The state of Iran's economy
Ali Ahmadi Motlagh (AM): How would you characterize the state of the Iranian economy? What are the most significant challenges currently faced by the government of Mahmoud Ahmadinejad?
Kaveh Ehsani (KE): The economy of Iran is in a deep recession, which has only been exacerbated by the recent round of sanctions passed by the United Nations, the European Union and the United States. Aside from more immediate concerns, the Iranian government is also grappling with several deep-rooted problems. First, it is dealing with the burden of a highly politicized, hybrid economic system that combines state, private, and semi-private ownership. The state exerts substantial control over the economy both directly and through semi-private entities such as foundations (bonyads), mutual funds, pension funds and companies linked to military organizations. Estimates vary as to exactly how much of the economy is under state control, partly because the semi-private sector doesn’t operate in a transparent fashion, but it is safe to say that these institutions dominate the economy. Since they are run by politically affiliated appointees, as opposed to managers hired according merit and competence, their activities tend to be highly politicized. Ideally, these institutions should be run according to transparent social and with economic rather than factional political aims, but any major changes will require resolute decisions by a government that is currently not prepared to pay the political cost of unpopular policies.
Another major challenge is reforming the multi-layered and burgeoning welfare system, which is administered through various state and semi-private organizations (such as Sazman-e Ta’min-e Ejtema’i, the Imam’s Rescue Committee, and other organizations supporting the veterans and the poor, etc.), all with access to substantial resources. While the welfare system has functioned fairly well, especially in regards to healthcare and population control, it is too politicized and will not be sustainable in the future if it is manipulated for short-term factional political expediency. Mohammad Khatami’s administration (1996-2005) tried to rationalize the welfare system and unify it under one administrative umbrella, the Ministry of Welfare, but it was not successful due to factional resistance. The main problem was and continues to be the politicization of debate surrounding reform, which tends to center mostly on the control and distribution of resources, rather than on the viability of possible long-term solutions.
The banking sector is equally politicized. One of first things Ahmadinejad did during his first term was to change a number of the directors of stateowned banks. Later he changed the manager of the Central Bank and pushed through measures to artificially lower interest rates, thus easing the flow of credit to selected segments of society. Historically there are good reasons to have a highly regulated financial sector while making sure that the Central Bank remains independent of political intervention. It is all too easy for the political administration of the day to run untenable deficits by borrowing from the banking system without the ability to pay it back through taxes or other means, or to award cheap money to favored segments of the population in exchange for political support. This is a sure formula for high inflation and the long term impoverishment of the vulnerable sectors of society who are on fixed incomes or who are not politically privileged enough to receive handouts.
Finally, there is a growing problem of acute poverty. Figures vary widely regarding the true extent of poverty, but Iran’s Department of Statistics recently announced that 10 million Iranians live under the absolute poverty line while 30 million live under the relative poverty line. How do we maintain the safety net? Instead of fighting over control of assets, the government needs to focus its efforts on creating jobs.
AM: How has the current administration dealt with these challenges? How do these policies compare to those of previous presidents? What has been the impact on Iranian society at large?
KE: Under Khatami, the government tried to bring greater monetary discipline to the banking system and created a reserve fund for oil revenues, so oil income wouldn’t be pumped directly into the economy and further exacerbate inflation. Instead, surplus oil revenues were geared to support the private sector. On occasion the government pulled money out of the fund, with approval of the Iranian Parliament (Majles), to fill gaps in its budget, but by and large it remained a development fund. The administration of Ahmadinejad completely scuttled these policies. Oil revenues increased substantially under Ahmadinejad due to international price increases, and nowadays the government dips into the oil fund as it pleases and uses the revenue to further its political agenda, aided by the carte blanche the Majles has given to Ahmadinejad in recent years.
The banking system, which was granted a certain level of autonomy under Khatami, has changed under Ahmadinejad. His administration has been lowering interest rates and creating cheap short-term personal as well as home loans, which are not sustainable. Other cheap loan programs to encourage entrepreneurial startups have backfired because there is little supervision and the necessary institutional commitment to make sure these programs come to fruition. The rate of non-returns on these loans has been very high, somewhere between 50% and 60%, meaning that most of the money loaned out is essentially not coming back. By arbitrarily lowering interest rates, and easing the standards of lending, the government has artificially cheapened the price of money to make it more readily available to certain segments of the population. As a result, inflation has gotten much worse, poverty has increased as income-streams lose their value, investment in productive sectors has dropped or has gravitated toward ever more speculative ventures and there is a serious problem with flight of capital abroad.
