Tuesday, February 08, 2011

On the Meeting of Two Forces in Iranian Economics: Subsidies and Sanctions

The Economist: The Regime Tightens Its Belt and Its Fist

Two major forces influence the Iranian economy: sanctions and subsidies. As a large oil producer, revenues from the sale of oil have helped subsidize various parts of the economy at an average rate of $4,000 per family per year, or a total of $100 billion annually. The government has subsidized the price of water, gas, diesel, electricity, and stapes to the extent that many Iranians were becoming wasteful. At the same time, Iran has felt the effects of various sanctions by the United Nations (including, begrudgingly China and Russia), the European Union and the United States. Since 2006, there have been six U.N. resolutions for sanctions against Iran. The nature of the sanctions and subsidies, are changing, and may have a significant effect on the future of Iranian economics and politics.

First, the United States and the European Union are pushing for greater sanctions and effectively dissuading the world from doing business with Iran. The effect of the sanctions has not destabilized the nation or caused political consequences, but the sanctions have definitely affected the Iranian economy. For example, U.S. sanctions on the sale of refined oil (since Iran lacks refining capacity) have significantly affected the price of gasoline in the country. The greatest effect of the sanctions has been on the merchant middle class who have become “cash-starved” as countries party to the sanctions have blocked off access to banking and commercial institutions. As the United Arab Emirates (a long-time and essential trading partner) tightens enforcement of sanctions, the $600 million-a-month trade between the countries will invariably decrease. While sanctions from Dubai are limited to specialized goods, they are likely to spread to foodstuffs and electronics. Commentators disagree about the actual effect of sanctions, but it is clear that the sanctions are increasing costs upwards of 15-30% according to Mohammad Nahavandian, President of the Iranian Chamber of Commerce.

Second, in December 2010, the Iranian government began the biggest economic reform of the last 30 years, ending subsidies on electricity, gas, diesel, staples and various other necessities. Despite a significant jump in the price of those commodities, Iranians seem to have accepted the change. The price of gas has gone up from $.38 to $2.64 and the price of diesel has gone up 2,000%. The current price of staples such as water and flour remain low as the government is infusing the market with stockpiles, but the expectation is that prices on staples and all goods will increase when the stockpiles run out. Some commentators have emphasized that such inflationary pressure will certainly have a destabilizing effect on the economy, yet others, including much of the Iranian population, believe that the changes are necessary to improve efficiency in the economy. Furthermore, the Iranian government has pledged to use the money saved on subsidies toward infrastructure and housing projects while curtailing waste. Ending the subsidies will certainly increase the prices of goods— the question is whether the new economic strategies will politically destabilize Iran.

At this time, it is unclear whether there will be additional, more stringent sanctions or to what degree U.N. members will continue to uphold existing sanctions. Furthermore, it is unclear what net effect the lifting of oil subsidizes will have on the economy, given that many Iranians believe the subsidies were creating inefficiencies in the market. While commentators disagree on the exact effect on the economy, many suggest that the immediate effect will be an increase in prices of goods and services. However, the ultimate political and social consequences remain uncertain.

Discussion Questions

1. If UN members increase sanctions, will Iran be able to mitigate the effect?

2. Are there any other results that might arise from the changing nature of sanctions and subsidies in Iran?

3. Did the Iranian government make a mistake by removing subsidies if it wishes to maintain its authoritarian control?

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