Iran's Third Development Plan: An Appraisal

Jahangir Amuzegar, Middle East Policy Council:

Abstract

Iran's Third Five-year Economic Development Plan finished its course in March 2005 with mixed results. While it approached or achieved some of its tactical targets (e.g., annual GDP growth and investment), it fell behind most of its strategic goals (e.g., reduced dependence on oil income, downsizing the government, privatization of state enterprises, increase in productivity). This third attempt since the end of Iran/Iraq war in 1988 has been based on the old, soviet-invented, notion that the Third World's economic salvation is ad hoc to central planning. Although long discredited and abandoned by its inventor and other prominent imitators, the Islamic Republic has faithfully continued the costly and futile exercise.

The latest experiment has proved once again that (1) central planning-- instead of offering an effective solution to Iran's deep-rooted economic problems-- is itself part of the problem; and (2) the Plan's outcome, far from being the fruits of the planners wits and wisdom, owes its successes and setbacks to unforeseen events and factors unbeknownst to them. The palpable achievements have been chiefly the result of the unprecedented oil boom in the country's 97-year oil history as well as some provident rainfalls. The failure to effectively reduce the economy's misery index of double digit inflation and unemployment has been rooted in the Plan's lofty and contradictory objectives, lack of discipline on the part of state agencies in charge of implementation, and the irresistible influence of powerful vested interests. READ MORE

MIDDLE EAST POLICY, VOL. XII, NO. 3, FALL 2005

Dr. Amuzegar was finance minister and economic ambassador in Iran’s pre-1979 government.

At 4:03 p.m., March 20, 2005 – the beginning of the Iranian New Year – the five-year odyssey of Iran’s Third Development Plan came to an unceremonious end in sharp contrast to its much-trumpeted start. Sending the bill for the plan to the Majlis in September 1999 subsequent to his stillborn 1998 Economic Rehabilitation Program, President Mohammad Khatami called it “new, innovative and unprecedented in the country’s planning history.”

Now seems an appropriate time to examine the plan’s performance against the backdrop of its principal objectives. The intention here is neither to present a total picture of Iran’s economy, nor to evaluate the Khatami administration’s overall economic performance, but simply to provide the Third Plan’s own scorecard for both its successes and its setbacks.

A TALL ORDER

The all-encompassing policy guidelines issued to the Khatami administration by Supreme Leader Ali Khamenei to serve as the basis for the preparation of the plan covered a list of 36 lofty objectives. The economic section of the guidelines alone highlighted 16 goals to achieve economic growth and efficiency, tempered by equity and social justice. In its cultural segment, the supreme leader’s directive contained similar high-minded ideals: to perpetuate Ayatollah Khomeni’s “religious and political thoughts,” pursue frugality and parsimony in consumption, and encourage selfreliance in personal behavior. Dignity, rationality and expediency were to serve as the plan’s foreign-policy anchor.1 The document prepared under these guidelines by the Management and Plan Organization was claimed to have been the product of 24,000 hours of toil by 1,000 experts over more than two years. The bill submitted to the Majlis included measures and actions for restructuring Iran’s state dominated and sclerotic economy toward a globally oriented market system. The proposed plan was to reduce the perilous dependence on oil exports, end state domination over major industries, reduce government control of private business, remove public and private monopolies, reduce budget-busting subsidies, and eliminate rent-based profiteering. The bill also included new measures dealing with domestic and foreign policies, national security, and cultural endeavors.

Not surprisingly, this was a scenario to which both the activist right (e.g., the bazaar and the rent-endowed clerics) and the ardent left (e.g., Islamic Marxists and welfare ideologues) in the Majlis and the Council of Guardians were adamantly opposed. In an ironic twist, a strange coalition of conservative and liberal groups thus rejected some of the key elements of the proposed bill, making the realization of its targets more difficult. Postponing the retirement age to help rescue the bankrupt government pension fund, establishing a means test for subsidized groups to reduce perennial budget deficits, and allowing state enterprises to recoup their costs through higher administered prices were all rejected by the Majlis. Furthermore, the legislators refused to end the tax exemptions of all public agencies and semi-public charitable bonyads (foundations). And, finally, ruinously low energy prices that were supposed to be gradually raised toward international levels were essentially retained.2 The fingerprints of both groups in the Majlis could thus be seen all over the final document.

The fifth Majlis ratified the Plan Law on April 5, 2000 – after nearly seven months of wrangling and nitpicking over its other reform proposals and scores of objections by the Council of Guardians.3 The final statute consisted of an elaborate piece of legislation dealing with the macro economy as well as specific sectors.

Its three basic parts with 26 chapters, 199 articles, and their 57 sub-clauses dealt with goals, means, directives, policies and appropriations in a convoluted and poorly organized format. As in the past, the full implementation of the plan was also made contingent upon a further series of legislative actions and executive orders to be passed in the ensuing months. Although the plan law itself kept its flowery rhetoric to a minimum, the reports accompanying the bill presented to the Majlis were faithful to the Iranian clergy’s preference for style over substance.4 The plan’s total cost of 804 trillion rials ($114 billion) was to be financed by about $60 billion from oil exports, $34.5 billion from non-oil exports, $7.5 billion from exports of technical and engineering services, and $12 billion from foreign credit and loans. The new plan also earmarked 23 percent of total expenditures to be spent by the provinces themselves.5

A NIRVANA ON EARTH

The approved Third Development Plan exhibited a welcome departure from the previous two in certain significant respects. Despite extensive modifications at the hands of the Majlis and the Guardians Council, its basic architecture still involved outward orientation and emphasis on a wide range of structural economic reforms. 6

According to the head of the Management and Plan Organization, the third plan was different from the previous ones in four significant respects: improvement of public services, specific appropriation for job creation, financial help to poor families, and more rational consumption of energy.7

The overarching objectives of the new plan, however, as in the past, focused on a nirvana of both efficiency and equity — that is, maximal prosperity achieved through high economic growth combined with optimum social justice guaranteed by employment-based poverty reduction. The plan’s basic goals thus involved (a) administrative and management reorganization (i.e., reinventing the government); (b) privatization of the large public sector; (c) reorganization of the social-security system and basic subsidies; (d) elimination or reduction of public and private monopolies; (e) decentralization of official economic decision making, including autonomization of monetary policy; (f) price decontrols; (g) fiscal reorganization; (h) trade liberalization; (i) greater reliance on non-oil exports; and (j) more effective environmental management. Other principal mandates of the third plan included a ceiling on external debt, the formulation of a “consumption model” and greater budget transparency.

