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    Middle East
     Sep 16, 2010
THE IRANIAN ECONOMY, Part 2
Ahmadinejad shuns a brighter future
By Hossein Askari

This article concludes a two-part report
Part 1: Iran's slide to the bottom

While all available figures confirm Iran's broad economic failures, the best proof of its dismal economic conditions may be the economic difficulties of life in Tehran.

A young couple with bachelor degrees and a few years of work experience as schoolteachers would have a combined monthly income of about US$1,000. If the couple had a young child, they would need at a minimum $1,000 to pay their monthly bills (food, clothing, electricity, gasoline, insurance, medical) and another $1,000 per month in rent for a modest apartment (which also

 

requires a significant security deposit). How can such couples, university-educated at that, survive? They can't. They need to get second jobs or rely on the support of their families.

While official numbers say that inflation is down, life in Tehran tells a different story. The prices of necessities over the past 12 months have soared - milk and yogurt prices have about doubled and chickens and lamb prices have increased by about 75%. At the same time, government-subsidized items, such as electricity and gasoline, have also increased in price. These are items that figure heavily in the Iranian consumer basket - what families have little choice but to buy. Contrary to government pronouncements, inflation has not declined to under 10%, as recently reported by the government; in all likelihood it has increased to over 20%.

More broadly, unemployment and underemployment may be the regime's Achilles' heel. Unemployment is around 20%. Most depressingly for the young, there is little hope of a better future, with the result that a significant proportion of young educated Iranians, the brightest and the best, have emigrated and will continue to emigrate from Iran.

The country is losing a generation of its most highly educated citizens to countries that promise a brighter future. While the government is concerned only for its short-term survival, the emigration of talented Iranians paints a bleak economic future for Iran.

Iran's economy and its export sector have diversified very little from oil in the past 30 years. This is in large part because of disastrous government policies, including an overvalued currency.

In short, the Iranian economy has structural problems that the regime has found politically difficult to address. The government has essentially used subsidies to buy short-term support instead of adopting reforms to develop and support a vibrant private sector, because it has been afraid of eliminating subsidies and redirecting the proceeds for supporting broad reforms.

The choices are difficult but are unlikely to get much easier than they have been in the most recent years with the support of a booming oil market. Some observers may attribute much of Iran's difficulties to economic sanctions. This is in my opinion incorrect. Sanctions have slowed the development of oil and gas reserves, increased the cost of trade by about 20% and limited Iran's ability to borrow on international markets. But in the future, at least the slow development of energy assets may be even seen as a beneficial effect of sanctions as the government has wasted much of its oil proceeds in the past 30 years.

To absorb the rapidly growing labor force, Iran has no choice but to achieve much higher gross domestic product (GDP) growth rates. The required growth cannot come from the overemployed and inefficient public sector, but must instead come from a vibrant private sector. Iran needs to grow at roughly 10% per year, a rate that it has never come close to achieving for many years, just to bring unemployment to the single digits.

The policies for an economic turnaround are obvious, but the regime has not embraced comprehensive policies in times of plenty because it feels threatened. It will be even less likely to adopt them in leaner times.

Over the past five years, under President Mahmud Ahmadinejad, much of Iran's oil revenues have been used to either buy domestic support for the regime or to make capital flight irresistible for the wealthy. While this harmful extravagance, whose purpose was to garner domestic support among the masses and the military, was possible during a period of record oil prices, the squeeze is now on. Difficult choices will have to be made. The choice for the government may come down to: tax the rich or starve the poor?

What does Iran need to do? Will it do what is necessary?

To have a chance of success, Iran must adopt comprehensive policy reforms and ensure that during the transition phase the majority of citizens (the less well-off economically) see and believe themselves to be better off than before the reforms.

This will require a well-designed social safety net (affording everyone necessities in food, shelter, healthcare and education) to compensate for the loss of indirect subsidies for the majority of citizens; a level playing field to give everyone a reasonable and equal opportunity for success; and a political campaign to convince the rich and those closely connected to the regime that in the absence of reform they are doomed.

A country that is heavily dependent on a depletable resource, such as oil, is different from other countries in at least one important way. The portion of its national output that is derived from the depletable resource is not sustainable. Simply said, when oil runs out its contribution to gross domestic product (GDP) falls to zero. Even more starkly, imagine a country that produces only oil. When oil runs out, its GDP will go to zero! So what is a country such as this to do?

The suggested policies are intuitive. Oil is a part of a country's capital base. When oil is sold it should be replaced by capital of another form. An oil exporter should first save at least a significant percentage of its oil revenues, resulting in a very high national saving rate. Then it could adopt one of two approaches.

The first approach is to invest the money and issue a check of equal real purchasing power to all citizens, now and in the future; in the United States, Alaska has adopted something along these lines. Abu Dhabi in the United Arab Emirates is investing so much already that it can support its population from just the return on these assets, and others such as Qatar may follow suit.

The second approach is to use the oil money to transform the economy into a fast growing non-oil economy to compensate for oil depletion. This would require the government to adopt policies to diversify the economic and export base away from oil, to provide non-oil sources of government income, and to provide attractive employment opportunities for its citizens.

