Iran is Losing Sight of its 'Developmental Vision'

This article was originally published by the Atlantic Council.

On December 11, Iran’s information minister announced via social media that he had a “surprise” to reveal. Mohammad-Javad Azari Jahromi, the Islamic Republic’s youngest-ever cabinet minister, had been the subject of intense criticism from the Iranian public following a week-long internet blackout. Authorities had taken the unprecedented step to cut internet access in response to the nationwide protests that erupted on November 15 following a subsidy reform that doubled fuel prices. Angered by the crackdown, many Iranians “surprised” Jahromi by blocking him on Twitter. 

Undeterred, Jahromi made his grand reveal on December 12: a slickly produced video that showed Iran’s postal service delivering a package to the information ministry by drone. While such drones may be helpful for rural communities and disaster response, Iranians were understandably bewildered by the PR stunt. 

Jahromi’s postal drone offers a metaphor for perhaps the central political challenge facing the Islamic Republic. In the wake of a brutal response to protests that has left over 300 dead, commentators have pointed to a crisisof legitimacy now facing Iran’s leaders and their ideological tenets. But in reality, it is the compounding failure of technocrats like Jahromi to manage a decade of economic volatility that best explains Iran’s new political turmoil. 

As a recent study of the fuel protests shows, “economic grievances were likelier to inspire protest in areas where frustration with the whole system was endemic… Economic hardship turned frustrations with the system into assertive protest activities.” The protests appear to have comprised largely of individuals newly confronting economic hardship, which suggests the emergence of a precariat class in Iran. Just last year, 1.6 million Iranians fell into poverty due to high inflation. The study details how the counties in Iran which saw protests were often those more dependent on state support, meaning that the withdrawal of that support—such as the reduction of the fuel subsidy—was felt most acutely. As the study observes, “the Islamic Republic, through its long-term developmental and welfare programs, has empowered a citizenry that now resists neoliberal policies, such as cuts to energy subsidies.” 

These long-term developmental and welfare programs are the underappreciated pillars of the Islamic Republic. As sociologist Kevan Harris has described, state-society relations in Iran have been shaped by a “developmental vision” established when the young Islamic Republic began to emerge from the brutal Iran-Iraq War. As revolutionary fervor and wartime zeal ebbed, a core group of technocrats, many of whom had served in the Shah’s civil service and who had been educated abroad, began to set the country’s development agenda. After a few years of structural readjustment, the country’s economy started to grow, and the technocrats became firmly ensconced in the powerstructures of the Islamic Republic. 

Iran’s GDP per capita peaked in 2012, buoyed by record-high oil prices. But the same year, the international community imposed strict sanctions on Iran over its nuclear program, triggering a 7.4 percent contraction and ending 23 years of consecutive increases in GDP per capita, which had risen from just over $2,200 in 1989 to just under $8,000 by 2012. The developmental vision of the Islamic Republic had significantly improved the welfare of the average Iranian. For millions of Iranian households, development meant the arrival of electricity, gas, refrigeration, personal mobility—and in the last decade, access to the internet. But success in economic development is inherently relative. Iran fared much better than Iraq in the two decades following their eight-year war. Iraq’s GDP per capita had been higher than Iran’s in 1989, at $3,800, but rose to just $6,800 by 2012, having lagged behind Iran even before the 2003 US invasion. In the same period, however, Poland, which emerged from its stagnation behind the Iron Curtain in 1989, saw its GDP per capita rise from just below $1,800 to $13,000, becoming a widely touted example of successful development. 

That Iran finds itself between Iraq and Poland on the measure of GDP per capita speaks to the predicament facing the country’s technocrats. The political establishment in Iran is, in some respects, the victim of its success. Economic development became, even in an ostensibly “revolutionary” state, the foremost expectation of governance among the Iranian people. The Islamic Republic has only recently ceased delivering consistent distributive economic growth, leaving chronic and underlying issues of inflation, unemployment, and corruption unassuaged by economic expansion. Sanctions—which have deprived the country of investment, stifled trade, and weakened the currency—have contributed to nearly a decade of stagnation. 

In a prescient 2011 study on the impact of economic crises on Iran’s youth, economist Djavad Salehi-Esfahani concludes with a question. He wonders how a lack of economic opportunity “shapes the attitudes of Iran’s youth about the country’s future and their ability to lead and build the nation.” Are Iranian youth “slowly losing not only their skills but also their hope and optimism?” 

