The Islamic Republic's Economic Failure
by Patrick Clawson
Middle East Quarterly
Fall 2008, pp. 15-26
The Islamic Republic's nuclear drive remains a focal point
of international concern. President Mahmoud Ahmadinejad speaks of becoming a
pan-regional if not world power. Much of his defiance is fueled by
unprecedented oil income. Iran
has built a US$82 billion foreign exchange reserve. But behind Ahmadinejad's
blustery confidence and defiance, decades-old systemic forces are eroding Iran's economic
has suffered perhaps more than any Middle Eastern country from the "oil
curse." As Iran
became addicted to oil, it postponed reform and let the rest of its economy
languish. While record oil prices insulate the Islamic Republic from the
consequences of its leaders' decisions, any significant decline may force an
The Imperial Era
Supreme Leader Ayatollah Ali Khamenei (R), here in Tehran, April 12, 2001, has shown only fitful interest in Iran's economic
problems. During his presidency, he consistently advocated the same kind of
oil-centered, statist, populist policies that Ahmadinejad now implements. His
hatred of the West may contribute to his distrust of economic reform as he sees
basic economic principles as Western.
As the Islamic Revolution completes its third decade, it
would be easy to blame all economic problems on its leadership. In reality,
though, economic mismanagement has remained a constant during Iran's imperial
and revolutionary eras.
Throughout the two decades between Prime Minister Mohammad
Musaddiq's fall and the 1973 oil shock, oil exports accounted for more than 80
percent of Iranian foreign exchange income. Broadly speaking, without the
revenue it earns from oil, the Iranian government would have been half its
actual size. Iran
used its oil income efficiently through 1972, funding reasonable development
projects and social infrastructure. The proof is Iran's exemplary record of
economic growth: In a 2004 report, the International Monetary Fund (IMF)
concluded, "During 1960–76, Iran enjoyed one of the fastest growth rates
in the world: The economy grew at an average rate of 9.8 percent in real terms,
and real per capita income grew by 7 percent on average. As a result, GDP
[gross domestic product] at constant prices was almost 5 times higher in 1976
than in 1960." Oil price increases do not affect these figures, which
are adjusted for price increases.
oil output increased far beyond the pre-nationalization peak of 600,000 barrels
per day (b/d). This expansion was driven by the shah, not by the consortium of
international oil companies producing in Iran. The image promoted by Iranian
nationalists and some historians that Musaddiq stood up to a shah who had obediently
provided oil to the West is distorted; in reality, the shah spent twenty-five
years pushing international oil companies hard to get more money for Iran. The
concession he negotiated with the international oil companies after Musaddiq's
overthrow was much more favorable to Iran than the pre-nationalization
agreement, providing a 50-50 division of the profits. By 1960, revenue was more
than eightfold above the 1950 level, a figure only partly due to a 50 percent
increase in output. The National Iranian Oil Company (NIOC), founded in 1955,
sought smaller oil companies willing to accept a 25-75 profit split in favor of
to develop fields outside the concession area, that is, the area over which the
consortium of international oil companies had a monopoly.
The shah kept pushing for more revenue. The February 1971
accord" between six Middle Eastern Organization of Petroleum Exporting
Countries (OPEC) and the major international oil companies forced the latter to
agree to higher prices and better terms. By 1973, the Iranian government, not
the oil companies, was in the driver's seat, setting prices, owning production
fields, and determining output levels.
The shah made good use of the additional oil revenue. Soon
after Musaddiq's fall, government provision of credit and a competitive
exchange rate facilitated rapid industrialization. In the late 1950s and early
1960s, industrial output grew as much as 20 percent per year. The government
invested in infrastructure, such as roads and utilities, for rapidly expanding
cities. Manufacturing employment more than doubled from 1956 to 1972,
accounting for one-third of all jobs created during that period. Manufacturing
output rose by 11.3 percent a year between 1963 and 1972. In practice, this
meant the annual output of motor vehicles went from a few hundred to 71,000,
and of radios and televisions from zero to 406,000. In a restricted report, the
normally sober World Bank summarized the changes in Iran as of 1971:
However impressive the rise in the macroeconomic aggregates,
they do not even begin to show the truly radical transformation of the Iranian
economy. In less than 15 years, modern roads and air services have reduced
distances many fold. In provincial centers, sleepy repositories of a crumbling
past, new industries have sprung up, urban facilities are being built up to
truly European levels ... In the new factories and on the construction sites, a
nation of farmers and nomads has learnt the technical skills of the modern age.
has built itself the bases of a large, complex, modern economy.
