Hossein Askari

WASHINGTON — The loud debate on economic conditions in Iran seems to be going around in circles. Are sanctions pushing the Tehran regime into a corner or are subsidies doing the damage? Will the removal of subsidies improve Iran’s economic conditions or make them worse? Is the regime removing subsidies now because it feels secure or because it feels threatened? Do Iran’s economic conditions affect its commitment to its nuclear program or not? Is it time to ramp up the sanctions on Iran or to relax them and push engagement?

Facts, myths and speculations are all in play. But which is which? It may be helpful to separate facts from myths from speculations.

Fact: Although US sanctions have been imposed on Iran since 1979, sometimes supported by allies and sometimes by the United Nations, the sanctions were as porous as Swiss cheese up to the time of the Clinton Administration, and even then they did not really bite. Sanctions have become much more effective since 2008. Financial sanctions are now doing their job, but they won’t give immediate results and could be tightened further if the US had the political will.

Explanation: Initially, the United States banned the importing of Iranian crude into the United States, but allowed refined products to enter the country. Then came a ban on importing refined products and all non-oil products from Iran, so Iran sold all it had to sell to other countries, albeit in the case of non-oil exports at a slightly lower price. Iran hardly felt even a side blow. In the mid-1980s, the United States embargoed all US exports to Iran, but this went unnoticed because most American goods were abundantly available, sometimes even at a lower price than in the US. These imports went through Dubai, where merchants took a 5 to 10 percent cut, which they shared with Iranian counterparts and officials. In 1996 the Iran Libya Sanctions Act (ILSA, now ISA after the removal of sanctions on Libya) was enacted under President Bill Clinton. Investment in Iran’s energy sector was banned and third countries were threatened with sanctions if they did not support the US effort. ILSA slowed Iran’s oil and gas development, however, the impact was more long term and had a minimal effect on the government’s short-term revenues.

Let’s face facts. Before 2008, sanctions on Iran were a porous hodgepodge. In November 2008, the Treasury revoked the U-Turn license of Iranian banks. The revocation of this license meant that US banks could no longer make dollar transfers to Iranian financial institutions. Most importantly, in December 2009 a record fine of $536 million was imposed on Credit Suisse for violating US sanctions on Iran; essentially, either Credit Suisse paid the fine or it was barred from operating in the US market. This was followed in 2010 by a fine of $350 million on Lloyds Bank and $298 million on Barclays. These fines were the key to making sanctions “bite” because Iranian banks were virtually cut off from the international financial system. Iran’s cost of trade (letters of credit) soared, in my estimation by some 20-25%, in turn squeezing Iran’s foreign currency reserves. The impact of these fines was more recently re-enforced by UAE banks, which, under pressure from the US Treasury, ended their role as a conduit of funds to Iran. This further squeezed Iran’s dwindling foreign exchange reserves and sparked a dramatic fall in the value of the Iranian currency of over 15% in a matter of two days.

Myth: Dismal economic conditions in Iran are due to sanctions and subsidies alone. If subsidies are eliminated and sanctions lifted, economic conditions in Iran will improve dramatically.

Explanation: Is this new round of effective sanctions the primary cause of increasing hardship on ordinary Iranians? No. Sanctions have done some harm, but Iran’s economic failures are largely self-inflicted. Iran’s economic performance since the 1979 Revolution has been absolutely dismal. While its economic failure in the 1980s can in large part be attributed to the war with Iraq, its performance during 1990-2010 is largely the regime’s fault. Although sanctions have undoubtedly slowed the development of Iran’s oil and gas reserves (since the adoption of ILSA in 1996), the government has had ample resources, namely, much higher revenues from oil than in the 1980s, to achieve sustained and rapid economic growth. But instead of adopting sound policies to encourage private sector growth—good institutions, rule of law, liberalization of goods, labor and financial markets, financial development, orderly privatization (of state assets and revolutionary foundations), and consistent macroeconomic policies—the government has shunned economic policies and programs that would benefit average Iranians. The regime has squandered oil revenues to buy support through wasteful subsidies, sweetheart contracts to the Revolutionary Guards, corrupt practices to enrich regime insiders and the pursuit of military programs and costly foreign policy adventures. Iranians have paid the price for these government missteps and will continue to do so as educated Iranians emigrate in record numbers in the hope of a better future elsewhere.

