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A Perspective on Iran’s Post-Revolution Political Economy

by Jahangir Amuzegar
The Noruz Lecture by a Distinguished Scholar of Iranian Studies
March 24, 2000

The Noruz Lecture by a Distinguished Scholar of Iranian Studies March 24, 2000

Speaking confidently about the behavior and performance of the Iranian economy requires a good deal of professional courage. While more data on basic economic indicators are officially published in Iran than in most other countries in the region, objective analysts are still left with three missing essential ingredients – reliability, consistency, and transparency. To begin with, the Central Bank’s data on inflation, foreign reserves and extended debt, the Plan Organization’s figures on unemployment and the Treasury’s budget reports are frequently questioned by independent analysts as biased or inaccurate. Second, statistics supplied by various public agencies on the same items such as population growth, gainful employment, aggregate investment and annual economic growth do not always match. Finally, and most significantly, information on public enterprises’ balance sheets, the financial status of parastatal bonyads (charitable foundations), direct and indirect public subsidies, and capital flows in and out of the country are missing, opaque, or deliberately camouflaged. There is virtually no consensus estimate on the size and functioning of the informal or "underground" economy. The existence of several exchange rates further makes the conversion of the local currency into dollars for international comparisons virtually meaningless, if not actually impossible.

With these caveats in place, the post-revolution Iranian economy may be described as: oil-based, state-controlled, interest-group oriented, imports-dependent, monopolies-dominated, under-taxed, overly subsidized and relatively stagnant. President Mohammad Khatami has repeatedly called the current economy "sick" in production, distribution and regulation. Others have described it as mismanaged, under-performing, and wasteful.

A Misunderstood Revolution

The country’s drastic reversal of economic fortune can be traced back to the devastating results of the 1979 revolution and its equally frustrating pursuit of the unattainable. Twenty-one years ago, in February 1979, a seemingly solid, militarily powerful, internationally respected, economically viable, technologically modern, and relatively prosperous monarchy in the Middle East was overthrown at the hands of a frail and aging cleric with no troops, no weapons, no visible source of finance, and no known foreign support.

Even in a century distinct for the frequency and ferocity of its violence and revolutions – in Russia, China, and Cuba – and its endless military coups in Africa, Asia, and Latin America, Iran’s February revolution and the ouster of the Pahlavi dynasty still stands out as an epochal event.

The portent, pitfalls and potentials of this unique revolution were, however, missed by the pundits. On the ominous side, Time magazine, in its "Man of the Year" issue of 1980, portrayed Ayatollah Khomeini’s victory as a threat to "the world balance of power more than any political event since Hitler’s conquest of Europe." It described the event as a "model for the future uprisings throughout the Third World," On the other side, an American academician, widely praised for his insights on Iranian affairs, argued that "the Shiite clergy were mentally and emotionally unprepared for the challenge of rebuilding Iran," and that the revolution would produce either an authoritarian leftist regime, a right-wing military junta, or a Western-style liberal democracy." A left-leaning Iranian scholar foresaw a quick defeat for Komeini at the hands of "the labor movement and the left." The collective wisdom was that Khomeini’s would be a "make-shift" government, and that he, himself, would be unlikely to play a central part in governing the new Iran. As it turned out, the post-revolution Islamic regime of velayat-e faqih astounded all experts. The Khomeini model was not followed in the region’s other Sunny Muslim "monarchies" (or hereditary governments); nor did it spawn similar tendencies in any Shiite-populated countries like Iraq, Pakistan or Azerbaijan. At the same time, predictions regarding the short life and early demise of the Khomeini government proved premature. And the regime that was subsequently put in place was neither a leftist dictatorship nor a military junta, and certainly not a Western democracy, as previously envisaged.

