By Dr. Abbas Bakhtiar
Last year I wrote two articles on Iranian economy, one on the U.S. plans for economic strangulation of Iran and the second on the existing systemic problems in the Iranian economy (Ahmadinejad's Achilles Heel: The Iranian Economy).
Since then the U.S. economic pressure on Iran has been increasing steadily. The U.S. to a large degree has been successful in cutting Iran from normal international financial institutions. Many European and Asian banks have been forced to reduce or cut their financial ties to Iran. Even some Chinese banks have come under pressure to restrict their dealings with Iran, not to mention UAE and Bahraini banks. This coupled with two successive UN sanctions have been hurting the Iranian economy much more than the government has been willing to admit.
Today, many Iranian businessmen find it increasingly difficult to do business with their foreign counterparts, simply because international business payments are mostly done through letters of credits which are issued by banks. In absence of a letter of credit, an importer has to pay cash; something that is risky and difficult. There are of course various ways to side-step these problems, but they all add to the cost of doing business, something that hurts the economy. In addition many companies are being scared in investing in Iran. The threat of being cut-off from US and many major European markets has effectively limited the foreign investment to only some oil related projects. Even in this sector, many companies (even governments) are under tremendous pressure not to invest.
All this has affected the Iranian economy in a negative way. But Iran can withstand this pressure for many years without being seriously hurt; provided the government acts wisely. Unfortunately, wisdom is currently in short supply. The government’s economic policies are doing what all the decades of U.S. pressure had not been able to do: seriously destabilise the economy.
Iranian economy suffers from some serious systemic problems, some of which (such as the role of Bonyads (charity organisations), corruption, excessive bureaucracy, etc.) I have already explained in one of my previous articles (Ahmadinejad's Achilles Heel: The Iranian Economy), so I will not mention them here again. Suffice to say that no Iranian President can fix the economy without addressing these fundamental problems.
Dr. Ahmadinejad came to power because of his economic promises to improve the lives of the unemployed poor, the working poor and the middle classes. People also hoped that he would clean-up some of the endemic corruption in Iran. He had promised to increase the salaries of pensioners and the low-paid government employees, to provide affordable housing for the young and the needy and many other commendable welfare programs.
However, in an economic system where large segments of the economy resemble the fiefdoms of the Middle Ages, there is very little room to manoeuvre. Upon winning the elections, Dr. Ahmadinejad increased the salaries, which should have alleviated some of the pensioners’ and low-income government employees’ economic problems. But it only increased their problems. Many economists blame this increase in salaries as one of the major contributing factors to the increasing inflation. However, this is only part of the problem. Other problems are: external factors affecting the prices of imports, excessive middle-men profits (usually because of existence of hidden monopolies), smuggling or exporting of subsided imported goods to neighbouring countries, excessive regulations, and excessive liquidity.
I have already mentioned the extra cost associated with importing goods for Iranian businessmen. The international sanctions, U.S. and European banks’ refusal to do business with Iranian banks have all added to the extra costs of doing business; all of which are transferred to the customer. The U.S. blockades of Iranian financial institution and businesses have been very effective; although the government denies this. Iranian financial institutions are under U.S. siege. Iran is fighting an economic war with a financial Goliath and if Iran is not careful it will lose. While U.S. is blockading Iranian banks and businesses, it is trying to drag Iran into an expensive regional arms race. The U.S. strategy is the same one that Ronald Reagan used against the Soviet Union. This time U.S. while blocking Iran’s access to international financial institutions and banking facilities, is arming the neighbouring Arab states and Israel. It is hoped that Iran will be dragged into an arms-race which it cannot afford; diverting the needed civilian resources to its military. In this way, over time, the current system will be unable to compete and will eventually collapse, just like the Soviet Union.
Lack of competition (large monopolies), excessive number of middle-men and the endemic corruption also adds to the problem. When these people see the opportunity to double their profit and they have the ability to control large parts of the market, they simply do so. If you are in a position to suddenly import few hundred thousand mobile phones without any difficulty while others have to jump through hoops to import a 1000, you can effectively control the market for mobile phones and hence prices. 3. Another factor that affects the prices of goods is the legal or illegal export of subsidised imported goods. Imagine you are a businessman who can import sugar. You import 10,000 tons of sugar at $100 a ton. The government pays you a subsidy of 20%. That is you get paid $200,000 in subsidy. Now as soon as you import the goods into Iran, instead of sending it to the local market, you export it (legally or illegally) to Iraq or Afghanistan. Even if you sell your product for the original sum, you are still ahead by $200,000. That is, you pocket the subsidy and government thinks that it has supplied the market with cheap and affordable necessities. This has been happening with subsidised fuel and is now happening with other products. During the last year of former president Khatami’s government, Iran imported $28 billion worth of imports of which 75% was investment and intermediate commodities. Last year this figure increased to $49.3 billion and it is expected that at the end of this Iranian year (ends 21 March 2008) this figure will reach $53 billion. One must note that a large part of these imports is consumer goods and food stuff. Officially the inflation rate is stated at 19%, however the independent economists and experts put the figure closer to 25% to 30%. So something must be happening to these imports, beside normal consumption.
