TEHRAN - Sanctions are actually encouraging Iran to be more effective and efficient in economic governance, and the subsidy reform plan is an indication of this, according to economist Richard Javad Heydarian.

Heydarian made the remarks in an exclusive interview with the Tehran Times on August 12.

Following is the text of interview:

A: Although we are still in the early period of implementation and reform, one could argue that by any measure Iran is engaging in one of the most audacious and decisive economic reforms in recent times. 

For decades, Iran has remained as an essentially state-dominated economy with the private sector playing a somehow marginal role. But things have been changing in the last two decades. In order to understand the nature of and the rationale behind the reforms, it is necessary to have a better grasp of the context within which these reforms are being implemented.

A: Let me briefly touch on the nuances of Iran’s complex economic structure. Since the 1990s, Iran has engaged in economic liberalization - from trade liberalization to privatization of state enterprises - and this has paved the way for more private-sector participation, economic dynamism, and overall improvement in competitiveness and openness. 

Iran boasts one of the largest middle class populations – around 40 million – among emerging markets, and previous liberalization schemes allowed this bourgeoning class to better integrate into global economy, import best business and economic practices, establish transnational economic linkages, and transform Iran into an increasingly-modern economy. 

Nevertheless, overall, the balance of economic participation has always tilted in favor of the state. But we have to recognize the fact that despite some understandable level of inefficiency and market distortions, the Iranian state has played a relatively successful developmental role, thus explaining Iran’s industrial and technological boom in recent decades. 

The centrality of the state in the Iranian economy has also allowed the country to have a better distribution of wealth and a more even development across the country, reversing huge economic gaps in the pre-revolution era. 

As a result, Iran has one of the best socio-economic indicators among developing nations, and levels of poverty and inequality are very low as compared to other major emerging economies in Africa, Asia, and Latin America. 

Access to basic services – from clean water and electricity to basic education and health services – are also above the global average, signifying Iran’s impressive records in many crucial developmental areas. 

Yet, we can’t deny that Iran has been facing challenges with respect to its economy, namely in the realm of price-stability and employment.

A: A more careful analysis of Iran’s economic architecture would reveal that persistent macroeconomic challenges are more a function of ‘demographic’ factors rather than economic-management schemes and overall fiscal-and-monetary policies of recent administrations. 

The population boom that Iran experienced in the 1980s exerted a long-term pressure on the economy, where - by the late-1990s and early 21st century - a huge number of young people relied on a disproportionately smaller, active and productive middle-age population. 

This is why unemployment is not uniform across generations, but it is more concentrated among the youth – similar to Turkey and other neighboring countries. 

Moreover, economic sanctions and 8 years of destructive ‘imposed’ war with Iraq carried hundreds of billions of dollars in accounting and opportunity costs. Absent these adverse ‘external’ and imposed conditions, Iran’s macroeconomic picture could have been radically different. 

The subsidies were the brainchild of a unique period in Iranian history. The very wisdom of the subsidies was to ensure that the Iranian nation – affected by adverse economic conditions in the 1980s – could afford basic commodities from food to fuel. 

The subsidies were a great help in terms of abetting people to overcome difficult conditions in the past. However, there are problems with large-scale subsidies. 

As the Iranian economy grew over succeeding decades, the boom – with an average of 6-7% annual GDP growth – led to the rise of a newly rich and upper-middle class population. 

The problem with subsidies is that they are not ‘targeted’ – since everyone accesses it directly or indirectly - and they encourage wasteful consumption. 

This is evident by the fact that Iran is among the world’s top consumers of fuel, even though Iran’s economy is only among top 25 or top 17 (depending on whether you use nominal or Purchasing Power Parity as the measure) countries and its population is hardly among top 10 nations. 

This means, average fuel consumption levels in Iran are several times bigger than that of the global average. 

Artificially low fuel and food costs have also led to inefficiency in many sectors. For instance, residential areas and industrial sectors have a very problematic energy-efficiency record, while many used to engage in ‘leisure driving’ simply because prices do not reflect the true market value. 

The absence of clear price signals has led to inefficient consumption and a huge pressure on the national budget. 

Instead of investing revenues in wealth-generating investments, the government has had to allocate a large portion of its national budget to subsidies, which disproportionately favor the more affluent sectors that could afford more of subsidized commodities. 

Subsidies have encouraged wasteful consumption; higher reliance on imported refined-fuel; and deprived the country of more surplus energy commodities for exports. 