Khatami also pushed for more transparency in various economic sectors. In particular he called for line items to be published in the national budget, instead of lump sum figures for, say, agriculture or the military sector. In other words, these sectors had to demonstrate exactly what they needed the money for and how they were going to spend it. Khatami’s administration never received proper credit for this major initiative, which has been shelved under Ahmadinejad’s administration. Currently, no one knows whether the figures in the government’s budgets are accurate, who allocates them or on what this allocation is based. This was one of the major issues that came up in the debates before the 2009 presidential election.
At this time little is being done to diversify the economy. Diversification means encouraging an autonomous private sector to get involved, invest and do business. This requires both political and economic stability so that companies can reasonably plan for future growth. Unfortunately, the main feature of Iran’s economy today is the unpredictability of the political and legal climates. In a highly politicized atmosphere, the government is making its own decisions and impacting the economy according to its own sectarian priorities and interests.
AM: Much has been made of the government’s plans to remove subsidies on essential goods and distribute the resulting savings to the population. The plan has been supported by Supreme Leader Ali Khamenei, but has faced great domestic opposition. What is the government’s aim in removing subsidies? Why is there so much opposition to the plan? How will removing these subsidies actually affect the average Iranian citizen both in the short term and the long run?
KE: The idea of removing public subsidies has been debated since the end of the Iraq-Iran war in 1988. The subsidies we are talking about here are wide-ranging and blanket-style subsidies for basic foods, energy, and utilities, which were put into place after the war to keep prices low and which are now unsustainable. For one thing, these subsidies are very expensive, with some estimates placing the cost at 25% of Iran’s GDP in 2009, a figure that will only rise as the population increases and is especially worrying given Ahmadinejad’s recent attempts to spur such population growth. Subsidies also lead to wasteful behavior. According to the Ministry of Agriculture, one third of the bread produced for consumption is wasted because it is too cheap. The same goes with water, though in that case some preventative non-market mechanisms have been implemented. Finally, instead of the poor, those benefitting most from the subsidies have been middle and upper income Iranians. In fact, according to Iran’s Ministry of Economics and Finance, the richest 30% have taken advantage of some 70% of government subsidies.
At the same time, proposals to reduce subsidies have historically been met with fierce public opposition. During Khatami’s presidency, the World Bank proposed a significant reduction in subsidies, but the government never pursued any plans to this end because of the political cost. Aside from the difficulties in figuring out what subsidies to cut and by how much, the Administration knew that any plans to reduce subsidies would be met with public disapproval.
In order to reduce dependence on oil revenues and remove a large portion of subsidies, the Iranian government needs to have a predictable and sustainable revenue source, that is, a more viable income tax system. Whether or not this tax structure is progressive, it cannot work without accurate statistics, the obtaining of which depends on accountability and transparency on the part of the government. This system needs be fair and impartial, and it must ensure that tax revenues are being spent for the right things and in the right way. The current system of taxation is both too politicized and quite partial. People with fixed incomes pay taxes, whereas merchants, farmers and anyone operating in the vast informal sector avoids detection.
At this point Ahmadinejad’s administration is considering a plan that would marketize subsidies by giving cash to select groups to pay for services. This plan is unfeasible, in part because it allows the government to punish opposition groups and reward its supporters via its economic policies. Subsidies in their current form are a huge problem and need to be addressed, but in order to succeed the process of reform must be democratic and inclusive of all social groups.
AM: According to the 5-year development plan of 2005-2010, the Privatization Organization of Iran, affiliated with the Ministry of Economic Affairs and Finance, is in charge of setting prices and ceding shares to the general public and on the Tehran Stock Exchange. Reformists, conservatives and even Khamenei have backed efforts towards greater privatization of the economy. How are these efforts proceeding? What are the main obstacles to privatization? Will privatization actually have a positive impact on the Iranian economy?
KE: The idea of privatizing the common sectors of the economy has been around at least since the presidency of Ali Akbar Rafsanjani (1989-1997), if not before. But privatization of the commons has always been a problematic notion, mainly because it is against the current Iranian constitution, which considers key sectors of the economy to be owned by the population (omumi). If you privatize commonly owned companies such as Iran Air, they will be run exclusively for profit, as opposed to providing a public service while economically performing at a reasonable level. The current debate on privatization has mostly been about the fate of companies in the common and semi-private sectors. Under the Pahlavi regime, most of these companies were privately owned, before being confiscated and made public or nationalized under the Islamic Republic.
