What Sanctions Mean for Iran’s Economy

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Introduction

As the UN Security Council debates options to deal with Tehran’s nuclear program, experts say sanctions—provided they include Iran’s oil and gas sectors—would have a damaging effect on Iran’s already-battered economy. Despite escalating oil prices, Iran’s oil-dependent economy remains hamstrung by high unemployment and high inflation. Economists say the government has failed to capitalize on its windfall of oil profits through its inability to scale back administrative controls, reform the bloated state-run sectors of its economy, and curb government spending on subsidies and its uranium-enrichment program, thus inviting future inflation. Others say Iran’s nuclear posturing has scared off foreign and domestic investors.

What is the status of Iran’s economy?

Not good, experts say. Iran’s unemployment level remains around 11 percent (Reuters says it could be as high as 25 percent). One out of every four Iranians lives in poverty, according to the New York Times. And double-digit inflation is expected to climb higher based on President Mahmoud Ahmadinejad’s recent budget proposals to ratchet up spending on job-creation programs and nebulous charity groups. "Massive foundations that are philanthropic only in name monopolize key sectors of the economy, operating with little competition, regulation, or taxation," wrote CFR Senior Fellow Ray Takeyh and Kenneth Pollack of the Brookings Institution in the March/April 2005 issue of Foreign Affairs. Experts say Ahmadinejad’s government continues to support these mullah-run groups.

Some 90 percent of Iran’s population receives its income from the state. Private enterprise in Iran is restricted mostly to farming and food-services industries, experts say. Meanwhile, with one-third of its population below the age of fourteen, Iran’s labor markets are becoming overstretched. An estimated million young Iranians look for jobs each year, while the economy produces less than half that many jobs, according to the Economist. That is in stark contrast to Iran’s pre-revolution era. In the 1970s, Iran’s gross domestic product (GDP) per person was 30 percent higher [in real terms] than it is today.

Are Iranians happy with Ahmadinejad’s handling of the economy?

It’s unclear. Ahmadinejad ran for president last year pledging he would distribute oil revenues more to Iran’s poorer classes. That has not yet happened, experts say. The president claims to have lowered unemployment over the past few months, but International Monetary Fund statistics indicate otherwise. His proposed budget reportedly offers loans to encourage job creation among small businesses as well as housing loans to help newly married couples. Yet factory workers are against the growing use of short-term employment contracts, introduced by Ahmadinejad’s predecessor to loosen up Iran’s state-heavy economy. On May Day, some 10,000 workers demonstrated in downtown Tehran against the use of these contracts, which allow employers to fire workers with greater ease.

How have high oil prices affected Iran’s economy?

Iran’s treasury is awash in cash, thanks to global oil prices topping $70 per barrel. Iran—the world’s fourth largest producer of crude oil, holding 7 percent of the world’s proven oil reserves—netted $45 billion from oil profits last year, its highest level since 1974. Yet some experts say Iran’s economy is too closely tied to its oil and gas markets. Mustapha Nabli, the World Bank’s chief economist on the Middle East and North Africa region, recently told reporters that Iran’s oil fortunes have actually slowed down the pace of economic reform. Others say a "Dutch Disease"—the effect high commodity prices has on driving up the value of a country’s currency, thereby making other goods less competitive abroad—could further cripple Iran’s economy.

How has Iran’s nuclear posturing affected its economy?

Tehran’s decision last summer to resume nuclear activities despite Western warnings prompted many foreign and domestic investors to pull their money from the market. Soon thereafter, stock prices in Iran plummeted as the stock market tumbled to its lowest level ever last October. It has since rebounded but the threat of sanctions continues to stymie investment. "The risk of sanctions translates into uncertainty and uncertainty is not good for investment, especially private investment," Nabli told reporters. A March 2006 IMF report on Iran says "[T]he possibility of a prolonged period of ’wait and see’ on the part of the private sector could adversely affect the economic outlook." Foreign direct investment, which was $500 million in 2004, has also since dropped significantly because of political uncertainties, according to the United Nations Conference on Trade and Development.

But the nuclear standoff has contributed to the soaring price of oil on world markets, which benefits Iran’s economy while hurting oil consumers like the United States. "I find a certain irony that the more pressure [the Bush administration] puts on Iran, particularly when the president says all options are on the table, the more the oil prices on the futures market spikes," says Mohammed Akacem, a petroleum expert at Metropolitan State College of Denver.

