Islamic Revolution and the Management of the Iranian Economy

Islamic Revolution and the Management of the Iranian Economy

Akbar Karbassian


THE Islamic revolution of February 1979 turned the Iranian economy upside down. It took wealth from the private sector and transferred it to the clerically-dominated Islamic state. Nationalization and confiscation of property substantially reduced the private sector, while the public sector became rich and was forced to run the country’s main businesses.

The public sector gradually grew fat as deprivatisation continued and more wealth and power was given to state-supported, clerically-controlled foundations, called “bonyads”. The majority of these revolutionary institutions still operate under the supervision of the Supreme Leader and are exempt from tax payment. The economic activities of bonyads now account for some 11 percent of the Iranian GDP.

Due to deprivatisation, the government in the 80s had been forced to run approximately three thousand companies and businesses, over most of which it still has monopoly control. The state managers in charge were young revolutionaries with few managerial skills and little experience. They have run the state enterprises inefficiently, with losses that abused the government budget. State subsidies to consumers on essential goods, while necessary for the augmentation of war-stricken, falling incomes, have aggravated the losses suffered by state industries. When President Rafsanjani took office in 1989, state budgets had begun to show huge deficits.

Rafsanjani was committed to the reconstruction of Iran, but he sought to decrease the state deficit by printing more money that the Central Bank of Iran could “loan” to the government. During his eight years in office, both money supply (M1) and broad money (M2) rose dramatically. The state injected unprecedented levels of paper money into the economy, causing nasty double-digit inflation and undermining citizens’ purchasing power. During Rafsanjani’s presidency, GNP increased, but the official inflation rate increased by an average of 25 percent per annum. Because wages and salaries were not indexed to increases in the cost of living, workers and state employees suffered enormously. Meanwhile, no structural reforms were initiated, and unemployment and inflation continued to devastate the middle class.

With lasting effects, the Islamic revolution of 1979 made property and capital insecure. Massive capital fled the country, a situation which has continued over the past two decades. The Islamic state developed socialistic tendencies based on its revolutionary agenda of social justice, and the country’s private sector, which had taken some time to develop the principle of free enterprise, was destroyed in the aftermath of the revolution. To date, most goods and services continue to be produced by hundreds of state-owned monopolies. Market economy is largely absent; state regulations and controls abound. Soviet-style planning for economic development of the country, introduced by the revolution, has not succeeded in delivering the anticipated prosperity. Per capita income and the standard of living are today still below pre-revolution levels.

The purpose of this paper is to discuss the key events and policy decisions that have led to the present economic situation in Iran. President Khatami has advocated democracy and the establishment of a “civil society” since taking office in 1997. His foreign policy aims at ending Iran’s relative isolation and integrating it into the world community. He has initiated domestic political reforms, with some success. His concept of freedom and democracy can well provide the needed foundations for a thriving private sector market economy.

The Creation of the Public Sector

The Islamic revolution in Iran succeeded in February 1979. In a popular referendum held in April 1979, some 98 percent of the participants voted “yes” to the establishment of an Islamic Republic. A constitution was hurriedly prepared and confirmed by another referendum held in December 1979. Representatives of a broad spectrum of divergent ideologies, ranging from hard-line Islamic Marxists to conservative religious Shi’i clergy, drafted the 175 articles of the Constitution. They united under the umbrella of opposition to the Shah and the struggle for Revolutionary Islam. The Shi’i jurists applied sharia-based scholastic criteria to wealth and property that had been acquired during the Shah’s regime. The left-leaning Islamists, however, sought to destroy what they considered to be remnants of trade capitalism that had started to blossom under the Shah, aspiring to establish a classless socialist Islamic state. Out of the interaction of these opposing views a three-sector economy arose. The Constitution of the Islamic Republic identified public, private and cooperative sectors as the components of the Iranian economy.

