Simulation in Islamic Economics Sami al-Suwailem IRTI, IDB Group Thul Kiadah 1428H -- November 2007G Sami al-Suwailem IRTI, IDB Group Thul Kiadah 1428H -- November 2007G

New Paradigm  Limits to Neoclassical approach  Features of Islamic Economics  Need for a different approach  Limits to Neoclassical approach  Features of Islamic Economics  Need for a different approach

Neoclassical Approach  Fixed and bounded choice set  Maximization decision rule  Deductive logic  No discovery or creativity  No entrepreneurship  Fixed and bounded choice set  Maximization decision rule  Deductive logic  No discovery or creativity  No entrepreneurship

Complex World  Unbounded choice set  Perpetual novelty  Non-computable options  Un-provable true statements  Unbounded choice set  Perpetual novelty  Non-computable options  Un-provable true statements

Complexity Theory  Model the process  Ecological rationality  Induction and exploration  Model the process  Ecological rationality  Induction and exploration

ComparisonComparison NTCT SimplifiedLandscapeProcess DecisionMaximizationAdaptation MethodologyDeductionInduction RationalityIndividualEcological

Complex Systems  Self-organization  Emergence  Self-organization  Emergence

Self-OrganizationSelf-Organization  Local interactions  Decentralized global order  Examples  Local interactions  Decentralized global order  Examples

Bird Flocks  Group of birds moving together  Why?  No leader  Rules:  Follow neighbors  Keep a distance  Avoid obstacles  Group of birds moving together  Why?  No leader  Rules:  Follow neighbors  Keep a distance  Avoid obstacles

SegregationSegregation  Two groups mixed  Rules:  If < 30% of neighbors, move  Else, stay  Unintended segregation  Two groups mixed  Rules:  If < 30% of neighbors, move  Else, stay  Unintended segregation

EmergenceEmergence  The whole is greater than the sum  The system performs functions the components can’t  Examples:  Brain  Ants & bees  Markets  The whole is greater than the sum  The system performs functions the components can’t  Examples:  Brain  Ants & bees  Markets

Structure of Complex Systems  Behavior governed by two sets of variables:  Independent variables  Relative variables  Behavior governed by two sets of variables:  Independent variables  Relative variables

PropertiesProperties  Connectedness  Positive feedback  Edge of chaos  Connectedness  Positive feedback  Edge of chaos

Economic Model

Relative Behavior  Widely observed  Evidently documented  Links complexity with psychology  Widely observed  Evidently documented  Links complexity with psychology

Relative Consumption  Unequal consumption levels  Consumption gap  How to close the gap?  Unequal consumption levels  Consumption gap  How to close the gap?

RibaRiba  Loan finances consumption  Interest adds to lender’s income  Lender’s consumption rises  Average consumption rises  The gap widens  Loan finances consumption  Interest adds to lender’s income  Lender’s consumption rises  Average consumption rises  The gap widens

Dynamics of Riba  Interest causes feedback loop  Debt accelerates till bankruptcy  The system moves towards chaos  Interest causes feedback loop  Debt accelerates till bankruptcy  The system moves towards chaos

Markup Finance  Finance restricted to new consumption  No refinancing  Problem of delay?  Cap on installment  Finance restricted to new consumption  No refinancing  Problem of delay?  Cap on installment

Dynamics of Markup  Debt is bounded by income  Feedback is limited  System is stable  Debt is bounded by income  Feedback is limited  System is stable

CharityCharity  Charity raises average consumption  Donor’s consumption thus rises  Aggregate consumption rises  Charity raises average consumption  Donor’s consumption thus rises  Aggregate consumption rises

SimulationSimulation  Types of simulation:  Mathematical simulation  Agent-based simulation  Types of simulation:  Mathematical simulation  Agent-based simulation

Agent-based Simulation  Tracks interactions of multiple agents  Each agent with different properties  Emergence of aggregate behavior  Tracks interactions of multiple agents  Each agent with different properties  Emergence of aggregate behavior

ABS Software  Netlogo  Agentsheets  Repast  Ascape  Netlogo  Agentsheets  Repast  Ascape

Model Aspects  Consumption  Wealth  Loans and Debt  Bankruptcy  Consumption  Wealth  Loans and Debt  Bankruptcy

ConsumptionConsumption  Determined by:  Income and wealth (indep. variables)  Consumption of local neighbors  Income is exogenous  Wealth is accumulated savings  Determined by:  Income and wealth (indep. variables)  Consumption of local neighbors  Income is exogenous  Wealth is accumulated savings

Surpluses & Deficits  Surpluses are managed centrally  Deficits are financed from accumulated surpluses  Loans are distributed equally to borrowers  Surpluses are managed centrally  Deficits are financed from accumulated surpluses  Loans are distributed equally to borrowers

WealthWealth  Total assets = cash + credit  Wealth = share in total assets – debt  Share = acc. surplus / agg. surpluses  Total credit = total debt  Agg. wealth = total cash  Total assets = cash + credit  Wealth = share in total assets – debt  Share = acc. surplus / agg. surpluses  Total credit = total debt  Agg. wealth = total cash

EquationsEquations

DebtDebt  Debt = acc. loans – payments  Interest accrues on loans + past-due  Markup accrues on loans only  Debt = acc. loans – payments  Interest accrues on loans + past-due  Markup accrues on loans only

BankruptcyBankruptcy  If installment > 2 mean income  Out of the system 15 periods  Wealth transferred to creditors  If installment > 2 mean income  Out of the system 15 periods  Wealth transferred to creditors

ResultsResults  Cyclical consumption  Concentrated wealth  Low efficiency  Cyclical consumption  Concentrated wealth  Low efficiency

Consumption

Net-income

Lorenz Curve

Wealth Distribution % of Agents StandardMarkupInterest

EfficiencyEfficiency StandardMarkupInterest Acc. loans 10,55111,13711,485 Acc. repayment 9,96913,67723,430 Acc. surplus 2,4402,59510,459 Repayment per $ Turnover Cost of finance 0%0.47%2.91% Rate of return 0%2.03%3.20%

CharityCharity z = 0% z = 2.5% z = 5% z = 10% Mean C Median C C of Donors 84.8* C of Receivers 63.6* * Potential donors and receivers

ConclusionConclusion  The need for an alternative paradigm  The importance of agent-based simulation  A fresh look at Islamic economics  The need for an alternative paradigm  The importance of agent-based simulation  A fresh look at Islamic economics