Macroeconomic policies deemed necessary to achieve these goals included (a) eliminating duplicate public services and consolidation of parallel agencies; (b) selling state-owned enterprises to the public (including a 49 percent share of state commercial and specialized banks) in order inter alia to help repay government debts to social security and pension funds; (c) assisting the private sector in job creation; (d) limiting the number of subsidized goods and eliminating across-the board subsidies in favor of aid to targeted groups; (e) limiting public monopolies, outlawing unfair trade practices, prohibiting money laundering and punishing unsavory stock-exchange manipulations; (f) moving away from administered credit allocation and interest-rate control in favor of competitive credit allocation and market determined rates on deposits and loans; (g) issuing 5 trillion participation papers to increase the capital of state banks, followed by strengthening banking regulation and supervision along with the expansion of stock markets; (h) broadening the tax base, reforming the tax system, and introducing a value-added tax regime; (i) removing non-tariff barriers and replacing them with tariffs, combined with a progressive reduction of average tariff rates, in line with World Trade Organization rules, and assistance to non-oil exporters; (j) establishing a special Oil Stabilization Fund to cushion the economy from unanticipated oil-price declines; (k) promoting domestic and foreign investments by strengthening the needed legal and institutional framework; and (l) upgrading the sewage system, reducing air pollution, improving the irrigation system, stopping soil erosion and deforestation, and preventing further spread of the desert. The planners promised to reduce the poverty head count from 15 percent to 7 percent at the end of the plan period and to cut the unemployment rate from 16 percent to 12.5 percent.8 As usual, the plan also enumerated a series of quantitative targets for each year of the five-year period. Thus, in order to tame the growing rate of inflation and unemployment, the plan aimed at 6.2 percent average annual real growth of GDP (6.8 percent for non-oil GDP) to be achieved through a 7.1 percent annual increase in investment divided between the public and the private sector. Specific targets were also set for aggregate as well as public and private consumption, unemployment, inflation, money supply, exports, imports and population growth (see table).9

A CLOSE-UP PICTURE

On paper, the new plan touches all the bases and pushes all the right buttons.

Fundamental problems were clearly identified, and standard academic solutions were boldly suggested. The overall objective of welfare-oriented, high-employment, non-inflationary growth was economically comprehensive and politically correct. The plan also reiterated a number of structural reforms that were promised, but not implemented, in the previous plans.

Looming large once again were clear references to the need for decoupling the economy’s fate from the vagaries of crude-oil prices, expanding new non-oil exports with higher domestic value-added, ending rent-based profiteering, and reforming the budget structure in the direction of greater reliance on taxes and more market based central-banking operations.

Yet these were neither new nor very exciting mandates. All Iranian governments in the previous 50 years of economic planning had subscribed to the same agenda with more or less similar enthusiasm. Furthermore, the plan’s major policy choices of competitive market orientation, privatization of state-dominated industries, increased labor productivity, reduction of public subsidies, non-oil export promotion and economic policy coordination were also repetitions of the promises made in President Khatami’s defunct Economic Rehabilitation Plan and his two previous fiscal budgets. The “novelty” and “uniqueness” claimed for the Third Plan were mostly marginal and, in retrospect, rather overblown.

In practical and operational terms, the plan still resembled a wish list rather than a cohesive, input-output-based scheme.

Apart from the futility of projecting precise targets in an economy where even the most primary data are lacking, unreliable or contingent upon exogenous forces, the plan’s elaborate quantitative targets, based on sophisticated econometric models with little or no regard to past experiences, seemed clearly unrealistic. For example, given the unimpressive average real growth rate of only 3.2 percent during the Second Plan, the new 6.2 percent target was admittedly difficult to achieve. And, while no more than 400,000 new jobs had ever been created in any previous year, the plan’s projection for 760,000 new job opportunities seemed farfetched.

The actual rate of growth of public consumption in the Second Plan had averaged 4.2 percent a year; yet the forecast for the coming five years was to be 2.5 percent.

Non-oil revenues never exceeded $4 billion in any one year, but the new projected figure was $8 billion. Similar projections were made for aggregate increases in liquidity, private investment, tourism revenues, and budget balance. In particular, such essential measures for the plan’s success as the dismantling of state and parastatal monopolies, reform of the Islamic banking system, prioritization of public subsidies, and wholesale privatization of public enterprises presented Herculean tasks. Any serious attempts at privatization were bound to cause rapid private wealth accumulation, personal enrichment, and further income disparities among various social strata, resulting in massive worker layoffs.

These unintended but inevitable consequences were not only counter to Ayatollah Khomeini’s revolutionary ideals, but also anathema to Mr. Khatami’s own left-wing supporters. The rare exceptions in all these rosy projections were the presumed price of crude oil at $12.50 per barrel, and the possibility of obtaining foreign loans and credits in modest ratios to the country’s GDP. For these reasons, considerable doubts were expressed at the time regarding the attainment of projected non-oil exports, success of the privatization program, and the political feasibility of price-rationalization efforts.10

PERFORMANCE HIGHS, LOWS

The Khatami government’s spin doctors have been ceaselessly boasting about such economic successes as respectable economic growth, relative foreign-exchange stability, lower consumer prices, reduced unemployment, selfsufficiency in some food staples, expanded capacity in the oil and gas fields, improved basic infrastructure (particularly highways and railroad extensions), rural electrification, and greater foreign-investor confidence in the economy.11

Khatami supporters at home and abroad also point to significant technological progress in dam construction, shipbuilding, aviation, high-rise construction, and both nuclear and conventional defensive capability.12

