Iran’s Beleaguered Economy

Sueddeutsche Zeitung Photo/Alamy Stock Photo

robert looney teaches economics at the Naval Postgraduate School in California.

Published September 20, 2017


In 2015, after enduring years of punishing international sanctions that slowed Iran’s economic growth to a crawl, the country’s leaders finally agreed to a standstill on nuclear weapons development. Under the sanctions regime, living standards had languished, particularly for young Iranians. Those who could emigrated in the world’s largest brain drain — one-quarter of all Iranians with college degrees have left — while the rest struggled with high employment and stagnant real wages.

The administration of President Hassan Rouhani, which had safely navigated the narrow political passage left by hard-liners, hoped the post-accord lifting of trade and investment sanctions would revitalize the country’s economy. But the end of direct confrontation has proved disappointing, with the initial benefits falling short of expectations. While oil exports and foreign direct investment (mostly in energy extraction) have increased, they have not triggered the broad-based economic expansion needed to beat back unemployment and bolster paychecks.

Indeed, one could argue that the boost to the oil industry could prove as much a part of the problem as part of the solution. While increased oil exports are generating revenue in the near term, they are also contributing to a chronic world glut likely to depress energy prices for years to come.

Tehran now seems resigned to the idea that oil alone cannot solve Iran’s pressing economic problems. Instead, the country’s leaders have proposed to pivot, creating a “resistance economy” designed to “fight unemployment and recession, control inflation and confront the threats of enemies.”

Those Devilish Details

Iran’s major power groups — centrists with a secular bent associated with President Rouhani and conservatives tied to the religious establishment and the Revolutionary Guard — apparently agree that reducing Iran’s 30-percent-plus youth unemployment should be the first priority since largely idle (but often educated) youth can be a powerful destabilizing force. However, liberals and conservatives disagree as to how to accomplish this.

This split in views on the form of the resistance economy echoes classic 20th-century economic debates. President Rouhani sounds like he’s channeling the IMF playbook when he talks of greater government transparency, private sector engagement and openness to global market forces. In contrast, Ayatollah Khamenei’s conservatives emphasize the need for greater self-sufficiency. To this end, they would increase the state’s reliance on para-governmental religious charities and the military-run industries that grew out of the crushing Iraq-Iran war. 

Under President Rouhani’s approach, investment (domestic and foreign) would be directed into key industrial activities to quickly revive growth. Social spending would be curtailed, while several industries would be partially privatized to generate the cash needed to contain budget deficits. The goal is socially inclusive growth — i.e., growth without increased inequality — that nonetheless gives the economy the flexibility to sustain development in a rapidly changing global environment.

For their part, Ayatollah Khamenei’s group appears willing to settle for lower rates of economic growth in return for decreased vulnerability to possible future economic sanctions down the road. In their view, globalization presents a threat, not only to an economy that isn’t really competitive but also to the fiber of the Islamic state. It undermines the ideals of the theocracy by exposing the public to all manner of foreign influences.

Self-interest complements ideology on both sides of this divide. Rouhani’s version of the resistance economy would undermine the power of the mullahs’ Tammany Hall-like patronage system as well as the profitability of business monopolies controlled by the religious establishment’s key allies in the military.

In the end, the internal debate may tip toward the side that can demonstrate tangible benefits to the Iranian public.
Who’s Winning?

The Rouhani camp currently has public opinion — or, at least, urban public opinion — on its side, as evidenced by his convincing victory in the May 2017 elections. However, the hard-liners’ argument that Iran must insulate the economy from subversion by the United States and the newly aggressive Saudi Arabian royal family has gained credibility in light of President Trump’s confrontational stance. In the end, the internal debate may tip toward the side that can demonstrate tangible benefits to the Iranian public.

The Trump administration’s approach toward Iran has complicated Rouhani’s efforts to jumpstart the economy with increased foreign investment. Uncertainty about the future of U.S. sanctions (exacerbated by the Iranian military’s ongoing inclination to bait the eagle with ballistic missile tests) has deterred foreign investors. At the same time, sanctions stemming from human rights violations and support of terrorist groups continue to exclude Iran from the dollar-dominated global financial market’s clearing mechanism. Thus, while Iran has enjoyed increased foreign private investment since signing the nuclear agreement, the amounts have been far lower than initially anticipated.

Rouhani’s ability to compensate for the shortfall in foreign investment with increased domestic investment is limited. In recent years, high government expenditures — in particular, on the military, whose budget has more than doubled during Rouhani’s years in office — have resulted in sharp cuts to development spending. And this lagging investment goes a fair way toward explaining why economic blues have lingered in the post-sanction period.

While reducing unemployment is the priority, getting the sort of sustainable growth needed for Iran to reach upper-middle income status would require a significant increase in productivity. And the experience of other developing countries suggests that this next stage of development requires fundamental political and social change — in particular, containing the crony capitalism that now serves both the military and the religious establishment.

The standard policy prescription for increasing productivity includes measures to reduce market power, improve labor mobility, increase the efficiency of financial intermediation, and allow prices to reflect costs. But, while Rouhani pays lip service to the importance of extensive structural changes, he rightly fears that the short-term impact of reducing subsidies would strengthen the mullahs’ hand. 

That puts the president in a box. With little prospect of a major increase in private investment, stepped-up development expenditures or structural reforms, Rouhani’s version of a resistance economy is unlikely to produce significant results in the critical time frame. Reducing youth unemployment will undoubtedly remain an attractive political slogan, but don’t hold your breath while waiting for results.

Khamenei’s Not-So-Secret Weapon

On its face, Khamenei’s conservative version of the resistance economy hardly seems more promising as a mid-term strategy for increasing living standards and toughening the economy’s vulnerability to Trump’s policies. However, the case of the Astan Quds Razavi (AQR) religious foundation in Mashhad (Iran’s second largest city) should give the skeptics pause.

The foundation, whose income is anchored on quasi-mandatory charitable contributions, controls a vast network of companies with a wealth of over $50 billion. Under its founder, Ayatollah Abbas Vaez Tabasi, the AQR was run as a private fiefdom, dispensing patronage to the loyal. Since Tabasi’s death in 2016, though, the foundation has been directed by Ebrahim Raisi, a key conservative and former student of Khamenei who ran against Rouhani in the May 2017 election and has expressed a particular interest in addressing unemployment.

Even if Raisi’s focus began as nothing more than campaign rhetoric, with support from Khamenei the AQR could yet evolve into an engine for job creation (albeit an inefficient one). And it could prove to be a model for the other charitable foundations that provide the safety net in Khamenei’s state-dominated resistance economy.

That’s not good news for those who assume that time is on the side of Iran’s reformers. And it would certainly complicate efforts to contain Iranian power in the ongoing game of thrones in the Mideast. But it may sustain the hopes of Iran’s religious conservatives wed to the goals of the Iranian Revolution — and to keep food on the tables of the poor through the hard times ahead. 

main topic: Region: MENA