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    Middle East
     Nov 6, 2008
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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 economic performance.

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 country.

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 revolutionary government.

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 competitiveness.

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

Continued 1 2  

US juggles double-edged Iran sanctions (Apr 16,'08)

Iran can't shake the sanctions shackle
(Feb 26,'08)

India seeks 'velvet divorce' from Iran

2. Send off the clowns

3. Nightmares at hyper-speed

4. The end of a subprime administration

5. Lesson redux

6. Big step across the Taiwan Strait

7. Business as usual with China

8. Chalco in the wings as Rusal stumbles

9. A strike against 'Iranophobia'

10. A repeat lesson for voters

(24 hours to 11:59pm ET, Nov 4, 2008)


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