After the Iranian Uprising

Even before the crisis over the election outcome broke, the prognosis for Iran in the coming year was not good.  Back in October oil prices had started to fall and the contractionary measures taken by the Central Bank several months earlier to rein in inflation had slowed the economy.  Last year, Iran’s imports had soared above $70 billion, flooding the market with cheap imports that hurt domestic production in agriculture and industry.  The economy was in need of policies that would allow it to continue to grow while it adjusted to lower oil prices.  Anticipating the need for adjustment, Ayatollah Khamenei, Iran’s supreme leader, called the new Iranian year 1388 (2009/2010) last March the year of “reforming the consumption model.”

Oil prices have recovered some, but barring a supply disruption, they will remain well below last year’s prices.  For more than six months, the government has faced large potential trade and budget deficits, but to help his reelection, [President Mahmoud] Ahmadinejad’s government continued to spend, raising salaries and giving transfers to the poor.

All three opposing candidates heavily criticized Ahmadinejad’s spending policies, especially for the high inflation they caused.  The hope before the election was that a new government would use its political capital to limit spending and to attract foreign investment and credit.

Ahmadinejad’s reelection and the growing political crisis that it has unleashed have dashed those hopes.  Economic growth averaged more than 6 percent during his first term (something that his opposition never acknowledged) but this year it will be at most half as high.  Depending on how this crisis develops — whether or not it spreads to strikes and disrupts production — the growth rate could become negative.

The economic policies of the first Ahmadinejad administration were characterized by redistribution.  There were handouts, such as sharp increases in salaries of retired and low-income civil servants, and “justice shares” worth up to $1,000 per person (about four months of minimum wage) that were distributed to lower-income individuals in rural and urban areas.  Those shares are expected to pay about $80 per year.  There was also a large credit program for small enterprises, which was run through the banks but was in part thwarted by the Central Bank’s effort to bring down inflation.

Ahmadinejad’s second term will likely face difficulties of two sorts.  First, heightened expectation among his base will bring enormous pressure to continue his redistributive policies.  Many who have received benefits expect them to continue, and many more are waiting in line to receive them.  Turning the spigot off now, especially at a time when his popularity among the middle class is at a low, would be politically very costly.  Second, economic recovery without the cooperation of the same middle class is very difficult.  They are the trained workforce that runs the government, operates schools and hospitals, and manages industrial production.  The modern middle class, which has grown substantially in size and importance thanks to economic growth, went into this election hoping for greater political representation.  What they got was an election result they could not trust and an ultimatum to stop questioning those results.

Given the unprecedented political crisis the government faces, the looming budget and trade deficits are unlikely to be filled by foreign investment or borrowing.  Furthermore, as a result of the course of events [following the contested vote], Iran’s middle class, which plays a critical role in the country’s development, feels snubbed and rejected by the country’s political leadership.  Unless a political settlement is reached that can ease these constraints, the prognosis is for the return of high inflation and very low economic growth.

Djavad Salehi-Isfahani is Professor of Economics at Virginia Tech University and a Guest Scholar at the Wolfensohn Center for Development, Brookings Institution.  This commentary was originally published as part of an interview conducted by Greg Bruno, Staff Writer at the Council on Foreign Relations, with four Iran experts on 29 June 2009, and reproduced at the Web site of the Brookings Institution on the same day.  It is reproduced here for educational purposes.