Dissecting Iran's Economic Jihad

By Richard Javad Heydarian

In the absence of genuine democratic institutions, a set of common economic grievances is galvanizing the Arab Street against a diverse host of unaccountable regimes across the Arab world. However, deep and structural economic problems also characterize much of the Middle East, including non-Arab Iran. Recognizing the depth and gravity of the country’s economic challenges, Iran’s supreme leader Ayatollah Khamanei has declared 2011 as the year of “economic jihad.”

A more careful analysis of Iran’s economy reveals a mixed legacy of both crucial developmental gains and persistent macro-economic challenges. Given Iran’s vast hydrocarbon reserves, among the world’s biggest, and its burgeoning industrial-technological complex, one of the largest among emerging economies, the country still represents a potential economic powerhouse in Asia. But Iran has suffered from successive rounds of international sanctions that have prevented the country from fully exploiting its tremendous economic potential. The region’s general insecurity is also affecting prospects for large-scale investment in the country.

In response Tehran has adopted a two-pronged policy. It is increasingly tilting east and south, trying to maximize its ties with major emerging economies across the globe. And it has introduced much-needed economic reform by restructuring its subsidy schemes, gradually privatizing its key economic sectors, and adopting a more conservative macroeconomic policy. As a result, the sanctions regime — designed to place economic stress on the country and force its leaders to alter behavior — has failed to substantially alter Iran’s foreign policy.

Iran’s Economic Rollercoaster

From 1960 to 1978 the Iranian economy experienced unprecedented levels of economic growth, creating a "Persian economic miracle" in West Asia. Rising oil prices enabled the Pahlavi monarchy to lay down the foundation of a modern industrial economy.

In All Fall Down, Gary Sick explains beneath the pretty picture of a country well poised to achieve developed country status well before the dawn of the century, growing inequality, political disenchantment, a glaring rural-urban divide, and high levels of inflation and urban poverty fueled a popular revolution against the monarchy. From 1978 to 1979, growing strikes, an exodus of skilled workers emigrating abroad, and massive popular protests brought the economy to a standstill. Just as the country’s leaders tried to consolidate power in a post-revolutionary period mired in political factionalism, Saddam Hussein ordered the invasion of Iran.

In economic terms, the 1980s were a lost decade for Iran. In The Great War for Civilization, British journalist Robert Fisk explains how the brutal Iran-Iraq war carried a tag price of around $100 billion in direct costs. According to former president Akbar Hashemi Rafsanjani, the opportunity cost of the war stood at $1 trillion.

Additionally, Iran went through a historic demographic transition, which would exert a heavy long-term pressure on the economy. Realizing the extent of Iran’s economic problems, the country’s post-war leadership focused on reconstruction and rehabilitation. Not until the 1990s did Iran experience significant recovery in its GDP. From 1990 to 2005, Iran’s annual real GDP growth hovered around seven percent. From 1990-2010, its nominal GDP increased from $84 billion to around $488 billion. Buoyant oil prices and expansion in trade with Europe and major Asian economies enabled Iran to rise into the ranks of middle-income countries.

But despite steady economic expansion, high levels of inflation and unemployment continue to plague the national economy.

Developmental Gains

The mainstream media and analysts have largely overlooked Iran’s socio-economic development. One of the most impressive aspects of post-revolutionary Iran is the striking improvement in education, health, rural development, and industrial expansion. Despite having a significantly lower per-capita income compared to its globally integrated and wealthy neighbors, Iran is among regional leaders in key social indicators.

According to the World Bank, “The country’s social indicators are fairly high by regional standards…. the poverty headcount rate was more than halved between 1998 and 2005, to 3.1 percent… Iran’s health outcomes have also improved greatly over the past twenty years, standing currently above regional averages.” In addition, “Iran has a large social protection system with some 28 social insurance, social assistance, and disaster relief programs benefiting large segments of the population.” Iran has one of the fastest rates of growth in the human development index (HDI), and it now ranks among high HDI countries like Lithuania, Malaysia, and Chile.

Prominent economist Jeffrey Sachs in his book Common Wealth identifies Iran as one of the world’s most successful countries in terms of population-management and adult literacy programs. Based on the World Bank’s report, “Iran’s family planning program in the past two decades has been considered international best practice: Iran managed to decrease the fertility rate from 4.8 to 1.8 births/woman during 1990-2008.”