Stripped of spin, the Third Plan was indeed successful in reaching some of its main quantitative targets and in addressing some of its promised reforms. As the table shows, while the outcome of principal quantitative indices often deviated from planned targets, the results were altogether reasonably satisfactory. The average annual real growth of both oil and non-oil GDP was only slightly less than the projected figures. According to official data, population growth during the period declined to 1.6 percent a year, close to the 1.5 percent projections. Although part of the success was due to the return of Iraqi and Afghani refugees to their homelands,the lion’s share of the credit should go to a decline in the fertility rate among women of childbearing age.13 Thanks to the government’s success in controlling population growth, the real per capita income also rose by 3.8 percent a year on average. Among the economic sectors, the largest contributors to the GDP growth were services and industry, followed at a great distance by agriculture and oil. The plan’s objective of reducing the growth of aggregate consumption in favor of faster fixed-capital formation, however, produced disappointing results as both public and private consumption expenditures overshot their growth targets by 65- 85 percent. Responsible for higher than projected private consumption were plentiful oil receipts, greater money supply, more effective advertisements, new possibilities for purchases on credit, and an across-the-board rise in oneupmanship among consumers. The unexpected rise in public consumption was due to the overspending tendency among public agencies and setbacks in selling state-owned enterprises (SOEs) to the public. Offsetting the unwelcome increase in aggregate consumption were notable outlays in both private and public gross investments. More striking, however, was the faster growth rate of private-sector capital formation, due in part to the government’s encouragement and assistance, including foreign-currency loans from the Oil Stabilization Fund. Total investments at 32.3 percent of GDP, however, were admittedly less than the 35 percent needed for achieving the full-employment goal.14 The plan’s official report card on reducing unemployment is both murky and widely contested. Data published by Iran’s Statistical Center, and repeatedly cited by President Khatami, show that unemployment was brought down to 10.3 percent in 2005 – beating the target.15 Yet, according to other official data, the new job opportunities created every year on average during the plan’s life were no more than 580,000, persistently below the projected 760,000 year after year. The president’s explanation for the discrepancy has generally been regarded as unconvincing.

The consumer-price index that was to average 15.9 percent a year also behaved better than expected, according to the Central Bank’s official CPI figures. But the consensus among domestic and foreign analysts is that official figures substantially underestimate real inflation by at least onefourth, due to the non-representative basket and unrealistic prices used in statistical calculations. Supporting the doubters’ disbelief in official data is the size of annual increases in private-sector liquidity, or money supply (M2), which increased by nearly 29 percent a year on average, exceeding the planned target by nearly 77 percent. With the low velocity of money in the Iranian economy, inflation has traditionally moved closely behind increases in money supply. Consequently, the wide gap between the two aggregates in the official data would be hard to fathom.16 In the trade area, the extraordinary magnitude of oil receipts in the last three years of the plan financed a record volume of imports and resulted in consecutive surpluses in both the trade and current accounts. Moreover, Iran’s actual longterm external debt, at $15.7 billion, at the end of the period was kept well below the amount permitted under the plan;17 and the country’s foreign assets of more than $30 billion reached an all-time high. The plan’s major emphasis on the promotion of non-oil exports, and a change in the composition of imports in favor of capital goods, however, both fell somewhat short of expectations, as total exports and imports far exceeded their planned targets. The value of total exports rose nearly three times as fast, due mainly to the highest crude prices in Iran’s 97-year oil history. Oil exports in the last years of the plan reached $36.8 billion. Non-energy exports also rose by doubledigit rates, from $4.2 billion a year to $7.6 billion, thanks mostly to a number of government-sponsored incentives: low-cost credit, low-rate insurance, exchange-rate guarantees, regular subsidies, export prizes and the establishment of a new Export

Promotion Organization in mid-2004. Nonoil foreign sales were also bolstered by exports of technical, engineering and professional services, which rose from $980 million in the first year to nearly $3 billion in 2004-05. Nonetheless, non-oil exports missed their planned targets by about 22 percent. At the same time, the unprecedented abundance of foreign exchange gave a fortuitous boost to imports, which rose more than two-and-ahalf times as fast as the planners had envisioned, from $14.3 billion in the first year to $36.6 billion in 2004-05 (in addition to an estimated $3-4 billion in smuggling from neighboring countries).18 Responsible for this extraordinary increase in imports – in addition to the oil windfalls – were lower tariffs and facilitated regulatory reforms as well as a depreciation of the rial

MARKET-ORIENTED REFORMS

In addition to quantitative gains, some major structural reforms in the exchange, trade, monetary, financial, fiscal and regulatory areas were also undertaken during the plan’s time frame. Thus, in March 2002, the multiple-exchange-rate regime was unified and most restrictions on current-account transactions were eliminated.

In 2004, Iran accepted the liberal obligations of the IMF’s Article VIII for the first time since joining the Fund in 1945.

In the first three years, the foreign-trade system was gradually liberalized: most export restrictions were removed, nontariff barriers were replaced with rationalized tariffs, and export-licensing procedures were streamlined. A pre-revolution law for the attraction and protection of foreign investment was replaced by new and updated legislation in 2002. Iran joined the World Bank’s Multilateral Investment Guarantee Agency.

In the financial sector, the Central Bank was enjoined from financing budget deficits and was authorized to issue “participation papers” (i.e., government short-term debt obligations) to mop up excess liquidity and contain inflation.19 Four private banks, two non-bank credit institutions and two private insurance companies were licensed for the first time since the 1979 banking and insurance nationalization. Rates of return on both deposits and loans by the state banks were made more flexible. Mandatory credit allocations by the Majlis were reduced.

Capitalization of the state banks was raised. And risk-based banking supervision was introduced. Several draft laws on capital markets, money laundering, central bank independence, check-writing fraud, and bankruptcy were prepared for legislative ratification. In 2002, the Islamic Republic made its first foray into global capital markets by selling 625 million euros ($833 million) worth of debt on two successive occasions. Toward the end of 2004, the rating agency Fitch upgraded Iran’s credit ratings to BB minus from B plus, due to low external debt, a current account surplus for the fifth consecutive year, rising oil revenues, and accumulating foreign-exchange reserves.20

In the fiscal area, an Oil Stabilization Fund was established to insulate the budget from oil-price fluctuations. A major tax reform was initiated in 2002 by significantly reducing corporate and income tax rates; strengthening tax assessment and collection; consolidating a host of small taxes, fees and charges in a single tax on all goods and services; and unifying nearly all import taxes and charges into a single customs duty. Meanwhile, a draft law on value-added tax (VAT) was submitted to the Majlis. A modicum of transparency was introduced in the national budget by closely identifying the cost of implicit foreign-exchange and energy subsidies in the budget document. The tax exemption for charitable bonyads was conditionally ended, subject in each case to the approval of the Supreme Leader.21

