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    Middle East
     Sep 15, 2010
Page 1 of 2
Iran's slide to the bottom
By Hossein Askari

This is the first article in a two-part report.

To get some perspective on the state of the Iranian economy, it may be useful to begin by providing a few benchmarks.

In 1970, Iran's gross domestic product (GDP) was US$10.6 billion (ranking 27 among all countries), while the commensurate figure for South Korea was $8.9 billion (32nd). Ten years on, Iran's GDP was $90 billion (19th) and Korea's $63 billion (28th); and in 2005, Iran had sunk to 31st in GDP ranking at $190 billion and Korea had climbed to 13th, with $791 billion.

Moreover, for Iran, real per capita income growth in the period 1980-2005 was about zero; and although it increased after 2005 because of rapidly rising oil prices, over the long haul there has


been insignificant growth in real per capita incomes over the past 30 years since the Revolution.

As for oil, Iranian and Saudi Arabian oil production in selective years show a position of effective parity four decades ago transforming into one where Saudi output was almost double that of Iran last year: in 1970, Iran 3.83 million barrels per day (mbd) and Saudi Arabia 3.8 mbd; in 1975, Iran 5.35 mbd and Saudi Arabia 7.08 mbd; and in 2009, Iran 4.04 mbd and Saudi Arabia 8.25 mbd.

For natural gas, although Iran and tiny Qatar have about the same level of reserves (Iran ranking second and Qatar third globally) largely as a result of a joint gas field in the Persian Gulf, Qatar became the world's largest exporter of liquefied natural gas (LNG) quite some time ago and is expected to export 105 billion cubic meters of LNG in 2010, while Iran does not export any LNG whatsoever. In fact, Iran has recently abandoned its two LNG projects (because of funding and needed technology transfer) in the natural gas field that it shares with Qatar, and is instead hoping in the future to become a big gas exporter through pipelines.

In oil, then, Iran's output has not kept up with Saudi Arabia's, and if we look at sustainable production capacity (because of low investment) and oil exports (because of rising domestic consumption), Iran has fallen even further behind Saudi Arabia. In natural gas development and LNG exports, Qatar, although quite backward in all areas of energy development 1980, today simply dwarfs once mighty Iran.

In terms of gross domestic product, to compare Iran's performance with South Korea may appear unfair given their present strengths, but the difference in performance is striking. In 1970, Iran had an economy that was about 10% bigger than Korea's; by 1980, around the time of the 1979 revolution, Iran's economy was about 50% bigger (in large part because of rising oil prices and revenues). Yet a mere 25 years later, in 2005, Korea's GDP was more than four times that of Iran's; and because of rapid population growth, Iran's per capita performance compares even less favorably to South Korea.

To say that the Iranian economy has underperformed since the Shah's overthrow in 1979 would be an understatement.

Emigration from Iran affords one reasonable overall verdict on economic (and political) conditions in Iran. Under the Shah, emigration was a trickle and was in large part motivated by political repression. Since the revolution, emigration from Iran has become a torrent driven by political, social and economic considerations; especially for the university-educated youth of Iran, the dearth of economic opportunities and hope for a better future has become the main motivating factor to emigrate.

According to the International Monetary Fund, Iran ranks first in brain drain among developing countries, with roughly 150,000 Iranians leaving Iran every year, and with about 25% of all Iranians with post-secondary education now living abroad in developed countries. It has been estimated that brain drain is costing Iran about $40 billion per year. Iranian officials dismiss the importance of the country's brain drain as inconsequential, but they do so at their own peril because the importance of a highly educated class for economic development and growth has become indisputable.

Another broad verdict on Iran's economic conditions is the size of foreign direct investment (FDI); this is an indicator of how foreigners perceive Iran's economic conditions and promise. FDI in Iran outside the energy sector has been paltry, and even in the energy sector it has been small relative to Iran's potential (as indicated by its reserves of oil and natural gas). The reasons are many: Iran's historically unattractive policies toward FDI, its sub-par economic performance and outlook, negative press coverage, a less-than-attractive business climate, and US sanctions. The failure in the energy sector (oilfield development, natural gas development in the Persian Gulf, Caspian Sea oil and gas development, pipeline development for Iranian exports as well as for transit) has been largely a result of US unilateral sanctions, shortage of capital and Iran's negotiating tactics.