Rural development, eliminating extreme poverty, improving literacy rates, and bridging the urban-rural economic gap were all at the core of Iran’s revolutionary philosophy, which emphasized social equity and empowerment of the downtrodden. This explains why the regime continues to enjoy immense popularity in rural and less-developed areas.

Iran has also made great educational, technological, and industrial advancements. Iran is among the top 45 countries in terms of quality of math and science education, and its universities are considered among the best in many fields. Iran is the world leader in growth in scientific output, is among the top 20 countries in total volume of scientific output, and is a leader in cutting-edge industries like stem-cell research and nanotechnology. It is also one of the few countries to send a satellite into space.

Iran’s relatively closed economy allowed it to protect its industrial base against foreign competition. Today, Iran manufactures most of its industrial and consumer needs, its car industry is among the world’s top 10, and its steel industry is in the top 20 countries in the world. Moreover, Iran’s annual rate of industrial growth is one of the highest among emerging markets. According to Goldman Sachs, Iran's GDP is projected to become the 12th largest in the world by 2025.

But Iran still faces substantial challenges including sustained and high-impact international sanctions and a limited number of high-quality scientists. Regulatory capture, excessive protectionism, and lack of clear price signals have also led to lackluster performance in innovation and quality control. Nonetheless, Iran has gradually built the foundations of an industrial economy with an advanced scientific-technological complex.

The Impact of the Nuclear Saga

Iran’s huge population, excessive levels of energy consumption — thanks to domestic price subsidies — and burgeoning industrial base have exerted a huge pressure on its hydrocarbon energy resources. Iran’s aging energy infrastructure means that production levels will decline unless necessary investments are made. These economic pressures have formed the peaceful rationale behind Iran’s renewed interest in the once-abandoned nuclear program, which dates back to the 1960s.

Ironically, Iran’s pursuit of nuclear technology based on economic calculations has led to political complications, namely sanctions. Unlike the initial sanctions, which were primarily symbolic, the latest rounds of sanctions have had considerable impact on Iran’s economy. One of the most affected areas is large-scale investment in the energy sector. According to U.S. officials, Tehran might have lost around $60 billion in oil investments as a result of sanctions.

Sanctions have made Iran’s substantial trade with major European and Asian economies increasingly difficult and expensive. The sanctions have also affected Iran’s trade with the United Arab Emirates, the source of many of Iran’s essential imports.  Further worrying Tehran, a multi-billion dollar oil deal between Iran and India is stalled because EU sanctions affect German-based financial intermediaries. According to The Financial Times, sanctions might have also prevented China from settling around $30 billion in oil payments. Premiums on shipping commodities have risen, with insurance and transaction costs increasingly biting into Iran’s export-earnings while raising import costs.

Recently, Maersk, the world’s leading container shipping line, predicted possible disruption of Iranian food imports, since sanctions have hit a number of Iranian port operators. Moreover, Iran’s airline companies have also been experiencing serious problems with refueling in European airports. With sanctions hitting Iran’s ability to import much-needed refined oil and gas, the government has been forced to intensify production at aging and less-efficient domestic refineries. This has increased refining capacity by 18 percent, but it has also led to higher emissions and air pollution.

Even the transfer of money from parents to children studying abroad is affected, because Iranian banks have been hit by sanctions. The sanctions are anything but targeted, since they affect millions of ordinary Iranians.

The Challenge of Economic Reform

Iran’s economic woes have always been at the center of its domestic politics. Iranian presidential elections have focused on issues such as unemployment and inflation. President Mahmoud Ahmadinejad’s victory in the 2005 elections was largely due to his promise to eliminate corruption, reduce poverty, and introduce large-scale infrastructure projects to boost the economy. Social justice and redistribution of Iran’s oil wealth were at the center of his economic agenda.

His first term was characterized by populist economic policies, combining a loose monetary policy with a Keynesian expansionary fiscal policy. Boosted by growing oil prices in recent years, his administration has continuously injected petrodollars into the domestic economy, which has resulted in strong GDP growth. But because of the lack of increase in the country’s productivity, Ahmadinejad’s policies have led to high inflation rates — reversing the price stability achieved by President Khatami’s administration. The 2009 elections were not only about civil liberties and political liberalization, but also about much-needed economic reforms to manage the repercussions of the global economic crisis and dampen Iran’s macroeconomic predicament.

In the last two years Iran’s economic growth has decreased amid persistent inflationary pressures and brewing political uncertainties both domestic and international. In a marked shift from his populist rhetoric, Ahmadinejad has adopted a more conservative economic approach. Currently, the focus of the administration is to lower the inflation rate — by tightening its monetary policy — and streamline government expenditures by restructuring Iran’s $100 billion subsidy program.

