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June 2020, No. 94


Economy

The Secret of Iranian Economyís Resistance


This is a phenomenon we see in the labor force statistics that Iran has created 500,000 new jobs in a year.


Why is the Iranian economic system still in place and why Trump has failed to achieve his goal of Iranís economic collapse? A goal that many even inside Iran anticipated to occur. But why didnít these projections come true?

Javad Salehi Esfahani, a Virginia Tech economics professor, cites at least three factors for Iranian economy resilience: first, the flexibility of the Iranian economy (especially in the exchange rate), the second is that a large part of the economy is state owned; and the third is the fragile (petty) economy that has little to do with political or negative news. He believes that the government should take steps in this context and increase investment in infrastructure to prevent further backlogs of production.

 

What factors, in your opinion, have caused the Iranian economy to withstand the sanctions and not collapse?

Several factors have made the Iranian economy somewhat resistant to the sanctions. The issue of resilience within Iran is related to the concept of resilience or flexibility in the economy. It is economically resistant to external shocks to be able to show flexibility against blows. The most important factor for flexibility is the use of markets. For example, when the Iranian oil sales fell and the value of the US dollar went up and the local currency was depreciated, the economy would not have been flexible if the government had forced all foreign currency transfers to take place at the government rate. But that flexibility gave rise to an incentive for many to turn to manufacture of substitute goods the price of which has now tripled.

This is a phenomenon we see in the labor force statistics that Iran has created 500,000 new jobs in a year. As we kept our economy somewhat flexible and took advantage of markets, prices went up and this made it possible for businesses to increase domestic production so that the economy would not decline too much. I think in Venezuela they were not allowed to do that and things were fragile. This is a very important lesson about the flexibility of the economy.

Another thing that is deterring Iranís economy is that much of Iranís economy is state-owned. We have always been accustomed to saying that the smaller a government is, the better it is and what the government does is not desirable. But not always. Suppose the electricity production in Iran was entirely in the private sector, and the producers were hearing that the Iranian economy was collapsing. In that case they would gather their supplies and would go abroad. Then the electricity would be cut and this would bring us closer to the state of disintegration.

The private sector is very sensitive to future expectations, and it would reduce investment and even production when negative news flows (about war and other issues). So the role the government has in the economy is somehow making the economy resistant to bad signals. If a manufacturer thinks that the bank he is working with is bankrupt, he may reduce its output. Banks in Iran have no such role to go bankrupt because the government has too much control and can inject capital into them. Our banks are somehow financially insured. In fact, many of the bad aspects of the Iranian economy may play a positive role in times of crisis.

The third factor is that part of Iranís economy is petty economy like agricultural production, which is less sensitive to important news such as the banking system crises. A person who owns a farm and the market for his crops is nearby will be resistant to any kind of situation in Tehran and internationally, doing his job. Most of the fragility are in places where the private sector has mass production and bad news (which Maynard Keynes calls animal spirits) suddenly changes the situation and, because of the dark future, they would either reduce their investment or the production, both of which are harmful. If they cut investment, production and employment will be reduced by double coefficient. If they conclude that production is no longer profitable and decide to shut down the plant GDP will decline rapidly.

 

What should decision makers in Iranian economy do to prevent this crisis from deepening?

Statistics show that the Iranian economy has been ineffective for about 10 years. This means that if you look at the economies of Iran and Turkey between 1991 and 2011, their per capita output has increased steadily. In fact, despite all the problems that the Iranian economy has had, it has been able to move in line with an economy that is almost successful. But after 2011, Iranís economy is virtually no longer booming, and the Turkish economy is growing at seven to eight percent. All the differences that you see between Iran and Turkeyís per capita income, which have now grown, are the result of the last 10 years. I think the only characteristic of these 10 years has been the sanctions that have hurt the Iranian economy a lot but have not led to its collapse. But the question of what might happen hereafter, I have no precise knowledge of what is happening in the Iranian economy, so I cannot predict correctly.

For example, if I am told that these 500,000 jobs that were created are because the factories were working at low capacity and now that the prices of many commodities have gone up the factories have also increased production and capacity, if this hypothesis is true I will be pessimistic about the future. Future job creation requires new production capacity, especially in industrial sectors that have a greater role in import substitution and investment in these sectors is relatively heavy.

When it comes to investing, on the one hand, we are looking at the question of whether these companies can get more money from the banking network, to invest and increase their production. This is questionable as banks are in crisis and reforms in that sector are slowly progressing. Another issue is foresightedness; an investor must be optimistic about the future if he wants to increase the capacity of his factory by investing.

 

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  June 2020
No. 94