Financing Economic Growth with Stability from Isl ā mic Perspective 1

Evidence has been mounting that the interest-based debt financing regime is under increasing distress. Evidence also suggests that the financial crises, whatever title they carried exchange rate crisis or banking crisis – have been debt related crises in essence. At present, data suggest that the debt-to-GDP ratio of the richest members of the G-20 is expected to reach 120% mark by 2014. There is also evidence that out of securities worth US$ 200 trillion in the global economy, no less than three-fourth represent interest-based debt. It is difficult to see how this massive debt volume can be validated by the underlying productive capacity of the global economy. This picture becomes more alarming considering the anemic state of global economic growth. There is great uncertainty with regard to interest rates. Although policy-driven interest rates are at near-zero level, there is no assurance that they will not rise as the risk and inflation premia become significant. Hence, a more serious financial crisis may be in the offing and a general collapse of asset prices may occur. This paper argues that the survival of the interest-based debt regime is becoming less tenable, as is the process of financialization that has accompanied the growth of global finance over the last four decades. The above has resulted in an unprecedented increase in economic risks; generating (adverse) nonlinearities in system’s behavior. Such a behavior is nothing but a demonstration of the verse, “Allah obliterates ribā ....” of the Qur’ān. As a result, the search is on for a paradigm shift towards a less volatile and more resilient financing regime. The paper proposes risk sharing based Islāmic financing as suitable alternative and also demonstrates empirically 1 The study is an expansion of the base papers by Abbas Mirakhor and Mughees Shaukat (2012, 2013) and by Mughees Shaukat, Abbas Mirakhor and Noureddine Krichene (2012, 2013). ∗ Mughees Shaukat is lecturing in the College of Banking & Financial Studies under CBO, Muscat, Oman and is a PhD Scholar at Islāmic finance at INCEIF, Kuala Lumpur, Malaysia. Prof. Dr. Zubair Hasan is the professor of Islāmic Economics, INCEIF and Prof. Dr. Datuk Syed Othman Alhabshi is the Dean of Academic Affairs, INCEIF, Kuala Lumpur Malaysia. Journal of Islamic Business and Management Vol.4 No.2, 2014 16 its better growth and stability characteristics by using advanced dynamic heterogeneous panel techniques.


Introduction
At a time when the global economy is suffering from a crisis of confidence, structural imbalances like large fiscal deficits, huge monetary overhangs, high inflation and unemployment, subdued growth prospects and a growing sense of uncertainty prevailing world over are increasingly visible.Evidence has been mounting that the interest based debt financing regime is under ever increasing distress.It has been shown that crises whatever label they carried− exchange rate crisis or banking crisis -have been debt-related crises (Reinhart and Rogoff, 2009).Empirical research suggests that debt-to-GDP ratio of the richest members of the G-20 will reach 120% mark by 2014 while by 2020 the U.S. and other major European centers would amass a ratio of at least 150%, with Japan and U.K. going to 300% and 200% respectively.Even more disconcerting is the projected interest rate paths on their debts which would increase from 5% to 10% in all cases, and as high as 27% in U.K (BIS, 2010).Moreover, there is also evidence that out of securities worth $200 trillion in the global economy, no less than three-fourth represent interest based debt (Rogoff, 2011).This picture becomes more alarming when it is realized that the growth of the global economy is anemic at best while the interest rate on debt is sure to exceed the rate of growth of global GDP for the foreseeable future.
Fiscal austerity measures taken as remedial response are further weakening growth and employment prospects, making fiscal adjustment and the repair of financial sector balance sheets all the more challenging.With still rapidly building debt, excessive fiscal deficits, massive unemployment, and falling real-incomes, uncertainty has increased regarding how economies, capital markets, and international trade and finance will evolve.Likely scenarios of hyperinflation or prolonged stagflation cannot be discarded easily.Stock markets and housing markets are going through renewed bubbles fuelled by credit multiplication and ϰ :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ sensitive to 'black swan' events.It will be argued that such outcomes are a clear demonstration of part of the verse 2:276 of the holy Qur'ān.Section three then puts forward the idea of risk sharing based financing, as the Islāmic finance alternative.While analytically advocating the proposed regime, the study empirically demonstrates its better growth and stability characteristics in section four.Section five concludes the study.
To start the discussion, we first briefly explore what 'financial instability' is and consequently connoting interest bearing debt as the chief culprit in generating instability.

Financial Instability
Of the major policy goals in economics, maintaining overall stability in the system is second to none in importance.Maintaining financial stability is all the more crucial because of the dominant position the sector occupies in modern economies.However, economies across the globe have witnessed periods of financial instability much more than spans of stability especially after the 1970s.The 2007-2008 financial turmoil has added much to the urgency of the issue as explained in section I. Today, dealing with instability has become the top concern for economic policy makers.However, what stability is and when instability replaces it is a ticklish question to answer.Perhaps it is easier to depict the notion of stability by pointing out what is instability?
The central bank of Sweden, Riksbank, has chosen to define financial instability as the inability of the financial system to maintain its basic functions 4 and the lack of strength to resist disruptions that threaten those functions (2012).A good example is a credit crunch, where access to credit shrinks relative to demand, because the banks are, for example, unable to fund their lending.To the Reserve Bank of Australia−RBA (2012), financial instability simply is the lack of ability of a business to meet its debts as they fall due.In support of this explanation, Mirakhor and Krichene (2008) too associate financial instability with notions of default, arrears, or insolvency.The result is a material disruption of the intermediation process with potentially damaging implications for the real economy.In line with the above, Belouafi (2012: 5) suggests that among the indicators of instability in the financial system, the main ones are as follows: The shocks that hit the financial sector have serious consequences in the functioning of the real sector and the financial system as a whole.
The financial system is unable to perform its basic roles of allocating resources and risks, mobilization of savings, and facilitating wealth accumulation, development, and growth.
The ability of the financial system to limit, contain, and deal with the emergence of imbalances is either absent or constrained."In a wellfunctioning and stable financial system, the above could be served in part through self-corrective, market-disciplining mechanisms that create resilience and prevent problems from festering and growing into systemwide risks and economic downturns".
It appears however, that the dynamics of present financial system, with its (inherent) ability to create worrisome economic turbulence, has made the task of overcoming financial instability increasingly difficult, if not impossible.According to Chapra (2007), the arguments of efficiency and stability in favour of the interest based system, as opposed to an interest free system, seems to have been substantially weakened by the crises it constantly experiences.According to one estimate, there have been more than 100 crises over the last four decades (Stiglitz, 2010: 54, see also IMF, 2008).Consequently, the system calls for scrutinizing the reason(s) which cause such (recurring) instability.