SETBACKS AND STALLED MAKEOVER

Dwarfing the plan’s recognized achievements has been a long series of unfulfilled promises and a clear inability to reach declared objectives. The first of the gross failures in eleven specific areas relates to administrative reorganization and the downsizing of the bureaucracy. Article 2 of the plan law specifically required that all functions related to energy, agriculture and industry be consolidated in a total of three ministries. In retrospect, however, neither of these goals was reached. According to a recent report, the ratio of annual government expenditure to GDP actually rose from 24.5 percent in 1999 to 27.2 percent in 2004.22 And, while the ministries of agriculture and rural crusades were merged, bureaucratic turf battles prevented the merger of energy ministries and agencies (oil, electricity and nuclear power). By contrast, a new Ministry of Welfare and Social Security was created to deal with public pensions and social security. Article 3 required that the number of government employees be cut by at least 5 percent by the end of the plan period. President Khatami’s last-day report to the Majlis claims that the total number was reduced by 2.9 percent.23 But, since the number of employees in several agencies (e.g., defense, security and intelligence) is never published, there is no way of knowing whether the total figure was actually reduced. Furthermore, even though the claimed reduction was still considerably short of the target, according to a recent World Bank report, governance effectiveness in Iran between 2000 and 2004 declined drastically, reducing Iran’s rank from 119 to 149 among 209 countries.24 Inability to control prices through cost cutting and higher productivity proved to be the plan’s second failure.

Article 5 placed a ceiling of 10 percent on the annual increase in prices of goods and services offered by SOEs, to be achieved through cost cutting and increased productivity. In practice, however, productivity failed to rise sufficiently, and SOE prices had to be raised repeatedly by special legislative authorizations. Labor productivity was to increase on average by 1.3 percent a year, capital by 0.2 percent, and total factor productivity by 0.86 percent. The outcome shows that total factor productivity rose by 0.8 percent a year on average. Capital productivity rose by only 0.1 percent, due to increased use of capital-intensive technology and the choice of capital-intensive projects. Labor productivity rose by 2 percent a year on average, mainly due to the preponderant role of capital in the production process, resulting from mandated low real rates of interest and stifling legal rigidities in the labor market.25 The total-factor productivity contribution to the annual GDP growth that was projected to be 14.8 percent also missed the target. Responsible for this shortfall were the inordinate completion length of capital-investment projects, management shortcomings, poor use of human talent, and selection of non-profitable projects under political pressure.26 With overall national productivity falling year after year, SOEs routinely had to raise their prices beyond planned targets to cover the costs of inefficiency, wasteful expenditures and self-authorized perks. According to a recent report, of the 21 publicly subsidized items, 11 cases involved goods and services supplied by the SOEs. And, in some years, the percentage of extra price rises allowed them by the legislature was higher than the overall consumer-price index.27

Meager privatization results were the third setback. Chapters 2 to 4 of the plan law were devoted to the rehabilitation of public enterprises, ceding the ownership and management of these entities to the private sector and exposing the economy to greater competition. The need for action in this area was never felt to be more urgent. The share of public enterprises in the comprehensive national budget had risen from 53 percent in 1992 to 67 percent in 2003. Of the 2,000 largest enterprises in the public sector, with a roughly estimated net worth of $110 billion and annual revenues of $61 billion at the start of the plan, nearly 41 percent reportedly operated in the red. In 2002, 31 of 94 major entities belonging to the National Iranian Industries Organization, the Industrial Development and Renovation Organization, and the ministries of Agriculture, Commerce, Industry, Labor, Oil, Post and Telegraph, and Transportation all lost money. The returns on investment in the profitable entities ranged between 6.1 percent and 6.3 percent a year during 2001 and 2003, while interest rates on one-year treasury bills and other guaranteed short-term deposits exceeded 17 percent, and the informal bazaar rates ranged from 30 to 45 percent. For the entire plan period, onethird of all SOEs had to be supported by fiscal subsidies, and the percentage of the budgets of money-losing enterprises in the total SOE budget rose from 10.2 percent at the start to 22.4 percent in 2003-04.28 Under the direction of a new entity called the Privatization Organization established in early 2001, shares of 523 selected SOEs had to be sold to the public. All enterprises designated for privatization were to be clustered in 53 holding (“mother”) companies for sale to the public through the Tehran Stock Exchange, public auctions or other means. The outcome was hugely disappointing. Although tentative estimates collected from available official data are contradictory, unreliable and confusing, they still show a grim picture. During the first year of the plan, privatization activities were limited to the transfer of shares of some public corporations to various public retirement funds in lieu of the Treasury’s mandated cash contributions. The target for the second year was 7 trillion rials ($875 billion), of which no more than 250 billion rials-worth was sold. Despite this unsuccessful experience, the third-year budget projected a total transfer of 12 trillion rials, or 48 times the previous year’s receipts. The new target was also missed, and no more than 8.3 trillion rials of public-enterprise shares were transferred. The fourth year’s goal was 18 trillion rials, of which only 9.75 trillion rials were realized. The least successful year of the entire plan period was the fifth, where a combination of diverse factors (including unrealistic prices in initial public offerings) resulted in an unprecedented cool reaction by the market, and the 22-trillion-rial target almost totally missed. Of the $570 million worth of shares of state firms put up for sale, only $17 million worth was sold. 29 The issue of crucial significance in this unflattering record is not so much the disappointing sales, as the status of the “buyers.” By official estimates, some 80 percent of shares “sold” by the Privatization Organization were actually transfers to other public agencies (such as the Social Security Fund and the Government Employees’ Pension Fund), or bought by the investment subsidiaries of state banks and insurance companies.30

Factors responsible for the privatization program’s setbacks were many. On the bid side, the absence of a proper politicoeconomic climate, unreasonable prices demanded by the Privatization Organization in its initial public offerings at the Tehran Stock Exchange, the inability of the small private sector to afford purchase prices, and the relatively low returns on such investments were the major reasons. On the supply side, there were the obvious reluctance of state and parastatal agencies to give up their economic clout; the resistance of incompetent managers who might be fired by new private owners; the opposition of redundant workers who might lose their jobs under cost-cutting initiatives; the hesitation of a large contingent of board members, consultants and other corporate beneficiaries who would be deprived of their perks; and – more poignantly – the legal requirement that 50 percent of the proceeds be turned over to the Treasury and no more than 48 percent kept by the privatization agency.31

The plan’s fourth disappointing story involves the goals of Chapter 5, regarding unfair and unaffordable public subsidies. By everyone’s admission, the most glaring failure of the plan was the continuation of the subsidy system, which veered away from its initial goal while gobbling up an increasing share of the budget year after year. Explicit subsidies included assistance to households and businesses. Subsidies to consumers covered a range of “basic necessities” (bread, rice, cooking oil, sugar, cheese and prescription drugs) that applied to all households regardless of income. Explicit subsidies to businesses covered certain raw materials and equipment used by industry. Implicit subsidies involved mostly public utilities sold by the SOEs (water, electricity, telephones, transportation and fuel products, particularly gasoline). These subsidies, in addition to imposing an unbearable burden on the treasury’s meager resources, encouraged wasteful consumption, smuggling and underground transactions.