The indicated policies are:
  • Provision of physical and social infrastructure (especially education).
  • Sound institutions to promote the rule of law, to reduce uncertainties and economic transaction costs, to enhance the market mechanism and encourage private sector growth, to provide sound regulations and its effective enforcement, and to generally improve the business climate (contract enforcement, transparency, low level of corruption, elimination of red tape, and so forth).
  • High savings and productive investments in areas that the country has a global comparative advantage.
  • Consistent macroeconomic policies, including a competitive exchange rate to support the development of non-oil exports.

    Developing better institutions is the key to reducing corruption, upholding the rights of each and every person in the benefits of oil wealth, eliminating waste and creating a healthy business environment for the private sector to flourish. But as in other countries, there is little short-run incentive for those in power to embrace better institutions as they stand to gain from their existing practices.

    Iran has by default chosen the second approach, but not the indicated policies that go with it. Iranian institutions are ineffective and corrupt. Instead of encouraging private sector growth, the government and its various organs, such as the foundations and the Islamic Revolutionary Guards Corps, dominate the economy, accounting for roughly 65% of national output.

    The government, instead of saving, is consuming as if there were no tomorrow; wasteful consumer subsidies, as opposed to productive investment, have dragged down the economy in the past decade. High-quality education is limited. The Iranian rial is overvalued, discouraging non-oil exports. The list could be easily expanded, but the results of these policies are everywhere to be seen.

    Oil has been a small blessing and a larger curse because of how it has been used. The clear message of social justice is that all current and future citizens must reap the same real benefit from resource depletion. Oil resources must thus be used in a just and efficient manner.

    The best approach would be to give each member of present and future generations a sum of money with the same real purchasing power by doing the following: (1) place all oil revenues into a fund; (2) invest the resources of the fund; (3) issue a check to every citizen from this fund (the amount calculated in a conservative manner and subject to change annually in order to ensure the same real benefit to all future generations); and (4) allow the government to borrow up to a fixed maximum percentage of the fund at an annual cost to be paid to the fund.

    In short, the government would develop economic policies assuming essentially that it could not use oil revenues as if they were current revenues. The size of payments to each citizen could only be approximated because a great deal of information would be needed, including the exact quantity of oil reserves and its quality (type of crude, cost of production and so on), the future path of oil prices and inflation, and population growth projections for all future time.

    Numerous secondary issues would also need to be addressed. Should each individual receive the same benefit annually or over his or her lifetime (assuming we knew everyone's exact life span)? Should transfers for children be made to their parents and if so up to what age? But assuming for the moment that all necessary information were available and all subsidiary issues were resolved, is this the most efficient way to allocate the benefits of oil depletion to all members of current and future generations of society?

    From an efficiency standpoint, it is better to give each individual the same fixed real sum of money every year than to give him or her the same amount through subsidies. The reason is simple. All individuals would not want the same subsidies and to the same extent. One may want food and shelter, while another may want clothing and healthcare.

    But what if social and private returns diverge significantly? The social return to certain infrastructure and other inputs such as education are so high that a dollar spent on these increases the welfare of society by more if that same dollar were divided up between all current and future members of society.

    The point is that if we had all such information and could make such interpersonal welfare judgments, it is possible that individual transfers may not always be the optimal solution. Even the provision of infrastructure from oil revenues (for example, the building of a road) could be questioned because future generations may benefit less (if the road is taken out in the future) or more (if the road results in a significant economic boom in the future). Moreover, if a road is constructed by the private sector, the builder might derive extra benefits if competition in the bidding process is suspect. To adjust for economic and social distortions, Iran desperately needs an effective system of taxation.

    Will Iran rise to the occasion? The prognosis under the Ahmadinejad government is not bright.

    Most recently, the government has been giving the impression that it is adopting reform. In reality, it is doing nothing of the sort. It is doing the opposite. It has announced its intention to eliminate subsidies and give direct cash payments to the needy. While the elimination of subsidies could have been a promising sign, in this case it is nothing of the sort.

    The government has no plan, no system and no process as outlined above under an oil fund. Instead this government initiative is driven by the government's desperate need of resources. Thus it will use some of the savings from eliminating (reducing) subsidies to finance its other expenditures, and the cash handouts will go to regime supporters as the government is being increasingly threatened from within. Politics is driving everything under the Ahmadinejad regime. It will be a continuation of its policy to use oil revenues to buy short-term support, no matter what the cost to current and future generations of Iranians.

    In sum, the post-revolutionary government has failed to deliver economic prosperity for the people. The regime has used and abused resources to stay in power. The only time over the past 30 years that the revolutionary government has done an okay job was during the eight-year Iran-Iraq War in the 1980s. During this brutal conflict, the country only limped along, but at least it did not incur a large external debt as might have been expected (as did Iraq). And even then, the reasons for this apparent success were that the constitution did not permit external borrowing and that no one would have probably lent Iran because of the attendant risk.

    Economic conditions have never been as bad as they are under Ahmadinejad. Economic performance and social justice are unlikely to improve in the foreseeable future, with or without US sanctions, as Iran's economic failures are largely self-inflicted. Unfortunately, the economic failures of the Ahmadinejad government will be felt for many years to come.

    Hossein Askari is professor of international business and international affairs at George Washington University.

    (Copyright 2010 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

  • Iranian unrest grows over economic woes (Jul 15, '10)

    Iran's Guards tighten economic grip (Jan 5, '10)


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