In the new Islamic Constitution, all property that had been acquired by “un-Islamic” means was declared illegal and made eligible for confiscation by the cleric-dominated state. The wealthy were automatically suspected of wrong-doing and foul play. In the pernicious atmosphere of frenzy and fear that followed the confiscation, several thousand companies and pieces of property were possessed, often forcefully, and transferred to the public sector. Many Iranian entrepreneurs and foreign owners fled the country. It took about 19 years and several hundred court cases until the Iranian government paid for each piece of confiscated foreign property, through the intermediary of the International Court of Justice at The Hague. Iranian entrepreneurs received no comparable compensation. Billions of dollars of liquid capital fled the country because of the widespread insecurity and revolutionary unrest.

The theocratic regime created a new balance between private property and public ownership. The public sector, which comprised the government and the bonyads, served the function of the Bait ol-Mal, the early Islam fiscal department described in Islamic text, and its wealth grew as confiscation and de-privatisation continued. As the public sector grew, official antagonism to capitalism grew as well, hampering the development of a free enterprise system. Free competition and market economy operations were replaced by state intervention. The Iran-Iraq war, which began in September 1980, occasioned additional state regulation and control, with national mobilization demanded by the war economy. Rationing of essential goods by coupon, a practice that still continues (although to a lesser degree) was also introduced at that time.

Though constitutionally recognized, none of the three sectors of the national economy was fully defined.(1) Wealth taken from the private sector was given to the public sector. The size of each sector and the extent of its participation in the national economy remained unspecified. State authorities occasionally talked about a private sector that more actively participated in production, distribution and trade, but the legislature and the clerical leadership of the Islamic state were on the whole satisfied with the balances among the emerging mix.

Without hesitation, the new constitution encouraged greater involvement of the state in the economy, at the expense of curtailing the free market. When the mass confiscation of private property was nearly completed, the management of a significant portion of this newly appropriated wealth was turned over to clerically-held, state-supported charity organizations. Through this change it became apparent that the Islamic government had no understanding of the significance of free enterprise and competition. Article 45 of the Constitution specifies that ownership of anfal, or spoils, and public wealth, such as mavat (barren lands without owners; abandoned lands, mines, lakes, seas, underground water, reed beds, natural groves, pastures, unclaimed properties and properties obtained by usurpation), must go to the state. Article 44 called for massive nationalization and threatened private capitol. It called for nationalization of all large-scale industries, mines, banks, insurance companies, power generating stations, dams, postal services, the telephone and telegraph service, shipping, aviation, roads and railroads, without compensation being paid to their owners. Some left-leaning clergy, against the clear evidence of history that casts prophet Muhammed as a private trader, managed to add nationalisation of foreign trade to this list. Thus, the multi-billion dollar foreign trade enterprise, hitherto in Bazaari hands,(2) was added to the list of public enterprises.

Article 49 of the Constitution was the mandate most antagonistic to private capital, treating as spoils of the revolution the thousands of profit-making privately owned enterprises that were confiscated and transferred to the bonyads and the state. With puritanical and moralistic judgment, this article specified that the government shall take over all wealth allegedly derived by usury, usurpation, bribery, embezzlement, theft, gambling, misuse of religious endowments, government contracts, transactions, and sale of original mavat and mubahat, meaning ownerless properties, centers of corruption and illegitimate acts. When in due course the content of this article was fully implemented, public sector ownership had increased enormously, and the private sector had been reduced to near extinction. A decade later an unofficial estimate put the Iranian state in charge of 80-85 percent of national resources.(3) At the expense of destroying a burgeoning economy, the Islamic state had now become one of the richest, and possibly the strongest, state-owned and controlled economies in the world.

Theoretically speaking, private sector activity was to be limited to areas and activities falling outside of those assigned to the state. The largest concentration of private sector activities was trade, followed by agriculture, small-scale enterprises, businesses, urban construction, and mining. Compared to the size and extent of public holdings and the power of foreign exchange generated by the state from the export of oil and gas, the private sector of Iran was extremely small. Semi-official estimates put the private-sector share of the national economy at between 15 to 20 percent. This made the Islamic state a mixed capitalist-socialist economy predominantly under clerical control.

Ever since the revolution, Iran’s private sector has had a second-rate, subordinate status in the Iranian economy. Private entrepreneurs are discredited by unofficial propaganda, often being portrayed as “blood-sucking capitalists” in slogans plastered on Tehran walls or printed in the semi-official press. The prestige of private businessmen has been continuously eroded, as the state pays lip service to increased involvement by citizens in the economy.