Initially, agriculture—the main source of income for most
Iranians—did not share in the boom. While the data is spotty, it appears that
output of the staple food crops rose less than 2 percent a year from 1953
through 1962. It was this agricultural stagnation which provided the backdrop
for the shah's 1962 decree of Iran's
first real land reform, part of a package of reforms that set the stage for the
1963 riots led by a reactionary cleric and future ayatollah named Ruhollah
Why a Revolution?
Iranians gave the shah little credit for Iran's booming
economy and the accompanying rapid rise in income. Rather, the general mood of
the time was one of unmet expectations. The shah had promised the Iranian
people European-style income, and he could not deliver. In a 1974 interview,
the shah promised, "In twenty-five years, Iran will be one of the world's
five flourishing and prosperous nations ... I think that in ten years' time,
our country will be as you [in Britain] are now." The shah's forecast,
which reinforced Iranians' self-conception of their country's natural
greatness, exacerbated the expectation gap.
Part of the problem was that not everyone in society
benefited equally from the prosperity. While the spending power of poor
Iranians increased, so too did the gap between the poor and the upper class.
There was also a huge geographic disparity; in 1971, average household
expenditures in Tehran were more than two and
half times those in the impoverished southeastern province of Kerman.
But the greater political problem for the shah was that economic modernization
was not well accepted by Iranian intellectuals.
The dominant intellectual trend at the time was Third
Worldism, a mix of socialism and anti-imperialism which blames the West, the United States,
and the local elites who pursue harmonious relations with the West for the
shortcomings of developing countries. In Iran, Third Worldism went beyond
the usual neo-Marxism to assume a strong nativist character. One of the most
influential books of the period was Jalal al-Ahmad's Gharbzadegi
(Westoxication). Ahmad argued that Iranians risked abandoning their culture
in favor of the West's, a eulogy for a passing era that melded Iranian
nationalism with anti-Western discourse.
The 1979 Islamic Revolution was not about the economy, but
the economic situation certainly helped undermine the shah. After oil prices
rose rapidly in 1973, the shah predicted the rapid transformation of Iran into an
advanced industrial country, but Iranians watched as government mismanagement
squandered much of the oil wealth. Paradoxically, the post-1973 flood of oil
income slowed growth: Too much was attempted, and the resulting logjams stopped
progress. In contrast to the preceding decade, the government badly mismanaged
the economy after 1973. Government revenue from oil rose from $5 billion in
1973 to $19 billion the following year. In August 1974, one year into his fifth
economic plan, the shah increased government spending from $44 billion to $123
billion. He pressed ahead full steam on every front, ignoring the serious
constraints to implementing so many projects simultaneously and changing policy
so frequently. The higher spending on everything from the military, to infrastructure
investments, government salaries, and social welfare programs increased demand
for goods and services to a level the domestic economy could not supply. Nor
could Iran's transport system handle the ensuing demand for imports; in 1975,
ships had to wait between 160 to 250 days to enter Iran's principal port,
Khorramshahr, at the tip of the Persian Gulf. Tehran had to pay more than $1 billion in
charges for ships stuck in ports unable to unload. The combination of high
demand and tight supply led to a sharp increase in inflation to an average of
15 percent per year between 1973 and 1978, from an annual rate of less than 4
Such dizzying economic changes caused a great deal of social
disruption and undercut the benefits of higher incomes. Even among the
relatively affluent Tehran
middle class, raging inflation and the doubling of consumer prices between 1973
and 1978 hit hard. Goals to improve social services were seldom met. For
example, while the government planned more than a million housing units
nationwide, it built only 124,000. The government tried to blame economic
problems on price-gouging merchants, and student squads hauled merchants
accused of violating price controls before special courts, which meted out
tough punishments. Meanwhile, the shah alienated industrialists when he ordered
they sell on generous terms 49 percent of shares in private companies to
workers to offset the impact of inflation. Few workers benefited from such
stock ownership; for one thing, the stocks were not easy to sell. And the
modern professional and industrial classes were unhappy at the high salaries
paid to the 60,000 foreign workers, whose very presence insulted proud Iranian
nationalists. Also fueling economic discontent was the impact of the overheated
economy on the mainstays of traditional Iranian life. The carpet industry,
which employed 300,000 people scattered in villages across Iran, for
example, could not compete with the salaries available in towns. Adding to the
public's frustration was the shah's profligate lifestyle and all-pervasive
influence. Few sectors of the economy were untouched by the activities of the
Pahlavi Foundation, which managed much of the shah's wealth.