While Jahromi was busy toying with postal drones, a new budget was being prepared for the forthcoming Iranian year (March 2020). As analyst Henry Rome explains in his study of the new budget, the Iranian government will seek to mitigate the harms of high inflation, which the IMF projects at around 30 percent next year, by instituting new cash transfers and increasing the wages of public sector employees. Overall, the new budget represents an 8 percent increase in spending in rial terms. But with the contribution of oil revenues down from 29 percent in last year’s budget to a likely-too-optimistic 9 percent, the government will be seeking to increase tax revenue in to fulfill its fiscal burdens, ostensibly increasing the importance of functional state-society relations. 

Iran’s technocrats will continue to seek policy solutions to address widespread economic frustrations and alleviate poverty. But as Salehi-Isfahani observes in his study from eight years ago, there is only so much that the technocratic solutions can achieve. In the face of myriad economic pressures, including “maximum pressure” sanctions, Iran’s resilience is a remarkable achievement, but it is nonetheless approaching a kind of political limit. Referring to the government’s response to the economic malaise of the Mahmoud Ahmadinejad years, Salehi-Isfahani notes, “there are new policy initiatives ranging from the reform of the nation’s decades-old subsidies, to amending the family laws, to reviving population growth, not to mention the nuclear standoff with the West, but none that help salvage Iran’s demographic gift.” That an article written years ago describes the current dilemmas so accurately speaks to Iran’s stagnation. 

In the aftermath of the protests, Iran’s political elites have begun to realize the stakes. In a speech one week after the fuel protests, Mohsen Rezaei, the hardline secretary of the country’s influential Expediency Council, acknowledged that Iran was failing to deliver economic development. Pointing to the importance of economic development in state-society relations, Rezaei stated, “Since the beginning of the revolution until today each government of the Iranian people has tried to make an impact on the economy, and particularly in the last two decades the focus various stakeholders has been the economy, but we have yet to find a pathway that gives us optimism for the future.” While the Islamic Republic had proven able to “address the issue of elections, defense, security, and freedom,” it had failed to reach the optimal model for “economic development and economic justice.”

Today, an Iranian precariat class is seeking economic justice. Iranian economic planners and policymakers, like their fellow technocrats around the world, are struggling to find the pathway to continued growth in the face of factional infighting and foreign interference. Signing-off in his announcement of the postal drone, Jahromi declared, “We must make Iran the best and most advanced country in the world!” 

If only it were so easy. 

Photo: IRNA

Just $10 Billion Could Fundamentally Change Iran's Economy

As we approach the end of 2016, the most important deal concluded for post-sanctions Iran this year was not among the headline-grabbing agreements signed by Boeing, Airbus, Renault, Siemens, Shell, or Total. Rather, it was a much smaller deal that received absolutely no coverage in the international business media.

In May of this year, German FMCG manufacturer Henkel purchased the remaining shares in its local joint-venture, Henkel Pakvash, taking its ownership to 97.7%. The company was able to deploy EUR 62 million to make the acquisition by purchasing shares on Iran’s Fara Bourse. In August, Henkel subsequently purchased the detergent business of Behdad Chemical for approximately EUR 158 million.

Henkel’s two transactions should be considered the most important of 2016, not only because they were successfully completed (in contrast to many of the larger deals that remain at contract stage), but also because these transactions are reflective of the most important kind of capital deployment for Iran’s near-term economic growth.

Both supporters and opponents of the Iran Deal have been focused on the billion-dollar contracts being made between major multinationals and Iranian state-owned enterprises. The logic is simple. Iran is a large economy and the true economic value of the Iran deal will only be reached when the country receives billions of dollars of foreign direct investment.

Iranian officials have boasted of a USD 50 billion target for FDI in 2016, a massive leap from the USD 2 billion registered the previous year. Reports suggest that Iran will more likely achieve around USD 8 billion. It took the Russian economy eight years (from 1999 to 2007) to see FDI inflows rise from levels commensurate with the current levels in Iran to the USD 50 billion milestone. While the process may take less time in Iran, business leaders and policymakers need to focus on what can be achieved in the next year.

By necessity, larger deals operate on longer timeframes. It will take years for Airbus and Boeing to complete their deliveries, or for Shell and Total to start pumping oil, and for Renault and Daimler to ramp up production. In effect, the contracts signed today will only manifest their full economic value in the next five to ten years.

In the private sector, timeframes for investment are much shorter. As the Henkel deals show, investment in private sector firms can happen quite quickly, even just months after Implementation Day. These transactions are the potential spark for Iran’s economic engine and they represent the overlooked landscape of Iran’s economy. The bulk of untapped economic value lies in the private sector.