Iran suffers from excessive regulations in some areas and lack regulations in others. For example, registering companies, getting an import permit, clearing goods from customs etc, are all heavily regulated, while there are no laws regarding monopolies. Some of the largest businesses in Iran (Bonyads) resemble black boxes. They do not pay tax and no-one knows the extent of their business activities. The tax system in itself is very complex and large parts of the economy don’t pay any tax at all.
Finally, the excessive liquidity. Money supply should be managed in such a way as to accommodate the normal and needed economic transactions. When you have a million dollars you can do several things: purchase goods, invest the money in some business, or keep it in the bank or under your mattress.
If you are uncertain about the economic outlook, you will not invest in stock market or in businesses. You put your money in the bank. But if the bank pays you less than the actual inflation, you don’t do that. If the government forces banks to lend money at uneconomical rates, the same banks cannot pay the necessary interest to their customers to cover even the inflation. Who would like to get 10% or 20% interest on his/her money when there is 30% inflation?
Then there is allure of the real-state. If there is a natural pressure on the housing market and prices are rising, you put your money there; hoping that even if you don’t make much profit, at least your money would be safe from inflation.
The point here is that in Iran excessive liquidity isn’t absorbed in productive long-term projects such as building factories, roads, etc. It is simply used for speculation in real-estate or other short term projects. The middle-classes are not the reservoir of this excess liquidity. They spend all their money on consumption. The excess liquidity is in the hands of the top 10% of the population who are earning unbelievable profits from speculating on anything from real-state to import and export of goods.
The Housing Bubble
When Dr. Ahmadinejad came to power he provided low-interest loans to the first time home-owners, especially the young and the poor. However, since new houses weren’t being built as fast as the increase in the liquidity, the pressure on the housing market just increased exponentially. To address this problem, the government tried to increase the building of new homes by subsidising raw materials such as cement and steel. But as I explained above, most of these subsidies were probably simply pocketed by the importers and the middle-men.
But this alone cannot explain the creation of the housing bubble. Speculation, excess liquidity and lack of safe venues for investment have all contributed to create a housing bubble that is threatening the economy of the country. For example, a small apartment (70 sq m) in Tehran’s lower-middle class neighbourhood today goes for 400 million toomans or $400,000. This is an astronomical sum for majority of the population, first-time buyer or not. This simply cannot continue without creating serious social problems, especially when one takes into consideration that 35% of Tehranis are tenants; that is at least 4.2 million people in Tehran alone.
The increase in house prices lead to the higher rents, making life increasingly difficult for these people. In addition it forces the young people to stay with their parents even when they are in their late 20s or early 30s Some even marry and still continue to live with their parents simply because they cannot afford to even rent a small apartment, and most of these people have work.
The official “Statistical Center of Iran” puts the unemployment rate (March 2007) among “youth” aged 15-29 at 22.4%. Unemployment for the same group in the urban areas the unemployment rate is stated as 25.6%. The underemployment for the total workforce is stated as 8.4%. So if we take the “official” underemployed and unemployed “young” people, we get 34% of the working-age young population that have no chance of even renting a room, let alone a small apartment.
Poverty: Gini Coefficient and Government Policies
Gini coefficient is used as a measure of inequality of income distribution or inequality of wealth distribution. It is defined as a ratio with values between 0 and 1, where 0 corresponds to perfect equality (everyone having exactly the same income) and 1 corresponds to perfect inequality (where one person has all the income, while everyone else has zero income). A Gini coefficient of 0.3 or less indicates substantial equality. A coefficient of 0.3 to 0.4 is generally considered an acceptable normality and 0.4 or higher is considered too large. A value of 0.6 or higher is predictive of social unrest. According to UN, the Iranian Gini coefficient is 0.44 and is increasing. This coefficient most likely is not correct since the Iranian economy is opaque and finding who has what is extremely difficult. At the same time the very existence of Bonyads (charity organisations) and the informal economy distorts the figures. In 2006 Iran had the unenviable ranking of 105th place out of 163countries on Transparency International’s Corruption Perceptions Index. In 2007 its positions worsened and jumped to 179th place among the 179 countries surveyed. With such a high level of corruption and lack of reliable statistics, even though this figure is very high, it is difficult to believe a Gini coefficient of 0.44. What is clear, however, is that there are a lot of poor people in Iran that are getting poorer by the minute; after all inflation hurts the unemployed, the working poor and the middle classes much more than the wealthy and rich.