Insufficient transparency in the budget and the variety of estimates in official documents make it difficult to assess the magnitude of public subsidies. According to the governor of the Central Bank, explicit and implicit subsidies amounted to $16 billion a year, of which 20 percent applied to basic consumer items and 80 percent to energy products (notably gasoline). A Majlis committee chairman, however, put the figure at $28 billion – 30 percent of the total budget and 6 times the funds set aside for public investment in development projects. Explicit subsidies are estimated by the World Bank to be about $6.5 billion, nearly 5 percent of GDP; implicit subsidies are estimated to be about 12 percent of GDP.32 By an official estimate, the annual opportunity cost of energy products exceeded $20 billion, of which one-fourth was considered totally wasteful.33 Nonetheless, the main flaw with the subsidy system was not its excessive magnitude but its unfairness. According to official figures, benefits from subsidized energy products to the richest 10 percent of recipients accounted for 43 percent of the total, compared to 7 percent to the poorest 10 percent.34 President Khatami, addressing a group of energy managers shortly before the end of his eight-year tenure, called the persistence of across-the-board subsidies “the greatest failure” of his presidency.35 The persistence of poverty proved to be the plan’s fifth shortfall. Article 36, designed to implement Principle 29 of the Constitution regarding “Islamic social justice,” emphasized poverty reduction. As one of the twin pillars of the plan’s objectives, social justice aimed at a fair distribution of income and wealth. The absence of data on annual income distribution, and bewilderingly contradictory figures cited by government officials or available from other sources make it hard to evaluate the plan’s performance in this regard. President Khatami’s last report to the Majlis claims that the social-welfare indicator improved every year, along with rising per capita income, as evidenced by a decline in the ratio of consumption between the richest and poorest 10 percent of the population, from 20.5 percent to 17.7 percent.36 Private analysts and foreign observers, however, dispute these claims and believe that the Gini coefficient remained at best the same during the plan period. Figures cited by other officials and some published private data fail to show progress in reducing poverty. On the extent of poverty at the end of the period, according to a recent report by the Majlis Research Bureau, some 50 percent of the rural population and 20 percent of urbanites fell below the relative poverty line.37 A Majlis committee chairman argues that 10-12 million of Iran’s 70 million people “live under the poverty line.”38 According to the minister of welfare and social security, some 7.5 million Iranians fall below the absolute poverty line, and 1.5 million people go to bed hungry.39 The director of the Anti- Poverty Program reports that 2 percent of the rural and 4.5 percent of the urban population live under the absolute poverty line, and some 15 percent of the rural and 17 percent of the urban population suffers from relative poverty.40 On relative income distribution, a reliable report, based on World Bank figures, shows that the wealthiest 10 percent of the population earned and spent 33.7 percent of national income, while the poorest 10 percent’s share was no more than 2 percent; the wealthiest 20 percent enjoyed about 50 percent, while the poorest 20 percent shared only 5.8 percent.41 By these calculations, five million Iranians, or some 7.3 percent of the population, lived on $2 a day while 1.4 million, or 2 percent lived on $1 a day.42 Among non-official sources, a report critical of the Khatami government claims that population below the poverty line increased during the plan’s time frame, and a total of 1.7 million people were added to the ranks of the poor.43 A Ministry of Social Welfare official confirms that “extreme poverty,” i.e., the inability to afford the bare necessities, increased considerably in both rural and urban areas during the period.44 On a related matter, despite the government’s obligation to provide a minimum of social security for the entire population, by the end of the period, a high welfare official admits that one-half of Iran’s population still lacked any social insurance.45 The continued shortage of job opportunities became the plan’s sixth failure. Chapter 6 was focused on the necessity of increasing employment. The ways and means of achieving this goal included the repatriation of foreign refugees, reduction of social-security and unemployment taxes for employers who took on more workers, various incentives for creating jobs in the depressed regions, low-cost credit for the self-employed, provisions for labor training, discounts on public utilities to new employers, and the export of workers to receptive countries under bilateral agreements. The official unemployment rate of about 15 percent in 2000 was to be brought down to 11.5 percent by March 2005. A total of 3.8 million new jobs (760,000 a year on average) had to be created in order to keep the number of jobless workers from rising further. According to various official estimates, however, no more than 2.9 million new jobs were created during the plan’s life. A labor official recently admitted, perhaps inadvertently, that only 77 percent of projected employment had materialized.46 The minister of economy and finance also later confirmed that the number of unemployed had increased.47 The seventh blemish on the plan’s record involves persistent budget deficits. Chapters 7 and 8 dealt exclusively with the proper preparation, execution and audits of the national budget. Annual budgets were to be prepared with eight objectives in view: an increase in employment, a reduction of current expenditures, completion of unfinished projects, limitations on starting new ventures, greater participation of the private sector in the economy, rationalization of the government’s scope of operation, structural improvements in budget efficiency, and greater transparency. Yet, according to a Central Bank analyst, no significant structural improvement beyond cosmetic presentation can be seen in the annual budget documents. By the plan’s own official admission, too, no significant changes occurred either in the formulation of the budget or in its major components. Except for some changes in the budget’s format (i.e., treating oil-export income as “disposal of non-financial assets” and calling public investment “acquisition of non-financial assets”), the age-old method of budget preparation was routinely followed. Some 80 percent of the budget still goes to salaries and subsidies, the third rail of Iranian public finance. The discretionary share left for development is small and shrinking in real terms.48

The annual budgets have thus routinely underestimated expenditures and exaggerated revenues to show balance. And, even when oil income, taxes and non-tax revenues were not sufficient to match total expenditures, below-the-line items such as borrowing from the banking system and foreign credits were treated as “revenue” to produce balance. According to a Majlis Research Bureau’s recent report, the budget suffered from ten specific flaws. 49

