Iran's Economy is Bruised, But Not Broken

This article was originally published in Lobelog.

Last April, in a column for this blog I predicted that sanctions are very unlikely to force Iran to renegotiate the multilateral nuclear deal known as the Joint Comprehensive Plan of Action (JCPOA). In particular, I argued that the belief held by Iran hawks in Washington foreign policy circles, that economic pressure will eventually force Iran to the negotiating table, exaggerated the importance of oil exports for Iran’s economy.

New data indicate that, while Donald Trump’s policy of “maximum pressure” has reduced Iranian oil exports to near zero and seriously hurt Iran’s economy, it has not caused anything resembling economic collapse. Furthermore, these data suggest that the economy is not in a steep decline, one that would anytime soon force Iran to capitulate.

The national accounts data, published by the Statistical Center of Iran (SCI), indicate that, in the Iranian year 2018/19 (21 March 2018 to 20 March 2019), GDP declined by 4.9 percent, which is far from a collapse of output. Coming after two years of robust growth following the July 2015 nuclear deal, it puts the economy still above its 2015 level.

This decline was, not surprisingly, led by the oil sector, which fell by 14 percent, followed by manufacturing (6.5 percent), which depends on imports of parts, and construction (4.5 percent).  However, non-oil GDP, which measures the level of domestic economic activity, fell by only 2.4 percent. This is because output in services, which accounts for 55 percent of Iran’s non-oil GDP, remained unchanged, and agriculture, accounting for another 10 percent, fell by 1.5 percent.

Iran’s economy has taken a beating, but it is not a disaster, as President Trump likes to describe it. To most Iranians, his remarks last September—which he repeated in June—that Iranians “can’t buy bread,” showed how out of touch he is with the consequences of his own policy.  Travelers to Iran have noticed, as I did this summer, that supermarkets shelves were full (though mostly with home produced goods at high prices), and there were no lines in government distribution centers, which are the hallmark of real disaster economies, like Venezuela.

High prices, triggered by the tripling in the value of the U.S. dollar since early 2018, have taken their toll on household incomes. The most recent SCI survey of income and expenditures shows that in 2018/19 average real incomes per capita fell by 6.7 percent in urban areas and 9.1 percent in rural areas, more than the decline in GDP per capita. These are sharp drops, but obviously not enough to ignite urban protests, as the Trump administration had hoped.

Going forward, the question is whether the Iranian economy is on a steep decline, is stabilizing at a lower level, or is on the road to recovery. This will influence Iran’s willingness, or lack thereof, to negotiate with the U.S., and should matter for Washington as it evaluates its Iran policy in light of its failure so far to yield the desired results. As always, Iran hawks recommend staying the course with “maximum pressure,” believing that Iran will “ultimately do a 180 if they perceive that there’s no way out.”

But what if there is a way out? What if Iran can restructure its economy to become less dependent on imports and truck along with reduced oil exports? Iranian leaders may be pinning their hopes on this scenario and thinking that the worst is over when they flatly reject negotiations.

In this belief they can draw support from the International Monetary Fund (IMF). In its April 2019 World Economic Outlook, the IMF predicted that negative economic growth in Iran will end in 2020 and positive growth of around 1 percent per year will prevail till 2024. Not a rosy scenario by any means, as it implies loss of economic growth and declining per capita incomes for the foreseeable future, but it may be enough to convince Iranian leaders not to capitulate.

IMF forecasts beyond a year do not always materialize, and we do not know their assumptions about when U.S. sanctions will end. But the latest evidence from Iran’s labor force survey suggests that an end to the recession may be in sight. They show that in spring 2019, compared to spring 2018 before sanctions came back in full force, employment increased by 324,000 and the number unemployed fell by 365,000. As a result, the unemployment rate fell to a five-year low of 10.8 percent.

Significantly, half of this increase in employment was in industry, the sector that is most exposed to sanctions because its production depends on imports of intermediate inputs. Nearly half of all Iranian imports are intermediate goods.

Cynics have reason to doubt official Iranian surveys, but the rise in employment reported by the SCI makes good economic sense. For over a year, Iran’s currency has been at a historic low and its labor costs the cheapest in memory (about $5 per day for unskilled labor, half that in China). With rising profitability, it makes perfect sense for businesses to increase hiring to fill in for lost imports.

But the switch to local production faces two obstacles. First, the U.S. sanctions themselves. To sustain the structural adjustment needed to reconfigure industrial production requires access to global markets, which trade sanctions inhibit. Second, it requires a banking system to finance businesses to restructure. Iran’s banking system is too weak to do so at present.

While the prospects of economic recovery remain uncertain, it is safe to reject the assumption that Iran’s economy is on a “death spiral,” to use a favorite phrase of Iran hawks. While economic conditions are desperate for many Iranians in need of jobs and medicine, they are not desperate enough for Iran’s leaders to risk getting into a costly war with their southern neighbors and the U.S. just to end the current stalemate. Iran’s Supreme Leader, Ayatollah Ali Khamenei, who has ruled out negotiations with Trump, is for one interested in finding out if the economy will rise to the challenge of sanctions and thus become the “resistance economy” that he has advocated for years.

