The Simple Reason Iran’s Economy Stopped Growing
Editor’s Note: The Bourse & Bazaar Foundation is proud to publish this new column from Djavad Salehi-Isfahani. The column shares a name with Salehi-Isfahani’s widely-read blog page, which has for many years been a foremost source of commentary on Iranian macroeconomics.
The political debate over the role of sanctions will remain unresolved so long as Iranians remain divided on larger ideological issues. In principle, the academic debate could be settled by relying on data. At the core of the academic debate is the attempt to separate the causal impacts of sanctions from the effects of the price of oil, corruption, and mismanagement on the Iranian economy. This task is difficult because it requires knowledge of a counterfactual—what would have happened to Iran’s economy had sanctions not been in force during the past decade? Simply put, no one knows what would have happened had the sanctions pressure not sharply intensified under Obama in 2011 and later under Trump in 2018.
To illustrate this point, let us begin with a comparison of GDP for Iran, Saudi Arabia, and Turkey. Even this seemingly easy task is complicated by the fact that there are different ways in which the GDP of Iran can be compared to other countries over time. The graph below uses the series provided by the Penn World Tables (PWT), which is the workhorse database of the empirical literature on economic growth.
The key feature of PWT data is that they apply the same prices (those of the US) to sectoral outputs of different countries. Because relative prices differ from one country to the next, this correction gets us closer to the true value of the GDP in different countries. For example, Iran and Turkey have very different energy prices. In Turkey gasoline cost multiple times more than in Iran. Therefore, converting Turkish and Iranian GDP’s in their local currencies to USD underestimates the value of energy produced in Iran. Adjusting for relative prices alone lifts Iran’s GDP relative to Turkey by some 10 percent.
According to the PWT series, the three largest economies of the region were of about the same size in 2011 at around 1.5 trillion dollars in Purchasing Power Parity (PPP). They had been growing at similar rates during 2003-2010, but diverged sharply after that. Iran’s GDP contracted while Saudi Arabia and Turkey continued to grow. This simple comparison eliminates the collapse of the price of oil as a reason for Iran’s stagnation because it occurred in 2014. The decline in Saudi GDP in 2014 picks this effect clearly. One can eliminate other factors that did not change exogenously before and after 2010, such as corruption and mismanagement, as causal, though sanctions most likely increased their incidence, in which case we can attribute the added cost to sanctions.
Of course, this graph does not settle the academic debate because Saudi Arabia and Turkey are not good counterfactuals for Iran. While it is true that Iran was subjected to harsh sanctions while the other two were not, the three economies differ enough that we cannot be sure that Iran’s GDP would have followed either country’s path after 2010 had it not been sanctioned.
Some analysts have tried to improve on single-country comparisons by picking a group of countries to construct a counterfactual. A popular technique, known as the Synthetic Control Method (SCM), helps researchers identify the “optimal” combination of countries from a larger pool of “donors” with their appropriate weights. In her 2017 paper, Orkideh Gharagozli ends up with seven countries (Algeria, Bahrain, Canada, China, Ecuador, Kuwait and Libya). In his 2021 analysis, Morteza Ghomi also selects seven countries (Algeria, China, Greece, Nigeria, Korea, Sudan, Saudi Arabia). If you run the experiment with different variables as predictors of the GDP, you will find another set of countries to include in the counterfactual. This fact alone should tell you that this procedure is very mechanical and may not be worth the extra effort. Can Bahrain or Kuwait, both small municipal emirates, really tell us much about how Iran’s more complex economy would have fared without sanctions? Do we think of Greece or Canada as places to look to answer questions about Iran? I do not think these studies add anything to eyeballing GDP data and thinking that, as it had in the past two decades, Iran would have grown a modest 4-5 percent had it not been under sanctions.
The appeal to econometric models can also lead to misunderstandings. If you have been following the debate on sanctions in Iranian social media you might have heard about a paper by prominent Iranian economist Hashem Pesaran written jointly with Mario Laudati, which, according to many social media users, estimates that sanctions explain only 20 percent of Iran’s economic problems. This is also how the paper’s findings were characterised in a recent exchange on a BBC Persian programme.
But there is no such conclusion in the paper. Those who like such a conclusion, most of whom have not read the paper and probably could not understand it even if they did read it, have been arguing that a scientific paper proves that 80 percent of Iran’s economic woes are internal. Even Iranian hardliners can find the claim useful and can use it to argue that abandoning the nuclear negotiations will have minimal consequences.
As far as I can tell, the one statement in the Laudati-Persaran paper that could have been misinterpreted to mean that 80 percent of Iran’s problems are internal, also on page 37 of the original draft, is this: “in the absence of sanctions and sanctions-induced mismanagement Iran’s average annual growth over 1989q1–2020q1 could have been around 4-5 percent”, which is higher than the 3 percent it in fact achieved over the 30-year period. This is already a large penalty because it implies that Iran’s GDP would have been at least one-third larger it is now.
But the size of the average impact over this period is not the question Iranian policy makers should be asking. It is the impact after the sanctions were tightened a decade ago that matters. Sanctions before that inflection point probably fit the 80-20 rule – growth was barely affected by sanctions, which were relatively weak. After all, how important could sanctions have been before at a time Iran when Iran’s oil revenues were reaching record highs.
The closest the authors come to quantifying the impact of sanctions is on page 37 of the original draft: “83 percent of variations in output growth remain unexplained, and most likely relate to many other latent factors that drive the Iranian economy.” But what the model cannot explain is the fault of the model not an indication of the importance of internal factors.
The role of sanctions in bringing Iran’s economic growth to a halt in the last decade is too important a matter to be left to dispute over statistical techniques. If there is a better reason than sanctions for explaining the sudden change in the growth rate, let us discuss that. Plenty of countries have bad policies and corruption yet do not experience a sudden loss of economic growth. Why should Iran? In 2016 and 2017—the two years when the JCPOA was briefly in effect—Iran’s GDP increased by 20 percent. Did corruption and mismanagement suddenly cease then? There is a simple explanation for the growth—implementation of JCPOA. The same should be expected if the nuclear deal is revived. A quick surge as Iran gains access to its external reserves followed by the expansion of non-oil exports as Iranian producers gain access to markets abroad. Having good prospects for growth, if not an actual growing economy, is a precondition for addressing the so-called “internal factors.”