In matters of substance, annual budgets have actually worsened in their revenue makeup. For example, the ratio of taxes to GDP, which averaged 6.7 percent during the Second Plan, and was to reach 10.6 percent in the Third, actually declined to 5.8 percent. At the same time, the share of oil income in total budget revenues exceeded its projected figure. According to the plan, the Treasury’s reliance on oil income was to be limited to 46 percent each year, while actual contribution averaged more than 64 percent. 50

In the last year of the plan, taxes accounted for only 25 percent of budget revenues.51 On the expenditure side, too, camouflaged annual budget deficits were made up by withholding disbursement of approved development outlays, with the result that typical investment projects took two to three times longer to be completed than the world average. In the last year of the plan, for example, only 52 percent of development expenditures were dispersed, while current outlays overshot their authorized amount, reaching 103 percent. And, although the budget was enjoined from relying on the banking system to finance deficits, the gap continued to be made up in various ways, with deficit financing higher in the last two years than in the first two. As a result, the Treasury’s debt to the Central Bank rose from 62 trillion to 112 trillion rials in the five-year period. The violation of this mandate, in turn, made planned targets for limits on annual increases in liquidity and yearly inflation impossible to reach. 52 The plan’s financing was also partly reliant on foreign direct investments, not only in the oil and gas projects, but also in non-energy sectors. Article 97 specifically authorized the Industrial and Mining Bank, the Agriculture Bank and the Export Promotion Bank to finance part of their private projects’ costs through foreign investment funds. Statistics regarding foreign direct investments in Iran are the least reliable and most controversial among all official published data – a fact that is repeatedly pointed out by local newspapers. State bureaucrats in the Foreign Investments Organization (who are seldom reprimanded for exaggerating their achievements) usually add together a number of different figures – simple expressions of interest by foreign investors, filings of required applications, memoranda of understanding between local and foreign parties, approved projects by relevant authorities, and actual flows of funds –to come up with billions of dollars.53 The amount invested on the ground, however, is always a small portion of these claims.54 Annual reports of UNCTAD, the most reliable source of global foreign investments, perennially place Iran at the very bottom of its list, in position 136 out of 140 countries in 2003, down from 132 in 2000. According to the latest Economist Intelligence Unit survey, during the 2000-04, the Islamic Republic was forty-fourth among 60 countries in terms of economic risk.55 The Business Monitor International considered the Islamic Republic the secondriskiest country in Asia.56 Other relevant foreign organizations (OECD, the French Foreign Ministry) also show a rather dim picture. Scattered private estimates point to a total of less than $1 billion of foreign direct investment in the non-energy sectors during the plan’s life.57 On the flip side, there are anecdotal reports about billions of dollars of capital outflows from Iran to the Persian Gulf emirates ($200 billion to Dubai!),58 and millions of dollars sent home by Iranian workers, businessmen and others residing abroad—none of which is ever clearly identified in the annual balance-of-payments statistics.59 Misuse of the Oil Stabilization Fund has been the plan’s eighth negative outcome. According to Article 60, all oilexport receipts above and beyond what was specifically earmarked in the annual budgets were to be deposited in the OSF. The fund was to be drawn upon in special circumstances and for specific purposes with permission from its board of trustees. The primary goals of the fund were to shield the economy from eventual oil-price declines and sudden revenue shortfalls. The government was thus authorized to draw from the OSF only if oil revenues fell below the budget benchmark for the year and there was no possibility of obtaining funds through taxes or other sources. Some 50 percent of the fund’s assets were also earmarked for lending to private entrepreneurs in foreign exchange at low interest rates to meet their import needs. The rial proceeds of the loans were, in turn, to be kept in a Rial Reserve Fund for eventual budget financing. In practice, however, the most egregious breach of the plan’s mandates involved the total disregard of the OSF charter. The formal balance sheet of the Fund has not so far been publised. Based on a series of different and conflicting figures by various government agencies, during the plan’s life, which coincided with an unprecedented steady rise in oil prices and the corresponding windfall for the Treasury, a total of $30.1 billion was deposited in the OSF and $22.6 billion withdrawn. Of the latter amount, the Majlis, ignoring the fund’s original purpose, repeatedly authorized $11.3 billion withdrawals from the fund to cover budget deficits. The rest was partly used for such purposes as helping the basij militia and war veterans, purchasing police equipment, aiding low-income families and the disabled, providing relief to farmers hurt by the drought, purchasing airplanes, expanding tourist facilities, promoting exports and financing short-funded subsidies. Ironically, the largest drawdown was in 2004-05, when Iran’s crude price and oil-export receipts reached record levels. The rainyday oil fund was thus repeatedly tapped when the sun was shining brightly. At the end of the plan, the fund’s total assets amounted to $11.9 billion.60 In strict accounting terms, the Treasury had no balance in the fund and actually owed it billions.61 According to a top OSF official, all public-sector withdrawals from the fund were in violation of the letter and spirit of the plan’s Article 60.62 President Khatami also criticized the Majlis for the misuse of the OSF reserves for transport, fuel, farm subsidies and other grants – calling such withdrawals “fatal poison.” 63 According to its secretary general, the authorities blatantly ignored the principles and procedures of the fund, and the OSF became a virtual government cash cow. The situation in the private sector was also far from ideal. During the plan period, some $11 billion was designated as the private-sector’s share, of which about $10 billion was allocated, $6.8 billion in loans was approved, and $3.6 billion was disbursed. Private undertakings financed by the OSF included projects in industry, minerals, chemicals, food stuffs, medicine, automobiles, textiles, aviation, machine building, electric power, tourism and export promotion.64 Yet the private borrowers’ ability to pay back their loans, even at a guaranteed exchange rate, is now doubted by many analysts. Ninth, the plan was not successful in protecting the value of the national currency. Chapter 9 related to foreignexchange policy and the government’s responsibility to preserve the value of the rial. Nevertheless, the rial’s domestic purchasing power fell by 80 percent during the period, and its foreign exchange value failed to hold steady. The official rial’s worth against the U.S. dollar and other major currencies steadily declined throughout the plan period. According to Central Bank figures, the rial’s exchange rate in terms of the U.S. dollar depreciated by 12.4 percent between 2002 and 2005. But, since the dollar had been falling in relation to other major currencies for part of the period, the rial actually lost more than 12.4 percent against the euro, the yen and the pound sterling – the currencies of Iran’s major trading partners. Tenth, continued wasteful use of energy resources (oil, gas, power and water) was another missed opportunity. Despite strong provisions in Article 121 for saving, rationalizing and conserving energy (including strict standards for appliances, factories and buildings), total energy consumption rose by close to 10 percent a year (and 12 percent for gasoline), five times the world average. As a result, with only one percent of the world population, Iran consumed nine percent of the world’s energy production, largely due to subsidized energy prices and partly to the absence of proper construction codes for private homes, public buildings, and industrial and commercial plants.65 By one reliable estimate, some industrial factories (e.g., cement) used 35 percent more energy than the world average; refrigerators built in Iran consume more electricity than imported ones; and domestically assembled automobiles use 37 percent more gasoline than foreign cars. Altogether, Iran’s per capita energy consumption was 64 percent higher than the world average. Finally, one of the critical objectives of the plan was elaborated in Chapter 12, setting forth environmental protection and resource conservation. The government was required to observe the ecosystem’s balance, reduce air and water pollution to the World Health Organization’s standards, contain deforestation and protect dwindling prairies. In retrospect, however, no significant headway was made. A report based on several international studies, in fact, paints a grim picture of the situation at the end of the plan period. Based on a Columbia University study of factors afflicting the environment, the Islamic Republic appears at the bottom of the list, with a rank of 132 among 146 countries in 2005, a significant deterioration from 105 in 2001 and 104 in 2002. Several studies by the World Bank and others point to significant annual deforestation of some 120,000 hectares, pollution of water sources by 20 million tons of sewage, 2 million tons a year of soil erosion, seepage of half a million barrels of oil into the Persian Gulf, and hazardous to crippling air pollution in Tehran and other major cities. And, despite Iran’s 2 percent share of greenhouse-gas emissions, the government has refused to join the Kyoto Protocol.66 On top of the foregoing specific targets, several other significant macroeconomic mandates of the plan, such as termination of public and private monopolies (Article 35), payment of 50 percent of the treasury’s debt to social-insurance funds (Article 39), repatriation of foreign refugees to their country of origin (Article 48), removal of all preferential treatment and tax exemption for public agencies and neo-governmental revolutionary institutions (Article 58), and the design of an ideal “consumption model”(Article 197) were all partially or totally neglected. Performance in individual sectors — agriculture, industry, telecommunications, transport, housing, education, health and others — which constituted the second part of the plan law, too, turned out to be erratic at best. Details of shortfalls in these areas have been regularly reported in the local press. 67