Interest-Based Debt as the Underlying Cause
Over the past few decades, a consensus had emerged suggesting that expansion of credit and debt is detrimental to the stability of developed as well as developing economies (Mirakhor and Krichene, 2008).Mirakhor and Bacha (2012) argue that regardless of where these crises originate from, whether developed or developing country, they all seem to have a single root cause, (interest bearing) debt.With high debts, interest payments also increase, thus increasing both the burden and servicing of debt.Evidence surveyed in many studies showed that every economic and financial crisis was preceded by an expansion of credit (e.g.Fisher, 1933).Askari et al. (2012: 3) argue that the financial system is inherently unstable, often shaken by periodic crisis requiring massive bailouts for essentially two reasons: i) it is a debt and interest-based system; and ii) it creates excessive debt and leveraging through credit multiplier (see also Hasan, 2008) while being backed by some form of government guarantee to reduce liquidity crisis and bank failures.Debt− that is the transfer of risk, they argue is at the foundation of financial crisis in the past and will ϲ :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ likely continue to do so in the future, unless a radical change in the financial structure is introduced.
In the modern banking system, a bank can simply create credit exnihilo simply by crediting the account of its customer for the amount of credit.An often sighted cause is the implication of credit and the ability of banks to create an inverted debt pyramid−through credit multiplier a 'house of cards', to such a degree that it becomes vulnerable to even small shocks, such as changes in expectations of entrepreneurs or the collapse of a speculative bubble in a stock or housing market.Theoretically, credit may expand in relation to created deposits according to the reserve requirements ratio.If a bank creates a credit of US$ 1,000 and if the reserve requirement ratio is five percent, then total money creation is equal to US$ 20,000 -a multiple of 205 (see Askari et al., 2010Askari et al., , 2012)).Such credit takes the form of deposits from the borrowers, on which they may issue orders for payments.Since every bank does the same thing, credit expansion can be very fast, and credit may far exceed the real savings in the economy.The excess of credit over savings is called fictitious credit by Henry Thornton (1802).It is called counterfeiting by Allais (1999).Askari et al., (2010) suggest that "It is not the expansion of credit as such that leads to an economic bust but the expansion of credit out of thin air, since it is through un-backed credit that real savings are diverted from productive activities to non-productive activities, which in turn weakens the process of real wealth expansion".
Excess credit creates price inflation and forces savings upon workers and fixed income households when price of staples increase considerably.Among the features relating to the 'interest' is its unique status and sensitivity as a 'price'; making the maintenance of its 'appropriate' level6 a very difficult, if not impossible task to attain.Stiglitz (1989) explains: "the interest rate is not like a conventional price.It is a promise to pay an amount in the future.Promises are often broken.If they were not, there would be no issue in determining credit worthiness".He further suggests that raising the rate of interest may not increase the expected return to a loan; at higher interest rates one obtains a lower quality set of applicants (the adverse selection effect) and each applicant undertakes greater risks (the adverse incentive effect)."These effects are sufficiently strong that the net return may be lowered as the bank increases the interest rate characterized by credit rationing".Buiter (2009) went further by stating that debt, characterized by fixed financial commitments, can be a poor financing choice in a risky, uncertain world where the private and social costs of default are high.
Similar doubts about the sustainability of a system based on the interest bearing debt financing had been expressed by John Maynard Keynes and later by Maurice Allais (1999), among others.Focusing on the interest rate mechanism, Keynes in as early as 1930s in his book The General Theory of Employment, Interest and Money (1936) argued that market capitalism, if left to it-self, would create two major problems.These are (i) poor income and wealth distribution and (ii) the fact that this system is incapable of creating full employment.A major cause of these problems, he asserted, was the interest rate mechanism which constituted "the villain of piece" (see Mirakhor and Krichene, 2009).Keynes' solution was the "euthanasia of rentier" by socializing financial resources through which financial capital would be provided for investment without the intermediation of the rent seeking class of the money lenders.Keynes's claims of poor income and wealth distribution could be further validated by a recent study which showed how high leverage and crises can arise as a result of changes in the income distribution (Kumhof and Ranciere, 2010).The authors empirically showed that the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and an eventual financial and real sector crisis.
Much earlier, Karl Marx (1867Marx ( , 1885Marx ( and 1894) ) had already put forward his understanding of the innate fragility of capitalism.While recognizing that the system may create economic growth, Marx argued that the growth will never be sustainable and the system will collapse on its own; taking back much more than what it gave.Hayek, (1945) contented that it is the price setting of money i.e. the interest rate and its manipulation by the policy makers that is at the root of generating crisis.
Nevertheless, to Schumpeter though, the ensuing instability is an essential part of the creative process of capitalism, by which capitalism develops new products and new institutions.Schumpeter famously termed such instability as 'creative destruction'.Janeway (2012) in his book 'Doing Capitalism in the Innovation Economy' argues that the 'Innovation Economy' is driven by financial speculation and this is part of the Schumpeterian creative process of capitalism."Occasionally, decisively, the object of speculation is the financial representation of one of those fundamental technological innovations -canals, railroads, electrification, automobiles, airplanes, computers, the internet -the deployment of which at scale transforms the market economy and indeed creates a 'new economy' from the wreckage of the financial bubble that attended its birth" (see also Keen, 2012).While Schumpeter was fond of role of technology in driving capitalism, Minsky (1986Minsky ( , 1992) ) considered the financial instability to be endogenous to a conventional financial system.Minsky was influenced by Keynes' notion of the fundamental instability of market expectation as well as Schumpeter's notion that capitalism renews itself through competition and innovation−"Creative destruction".While putting forward his 'Financial Instability Hypothesis' (FIH), Minsky (1992), focused upon the tendency for the instability to lead to excessive debt and, ultimately, a Depression.Minsky hence concluded that the destructive instability was endemic to capitalism, as much as the creative instability was, because finance necessarily had to be destabilizing."Finance's destructive tendencies arise because we let the banks finance Ponzi schemes --bubbles in real estate and shares --that add to debt without adding to the capacity of society to finance that debt" (Keen, 2012).
The result is an increasing trend of 'financialization' in the global economy; leading to increased non-linearity and fragility of the financial system.

Financialization of the Global Economy
Scholarship has argued that the ensuing credit expansion has contributed to the financialization of the economy7 .To Askari et al., (2012: xii), "when risk transfer is combined with high leverage, the growth of interestbased debt contracts and their pure financial derivatives−those with little or no connection to real assets−outpace the growth of the real sector leaving the liabilities in the economy a large multiple of real assets needed to validate them.This phenomenon has been coined as "financial decoupling" or "financialization", whereby finance is no longer anchored to the real sector".Argitis (2010) has termed it as a wave of 'Neoliberalism'; suggesting that policy structure has increased the share of :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ ϵ national income and profits going to rentiers, bankers and other groups of financial capitalists.Consequently, it has become more a 'rentier economy' than 'value addition economy' (Bogle, 2012).
A crucial feature of financialization has been an increase in the volume of debt via proliferation of unregulated intermediaries and rapid expansion in trading of derivatives (Askari et al 2012;Hasan 2010b).With very low interest rates, speculators, in search of yield, engineered products to increase monetary returns and play games against each other.According to Bogle (2012: 6), "trading in S&P 500-linked futures totaled more than $60 trillion in 2011, five times the S&P 500 index total market capitalization of $12.5 trillion.The credit default swaps alone had a notional value of $33 trillion.Add to this total a slew of other derivatives, whose notional value as 2012 began totaled a cool $708 trillion.All this in comparison to $150 trillion: the aggregate capitalization of the world's stock and bond markets".The loss of J P Morgan of about US$ 5.8 billion in July 2012 is a gain of hedge funds who bought its structured products.
The above developments indicate the presence of what the noble laureate James Tobin (1984) termed as 'paper economy'.Tobin suggested "we are throwing more and more of our resources into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity: a 'paper economy', facilitating speculation which is short-sighted and inefficient" (see also Mirakhor and Bacha, 2013).Bogle (2012: 4-5), in his latest book titled "The Clash of Cultures: Investment v/s Speculation", has described this unprecedented surge in financialization and speculation as Capitalism's 'mission aborted'.
"The general mission of the markets was/is capital formation, involving allocation of investment capital to most promising industries and companies, both existing and upcoming.However, out of $33 trillion stock trading in financial markets, only 0.8% or $250 billion of the financial activities fulfill the original mission and the rest 99.2% or $32.73 trillion, some 130 times the volume of equity capital, aborts it".Bogle (2012) further argues that the increased financialzation has made the world of investment move from a culture of long term to shorttermism.There is hence a further blurring of the difference between investment and speculation.Hans Tietmier, the former President of Bundesbank, warned in international fora that "financial decoupling" was increasing the risks in global finance, (Menkoff and Tolksorf, 2001).These warnings were not attended to and consequences followed (Epstein, 2006).According to Turner (2012), both economic history and theory make it close to certain that we could not have achieved the economic transformations of the last 200 years without the development of modern financial systems.It is hence argued that financial deepening has an important role to play in the economic development process.However, the fact that 'financial deepening', is beneficial across some range of increasing financial intensity, does not mean that it is limitlessly good.
The above can be supported by a recent study, (Cecchetti and Kharroubi, 2012) that investigated, 'if finance is really good for growth', regardless of the size and growth of the financial sector?For an answer, the authors came to two important conclusions.First, with finance you can have too much of a good thing.At low levels, an increase in the size of the financial sector accelerates the growth of productivity.But "there comes a point -one that many advanced economies passed long ago -where more banking and more credit are associated with lower growth."Second that when the financial sector accounted for more than 3.5% of total employment, further development of finance tended to damage economic growth8 .Consequently, the study stressed to a pressing need to reassess the relationship of finance and real growth in modern economic systems.Already, financialization has oriented the economies from a savinginvestment-production-export to a borrowing-debt-consumption-import orientation (Askari et al., 2012).To Rajan (2005), such dynamics have indeed made the world more risky and the system in turn has become highly sensitive to register events that can be termed as the 'black swan' events (Taleb, 2007(Taleb, /2012a).