We should also understand Iran’s dilemma when it comes to inflation and unemployment.

In the last two decades, the government had to balance price-stability with employment-generating high economic growth.

The problem is, if one injects too much liquidity into the market and engages in expansionary fiscal and monetary policies, in order to spur economic growth and reduce unemployment, one could face upward inflationary pressures.

This has been the concern in the last decade. The subsidies allowed for a level of stability in prices – below market prices - but this was accompanied by inefficiencies and fiscal pressures, which have limited the government’s ability to more aggressively invest in the economy’s productive capacity. 

So when oil prices skyrocketed, the injection of petrodollars into the economy – through higher money supply and low interest rates – led to high economic growth, but at the same time – in absence of corresponding increase in economic productivity – inflationary pressures kicked-in. 

With recent unilateral economic sanctions – by the European Union and the United States – targeting Iran’s ports, fuel imports, financial system, and energy investments, the pressure on the Iranian economy has been intensified. 

Therefore, there is a perfect justification for crucial and high-impact economic reforms, which would streamline the $100 billion subsidy regime, and inject more energy-efficiency while providing more fiscal space for the state. 

A: Somehow, ironically, the sanctions are serving as an impetus for better economic governance. Arguably, the government has been relatively smooth, calculated, and successful in pushing with the reforms, but sure there is room for improvement and there is a long way to go.

So far, the current administration has veered away from its previously semi-Keynesian approach to economics, and is increasingly employing neo-classical macro-economic policies in order to liberalize the economy by focusing on price-stability, balanced budget, and more conservative monetary and fiscal policies. 

Perhaps, one could say that a more conservative economic turn is reasonable given Iran’s current economic situation. 

A: Large-scale subsidy reforms are extremely difficult, both in technical and political terms. 

However, it seems that, so far, the general population is ‘understanding’, if not sympathetic, vis-à-vis the subsidy reform schemes, precisely because they appreciate the urgency for instituting policies that are geared to revitalize the Iranian economy. 

Moreover, given how the global economic outlook is shaky, people are more or less aware of how economic hardships have gripped most countries. The aftermath of the 2008 global financial crisis has been difficult for most countries, and ‘economic reforms’ are the main game in the town. 

In recent months, the government has engaged in measures, which seek to cushion citizens against possible price shocks, while subsidies are being phased out. 

For instance, citizens receive a monthly amount from the government – deposited in their accounts – to manage their increasing expenses. 

This safety-net is acting as a sort of buffer against increasing prices. 

A: Perhaps, over the medium-run, what Iran could do, as indicated by policy-makers, is to institutionalize a more targeted subsidy-scheme, where the most vulnerable sectors are given enough financial cushion to manage rising prices. 

This means, efforts should be invested in developing accurate statistical data, based on which these proposed safety-nets could be appropriately allocated. 

The gradual and cautious pace of subsidy-reduction has so far prevented a major destabilizing price shock – although there are reports that some industries and families are really feeling the crunch – therefore the fears of ‘stagflation’ – simultaneous reduction in economic output and increase in prices - is out of question. 

A: Given the extent of subsidy reductions, both its economic and psychological impact, the country has so far avoided potential destabilizing shocks.

Looking at the data by reputable financial and forecast institutions like the Economist and the IMF, Iran’s annual GDP growth for 2011 is expected to be at around 2-3.5 percent. 

Moreover, according to the Economist, Iran’s GDP is expected to double in the next 5 years. Relatively high oil prices are also helping the Iranian economy to remain buoyant, avoiding budget deficit and the necessity for borrowing. 

Iran’s economy has other strong points. Some reports put Iran’s foreign exchange reserves at around $100 billion, while Iran’s economy does not suffer from serious levels of sovereign debt, similar to many Western economies, given how deleveraged is the national economy. 

The IMF puts Iran’s inflation at around 10-15 percent, which could be corroborated by data from other reputable sources. 

So overall, the reforms are incrementally pushing Iran closer to economic objectives set by the administration. 

To gain a better insight of seismic shifts in Iran’s economic landscape, we could look at other comparable cases. In many ways, Turkey – a country with similar population and economic weight – went through a series of major economic reforms and crises from the 1990s to 2001.

After instituting decisive reforms – from privatization, reduction of non-performing loans, tightening interest rates, reforming the currency, introducing reforms on capital mobility, and opening up the economy to global markets – it was able to leverage its human resources and infrastructure in order to revitalize its initially struggling economy. Today, Turkey is a booming economy.