What role does Iran’s economy play in the nuclear negotiations?

A huge role, experts say. "What we’ve seen from the Iranians over the last fifteen years is that they are hypersensitive to threats to their economy," said Brookings’ Pollack, speaking at a recent CFR symposium on Iran. "Everything they have been trying to do arguably since 1990, but certainly since 2002, is to keep the United States and Europe from coming to a common position on economic sanctions against them. That is their great nightmare." It is the economy, not Iran’s nuclear program, which is most on the minds of everyday Iranians, says Karim Sadjadpour, an expert on Iran at the International Crisis Group. "So the idea that the average Iranian is waking up in the morning in Yazd or Shiraz and says, ’You know, what’s missing from my life is enriched uranium’ [is misguided]," he said at the CFR symposium. Opinion surveys, however, show that many Iranians favor a peaceful nuclear program because, from a power and technology perspective, they think it will boost their economy.

What effect might sanctions have on Iran’s economy?

It depends on the scope of sanctions as well as the type, experts say. "Any sanction that doesn’t include oil will not have any serious effect," says Abbas Milani, co-director of the Iran Democracy Project at Stanford University’s Hoover Institution. Given Iran’s energy ties to Russia and China, sanctions would severely impair its oil and gas industries. But most experts say such sanctions are highly unlikely so long as oil prices remain above $70 per barrel. Further, sanctions could backfire and rally the Iranian population around its leadership. "Harsh sanctions would punish the Iranian people—not the Tehran elite, the army, or the police," write Gary Clyde Hufbauer and Jeffrey Schott of the Institute for International Economics in a recent paper. "[They] would inflame Iranian nationalism while accelerating mortality among infants and the elderly." More effective, Milani says, would be so-called smart sanctions, which target the assets of individual Iranian political and clerical leaders. "The way to get to the mullahs is to get their money," he says. "They hold their money very dear to their heart."

How have U.S. sanctions affected Iran’s economy?

Experts, as well as Iranian officials, say decade-long U.S. sanctions—sharply limiting U.S. trade and investment in Iran and penalizing foreign companies that invest in Iran’s energy sector—have not crippled Iran’s economy but have had an impact. Hamid Reza Baradaran Shoraka, head of Iran’s Management and Planning Organization, has publicly stated that sanctions by Washington have stalled economic progress. "Iran’s clerical oligarchs are hoping to use Tehran’s nuclear ambitions to force negotiations with and extract [economic] concessions from Washington," Takeyh and Pollack write. Iran’s oil industry has particularly suffered from U.S. sanctions, experts say. "U.S. oil companies would love to go to Iran," Akacem says. "So sanctions have retarded a little bit of Iran’s ability to improve its oil sector." Iran, whose fields are old and installations badly damaged, has done little exploration since the 1970s. Yet Iranian regulations forbid foreign companies from operating oil projects or participating in production-sharing agreements.

How damaging would a military strike be to Iran’s economy?

It would depend on the size and scope of attack, experts say. Radzhab Safarov, director of the Moscow-based Center of Modern Iranian Studies, told the Russian news agency RIA Novosti that Iran would probably suffer significant damage from a military strike and as many as 15,000 Iranian workers might be killed, but that its economy would not be "paralyzed." He points out that Iran has a six-month stock of oil and could negatively affect global energy markets if, following a military attack, Tehran refused to sell its supply to Western markets. A military strike might also push oil prices above $100 per barrel, wrote CFR President Richard Haass recently in the Financial Times. "Iran," he wrote, "could push the price even higher if it reduced its oil exports or took action to disrupt the regional outflow of oil."

Which economic concessions are most important to Iran?

In addition to specific security guarantees, Iran has called for increased investments in its economy from Europe, particularly its oil industry, as well as support for its decade-long bid to join the World Trade Organization, which the United States has historically blocked. Annual trade between Iran and the European Union is roughly $25 billion. In the past, Tehran has also sought European assistance procuring reactor fuel and parts for commercial planes. All of the above concessions were presented by the EU-3—Britain, France, and Germany—in negotiations with Tehran last year. But Charles Ferguson, CFR fellow for science and technology, says Iran, emboldened by high oil prices and its own nuclear progress, would "have to be offered something incredibly richer in terms of carrots because its nuclear program has become such a nationalist issue."