Interest-free economy

A question of efficiency

The analysis in the preceding chapters shows that resources are allocated efficiently in an interest-free economic system and inefficiently in a system where interest is used as an incentive to reward capital providers for taking part in business enterprise. The reason is that in interest-free financing (risk sharing) the returns to the providers of capital depend on the efficiency of the businesses they finance. As investors are required to share risks with entrepreneurs, rewards to investors (dividends) rise and fall in tandem with profits. The risk facing investors provides a powerful incentive to them to invest in enterprises that have realistic prospects of earning profits. Put differently, risk provides a powerful motive to investors to exercise due diligence and thereby ensure an efficient allocation of resources.

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Chapter V – Interest-free economy