Page 1 of 2 Iran also ripe for change
By Hossein Askari
United States presidents have understandably become gun-shy of dealings with
Iran. Starting with Jimmy Carter, they have all had difficult encounters with
the country. The 1979 hostage-taking at the US Embassy in Tehran defined
Carter's presidency and cost him his re-election. President Ronald Reagan was
preoccupied with US hostages in Lebanon and the bombing of the marine barracks
in Beirut; both were blamed on Hezbollah backed by Iran. Reagan's presidency
was also seriously tested by the Iran-Contra affair.
President George H W Bush oversaw the release of the last US hostage in Lebanon
and indicated to Iran that Tehran's good will would lead to reciprocity, but he
never followed through on the promise. President Bill Clinton tried all sorts
of blunt sanctions to force Iran into submission, principally against the
country's oil and
gas sectors, but failed to get results. The outgoing President George W Bush
worked with Tehran to throw the Taliban out of Kabul but went on to name Iran
as a founding member of the axis of evil, where it now resides, its only
remaining member; the others were Iraq and North Korea. Bush has also locked
horns with Iran in Iraq and on the question of Iran's nuclear ambitions.
US presidents, not surprisingly, are increasingly hesitant to engage with Iran
unless there is a relatively high probability of success. The initial attitude
of president-elect Barack Obama, will, in all likelihood be similar. But Obama
may be in a much better position than any recent president to succeed where
others have failed - thanks to factors at play within Iran and the possibility
that he might bring fresh insight, perspective and advise to the problems in
dealing with the country.
Iran already has one strike called against it - it is on the verge of an
economic implosion - and is facing a second and a third strike in rapid
succession over the next six months. Indeed, for the first time since the early
days of the Iranian revolution in 1979, regime change, more accurately a
"velvet" regime change, in Tehran may not be out of the question.
If regime change occurs, it will be from self-inflicted economic failures,
international economic developments and a thoughtful US response.
Strike one: Economic failure
Before the Iranian revolution, Iran's economy was heavily dependent on oil.
Since then, an eight-year war with Iraq, low oil prices in much of the 1980s
and 1990s, an influx of refugees, rapid population growth, US economic
sanctions and ill-conceived policies have all adversely affected Iran's
In addition to the heavy human toll, the comprehensive cost of the Iran-Iraq
war was of the order of US$800 billion, amounting to about 60% of Iran's
aggregate gross domestic product during the entire period of the war. As a
result of regional conflicts, Iran became host to the largest population of
refugees in the world, placing an added financial and social burden on the
Iran's economic performance continues to be determined to a significant degree
by conditions in the international oil market. From the mid-1980s through 2003,
oil export revenues were adversely affected by generally low oil prices. Yet
when oil prices reached record heights, oil export revenues remained
disappointing, due to declining oil output and to rising domestic consumption
and smuggling of gasoline for export, both encouraged by low domestic prices
that remain highly subsidized.
The inability of the United States to shape Iran's foreign policy has
frustrated US leaders since the Iranian revolution. To show its displeasure and
to further frustrate and keep pressure on Tehran, Washington has used
indiscriminate economic sanctions as its weapon of choice, with limited effect.
Sanctions have served to reduce significantly foreign direct investment in the
country, raised Iran's cost of capital and in delayed exploitation of Caspian
Sea oil and gas. A second difficulty with regard to Caspian exploration has
been Washington's efforts to generally reduce Iranian revenues by vetoing
pipelines through Iran.
It is evident that these adverse developments, which were largely outside
government control, have had an impact on Iran's economic performance. Yet the
effects of Iran's own policies have arguably been the most detrimental.
In the immediate aftermath of the revolution, nationalization became
widespread, reflecting the regime's political and social philosophy, continuing
to the present day after much of the rest of the world has embraced
privatization. The government created a number of new foundations to further
its social and revolutionary agenda. These foundations manage the vast holdings
inherited from the shah's regime, companies that were nationalized and private
assets that were expropriated.
The foundations have had privileges and access to credit that have been denied
to the private sector. Most of them operate outside government oversight and
have at times frustrated government economic policies.
Under President Mahmud Ahmadinejad, enormous economic privileges have been
extended to the Iranian Revolutionary Guards Corps. The guards have been
favored for large government contracts and have received preferential tax
treatment, especially with regard to import duties. The guards, though
inefficient, are well on their way to becoming the single-largest business
enterprise in Iran.
As is the case in the aftermath of many revolutions, the government attempted
to improve working conditions by adopting restrictive labor laws and making
layoffs costly. Indeed, under Iran's labor laws employers have to give workers
lifetime employment contracts. Despite the government's best intentions,
policies intended to protect labor have exacerbated the unemployment picture.
Iran does not have an efficient tax system and relies heavily on oil revenues
to finance its expenditures. It is estimated that oil and gas revenues
constituted over 75% of total central government revenues in 2006, with tax and
non-tax revenues contributing the balance.
A modern government needs an efficient tax system to provide relatively stable
revenues, a mechanism for effecting income distribution and a tool for
macroeconomic management. In Iran, only government employees pay their complete
income tax bill because the tax is taken out of their paychecks; the private
sector does whatever is necessary to minimize its tax obligations and hardly
anyone pays capital gains taxes. The absence of an effective progressive income
tax and a capital gains tax have in turn been a major determinant of Iran's
highly skewed income distribution, a large blot on the record of any
Iran's economic shortfalls have been dramatically exacerbated by widespread and
regressive government subsidies, and by administered prices. These were a
legacy of the war with Iraq, but the subsidies have been continued for the sake
of political expediency. The single largest subsidy, that for gasoline, was in
the range of 11-22% of GDP during 1997-2006. Implicit and explicit subsidies
typically have accounted for 15-25% of GDP.
In the 1990s, the Iranian government correctly realized that it needed to
establish an oil stabilization fund (OSF) to cushion fluctuating oil revenues.
Unfortunately, the government has not abided by its own legal terms for
managing this fund. As a result, over the past three to four years, with record
oil prices and at a time in which it should have built up the fund, the
government has instead drawn it down.
While the government will no longer reveal the balance of funds in the OSF, by
my estimate the current balance (at less than $20 billion) is lower than what
was in the fund when Ahmadinejad took office over three years ago. Every major
oil-exporting country has increased its level of financial reserves during
these boom years, save Iran. Why?
Iran's macroeconomic policies over the past decade defy logic. With rising oil
revenues, the Iranian government has increased government expenditures freely,
resulting in inflation rates that have been in the 20-30% range and real
interest rates on the order of minus 10-15%. At the same time, the exchange
rate, although categorized as a managed float, has moved in a narrow range of
about 10% to the US dollar.
Prices for imported goods have increased somewhat along with global inflation
but prices of non-tradeables have increased at a much faster rate (with
Tehran‘s real estate prices increasing by about 1,500-2,000% over the last 10
years), resulting in a highly overvalued currency and great damage to Iran's
The wealthy have gained beyond belief, through a real estate bubble that makes
the US bubble look like a little blip. The wealthy have taken much of their
capital out of the country, with oil revenues supporting their capital flight
at an essentially fixed exchange rate, while the average citizen has suffered
and received little benefit from oil depletion. Iranian citizens have
essentially been fleeced. All along, the central bank has played an
accommodating role (increasing credit by about 25-30% per year) as it has very
limited independence from the government.
What is the result of these policy failures?
The most serious consequence of Iran's economic failure for the regime is an
unemployment crisis. Over the last 10 years, Iran's unemployment rate has been
in the range of 15-25% and is