The Black Swans and the Non-Linear 9 Destructive Debt Dynamics
When risks are higher, more could be the lack of ability to understand, control and mitigate such risks.This is a situation where risks get transformed into their stronger cases of 'uncertainty' and 'ambiguity'.Frank Knight explained that, at times, decisions are made based on available probability distribution of expected events.This is decision :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ ϭϭ making under risk.Unlike risk however, uncertainty describes a situation where a known probability distribution is not available but it is still possible to make decisions with some subjective estimates of probability of outcomes of actions or decisions (Knight, 1921).In the 1960s this view was modified to cover circumstances under which human cognitive ability and information availability are so constrained that even subjective assessment of outcomes was not possible.Ambiguity arises under such circumstances where the intensity of "ignorance" can create paralysis in the decision making (Ellsberg, 1961;Erbas andMirakhor, 2007 andMirakhor andShaukat, 2012).The result is an ideal recipe for the occurrence of those events which were deemed as highly improbable or never occurring.As a result an important concept has been added to the economic vernacular; termed as 'Black Swan' events.Taleb (2007Taleb ( /2010)), the inventor of the term, refers to them as those events which (i) usually lie outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.As a result, the probability of the occurrence of such events is extremely low (ii) though they have a low probability of occurrence; however, when they do occur, the events carry an extreme impact; (iii) lastly, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
Recently, the global system has experienced events that would have been thought of as low probability events not long ago.These include, inter alia, the down grading of U.S from its 'AAA' rating, the looming collapse of the much hailed Euro zone, the effort by Switzerland to convince the world that Swiss franc is not a safe haven, the Brazilian suggestion of bailout of advanced economy by emerging markets, China's contemplation of buying Italy's debt, the LIBOR's rate fixing and Cyprus's provocation of removing deposit guarantees on certain amounts of deposits.The list can go on.However, looming in the back ground of the present uncertainties in the global economy, there is a potential event termed as "the mother of all black swans" the effects of which may be chaotic to global economy: contagion-riddled events of sovereign default.
It can be observed that the occurrence of black swans and non-linearity of the debt dynamics is a pure demonstration of the Qur'ānic concept of "yam╒aq".Allah (swt) tells us about the debt dynamics in sūrah al-Baqarah (2: 276) of the Qur'ān: "yam╒aquAllah-ur ribā wa yurbias ╗adaqāt" (Allah (swt) annuls, obliterates al-ribā and increases ╗adaqāt).The part that is most relevant here is the first part of the verse "yam╒aquAllah-ur ribā".Reference, for example, to al-Mu'jam al-Wase═, Maqāyees al-Lughah and Mufradāt al-Qur'ān reveals that "yam╒aq" that makes the "ma╒aq" of ribā means to decrease, to destroy completely, to take away the blessings from a thing, to negate or cancel out the positive impact of a thing, or to erase suddenly.It is thus a state of sudden and rapid decline, with the speed of destruction picking up acceleration (Shaukat, 2013).
In order to give evidence of the adverse and non-linear debt dynamics, that is to signify the Qur'ānic 'ma╒aq' in full operation in the global economy, the findings of Reinhart and Rogoff (2008, 2009a, b, 2010a, b, 2011, 2012) and Kaminsky and Reinhart, (1999) put forward among the most finely textured, historical, analysis of the financial crisis10 .The data covers seventy countries across all regions.The range of variables comprises external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodities prices.The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.The authors showed that crises whatever label they carried− exchange rate crisis or banking crisis -have been at root debt crises (Reinhart and Rogoff, 2009).
The authors refers to the non-linearity of such consequences as the "Deadly Ds": Sharp economic 'downturns' follow banking crises; with government revenues dragged down, fiscal 'deficits' worsen; deficits lead to more 'debt'; as debt piles up, rating 'downgrades'11 follow and 'defaults' ensue; the result of a vicious 'debt circle' (see also Mauldin and Tepper, 2011).The studies revealed that three years after a financial crisis, central government debt increases, on average, by about 86 percent; implying that the fiscal burden of banking crisis extends far beyond the common cost of the bailouts.Moreover, real housing price declines average 35 percent, stretching out over six years.Equity price collapses on average 56 percent with the downturn spanning around 4 years.ϭϰ :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ which manifests itself in the extreme duress many economies experience at seemingly manageable debt−argue that "safe" external debt-to-GDP thresholds for debt intolerant countries could be as low as 15 percent.
However, as stated earlier, the present debt-to-GDP ratio of the richest members of the G-20 threatens to touch the mark of 120% -300% with interest rates on debts projected to be as high as 27% (BIS, 2010).The picture becomes more alarming when the ensuing disequilibrium is realized.While the global GDP is growing at 3%, the debt is increasing at 7%.It would take 24 years for the global GDP to double itself while a mere 10 years for the global debt to get twice as large.It is difficult to imagine how this massive debt volume can be validated by the underlying productive capacity of the global economy.
Thus far the search for ways and means of reducing the instability of the interest-based debt system has focused only on improving regulatory/supervisory structure and few reforms of financial system.Much less effort has been devoted to finding an alternative paradigm.Question arises as to whether there is such an alternative to the present dominant global finance system.Perhaps a more practical alternative would be to step back from targeting the interest rate mechanism and focus on the incentive structure that has rendered the interest rate based debt financing such a destabilizing force in the global system.This can be accomplished by re-orienting the system from relying on risk transfer and risk shifting to risk sharing-the essence of Islāmic finance.

Islāmic Finance is Risk Sharing 14 and a Rule-Based System
Driven by the Qur'ān and the Sunnah, the Islāmic economic system is risk sharing and a rules-based system.There is a network of prescribed rules that govern the socio-economic-political life of the society.Compliance with these rules renders the society a union for mutual support by requiring humans to share the risks of life (Mirakhor, 2011c).The adoption of these set of rules is expected to lead to a dynamic and growing economy, without which the higher objectives of Islām cannot be achieved (Khan and Mirakhor, 1994).The objective of Islāmic finance is to promote sustained growth and full employment thus contributing positively to poverty alleviation and, ultimately, to economic and social justice.The epistemological root of risk sharing, as the organizing principle of the Islāmic financial system, is discernible from the Verse 2:275 of the Qur'ān.This verse, in part, decrees that all economic and financial transactions have to be conducted via contracts of exchange (albai') and not through interest-based debt contracts (al-ribā).It can be argued that risk sharing -the crux of Islāmic finance -serves as one of the most important desideratum of Islām i.e. the unity of mankind.Since in the Verse the contract of exchange appears first and the prohibition of ribā thereafter, it can be argued that requiring contracts to be based on exchange constitutes a necessary condition and "no-ribā" the sufficient condition of existence of an Islāmic financial system.Together, these conditions constitute the organizing principle of that system (Mirakhor andShaukat, 2012, 2013).The necessary condition (albai') and sufficient condition (no ribā) must be met for a contract to be considered Islāmic (Mirakhor, 2011b)."A careful consideration of all the permissible contract modes that have reached us reveals that they should basically be risk sharing contracts.The instruments designed to financially empower them must also be risk sharing instruments" (Mirakhor, 2010(Mirakhor, , 2011a, b), b).
Classical Arabic Lexicons of the Qur'ān define contracts of exchange as contracts involving exchange of property rights claims in which there are expectations of gains and probability of losses (Mirakhor, 2010;2011a, b). 15 There are no predetermined fixed ex-ante returns (Shaukat andMirakhor, 2012, 2013).By entering into contracts of exchange, parties improve their welfare by exchanging the risks of economic undertakings, thus allowing division of labour and specialization.The exchange of one set of property rights claim for another, as the necessary and "no-ribā" as the sufficient condition has important implications.Exchange requires the freedom to contract for the parties involved and this implies freedom to produce, which then calls for well-protected property rights to allow and facilitate production.For exchange to take place, there is a need for markets and then for rules that govern behaviour of market participants.
Over the past three decades, an important field of enquiry, namely the 'New Institutional Economics' (NIE), has made significant contribution to understanding how economic system functions.Most importantly, the NIE has focused on reasons why some economies perform strongly while others lag behind with substantial margins.The reasons, the NIE explains is the "institutional scaffolding" of the economy.NIE defines institutions as rules and norms governing economic behaviour in a society.ϭϲ :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ Accordingly, how well an economy performs depends crucially on the rules governing economic behaviour.Principal among these are: rule of law, well defined property rights, and a high degree of trust, efficient contract enforcement, and good governance.The Qur'ān makes clear that the compliance with the prescribed rules is the guarantor of: better socio economic justice and cohesion, unity and order in any human collectivity and economic growth and stability (see for example verses 5:2, 3:103, 8:46).The promise made in the verse 96 of chapter 7 of Holy Qur'ān can also be seen in verses 65:2-3; 5:65-66, 12:90, 5:66, 8:53, 10:9, 2:25, 16:97, 24:55 and 40:40).Conversely all prohibited behaviours are those that ultimately lead to social injustice and disintegration 16 .