Contrary to the experts’ predictions, Ayatollah Khomeini managed not only to survive the early turmoil, but gradually and methodically eliminate all its major opponents, as well as former allies and co-revolutionaries in order to establish a political system that has endured to this day. The Islamic Republic has so far succeeded to shed its pariah image, come out of its wartime political isolation, and expanded its diplomatic relations with all major world powers and trading nations, except the United States and Israel. This unique system, with all its flaws, has managed to show an extraordinary instinct for survival. Despite violent early revolutionary turmoil, the loss of a large number of its top religious, political, and military commanders at the hands of domestic opposition groups, a long, bloody and disastrous war with Iraq, ethnic separatist insurrections, international sanctions, burgeoning population, and repeated natural disasters, the clerical establishment has managed to survive. Despite its inherent capriciousness, political repression, human-rights violations, and an anachronistic moral code, the Islamic Republic has also been successful in eliciting support and loyalty from a considerable segment of the population. The regime has also rebuilt its military power after the cease-fire with Iraq, increased its defense capabilities on land and sea, and reportedly been successful in the development of medium- and long-range ballistic missiles. And, above all, it has stood up to the world’s only super power—the United States—and obtained political concession.

A Lackluster Economic Performance

The bleakest spot on the Islamic Republic’s 21-year performance record, and a constant threat to its survival, has been the economy. Downgraded by the regime’s founding father as unworthy of revolutionary pursuit, and described in the 1979 Constitution as "not an end in itself, but a means intended only to contribute to the attainment of the ultimate goal," namely, "a movement toward God," the post-revolution Iranian economy has remained the regime’s Achilles’ heel. Striving in vain to find an "Islamic model" which could put an end to what the revolutionaries called "crass materialism" and "consumerism," the national economy has been managed in an ad hoc, improvised, and inconsistent manner. An unstable mixture of capitalism, populism and pragmatism with some ornamental Islamic topping has served as its anchor. As a result, the economy has moved from one crisis to another in an almost uninterrupted course.

In the last 21 years, Iran’s economy has gone through four distinct phases under several half-baked ideologies.In the first two years after the revolution, the regime toyed with a novel and bizarre experience called "divine harmony," whose basic premise was not scarcity and the need for rational allocation, but plenty and the task of economic distribution. Under a mixture of revolutionary ideology and Islamic religion in this period, all major industries were taken over from private owner/managers. All private banks and insurance companies were nationalized. Thousands of business firms in agriculture, small industries, trade and tourism, belonging to the Shah’s associates and supporters were confiscated and turned over to a number of parastatal, charitable, foundations (bonyads). The result was a disastrous fall in production and income.

The second period, coinciding roughly with the Iran/Iraq war, was dominated by a Soviet-Indian economic model characterized by widespread state intervention, wartime restrictions and Big Brother controls where economic austerity, insularity and emphasis on self-sufficiency was in vogue. The outcome was a series of ups and downs in output with a net stagnant average annual growth.

The third period of post-Iraq war reconstruction and development adopted the so-called "structural adjustment model" in 1989 with its emphasis on free-market principles. But this so-called Rafsanjani’s perestroika was soon abandoned when its predictable social costs proved politically unbearable. The overall outcome in this phase was better tan the first two phases, but still below the planned target growth.

The fourth period, from 1997 to the present, has again been one of stagnation and slow growth. Mired in a bitter internal struggle between two groups in the cabinet-- the discredited but still active statist/interventionists of the wartime era, and the red-face apologists inherited from the Rafsanjani administration, the economy has simply muddled through with mounting difficulties. Speaking about their 21-year balance sheet, the regime leaders (and particularly ex-president Rafsanjani) repeatedly point with great pride to: the progress achieved in expanding economic infrastructures (road building, railway construction, irrigation networks of dams, sea and airport facilities); increased farm production (wheat and barley); expansion of light and heavy industries (cement, steel, aluminum, copper and defense); rural electrification; electric power generation; and extension of gas lines to hundreds of new cities; and urban beautification (Tehran and Isfahan parks and freeways).

