Iran and the West: Who Needs Whom? A Look at the Consequences of Ahmadinejad’’s Economic and Foreign Policies

By March 7, 2006

BESA Center Perspectives Paper No. 14

EXECUTIVE SUMMARY:Iranian President Mahmoud Ahmadinejad has repeatedly asserted that the West needs Iran more than Iran needs the West. This article examines the accuracy of this statement in light of Iran’s current diplomatic and economic predicament and concludes that, while Iran has the economic influence to inflict significant damage on the world economy, President Ahmadinejad’s flippant remarks have little basis in reality and that his policies are likely to incur significant damage to his country.

Introduction

Iranian President Mahmoud Ahmadinejad has stated repeatedly that the West needs Iran more than Iran needs the West. Hence, his casual dismissal of the threat of international sanctions against Iran. Is this indeed so? A careful analysis of Iran’s diplomatic and economic situation suggests that Ahmadinejad’s bravado is misplaced.

Iranian Enhanced International Leverage

To a certain extent, Ahmadinejad is on the mark. Iran is the second-largest oil producer in OPEC, holding about 10 percent of the world’s crude oil reserves. Iran is second only to Russia in terms of its natural gas reserves. Iran has also become a major supplier to the leading, but most economically vulnerable, economies in the world, namely China and India. These manufacturing powerhouses have become critical to the stability of the world economy.

The ability of China and India to manufacture cheap goods and services for the American and European markets is dependent on affordable Iranian oil. Any severe disruption to Iran’s economy through sanctions would raise the price of oil drastically, and have direct and significant economic repercussions on the Chinese and Indian economies (as well as other Western economies). Thus, China and India are sure to protect Iran against any Western attempt to impose sanctions.

On the diplomatic front, Iran has been buoyed by the demise of the Saddam Hussein regime and its replacement by a Shia-dominated government. Iran is heavily influential among the Iraqi Shia militias who call many of the shots in post-war Iraq.

As for military power, Iran is surging forward. Even during the pre-Ahmadinejad ‘reformist’ period, Iran was building up its military power. Teheran already has the capacity to strike European capitals with non-nuclear weapons. Gholamreza Aghazadeh, the head of Iran’s Atomic Energy Organization, claims that Iran will obtain its nuclear bomb without Western assistance or technologies – a statement that is not difficult to believe. Future sanctions against Iran are unlikely to significantly impede the Iranian nuclear drive.

Iranian Vulnerability

On the other hand, Iran is risking its newfound importance by confronting the West at this stage. While Teheran has benefited from the international hike in oil prices and the other factors mentioned above, it is neither an economic nor a military superpower.

International sanctions would hamper Iranian technological progress. Iran’s oil industry is not in good shape. Without Western assistance, Iran’s stated goal of doubling its oil output to 8 million barrels a day by 2020 will not be realized. Iran’s ability to pump oil, and hence its ability to hold its economy together, is contingent on reliable maintenance of its infrastructure.

Iran’s oil industry has not even entirely recovered from the damage wrought during the Iran-Iraq war to oil installations, electric power plants, bridges, manufacturing plants, and other elements of its infrastructure. Moreover, to realize its full potential revenues from its oil reserves, Iran needs to carry through its stated plans of diversifying through investing in petrochemical and profitable crude oil derivatives. Again, this requires outside investment.

In fact, Iran is a net importer of refined oil products, including gasoline! According to the latest Iranian estimates, gasoline imports are expected to cost the country US$4.5 billion in the current Iranian year (1384), which ends in late March 2006. In the previous year, the figure was US$3 billion. These imports are expected to continue, and consumption of oil products is set to grow by at least five percent per annum.

Iran’s total gasoline refining capacity is 40 million liters a day; its gasoline consumption is estimated to exceed 64.5 million liters a day. Thus, sanctions that bar Iran from importing refined oil products might lead the Iranian economy to a halt. This situation will have the potential to undermine the political standing of President Ahmadinejad.

In summary, while the US-imposed boycott has not stalled Iran’s oil industry, it has inflicted an economic price. International sanctions – if effectively upheld – will inevitably have an even more severe effect.

