By any measure, Iran and its economy ranks near the bottom of the barrel. For example, the Cato Institute’s comprehensive Human Freedom Index presents the state of human freedom in the world based on a broad measure that encompasses personal, civil, and economic freedom. And in this authoritative index, Iran ranks 154th out of the 159 countries covered. Not surprisingly, the Iranian economy performs poorly, producing widespread poverty.
Many, both inside and outside of Iran, assert that the major cause of Iran’s economic maladies is the cascade of primary and secondary sanctions that the “allies” have imposed. This is a bit of a red herring.
While sanctions bite and disrupt, they are overrated as a means of waging a war. Indeed, they are massively oversold. John Mearsheimer, in his masterpiece, The Tragedy of Great Power Politics (W.W. Norton & Company, 2001), provides more than ample evidence to show that naval blockades and strategic bombing (and I would add financial sanctions) rarely produce their desired results, and are not elixirs that win wars.
“...the populations of modern states can absorb great amounts of pain without rising up against their governments. There is not a single case in the historical record in which either a blockade or a strategic bombing campaign designed to punish an enemy’s population caused significant public protests against the target government. If anything, it appears that ‘punishment generates more public anger against the attacker than against the target government.’”
Even though the sanctions contribute to the Iranians’ misery, history suggests that a good dose of skepticism about whether Iran’s theocracy will comply with the demands of the allies is in order. As Mearsheimer writes:
“...governing elites are rarely moved to quit a war because their populations are being brutalized. In fact, one could argue that the more punishment that a populations suffers, the more difficult it is for the leaders to quit the war. The basis of this claim, which seems counterintuitive, is that bloody defeat greatly increases the likelihood that after the war is over the people will seek revenge against the leaders who led them down the road to destruction. Thus, those leaders have a powerful incentive to ignore the pain being inflicted on their population and fight to the finish in the hope that they can pull out a victory and save their own skin.”
So, while the sanctions might be contributing to the Iranians’ misery, they will probably fail to force the Islamic Republic to comply with the demands of the allies.
Iran’s economic death spiral is largely made in Iran by Iranians. Sanctions imposed by foes of the Islamic Republic only contribute in a minor way to the spiral. Iran’s downward spiral predates the Islamic Revolution of 1979. Recall that, before the last Shah was pushed off the Peacock Throne, his visions of grandeur had led him to embrace Soviet-type schemes, such as five-year plans, megaprojects, rural collectivization, model towns (shahraks), and central planning. The “Soviet” Shah, who was propped up by the United States, made a mess of the economy and set the stage for Iran’s economic woes.
The theocratic regime has only further suffocated Iran’s tiny private sector and caused the death spiral to spin more rapidly.
So, what should be done to push the Grim Reaper aside? Poverty is a scourge which leaves those in its grip to lead lives that are brutish, dangerous, and short. Economic growth is a poverty elixir. From the works of the earliest economists — Richard Cantillon (1680 — 1734), Adam Smith (1723 — 1790) and Jacques Turgot (1727 — 1781) — we have learned that economic liberty is a crucial precondition for sustained economic growth, and a concomitant reduction of misery. Just what elements are necessary to produce such a liberal economic order?
Private property and contract rights should be established. The following criteria should guide the establishment of private property: universality, exclusivity and transferability. Universality guarantees that all resources are either owned or ownable by a private person or entity. Exclusivity guarantees that those who own property have the exclusive right to use their property as long as that it does not harm other property owners. And transferability guarantees that owners can freely transfer their property rights.
Fiscal order and transparency should be established. To establish control over public spending and reduce waste, fraud, and corruption — governments should publish national accounts that include a balance sheet of its assets and liabilities, and an accrual-based annual operating statement of income and expenses. These financial statements should meet international accounting standards and should be subject to an independent audit.
Budget deficits and government spending should be kept under control. One way to achieve control over the scope and scale of government is to require a “super majority” vote for important fiscal decisions: taxing, spending, and the issuance of debt.
Inflationary pressures should be kept under control. To encourage economic development, inflation rates should be kept low and predictable. For many developing nations, this inflation objective can best be achieved by abolishing their central banks and replacing them with currency boards. A currency board would issue fully convertible, stable, domestic currencies that is clone of an anchor currency.
The advantages of open international trade should be exploited. Liberal trade policies facilitate the efficient allocation of resources and stimulate economic growth. This is particularly true in small economies, where real competition can only be obtained by allowing foreign producers to compete freely in domestic markets.
Complex tax systems and excessive tax rates should be avoided. Complex tax systems coupled with excessive tax rates distort behavior, create large disincentives to economic activity, and force that activity to go underground (read: into the black-market).
Subsidies and tax incentives for private industry should be avoided. Subsidies and tax incentives that are designed to achieve particular objectives may or may not actually assist in obtaining those goals. One thing is certain: they distort economic choices and resource allocation, reduce fiscal discipline, and retard economic growth.
Privileges and immunities should be avoided. For example, state-created monopoly privileges and immunities for unions, such as exclusive representation, compulsory union membership, and immunity from antitrust laws, should be avoided. Privileges and immunities distort markets and act as a drag on economic growth.
Price controls should be avoided. Price controls, including interest rate ceilings, cannot be justified on economic grounds. They tend to vitiate the signaling role that prices play. Hence, price controls impede the movement of resources from lower-value to higher-value uses, and result in resource misallocation, shortages, and lower economic growth.
Market interventions and restrictions on competition should be avoided. Market intervention and restrictions on competition, such as the use of marketing boards, result in the politicization of economic life, inefficient enterprises, resource misallocation, and the retardation of economic growth.
State-owned enterprises should be privatized. State-owned enterprises are inefficient. For example, sales, adjusted profits, and productivity per employee are lower for state-owned enterprises than they are for private firms. Sales per dollar of investment are lower, profits per dollar of assets are lower, wages and operating costs per dollar of sales are higher, sales grow at a slower rate, and, with few exceptions (petroleum), state-owned enterprises generate accounting losses that are passed on to taxpayers.
Unclear boundaries between public and private activity should be avoided. Unclear boundaries between the public and private sector are symptomatic of poorly defined property rights. Government bailouts of insolvent private firms are but one example of unclear boundaries between public and private activity. These Ill-defined property rights distort resource allocation and retard economic growth.
The manipulation and repression of private capital markets should be avoided. The manipulation and repression of private capital markets distort the savings and investment process, retard foreign direct investment, promote capital flight, and generally act as a drag on economic growth.
For decades now, Iran has flaunted economic principles. Private property and contract rights are not secure. This lack of security, particularly for foreign investors, has thrown Iran’s oil and gas development into a cocked hat. Fiscal order, transparency, and control are nowhere to be found in Iran. Populist proclivities call the budget’s tune. Price controls and subsidies are widespread. These are a deadly cocktail.
Banks are mandated to extend credit to certain favored sectors of the economy. The specific sectors and levels of credit are laid out in Iran’s five-year development plan. Not surprisingly, credit is misallocated, and banks are zombies loaded down with mountains of non-performing loans.
Even things like privatization are perverted in Iran. For example, when state-owned enterprises are privatized, the majority of the shares are often purchased by other state-owned entities.
While blaming Iran’s death spiral on external enemies of the Islamic Republic might play well in Tehran, the reality is that the Republic’s economic policies cause the death spiral to spin. The only way to avoid more impoverishment is to remove the internally imposed shackles on Iranians. It’s a tall order. But, just look at what China has accomplished since Deng’s December 1978 Revolution.