Islāmic Finance and Equity Financing
Considering the aspects of an Islāmic financial system based on risk sharing, where there is no room for any return that is determined ex-ante to the contractual outcomes, independent of any profit or loss, the system becomes one that is based on 'no risk free assets', where all the financial assets are contingent claims (Mirakhor and Krichene, 2009).It can be stated that shares or equity issues of corporations appear to best fit the criteria.In a typical risk sharing arrangement such as equity finance, parties share the risk as well as the rewards of a contract.Assets are invested in remunerative trade and production activities.The return to assets is not known at the moment assets are invested, and is therefore a random variable making equities risky.In equity investment, the income is random and depends on the performance of the equity investment.To Mirakhor and Krichene (2008) (Mirkahor, 2010: 13).Mirakhor (2003), while citing the Goitein' (1954,1955,1962,1964,1967)  It is often argued from those who favour debt financing that the unprecedent development particularly in the last fifty years is essentially an outcome of the capitalistic system, based on interest bearing debt financing."To them the reduction, let alone elimination, of debt financing and bank money creation would reduce economic growth" (cf: Askari et al., 2012).The latter is an empirical issue that needs careful estimation alongside considering the social cost and benefits under such a regime.However, while not denying the development and overlooking the aspect of sustainable development, question arises as to how much of the ensuing development has only been through debt financing.It can be safely argued that most of the advances that seemed to have changed the dynamics of the world-particularly in the technological arena-have been through risk sharing modes than debt financing (see Shaukat, 2013 and Taleb,   18 According to Cybercities (2008) 2012).To Askari et al., (2012), "much of the assumed contributions of finance over the last 30 or so years, and thus debt financing and leverage, have only been a mirage", given also the pro tax and legal support.
Further, Allah has ordained the believers, not to get discouraged by the apparent well-being of the non-believers (Quran; 43:33-35).
While highlighting the growth benefits of a system predominantly based on equity financing, Toutouchian (2002) asserts that the world could have indeed seen much more growth and development had it resorted more on equity financing.Einaudi (2006) and Turner (2012) suggest "A modern market economy needs financial contracts.In theory these could all take equity form, and if they did economies would suffer less macroeconomic instability".Taleb (2012) argues that for a financial system to avoid fragility and the occurrence of black swans, the system needs to get rid of debt financing and resort to equity financing instead.With equity financing, all stake holders will have more skin in the game.This would necessarily constrain and even diminish moral hazards and agency problems; aspects always pervasive in a debt based system (see also Hellwig, 1998).Mirakhor and Krichene, (2009) argue that "equity based finance is stable as assets and liabilities adjust to shocks; making the system immune to banking crisis and disruptions in payments mechanism".

Islāmic Finance a Two Tired System
Based on the above discussions, an Islāmic financial system can be envisioned as a two-tier financial system19 : A 100 percent reserve depository and safekeeping banking system for domestic and international payments.
Equity based risk-sharing investment banking that places real saving directly in private or public projects or indirectly via the stock market.Investors are shareholders.
The first sub-system keeps money deposits in trust and settles payments via clearing, withdrawals and other forms of payments.The second part of the system receives savings, which it invests in productive projects or in more liquid investment such as mutual funds or stocks.Depositors receive transferable or marketable shares that enable them to liquidate their investment if they chose to do so.Returns from the funds :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ ϭϵ invested are ex-post and are distributed to the depositors as to the shareholders of equity capital.As a result, they share in profits and losses as well as in capital gains and losses.Islāmic capital markets intermediate between saving units and investing units by way of risk sharing through investment banking, stock markets, mutual funds, exchange-traded funds and other forms of intermediary risk-sharing institutions.
A number of influential scholars 20 , in the past, proposed reforms that would abolish the credit system and replace it by an equity-based investment system.For instance, Walker (1873); von Mises (1953);Carrol (1965), Simons (1948); Friedman (1969) andRothbard, (1994), opposed fictitious credit creation by banks and favoured the creation of joint stock companies which use savings to buy equities.Among the most celebrated proposals along these lines was the plan formulated in the University of Chicago, 'Chicago Memorandum' or commonly called 'Chicago Plan' in 1933 which called for 100% reserve money and for an equity-based investment system.Irving Fisher (1936) claimed the following advantages for this plan: (i) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money (ii) Complete elimination of bank runs.(iii) Dramatic reduction of the (net) public debt (iv) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation.A recent IMF paper titled "the Chicago Plan Revisited", studied the claims made by Fisher and others in favour of the 'Chicago Plan'.By embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy, they found robust support for all of claims made in support of the proposed plan (Benes and Kumhof, 2012).Kotlikoff (2010) also made a proposal on similar lines suggesting "Limited Purpose Banking (LPB)".LBP would essentially transform all financial intermediaries with limited liability into mutual fund companies, with a single regulatory agency the "Federal Financial Authority" taking care of the regulatory and supervisory roles.LBP would maintain a close link between the real and the financial sector where the former will drive the later.Askari et al. (2012: 11) in their book titled "Risk Sharing in Finance" suggest that: One way to ensure the stability of the financial system is to eliminate the type of asset-liability risk that threatens the solvency of all the financial 20 See also Haque and Mirakhor, (1987); Khan andMirakhor, (1989, 1994); Mirakhor et al., (2012Mirakhor et al., ( , 2013)); Mirakhor and Krichene, (2013) among others.
institutions, including commercial banks.This requires commercial banks to restrict their activities to two: (i) cash safe keeping; and (ii) investing clients' money as in mutual fund.Banks would accept deposits for safe keeping only (as, for example, in a system with a 100 percent reserve requirement) and charge a fee for providing this service and for check writing privileges.In their intermediation capacity, banks would identify and analyze investment opportunities and offer then to clients; they would charge a fee for this service much like a traditional investment bank.In this way the bank would not be assuming any asset-liability exposure, just a potential loss of some (but not all) of its capital, which would not endanger the bank's solvency.In other words, in such a financial system, there would be no debt financing by institutions, only equity financing; and there would be no risk transfer or risk shifting, only risk sharing.
A pivotal feature of the above dynamics is that the Islāmic financial system is protected from un-backed credit expansion since banks would not contract interest bearing loans and also not create and destroy money 21 .It is thus assumed that in an Islāmic bank there will be a maturity match between deposits and investment (with no need for asset and liability management)."Short-term deposits may finance short-term trade operations, with bank purchasing merchandise or raw materials and selling to others companies; liquidity is replenished as proceeds from sales operation are generated.For longer-term investment, longer-term deposits are used" (Askari et al., 2010).There is hence greater interdependence and close relationship between investment and deposit yields, since banks primarily accept investments on the basis of profit-loss sharing.The funds to the enterprise are also provided on the same basis (Khan and Mirakhor, 1994).An Islāmic bank is a direct owner of the investment process.It identifies investments opportunities based on due diligence process and evaluates them to minimize risks; participates directly in the management, monitoring and execution of the trade and investment operation (see also Kazem, 1999).The funds are further released for the purchase of goods and services as required for the completion of these operations.
The above dynamics would in turn not only translate into a coordinated asset/liability maturity structure, but the real values of assets and liabilities −of financial institution− would be equal at all points in 21 There is no credit creation out of thin air in Islāmic finance.Under fractional reserve banking, deposits at one bank can be instantaneously loaned out and become reserves and a basis for a new loan at a second bank.The credit multiplier is determined by the reserve requirement and could be high.In case of securitization and over-leverage, the credit multiplier is theoretically infinite, leading to violent asset and product price fluctuations.
time such that the value of both sides of the balance sheet move simultaneously and in the same direction in response to changes in asset prices.In addition to the prospect of instantaneous equilibrium between the asset and liability sides, there would also be Asset/liability risk matching.While the individual financial institutions engaged in investment activities face the given risks, but these are not systemic and do not affect the overall stability of the financial system, as this system is immune to speculative mania, liquidity expansion, and instability of returns.If asset prices decline, so will the liabilities, unlike what happens in a system dominated by interest-based debt contracts 22 ."Due to the fact that the returns to liabilities will be a direct function of the asset portfolios and also assets are created in response to investment opportunities in the real sector, the return to financing is removed from the cost side and relegated to the profit side, thus allowing the rate of return to financing to be determined by productivity of the real sector23 " (Khan and Mirakhor, 1994).Immediately, the system renders a tight coupling between the financial and the real sectors and the financial sector is found fulfilling its real aim i.e. serving the real sector.
Given the importance of credit in the Western financial and economic model, if credit supply is constrained by increasing its price i.e. increasing interest rates, then a reverse of the above dynamics is achieved.High interest rates lower investments which in turn lower consumption leading to a build-up of inventories and lowering growth in national output.Fallout is an increase in unemployment.If the decline in employment is more pronounced, consumption and investments decline further which further affects the national output."In case this decline continues for more than two consecutive quarters, then an economic recession is upon us" (Askari et al., 2010).It can be observed how the dynamics of the economy would change for better if it is driven by the rate of return to the real sector.As suggested, there would be one to one mapping of both the real and financial sector where the increase in investments, consumption, employment and hence economic growth would be in direct proportion with the increase in the rate of return to the real sector.An ensuing feedback process further adds impetus to the growth cycle.
In consideration of the given growth and stability characteristics of risk sharing based financing, recently, a group of elite Sharī'ah scholars as well as economic experts has passed two 'Declarations' (namely the Kuala Lumpur and the Jeddah Declarations) asserting that risk sharing based financing is the only way forward and that financing must move away from debt and rely more and more on equity financing.The declarations further suggested governments (particularly governments of Islāmic countries) to essentially adopt risk sharing modes when devising the monetary and fiscal policies.Similar conclusions were reached in IFFS (2013), asserting the adoption of risk sharing and equity financing and less reliance on interest bearing debt.