The private sector has been represented by a non-private, state-supported chamber of commerce, the aim of which is the promotion of industry and trade. This is a semi-public agency that has its main office on state premises in Tehran, while collecting dues from members. The Iran Chamber of Commerce, Industry and Mines mainly represents the bazaari interests, which have always supported the Islamic State. The private sector licencees involved in major foreign trade are required to be members of the Chamber of Commerce. But the Chamber of Commerce remains powerless, and has been able to do little to enhance the prestige of the Iranian private sector. The Ministry of Commerce is trying hard to give non-government autonomous status to the Chamber, though the Minister of Commerce still appoints the Chamber’s director, who is generally selected from among the ranks of conservative bazaaris.

In 1993, the first serious steps were taken to strengthen the cooperative sector. Dormant for nearly 15 years, a Cabinet Minister was appointed and the Ministry received a budget allocation. This means that the cooperative sector is state-generated rather than self-generating, as in other countries. In the meantime, several thousand cooperatives have been set up adjacent alongside the public sector. However, these Iranian cooperatives depend heavily on the state’s financial support. The cooperative sector was included in the Constitution because some Islamic jurists and Shi’i clergy believed that cooperatives truly reflect the spirit of equality and brotherhood in Islam. A large number of the cooperatives in Iran are consumer cooperatives, followed by producer coops, active mainly in the agricultural sector.

In terms of administration, the government of Iran has been divided into three main parts. One part includes the 24 government ministries and the hundreds of related government organizations, state agencies, and units functioning under the ministries. The ministries are generally involved in the exercise of political authority. A larger part of the administration includes some 2,000 state-owned enterprises, banks, and insurance companies, all operated by state managers. These state enterprises produce several thousand types of goods and services. Many of these companies are outright monopolies, exercising economic authority in the name of the Islamic state. Finally there are the para-statal foundations that continuously receive heavy foreign exchange subsidies and special trade privileges from the state. For the purposes of accountability, however, they are considered independent units, active in the private sector. Many of the charity organizations and foundations, such as the famous Bonyad-e Mostazafan va Janbazan (Foundation of the Deprived and War Veterans), and Bonyade-e Shahid (Foundation of Martyrs), as well as municipal authorities, fall under this section. Overlapping and duplication of functions is common among the three parts that make up the public sector.

State authorities have often spoken of reducing the size of the public sector, because it has grown too large, now accounting for almost 2/3 of the GDP. By controlling the public sector, the government intends to decrease the number of public employees and stop the growth of new state agencies, the number of which continues to increase every year. Nevertheless, anti-private-ownership slogans can still be seen on the walls of Tehran and in some of the press. These signs indicate that there is still no collective will to increase the prestige of the private sector or to provide it with greater security. The government continues to be suspicious of the private sector, and the old leftist faction remains hostile. While the present government wants to encourage more private investment, sporadic arrests on corruption charges of businessmen and state officials has further damaged the prestige of the private sector. In the public eye, the private sector spells corruption. Consequently, the economy continues to be lopsided and heavily run by and in favor of the state. This means that the Iranian government remains heavily involved in production, distribution and trade, failing to consider economic efficiency, price competition by producers and public accountability of state-run enterprises.

Economic Structures Prior to the Islamic Revolution

Prior to the Revolution, private property and individual ownership had been considered legitimate and religiously tolerated under Islam. It is quoted from the prophet Muhammed that “people have (absolute) power over their own properties and lives.” The elaborate inheritance laws of Islam, folded into the Iranian Civil Code in the 1930’s, testify to this fact. But the state ownership of resources has also had a long and parallel history in Iran. After the Constitutional Revolution of 1906, all sub-terrianian deposits were declared the property of the state, even accidentally found treasure troves, a practice that continues to this day. Principles of private ownership, therefore, do not apply to all areas and are not considered absolute. In contrast to property laws of many Western countries, private ownership in Iran is a conditional and relative matter defined by the law. Thus, ownership of resources has generally been held by the state.