To understand the problem facing the people one has to look at the social security. According to the minister of social security and welfare Mr. Abdolreza Mesri, the minimum payment to those under its ministry’s cover is 25,000 to 50,000 toomans or between 25 to 50 dollars per month. This figure, according to him, is only from his ministry, while charity organisations and others also help. One must note that the 50 dollars is for a family and not a single person. Now the rent for “a single room” in Shiraz (Shiraz is much smaller than the country’s capital Tehran) is about 100,000 toomans or $100.
Add to this the price of a kilo of mutton which is 7500 toomans or 7.5 dollars per kilo ( which incidentally was 1800 toomans or 1.8 dollars in the beginning of 2006) or a kilogram of chicken that costs 4500 toomans or 4.5 dollars and you’ll get the picture. Prices for vegetables also follow the same pattern. (It should be noted that last year 200,000 lambs were sent to Saudi Arabia for Hajj sacrificing ceremonies by the Iranian pilgrims.)
According to the minister there are currently 9 million people in Iran receiving assistance from his ministry and he is proud of stating that no-one under his ministry’s cover gets paid anything under the UN minimum poverty line, which is between 1 and 2 dollars. The 9 million people that the minister speaks of receive a coupon worth 32,000 toomans or 32 dollars per month for purchasing of food and other necessities.
The minister admits that there is no way for him or others to gauge the real need of the people. He uses the example of the healthcare costs, in which he mentions that in the past 6 months private health care prices have risen by 1,000% (10 times the original). One must note that Iran lacks universal healthcare system, leaving millions to rely on private sector for their needs. How this 1,000% increase in healthcare costs has affected the people is anyone’s guess.
The Need for a War Economy
By now it should be clear to all that Iranian economy is in serious trouble. Iran is fighting an economic war with the U.S. and Europe, while at the same time suffering from systemic problems and bad economic management which has resulted in stagflation, which means high inflation and unemployment. The government’s free-spending policies, no matter how well intention, has only worsened the problem. But as I mentioned above, the economy suffers from systemic problems that cannot be solved by this or that president. The right policies can only limit the damage, not solve the problems.
Now that Iran is caught-up in the sand-storm of stagflation and fighting an economic war, it has to tighten its belt and enact drastic economic measures. It cannot simply check inflation by importing more goods, without making sure that those goods are actually delivered to the people at subsidised prices. It is evident that simply increasing the imports doesn’t help.
It cannot reduce its payroll either, because if it does, it simply increases the unemployment rate and hence social dissatisfaction. It cannot reduce liquidity by increasing the interest rates either; since this will mean a large scale defaults by the middle classes and small businesses, not to mention a proper recession. It cannot increase taxes much either, since large segments of the economy are tax-exempt, leaving the burden on the shoulder of government employees (who have to pay taxes) and again small businessmen.
So far the government has been dipping into the oil-reserve fund to finance its increasing imports and social programs. But that has only fuelled the inflation. So what can this government do?
Well, to start with it has to get serious about fighting corruption and cronyism. Corruption is one of the major problems facing Iran and government ignores it at its own peril. Government should also inform people that it is in a state of economic war and everything is not so rosy. The government should know that people already know this.
The government has to implement a war economy; that is to say, it has to reinstate the coupon system that it used in Iran-Iraq war. The introduction of the coupon system will also relieve some of the poverty while reducing inflation. The government should drastically reduce the import of luxury goods. It has to encourage the local industries and food manufacturers, something that generous imports tend to undermine. In addition, the government has to start a large scale house building program to reduce the pressure on the housing market. Leaving it to the market to address this issue, in the current inefficient system, doesn’t produce any results except inflation.
I am against a command economy, but under the current system with all its inefficiencies and endemic corruption, nothing else will do the job. Instituting a war economy will be a drastic measure, but a welcomed one by the majority of the people. Those who are sleeping hungry at night (and there are many) will thank the government, while those that live in luxury villas will curse the government. It is up to this government to decide whose praise it is after. The poor and the middle classes find themselves between the hammer of the inflation and the anvil of the unemployment. How long will they continue to accept the blows is anyone’s guess, but if it continues, it will end badly not only for Dr. Ahmadinejad’s government but also for the Islamic Republic of Iran.
About Dr. Abbas Bakhtiar
Dr. Abbas Bakhtiar lives in Norway. He is a management consultant and a contributing writer for many online journals. He is a member of the editorial board of CASMII. He's a former associate professor of Nordland University, Norway.
Dr. Abbas Bakhtiar can be contacted at: email@example.com