Some of the worst policies after 1973 applied to the
countryside. What little development funds Tehran allocated to rural areas were diverted
into mechanized agricultural corporations, which operated at a loss and did not
increase the farmers' well-being. The main impact of the oil boom on
agriculture lay in the devastating effect on farmers of the pro-urban
development policies. The government used oil revenue to subsidize imports of
grain, meat, and milk products, which served to reduce the prices received by
farmers. Meanwhile, the government imposed price controls on key crops, most of
which were required to be sold through government-run marketing monopolies. The
cost of inputs soared while labor was attracted away by better opportunities in
the cities. The result was stagnant production. By the time of the Islamic Revolution,
agriculture provided only 15 percent of non-oil output and just 9 percent of
By late 1976, the economy was in bad shape, with national
income growing only slowly while shortages of electricity, water, cement, and
some foodstuffs constrained output and fed popular discontent. At last, the
shah reversed course, acknowledging he had wrongly pushed too fast. He
appointed a new prime minister who suspended many development projects and
introduced an International Monetary Fund-style stabilization program in March
1978. The overheated economy began to cool and inflation abated. But the price
of curtailed government spending was fewer new jobs and falling real incomes
while the supply constraints caused shortages to persist. The economic
constraints played no small part in feeding the political discontent that
exploded in Iran's
streets in 1978.
Running the Economy into the Ground
The Islamic Revolution, of course, was about politics, not
economics. Once the revolutionaries came to power, the Iranian economy
deteriorated due to both quasi-socialist policies and the war with Iraq. Every
time it looked like the revolutionaries would be forced to compromise their
hard-line stances, oil income came to their rescue. By the time the Iran-Iraq war
ended in 1988, average incomes had dropped by more than half. Grand hopes for
postwar recovery floundered as entrenched revolutionaries, who benefited from
the crazy-quilt of regulations, reasserted their power, and the government fell
back on its old ways of muddling through on the strength of oil income.
The economy was not a priority for Ayatollah Ruhollah
Khomeini. He quipped, "I do accept that any prudent individual can believe
that the purpose of all these sacrifices was to have less expensive melons."
Within just a few years, a Third Worldist group of clerics and bureaucrats
espousing interventionist policies in the name of social justice triumphed over
bazaar merchants, traditionalist clerics opposed on religious grounds to almost
any state intervention, and Western-oriented technocrats. Faced with chaos in
factories and a banking system close to collapse, the revolutionary government
nationalized much of the economy and transferred assets of the former shah and
his supporters to revolutionary foundations (bonyads). Only small industries
remained in private hands.
Over time, the government's control over the economy
increased. State-controlled prices dissuaded foreign investment, and the
government regulated all economic activity through an unwieldy permit system.
Mosques distributed ration coupons. Since the cost of rationed goods was well
below market prices, farmers had little incentive to increase output. The
manufacturing sector suffered from both price controls and shortages of foreign
investment. Making a profit depended on manipulating complicated regulations.
In this atmosphere of legal confusion and bureaucratic restriction, the
companies that did best were those owned by the state or the bonyads.
Because the official exchange rate was not adjusted despite
soaring prices, the price of the dollar on the black market increased to more
than ten times its official rate. Anyone who could get permission to buy
dollars at the official rate in order to import goods was able to sell the
dollars or, more often, the goods imported with those dollars, at a huge
markup. To make matters worse, the government went through bouts of
overspending, which exhausted its available foreign exchange, followed by
excessive restrictions, including periodic bans on "luxury" imports
that largely served to drive up prices and enrich those who managed to import
Even though the labor force was better educated than it is
now, the economy performed poorly. National income adjusted for inflation fell
more than 20 percent between 1977 and 1989 while population rose at a brisk
clip. As a result, per capita income fell by nearly half. According to the
IMF's calculations, Iran's
economic growth should have been 7.2 percent a year between 1977 and 1989, but
the economy actually shrank 2.4 percent a year. The government's surveys on
household budgets confirm the dramatic decline in living standards. Adjusted
for inflation, the average urban household's income fell in 1988 to less than
half its pre-revolutionary level. The modern middle classes and professionals
were particularly hard-hit while those with good political connections did
The Iranian leadership blamed economic problems on the war
but there is little evidence that this was the case: Without the war, the
inappropriate revolutionary policies would probably have led to much the same
result. Having criticized the shah for excessive dependence on oil exports, the
revolutionaries did worse: Oil's share in government revenue and exports rose
as non-oil revenues and exports fell. Oil exports, which suffered in 1980-82
from the continuing impact of the revolution and then the start of the war,
recovered in 1982 to 1.7 million barrels a day and then stayed more or less at
that level throughout the remainder of the decade.