During the 1930’s Reza Shah(4) created a modern public sector and many new state-owned monopolies, such as the tobacco, sugar and tea enterprises, and initiated modern tax schemes. The State Tobacco Monopoly, still in operation, was established to augment government revenue. Since then many new state-owned and state-managed enterprises have been created, which continue to function up to the present.

The oil industry is the prize of all state-owned enterprises, and oil revenues have continued to lubricate the Iranian economy. In the late 19th century, William Knox D’arcy received a mining concession from the Qajar Shah, and formed the Anglo-Iranian Oil Company to exploit the oil deposits. Oil was discovered in Khuzestan province in 1908. During the 1930s, the Iranian state share of the oil royalties was deposited into a fund in London, established for the purpose of buying modern British-made military hardware. The oil industry was finally nationalized in 1952, at which time the National Iranian Oil Company was created. Between 1954 and 1979 the industry operated in conjunction with a consortium of international oil companies, 60 percent of which was American. In the early 1960’s Iran joined the Organization of Petroleum Exporting Countries (OPEC) and is still an active member. Since the Islamic revolution, the Ministry of Petroleum has overseen the operations of oil and gas sectors. Revenues from oil and gas exports provide up to 70 percent of the state’s general budget and account for some 80 percent of all foreign exchange earnings in the country. Although it is vulnerable to world price fluctuations, both the government and the economy of Iran are highly dependent on oil.

For years revenues generated by the state oil industry have provided the main source of foreign exchange in the economy. Oil revenues provide for the import of consumer goods, raw materials, spare parts and capital equipment, etc. Refined oil products also provide cheap energy to the Iranian industry. Sold below actual cost, oil products also give a hidden subsidy, worth $11 to $13 billion a year, to the Iranian industry and to car owners. The bazaaris, merchants and traders represent many of the international firms from whom state companies and ministries procure required goods and services, and these foreign purchases are paid for mainly by the petrodollars, enriching many Iranians and making many individuals quite wealthy. Such “easy money” has further delayed the formation of an indigenous industry, run by a respected private sector, and instead has fostered popular envy towards Iranian entrepreneurs.

A relatively competitive, small-scale, viable private sector did develop in Iran during the 1970s, and the government promoted its success through the generous extension of credit and consumer subsidies. High tariff walls were created against many imports to protect the infant industry, and tax holidays and tax cuts were initiated. Moreover, the state encouraged the private sector to expand into new areas offering purchase-and-payment schemes that paid for goods and services several years prior to the commissioning of projects. These schemes encouraged private sector participation and investment. The state also set up new industries and manufacturing units of its own, with the intention of ultimately selling the state shares to the public. The boost in oil revenues that came with the 1973 oil price boom also led to the creation of many new enterprises. Nevertheless, on the eve of the Islamic Revolution, the Iranian government possessed only 133 state enterprises.

In the pre-revolution period direct foreign investment in Iran was successfully encouraged, and joint ventures were the most popular means of foreign investment. A law passed in 1954 protected and guaranteed all foreign investments, thus attracting many international firms to almost every field of economic activity. An automobile industry was created in 1966. Parts for the imported, British-made Hillman-Hunter car were assembled locally. The introduction of the assembly line as a means of production, however, was criticized by some Iranians, who argued that it was not indigenous and created economic dependency on foreign suppliers. As a gesture of appeasement to the country’s powerful pro-commonist force, a steel mill was also constructed in Isfahan with the help of the Soviet Union. However, a large majority of the foreign firms investing in Iran were American. All major United States international companies were active in Iran, and upon the nationalization of foreign companies, all investors in Iran were fully compensated by the Islamic State.

During the revolutionary period, the private sector of Iran provided many people with jobs and incomes. More importantly, it offered alternative employment opportunities to the young Iranian returnees, educated in the West. Private sector salaries were generally higher than those in the public sector, and millions of families were formed based on the wages and salaries earned in the private sector. Highly skilled engineers, technicians and specialists were employed in the private sector, and even some of the more experienced state employees left their secure positions for higher-paying private sector posts. However, the struggling private sector is no longer strong or diverse enough to absorb the rising number of educated well-trained young Iranians. Out of desperation the unemployed now turn to the state for jobs, at grossly inadequate salaries.