Photo: IRNA

7 Charts That Challenge the Distorted View of Iran's Economy

Recently, a number of people have insisted to me that Iran has squandered its chance to joint the ranks of the BRICs—Brazil, Russia, India, and China—which count as the great emerging markets of the world. As sanctions return, as the rial sheds value, and as protests become routine, Iran is increasingly portrayed as an economic basket case where state collapse is just around the corner.

But even a cursory look to the recent experiences of BRIC markets makes it clear that Iran’s pains are not unique. In particular, Brazil has been in a near constant state of political and economic crisis since 2014, when an investigation called Operation Carwash uncovered massive corruption within Petrobras, a state-owned energy company, which was at the center of a “corruption machine” enriching allies of then President Dilma Rousseff. Since these revelations, millions of Brazilians have participated in protests around the country, their anger only increasing as a recession brings higher inflation and rising unemployment.

As I relayed in an interview with Brazilian newspaper Folha de S.Paolo, in January of this year, the slogans of the protests then emerging across Iran and still visible today, echo those of the protests that have been roiling in Brazil. The reason for this is simple. From a developmental standpoint, Iran’s economy is very similar to those of the BRIC countries, especially Brazil.

The policy failures of the Iranian government have garnered much attention in light of the recent protests. But they are not unique. They are the same failures that can be observed in Brazil, as well as other upper-middle income economies undergoing complex economic transitions. The frustrated cry of the Iranian protestor is the same cry as that of the Brazilian protestor. Sure, there is some local political and economic dialect. But the language of corruption and inequality is the same.

Despite this, the economic crisis in Iran has been characterized as a uniquely Iranian phenomenon, resulting from a set of political circumstances which can be traced back to the 1979 Islamic Revolution. Looking to Iran and Brazil in a comparative framework offers an important corrective to this characterization. Similar combinations of macroeconomic conditions produce similar political manifestations—protests against corruption, anger at social injustice, even calls to overthrow the government.

Put in its proper context, what is most unique about the crisis in Iran is not the economic reality, but the political reaction. Despite the clear parallels between the cases in Brazil and Iran, we do not see foreign powers “reaching for a regime change strategy” to alleviate the frustrations of the Brazilian people. No doubt, the failures of the Iranian government to create a robust economy are partially political failures. The country has an antagonistic relationship with the world’s superpower and its political elites are continually embroiled in needless scandal.

But as the seven charts below show, Iran is not an outlier when it comes to its economic performance. Governments of very different political persuasions and institutional frameworks—like those of Brazil and Iran—routinely fail to solve the fundamental challenges of economic development precisely because economic growth is difficult to achieve, harder to sustain, and insufficient to improve living standards. This is the context in which we ought to objectively understand and grapple with the idea of economic reform in Iran.

1. Struggles with Inflation

Both Iran and Brazil have long tried to keep inflation in check. Brazil suffered from extreme inflation in the early 1990s, hitting nearly 3000 percent. Iran also went through a period of chronic inflation, hitting an official rate of 50 percent in 1995. By the later part of the decade, both countries began to bring inflation under control. In 2016, the inflation rates in Brazil and Iran converged. Both are back on an upward trend, contributing to public frustration over the cost of living.

2. Stubborn Unemployment

One of the main drivers of recent protests in both Iran and Brazil has been anger over chronic unemploument. In Brazil, unemployment has risen sharply due to the recent economic downturn, and is now approaching levels seen in Iran. Revelations of deep-seated corruption in government have led Iranians and Brazilians to share the belief that their government officials are more concerned about their personal economic wellbeing than about creating jobs and tackling inequality.

3. Ease of Doing Business Rankings

Weak rule of law and the lack of transparency which enable corruption also serve as barriers to investors and entrepreneurs. Iran and Brazil are ranked 124th and 125th respectively in the World Bank’s Doing Business rankings. While the performance of Iran and Brazil varies across the constituent parts of the overall score, it is clear that conducting business in the two countries is similarly onerous and risky.

4. The Role of Foreign Direct Investment

However, despite the fact that Brazil is just as difficult a place to do business as Iran, the Brazilian economy has attracted nearly 25 times more net foreign direct investment (FDI) than Iran in the period from 1980 to 2016. Brazil’s economy has been burnished with over USD 1 trillion dollars in FDI, while Iran’s economy has secured just USD 44 billion in the same period. Brazil’s success in attracting foreign investment began around 1995, when the country was coming out of its hyperinflation crisis and when a new class of emerging market investors began to finance the new wave of globalization. Iran missed out on this emerging markets gold-rush. The passing of the Iran Libya Sanctions Act in 1996 by the U.S. Congress and the intensification of sanctions in 2008 at a time when global investors sought elusive growth in emerging markets in the aftermath of the global financial crisis, saw Iran’s FDI inflows stagnate.

