Buying Time in Tehran; Iran and the China Model

Afshin Molavi. Foreign Affairs. Volume 83, Issue 6. November/December 2004.

Ayatollah Ruhollah Khomeini once famously dismissed an aide worried about inflation by telling him that “this revolution was not about the price of watermelons.” Today, Khomeini’s successors are finding the high price of watermelons-not to mention of meat, housing, and cars-much harder to ignore. The untold story of postrevolutionary Iran is one of economic decline: the steady, 25-year deterioration of a nation that once boasted a per capita income equivalent to Spain’s, pumped six million barrels of oil a day, and nurtured a vibrant middle class. Today, Iran’s real per capita income is a third of what it was before the revolution; oil production is two-thirds of the 1979 level, and the middle class is being squeezed by chronically high inflation, widespread UN-and underemployment, and debilitating wage stagnation.

In May 2005, President Mohammad Khatami, who thundered into office in 1997 on a platform of political and social liberalization, will leave his job chastened and largely defeated by his conservative foes. Not only did he fail to achieve political change, he also proved unable to heal the sick economy he inherited or to ward off a looming employment crisis. With its extremely young population-two-thirds of which is under the age of 30-Iran needs to create more than 800,000 jobs a year. So far, the government has failed even to come close to that target. As a result, Iran’s young people have grown deeply frustrated and hungry for political change and economic relief-even as they remain unsure of how to achieve them.

The newly resurgent conservatives think they have the answer. Having beaten back the reformers’ challenge through bureaucratic infighting, organized violence, the jailing of leading reformers, and election-rigging, the conservatives now want to embark on a program dubbed the “China model” by Iran’s media. The idea-which is neither new nor profound nor uniquely Chinese-is to offer economic growth, jobs, and limited social freedom in exchange for continued control of the political sphere. The conservatives are betting that Iran’s citizens will be satisfied with consumerism and thus give up their demands for pluralism.

Will the Islamic Republic pull it off? If Tehran’s goal is to create an economic dynamo on a scale similar to China’s, the short answer is no. With U.S. sanctions firmly in place, a poor regulatory environment for foreign direct investment, a relatively uncompetitive manufacturing sector, and a cronyist business climate rife with corruption, Iran is hardly primed for an economic renaissance. Moreover, the hard-line wing of the conservative faction has shown little interest in real economic reform, preferring instead a form of crony capitalism that spends state resources on political patronage of key constituents, including the security services-a model followed widely in the Middle East, most notably in Saudi Arabia, Egypt, and Syria.

If, however, Tehran’s goal is more modest-to get through a politically bumpy period by creating limited economic openings that produce minor job growth and forestall unrest-the conservatives may succeed. And such modesty is likely, given that a genuinely expansive economic reform program that enlarges the private sector, creates jobs, and strengthens the middle class could undermine the stability of the regime. Indeed, Iran’s 1979 revolution occurred during a time of economic improvement and relative social liberalization.

Thus the conservatives are likely to tread carefully. This regime has had its obituary written before, and as one conservative official told me, Tehran is “good at crisis management.” The Islamic Republic has already weathered postrevolutionary instability, a devastating eight-year war with Iraq, international isolation, a spirited reformist challenge, a grassroots democracy movement, student unrest, enormous popular discontent, and two U.S. wars in the neighborhood.

Moreover, Iran’s public has grown deeply apathetic, its hopes for change snuffed out by the failure of Khatami’s reform program. The regime is therefore likely to survive the current economic crisis, as it has crises of the past. As crisis management, an authoritarian bargain-a China model “lite”-could work for Tehran, even if fundamental economic changes of the sort Beijing has enacted are unlikely anytime soon.

The Tehran Tango

Will the Iranian public-justifiably viewed as one of the great hopes for popular democracy in the Middle East-accept the crude authoritarian bargain of the China model? At the moment, they seem more likely to ignore it. Frustrated by the failure of the reform movement, Iranians are starting to show signs of widespread political apathy. After nearly 3,000 reformist candidates were banned by the hard-liners from running in February’s elections for the Majlis (Iran’s parliament), voter turnout (at 51 percent nationwide and 28 percent in Tehran) was lower than in any other election since the revolution. (There was also an inordinately high number of spoiled ballots.) Iranians might not like what the conservatives are planning, but they seem to lack the energy and will to oppose it. Political apathy has also been compounded by fear, a result of the hard-liners’ consistent and ruthless use of violence and intimidation.

Even with public support or indifference, reforming Iran’s economy won’t be easy, despite the country’s enormous potential. Iran boasts a cheap work force of both skilled and unskilled labor, a large market of 70 million people, low-cost energy resources, ample cash reserves to cushion the inevitable blows caused by liberalization, a strategic location adjacent to the markets of South and Central Asia and the Persian Gulf, wealthy potential investors in the Iranian diaspora, and a well-educated technocratic elite comfortable with Westerners.

