent
“economic interest”, a situation, which naturally led to the emergence of a secondary capital
market. Indeed, it has been shown that some trustees borrowed money from the very waqfs
they managed in Bursa, only to lend it with a margin to the money dealers in Istanbul. See M.
ÇIZAKÇA, Philanthropic Foundations, cit., p. 49. This has been confirmed most recently by R. DE-
GUILHEM, Wakf, the Ottoman Empire, in Encyclopaedia of Islam, Leiden 2004 (Brill), p. 89. It has
been argued that strict application of price controls was observed primarily in the periods;
1550 (?) -1650 and 1789-1850. S. ÖZMUCUR, S. PAMUK, Living Standards, cit., p. 297.
71 A. SMITH, The Wealth of Nations, New York 1937 (Random House), pp. 96-97.
72 A. RAYMOND, Artisans et Commerçants au Caire au XVIIIe Siècle, I-2, Damas 1973 (Institut
Français de Damas), 1, p. 292. Flight of capital from the Ottoman Empire to abroad (Russia
and Austria) has also been documented. See T. STOIANOVICH, Cities, Capital Accumulation and the
Ottoman Balkan Command Economy, 1500-1800, in Cities and the Rise of States in Europe, cit., pp. 60-
100, 84, 86.
73 If the state settled for a fixed return, it was because of the risks involved. Forced to
channel the bulk of its earnings from the tax-farming system to the military, whose salaries had
to be paid regularly, the state did not wish to share with the tax-farmers the fluctuations
inevitably associated with economic conjuncture. For the evolution of the Ottoman state
finance and an explanation as to why tax-farming was a better bet for Ottoman investors, see
M. ÇIZAKÇA, Comparative Evolution, cit., ch. 5. Suffice it to say here that under all the three fiscal
systems applied from the fifteenth to the middle of the nineteenth centuries, (iltizam, malikane
and esham) the risks were shifted to the entrepreneurs and, in return, their profit margins were
not controlled. In short, it was the risk averseness of the state which led to the discrepant rates
of profitability in the state and private sectors.
MURAT ÇIZAKÇA
26
institutional evolution in the private sector was mostly stagnant between the
fifteenth and nineteenth centuries, it was highly dynamic in the state sector.74
It can be argued that with these discrepant rates of profitability in the private
and state sectors and the available capital flowing to the latter, a massive
crowding-out effect must have prevailed in the Ottoman economy over the
long term. The discrepant paths of institutional evolution observed above,
can be considered as an indirect vindication of this argument.
To sum up, if European corporate law was not borrowed by the Ottoman
jurists, that may well have been because it was not needed. In the Ottoman
economy, where the private sector was consciously constrained and
vigorously controlled75, the need for corporations probably simply did not
arise. Indeed, to own a powerful company, would have invited the state’s
wrath, as painfully experienced by those merchants, celeps, who were made to
contribute to the provisioning of Istanbul at administered prices, the narh.
Thus, being a celep, often, but not always, meant complete economic ruin.76
Similar practices have also been observed in corn supplies to Istanbul.
Once again, the obligation to supply corn at narh prices was imposed on
certain individuals, who had to buy the corn from the coastal provinces along
the Black Sea and then transport it to Istanbul on state ships, where it was
sold to the bakers at prices fixed by the state. Baron de Tott, who has
described the corn delivery system, has also observed that massive quantities
of corn were stored in and near Istanbul only to become frequently spoiled.
Meanwhile, famines would occur elsewhere reflecting the tragic failure of
these provisionist policies.77 It is due to the overall importance of these
supply systems in the Ottoman economy that Mehmet Genç considers
provisioning as one of the pillars of the Ottoman economic system. This
importance is also confirmed indirectly by Şevket Pamuk, who has shown
that price controls were selectively applied and were used primarily for
provisioning the capital city78
Indeed, much as in the socialist countries of the twentieth century, to
accumulate wealth and power was deemed dangerous and considered