The gradual rise in oil revenues from 1973 kept the national currency and the foreign purchasing power of the rial high. The rial was stable at 70 rials to the dollar up to 1979. A continued surplus in the balance of trade put Iran among the contributors to the newly created Special Drawing Rights (SDR) by the International Monetary Fund (IMF). But the new wealth was also unevenly distributed. While the Shah’s government paid for many consumer subsidies and provided for free lunches for school children, the revolution later proved that too little was done too late. Social tensions, popularly believed instigated by “foreign interests,” gradually led up to social unrest, labor strikes, street demonstrations, social disruptions by dissidents, etc. that finally led to the Islamic Revolution.

An immediate and expected effect of the political persecution and confiscation of peoples’ properties was the mass exodus of mid-level management from Iran. During the first two years after the 1979 Revolution thousands of entrepreneurs and professional managers, who could not cope with the new situation, left the country. For the most part, they left illegally and without travel documents. The new masters of the state enterprise were extremely hostile to private capital and the remaining privately active firms. Thus, in a short time, in the heat of turmoil, billions of dollars also fled the country, along with the entrepreneurial talents. Nationwide purges and political elimination of the alleged old regime’s sympathizers took their toll on the middle-ranking managers. The confiscated enterprises fell into the hands of inexperienced, lower-level–but ideologically correct–state employees who possessed no management skills. Up to the end of the Iran-Iraq war, in 1988, the new managers of the state enterprises were appointed from the ranks of the young intelligence and security cadre. As then prime minister Mir Hossein Mousavi(5) said in a TV interview, the main tasks of the appointed managers were to keep the premises clear of enemy (Iraqi and MKO) sabotage and to keep state personnel under control.

The War Years (1980-88)

In 1979, by an unexpected turn of events, radical students took 53 United States diplomats hostage and held them for 444 days at the United States embassy in Tehran. Imam Khomeini, the leader of Islamic Revolution, supported this move. The United States government retaliated with an abortive rescue operation in April 1980 and by imposing economic sanctions on Iran. During the eight-year war Iran-Iraq war that followed, Iran claimed that the United States had instigated Iraqi aggression. This allegation was confirmed by the support the United States openly gave Iraq in the form of arms, intelligence, information, and financial help.

In 1984 Washington imposed additional sanctions on Iran. The Islamic Republic was refused the desperately needed spare parts for its largely American-equipped armed forces. Sanctions culminated in a total embargo on all bilateral trade and investments. In 1995 further sanctions were imposed, including secondary boycotts intended to penalize non-US companies investing in the oil and gas industries in Iran. While imposition of sanctions have been costly to Iran, they did create a “blitz mentality” that has led to greater national solidarity. The sanctions made survival of the Islamic regime–at any–cost a national priority.

The “Imposed War,” as the 1980-88 Iran-Iraq war is called in Iran, enlarged the public sector even further. As the state mobilized the economy for war, oil earnings were totally allocated for two main purposes: the procurement of spare parts and the procurements of essential goods for public needs. Public sector employment increased while private employment gradually dropped, and the Islamic state soon became the employer of last resort to which everyone turned for jobs and income. State salaries were kept relatively low even as inflation soared to double-digits, undermining the already inadequate purchasing power of its own personnel. No cost-of-living index was applied to the wages and salaries of workers, and pay increases continuously lagged behind the inflation rate by significant margin, leading to a drop in the standard of living. During the 1990’s people had to seek second jobs just to make ends meet. With little time at home, the quality of family life, highly valued in the Islamic system, rapidly deteriorated.

Obstruction of competition has come as a by-product of the expanded involvement of the state in production. The state has played two contradictory functions in the economy, on the one hand, consolidating its political authority for better regulation of industry and of trade and draft national policies for socioeconomic development, and on the other hand, managing its newly acquired wealth to obtain further profit through investment. State companies, possessing the bureaucratic advantages of insider information, informal connections and financial support, competed with the private sector from a position of dominance and authority: The financial resources of the entire state apparatus (state-owned banks) were available to the public sector.