It is important to note that one of the main reasons that Libya finally acceded to international demands regarding dismantlement of its nuclear effort was the long-term damage wrought on its oil industry by Western sanctions.

Iranian hardliners boast that they are immune to such pressures thanks to the economic ascendancy and industrial might of China. Indeed, the current Iranian regime has invested a lot of faith in China; and Iranian media often report with fanfare on the ‘Chinese miracle.’

Indeed, China Petrochemical Corporation and Iran are close to finalizing plans to develop Iran’s Yadavaran oil field, in a deal worth about $100 billion. There is also pent-up interest in foreign investment in Iran – held up only by the political situation and Iranian attitudes to foreign investment. Given Iran’s extensive reserves, foreign oil firms are more than willing to put up with tough commercial conditions in order to crack into the Iranian fields. (In Iran today, exploration companies do not have the automatic right to exploit reserves they discover. Successful exploration companies must enter a state-run tender to develop their discoveries, with no guarantee of success!)

However, Iran’’s current rhetoric puts international commercial interest in Iran in peril. Mohammad Mir-Mohammadi, a conservative member of parliament from the constituency of Qom, has argued vociferously against what he terms ‘foreign exploitation of Iran’s resources’. This extends to all aspects of foreign investment. Iran’s parliamentarians have also spoken out against awarding a $3 billion cell phone deal to Turkish operator Turkcell, and have opposed a Turkish consortium running Tehran’s new international airport. The French car manufacturer Renault has spent considerable time and money on plans to build Megane cars in Iran in 2006 with an Iranian joint venture, but it too has encountered many difficulties. This will make it harder for Iran to become a regional economic powerhouse. Isolationism will alienate potential investors – even from the Muslim world. With commercial terms set to become even more severe, investor patience is likely to run out soon.

Moreover, Iran cannot solely rely on China. China’s economic boom depends on massive global demand for manufactured items – something that Iran and other vehemently anti-American states such as Syria, North Korea and Venezuela cannot supply. China has significant commercial interest in Iran’s oil and petrochemical industry, but China will not back Iran at the expense of its own economic growth. The current Iranian isolationist policy is against China’s interests, especially if it creates an energy crisis and pushes up the price of oil.

It should be remembered that the oil crisis of the 1970s forced the world into becoming more efficient in its oil consumption, eventually pushing the price down and creating near macro-economic crises in the Gulf and Iran. China and India are investing in plans to become more energy efficient. Alternatives to oil, such as fuel cells, are already attracting considerable investment – much more so than in the past.

Moreover, China, Russia and Pakistan have no strategic reason to side with Iran for the foreseeable future. There is no chance of either a commercial or military union between these countries and Iran with which to challenge America and Europe.

The Welfare of Iranians

On a grassroots level, most Iranians are not feeling any economic boom. Fifty percent of Iran’s 70 million people are under the age of 25. Iran must create almost one million new jobs every year in order to keep its unemployment rate at the present level of about 11 percent. In all likelihood, the actual unemployment rate is much higher, while emigration too continues to climb.

Iran’s per capita income in 1977 was equivalent to that of Spain before the revolution. At the time, Iran pumped six million barrels of oil a day. Today, Iran’s real per capita income is a third of what it was then, oil production is two-thirds of the 1979 level, and the middle class has been hit by spiraling inflation, inadequate employment opportunities, and wages that are decreasing in value. According to official estimates, average living standards have dropped by 20 percent since the revolution.

Moreover, these are economy-wide averages. There is a growing gap (worsened by pervasive corruption) between a wealthy minority and vast impoverished majority. Taking into account the unequal income distribution, the poorest and middle-income groups have suffered an even greater decline than indicated by the national averages, while the wealthiest elites have become even richer.

It is important to remember that redressing inequality was President Ahmadinejad’s election campaign mantra. However, while Ahmadinejad promised to address the unfair distribution of wealth in Iran, he is going to have a hard time doing so while concurrently acting to further isolate Iran from the rest of the world.

