Their distinctions are many, but perhaps the fundamental difference between capitalism and socialism lies in the scope of government intervention in the economy. The capitalist economic model allows free market conditions to drive innovation and wealth creation; this liberalization of market forces allows for the freedom of choice, resulting in either success or failure. The socialist-based economy incorporates elements of centralized economic planning, utilized to ensure conformity and to encourage equality of opportunity and economic outcome.
In a capitalist economy, property and businesses are owned and controlled by individuals. In a socialist economy, the state owns and controls the major means of production. In some socialist economic models, worker cooperatives have primacy over production. Other socialist economic models allow individual ownership of enterprise and property, albeit with high taxes and stringent government controls.
The capitalist economy is unconcerned about equity (in the sense of equality). The argument is that inequality is the driving force that encourages innovation, which then pushes economic development. The primary concern of the socialist model, in contrast, is an equitable redistribution of wealth and resources from the rich to the poor, out of fairness and to ensure "an even playing field" in opportunity and outcome.
The capitalist argument is that the profit incentive drives corporations to develop innovative new products that have demand in the marketplace. It is argued that the state ownership of the means of production leads to inefficiency because without the motivation to earn more money, management, workers and developers are less likely to put forth the extra effort to push new ideas or products.
In a capitalist economy, the state does not directly employ the workforce. This can lead to unemployment during times of economic recession. In a socialist economy, the state is the primary employer. During times of economic hardship, the socialist state can order hiring, so there is full employment even if workers are not performing tasks that are particularly useful.
Some countries incorporate both the private sector system of capitalism and the public sector enterprise of socialism to overcome the disadvantages of both systems. These countries are referred to as having mixed economies. In these economies, the government intervenes to prevent any individual or company from having a monopolistic stance and undue concentration of economic power. Resources in these systems may be owned by both state and individuals.
Islam does not deny the market forces and market economy. Even the profit motive is acceptable to a reasonable extent. Private ownership is not totally negated. Yet, the basic difference between capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions. Their liberty is not controlled by any divine injunctions. If there are some restrictions, they are imposed by human beings and are always subject to change through democratic legislation, which accepts no authority of any super-human power. This attitude has allowed a number of practices which cause imbalances in the society. Interest, gambling, speculative transactions tend to concentrate wealth in the hands of the few. Unhealthy human instincts are exploited to make money through immoral and injurious products. Unbridled profit making creates monopolies which paralyse the market forces or, at least, hinder their natural operation. Thus the capitalist economy which claims to be based on market forces, practically stops the natural process of supply and demand, because these forces can properly work only in an atmosphere of free competition, and not in monopolies. It is sometimes appreciated in a secular capitalist economy that a certain economic activity is not in the interest of the society, yet, it is allowed to be continued because it goes against the interest of some influential circles who dominate the legislature on the strength of their majority. Since every authority beyond the democratic rule is totally denied and 'trust in God' (which is affirmed at the face of every U.S. dollar) has been practically expelled from the socio-economic domain, no divine guidance is recognized to control the economic activities.
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The evils emanating from this attitude can never be curbed unless humanity submits to the divine authority and obeys its commands by accepting them as absolute truth and super-human injunctions which should be followed in any case and at any price. This is exactly what Islam does. After recognizing private ownership, profit motive and market forces, Islam has put certain divine restrictions on the economic activities. These restrictions being imposed by Allah Almighty, Whose knowledge has no limits, cannot be removed by any human authority. The prohibition of riba (usury or interest), gambling, hoarding, dealing in unlawful goods or services, short sales and speculative transactions are some examples of these divine restrictions. All these prohibitions combined together have a cumulative effect of maintaining balance, distributive justice and equality of opportunities.
Source: MuftiMuhammad Taqi Usmani, An Introduction to Islamic Finance. Republished with permission.