Events | Number 5, June 2004 | Iranian Economy in a Global Context

Iranian Economy in
a Global Context

What follows is a shortened version of a paper that was presented by Dr Hashem Pesaran of Cambridge University at Iran’s 6th Petrochemical Forum.

World trade and output growth
Export expansion is one of the key factors for sustained economic growth. Recent empirical studies reveal that a 1% increase in growth of exports is associated with 0.20% increase in economic growth. However, the patterns of world trade and output growth have not been uniform across the different regions. Trade has been growing much faster in the case of OECD economies and the countries in South East Asia as compared to Latin America and Africa, with oil exporting countries showing the lowest rate of trade expansion, both absolutely and in relation to their output growth. This is partly due to the fact that world trade in primary products has been growing much more slowly than trade in manufactured goods. For example, exports of low and medium technology manufactured goods show an average growth rate of 6.8% per annum as compared to 3.2% growth for exports of primary products.

Oil exporters in general, and Iran in particular, have suffered too much from reliance on exports of crude oil as compared to countries that export processed or manufactured products. Over the period 1979-2000, trade-output growth ratio was below 1 for the oil exporters and negative in the case of Iran! However, since 1989 (beginning of economic reconstruction and after the Iran-Iraq War), trade has started to grow by 1.76% as compared to an average output growth of 5.7%, yielding a positive trade-output growth ratio (0.30), still well below unity, and substantially below the average ratio of 2.35 achieved in the case of the OECD economies.
To enjoy the fruit of technological advance it is critical that Iran become an active participant in the world export market in medium and high technology manufactured goods.

Reasons behind Iran’s sluggish trade
One of the important factors contributing to Iran’s low trade-output growth ratio is the dominant role that crude oil exports have continued to play in the Iranian economy. Although the share of oil GDP in total GDP has been declining and currently stands at 20%, oil and gas exports still form as much as 80% of Iran’s total merchandise exports and 60% of government’s revenues. Dependence of the Iranian economy on oil exports is amongst the highest in the world, particularly if due allowance is made for the overall size of the Iranian economy and its population.

Existence of substantial oil revenues tends to reduce the urgency of politically unpopular policies, such as removal of subsidies, establishment of an effective taxation system, and the reform of investment and labor laws in favor of private capital investment. By substantially diverting potential resources from export markets to domestic requirements, the eight years of war with Iraq has clearly been another important cause behind Iran’s sluggish trade. Twenty-four years of US trade sanctions, intensified since the Persian Gulf War (1991), is another important factor in holding down Iran’s foreign trade. Finally, government policy, particularly during the first decade after the Revolution, by placing too much emphasis on self-sufficiency and not enough emphasis on promotion of non-oil exports, has contributed to Iran’s low trade-output growth ratio.

Iran’s response: geographical diversification of imports and exports
Iran has responded to trade sanctions by geographical diversification of her international trade. The share of G7 countries in Iran’s imports has fallen substantially from 48% to 36%. Similar trends can also be seen in the geographical patterns of non-oil exports. Iran has also been successful in establishing closer trade and political ties with (old) Europe and her own neighboring countries (particularly UAE), as well as China, South Korea and Malaysia.

Promotion of non-oil exports
Important steps have also been taken to promote non-oil exports. The share of non-oil exports has risen from 10% to 20%. Amongst the non-oil exports, chemicals have shown the largest rate of increase. They are now as important as exports of carpets.

Approval of the Law for Protection and Promotion of Foreign Investment signed by the Expediency Council in May 2002, is another important step in facilitating the exports of high technology manufactured goods. Also Iran has now signed up to New York Convention for international agreement on enforcing arbitration awards, and applied to join the World Trade Organization in 1995-96, although so far her application has been vetoed by the US. These developments show that Iran is serious in moving into medium to high technology sectors and providing the necessary institutions and the legal and accounting infrastructures needed for the promotion of foreign investment and exports of high technology products.

Other economic reforms
Other important developments aimed at Iran’s greater participation in the global economy include: liberalization of imports, some reduction of implicit and explicit food and energy subsidies (oil consumption has stopped rising for the first time, although implicit subsidies on oil and gas are still at record levels); unification of the exchange rate system, attempts at privatization and modernization of the industrial sector, and the formation of Oil Stabilization Fund in 2000 ($5.90 and $7.44 billions deposited in the Fund during 2000/01 to 2001/02). These are steps in the right direction – but a great deal more needs to be done.

An overall assessment on the positive side
Over the past 3-4 years the Iranian economy has started to become more integrated in the global economy. It enjoys a highly diversified trade links. GDP has been growing around 5-6% per annum. The Iranian rial has remained remarkably stable against the US dollar, largely thanks to higher international oil prices and better policies (Oil Stabilization Fund is an example). Some of the reforms have started to pay off. Fewer goods enjoy subsidies. Domestic consumption of oil has stopped rising partly due to recent oil price increases for domestic consumption. Non-oil exports, particularly exports of petrochemicals have been expanding and further major expansions are expected.

On the negative side
Inflation is still high and may rise further – monetization of subsidies are likely to be inflationary, at least in the short run. With inflation running well in excess of the world rate of inflation, renewed pressures on the rial seems inevitable, just a matter of time! Unemployment has been in excess of 15% and is still rising. The unemployment situation is particularly serious amongst the youth. Financial markets are largely underdeveloped. The Banking System and Tehran Stock Exchange are in need of significant reforms. The existence of powerful economic entities such as the Bonyads with excessive monopoly power, pose important impediments to efficient resource allocation and competition.

Prospects
The overall economic prospect is favorable. GDP growth is estimated to be around 6% for the year ending March 2004, and is expected to be around 4% for 2004/05. There are significant investment opportunities in medium technology manufacturing industries as well as in oil and gas related manufacturing such as petrochemicals. With new opportunities there are naturally new challenges. High inflation and rising unemployment present important risks. A stable economic and political environment is the key to the attraction and success of foreign investment.

A final word
Over the past decade the Iranian economy has made significant progress, reversing a downward trend after a decade of revolutionary upheavals and a costly war. But its sustainability critically depends on the continuation of the economic reform and liberalization at home, a sound macroeconomic management, and a fuller economic integration in the global economy. It is difficult to imagine how this could be achieved without further political democratization of the Iranian society.