Privately-owned companies maintain dominant positions in consumer-facing sectors such as FMCG, food and beverage, pharmaceuticals, consumer technologies, and hospitality and tourism. These companies, some of which are family-owned and some of which are publicly-held, are led by a globalized class of managers, many of whom have studied and lived abroad. Therefore, these companies operate much closer to international best practices for key functions such as accounting, supply chain management, human resource management, and marketing and communications. While many of these firms are under financial duress due to the lasting effects of sanctions, they nonetheless possess strong market share and significant cash flow, making them ripe for turnarounds. Some are in superb financial shape.

Most importantly, these companies are identifiable, if not widely known. While the firms and their owners have remained out of the limelight of Bloomberg, Reuters, or the Wall Street Journal, the grapevine in Tehran has a way of determining which companies deserve to be counted among the top 100, and which are the true standouts. The much talked about “positive list” of clean and compliant companies already exists—one just has to be on the ground in Tehran long enough to catalogue it. This is a small group of companies, at most numbering around one hundred . The very largest of these companies generate around USD 1 billion in revenue. As such, most of these enterprises would require relatively little capital for a strategic or financial investor to take a meaningful, if not a majority, ownership position. This is particularly true if one considers that leveraged buyouts—with debt financing coming from Iran—could be part of the capital solution. Realistically, the value of the purchased stakes, whether majority or minority, would rarely exceed USD 200 million and would probably average between USD 20 to 50 million.

Such transactions are small enough that they would enable the investing company or fund to mitigate the banking sector challenges that are currently throttling Iran trade and investment. The smaller banks that have begun to work with Iran are equipped to handle transactions of this size without breaking their balance sheets. By the same token, it is far easier to convince a large bank to facilitate a smaller transaction on the back of significant investor-led due diligence. Strong evidence for this can be seen in the success of Pomegranate, a Swedish investment fund, in deploying approximately EUR 60 million into Iran's tech sector. 

Looking for one hundred companies with a high average acquisition transaction value of USD 100 million dollars means that a total of just USD 10 billion is needed to trigger a fundamental change in Iran's economy across numerous levels, from company operation to macroeconomic conditions. 

Foreign investment is a protracted process. It will make an impact on the acquisition target at numerous stages, as new strategic shareholders take positions across Iran’s private sector. In the vetting stage, private sector firms will need to prepare themselves for due diligence, taking further steps towards better accounting and corporate governance practices. These firms will also have to embrace internationalization, becoming more knowledgeable of the global commercial landscape, and improving their capacity to engage with foreign investors or partners. When executed, the investment itself will fund knowledge and technology transfers, with the new foreign owner proving their “value-add” by helping the Iranian company make improvements in management and operations.

While the above benefits take place at the microeconomic level, there is a strong body of economic research from Iran that outlines the macroeconomic impact of private sector investment. In 2005, economists Pirasteh Hossein and Farzad Karimi examined how investment priorities in Iran could be aligned to “priorities in production and employment” in order to reduce unemployment and better address “[Iran’s] process of development.” One key finding was that “from an investment point of view, "the service sector and FMCG manufacturing are the two areas that can be considered the “‘great winners’ in generating aggregate employment due to investment.” The authors further note that private firms dominate these sectors. Therefore, “more private sector activity is warranted, since this will spread employment opportunities all over the economy with a faster pace.”

While the paper and its data are over a decade old, the fundamental findings may be even more valid today. Given the date of publication, the authors did not account for the additional impact of post-sanctions investment. They could not have predicted the great strides the private sector has made over the last decade. Certainly, there is ample research that establishes the “positive correlation between growth of national incomes and private investment ratios.” Research also shows that foreign direct investment drives greater private domestic investment in what is called a “crowding in” effect.

Finally, in today's world, trade flows are fickle. An anti-globalist turn in politics makes trade a weaker link for constructive international relations. For Iran to achieve true integration into the global economy, shareholder equity will be the tie that binds. By bringing more foreign shareholders into it's economy, Iran will rise in importance in the economic agendas of its European partners.

A direct investment of USD 10 billion is smaller than the total value of the Boeing/Iran Air deal. Growth capital, triggering value-creation, is what is needed at this crucial moment. Deploying a mere USD 10 billion of such resources into Iran's private sector in the next few years will create more economic value than pouring even larger amounts of capital into mature, state-owned enterprises. Investors and policymakers should take note. 

Photo Credit: Henkel