Without the advantage of such support, the weaker private sector sank even further. As far as the hard-line Islamists and left-leaning clergy were concerned, the multi-billion dollar foreign trade had entered the public domain. Iran went backward from an emerging free enterprise system to state socialism. In addition, during the war years, Iran became further isolated from the world economy–this in a decade in which the world underwent major changes with regard to privatisation and de-regulation.

To exploit the state monopoly over foreign trade, the Islamic state created some 12 “Procurement and Distribution Centers,” each connected with a given ministry. Each one of the twelve centers was in charge of importing a cluster of related goods. These centers acted as intermediary agents between the industry as the end-user and the foreign suppliers. They collected service charges, taxes, and levies from the clients. Orders for imports of raw materials, machinery, spare parts, and finished products had to be placed with these centers and paid for by the state banks. The trade centers generally imported, with delays, the lowest quality raw materials at uncompetitive prices. The state monopoly of foreign trade created a huge government bureaucracy and cumbersome, wasteful procedures, and contrary to the laws of the free market. The system was not in tune with the requirements of a country planning for economic progress. By paying high prices for low quality goods, both consumers and producers suffered.

The public monopolization of foreign trade placed the bazaaris, the traditional merchant class and staunch supporters of the Islamic state, at a huge disadvantage. During the Iran-Iraq war, when the state centralization and heavy-handed regulations dominated the country’s war economy, bazaaris remained complacent, if unhappy with the state’s monopoly of foreign trade,. Meanwhile, they collected fatwas, religious edicts, from prominent Shi’i jurists on the legitimacy of state monopoly of foreign trade, intending to reverse the relevant articles of the Constitution. Their efforts paid off in 1989, when the powerful Guardian Council(6) issued a ruling that the state monopoly over foreign trade is “contrary to Islam.” They argued that all economic monopolies caused ezrar-e be gheir, meaning, “harm to third parties.” All harmful acts to other individuals are contrary to Islam. As a result of this verdict, the state gave up its direct involvement in foreign trade and left these activities to the private sector. The President and the bazaaris welcomed the ruling, but the relevant article in the Constitution remained unchanged.

De-nationalization of foreign trade did not mean encouragement of competition or enhancement of free trade. On the contrary, while private players were now free to act, the country’s import and export rules were made more strict. For example, banks required one hundred percent cash deposits from Iranian importers prior to the opening of letters of credit (L/Cs). Cash and bank guarantees were also required from the exporters for insuring the return of foreign exchange proceeds. Trade proceeds had to be sold to the Central Bank of Iran at rates generally below the free market. Meanwhile, the rise in population and high costs of the war devastated the economy. From 1979 to 1989, per capita income of Iranians dropped by 50 percent. In 1989 most shops in the bazaars and streets of Tehran were generally empty of merchandise.

The Rafsanjani Era

The election of Akbar Hashemi Rafsanjani as President in 1989 generated a post-war reconstruction euphoria embued with hopes of prosperity. Rafsanjani was basically pro-private-sector, and he favored the greater involvement of private individuals and companies in trade and production. He had vowed to stop the growth of public sector, which had begun to bloat during the war. His term coincided with the passing of the country’s first five-year development plan (1989-93) by the Majles (parliament). When in office, he proposed an IMF reform package that came to be known as “the structural adjustment program.” This package included an orderly exchange-rate unification, increased fiscal discipline, trade and business deregulation, reduction of consumer subsidies, attraction of private foreign investment to the country, greater budgetary control over the parastatal public foundations, and privatization of loss-making public enterprises. The left-leaning Majles, however, resisted the president’s reform packages and blocked the passage of the necessary legislation. Disillusioned, the President quickly abandoned his proposals and reversed course. In tune with the faction dominating the Majles he asked for larger subsidy payments and embarked upon spending on public sector reconstruction projects. The five-year plan was financed by state revenues from oil exports, and heavy foreign borrowings. It also included heavy borrowing from the Central Bank and the domestic banking sector. Massive state budgetary deficits were created, financed by large-scale Central Bank loans and commercial bank credit facilities. Bank loans caused inflation to dramatically increase. During the first five-year development plan, inflation averaged 24 percent per year. It soared up to 50 percent in 1996.