SUMMING UP

Five-year central planning has now become a sacred ritual in the Islamic Republic. Inserted in the 1979 constitution by Islamic Marxists as an economic quid pro quo for the ayatollahs’ insistence on the velayat-e faqih (rule by the clergy), these rites have since been faithfully observed. And, although planning has proven to be a costly exercise in futility, it is still regarded as a talisman for Iran’s economic salvation.68 The tangible effects of the Third Plan once again prove the point. Although much better than those of the Second, the achievements attributable to planning have been mixed and altogether modest — it has achieved some tactical successes while falling behind in strategic goals — mostly because the plan has been neither effectively formulated nor meticulously implemented. Fundamental contradictions among the plan’s basic objectives, lack of commitment by executive agencies to abide by the plan mandates, and ambitious goals with little or no regard to the feasibility of their attainment have been some of the plan’s major flaws. As a result, some of its quantitative targets were partly or largely missed. A number of structural reforms were only partially implemented, reversed after initiation or largely untouched. And most of the plan’s claims of novelty and innovation never materialized. Not only did the size of the government grow instead of shrinking, the state machinery became less disciplined, further oil-dependent and more corrupt. Unemployment, and particularly the shortage of job opportunities for the college educated, intensified. Budget balance and transparency proved elusive. Income gaps among various social strata widened. Productivity remained largely stagnant. The rial lost some of its value. The misery index (combination of inflation and unemployment) was not palpably reduced. More distressingly, no real headway was made in price decontrols, privatization of money-losing state enterprises, replacement of the wasteful and inefficient across-the-board subsidies, and significant attraction of foreign direct investment in the non-energy sectors. Externally, the plan’s underlying strategy of gradual integration with the global economy made little progress. In a recent globalization survey of 62 countries, with 96 percent of global product and 85 percent of world population, the Islamic Republic was ranked fifty-eighth in terms of economic integration, political democracy and technological advance.69 Of the 60 countries surveyed by the Economist Intelligence Unit, Iran was ranked fiftyninth in overall openness to the world economy. With respect to the macroeconomic climate, market opportunities, attitude toward foreign investment and exchange regulations, Iran’s place has ranged between 56 and 58.70 Iran’s repeated requests to join the WTO during the plan period were rebuffed due to the absence of consensus among members.71 On closer scrutiny, it can also be seen that even the plan’s quantitative achievements were due not so much to the planners’ ingenuity or the planning process itself, but largely to a host of such exogenous factors as bountiful rains, an enormous increase in imports of capital and semi-processed goods, sizable foreign investment in the energy sector, and — most significant — the unprecedented oil windfall. The oil boom prevailing in more than half of the plan’s life was the crucial savior of the plan’s quantitative objectives. The record-high receipts from oil exports financed an ever-increasing share of the budget, repaid external debts on schedule,

MIDDLE EAST POLICY, VOL. XII, NO. 3, FALL 2005

1 Mostanadat-e Barnameh Sevvom [The Third Plan’s Supporting Documents], (Tehran: Management and

Plan Organization, September 1999).

2 See Hamshahari (Tehran), November 29, 1999; Reuters, November 30, 1999.

3 See Jomhouri Eslami (Tehran), December 9, 1999.

4 For a scathing criticism of the plan’s format, see statement by the Secretary General of the Islamic Labor Party in Jomhouri Eslami, November 1, 1999.

5 Islamic Iran News Agency (IRNA), October 3, 1999.

6 For the highlights of the Third Plan in English, see Economic Trends, No. 18 (Tehran: The Central Bank, 1999).

7 Hamshahri, November 12, 1999.

8 For details of these provisions, see Iran: Interim Assistance Strategy (Washington: The World Bank, April 2001); and Iran: Recent Economic Development (Washington, IMF, July 2000).