Let me make this point clear. We need to distinguish between three forms of ownership: private, public (or state owned) and common. Public/state owned property could be bought and sold by the government to satisfy policy goals, but common property does not belong to the government to do with as it chooses. Rather, it belongs to the whole population and to future generations. The state may act as the guardian of this public trust, but cannot act as its owner. National parks or nature preserves in the United States, for example, cannot be sold by the federal or local governments. In Iran, oil reserves or water sources do not belong to the state. The current constitution is not quite explicit on this point; the language is ambiguous, but the public spirit at the time these fundamental laws were written was unmistakable. The issue of privatization of common goods is and should be very contentious. First, we live in a global environment where market fundamentalism seems to be accepted as common sense, and one of the most misguided tenets of this form of market fanaticism is the claim that private ownership is better or more efficient than public. All you have to do to is travel on a state owned and operated French railroad system and compare it to the privatized British system to realize the superficiality of this notion. Since 1979, but especially after the end of the Iran-Iraq war, there has been an ongoing debate among the political elite in Iran about what should be done with the issue of ownership of resources and assets.
In effect Rafsanjani, and later on Khatami, adopted the view that common and public property were one and the same, and both should be privatized. Conservatives managed to block privatization efforts, not because they were against it, but because they wanted themselves and their allies to benefit from this privatization of common wealth. Since the election of Ahmadinejad, the process of privatization has actually accelerated exponentially, benefiting neither the general public nor a genuinely independent private sector but mostly semi public entities and institutions closely associated with the current ruling political faction. Worse still, a secure and independent private sector has not been allowed to flourish. The uncertainty of the domestic economy, combined with the impact of sanctions, has led to a substantial amount of money being taken out of the country. Instead of production and manufacturing, then, the main venues for private business have been trade and real estate, both of which are high risk and speculative ventures.
AM: Historically, two of the major players in the Iranian economy have been the bazaar and the powerful foundations. Can you briefly discuss the role of these institutions?
KE: Well, according to Arang Keshavarzian, the bazaar is no longer the significant economic force it once was because it has been largely depoliticized. Historically, the bazaar was a locus of liberal thinking and an active participant in Iranian politics. Now members of the bazaar are more concerned with economic well-being and less with fighting for political rights. However, during the recent agitation against government proposals to raise value-added (VAT) taxes on certain goods, the bazaar showed that it still had some resolve and solidarity in forcing the government to halt its plans. It’s probably safe to say that if the business climate gets worse, the bazaar will definitely react, even if it no longer possesses the economic muscle of times past.
As for the bonyads, they are many in number and they perform very different functions. The important point about the bonyads is that they are under the supervision of the Supreme Leader, not the parliament or the government. As a result they have a massive presence not only in society and in the economy, but also in politics and the public culture of the country. The Imam’s Rescue Committee, for example, provides direct financial aid to the destitute. But how do you define who is destitute and who is not? Well, the destitute by definition are dependent on the trickle down of money and services provided by this institution. And here is a great example of political clientelism. The function this bonyad performs is important given the reality of chronic poverty and unemployment, yet the several million recipients of aid form a bulwark of political support for conservative politicians when it comes to voting or confronting public protests. The Foundation of Martyrs plays a similar role in securing the support of war veterans in defense of the regime. On the other hand, the Foundation for the Downtrodden (Bonyad-e Mostaz’afan), one of the largest foundations in the country, is a veritable economic conglomerate with interests and assets in nearly all sectors. It acts increasingly as an economic empire, albeit secretively and clearly with a conservative political agenda. Then you have the foundation associated with the shrine in the holy city of Mashhad (Astan-e Qods’e Razavi), a centuries old foundation, also controlled by the Supreme Leader’s appointee, but administered by the clergy of the city.
Iran’s bonyads are comprised of many complex and different institutions that cannot be lumped together. Some perform vital roles in maintaining a safety net and provide needed social services, but these functions are linked with a regressive, murky and clearly undemocratic role in the political domain. Other foundations are giant economic conglomerates, but they perform more or less outside parliamentary oversight and bureaucratic regulation. Some pay taxes, but whether their contribution to the public economy is adequate is unclear. By and large, they are a significant part of the economy but, as I mentioned at the beginning, an economy that is highly politicized in the sense that it is not transparent and accountable to the population and their representatives.
AM: How are Iran’s trade relations with neighboring countries? How are its economic relations with Russia and China?
KE: Iran’s relations with China and Russia are very fluid. Both are contemporary global rivals of the United States and Europe, and they understand the reality that Iran is a key player in a vitally strategic region. They see the Iranian economy as a significant market where they don’t face intense rivalry from the United States and the EU. Furthermore, they are not unhappy that United States’ blunders have significantly weakened its status as the sole superpower. Iran’s alienation and hostility to the United States can be seen as an asset that allows these countries to maintain a foothold in the region. On the other hand, as a strategic asset and an ally, Iran is nothing if not problematic and risky. The cost of doing business with Iran is getting higher for China and Russia, especially as the United States and EU press ahead with financial sanctions. At some point, these countries may get exasperated and decide to stop protecting Iran in the Security Council, despite being highly skeptical of United States intentions. But I don’t think we are there yet.
