With the collapse of the Green Movement—a reality that even some of its more ardent partisans in the West have had to acknowledge—America’s Iran watchers have searched hard for some new Achilles heel that would provide the key to the Islamic Republic’s eventual implosion. Over the past few months, many of them focused on the Iranian economy and, in particular, the prospect of cuts in domestic subsidies, highlighting the potential for domestic political blowback against Iranian President Mahmoud Ahmadinejad over the reforms. Some even went so far as to suggest that negative domestic reaction to subsidy cuts might even bring down the Islamic Republic’s established political order.
Earlier this week, William Yong published an article in The New York Times, entitled “Iran Cuts Subsidies on Fuel and Other Consumer Goods”, see here. The piece has its share of strained analysis, to be sure. But, in comparison with much of the intellectually ungrounded to-ing and fro-ing in Western media coverage—not to mention commentary—about Iran’s economy, Mr. Yong’s article is relatively straightforward, at least in its reporting on subsidy reform. After a factually accurate headline, Mr. Yong writes,
“Iran has embarked on a sweeping program of cuts in its costly and inefficient system of subsidies on fuel and other essential goods that has put a strain on state finances and held back economic progress for years. The government’s success in overcoming political obstacles to make the cuts and its willingness to risk social upheaval suggest that President Mahmoud Ahmadinejad may have consolidated power after the internal fractures that followed his bitterly disputed re-election in 2000…
Tehran has long sought to cut the subsidies—even under the reformist administration of President Mohammad Khatami—and particularly for oil. The logic is compelling: artificially low prices encourage greater consumption, leaving less oil to export for cash. And the higher oil prices rise, the greater the ‘opportunity costs’ in lost exports. But the timing, whether for political or economic reasons, was never right to cut the subsidies…
While the government may be feeling economic pressure now, analysts say, the current program of cuts is principally a sign of its political strength…The subsidy cuts, which the International Monetary Fund says have amounted to $4,000 a year for the average Iranian family, began in earnest last month when the rationed price of gasoline jumped to about $1.44 a gallon from just 38 cents. With a ration of only 16 gallons a month at the subsidized rate, most motorists buy the bulk of their fuel now at the even higher market rate of $2.64 per gallon, significantly more than the $1.80 that people pay in nearby Dubai.
In recent weeks, subsidies have also been reduced on flour, water and diesel. But the spike in prices has not provoked the angry protests that followed the introduction of fuel rationing in 2007. The price of bread has tripled, on average, the government says; water, which used to be practically free, now costs between 10 cents and 85 cents per cubic meter, based on a sliding scale under which consumers pay a higher rate the more they use.
The government says these are just the first steps in what it calls an ‘economic transformation plan’ that will also include banking reform, sweeping changes in Iran’s tax and customs system, and ever more privatization of state-owned industries. And with officials already reporting drops in the consumption of gasoline, flour, diesel and electricity, even before the prices were raised, Mr. Ahmadinejad has been exultant…
Depending on how well Iran’s government can stave off the worst effects of the price shocks, the subsidy reforms could be a political victory for Iran’s new right win—a success for Mr. Ahmadinejad where liberals, now almost entirely excluded from Iran’s political scene, had failed.”
So, at the beginning of last year, Western analysts were predicting en masse that the Green Movement would bring down the Islamic Republic during 2010. By the end of 2010, some of the same analysts were predicting that economic distress exacerbated by subsidy reform would accomplish the same objective.
In his New York Times article, Mr. Yong does not escape the temptation of wasting a few paragraphs on speculation about how the government’s success in launching subsidy reform might lead it to take a more “confident”—and, hence, from an American perspective, “tougher”—stance in the next round of nuclear talks in Istanbul. Alternatively, as Mr. Yong also speculates, a “confident” government might be better positioned to reach an agreement with the United States and its international partners. (Or—as we would suggest—perhaps Iran has a well-developed and internally coherent set of positions regarding international nuclear issues.) Additionally, Mr. Yong parrots claims made about Ahmadinejad in some of the U.S. diplomatic cables published online by Wikileaks, seemingly without scrutinizing the sources of the claims to evaluate their credibility.
Still, Mr. Yong’s reporting on subsidy reform is, as we said, relatively straightforward—and, for that reason, welcome. However, his article does not address what we believe is a critically important dimension of the story—the strategic impact of economic reform. As the International Monetary Fund noted in September 2010, subsidy reform “could transform the way the country’s economy works”. For an informative interview with two IMF economists who work on Iran, see here. For the IMF’s last major assessment of Iran’s economy, see here. What will be the strategic impact if subsidy cuts and other elements of the Ahmadinejad administration’s “economic transformation plan”, such as the restructuring of large, state-owned economic enterprises, result in substantially higher levels of economic growth, productivity, and economic dynamism in Iran?
To produce such results, the Iranian government will need to “stay the course” with its reform initiatives. It will also need to avoid mistakes in monetary and fiscal policy which, as has been shown in other countries, can undermine the positive impact of reform. But the potential payoff for Iran is huge. As one of the IMF economists referenced above describes the Islamic Republic’s present economic situation,
“Iran is the 17th largest economy in the world. Holding little foreign debt—less than seven percent of GDP—the country has sizeable energy reserves, with underground hydrocarbon resources estimated at $10 trillion in oil alone (at $75 a barrel) and natural gas reserves at between $3 ½ – 4 ½ trillion…Inflation has declined dramatically—from close to 30 percent two years ago to less than 10 percent since September 2009 as the central bank withdrew liquidity.”
But, the IMF economist also notes that “Real GDP growth is estimated to have been about 1-2 percent [in 2010]. This relatively low GDP growth is due mainly to weak domestic demand…”
If economic reform—not just subsidy reform, though that is critical, but also banking and enterprise reform—ends up boosting domestic demand and productivity (as it ultimately should), Iran has the potential to emerge in coming years as a regional economic superpower. Ahmadinejad has said recently that he wants Iran to be ranked as the world’s 12th largest economy by 2015—not that far away. In such a scenario, among other things, sanctions would become increasingly irrelevant, as more and more people around the world decide that appeasing Stuart Levey’s blatantly illegal extraterritorial application of U.S. national law does not make sense anymore.
–Flynt Leverett and Hillary Mann Leverett