The economy did well for a time after the war ended in 1988.
Ali Akbar Hashemi Rafsanjani took over as president in 1989, soon after
Khomeini died. Rafsanjani, the first Iranian revolutionary leader to prioritize
economic development, inaugurated the Islamic Republic's first five-year plan,
which sought to roll back state control. Under the limited reforms he
introduced, the economy recovered nicely with real GDP rising 8 percent per
annum between 1988 and 1993. Iran
increased its oil production over the same period from 3 million barrels per
day to 3.9 million. But even with the injection of oil income, the government
spent beyond its means. Determined to show that the privation of the war years
was over, the Rafsanjani government ran up a $28 billion foreign debt, much of
it short-term borrowing. This money, raised mostly in Europe,
financed a wave of imports, which soon doubled to $24 billion a year. Personal
income rose 20 percent in the first three years after the cease-fire but, just
as under the shah, such an increase did not match Iranians' expectations.
Revolutionary authorities had long told Iranians that after the war ended,
their lives would be better than they had been under the shah. While
revolutionary authorities had been able to improve the basic social indicators—
infant mortality had been cut in half; consumption of staples such as meat,
sugar, and rice increased; ownership of consumer items including telephones and
washing machines rose—by 1991, income was still only about 60 percent of its
For all of Rafsanjani's hopes, his reforms did not progress
very far. Entrenched revolutionary interests fought to protect their sinecures,
and Rafsanjani was unwilling to risk confrontation. The limited character of
reforms can be seen by the charade of privatization. In most cases,
privatization consisted of selling shares in the state-owned firms to
state-owned banks. Gasoline prices remained highly subsidized. In 1993, Oil
Minister Gholamreza Aqazadeh warned that fuel subsidies cost $6.3 billion.
Foreign exchange remained subject to complicated rules that encouraged
corruption. Rafsanjani's standing as a reformer also eroded as his family
members enriched themselves and openly engaged in influence-peddling. Indeed,
at around this time, the term aqazadeh—son of an important person—entered
Iranian parlance to describe family members of high-ranking figures who cashed
in on their positions. Powerful foundations used their political connections to
stifle competition, especially the Imam Reza Foundation that owned 90 percent
of the arable land in Khorasan, and the Foundation for the Oppressed and
Self-Sacrificers (Bonyad-e Mostazafan va Janbazan) that ran industries
employing 400,000 workers and controlling $12 billion in assets.
After 1993, the economy was hit hard by the combination of
stalled reforms and the exaggerated postwar boom. When the oil market weakened,
Tehran was no
longer able to service its substantial foreign debt. The Central Bank declared
a moratorium on most debt payments, and new loans came to a halt. The
Rafsanjani government had little choice but to throttle back on imports so that
oil income could be used to repay its foreign debt. That required reversing the
postwar market reforms and returning to the unpopular government-controlled
allocation of foreign exchange. Imports were cut almost in half in 1994 while
payments on the foreign debt reached $5 billion. The debt crisis, which lasted
five years, brought an end to the postwar boom. The popular mood was sour, and
Iranians blamed their government's hard-line policies, especially its isolation
from the United States.
The Rafsanjani government had hoped to offset the worst
effects of the foreign debt fiasco by attracting foreign direct investment in
its oil and gas production, a remarkably bold initiative given the historical
sensitivity in Iran
about oil nationalization. But, again, reality fell short. After a sharp
deterioration in U.S.-Iranian relations because of Tehran's
support for terrorism and opposition to Israeli-Arab peace, President Bill
Clinton forbade U.S. firms
from making oil investments in the Islamic Republic, effectively torpedoing the
deal that Tehran had negotiated with the U.S. oil firm
Conoco. Two months later, he reinforced the policy by banning all investment in
and trade with Iran.
In 1996, Congress passed the Iran-Libya Sanctions Action, designed to press
European and Japanese firms to eschew investment in the Iranian oil sector.
Tehran's failure to offer attractive business terms simply compounded the
problem for Iranian industry. Rather than allowing straightforward foreign
investment, Iranian officials insisted on complicated "buy back"
arrangements in which foreign oil companies were required to invest money
up-front and receive oil in payment. Nationalistic pride and exaggerated
expectations about Iran's
importance to oil firms led Tehran
to negotiate too hard, leading many willing partners simply to stall or walk
away. Once again, Iran's
assumption was that its oil wealth would in the end prove its trump card—and
once again, Iran
Do Factions Matter?