Iran could learn a lot from experiences of other comparable successful transition-economies. Given how Iran enjoys huge hydrocarbon-based revenues and resources, it means that Iran’s economic potential are even greater. 

A: Prior to the 2008 global financial crisis, Iran grew at around 6 percent annually for around two decades. 

During this period, Iran’s GDP almost quadrupled. No wonder, Iran was always considered as one of the major emerging economies, as reflected in reports by leading financial institutions such as Goldman Sachs. 

Sure, many emerging economies – from Turkey to Vietnam, China and India – have somehow overshadowed Iran in terms of attracting foreign capital and sustaining very high rates of annual GDP growth. 

Most of these countries are members of the World Trade Organization (WTO), plus a plethora of preferential trade agreements, and they enjoy strong and stable relations with major center-economies, while Iran’s unique geopolitical realities have somehow affected its ability to attract similar levels of Foreign Direct Investments (FDI). 

Nonetheless, a combination of diplomatic savvy and very attractive investment opportunities has allowed Iran to sustain growth, despite growing external pressure on the country. 

Iran has the world’s second largest reserves of gas (and even oil by some measures) and a huge portion of its reserves are largely untapped. 

Moreover, the country possesses one of the largest consumer markets among emerging economies, and there is a growing appetite for high-end consumer products from electronics to machinery. 

For instance, reports such as the Global Competitiveness Index and the ‘Next-Eleven’ reflect the significance of Iran’s huge market.

Iran also has one of the best-trained and skilled professionals and workers in the region, with many of its technical universities competing with the best in the continent and the world. 

Given these factors, it should not surprise us to see huge interest on the part of major companies, both from Europe and major emerging economies, to invest in Iran, increase their market shares, and deepen economic ties with the country. 

A: Sure, sanctions have affected many investments, especially by multinational western companies, and they have also created some difficulties in oil and commodity transactions, but Iran’s strong economic fundamentals – market size, resource-abundance, and educated population – have always provided the country with sufficient economic dynamism to ameliorate external pressures. 

Moreover, Iran has been aggressively pushing forward with its policies to develop its energy-reserves and diversify its exports by increasing non-oil commodity exports, from cars to construction materials and agricultural products. 

Iran’s industrial growth could have had moderated, but the country’s major car manufacturing industries have posed around 8 percent in growth. 

So, more skeptical analysts might have overemphasized the price shock factor. 

Iran’s booming trade with Turkey, China, Iraq, and other countries – potentially Latin American booming economies like Brazil - has also allowed Iran to expand its foreign trade. 

In addition, despite all the sanctions, Iran’s exports to some major European economies has shown great resiliency and in some cases and periods it has even grown. With oil prices also remaining buoyant, there should not be much of a surprise if Iran’s GDP and investment portfolio is reflected in such manner. 

A: Well, if one looks at the literature and history of sanction regimes, it is very clear that they hardly achieve their main and expressed political purpose. 

Sanctions are always plagued by free-riding, non-compliance, weak implementation, leakages, lack of precision, and unfortunate collateral damage. 

The sanctions have made life difficult for many ordinary Iranians, since they target financial transactions, food imports, and refined-fuel imports. The sanctions also seek to reduce large-scale investments in Iran’s economy. 

No economy is completely immune, and all economies possess a level of vulnerability to external shocks. 

In the age of interdependence, domestic economic conditions are somehow affected by broader international developments, although the extent of it would differ across countries.

In the case of Iran, sanctions have had some effect, especially those that are outside the gambit of the United Nations’ Resolutions. 

Despite his rhetoric of reaching out to Iran and introducing a more humanitarian-progressive foreign policy, President Obama has pushed with sanctions that are hardly targeted, because they are affecting the entire country. 

Iran has also intensified production in its refineries and the reduction of subsidies has dramatically dropped wasteful consumption, thus helping Iran to be self-sufficient in refined petroleum. 

A: Although the sanctions are affecting mainly European companies, which seek to invest in Iran, companies from other emerging economies, from Istanbul to Beijing, are investing in Iran. 

Given Europe’s economic difficulties, one could expect some European companies to insist on investing in and doing business with Iran, simply because Iran represents an important economy in the region and beyond. 

In short, the sanctions surely alienate the Iranian populace, but they are not strong enough – due to Iran’s inherent economic assets and proactive economic policy - to achieve their political goals.