Empirical Essays on Islamic Finance and Sustainable Development Nexus: Sources of Growth, Socio-Economic Development, and Degrowth

Abstract

Growth and development have been the central objective of economic policy making all over the world, for which the financial sector has been an essential instrument. However, with the emergence of ‘financialisation’, the focus has shifted to financial resources as the source of economic growth and their gain at the expense of other stakeholders. Consequently, among other things, social welfare and environmental health have been negated, which has created pervasive economic and social inequality.
To moderate the consequences of neo-liberal economic policy, since the 1970s a number of alternative positions have emerged. The Islamic economics movement, as one of such movements, emerged as a counter-hegemonic movement, aimed at rescuing ‘human, land, labour and capital’ so that extended stake-holding governance can be achieved. Within this paradigm, Islamic finance is expected to essentialise justice and beneficence and equalize development opportunities for all stakeholders so that they can fulfil their development path towards perfection. Islamic finance is expected to operate and produce consequences according to the substantive morality of Islam and its principles, as opposed to the institutional logic of conventional finance. In order to assess the performance of Islamic finance in relation to the Islamic moral economy, this essay-based research, hence, aims to explore the relationship between Islamic financial development and sources of growth, socio-economic indicators, and environmental degradation.
The first essay in this research aims at examining the contribution of Islamic financial development on the sources of growth in the form of capital accumulation and total factor productivity growth in a number of sampled countries for the period 1989-2014. The variables of Islamic financial development explored include: the operational activities of Islamic banks, sectoral financing provided by Islamic banks, the mode of financing employed by Islamic banks, and the volume of sukuk issuance. Following the theoretical finance-growth nexus, this essay employs the ordinary least squares (OLS) method, comprising static and dynamic panel estimation for countries having Islamic banks and issuing sukuk. The results show that Islamic banks with higher capital adequacy ratio and lower non-performing loans display a positive relationship with capital accumulation growth. On the other hand, Islamic banks with higher operational costs have higher capital accumulation and total factor productivity growth. In relation to sectoral financing and types of contract used for financing, it seems that Islamic banks still focus on profitability, rather than productivity. The results from the sukuk market is not much different, showing that sukuk has lower impact to the ‘real’ economy.
The second essay explores and examines the contribution of Islamic finance to socio-economic development as measured by various indices related to social, economic, governance, and environmental development for a sample of countries during the period 1989-2014. In the analysis, social indicators, such as health, education, technology, and life expectancy, are included in measuring development. In order to support socio-economic development, it is believed that financing is necessary to provide funds for building the necessary infrastructure, or through supporting economic growth to increase individual purchasing power. Employing linear and non-linear empirical models, the results show that the volume of sukuk issuance has not been able to support socio-economic development, which needs to reach a certain threshold to be able to support the gender development index and the gender inequality index. Additionally, the intermediating Islamic banking variable through financial inclusion index shows that Islamic banks can support socio-economic development by serving more consumers in their operational activities.
The third essay examines the impact of Islamic finance on the fulfilment of the Islamic moral economic objective of sustainability in terms of de-materiality and degrowth by analysing the relationship between Islamic financial development and its impact on carbon emissions for a sample of countries during the period 1989-2014. This essay aims to identify the sustainable development impact of Islamic finance by considering CO2 emissions as the initial benchmark and an environmental health indicator. In addition, this essay considers financing provided by Islamic banks for different sectors, its types of contracts, and also the volume of sukuk issuance and their relationship with carbon emissions. The OLS method-based results show that the degrowth and ‘Islamic moral economy’ is located in the positive relationship between financing of the consumer durables sector and the volume of CO2 emissions from fossil fuels. This should, however, be considered as an evidence for Islamic bank operations taking place under the linear growth model and mainstream economic framework, although Islamic banks still may provide financing for productive activities through profit-loss sharing. Therefore, this essay suggests that Islamic banks and financial institutions are embedded in the institutional logic of capitalism rather than fulfilling the aspirations of Islamic moral economy.