Page 1 of 2 THE IRANIAN ECONOMY, Part I 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.
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