Iranian economy’s biggest vulnerability: Iran

Posted By Patrick Barry Thursday, April 29, 2010 - 4:05 PM

"When your adversary is making a fool of himself, get out of the way." So said Pat Buchannan last year in response to conservative hawks pushing for U.S. intervention in the wake of Iran's controversial Presidential election. At the time, those words made a lot of sense. Better for the U.S. to not give the Iranian government a handhold as it descended into infamy by making itself the focus of attention. Buchanan's advice could just as easily apply to the now-urgent question of U.S. economic sanctions. As a congressional conference committee begins to put the finishing touches on an Iran sanctions package, it's worth considering the evidence that the biggest threat to the Iranian economy is actually the regime itself. Economic sanctions might actually rescue the regime from its own failings, and produce the opposite of what their backers expect.

Iran's economy may not be on life-support, but it is in pretty terrible shape. While the statistics reported by the Iranian government paint a rosy picture, the reality is quite different. Iran's real per capita growth rate was 3.5 percent per annum from 2002-2009, but this period of growth coincided with a period of a steady rise in oil prices, suggesting the "government has not been very successful in achieving diversification of the economy." Inflation is also on the rise, reaching 10.4 percent in April. Though that's much lower than the annual rate of 30 percent from last year, the current government has consistently struggled to contain rising inflation (which is often attributed to President Ahmadinejad's redistribution of oil revenues). Actual inflation may be much higher. Looking at prices in downtown Tehran, the real number might be hovering around 20 percent.

If that wasn't bad enough, Iran continues to struggle with pronounced inequality. Virginia Tech Economist Djavad Salehi-Isfahani notes that between 2005 and 2007, at a time when Iran was experiencing respectable economic growth, "the income of the top 20 percent rose more than four times as fast as that of the bottom quintile." Here again, rising oil prices appear to have had a negative effect. "The influx of oil revenues, which trickle down Iran's unequal structure of access to power and position, always seems to worsen the distribution of income," writes Salehi-Isfahani.

Iran's economic circumstances are sometimes attributed to sanctions, and sanctions proponents might be tempted to seize on the weakness of the Iranian economy as evidence that punitive measures are working to undermine the foundations of the regime's support. But this leaves out the role that Iran's own leadership has played in bringing the country's economy to such abysmal straights. Estimates are that the Iranian regime is involved, either directly or indirectly, in 70 percent of the country's economy. Former minister of commerce, minister of finance, and ambassador-at-large in Iran, Jahangir Amuzegar, slams the Ahmadinejad administration for having "established a dysfunctional economic environment" and for "worsening the business climate."

President Ahmadinejad once supported large consumer subsidies, which had been a significant contributing factor to rising inflation. Now, recognizing that his own policies have come to roost, Ahmadinejad has proposed a $40 billion cut in state subsidies. But if done improperly, such a cut could result in sky-rocketing prices in Iran's subsidy dependent energy sector. Iran's currency is also believed to be kept at artificially high levels, increasing imports to what Amuzegar calls "unprecedented levels," with attendant effects on Iran's domestic producers.

Skeptics could charge that Iran's oil and natural gas sectors ensure the regime's survival, even as the government's leadership does fundamental damage to the Iranian economy. However, as PFC Energy Partner and Gulf energy analyst Fareed Mohamedi has observed, the picture of the country's energy sector is quite mixed. Iran's oil supply is steadily diminishing. Perhaps more importantly, its ability to influence world oil markets may be hemmed in by growing production by non-OPEC countries, particularly Iraq. In Iran's vaunted natural gas industry, the picture also remains unclear. Mohamedi observed that worldwide, natural gas production, exploration, and technological innovation will likely increase in the years ahead, possibly reducing Iran's clout in that area as well. As is the case with the economy writ large, Iran's leaders have behaved irresponsibly, failing to pursue the diversification necessary in case of a decline in energy prices.

So where do the sanctions being considered by congress fit in with all this? Congress's sanctions are designed to place an economic stranglehold on Iran, in particular, by exploiting what is thought to be an Iranian dependence on imported refined petroleum. As petroleum costs rise, Iran will begin to feel the pinch. Unfortunately, the effectiveness of such sanctions doesn't quite match the hype. Gal Luft has cautioned that Iran's petroleum dependence is not what it appears. Thanks to combination of investments in domestic refinery infrastructure, pursuit of energy alternatives and effective rationing schemes, Iran is projected to be gasoline self-sufficient by 2012. This suggests that while the sanctions up for consideration may have a short-term effect, over the medium and long-term, the squeeze put on the Iranian economy is likely to be negligible. But the regime is sure to blame its economic woes on western sanctions in order to distract from its own mismanagement.

The overall picture is one of an Iranian economy that is heavily straight jacketed already. The current government is largely to blame. Based on the regime's track record of incompetence and the consequences of that incompetence for the Iranian economy, the U.S. would be wise to take a step back, allowing Iran to continue on its present course. As its position grows weaker, the U.S. position would grow stronger, shoring up American diplomatic leverage or at least making Iran easier to contain or deter. The U.S. would also sidestep accusations that its policies had contributed further hardship to the Iranian people. Congress is searching for the most effective means to weaken the Iranian economy; the best approach may be for it to do nothing at all