To be fair, one should begin by acknowledging that on the eve of the revolution, the Iranian economy had a number of structural deficiencies that were much like those of other developing countries of the time. The economy was heavily protected from foreign competition and import substitution was seen as the way to develop and grow; at that time, this was the norm, or the perceived prescription, among developing countries, even among countries in Asia that have since excelled. At the same time, because of its dependence on oil exports, the public sector played a dominating role, in part stifling private sector development.

In retrospect, however, the low quality and inefficiency of Iranian institutions may be seen as Iran's major deficiency for economic growth at the time of the revolution. Although economists have been latecomers in recognizing the obvious, namely the importance of institutions, the contributions of institutions as the foundation for development and growth is today indisputable. Without efficient institutions, such as the legal system and the rule of law, confidence is diminished, and with it the desire to save and invest in long-term projects. Sadly, the revolution not only did not support and enhance institutional development, instead, and as will be discussed later, it has even eroded what was in place in 1979.

But why has the revolutionary government of Iran failed so? And is there any hope for a turnaround anytime soon? With this long-winded preamble, we can now turn to how and why Iran regressed after the revolution to be where it is today.

In the aftermath of the revolution in 1979, the regime nationalized much of the private sector. Nationalization increased the role of the government even further and stifled the nascent private sector that it had inherited from the previous regime. Nationalized industries were handed to newly created foundations run by political cronies. Import substitution policies were continued by the revolutionary government, but more forcefully than ever before because political cronies were inept managers and needed more protection from foreign competition to survive. Thus nationalization increased structural inefficiencies further and impaired economic growth.

Explicit and implicit subsidies, such as high tariffs, have supported most of Iran's industrial and manufacturing production. Although privatization policies to reverse these adverse trends started in the 1990s, they have achieved little. There has been more talk than action. Today, the public sector is responsible for well about 65% of Iran's total employment. In fact, with the increasing economic role of the Islamic Revolutionary Guards Corps (IRGC), the role and potential of the private sector may have been dealt a mortal blow (more on this later).

Iran's economic failures have been exacerbated by widespread, regressive government subsidies and administered prices. Although these were in part a legacy of the Iran-Iraq War between 1980 and 1988, they have been continued for political expediency. The regime has used subsidies to hide its economic failures and to gain support of the less-fortunate Iranians who have become dependant on government handouts because the economy has not created sufficient well paying jobs.

The single largest subsidy, namely that for gasoline, was in the range of 10% to 25% of GDP during 1997-2008; the cost of this subsidy has varied largely because of fluctuations in world oil prices, which are used to calculate the extent of the subsidy. The explicit (budgeted) consumer subsidies, for staple food items, water, electricity and the like, have amounted to another 5-10% of GDP in recent years. If everything were added up, subsidies have, on average, probably amounted to about 25-30% of GDP during the period 2000-2008.

These large subsidy expenditures, besides being inefficient by encouraging waste, have severely limited the resources available for investment in education, healthcare, infrastructure and industrialization. Many schools operate in shifts because of a shortage of space. The availability of university education is limited and its quality has deteriorated since 1979. Public healthcare is of low quality and limited in rural areas. And growth outside of the energy sector has been painfully slow

Although strapped for resources when oil prices were low from the mid-1980s to the turn of the century, the regime in Tehran has been unable to adopt an efficient and equitable tax system to enhance revenues and has continued to rely largely on oil revenues to finance expenditure. It is estimated that oil and gas revenues constituted more than 80% of central government revenues in 2007.

The absence of an effective progressive income tax and a capital gains tax have in turn been a major determinant of Iran's income distribution, which has only become more glaringly unequal since the revolution. The rich pay little or no tax. The poor have little income to afford taxes. As a result, the limited tax burden has fallen on government employees.

While institutions were inefficient and corrupt prior to the revolution, they have become even less effective and more corrupt under the revolutionary government. Corruption has permeated every level of society. Under the Shah, corruption was more or less limited to members of the royal family, ministers and other senior officials. In today's Iran it is even at the level of the doorman to government buildings. To go anywhere and get anything done requires a payment.

Continued 1 2  

Energy trumps all in Iran-China ties
(Sep 14, '10)

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3. The 'tragi-terror' that is Pakistan

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5.Energy trumps all in Iran-China ties

6.Nobody expects the American Inquisition

7.Greening China, from a paint pot

8. Taliban and US get down to talks

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(24 hours to 11:59pm ET, Sep 13, 2010)


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