Page 2 of 2 THE IRANIAN ECONOMY, Part I Iran's slide to the bottom
By Hossein Askari
Corruption can be seen even in the day-to-day policies of the government, and
especially of the Mahmoud Ahmadinejad administration. For instance, why have so
many large contracts been lavished on the IRGC? This might be justified if the
IRGC was qualified for the contracts it contested and if the bids were fairly
evaluated. Even before the Ahmadinejad government took power in 2005, the IRGC
would routinely bid on contracts (such as developing gas fields and off-shore
oil fields) where it had no expertise; it would then turn around and
subcontract its "winning" bid to a foreign firm, invariably one that was not
eligible either (due to factors such as propriety technology or financing), and
then take a large cut from the top.
The net result: the projects cost more, unqualified firms undertook them and
the role of the private sector was discouraged. But also
with the result that the senior members of the IRGC were enriched and then in
turn supported the government (a very costly and roundabout way to enrich
cronies). President Ahmadinejad has practiced the same policy more openly and
taken it to new highs. For example, while Bechtel developed Qatar's gas field
and built its LNG capacity with the most effective technology (Conoco
Phillips), Iran relied on the IRGC and European companies that were not fully
qualified; and the consequences are clear.
Over the past five years, a period when oil peaked at nearly $150 per barrel in
July of 2008, the Iranian government spent oil revenues with no regard to
Iranian law or to the impact on the economy.
In 1999, Iran established an Oil Stabilization Fund (OSF) to reduce
fluctuations in government budget revenues through periods of rising and
falling oil prices. The Iranian parliament adopted strict procedures for the
operations of the OSF. Yet, while the holdings of the OSF should have increased
significantly during the period of rapidly rising oil prices, they in fact
decreased. Moreover, although Iran adopted a law that would require the
government to wean itself from oil revenues over a period of 10 years, its
dependence has instead increased during Ahmadinejad's presidency over the last
five years.
The populist Ahmadinejad has ordered the central bank to withdraw funds from
the OSF to support his expenditure policies. Central bank governors who have
not followed his orders have been summarily fired. In fact, Ahmadinejad spends
from the national treasury as he wishes, without parliamentary approval, to buy
support as needed. In a country where the president behaves so, the rule of law
is only a mirage and affords no comfort to long-term investors.
Iran's macroeconomic policies over the past decade have not been supportive.
With rising oil revenues, the government has increased its expenditures freely,
resulting in inflation rates that have been in the 20% to 30% range and real
interest rates of minus 5% to 15% during the last seven years.
At the same time, the exchange rate, although categorized as a managed float,
has moved in a narrow range of about 15% to the US dollar over the last 10 or
so years. Prices for imported goods have increased along with global inflation,
but prices of non-tradables have increased at a much faster rate (with Tehran's
real estate prices increasing by about 1,500% to 2,000% between 1998 and 2008).
The result has been a highly overvalued currency that has damaged Iran's
international competitiveness.
The wealthy have gained through a real estate bubble that dwarfs that of the
US, prompting the rich to sell, with oil revenues subsidizing their capital
flight at an essentially fixed exchange rate. The estimated size of massive
capital flight over the last eight years has been about $250 billion.
In addition to all these failures, the government initially encouraged rapid
population growth (later reversed) which resulted in roughly a doubling of the
population between 1979 and 2001 and heavy pressure on infrastructure,
education and healthcare.
Creating gainful employment for the country's youth has been, and will continue
to be, the major challenge for at least another 15 to 20 years. Iran's official
unemployment rate has been 10 to 17% over the last five years, with the true
figure in the 20-25% range. Given this depressing landscape, it is no wonder
that the highly educated university graduates are attempting to leave Iran with
little intention of coming back, with dire implications for the country's
future.
Besides these self-inflicted policy and institutional failures, Iran has had
two other setbacks that have been to different degrees outside of its control.
First, the Iran-Iraq War took a heavy toll on Iran (as well as on Iraq). In
addition to a major loss of human life (exceeding 500,000) and the seriously
injured (in excess of 500,000), the direct economic damage was high; most
estimates are in the range of $600-$900 billion, with about $800 billion as a
consensus figure.
Such damage is significant for an economy the size of Iran's, representing
about 150% of aggregate 1980 to 1988 GDP, and 160% of aggregate oil revenues
earned by Iran from 1975 through 2000. Damage to Iran's infrastructure alone -
which amounted to $257.3 billion - was equal to almost half of the country's
aggregate GDP from 1980 to 1988.
Second, US unilateral sanctions (and to a much lesser extent United Nations
sanctions) have had an impact on Iran's development and growth. While US
sanctions on Iran have had a long history going back some 30 years and there
have been several rounds of UN sanctions, two broad actions stand out for their
effect on Iran: the Iran-Libya Sanctions Act (ILSA) adopted under President
Bill Clinton (later modified to Iran Sanctions Act, or ISA), and the
ever-tightening financial sanctions engineered by the US Treasury (especially
since 2008).
The major impact of ILSA has been to slow down, and in some cases halt, the
development of Iran's oil and gas reserves. The US has used its sway over the
global economy and has adopted practices that go beyond its borders
(extraterritoriality). Energy firms have been threatened with US fines and
sanctions if they invest in Iran's energy sector. This has essentially stopped
the participation of US, European and Japanese firms in Iran; it has stopped
the development of Iran's interest in the Caspian basin; it has excluded Iran's
territory from being used as transit for bringing other Caspian oil to market
(the least-cost route and again reducing Iranian revenues).
These measures have thus reduced government revenues. Whether this is all bad
or good for the people of Iran is open to debate as corruption and government
waste would have squandered these revenues.
The most effective and immediate sanctions on Iran have been the financial. The
US Treasury has essentially tried to cut off Iranian financial institutions
from the international payments system. This has been done more deliberately
and effectively since November 2008. Essentially the US has again used its
extraterritorial powers to fine and threaten any financial institution that
deals with institutions that the US has sanctioned.
Still the US has not gone all the way. It has not sanctioned the central bank
of Iran and it has not used all its powers to pressure countries (over which it
has influence) that still cooperate with Iran, such as the United Arab Emirates
and Malaysia. But even existing US measures have increased the cost of letters
of credit and of all other financial transactions for Iran. The broad impact
has been to increase the cost of imports by about 20%, further pressuring the
government budget and reducing the government's room for maneuver and limiting
its ability to buy support domestically.
Meanwhile, the average citizen suffers, receiving little benefit from the
depletion of the country's oil reserves. Iranian citizens and future
generations have essentially been fleeced in favor of the wealthy and resources
have been wasted in inefficient subsidies.
Simultaneously, the government touts its commitment to economic and social
justice, while inflation and unemployment are high, good paying jobs scarce,
social services limited and there is little hope for a better future. All the
while, Gulf Arabs, with the exception of Iraq, whom Iranians have historically
belittled as Bedouins with little cultural heritage, prosper economically and
move ahead of the once proud Persian people.
In short, the policies of the revolutionary government of Iran have failed the
Iranian people miserably. Economic failure and the resulting hardships are more
of an issue than political repression for the average Iranian. Economic failure
for some has become increasingly a question of survival.
Next: Ahmadinejad shuns a brighter future
Hossein Askari is professor of international business and international
affairs at George Washington University.
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