Beneath the surface, however, the conditions are less promising. A key problem is the degree to which Iranian politics have become factionalized, paralyzing economic policymaking. During his tenure, President Khatami complained that “a crisis every nine days” made it hard to get anything accomplished. Although the conservatives have since recaptured the Majlis, they are not a monolithic bunch. Differences and personal rivalries remain and will ensure continued conflict. Pragmatic conservatives, led by former president and perennial power player Akbar Hashemi Rafsanjani, view the world, the economy, and the China model differently than do hard-line, ideological conservatives, who control key institutions such as the judiciary and the security services and influence Iran’s Supreme Leader Ayatollah Ali Khamenei.

The hard-liners see the China model principally as a means to forestall unrest. They are thus less interested in real economic reform and more prone to think in terms of patronage politics. Their approach-more a distributive model than a China model-will use oil wealth strategically, doling out subsidies to the population and interest-free loans and cash to their supporters while creating a few highly restricted and tightly controlled openings for foreign investment and the private sector. Hard-liners view Iran’s economy as a small party with a closely guarded invitation list. And the party, they believe, should remain socially conservative.

The pragmatists, on the other hand, are less interested in controlling how people live and have a better grasp of how the global economy works, of the need for liberalization, and of the obstacles to economic growth. They, too, view the China model as a safety valve, but their economic vision promises more opportunities for the private sector and foreign investment. Unfortunately, the hard-liners already have the upper hand. In August, the Majlis overturned laws passed by the earlier, reformist parliament aimed at easing foreign investment and facilitating the entry of foreign banks into Iran. Mohammad Mir Mohammadi, a hard-line member of the Majlis, announced that the vote had prevented “foreign dominance of Iran’s economy.”

The hard-liners also have an advantage thanks to three years of high oil prices, which have translated into a cash windfall for Tehran. Swelling foreign reserves ($35 billion, at last count) have allowed the government to put much-needed reforms on hold without disrupting its patronage networks. One influential hard-line parliamentarian, Ahmad Tavakoli, has even begun talking about further reducing the cost of gasoline, which is already kept artificially low (at about nine cents a liter) by high government subsidies.

Since Iran earns some 85 percent of its foreign currency from oil exports and gets an extra billion dollars a year with each $1-per-barrel rise in global oil prices, the current spike in prices has inflated Iranian GDP growth figures, which have ticked above 6 percent in the last two years. High oil prices have also contributed to a property boom and a bull market on the Tehran stock exchange. But they have not yet resulted in significant job growth, which could spell real trouble for the conservatives in the near future.

Thus the pragmatists may eventually regain control. Yet the only thing that seems certain is that progress toward economic reform in Iran will remain halting, following the familiar Tehran tango: one step forward, one back, one step to the left, another to the right.

Rafsanjani Redux

The Iranian public, meanwhile, could be forgiven for feeling a strong sense of dj vu. Iran has tried the China model before, and the results only contributed to the current economic woes. In 1989, Rafsanjani, then president, made a similar attempt to buy off the discontented populace with stability, jobs, and limited social freedoms. His initiatives were welcomed by Iran’s war-weary population, which, having just concluded a brutal eight-year conflict with Iraq, embraced his non-ideological and pragmatic approach.

Rafsanjani significantly liberalized the economy, foreign investment began trickling in, and a new generation of Iranian business elites-many of them government apparatchiks with close ties to those in power-arose. In 1995, the Iranian president even made an overture to Washington, offering Conoco an offshore oil contract (although the U.S. government ultimately rejected the deal).

Rather than truly opening the economy, however, the Rafsanjani era only ended up strengthening Iran’s bonyads-government-linked Islamic charities and businesses that today control as much as a quarter of the nation’s GDP-and further wove government into the tapestry of Iranian private business. In the highly incestuous business climate, companies associated with the bonyads or government ministries won the lion’s share of government reconstruction contracts and used their access to licenses and cheap credit to become leading traders. Well-connected conservative merchants (known as bazaaris) with established trading networks also used some of their accrued wealth to enter industry, which had been the preserve of the state in early revolutionary Iran (and of Western-oriented business leaders before 1979). As a result of these developments, Iran’s private sector is today hampered not only by government obstruction, but also by government competition. The country’s chaotic business sector is filled with government-linked and government-owned firms engaged in crony capitalism, insider dealings, and predatory practices to crush large competitors. Reformist journalists deride “business mafias” that exploit their access to state insiders for personal gain.

Khatami-era reforms opened some new spaces for a genuine private sector, and a string of recent business successes by outsiders-that is, those not linked to Iran’s state power networks-shows that opportunities have increased. Still, those opportunities remain far too constrained. The bonyads, accountable only to Khamenei, still own everything from banks, hotels, and shipping lines to car manufacturers and fruit juice producers. They dominate many industries, squelching some private competitors and rewarding others who play by their rules. Several government ministries even run their own businesses: the Intelligence Ministry owns telecommunications and information-technology companies and the Agriculture Ministry owns agribusinesses. Companies affiliated with Iran’s Revolutionary Guard Corps have won contracts to build roads, pipelines, and apartment blocks, occasionally even using army conscripts as free labor to lay bricks and pour cement.