Subsidies should have been reduced and even eliminated in the context of a broad program of reform to lay a solid foundation for Iran’s economic prosperity. After the Iran-Iraq War, senior members of the clerical regime were fully aware of a sensible approach to address Iran’s long-term economic reconstruction and development. They saw that subsidies that had understandably proliferated during the war were costly, inefficient, regressive (affording more benefits to the those well off as opposed to the needy) and detrimental to private sector growth. Leaders have always known that oil resources must benefit all generations of Iranians (the clear message from Islamic teachings). Placing oil revenues in government hands has only encouraged corruption and waste. The regime should have invested oil revenues and issued an annual check to Iranians of every generation (similar to Alaska’s approach). It should have reduced subsidies in an orderly and manner and implemented an effective tax system, which, in turn, would give the government much-needed revenues along with an instrument to address glaring income and wealth disparities. Although the regime adopted some helpful laws along these lines, they have not been followed. Things have instead continued as before.

If senior members of the regime realized all this, why did they fail to act? The answer is simple: they were greedy and scared. Let me explain. Iran had emerged from the war quite battered. The war had been everyone’s preoccupation. Now the race was on for personal enrichment and not for fundamental changes that would benefit Iran. The government even borrowed about $30 billion from abroad (borrowing had originally been banned in Iran’s new constitution) and the money was almost totally squandered. At the same time, regime insiders could not see how the people would ever sign up for a program that promised subsidy elimination to be replaced by direct cash payments for doing nothing! Iranians, by nature suspicious, would simply think this a scam! The regime decided that since the system was not broken, why risk a public backlash? And with every passing year, subsidies took a bigger toll and became harder to eliminate.

In sum, sanctions have slowed Iran’s oil and natural gas development and over the last two years financial sanctions have increased the cost of Iran’s imports. At the same time subsidies have taken a larger and larger toll, because oil prices have increased from about $20 to nearly $150 per barrel since 2003 (thus increasing the difference between the world price and the price in Iran for energy products, in turn increasing the implicit energy subsidy in Iran). But Iran’s real per capita economic growth since the Revolution has been consistently dismal with the exception of less than a handful of years. While sanctions and subsidies have had a deleterious effect, Iran’s economic policies hurt Iran long before sanctions began to bite and the burden of subsidies became so onerous. The reduction of subsidies by the regime and the lifting of sanctions by the US would give Iran some short-term breathing room but would not solve the country’s economic challenge. All of this is evident to economists and politicians in Iran, but most have been frightened into supporting the regime’s deleterious decisions, or at least not criticizing them (a recent six-year verdict of imprisonment for expressing such views is an effective deterrent).

However, reducing subsidies would increase the price of all energy products (by as little as 300-400 % for gasoline and by as much as 2,000% for diesel fuel) and the price of a number of staple foods (such as bread). To the extent that the price of final consumption goods goes up (for example, gasoline and bread), inflation will spike (but note that this increase in inflation is not a continuing phenomenon unless these prices keep on increasing) and as the price of energy inputs go up (for example, diesel for trucks and industry), inflation will also permeate the entire economy and work its way through to consumer goods. The increase in prices would impose further hardship on average Iranians unless the government fully makes up for the increased price of final consumption items that were previously subsidized and all other price increases of final consumption goods whose prices would increase because of higher input prices in industry and transportation. It is unlikely that the government is planning to make up for all these price increases. But another danger is that today’s inflation could increase inflationary expectations of consumers and producers and that this fuels inflation further.

Speculation: The regime has started to reduce subsidies now because it feels in control.

Explanation: After the presidential election of June 2009, the regime’s brutality frightened Iranians into submission. The regime has adopted force as its policy of choice and no longer seeks even the veneer of popular rule. While the clerics’ position of total control is one possible explanation for reducing subsidies now, there are a number of competing explanations.

Some observers have speculated that Iranians have simply acquiesced; they are plain tired after a revolution, a brutal war, thirty years of economic deprivation and now a failed revolution with less liberty and freedom than before. The regime can take the risk of reducing subsidies because the citizenry feels crushed and is without hope. Others claim that Iran’s budgetary picture is much worse than has been reported. Oil revenues are down because domestic oil consumption continues to grow with oil production stagnating and declining. At the same time, the costs of Iran’s imports are up (from sanctions and higher food prices). Iran’s financial expenditures in Lebanon, Iraq and Afghanistan are up. Iran’s expenditures on military programs keep increasing. Capital outflows are up. The convergence of all these developments is squeezing the budget as never before and threatening all of Iran’s commitments. The regime could possibly be forced to devalue the Iranian rial. If these speculations are correct, then the budgetary picture may have left the regime with no choice. Yet another speculation is that the regime needs to shore up its hardcore support, and that reducing subsidies and introducing cash payments gives Tehran another channel to reward those who support the regime.