74 Ibid., p. 209.
75 I am aware of two exceptions to this; the Ottoman state protected the so-called Kapan
merchants, who were serving the provisionist policies of the state and granted monopolist
privileges to certain waqfs. But neither of these can be considered as private sector promotion.
Ibid., pp. 117-123; and Ö.L. BARKAN, E.H. AYVERDI, Istanbul Vakıfları, cit., p. xi.
76 A. GREENWOOD, Istanbul’s Meat Provisioning: A Study of the Celepkeşan System, Ph. D. diss.,
University of Chicago, 1988, pp. 77, 81, 85-86, 140-141.
77 T. STOIANOVICH, Command Economy, cit., p. 78.
78 S. ÖZMUCUR, S. PAMUK, Living Standards, cit., p. 298.
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
27

suspicious by the Ottoman state. No wonder the system has been called a
“command economy”79 or “proto-pseudo Ottoman socialism”: “proto”
because it antedated Karl Marx by several centuries and “pseudo” because it
was not based on class conflict but aimed at preserving the age old balance
between the classes and impeded the rise above the others of the merchant
class.80
Thus the twentieth century struggle between socialism and capitalism was
by no means unique. Its precursor was the struggle between the “proto-
pseudo Ottoman socialism” and European capitalism. Like its twentieth
century counterpart, the earlier struggle also ended with the demise of the
command economy. Ottomans started to suffer defeats in 1683 at the gates
of Vienna and began their long retreat. The era of retreat lasted more than
200 years and culminated in the destruction of the Ottoman Empire in 1918.
The nineteenth century was a period of intense institutional borrowing
caused by the shock and panic of military defeats. First to be borrowed were
military techniques. But when it was realized that this was not sufficient, with
the so-called “Tanzimat” reforms of the early nineteenth century, wholesale
institutional borrowing followed. If the era of retreat lasted for two centuries,
by way of comparison more than twice as long as the entire life-span of the
Soviet Union, it may well have been thanks to the pockets of decentralized
decision making, i.e., institutions like the waqfs, which were relatively free of
state interference and which played a decisive role in the building up of
human capital. Meritocracy; continuous reforms in public finance; a relatively
efficient bureaucracy as well as technology borrowed from the West must
have been important as well.81
We are now in a position to reach some general conclusions pertaining to
the comparative evolution and cross-cultural borrowing of economic
institutions between the Islamic world and the West. From about the seventh
to the twelfth centuries, the Islamic world was the more advanced civilization,
which in addition to its great achievements in philosophy, medicine and
sciences also possessed important financial institutions such as partnership
law and waqfs. Moreover, since Islam discouraged barter and promoted trade

79 T. STOIANOVICH, Command Economy, cit., p. 60.


80 M. ÇIZAKÇA, Comparative Evolution, cit., p. 210.
81 The resilience of the Ottoman economy has also been confirmed by Özmucur and
Pamuk, who have observed a slow and modest rise in productivity before the industrial
revolution. They attribute this to the diffusion of new technology from western Europe, S.
ÖZMUCUR, S. PAMUK, Living Standards, cit., p. 317.
MURAT ÇIZAKÇA
28
with cash, it was also much more monetized.82 Consequently, several
economic institutions were borrowed by Europe from the Islamic world in
this period. Often these institutions were first noticed by the crusaders or by
the European merchants involved in trade with the Islamic world and then
introduced to the West first in the form of law merchant, which was diffused
throughout Europe when these customary laws were compiled and
incorporated into the European legal system. Recently, Daniel Panzac has
shown that the borrowing occurred much more directly – by translation of
Islamic legal texts and their adaptation into the Rhodian, Oleron and Consolato
del Mare compilations.83 Transaction costs must have played an important role
in this process of borrowing. Obviously the Islamic civilization with its more
advanced institutions must have enjoyed lower transaction costs so that the
European merchants desiring to lower their own transaction costs must have
been willing to borrow.
The period approximately from the eleventh century to the fifteenth,
which coincided with the commercial revolution, was when Europe caught
up. It was characterized by a synthesis of the institutions borrowed from the
Islamic world and the indigenous ones, particularly the concept of
incorporation. I would argue that this synthesis, together with the increased
trade with the Islamic world facilitated by the formation of a common
judicial infrastructure, allowed Europe to develop at a much faster rate,
facilitating leapfrogging and paving the way to the European commercial
revolution of the thirteenth century. The path was thus opened for sustained
growth in Europe, where competition between the city-states, nobility and
princes in the medieval era and interstate competition in the following
centuries led to liberalism and further dynamism.84 By contrast, this was a
disastrous period for the Islamic world. Hit by the crusaders and the
Mongols, it was forced to unify under the powerful centralized Turkish
empires for its very survival. While we are not well informed about the earlier
Selçuks, the Ottoman economic doctrine was clearly designed for military
superiority and perpetuation of the state. This goal was achieved at the cost