Through much of the Islamic Republic's first two decades,
vigorous political debate within the narrow limits set by the revolutionary
authorities has resulted in several changes in government leadership while real
power always remained in the hands of the revolutionaries overseeing the formal
government structure. The surprising 1997 landslide presidential election of
reformist Mohammad Khatami inaugurated a short period when widespread reforms
appeared inevitable. Then came the conservative reassertion, with violent
repression and engineered elections spearheaded by the supreme leader and
Revolutionary Guard veterans, leading eventually to the 2005 triumph of Mahmoud
Ahmadinejad. Through all these maneuverings, inappropriate economic policies
have been constant. The Iranian government wastes billions each year on
subsidies and inefficient capital-intensive industries while small businesses
drown in red tape and millions of young people face unemployment or
If Khatami had well-formed and articulate social and
political views, he had no comparable economic expertise. His long-awaited
August 1998 Economic Rehabilitation Plan was blunt in its description of
problems but modest in its proposals, and his third five-year-plan, announced
the following year, was no different. Different political factions agreed that
the economy was in bad shape and that drastic changes were needed, but no one
was willing to tackle the entrenched interests that supported subsidies for
consumer goods, which drained public coffers, or rampant corruption, which
scared off foreign investors.
Failure to make headway on economic reform led to lackluster
performance between 2000 and 2004. When the third economic plan was drafted in
oil and gas exports were at their lowest level since the Iran-Iraq war,
totaling only $9.9 billion for the year. As oil prices rose sharply, Iran's oil
and gas exports shot up to $36.8 billion during the plan's last year. As
Arab states such as the United Arab Emirates, Qatar, and Kuwait diversified
their economies and investments to become less dependant on oil revenue or at
least built up financial reserves abroad to cushion their economies in the
event of a downturn in oil revenue, the Iranian government grew more reliant on
oil revenues, which, by 2004, provided 64 percent of the government's income
without calculating massive, implicit subsidies from cheap energy.
Thanks to the buoyant oil income during the plan period,
consumption grew handily at a rate of 6.6 percent per year, and unemployment
fell somewhat, but even this was not impressive given the far greater
performance of oil economies elsewhere in the region. By 2000, many Iranians
had grown disillusioned with Khatami as regime elites—both hard-liners and
reformers—diverted much of the oil wealth into their own pockets.
In 2006, the IMF published a pessimistic assessment of Iran's economic
prospects even if world oil prices remained around $65 per barrel. The
organization predicted that between 2007 and 2011, inflation would remain at 17
percent a year, the government budget would slip into considerable deficit, and
the unemployment rate would gradually increase from 11 percent in 2005 to 13.2
percent in 2010. The Iranian government's estimate that the labor force is
growing by 700,000 per year almost certainly understates the number of people
who would like to work since many young women no longer even bother to look for
Skyrocketing oil prices have far exceeded IMF forecasts. The
Islamic Republic's oil and gas exports between March 2007 and March 2008 were
higher than the combined total for all four years of the first Khatami term.
Despite this windfall, economic conditions have deteriorated far beyond the IMF
forecast. In mid-2008, Iran's
Statistics Center estimated unemployment at 11.9
percent with the rate for those aged 15 to 24 reaching 25.6 percent. Were
oil prices to fall, the situation would be grim. Should oil prices fall
significantly, the Iranian regime could not easily cope.
Insofar as Tehran's
dependence on high oil prices distorts the economy, Ahmadinejad's
administration has made it even more vulnerable. The Iranian president has
exacerbated the worst aspects of past economic policies: He has expanded price
controls, increased subsidies, and tied bank credits more to political factors
than to business considerations.
He has implemented some economic reforms but only
halfheartedly. Consider the long-debated move to ration energy supplies, a
policy recommended by Iranian economists and their World Bank colleagues
because of the lack of political will to raise energy prices to their actual
cost. Rationing began in June 2007 but has been steadily undermined by periodic
announcements of extra rations for populist reasons, such as summer and New
Year's vacations. In addition to the monthly 26-gallon ration at $.48 per
gallon, motorists can purchase extra amounts at $1.91 per gallon. While these
measures may have slowed the growth of gasoline consumption, the total amount
of gasoline sold in Iran in March 2008 was, at 618,300 barrels per day, above
the 566,000 b/d pre-rationing level—hardly surprising given that the Islamic
Republic is proudly pushing automobile production. With Iran's refineries
uninterested in producing gasoline for which they receive such meager prices,
the Iranian government has been forced to rely on imports. While these have
oscillated, in 2006, for example, they amounted to 192,000 barrels per day.