5. Similar Growth, Differing Volatility

Despite missing out on FDI inflows, Iran has not been a growth laggard. Over the period of 1980 to 2017, Brazil and Iran achieved the exact same average annual GDP growth: 2.45 percent. The key difference is that Iran’s growth has been more volatile given that it is principally driven by oil revenues and is therefore tied to fluctuations in the global oil price. International sanctions have also frustrated economic growth in Iran.

6. Brazil’s Debt-Fueled Growth

But if Iran’s growth has been fueled by oil, Brazil’s growth has been fueled by its own global market—the debt market. Brazil’s external debt has skyrocketed, exceeding 70 percent of GDP, as the country has repeatedly turned to international bond markets and IMF loans in order to counteract domestic economic fragility and soften the impact of recessions. The recourse to debt allows Brazil to reduce economic volatility. While Iran’s oil buyers can be fickle, creditors are always ready to offer Brazil more financing.

7. GDP Per Capita

Iran and Brazil have seen similar overall levels of economic growth in the last four decades and standards of living, as measured by purchasing power, have likewise been improving at a similar rate. But this is all the more remarkable given that Brazil has enjoyed much greater access to international investment and financing. Even so, the average Iranian today enjoys greater purchasing power than the average Brazilian. The gap in GDP per capita widened during Brazil’s recent economic downturn, but it will likely narrow again as Iran enters its own economic crisis, marked by returning inflation and a devalued currency. Nonetheless, Iran can be said to have delivered greater economic dividends to its population than one of the vaunted BRICs, even without the stimulus of international finance.

Photo Credit: Bourse & Bazaar

How Entrepreneurship Can Help Address Unemployment in Iran

Unemployment is a major concern for both labor force participants and for policymakers, especially during periods of economic downturn. Unemployment has been shown to have long-term negative effects on an individual's happiness, even after he or she finds employment. Furthermore, the resultant decrease in tax revenue from unemployment affects many aspects of an economy. Not only is infrastructure investment reduced, but social welfare payments are increased, producing strains on any government. Iran has a considerable unemployment rate (12.2% in July, 2016) and an even higher rate of youth unemployment (26.1% in July, 2016). For decades, the Iranian government has tried unsuccessfully to reverse this trend.

In a number of countries (e.g. Germany, India), self-employment is considered to be an important labor market option for the unemployed. In such countries, governments have successfully developed policies to support unemployed individuals in establishing their own businesses. In both these countries, financial subsidies  are coupled with non-financial support, such as mentoring and training. In Germany, two programs (Start-up Subsidy and Bridging Allowance) have helped the unemployed to successfully reintegrate into the labor market. Participants who fulfill certain criteria enter one of these programs and are allotted a monthly salary for a specified period of time, all the while receiving mentorship and business advice. In India, several programs such as Rozgar Yojana (introduced in 2001), have incentivized candidates to start new ventures. Rozgar Yojana is exclusively designed for unemployed educated youth. Since its inception, the program has provided employment for over 3.8 million candidates.

The Iranian economy would need to achieve a sustained annual economic growth rate of 8% in order to successfully integrate all job-seekers into the labor market—a virtual impossibility even with the post-sanctions rebound. Thus, innovative solutions for unemployment, such as entrepreneurship training programs, are paramount. To date, Iranian policy-makers have neglected to explore this kind of "bottom-up" job creation, despite the fact that 16% of the labor force is already self-employed. 

From a cultural standpoint, significant research suggests that Iranians hold positive attitudes toward entrepreneurship. More importantly, young Iranians have both the ambition and the confidence needed to launch new ventures. What these youth lack is strong government-supported programs and incentives for them to pursue potential self-employment.

Factors that increase the expected benefits of entrepreneurship or decrease its opportunity costs can positively influence an individuals’ tendency to become an entrepreneur. The provision of subsidies and the creation of apprenticeships for the unemployed can encourage entrepreneurship. The most significant deterrent to setting up a business is the lack of start-up capital. The government can provide subsidies to alleviate this problem, particularly as private sources for so-called venture capital remain limited.

Implementing a successful entrepreneurship program for the unemployed must include three components. Firstly, it is important to define specific eligibility criteria for potential candidates. Secondly, the performance of participants must be evaluated throughout the mentorship process. Thirdly, the government must include successful start-ups and other ventures in the design and implementation of such programs. Iran's vital business ecosystem is rife with the elements needed to greatly improve its serious unemployment problem. The government must play a more vital role in remedying the issue.

Moreover, higher levels of human capital investment have been shown to engender entrepreneurship. It is important to note that for many who have recently lost their jobs, clear access to new opportunities is important to keep confidence high. A well-designed re-integration and training program that compensates participants would allow these individuals to consider shaping their own futures through an entrepreneurial project. My research suggests that education is one of the strongest drivers of entrepreneurial performance so courses and mentorship can help unemployed persons to create successful ventures. 

Even if most of these candidates eventually return to working for others, the skills and confidence they would garner would be instrumental for their future job security in a dynamic economy. As long as participants of such programs successfully re-integrate into the labor market, the entrepreneurship program will have reached its aim.

Photo Credit: Thomas Christofoletti