While there are a number of plausible theories, in the end they are just that, theories. Yes, some commentators who have close relations with Iran or who visit the country frequently may have better odds of being closer to the truth, but hard facts are difficult to come by. Some commentators who visit Iran and claim to have been told “facts” by senior officials are naïve to believe them.

Fact: Iran’s changing economic conditions will not change the clerical regime’s nuclear quest. The only development that could change Iran’s nuclear quest, or at least remove the perception that it poses a threat to other countries, is if Iranians swept away the regime.

Explanation: The mullahs have no interest in abandoning their nuclear quest. Nuclear capability is the clerics’ key to long-term immunity from foreign interference. They will not abandon their nuclear quest. They will happily drag out negotiations. They will even sign a piece of paper to get some sanctions lifted, all the while secretly continuing their nuclear quest and meddling in the region to pressure the US. They know full well that once a sanction is lifted it would, for many reasons, take time to be re-instated. In short, they have little to lose by talking, bargaining and signing on to an agreement, and everything to gain by continuing their quest.

Let’s be frank. The US sees Iran’s nuclear program as a threat because of the nature and behavior of the regime. Under the Shah, the US and its European allies supported nuclear power plants for Iran. France even entered into a nuclear partnership with Iran, and in all likelihood the US would have supported low-level enrichment. The US problem with Iran today is not nuclear enrichment; it is instead the regime and what it may do with enriched uranium. No agreement with the Tehran regime would diminish that threat.

Fact: There are a number of additional financial sanctions that would put much additional pressure on the Tehran regime.

Explanation: As explained above, financial sanctions have succeeded by increasingly cutting off Iranian financial institutions from the international financial system, increasing the cost of letters of credit and in turn Iran’s cost of trade. Two channels to the international payments system have in part reduced the damage to Iran. First, the Iranian central bank has stepped in to do what Iranian commercial banks were doing. If the US wanted to cut off this channel of financial transaction and payments settlement, it could sanction the Iranian central bank. The US could do this unilaterally and threaten countries that do not comply. There is also a second channel that has been increasingly used by Iran—the Asian Clearing Union or ASU. The ASU acts as an intra-regional payments settlement system. The ASU was created during the reign of the Shah and Iran is a member. This has allowed Iran to sell oil to one member and to import goods from many other members. Theoretically Iran could sell oil to one member, for example, India, and import goods even from non-members with the member (in this case India) settling the payments. The US could close this loophole by sanctioning the central bank of Iran and threatening any central bank that dealt with the Iranian central bank. In addition to these two options for putting the financial screws on the clerical regime, the US has a number of options that would, with near certainty, create a run on the Iranian rial and thus a financial panic in Iran. During the week of September 25, the Iranian currency lost about 20 percent of its value against the dollar because the demand for dollars was rising and the central bank did not offer enough dollars to calm the market and keep the exchange rate to the dollar stable. As a result, the central bank has had to resort to foreign exchange rationing.

Speculation: Additional financial sanctions would topple the clerical regime.

Explanation: This is pure speculation. There are two very different scenarios in play. While some believe that a significant ramp up of economic hardship will motivate millions to demonstrate against the regime, major merchants in the bazaar to go on strike and even regime loyalists to desert the regime, others feel that people are tired in Iran, they have enough on their hands just to feed their families and, most importantly, that this regime will kill Iranians by the thousands if need be to stay in power. There are initiatives that could increase the likelihood of one or the other of these scenarios. To this end, focusing on the regime’s nuclear policies is not the way to go, because a majority of Iranians may support Tehran’s nuclear quest. A policy that focuses on the regime’s human rights abuses and economic deprivation is much more likely to succeed.

Fact: When it comes to Iran, there are facts, myths and speculative predictions, and it is essential to know which is which.

Hossein Askari is the Iran Professor of International Business and International Affairs at George Washington University. He is a prolific author of books on the Iranian economy. During the mid 1980s, he was director of a team of international energy experts contracted to design an energy plan and energy planning capabilities for Saudi Arabia.