Those imports have become harder to obtain as Western banks have stopped
offering letters of credit; two major suppliers—Reliance of India and Vitol of
Switzerland—quit the Iranian market in 2007.
Continuing energy subsidies cost Iran $45 billion a year, according
to former Central Bank governor Mohammed Hossein Adeli. But even with that
expenditure, the Islamic Republic cannot guarantee its citizens a secure energy
supply. Natural gas consumption, on which most Iranians depend for heating and
cooking, continues to be highly subsidized with the result that consumption is
booming, forcing Iran to
import more gas than it exports even though Iran has the world's second largest
reserves. The government has difficulty paying for imports. When Turkmenistan cut off supplies in the midst of
one of the coldest spells of weather Iran
had experienced in decades in order to pressure Tehran to pay higher prices, the Iranian
government had to shut off gas supplies to at least 1.4 million people.
The real state of Iran's economy is becoming harder to judge
as economic data becomes increasingly untrustworthy; for instance,
Ahmadinejad's first minister of industry and mining, Eshaq Jahangari, reported
that Ahmadinejad once ordered him to falsely double the reported economic
growth rate. Ahmadinejad's 2008 budget was devoid of the detail that
normally accompanies such documents. In order to make up shortfalls, the
Ahmadinejad government has repeatedly raided the Oil Stabilization Fund, meant
to accumulate a reserve when prices are high, as at present, for use when
prices drop. Despite statutory provisions dictating that it is to receive the
excess between the budget's estimated oil income (traditionally set
conservatively) and actual revenue, the fund's balance actually decreased
between March 2006 and December 2007, a period for which the fund should
have received tens of billions of dollars. Annoyed at the few constraints he
faced in such raids, Ahmadinejad simply dissolved the board charged with
administering the fund.
Ahmadinejad often denies that standard economic principles
apply to Iran.
The most acute controversy has been about inflation. To the chagrin of many
Iranian economists, the president denies that increasing the money supply 40
percent a year contributes to inflation. His anti-inflation policy centers on
lowering the interest rate, first to 12 percent and then to 10 percent for most
loans with his goal being to bring it into the single digits; sometimes he
speaks about eliminating interest altogether on most bank loans. He has
fired several top officials including two Central Bank governors and an economy
minister for opposing this policy. Not surprisingly, its application has resulted
in demand for loans that vastly exceeds supply, meaning that the only people
who can get loans are the politically well-connected. By the government's own
accounting, inflation has increased to 24 percent although many observers think
the figure an understatement. Iran
has been hit especially hard by the worldwide increase in food prices,
particularly for wheat and rice, which are staples of the Iranian diet.
With price controls, loans hard to come by, and oil income
allowing a flood of imports, production inside Iran is unattractive. With nowhere
else to put their money, Iranian investors have speculated in real estate, a
phenomenon that has widened the gap between poor and rich into a chasm.
Mid-level bureaucrats or high school teachers might make a monthly salary of
$300, but upscale apartments in Tehran
sell for $600-$1,000 per square foot. One 15,000 square foot apartment in Tehran recently sold for
$21 million. A whole industry has arisen to furnish the palaces of the
nouveau riche. This mix of developments—huge profits for the wealthy and
unprecedented oil income on the one hand, and rising unemployment and soaring
inflation on the other—is politically explosive.
Western Pressure Adds to the Problems
While Ahmadinejad grabs headlines in Iran for his
economic policies, real power on the issue rests with the supreme leader, Ali
Khamenei, who has only fitful interest in the problem. While he makes sensible
general statements from time to time, during his presidency (1981-89) he
consistently advocated the same kind of oil-centered, statist, populist
policies that Ahmadinejad now implements. Khamenei appears skeptical of any
economic reform proposals. His hatred of the West may contribute to his
distrust of economic reform, perhaps, because he sees basic economic principles
as Western. He speaks often with evident passion about his conviction that the
Islamic Republic is deeply threatened by Western cultural invasion, which could
overthrow the regime as quickly as the Eastern European communist regimes
As the nuclear confrontation between the West and Iran has
accelerated, the U.S. government has developed an effective program of
"informal sanctions" to press banks around the world to restrict or
cut ties with Iran. By emphasizing the shady transactions in which Iranian
banks have engaged, the U.S. Treasury Department has persuaded several
important banks to withdraw from Iran; the number of foreign branches operating
in Iran dropped from twenty-six in 2006 to twenty in 2008. In February 2008,
the 32-nation Financial Action Task Force—the major body monitoring money
laundering for illicit activities—warned of Tehran's "deficiencies"
at preventing money laundering for terrorism and weapons of mass destruction
development and called on banks to exercise "due diligence" when
dealing with the Islamic Republic. Iranian officials complained that not
only European but also Chinese banks cut their activities in Iran. Denied
bank services, Iranian traders had to carry suitcases of cash to pay for
International sanctions have also played a part even if the
need for international consensus watered them down significantly. The U.N.