Endless Friday sermons and reams of official statistics are presented to show eye-catching advances in human capital investments (larger school enrollments, healthcare clinics, the number of physicians and nurses per 1000 of population), access to safe water and sanitation, new recreational facilities, and vastly improved communication (radio, television, mobile phones, satellite links and the internet connection). Equally strongly, the leadership boasts, with some justification, to sustain a modest (albeit declining) level of living for its fast-growing population; avoid back-breaking shortages of essential goods and services; finance the entire war out of domestic resources without runaway inflation and without crushing foreign debt; and vastly build upon Iran’s defense capabilities from home-made tanks to ballistic missiles.Yet, despite these valiant attempts to magnify and flaunt positive achievements, and equally strenuous efforts to downplay glaring setbacks, the consensus among domestic and foreign observers remains that Iran’s economy is now in worse shape than it was before the revolution. Judged by official government statistics, all common indicators of economic health show negative signs. Per capita income is one-third less; income gaps among households has widened; economic growth is lower; inflation is higher; unemployment and underemployment are more extensive; the government is deeper in debt; and net foreign reserves are smaller.

Furthermore, the economy’s slow growth, double-digit unemployment, double-digit inflation, and continued fiscal deficits, are accompanied by publicly acknowledged shortages of housing, classrooms, teachers, health clinics, and vital prescription drugs; significant air and water pollution; considerable soil erosion; and alarming deforestation. Added to these economic woes are closely related social scourges of widespread drug addiction, prostitution, and urban crimes. During the last six years, where the United Nations ranks some 174 countries in terms of what it calls "human development" index, the Islamic Republic has been downgraded from 86th to 95th place.

Promises and Delivery

Of more significance in this context is a comparison between what the Islamic revolutionaries promised and what they have achieved. As one recalls, the Shah’s regime was faulted for adopting a "consumerist" economic strategy responsible for Iran’s dependence on foreign trade, technology and managerial know-how for its survival and prosperity; too rapid exploitation and export of depleting oil reserves to pay for consumer-goods imports and useless advanced military weapons; insufficient attention to agricultural self-sufficiency; a wrong industrialization policy based on assembly-plant operations; undue reliance of the national budget on oil export revenues; neglect of non-oil exports; a widening gap between income groups and geographic regions; and wasting precious national assets on nuclear energy. All of these policies were to be undone once the Islamic regime was finally installed.

Irrespective of the validity or justification of these criticisms, clear evidence shows that none of the economic policy measures for which the Shah’s regime was castigated has been drastically changed, and none of the promises to restructure the economy toward greater efficiency, social justice and self-reliance has been delivered. Despite the regime’s relentless efforts to mold the economy into an "Islamic example" through the rejection of materialism, and construction of a frugal "consumption model," the country’s basic economic structure and behavior have defied Islamization. Conspicuous consumption, profit-making through hoarding and speculation, money-lending at exorbitant rates, rent-seeking activities and special sweetheart deals have, if anything, vastly expanded. Except in occasional religious sermons, basic economic policies now hardly refer to Islamic principles. Some are in direct contravention of the Constitution.

º Economic self-reliance, which was initially considered by Ayatollah Khomeini a sine-qua-non of political independence, has now fallen by the wayside, and Iran is currently actively seeking membership in the World Trade Organization, and openly soliciting foreign private investment, technology and managerial know-how.

º Daily exploitation and export of crude oil at nearly 6 million barrels in the late 1970s, which was denounced as tantamount to the betrayal of future generations’ rightful heritage, has now become the envy of the regime, and its new unreachable goal. Iran is now more dependent on oil and gas than ever before.

º Agricultural self-sufficiency, which was to be reached in ten years, namely 1980, still remains a distant goal, while Iran has lately become one of the world’s largest importers of foodstuffs. º Assembly-plant operation of the Shah’s period, which was condemned as wrong-headed industrialization and a waste of precious oil income, is now several times as prevalent as before.