Economic Growth and Stability: Risk sharing based financing: An Empirical Support
In order to seek empirical support for the hypothesis that risk sharing finance helps better, for growth and stability, than interest-based finance, we use production function, the tool frequently used in order to assess the efficacy of factors claimed as contributing to economic growth.The present study adopts the augmented production function approach as put forward by Cowen and Tabarrok (2011).The basic growth model 24 takes growth in GDP "Y" as a function of capital 'K' and labour 'L', with ideas/technological shifts 'A' as exogenous to the model (see, for example, Solow 1957).
Although the model could explain the differences in economic development based on capital investment and the saving rates, while keeping labour growth constant, nevertheless it failed to fully explain the large magnitudes in the difference of income levels of individual countries.A study by Mankiw et al., (1992) tried to further enhance the explanations for the large differences by introducing the notion of 'human capital' in the production function.The authors suggested that labour's share is not all about payments or return to pure labour, it also represents the payments or return to human capital i.e. the labour which through 24 The growth model is also presented in the Cobb-Douglas formation.The basic model in essence remains the same as in the Solow's version i.e.Y= f (K, L).However, the main difference between the two is that for the former's version, there is an addition of 'α' on both 'K' and 'L' suggesting the proportion of each variable's contribution to economic growth (the notion of diminishing return).The given model would then be Y= A K α L 1-α .Moreover, assuming the labour as constant in an economy, the Cobb-Douglas model has further evolved to its reduced form of y = Ak α .Nevertheless, Hicks-neutrality' is the assumption often used by economists to neutralize the effect of 'α' for each variable (see later).
education takes time to produce.Therefore, human capital is ought to be considered a type of capital.Given the assertion, this increases the share of capital in the model and could explain the large differences in incomes.With empirical support, it was emphasized that the saving rates and abundance or lack of capital, which includes the human capital, are at root of explaining the comparative growths.The more capital intensive the economy is, the more the capital accumulation, leading to more savings and hence investments and growth.
As a result, it was argued that the economies with lesser capital stock and human capital can match up to the growth of more developed provided the rate of savings can go up, since the return to capital and human capital is excessive-the notion of convergence hypotheses 25 .In theory the process should start naturally as higher rates of return should attract more savings as well as the flow of global capital, increasing capital stock and economic growth.However, evidence fails to fully support the convergence.For instance, the Soviet Union under Stalin saved a higher percentage of national income than the US.Given the higher savings rate as well as a lower level of capital, the Soviet was expected to have caught up very rapidly.However, it did not.The dynamics are found true on most less developed countries.It appears that, in general, the less developed are struggling to catch up to the developed.Indeed, in many cases, the gap is increasing.Moreover, the flow of global capital, on the contrary, is constantly directed towards wealthier nationseven the richer individuals of the poorer regions tend to invest outside.Additionally, there is also a relentless 'brain drain' severely tilted towards the more developed parts.
Given these facts, the growth models fail to properly explain the reasons necessitating the dynamics.However, a crucial contribution by Cowen and Tabarrok (2011), akin to the findings of NIE, essentially held institutional arrangements and the incentive structures in an economy as the most vital in explaining the above.The authors argued that the 25 Simply put, the idea of convergence in economics (also sometimes known as the catchup effect) is the hypothesis that poorer economies' per capita incomes will tend to grow at faster rates than richer economies.As a result, all economies should eventually converge in terms of per capita income.Developing countries have the potential to grow at a faster rate than developed countries because diminishing returns (in particular, to capital) are not as strong as in capital-rich countries.Furthermore, poorer countries can replicate the production methods, technologies, and institutions of developed countries.However, It does not explain why in general nations have failed to converge and even had zero growth for many decades (e.g. in Sub-Saharan Africa).
convergence hypothesis is a 'conditional convergence hypothesis' 26 : conditioned crucially on the most suitable and efficient institutional and the ensuing incentive structure in the economy.As a result, the theoretical perceptions can only be put right provided the right kind of institutional/structural arrangement is assured.This in turn would best determine the way in which the capital and human capital are utilized to the best of economic productivity and growth.
So given the technology as exogenous and available to everyone, it is hence the institutional arrangement and the ensuing incentive structure that lies at the root of explaining comparative growths.The augmented model then stands as below.

Y = F (XKL) (1)
Where 'Y' is the output (measured as annual growth in GDP), 'K' is the physical capital and 'L' represents the human capital portion of capital.However, 'X' the authors referred to as the 'productivity' which solely derives the most efficient combination of the factors of production.This, as argued, essentially depends on the right nexus of the institutional and incentive structure provided in an economy 27 .Thus

Output = Productivity x Factors of production (2)
If such is the importance of having the right institutional arrangement for economic growth, the financing mechanism can then be considered as among the most crucial components in the configuration of the required arrangement.As a result, this provides justification for the inclusion of financing arrangement as among the variables explaining economic growth in the production function.In the present economic framework, the financing mechanism is governed by interest bearing debt finance.It has been claimed that (nation's) debt plays a significant role in influencing the productivity of labour and capital, hence the economy.However, as can be inferred from the findings of previous sections, debt does not remain a blessing after it gets accumulated beyond a certain limit.In fact, too much of debt can and has dampened growth by hampering investment and productivity.This apparent paradox is the result of what is called as debt overhang (Krugman, 1992).Basically, it implies that if the accumulated debt of a country exceeds or is expected to surpass its repayment ability, 26 Given the fact that the convergence hypotheses cannot explain as to why economies fail to converge, the notion of 'conditional convergence' then identifies the variability in the structural (institutional) characteristics of economies as the key determinant. 27The more suitable the institutional and incentive structure, the higher the effect of 'X', resulting in a more efficient combination of labour and capital.expected default will lead to lower domestic and foreign investment with adverse implications for its economic growth.
More specifically, when the debt overhang is such that future increases in output are drained away in the form of higher debt repayments; debt acts like a tax on output.So, larger the debts stock the lower the probability of debt repayment by the borrowing country.The obvious reason is that when greater percentages of any return on investments as well as reserves (foreign currency) are consumed in meeting debt service, creditworthiness erodes causing reduction in economic growth and further access to financial resources.It is further pointed out that when a nation suffers from heavy debt burden, the need to service that debt determines the manner in which labour and capital are exploited in the production process (Hameed et al., 2008).
As a result, debt service can thus be regarded as 'I' in the above function 28 .The model29 would then suggests economic production as a function of debt burden 'DB', measuring debt service, physical capital 'K' and human capital 'L'.