Security Council adopted three resolutions placing restrictions on financial
transactions for Iran's
nuclear or missile programs, including banning transactions with one bank and
urging diligence about other financial dealings. The Security Council
resolutions also ordered tight limits on the export of "dual use"
goods that could benefit Iran's
nuclear or missile programs, some of which also have important civilian
The European Union imposed further restrictions, which some
European countries implemented with vigor. The effect has been to make Iran a less
desirable market for European firms. For instance, German exports to Iran have
fallen sharply in recent years while export credits backed by the German
government were only 20 percent of the 2004 level in 2007. While there is
no reliable estimate of how such financial sanctions have hit Iran, it would be
safe to say that their direct cost is in the billions of dollars a year, and
they have made the Islamic Republic even less attractive as a business
Both because of Tehran's own
internal economic difficulties and its political radioactivity, few foreign
industrial firms have sought to locate inside Iran,
other than Renault, which built a large automobile assembly plant. Not even
its oil and gas reserves have tempted foreign companies to invest significantly
British and French government pressure reportedly led Shell and Total to
postpone development of a large natural gas project; Japanese firms backed
off from the large Azadegan oil and gas field development for the same reasons.
That creates a real problem for Iran's
oil-centered economic development model. Each year, Iran's
oil fields produce 500,000 barrels per day less oil, according to Iran's oil minister. Iran's National Oil Company has used domestic
financing and expertise to mitigate this decline, but Iran has made
painfully slow progress at realizing its 20-year-old ambition to raise
production capacity to 6 million barrels per day. Indeed, capacity is
substantially lower than it was thirty years ago. While Iranian firms are
developing Azadegan on their own, they are proceeding at a fraction of the
hoped-for pace with foreign partners. The same is true of other major oil and
gas projects, such as the construction of Iran's first liquefied natural gas
facility to export gas by ship.
Ahmadinejad's attitude seems to be similar to that of his
predecessors: that, at the end of the day, Iran's ample oil and gas reserves
will make up for any shortcomings. And to be sure, the oil income increase of
recent years is arguably the single most important reason Iran has been able to
carry on its aggressive foreign policy, confront the international community
about its nuclear program, and boldly support anti-American forces across the
Middle East if not the world.
Through war, revolution, and factional battle, there has
been one Iranian constant: erratic financial policies which have frittered away
the country's impressive economic potential. When the shah tried to force a
rate of growth after 1973 that was not achievable, the economy stalled and
social problems mounted, setting the stage for the Islamic Revolution in 1979.
Once in power, the revolutionary authorities implemented the worst aspects of
Third World socialism with predictable results: The economy went downhill—a
situation compounded by the long war with Iraq. Postwar, sporadic economic
reforms resulted in modest results but have been insufficient to absorb the
baby-boom generation. The result is that the income of the average Iranian is
not much higher than it was thirty years ago. Had oil income been more limited,
have long ago been forced to undertake far-reaching structural reforms, much as
the shah undertook in the early 1960s. As then, the result would have been
rapid growth. Instead, policymakers have let their ideologies prevail over
common sense and economic wisdom, convinced that high oil income would sustain
the country. Even as oil prices reach record levels, the Islamic Republic's
leadership may soon find how wrong such a conviction is.
Patrick Clawson, Middle East Quarterly senior editor, is
deputy director for research at the Washington Institute for Near East Policy.
 Tehran Times, May 4,
2008; Fars News Agency (Tehran),
July 16, 2008.
 "Statement at the Conclusion of the 2008 Article IV
Consultation Mission to the Islamic Republic of Iran," news release,
International Monetary Fund (IMF), Washington,
D.C., May 12, 2008.
 The section on the imperial era, the revolution, and the
Rafsanjani-Khatami period draws upon facts and figures cited in Patrick Clawson
and Michael Rubin, Eternal Iran: Continuity and Chaos (New York: Palgrave,
2005), pp. 69-86.
 Islamic Republic
of Iran: Selected Issues (Washington, D.C.:
IMF, 2004), p. 7.