These problems are replicated on a smaller scale: civil servants commonly open small businesses, using their access to insider information to win subcontracting work or to procure necessary (but otherwise hard to come by) licenses. Many bureaucrats also regularly accept bribes. One small-business owner I know in Tehran even employs a mid-ranking government tax auditor to fake his taxes. “He knows how to fool his bosses better than I do,” the businessman explains, “and I pay him better than his government salary.”

Wasting and Wanting

Of course, oligarchic and kleptocratic governments and low-level corruption are common in much of Asia, even in its fastest-developing economies (including China’s). But aside from Iran, none of these countries also faces exclusion from the world’s largest market and largest foreign investor. And U.S. sanctions are not likely to be lifted in the near term. In fact, Washington is currently increasing its pressure on Iran due to Tehran’s alleged pursuit of nuclear weapons. Still more pressure may be brought to bear as international human rights groups such as Human Rights Watch and Amnesty International-which pulled their punches on Iran during Khatami’s era-renew their sharp criticism of the country, calling on the European Union to impose penalties on Iran for its persistent political repression. Meanwhile, the July 2003 killing of Zahra Kazemi, an Iranian-Canadian journalist, and the subsequent cover-up may undermine what were growing business ties between Canada and Iran.

Even if the external climate were friendlier, Iran’s prospects for economic rejuvenation would be uncertain. A good example of the failure of Tehran’s state-directed economic ventures is the status of the country’s natural gas industry. With the world’s second-largest reserves of natural gas, Iran should, by the end of the decade, be able to claim around ten percent of this increasingly vital energy market. But as the veteran Iran energy watcher Vahe Petrossian has noted, Tehran is unlikely to meet this goal, thanks to a late start and a lack of skilled negotiators. Meanwhile, Qatar, which shares natural gas fields with Iran, is now poised to become the leading natural gas supplier in the area.

Successfully adopting the China model would also require large infusions of foreign investment, and on this score too, Iran’s prospects look bleak. In addition to the uncertain climate created by the Majlis’ scrapping of the 2002 Foreign Investment Protection and Promotion Act, two high-profile foreign investments have recently become ensnared in the familiar mix of ideological, political, bureaucratic, and personal rivalry that often paralyzes Iranian politics. On May 8, a Turkish-led consortium, which had won a contract to operate the newly opened Imam Khomeini International Airport, found its contract abrogated on the first day when the Revolutionary Guards shut the airport down. The guards said that having foreigners operate the airport was “an affront to Iran’s dignity” and charged that the Turkish consortium had ties with Israel, a charge the Turks deny. Another explanation was that the Revolutionary Guards wanted one of their own companies to get the contract and hoped to embarrass Ahmad Khorram, the reformist transportation minister detested by most hard-liners (and currently under impeachment threat in the Majlis). Whatever the reason, future investors will be wary.

Indeed, it is not surprising that foreign direct investment in Iran continues to lag behind that in other players in the region, such as Egypt, Tunisia, Morocco, and the Persian Gulf sheikhdoms. Already, the tiny emirate of Dubai, with a population of just over one million, attracts far more foreign investment than Iran. In fact, many businesses that sell to the Iranian market prefer to locate in the more business-friendly Dubai or send goods to more efficient Dubai ports, where Iranian traders and Dubai merchants do brisk business in re-export to Iran. One Dubai merchant explained, “We benefit from Iran’s government incompetence.”

Not only are they incompetent, but many hard-line Iranian officials also still view foreign investors as “exploiters.” Iran’s constitution itself reflects this suspicion, virtually banning all foreign investment. The hard-liners fear that foreign money would mean giving strangers control over their country. Iranian political discourse reflects this suspicion as well, distinguishing between “insiders” (khodi) and “outsiders” (gheyr-e-khodi). Insiders are generally thought to include all revolutionary players (including the religious reformers around Khatami) and to exclude secular democrats and nationalists. Now the hard-liners want to restrict the political and business playing field still further, keeping out everyone except like-minded individuals with social or family links to those in power. Already, such thinking has produced a version of crony capitalism that can be called khodi capitalism: a system dominated by Iran’s Islamic apparatchiks and business elites, who maintain incestuous business relationships that mix the public and private sectors and reward only those with the right connections.

Despite the conservatives’ best efforts to sabotage investment, Iran will continue to attract foreign interest in its oil and gas sector. Still, beyond its natural resources, the prospects are bleak. China can at least offer foreign businesses the tantalizing prospect of a market with more than a billion consumers and an army of cheap laborers. Iran, with only 70 million people and an unproven labor force, promises much smaller rewards.

A “China model lite” could marginally improve Iran’s economic prospects if oil prices remain high and at least limited reforms are undertaken. Thus far, however, Iran’s hard-liners seem to understand the repressive side of the China model better than its reformist side. Iran’s economy is likely to remain afloat, buoyed by oil money. But the country will fail to live up to its enormous economic potential and will do just enough to get by, frustrating Iranians, enriching insiders, and alternately tempting and repelling foreign investors. Given the long-term facts of Iran’s demography, dramatic changes are inevitable at some point in the not-too-distant future, despite the present public apathy. In the meantime, however, the mullahs seem likely to do just enough to avoid the abyss. Major economic reform is not likely, but neither is a serious collapse.