Y = f (DB, K, L)
(3) As per the objective of the study, as well as from the evidence presented in earlier sections, it is asserted that unlike interest bearing debt financing, the financing through risk sharing arrangement has all the ingredients to better influence the growth and productivity of an economy.There are no servicing commitments in form of interest payments which serve as cost to the system.The inclusion of risk sharing based financing in the production function could be best proxied by the stock market.

Empirical Tests and Findings
Since it is both a temporal and a cross sectional assessment, with the aim of assessing contribution to growth and stability, the study considers the application of the latest dynamic heterogeneous panel technique as the most appropriate 30 .The present study apparently is at the forefront to apply such techniques in assessing the impact of debt burden as well as risk sharing financing via stock market on the economic growth of the selected countries.The results are expected to not only yield the long-term relationship between intended variables viz-a-viz economic growth, but we can also derive an error correction term (ECT) that allows us to study the short run dynamics towards long run equilibrium.The stability of the systems could be judged by observing the speed of adjustments of any short run deviations, back to the long run equilibrium.

Data and Sources of Data
Stock market data from a sample of 18 Islāmic countries 31 is used to assess its role in determining a better and a more stable economic growth.The sample includes countries in which the proportion of population professing Muslim faith exceeded 50% and for which stock market data, as well as data for other intended variables, were available 32 .The data is obtained from World Bank, IMF, central bank of each country and Datastream.The data on population and religious fractionalization was sourced from the World Development Report (2012), Central Intelligence Agency (CIA)'s World Fact book (2011).However, data on countries for which the above sources did not record the exact proportion of Muslims in the society was extracted from the Association of Religion Data Archives.The sample comprising of 18 countries is inhabited by nearly a billion people.The yearly data used cover the time span from 1990 to 2010.Using our sample and given the models, the study will first try and assess the impact of debt burden on the overall economic growth.This would lend more tenable support to our claims of better growth and stability in a risk sharing environment.

Panel Models
The basic framework for panel models is: 30 Our thanks to Prof. Mansur Masih of INCEIF for his positive feedback on the results. 31The sample includes: Bahrain, Bangladesh, Egypt, Indonesia, Iran, Jordan, Kuwait, Lebanon, Malaysia, Morocco, Oman, Pakistan, Qatar, Saudi Arabia, Sudan, Tunisia, Turkey, UAE.The given sample was chosen on the argument that if Islāmic finance, based on risk sharing and no ribā, can render the economies more growth oriented and stable, the first best demonstration should be assessed on the group of Islāmic countries.The above group represents more than 70% of growth engine of the whole OIC countries. 32Effort was made to cover all those countries, given in the latest list of "Stock Exchanges of the OIC member states" (see 'Final report of the sixth meeting of the OIC member states' Stock Exchange Forum", 2012).:ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ Ϯϳ Y it = α b + β it + e it Where b = 1 …18 and t = 1990…2010 The models used for the purpose of the study are as below: Where 'LNY', represents the natural log of GDP per Capita on annual basis, 'LNS' is the ratio of GFCF (gross fixed capital formation) to real GDP 33 , 'LNN' is the annual population growth (representing labor) and 'LNX DB ' is the ratio of total debt burden/service on public and publically guaranteed debt to real GDP.'ε' stands for the error term that satisfies the classical regression assumption.The 'suffix 'it' given with each variable stands for the respective country and the given year.For example, LNX DB it represents the total public debt burden for country 'i' in year 't'.
As mentioned earlier, since the main objective of the section is to empirically suffice that risk sharing based financing can deliver a more stable and resilient economic order, the above model is then adjusted for introducing stock market as represented by the natural log of the ratio of 'market capitalization to real GDP−LNX sm .To counter for the argument that performance of stock markets is influenced by debt financing-which generates speculation-via the use of debt, for example, through direct bank lending, the study introduces variable 'LNDTM'− defined as percentage change in the ratio of bank credit to private sector to market capitalization 34 .The variable assesses any impact of debt/speculation on stock market dynamics.A coefficient of less than 1 or a negative or insignificant relation would suggest minimum influence of debt financing and vice versa.
The empirical tests will be performed in three steps.First, we test for the order of integration in the time series data.Since the time span of the 33 Given at steady state, savings equals investments, the study uses GFCF as a flow value; it measures the value of acquisitions of new or existing fixed assets by the business sector, governments and households (excluding their unincorporated enterprises) less disposals of fixed assets.GFCF is a component of the expenditure on GDP, and shows how much of the new value added in the economy is invested rather than consumed. 34Assuming that it is only through the channels that debt can influence stock market performance and that all private credit is rendered to stock market.(Thanks to Prof. Dr. Zubair Hasan of INCEIF for introducing the variable 'LNDTM').Moreover, to check for the presence of any co-linearity between the variables of model 2 i.e. 'LNX SM ' and 'LNDTM', the study ran the correlation check between them.The correlation was found to be-0.48212.:ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ Ϯϵ LNN -2.77 -3.47* 2.22 -6.33* LNDTM -0.017 -4.39* -5.00 -7.13* * Significant at 1% and **, *** significant at 5% and 10% level

Heterogeneous Panel Co-integration
The study utilizes two types of the heterogeneous panel co-integration test developed by Pedroni (1997Pedroni ( , 1999)).In addition to using panel and overcoming the problem of relatively small samples, the test permits different individual cross-section effects by allowing for heterogeneity in the intercepts and slopes of the co-integrating equation.Pedroni's method includes a number of different statistics for the test of the null of no cointegration in heterogeneous panels 35 .The first group of tests is termed "within-dimension".It includes the panel-v, panel rho(r), which is similar to the Phillips and Perron (1988) test, panel non-parametric (pp) and panel parametric (adf) statistics.The panel non-parametric statistic and the panel parametric statistic are analogous to the single-equation ADF-test.The other group of tests is called "between dimension".It is comparable to the group mean panel tests of Im et al. (1997).The "between-dimension" tests include three tests: group-rho, group-pp, and group-adf statistics.
The seven of Pedroni's tests are based on the estimated residuals from the following long run model: are the estimated residuals from the panel regression.
The results in table 4.1 reveal that null hypothesis of absence of cointegration is rejected in both the models.Although Pedroni's co-integration methodology allows us to test the presence of the long run relationships, it could not provide estimation by error correction model.As suggested earlier, to estimate a long-run relationship between the variables in panel framework in presence of cointegration, Pooled Mean Group (PMG) and Mean Group (MG) estimates are applied.STATA 10.0 is used to obtain these estimates.

Pool Mean Group
It allows the intercepts, short-run coefficients and error variances to differ freely across groups, but constrains the long-run coefficients to be similar across the groups.It has advantage to determine the long-run and short-run dynamic relationships.Based on a combination of pooling and averaging of coefficients; if the data allows, it estimates the model as a system.The PMG method of estimation occupies an intermediate position between the MG method-both slope and intercepts are allowed to differ across countries-and the fixed effects method where slopes are fixed and the intercepts are allowed to vary.The unrestricted specification for the ARDL system of equations for t = 1, 2, …T, time periods and i = 1, 2,….N countries for the dependent variable Y is: Where x i,t-j is the (k x 1) vector of explanatory variables for group i and u i and represents fixed effect.The model can be re-parameterized as a VECM system: (6) Where the β i are the long-run parameters and θ I are the equilibrium (or error)-correction parameters.The PMG restriction is that the elements of βare common across countries: (7) The group-specific short-run coefficients and the common long-run coefficients are computed by the pooled maximum likelihood estimation.