 International Bank for Reconstruction and Development,
Current Economic Position and Prospects of Iran, Report SA-23a (restricted),
May 13, 1971, vol. 1, p. 13.
 Quoted in Ali Ansari, Modern Iran
since 1921: The Pahlavis and After, 1st ed. (London: Longman Publishing, 2003), p. 184.
 Jalal al-Ahmad, Occidentosis: A Plague from the West
(Gharbzadegi), R. Campbell, trans. (Berkeley: Mizan Press, 1983).
 Ayatollah Khomeini on Tehran radio, Sept. 8, 1979,
trans. by Foreign Broadcast Information Service (FBIS), Sept. 10, 1979, and
reprinted in Barry and Judith Rubin, eds., Anti-American Terrorism and the
Middle East (Oxford: Oxford University Press, 2002), p. 35.
 Islamic Republic
of Iran: Selected Issues,
2004, p. 14.
 Patrick Clawson, "Alternative Foreign Policy Views
among Iran's Elite," in Patrick Clawson, ed., Iran's Strategic Intentions
and Capabilities (Washington, D.C.: National Defense University Press, 1994),
Economic Morass: Mismanagement and Decline under the Islamic Republic
(Washington, D.C.: The Washington Institute for Near East Policy, 1997), p. 21.
 Clawson and Rubin,
 "H.R. 3107, The Iran
Sanctions Act of 1996"; CNN News, Aug. 5, 1996.
 Data on oil exports are from Islamic Republic of Iran:
Statistical Appendix: March 2007 (Washington, D.C.: IMF, 2007), p. 6; Islamic Republic of Iran:
Statistical Appendix, September 2003 (Washington,
D.C.: IMF, 2003), p. 7; Islamic Republic of
Iran: Recent Economic Developments, September 2000 (Washington, D.C.:
IMF, 2000), p. 135. These are also the sources for the data on oil and gas
exports during 1997-2001 cited below.
 Islamic Republic
of Iran: Staff Report for the 2005
Article IV Consultation (Washington
D.C.: IMF, 2006), p. 31.
 Abrar-e eqtesadi (Tehran),
Feb. 10, 2008.
 Financial Times, Feb. 28, 2008.
 Middle East Economic Survey (Beirut), May 19, 2008, p. 19.
 Middle East Economic Survey, Apr. 7, 2008; on Iran's gasoline imports, "Country Analysis
Brief: Iran," U.S.
Energy Information Administration, Washington,
D.C., Oct. 2007, accessed July 2,
 Middle East Economic Survey, Feb. 11, 2008; Iran Times (Washington, D.C.),
Jan. 18, 2008.
 Reuters, Mar. 22, 2008.
 Mustafa Pur-Mohammad, Iranian interior minister, quoted
in Iran Times, Jan. 18, 2008; Associated Press, Jan. 22, 2008.
 Ali Alfoneh, "Ahmadinejad versus the
Technocrats," AEI Middle Eastern Outlook, May 2008, p. 6; Norooz (Tehran),
Jan. 14, 2008; Middle East Economic Survey, Jan. 14, 2008.
 Middle East Economic Survey, Jan. 14, 2008; Islamic Republic of Iran: Statistical Appendix: March 2007,
 Alfoneh, "Ahmadinejad versus the
Technocrats"; Financial Times, Apr. 23, 2008, May 16, 2008.
 Mehdi Khalaji, "Iranian Parliamentary Elections
and Ahmadinezhad's Discontents," PolicyWatch, no. 1364, Washington
Institute for Near East Policy, Washington, D.C., Apr. 22, 2008.
Times, June 6, 2008; Financial Times, Mar. 14, 2008; The New York Times, Feb. 3, 2008.
 Karim Sadjadpour, Reading Khameini (Washington, D.C.:
Carnegie Endowment for International Peace, 2008), pp. 17-9.
 The New York Times, Feb. 29, 2008; Los Angeles Times, Jan. 20, 2008; Financial
Times, Feb. 12, 2008.
 The New York Times, Feb. 29, 2008.
 Reuters, Feb. 4, 2008.
 UNSCR 1737 (2006); UNSCR 1747 (2007); and UNSCR 1803
 Financial Times, Feb. 12, 2008.
 BBC News, Oct. 6, 2004.
 Associated Press, May 12, 2008; Economist Intelligence
Unit Views Wire, May 13, 2008; Middle East
Economic Survey, June 2, 2008.
 Middle East and Africa Oil and Gas Insight (London), Nov. 2006.