82 F. SEZGIN, Einführung, cit.; A. WINK, Al-Hind, The Making of the Indo-Islamic World, 1, Lei-
den 1991 (E. J. Brill); M. ÇIZAKÇA, ‘Economic Islamization’ of Medieval Eurasia: An Institutional
Framework, in “Library of Mediterranean History”, I, 1994, pp. 47-77, and M. MCCORMICK,
Origins, cit.
83 D. Panzac, “Le Contrat”, cit.
84 W.P. BLOCKMANS, Voracious States, cit., and E. JONES, Foreword, in Political Competition, In-
novation and Growth in the History of Asian Civilizations, P. BERNHOLZ, R. VAUBEL eds., Chelten-
ham 2004 (Edward Elgar)
CROSS-CULTURAL BORROWING AND COMPARATIVE EVOLUTION
29

of neglecting or curbing the private sector.85 The result was slower growth. By
the nineteenth century the gap had widened so far that there was panic
borrowing which had strong negative “transplant effects” impeding growth
even further.

85 Goitein confirms this for the Mamluks, another Islamic empire governed by a Turkic
military class ((S.D. GOITEIN, Studies, cit., p. 351).
On the topic of this essay, see also: Leading Issues in Islamic Banking and Finance, ed. S. AL-
HARRAN, Kuala Lumpur 1995 (Pelanduk Publications); M. ÇIZAKÇA, Demokrasi Arayışında
Türkiye, Ankara 2002 (Yeni Türkiye Yayınları); IDEM, Mehmet Genç ve İktisat Tarihi, forthcoming;
O.R. CONSTABLE, Trade and Traders in Muslim Spain, Cambridge 1994 (CUP); S.D. GOITEIN, A
Mediterranean Society, 1, Berkeley 1967 (University of California Press); L.E. HARRISON, Who
Prospers: How Cultural Values Shape Economic and Political Success, New York 1992 (Basic Books);
Z.A. KHAN, Characteristics and Structure of an Islamic Bank, in Encyclopaedia of Islamic Banking and
Insurance, London 1995 (Institute of Islamic Banking and Insurance); T. KURAN, The Economic
Impact of Islamic Fundamentalism, in Fundamentalisms and the State: Remaking Polities, Economies, and
Militance, M. MARTY, S. APPLEBY eds., Chicago 1993 (University of Chicago Press),pp. 302-341;
V. NIENHAUS, Islam und moderne Wirtschaft, Positionen, Probleme und Perspektiven, Wien 1982 (Verlag
Styria); D. NORTH, The Evolution of Efficient Markets in History, in Capitalism in Context, Essays on
Economic Development and Cultural Change in Honour of R.M.Hartwell, J.A.JAMES, M. THOMAS eds.,
Chicago 1994 (The University of Chicago Press); F. SEZGIN, Geschichte des Arabischen Schrifttums,
I-IX, Frankfurt n.d. (J. W. Goethe Universitaet).

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