Market for Lemons and Cigarettes: An Islamic Perspective on Market Failure and a Lesson for Eliminating Interest from Economy

Abstract

The existence of interest and interest based institution in a market economy is in fact a market failure which remains unrecognized even by such Nobel Laureates who have been awarded Nobel Prizes on their research on capital and financial markets. Just as the market of cigarettes is a failure of market to turn away the smokers from their killers, similar it is the failure of interest based financial market to turn away the finance seekers from their killers (providers of finance on interest). This market failure needs to be recognized and the solution for this failure should be found not by intervening in the market but should be found in human behavior. As putting filters on the cigarettes does not stop smokers from being killed and something is needed to change in the consumer behavior to make them turn away from their killer, similarly, correction is needed in the interest based lending and borrowing to turn them away from their killer, the interest based financial institution.