To whet the appetite of the people for a better life, President Rafsanjani resorted to massive short-term suppliers credit financing of imports. This was a way to sidestep the constitutional prohibition on foreign borrowing without obtaining consent of the Majles. Afterwards, when the total bill for the mainly luxury goods imported into the country was finally tallied, an expensive foreign debt–estimated between $35 and $45 billion–had been created. President Khatami, who succeeded Rafsanjani in 1997 put, an end to the short-term suppliers credit, saving Iran some $3 billion in interest payments.

The state regulation of prices and the market also intensified under President Rafsanjani. His relinquishment of pro-private, free-market-oriented policies came at very high social costs to Iran. The annual inflation rates of between 18 to 50 percent always exceeded the increases in wages and salaries and the New Year bonuses paid to state employees. The trader-merchant class welcomed the higher prices, which came at the expense of industrial wage-workers and salaried employees. Price controls were initiated to stop profiteering by shopkeepers, middlemen and merchants, but controls were not always beneficial to the consumers. A portion of the price of numerous items was collected by the state-managed Organization for Protection of Consumers and Producers (OPCP). In some years these proceeds exceeded Iran’s national customs revenue. By the Presidents’ decree, proceeds collected by OPCP from price differentials financed up to 95% of the billion dollar bread subsidies.

Various ministries in Rafsanjani’s administration have been accused of creating, with public funds, several hundred new semi-public enterprises with no clear sector affiliation. Ministries and state agencies deliberately held minority shares of these legally dubious enterprises, which acted as profit-making concerns in trade and procurement, in order to avoid accountability to the State Auditing Agency. The procurement department of a given ministry would function as a company, selling supplies acquired with the ministry’s funds to the ministry, for profit. The profits were then distributed among shareholders, who were mostly the same ministry’s personnel. This was a way to augment the faltering purchasing power of the state employees, but these companies also had a parasitic nature, milking the state budget and giving the private sector a bad name. By the order of President Khatami, these units have been largely dismantled, although some continue to function.

Since the revolution, Iran has been far from self-sufficient in food production. One of the many inappropriate policies adopted by the Islamic state concerned state pricing of domestic wheat. Payment of consumer subsidies, which began during the Iran-Iraq war, increased substantially during the 1990’s, while no similar subsidies were paid to producers. As inflation soared, people’s dependency on subsidized essential goods also increased. The Iranian government earmarked billions of dollars for the imports of seven essential goods, including wheat, sugar, vegetable oil, and rice, when such items could be domestically procured with rials. Since the government is the only buyer of Iranian wheat, the Economic Council had been setting the price of wheat just about at cost, but way below world market prices. Thus, Iranian farmers not only were discouraged from production, they were actually penalized for production. As a result, domestic wheat has been produced in amounts far below the nation’s requirements. Imports have fluctuated from 6.5 to 8 million tons of wheat annually. Ruined by the low price of imported wheat, many farmers have left the countryside and migrated to the periphery of larger cities. In search of better jobs and incomes, they live in shantytowns with limited asccess to basic necessities, forcing public services by municipal governments to stretch. In the meantime, Iran has become the second largest importer of wheat in the world, after Japan.

In spite of much political rhetoric about the necessity of privatising state enterprises, their fate remains uncertain. During the past twenty years many state enterprises have become over-staffed with underpaid workers, and many still continue to operate at a loss. Only some 200 of these companies have been sold so far, and not without problems. A few have been bought jointly by active state managers and employees. There is no consensus about the fate of these enterprises. The private sector still remains distrustful of the state’s intentions, arguing that privatization will not succeed without accompanying deregulation of the economy. Some privatized companies have been de-privatized during the past few years and taken over once again by the selling state agencies. Problems have occurred when, due to the layoff of redundant workers, labor went on strike. Disturbed by the possibilities of widespread unrest and other undesireable social consequences, the government ordered reposession of the sold companies, without immediate payment of indemnity to the owners. Full-scale privatization has been under consideration by the reformist government of President Khatami for the past two years. The third five-year development plan (2000-2005) contains the government’s commitment to privatization and to the creation of a greater market economy.