Mean Group
Mean group is the least restrictive procedure and allows for heterogeneity of all the parameters (imposes no cross-country restriction).It derives the long-run parameters for the panel from an average of the long-run parameters from autoregressive distribution lag (ARDL) models for individual countries .The MG estimator estimates separate regressions for each country and computing averages of the country-specific coefficients (see for example Evans, 1997;Lee et al., 1997), which provide consistent estimates of the long-run coefficients.For example if the ARDL is the following: For country i, where i = 1, 2, …N.The long-run parameter θ i for country i is: (9) And the MG estimators for the whole panel will be given by: (10) The assumptions are quite strong -require that the group-specific parameters are distributed independently of the regressors, and the regressors are strictly exogenous.The MG estimates does not take account 1 ˆθ θ of the fact that certain parameters may be the same across groups.The MG estimators are consistent and have asymptotic normal distributions for N and T sufficiently large.

Hausman Test
Recall that the PMG estimator constrains the long-run elasticities to be equal across all panels.This pooling across countries yields efficient and consistent estimates when the restrictions are true.Often, however, the hypothesis of slope homogeneity is rejected empirically.If the true model is heterogeneous, the PMG estimates are inconsistent; the MG estimates are consistent in either case.The test of difference in these models is performed with the familiar Hausman test (Hausman, 1978).With respect to the Hausman test, under the null hypothesis of homogeneity, if the parameters are in fact homogenous, the PMG estimates are more efficient than MG.Given the results from the Hausman tests, it concludes to PMG as the true estimator for both the models.

The Error Correction Term
Consider for example Model (1) of the study: If the variables are I (1) and co-integrated, then the error term is I (0) for all i.A principal feature of co-integrated variables is their responsiveness to any deviation from long-run equilibrium.This feature implies an error correction model in which the short-run dynamics of the variables in the system are influenced by the deviation from equilibrium.Thus it is common to re-parameterize for example in our case model ( 1

Discussion of Results
From the above findings it can be observed that in both the models, the study found a long-term relationship of the specified variables with 37 Out of 18 countries, 11 were lower than the average sample ratio of 'DM' and rest were with a higher ratio than average.T-value calculated as = 2.04.The Critical value of 't*' at α = 5% for the two populations was calculated as follows: = 1.99 economic growth.However, as per the PMG estimates, decided by the Husaman test, these relationships varied.As additional support, table 4.2 also provides the MG estimates to make the results more robust.Judging from the long-term coefficients in the PMG and MG for a sample of 18 Islāmic countries, it is shown that in case of model 1, the debt dynamics although show a positive impact on the growth of the economy, however, this influence is a lot less viz-a-viz the stock market dynamics in model 2.
As can be seen, the long-term contribution of stock market to economic growth is much stronger in both cases of PMG and MG with coefficients of 1.709 and 1.801.The influence on the contribution of labour and capital in both models also varies.Debt financing has a lower impact on growth, detrimentally affecting the productivity of capital as well as labour.This can be observed by a weak coefficient for both the capital and labour contribution to the economic productivity in the long run.In contrast, the influence on capital productivity in model 2 is much more pronounced and effect of population growth is less negative; suggesting that in risk sharing finance, the two factors of production are utilized much better to the benefits of the economic growth.To the argument that debt financing through direct bank lending may influence equity performance, the results clearly show that the expected debt effect as measured by coefficient of 'DM' although positively significant, but lower than 1.A coefficient of 1 or above would have sufficed the claims of any meaningful debt influence in the stock market performance38 .
The findings are in line with the assertion made particularly in the first few sections of the study.In, as much as, a nation has significant debt burden, the need to service its debt i.e. the interest payments, will affect how the labour and capital will be employed in the production function.More specifically, if the gains of the productivity increases are transferred to creditors-foreign or domestic, little incentive will be left to increase the productivity of capital or labour (Hameed et al., 2008;Qureshi andAli, 2010 andHaider andAli, 2012).It implies that the need to service the debt will determine the manner in which labour and capital are exploited in the production process.From the above results, this exploitation is clearly on the depressing trend.As a result, with an increase in debt, the investment and productivity are hampered in the economy; dampening economic growth.Looking at the average ECT coefficient given as 'Φ i ', the speed of adjustment for model I is -0.180 for PMG and -0.179 in MG which means that if there is any shock to the system, it will be a lengthy progress for a system to get back to the long-term equilibrium relation; taking a minimum of 5 years and more.
However, for model 2, measuring the effects of risk sharing financing, the ECT coefficient 'Φ i ' is much higher.The speed of adjustment is -0.281 and -0.266; suggesting that a risk sharing/equity based financing is much more resilient and stable to economic shocks with the adjustments back to long-term equilibrium relations taking place in nearly 3.5 years.It can be further argued that given a pure Islāmic financial system with no interest bearing debt avenues, it is expected that the stock markets will contribute to economic growth more effectively and efficiently since any influence via debt financing will be minimum if not completely absent.
The assertion can be empirically verified by the findings of table 4.4.Based on the average 'DM' ratio for the whole sample, the sample of the given countries was bifurcated into two groups: (i) countries which had lower DM ratio than the sample average and (ii) countries which accounted for a higher DM ratio than sample average.The Mean (measuring growth) and Standard Deviations (measuring volatility in that growth) of each group's real GDP growth was assessed.As can be seen from table 4.4, for the group of countries which have a less influence of debt in stock market, not only have a higher GDP growth, but the growth is more stable as well.Moreover, the growth and stability are also higher when seen in relation to similar estimates for the whole sample.
All in all, the above results are a further assertion of the analytical and theoretical claims made in the earlier sections, opposing a debt based financing regime and proposing risk sharing finance for fostering a more prosperous and stable economic growth.The findings also lend support to the claims made by Cowen and Tabarrok (2011) that given the right kind of institutional structure (in this case risk sharing based financing), economies can grow steadily and more efficiently-potentially serving the notion of conditional convergence hypotheses.Moreover, the results could also signify the contention that a growing economy, driven by the rate of return to the real sector, will always tend to show positive returns and there would be less chances for the returns to become negative.Among the dynamics that would assure such an outcome will be the feedback loop from an ensuing productivity of the economy.It can thus be claimed that findings of the study suffice clearly as to why the Qur'ān ordains the societies to render their efforts to risk sharing as opposed to ribā based debt financing.:ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ ϯϳ