º The budget’s undue reliance on oil revenues, which was blamed for harmful economic ups and downs, has hardly diminished.

º Non-oil exports which were considered badly neglected by the Shah’s regime has now increased considerably in current dollar terms, but once they are adjusted for inflation and stripped of their import contents, they are likely to be less, both as a percentage of national product, and certainly in per capita terms. Annual non-oil export receipts now can finance only three months of imports. The total annual receipts from non-oil exports are roughly equal to what Iranians spend on foreign travel and tourism.

º Reliable statistics on internal income distribution in Iran is not available, but both anecdotal evidence and scattered partial analyses indicate a worsening of income gap within the middle classes and in comparison with the nouveaux riches. More significantly, the middle classes which had started to grow in the Shah’s regime has since been on the decline.

º National expenditures on both armament and nuclear power for which the old regime was taken to task as profligate and wasteful are now being expanded both openly and discreetly.

Thus, even in terms of its own socio-economic objectives and priorities, the Islamic Republic’s economic performance has not been a success. While each of the five post-revolution administrations has obliquely, or by insinuation, blamed part of its economic problems on the preceding government, the standard official excuses have ranged from the sabotage by the foreign-based opposition, and the "imposed" war with Iraq to U.S. economic sanctions, oil price fluctuations, natural disasters, and antagonistic Western publicity against the Islamic Republic.

While the negative and impact of some of these elements (particularly the costly and ruinous war with Iraq) should by no means be4 overlooked, the regime’s own responsibility for creating some of them (e.g., condoning the American hostage taking, prolonging the war with Iraq after l982, the fatwa against Salman Rushdie, and alleged involvement in some high-profile international terrorist acts) could hardly be ignored or underestimated. Nor should face-saving excuses and spins obscure the real reasons.

Underlying Faultlines

The root causes of Iran’s crisis-prone economy should be sought in its state-dominated structure built on top of some economic, ideological, cultural, and managerial faultlines. Economically, the country has been plagued with a young demographic make-up, low labor productivity, high consumption, heavy reliance on unpredictable oil incomes, an d a good dose of economic mismanagement.

Iran has one of the youngest population on earth with some 40 percent under 15 years of age. The active labor force is less than 30 percent of total population compared with 46 percent in Turkey and Indonesia and 60 percent in China. Women also make a relatively smaller part of the labor force than is the case in those three countries.

Labor productivity, i.e., total annual product divided by total hours of work has been rising at about 1.2 percent a year in recent years—one of the lowest in the developing countries and far below the rate of population growth.

Iranians consume most of what they produce and save relatively little. The national savings rate has consistently been about 20 percent on average in recent years and as low as 15 percent in some as against a need for 30 to 35 percent. A significant chunk of the domestic product is also wasted due to inefficient distribution and artificially low prices.

Oil export revenues constitute more than 80 percent of annual foreign exchange receipts, and more than 50 percent of the budget’s revenues. Oil price fluctuations thus play havoc with government planning and budgeting. Since the country is dependent on imports for some 30 percent of its foodstuffs and between 25 and 60 percent of raw materials and semi-processed goods in some industries, even a slight decline in crude oil prices invariably results in reduced foreign exchange allocation, and compression of imports, reducing growth and employment.

Entry into the labor market of some three-quarters of a million job-seekers each year requires a minimum real growth of output of six percent or more. Such a growth rate in turn needs some 30 to 35 percent of the annual output to be invested in both physical and human capital. The gap between national savings and needed investments has to be filled by external funds. But, for a variety of reasons, (particularly political uncertainty and private business insecurity) Iran has been inordinately deprived of foreign private investment (except for minimal outlays in its oil and gas sector).

Finally, more than two decades of wage and price controls, and a highly overvalued exchange rate have caused enormous cost/price distortions which now defy any easy or quick solutions.Ideologically, the regime has been hidebound by a centralized economic system and basic commitments to an ill-afforded welfare agenda.