The subsidy-reduction has been understandably unpopular, as prices of gasoline and other commodities have more than doubled. Consequently, domestic demand has dramatically dropped, while many industries struggle to keep up with the price shocks. To avoid backlash, the government has provided a targeted subsidy to more vulnerable sectors, while depositing a certain sum — as a cushion against rising prices — in citizens’ bank accounts.

According to the International Monetary Fund, “While the subsidy reform is expected to result in a transitory slowdown in economic growth and temporary increase in the inflation rate, it should considerably improve Iran's medium term outlook by rationalizing domestic energy use, increasing export revenues, strengthening overall competitiveness, and bringing economic activity in Iran closer to its full potential.” The Economist Intelligence Unit reports that Iran’s economy is expected to double in the next five years, and its real growth rate, according to the Global Forecasting Service, is to stabilize at around 3.4 percent over the same period.

The country has also embarked on a series of privatization schemes encompassing state-owned enterprises such as the two giant automobile manufacturing companies, Saipa and Iran Khodro. Private companies are also emerging as major players. Last year, an Iranian company, Entekhab Industrial Group, purchased the Daewoo Electronics Corporation, while local companies won crucial contracts in Iran’s vast oil and gas fields.

However, despite massive subsidy cuts, the proposed budget for 2012 is 40 percent higher than the previous one, indicating even more government expenditures in other areas. Overall, it is still too soon to assess the real medium-term impact of the current reforms, but inflation rates are at least moderating — in light of price shocks — at around 10-15 percent.

The Policy of Looking South and East

The lure of Iran’s vast hydrocarbon reserves is the main challenge to the efficacy of sanctions. According to IMF economist Dominique Guillaume, “the country has sizeable energy reserves, with underground hydrocarbon resources estimated at $10 trillion in oil alone (at $75 a barrel) and natural gas reserves at between $3.5-4.5 trillion.”

Given Iran’s large national budget of $508 billion and small national debt, favorable oil and gas prices are keeping Iran’s economy relatively buoyant. This means the sanctions only hurt ordinary Iranians by raising the price of food and basic commodity imports, slowing down GDP growth, and driving away investments from Iran’s capital-hungry economy.

However, the impact of sanctions is not sufficient to make Tehran reconsider its nuclear ambitions. Sanctions regimes have been plagued by free-riding, non-compliance, and lack of a coordinated action. This is very understandable given how many major non-Western economies rely on Iran for a significant proportion of their energy imports.

Tehran’s strategy to counter its isolation within the Western order has been relatively successful. Leveraging its immense energy reserves, Iran has considerably expanded its economic-financial-investment ties with major economies such as China, South Korea, Japan, Russia, Turkey, Brazil, and India. Despite incessant U.S. pressure on these countries, the bilateral relationships continue to grow. Although Iran’s forays into Latin America have provoked much reaction in Washington, Iran's ties to China, Turkey, and even India represent its economic future. These countries are among the fastest growing economies, yet they continue to suffer from endemic energy insecurity as their energy consumption is set to grow in coming decades. With this in mind, Tehran has utilized a policy that combines diplomatic savvy and attractive investment opportunities.

Noticing emerging economies’ growing political independence, Iran has been able to increasingly embed Chinese and Turkish investors in its vast domestic market in order to plug the gap left by Western companies. Given how emerging economies are rapidly closing the technological gap, these alternative partners could likely assist Iran in developing its tremendous economic potential.

In general, neither an economic sanctions regime nor the military option seems to be the optimal solution to the controversy over Iran’s nuclear program. The status quo achieves nothing but more economic hardship for Iranian citizens without effectively altering their leaders’ strategic calculus.

Instead, the United States and Europe should focus on carrots, emphasizing how Iran can reverse decades of investment vacuum and economic isolation if it chooses a more moderate path. No major policy shift is expected unless and until the West realizes that Iran has achieved sufficient level of development and international cooperation to ameliorate the effects of, if not totally counter, any set of unilateral sanctions by major powers. So far, the West has not provided Iran with real incentives to alter its nuclear policy such as meaningful technological and financial assistance. Nor has it assisted diplomatic efforts when it ignored the Brazil-Turkey brokered deal, which held the promise of breaking the decade-long deadlock.

-This commentary was published in Foreign Policy In Focus on 28/07/2011
-Foreign Policy In Focus contributor Richard Javad Heydarian is a foreign affairs analyst based in Manila