Iran is currently taking active measures to isolate itself. On March 20, 2006, Iran plans to participate in a new International Oil Bourse, trading oil priced as Petroeuros, rather than Petrodollars, though oil is traditionally traded in dollars. In addition, just this month, Iranian First Vice President Parviz Davoudi announced a ban on government purchases of foreign durable consumer goods that have made-in-Iran equivalents. The list of prohibited goods covers more than 60 items, from stationary, light bulbs and household appliances to refrigerators, bicycles, cars and small planes. With the public sector controlling more than 65 percent of the Iranian economy, this will impact exports to Iran.

Distributing Iran’s considerable wealth through further expanding the already over-sized state sector – something Ahmadinejad talks about – is a mistake often made by well meaning, but na?ve, governments.

Industry in Iran, which includes large state-run textile and automotive companies, accounts for about 41 percent of annual gross domestic product. Service industries, meanwhile, generate 49 percent of GDP, with agriculture making up the remaining 10 percent. Aside from oil and gas, exports include pistachio nuts, fruit and carpets, and are worth close to $39 billion a year. But these industries are not significant job creators.

Economists know that the encouragement of private entrepreneurship is a central mechanism in raising the standard of living and level of services in a country. But small and medium-sized businesses are rare in Iran, and Ahmadinejad’s plans to expand the public sector and more centrally control industry will only exacerbate Iran’s core economic problems.

Autarky has been tried before by Iran – and then reversed. Ayatollah Khomeini was ideologically opposed to external borrowing and aggressively reduced the foreign debt he inherited from the Shah. But Rafsanjani rapidly increased Iran’s foreign debt as a means of speeding reconstruction and development. Although Iran’s oil export revenues rose sharply as a result of the higher oil prices accompanying the Persian Gulf War, imports rose even more rapidly and led to large deficits in the balance of payments. These deficits were financed, directly and indirectly, by external short-term credits.

Alex Vatanka, Eurasia Editor for Jane’s Information Group, recently estimated that economic sanctions will severely hurt the average Iranian, who will blame the ruling clerics for making life difficult. If sanctions are imposed on Iran, Vatanka said, the level of frustration among the Iranian population will rise to a point at which Ahmadinejad’s position “will become untenable”.

Conclusions

President Ahmadinejad is overstretching himself both diplomatically and economically in the international arena.

On the one hand, Ahmadinejad’s economic and diplomatic boldness is backed up by the strength of Iran’s energy sector and newfound diplomatic importance. His internal revolution, promising to root out corruption and share oil windfalls with the disadvantaged, may have positive effects on Iran’s weak bureaucratic system.

However, his intent to expand the public sector and to crowd-out foreign investment is extremely risky, and unlikely to improve the average Iranian’s standard of living.

Additionally, Ahmadinejad’s strategy of relying on China and on anti-American regimes in South America and North Korea, is likely to prove to be of limited value. China still cannot provide the technological and financial investment needed to transform Iran’s petrochemical industry. Oil wealth by itself cannot guarantee Iran’s 70 million citizens a high standard of living without developing downstream industries. Iran’s other allies certainly cannot compensate for decreased European investment. In short, President Ahmadinejad can get away with autarky for a few years – but such a policy will not be sustainable over time.

Obtaining nuclear weapons will certainly consolidate Iran’s newfound diplomatic strength. However, the economic cost of going ahead with current nuclear policy in terms of international sanctions could be disastrous. China has no interest in Iran having nuclear weapons. Russia is benefiting diplomatically from the current tension by proving itself to be an international broker once more. But powers such as Russia and China will only support Iran if it is in their commercial interests to do so. If the world gets serious about sanctions, it will not be in China or Russia’s commercial interests to continue backing Iran.

In conclusion, should an effective international regime of sanctions be imposed on Iran, it will have very adverse ramifications for the Iranian economy – from which it will take Teheran years to recover. While Iran has the economic influence to inflict significant damage on the world economy, President Ahmadinejad’s flippant remarks about the West “needing Iran more than Iran needs the West” have little basis in reality and in time, will come to haunt him.

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Dr. Gil Feiler
Dr. Gil Feiler

Dr. Gil Feiler is managing director of Info-Prod Research, Ltd, and a research associate at the Begin-Sadat Center for Strategic Studies. Email: [email protected]