Conclusions
The aim of the study in hand was to argue that the present interest-based debt financing regime is inherently unstable and crisis prone.This was shown by referring to the findings of both the earlier as well as the current intellectual pedigree.All contend that debt and leveraging are the main sources of instability in the current system.These features are the prime result of the existence of an ex-ante predetermined rate of return in the form of 'interest'; turning debts into unmanageable and unsustainable super cycles.The system breeds a financial society more on risk transfer and shifting than on risk sharing− a favoured reason for globalization.Moreover, such attributes of the system have given rise to an increased financialization of the global economy; decoupling the real and the financial sectors while amplifying both the overt and covert risks in the economy.Consequently, the system is obeying an increasingly non-linear behavior, evidencing a clear application of the Qur'ānic concept of 'yam╒aq' given in verse 2:276.It has made the system harder to understand, predict and control, translating into an increasing sense of uncertainty regarding the survival of the system.
It was hence argued that Islāmic finance, based on its tenets of sharing risks and no ribā, can serve as an alternative to the interest-based debt financing.The study has empirically supported the assertions of better growth and stability aspects of risk sharing financing regime.Moreover, theoretical research has also shown that a non-interest-based financial system promotes financial stability (Mirakhor, 1990).Islāmic finance prohibits interest-based debt contracts and therefore interest-based credit.Investors share in the risk of economic activities; they select most efficient and profitable projects, and share in profits.Return to investment is based on real capital productivity.It would be expected that in this system, the private sector would have significant potential for investment and growth.Because of one-to-one mapping of the real and financial sectors, Islāmic finance would be significantly simpler than the interest-based financing system.Since growth in finance has to reflect growth in the real sector only, it is not likely that there would be a decoupling of finance from real sector activities in order for the financialization phenomenon to occur.Besides, as interest-based contracts are prohibited, debt cannot build up; thus debt overhangs symptomatic of interest-based financing are avoided.
The other main sources of the stability in a risk sharing regime are the operational characteristics that remove major sources of volatility and instability.Among these characteristics are the following: Transparency, trust and faithfulness to terms and conditions of contracts; Say's law applies all the time; (e.g., investment arises from real purchasing power and not from fictive credit; for instance, consumers spend from earned income and not from consumer loans or government transfers; similarly, enterprises invest genuine saving).The real values of assets and liabilities would be equal at all points in time.The prospect of instantaneous equilibrium between the asset side of the banking system -driven mainly by the real sector of the economyand the liability side means that there must necessarily be a close and direct relationship between investment and deposit yields.Due to the close relationship between finance and the real sector activities, the rate of return to the latter determines that of the former rather than the reverse.A coordinated asset/liability maturity and risk matching structure; Asset/liability value matching -the value of both sides of the balance sheet move simultaneously and in the same direction in response to changes in asset prices; and Limitations on credit expansion and leverage, naturally arising from the need for credit growth that is tied closely to the expected rate of growth of the real economy.
One of the most vital arguments put forward in favor of globalization was that of improved risk sharing that would result from intensified human interaction across the world.On theoretical ground, this would mean expecting much greater degree of risk sharing between and among economies -resulting from greater freedom of movement of resources, and hence, providing a major source of consumption smoothing in the world economy.These developments were expected to lead to progress towards market completion, which means increasing the number of marketable securities to meet a large number of contingencies -a condition of optimal risk sharing posited in Arrow's (1971) conception.Or, at least, progress could have been expected towards the design and use of Arrow's idea of having securities with pay-offs contingent on the performance of the underlying asset, for example, equity-based securities with close links to the real sector of the economy (Mirakhor, 2011a).Theoretical research has demonstrated sizeable potential welfare benefits of risk sharing 39 .However, empirical studies have shown only marginal gains in risk sharing from globalization.For example, study by Kim et.al. (2005) has shown that even in the fast growing East Asia-10 countries risk sharing has not been as significant as would have been expected.
It appears that the contribution so far of the present configuration of Islāmic finance industry to the growth of real sector has fallen well short of expectations.Perhaps the main reason has been the fact that the practitioners and financial engineers of this new asset class -growing within the conventional financial system -had to design instruments that resembled those prevalent in the host system without violating the "noribā" sufficient condition.This meant creating instruments with tenuous relationship with the real sector to weaken the risk of Islāmic financial transactions borne by market players.Moreover, the instruments have been benchmarked to the LIBOR or closely related reference rates to make them acceptable to large international banks and investors.Hence, the Islāmic finance industry has focused on strategy of asset concentration in short-term maturities and real estate in the medium-to-long-term maturities, thus replicating the vulnerabilities of the conventional system.
Aside from these problems, there is a risk of path dependency: the risk that the industry will continue following the same pattern of behavior because it has proven profitable thus far.This growing complacency and doing 'business as usual', runs the risk that path dependency will render deviations from the true practice of Islāmic finance irreversible.This would mean continued development of debt-like instruments that are low risk but are devoid of risk-sharing elements -a vitally important element of Islāmic finance.After all, finance is well aware of the theory of "spanning" -where one basic asset can span into an infinite number of derivative instruments.This theory served as the basis for the rapid development of debt-based derivative markets worldwide which eventually undermined the stability of global finance.
In general, the industry players in their defence argue that "our clients" are not interested in placing their funds at risk, thus discouraging us from risk sharing 40 .Apparently, this argument is unaware that, conceptually, there is a difference between risk taking and risk sharing.The former is prior to the latter.The risk of a given project in the real sector is determined in that sector; and one bears such risks before entering into the financial sector to seek financing.On the other hand, it is at the point of financing where the decision regarding the modality of financingwhether it will be in the form of risk sharing, transfer or shifting -is made.The nature and magnitude of risk taken remains the same and immutable as it enters the financial sector at the stage of funds seeking. 40Such arguments are a norm and were also pervasive in the 3 rd International conference on Islāmic Business, Islamabad, Pakistan (2012) as well as in a conference of security commission Malaysia (2011) held with the theme of Risk Sharing in finance.
Industry players display a further dimension of inertia in resisting risk sharing.This relates to the conceptual "framing" of Islāmic finance.Framing refers to the fact that people's response to risky situation depends on how they form their perception of a given situation and that depends on how an event is formulated.Framing is closely related to the idea of "prospect" which refers to perception of gains or losses attached to decisions.The way prospects are framed can lead to inconsistent behavior; if the same objective outcome is framed differently in terms of gains and losses, people respond differently.Since losses, are given greater weight than corresponding gains, people are in general loss averse.If the outcome is framed either as a gain or loss, people prefer to choose gain.For example, the prospects of 10 percent loss and 90 percent gain can be framed focusing either on the probability of the loss or the expectation of the gain.Hence, it can be argued that a major reason for the inertia in the industry for resistance to progress towards risk sharing is due to the inability of the stakeholders and practitioners to first understand and then frame risk sharing prepositions correctly and effectively.
While the disappointment with the present performance of the Islāmic finance industry is understandable, it should be noted that the industry has a short history in which it nevertheless has demonstrated remarkable growth.Perhaps it is this performance that has triggered evidence of growing interest in non-interest rate based finance.Indications are that emerging markets and developing economies are actively considering adoption of instruments of Islāmic finance.Governments, particularly in Malaysia, have been major sources of support for the growth of Islāmic finance.Few are leveraging the "first-mover" status of Malaysia in education, manpower training and instrument innovation in Islāmic finance to introduce their own brand of risk-sharing method of financing.If these efforts succeed, perhaps even the benefits of emerging multiple growth centres in the global economy will be further enhanced with greater stability and resilience in supporting financial transactions through risk sharing (Mirakhor, 2011c).As suggested by Mirakhor (2012), in the last three decades important strides have been made in applying the rule of no ribā based contracts to create an Islāmic system.Much more effort needs to focus on the risk sharing aspect of the prescribed rules of the Qur'ān as specified in the verse 275 of chapter 2. This potential move is referred to as moving Islāmic finance from version 1.0 which only focused on the no-ribā part of the verse to now Islāmic finance version 2.0; rendered to apply risk sharing in finance-the essence of Islāmic finance.
Historical accounts suggest that e1970) financing has been a :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ ϭϳ centuries old phenomenon in the Muslim world as well as in Europe of the Middle Ages.Enterprises were established with share ownership and were recorded as share owned or anonymous enterprise.Among the most used instruments were the 'mu╔ārabah' and 'mushārakah' partnership contracts.Borrowed from the Muslims and later came to be known as 'Commenda' and 'Maona', such financing modes were commonly used for financing long-term trade and investment in Western Europe(Brouwer  2005; Udovitch, 1967 and1970).Further historical research submits that Commenda's contribution to industrial development of Ruhr Valley in Germany and in building railroads in Europe were particularly pronounced" , unlike a debt contract, shares / common stocks of open corporations are not redeemable and the payoffs are contingent upon a certain state of occurrence; Akin to Arrow-Debreu securities.They are "proportionate claims on the pay offs of all future states"(Fama and Jense, 1983)."The notion of Arrow-Debreu securities , in 2008, Silicon Valley was the third largest hightech centre (cyber-city) in the United States, behind the New York metropolitan area and Washington metropolitan area, with 225,300 high-tech jobs.The Bay Area as a whole however, of which Silicon Valley is a part, ranked first with 387,000 high-tech jobs.Silicon Valley has the highest concentration of high-tech workers of any metropolitan area, with 285.9 out of every 1,000 private-sector workers.Silicon Valley has the highest average high-tech salary at $144,800.[Cybercities 2008: An Overview of the High-Technology Industry in the Nation's Top 60 Cities].ϭϴ :ŽƵƌŶĂů ŽĨ /ƐůĂŵŝĐ ƵƐŝŶĞƐƐ ĂŶĚ DĂŶĂŐĞŵĞŶƚ sŽů͘ϰ EŽ͘Ϯ͕ ϮϬϭϰ

Table 4
) into the error correction equation, by modifying the equation such that 36 :