A significant negative consequence of the intensive regulation of the economy has been the lack of interest shown by small private-sector players in making new investments. Taxes on profits are high, and non-tax charges are numerous. Labor law continues to be a nagging nuisance to the producers. Problems involved in starting a new manufacturing unit are numerous, and often considered not worth the effort. Trade is still more popular, and more profitable, than industry. Tax evasion is rampant in trade. Services constitute a disproportionate share of the national production, making up for some 50 percent of the GDP. According to international standards, this is an unhealthy proportion for any progressive economy.

Khatami’s Reform

Although Iranian officials have attributed their deficits to reasons beyond their control, such as the imposed eight-year war (1980-88), during which the American army helped Iraq, or the pernicious US-led press and antagonistic media, which have also destroyed Iran’s international image. However, much of the Iranian predicament has been self-imposed. With the election of Mr. Khatami as President in May 1997, new hopes have been created and many new political reforms have been initiated. Meanwhile, the old economic trends that have plagued Iran persist. The economy remains overly dependent on oil. There is no serious manufacturing sector. Pistachios and carpets still account for a large percentage of non-oil exports. The inefficient government sector is bursting with poorly paid employees. The state bureaucracy, which dramatically expanded after the revolution, is still intact. Both inflation and unemployment remain high. The current account of the Iranian country has improved, not because of any structural reforms because of rising oil prices.

The third five-year economic development plan, which runs to 2005, aims at downsizing the government sector by merging some ministries. It intends to privatize a large number of state enterprises and bonyads. But the subsidy payments on fuel and other strategic goods, the budget deficit with inflation financing, and the fall in purchasing power of Rial will all continue for the next few years. The expected annual increase of 8.5 percent in the private sector investments, envisaged in the third five-year plan, require cataclysmic changes in the state’s attitude toward a free enterprise system.

President Khatami also intends to improve Iran’s international image and integrate Iran in the world economy. He has sought to attract more direct foreign investment, and several international companies have been attracted to the oil and gas industries. Committed to the ideals of a “civil society,” the Khatami intends to push forward with reforms. He wants to establish freedom under the rule of law but within the bounds of the constitution. Economic improvements will come by diversification of the economy and moving away from oil dependency. Labor law and tax law need to be overhauled. So far, President Khatami’s priorities have been political reforms, but people are increasingly concerned about their falling real incomes.

Under President Khatami, Iran is at a crossroad. The president’s ideal of “civil society,” promising greater democracy and freedom, is in tune with privatization and the promotion of the market economy. But if he and his supporters choose the socialist interpretation of democracy, he shall fall into the trap of statism and his efforts shall be in vain.

The Final Word

Post-revolutionary Iran has produced an economic structure that the current Iranian President calls “sick.” In August 1998, when presenting his Economic Recovery Plan, President Khatami stressed: “The Iranian economy is sick; it is sick in production, sick in distribution and sick in consumption.” This honest account by the country’s chief executive could be understood as the beginning of a new era of thinking about economic structure. However it is clear that the process of restructuring will be long and painful, and must be accompanied by major domestic, legal and economic reforms.


(1) The Article of the Constitution that defines the scopes of the three sectors is Article 44.

(2) Bazaaris are a reference to traditional merchants in the Iranian economy.

(3) This figure also includes the semi-state revolutionary and charity foundations.

(4) The founder of the Pahlavi dynasty and the ruler of Iran from 1925 to 1941.

(5) Mir Hossein Moussavi was Iran’s prime minister from 1981 to 1989.

(6) The Guardian Council is the Higher Chamber of the legislative branch and the main interpreter of the Constitution.

Akbar Karbassian is a Lecturer at the Iran Banking Institute and is also affiliated with Azad University. Among his recent publications are “Budget and Budget Planning in the Iranian Economy” (in Farsi, 1999) and “A Note on the Islamic Banking Practice in Iran” (in Relazione Internationale, 48: [1999]). His book Iran: A SocioPolitical Assessment is forthcoming in Italy.

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