Iran’s Economy: Trouble in Tehran

Djavad Salehi Isfahani
Djavad Salehi Isfahani
Djavad Salehi Isfahani Professor of Economics - Virginia Tech

June 22, 2009

Editor’s Note: Djavad Salehi-Isfahani assesses Iran’s recent economic performance in Foreign Policy magazine, arguing that the country’s policymakers have amassed a mixed record. While government spending in the past year was based on safe estimates of oil prices, high levels of social spending will be hard to maintain and the private sector will struggle to revive the Iranian economy in 2009. This was originally published under the title “Trouble in Tehran”.

When the U.N. Security Council slapped a third round of sanctions on Iran for its nuclear program in March 2008, the country’s economy, bolstered by record crude prices, still looked set to roar. Oil revenues had helped Iran grow at a healthy 6.9 percent clip during the previous year. Even poverty levels were down, according to the World Bank. So how could the country jump 11 ranks in the Failed States Index this year?

The index correctly penalizes Iran for macroeconomic mismanagement. Inflation doubled in annual terms from 15 to 30 percent in 2008 after President Mahmoud Ahmadinejad boosted social spending to “bring the oil money to people’s dinner tables.” As demand expanded, prices for nontraded goods such as housing rose sharply, squeezing the poor and the middle class. A flood of cheap imports kept inflation from going even higher, but jobs were lost as imports undercut local industries. The central bank restricted credit sharply to reduce inflation, hurting businesses further and putting more people out of work. Inflation did come down to below 20 percent by December, but unemployment probably increased. Iran’s jobless rate hovers around 12 percent, with three out of four unemployed Iranians under age 30.

Festering discontent about inequality helped inspire Ahmadinejad’s drive to redistribute the oil cash. But on this score, the results were also disappointing. Between 2005 and 2007, the income of the top 20 percent rose more than four times as fast as that of the bottom quintile. The influx of oil revenues, which trickle down Iran’s unequal structure of access to power and position, always seems to worsen the distribution of income.

But Iran’s economic weakness should not be exaggerated. The Failed States Index, for instance, too harshly critiques Iran for deficit spending and price controls. The government’s 2008 budget was tied to a predicted oil price of $39.70 a barrel, far lower than the actual price for much of the year—meaning that “deficit spending” was probably well paid for. And though Iran began to limit purchases of subsidized gasoline, plenty of fuel was available at a higher—but still well below market—price. Finally, any rise in poverty will be cushioned by Iran’s free education system, universal basic health insurance, and income assistance.

What the index claims happened in 2008, however, may already be occurring in 2009. Much lower oil prices will cause a massive deficit. If the government tries to keep up its expenditures, inflation will return with near certainty. If the government gives in to the temptation to control key prices, the exchange rate, or interest rates, it would hurt exports. Unless a new administration reverses some of the worst policies of recent years, it is unlikely that the private sector will revive in time to help the economy this year.