9 For the full text of the Third Plan Law in Persian, see Qanoon-e Barnameh Sevvom Tose-e Eqtesadi, Ejtema’i va Farhanqi-e Jomhoury Eslami-e Iran (Tehran: Rooznameh Rasmi, 1378).

10 See “MPs Criticize and Examine the Third Five-Year Plan,” Tehran Times (Tehran), October 4, 1999; and “The Third Plan Was Prepared with Undue Haste,” Jomhouri Eslami, November 1, 1999.

11 Emrouz (internet web site), March 6, 2005.

12 Cf. www.radiofarda.com, May 21, 2005.

13 Hamshahri, January 16, 2005.

14 Stated by the minister of economy and finance, reported in Donya-e Eqtesad (Tehran), May 24, 2005.

15 For a discussion of jobless figures and their apparent contradictions, see Jahangir Amuzegar, “Iran’s Unemployment Crisis,” Middle East Economic Survey, October 11, 2004.

16 For instance, while the liquidity increase of 32 percent in 2004/5 was higher than the year before, inflation is claimed to have declined during the same period!

17 Total foreign commitments (including interest on actual debt) was $40 billion at the end of the Plan period.

18 Reported in Hamshahri, June 2, 2005.

19 To comply with this mandate, the Central Bank issued a total of Rls 23 trillion worth of bonds during the Plan period.

20 Reuters, December 14, 2004.

21 For details, see Islamic Republic of Iran: Staff Report for the 2004 Article IV Constitution (Washington: IMF, August, 2004).

22 Islamic Republic of Iran – Statistical Appendix (Washington: IMF, August 27, 2004).

23 Hamshahri, August 2, 2005.

24 Governance Matters IV (The World Bank, May 2005).

25 Cf. Baztab (internet web site), February 6, 2005. See also annual reports of the Management and Planning Organization for each year, as well as the entire plan period.

26 According to an aviation official, in some of Iran’s recently built airports there was not even one single takeoff or landing a day. See Iran Emrooz, May 31, 2005.

27 See “Viewpoint,” Hamshahri, December 22, 2004, and December 24, 2004.

28 Cf. Iran Economics (Tehran), November 2004. paid for fast-growing imports, supported the vulnerable rial, kept foreign borrowing to a minimum, and filled various other economic potholes. During the Third Plan, Iran received more than $130 billion from crude-oil exports while the planned expectation was for only $64 billion. The average price of Iranian crude-oil exports fluctuated between $21.4 and $44.7 per barrel during the plan period—compared to a notional $12 per barrel. That Iran’s economy still requires a complete makeover is universally acknowledged. All seven presidential candidates in the June 2005 presidential elections ardently called for a total restructuring to deal with poverty, unemployment, ill-gotten wealth, unfair income distribution and corruption.72 Yet five-year development planning would hardly be the solution. In fact, centralized plans and directives are themselves an integral part of the problem.

30 For background materials on the subject, see Radio Azadi, May 9, 2002; Iran News (Tehran) May 15, 2002; Iranmania.com, July 26, 2002; Hamshahri, September 3, 2002 and November 11, 2002.

31 See Jahangir Amuzegar, “Iran’s Privatization Saga,” Middle East Economic Survey, June 17, 2002.

32 For a detailed discussion of these subsidies, see Iran: Medium-Term Framework for Transition (Washington: The World Bank, April 30, 2003), Ch. 9 and Appendix 5.4.

33 Statement by the energy minister, reported in Hamshahri, May 7, 2005.

34 Iran Times, May 13, 2005.

35 Hamshahri, May 20, 2005.

36 Hamshahri, August 2, 2005. See also Gozaresh Eqtesadi 1382 [Economic Report, 2003/4] (Tehran: Management and Plan Organization, 2004).

37 Baztab, February 6, 2005.

38 www.radiofarda.com, January 19, 2005.

39 Kayhan (London), June 1, 2005.

40 Siasat-e Rooz (Tehran) July 21, 2005. See also Jomhouri Eslami, July 29, 2005.

41 See World Development Indicators 2005 ( Washington: The World Bank, 2005)

42 See Hamshahri, June 13, 2005.

43 Jomhouri Eslami, May 5, 2005.

44 Hamshahri, June 26, 2005.

45 Iran Emrooz (internet web site), November 30, 2004.

46 Hamshahri, May 5, 2005.

47 Donya-e Eqtesad, May 24, 2005. See also Hamshahri, July 20, 2005, for the failure of the much-heralded self-employment program.

48 Hamshahri, August 1, 2005.

49 See Jomhouri Eslami, June 18, 2005.

50 Hamshahri, December 5, 2004.

51 Hamshahri, June 11, 2005.

52 See Hamshahri, November 25, 2004, and Jomhouri Eslami, November 25, 2004.

53 For the latest statement of the official in charge, see Hamshahri, June 26, 2005.

54 See, for example, the convoluted statement by the head of FIO in IranMania (website), June 26, 2005.

55 Hamshahri, July 25, 2005.

56 Iran Times, May 20, 2005.

57 Cf. Hamshahri, May 27, 2005.

58 Statement by a Majlis deputy reported in radiofarda.com, June 26, 2005.

59 Hamshahri, June 2, 2005.

60 Ravand (Tehran), Spring 2005; Hamshahri, August 2, 2005; Jomhouri Eslami, July 8, 2005.

61 Jomhouri Eslami, January 6, 2005.

62 Hamshari, April 3, 2005.

63 Daily Star (Beirut), January 10, 2005; and Donya-e Eqtesad, April 13, 2005.

64 Hamshari, December 24, 2004, and February 21, 2005.

65 See Hamshahri, November 25, 2004, and Jomhouri Eslami, November 25, 2004.

66 See “132 Rank for Iran,” Iran Emrooz, March 24, 2005.

67 See, for example, Jomhouri Eslami, May 21, 2005; Iran Times, May 13, 20, and 27, 2005; and Payvand’s Iran News (internet web site), April 24, 2005.

68 For background, see Jahangir Amuzegar, “Iran’s Post-Revolution Planning.” Middle East Policy, March 2001.

69 Donya-e Eqtesad, May 5, 2005.

70 Hamshahri, May 6, 2005.

71 In June 2005, the Islamic Republic was finally given an observer status as a first step to eventually become a WTO member.

72 According to Transparency International’s 2004 report, of the 146 countries surveyed, the Islamic Republic ranked 88th, down from 81st in 2003.