Turkey, meanwhile, is trying to replace Dubai as Iran’s main trading hub in the region. Recently, there has been much talk of increasing trade with Turkey by reducing tariffs. Turkey is undergoing some major internal and international rethinking of its regional role. The recent referendum in Turkey has reshaped the political map and I think the AKP (Turkey’s Justice and Development Party) is eager to capitalize on its position of strength to push forward with an assertive role for Turkey in the region. Iran and Turkey are neighbors, with a millennial history of complex rivalries and cooperation. I think the current Turkish government is rethinking its relations with Iran pragmatically and strategically, rather than ideologically as did under previous secularist regimes. It sees Iran as a key regional presence who will not go away, and who cannot be ignored. Iran’s hostile position towards the United States is perceived as an opportunity for economic alliances, but only if international tensions don’t reach an explosive point.
AM: Will acquiring nuclear capabilities help Iran economically?
KE: There is no way to predict the actual economic impact of a nuclear program because we don’t know how much it will eventually cost and whether the benefits will be worth it. By the time of Khatami’s presidency some $18.5 billion had already been invested in the nuclear program, but as of right now not a single kilowatt of nuclear energy has been created. We also cannot predict the future environmental costs.
Khatami claimed that Iran could become self-sufficient by harnessing nuclear energy, but his own vice-president stated that Iran does not have the mining capacity to maintain a nuclear program. In my opinion, the quest for nuclear capability is driven by political rather than economic considerations, and has more to do with Iran’s defensive strategies than anything else. No economic rationale exists because this would require a cost-benefit analysis that is impossible to obtain without accurate and reliable figures.
The Iranian regime is a rational player on the international stage – they respond to problems with an instrumentalist approach that seeks to maximize short-term gains but does not yield long-term solutions. Iran is willing to negotiate on its nuclear program, but it will not accept any preconditions, which is what the United States wants. Under Khatami, Iran stopped enrichment unilaterally and then it was slapped in the face with the Axis of Evil rhetoric and a hostile Bush administration. This is a game that Iran is playing, using the nuclear program as a bargaining chip. The Arab countries are worried and will respond accordingly. The idea that Iran will gain security by possessing nuclear weapons is very short-sighted. As soon as they acquire such capabilities, all the other countries in the region will also rush to acquire them, creating a military stalemate that is not really worth the cost. Gulf countries are pushing the United States to confront Iran, but at the moment the situation is turning into a huge arms race.
AM: How have the recent round of sanctions impacted the government? What will be their impact for the general population?
KE: Among other things, because the recent round of sanctions has affected credit and financial structures it has made it more difficult for Iran to sell its oil. Iran has lost a number of customers, especially in Europe, and now has a smaller pool of business partners in the international arena. Contrary to the claims made by Ahmadinejad, economic signals indicate that sanctions are also hurting the private sector. Whether large or small, private enterprises cannot obtain letters of credit or do business internationally. The Majles is battling Ahmadinejad over this issue and Khamenei is also getting involved. By making it more difficult for private companies and multinationals to work in Iran, the sanctions will only further decrease competition, allowing for the state and the aforementioned semi-private institutions to wield even more influence over the economy.
The ruling elite is very uneasy right now and inter-factional fighting is taking its toll. In the short term, inter-conservative battles will become heated, but it is tough to gauge the public’s mood going forward because of the absence of a free press and credible data. However, it is clear that a worsening climate of insecurity and the tightening of international financial circuits will affect the general population negatively. Investors will withdraw their capital from circulation and either move it to safer places or convert it into fixed assets. Cheap imports have been used as a way of countering inflation and rising poverty, even though they clearly exacerbate and cause these problems. Now that imports are falling, prices will rise further and it is not clear domestic producers will fill the gap if they fear devaluation of the currency and further isolation and economic insecurity. I fear that, contrary to the claims of president Obama and Hillary Clinton, these sanction are anything but “targeted.” They will hurt ordinary people, especially the middle classes. They might even play into the hands of the Ahmadinejad administration and help him unify the disgruntled conservatives and their supporters by pointing to the negative and indiscriminate effects of sanctions on the lives of ordinary Iranians. Let us remember Iraq in the 1990’s, where the sanctions imposed by the United States and the U.N. hollowed out Iraqi civil society and ushered in the most brutal and corrupt period of rule by the Baath party. When the Americans invaded, impoverished and brutalized Iraqis went on a rampage, stealing whatever they could get their hands on from their national antiquities to the copper they found in electrical wires. The notion that the people will challenge their government if they feel the pain of the sanctions is simply bogus.
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