Foreign Exchange Gap, Structural Constraints, and the Political Economy of Exchange Rate Determination in Iran Author(s): Sohrab

Behdad Source: International Journal of Middle East Studies, Vol. 20, No. 1 (Feb., 1988), pp. 1-21 Published by: Cambridge University Press Stable URL: http://www.jstor.org/stable/163583 . Accessed: 10/08/2011 10:01
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Int. J. Middle East Stud. 20 (1988), 1-21. Printed in the United States of America

Sohrab Behdad

EXCHANGE GAP, STRUCTURAL AND THE POLITICAL CONSTRAINTS, ECONOMY OF EXCHANGE RATE IN IRAN DETERMINATION FOREIGN
Foreign currency transactions have come under stringent controls in postrevolutionary Iran.' This is a relapse into the prevailing conditions in the years preceding 1974,2 before the increase in oil revenues eliminated the foreign currency gap.3 Initially, the Islamic Republic of Iran (IRI) imposed exchange controls to stop the postrevolutionary capital flight. Soon, however, exchange controls became an integral policy instrument of the government for rationing the existing supply of foreign currency in the face of a widening foreign exchange gap. Recently, some economists and business circles have come to advocate devaluation policy as a means for coping with the existing foreign exchange problem in Iran.4 The IRI has not let this view surface in the arena of public debate. The issue, however, has been confronted in an informative and timely article by Wolfgang Lautenschlager in a recent issue of the International Journal of Middle East Studies.5 Lautenschlager has formulated what I call the "devaluation thesis." He asserts that the Iranian "rial is one of the world's most overvalued currencies,"6 which "has strongly affected" the Iranian economy,7 and that the inflow of cheap imports, resulting from the overvalued rial, has caused a decline in the market share of Iranian industries. Lautenschlager maintains that "[i]f Iranian industry had not lost this market share, its output would possibly have been as much as one-third higher" (italics added).8 That is, according to the author, "[w]hile the war, the oil glut and departure and purge of skilled personnel have certainly been important influences on the economy ... [a]griculture and industry would both have fared better had it not been for the unrealistic exchange rate policy."9 The "devaluation thesis" explains the seemingly irrational exchange policy of the IRI by pointing to the existence of a close alliance between the IRI and the powerful bazaar merchants who benefit from the exchange control schemes. In the words of Lautenschlager, "the Islamic Republic has tailored its economic policies to meet the interest of bazaar merchants . . . [against] their major competitor ... namely, modern industry managed by westernized technocrats."1' I maintain that the "devaluation thesis," as represented in Lautenschlager's article,1' understates the complexities of the Iranian economic structure and
? 1988 Cambridge University Press 0020-7438/88 $5.00 +.00

Sohrab Behdad

Iran's postrevolutionary economic conditions. I argue that Iran, as an oilexporting economy,12 is heavily dependent on imports of industrial inputs, whereas the possibilities for any major expansion of its non-oil export earnings within the existing economic structure are severely limited. A general devaluation, unless accompanied by a comprehensive economic plan aiming to overhaul the existing industrial structure, will do little to increase the country's exchange earnings, but can cause serious interruptions in industrial activities. Because the IRI has come to commit itself to the revitalization of the existing industrial structure, it finds itself committed also to maintaining an overvalued rial to provide the inflow of "cheap" industrial inputs, which constitute the most significant portion of Iran's import bill. Contrary to Lautenschlager's claim, Iran's industries have lost little of their market share to cheap imports. Although the demand for imported consumer goods has increased in the postrevolutionary period due to interruptions in domestic production and changes in the distribution of national expenditures and the structure of demand, quantitative import restrictions have prevented imports from making up for the domestic supply shortages. I also maintain that because of the high black-market prices for many imported products, the burden of the external adjustment of a general devaluation will merely fall upon those who receive the imported goods at their official prices: mainly the protected large manufacturing establishments (public or private) and some consumers of certain politically sensitive items of mass consumption. Therefore a devaluation is most effective in achieving external equilibrium exactly where the IRI finds its effects, for economic or political reasons, least desirable. The IRI may continue to devalue the rial within the present system of multiple exchange rates in order to increase government revenues, to achieve limited reductions in imports of consumer goods, and to boost exports. The IRI would not, however, want to close the foreign exchange gap fully by devaluation and/or import restrictions, for fear both of a negative impact on Iranian industries and of intense public discontent. In the absence of a significant increase in oil revenues, external financing remains the only possible alternative. As unpatriotic and reproachable as the IRI viewed foreign borrowing only a few years ago, overtures are being made toward external financing of Iran's import bill. In this article I will analyze the elements contributing to the present foreign exchange problem of Iran, and the effects of a devalution on the various segments of supply and demand for foreign exchange in the context of the political economy of the postrevolutionary Iran. The structure of Iranian exports is presented in Section 1, the demand for import of consumer goods in Section 2, and the demand for import of producer goods in Section 3. In Section 4 transfer payments and capital flight from Iran are discussed. Finally, conclusions of the analysis and implications of the present conditions are discussed in Section 5.
1. OIL AND OTHER EXPORTS OF IRAN

In every year in the past decade, income from oil exports has constituted at least 95 percent of the Iranian export earnings (Table 1). The volume of oil

Foreign Exchange Gap in Iran

TABLE 1.

Major Sources of Foreign Exchange Receipts and

Payments (1977-1983)a
1977 Receipts Oil exports Non-oil exports Services Payments Imports Consumer goods Primary and intermediate goods Capital goods Nonclassified imports (mostly defense related) Servicesh Private Government 23.5 0.52 4.5 18.9 (2.7) (7.9) (4.0) (4.3) 7.9 (5.0) (2.6) 1978 15.6 0.54 4.2 13.8 (2.1) (5.3) (2.9) (3.5) 7.7 (4.8) (2.3) 1979 24.2 0.81 2.8 10.0 (2.6) (5.3) (1.8) (0.3) 5.0 (3.5) (0.7) 1980 11.6 0.65 1.4 13.4 (2.9) (6.2) (1.7) (2.6) 3.1 (1.9) (0.8) 1981 10.6 0.34 1.5 15.5 (3.1) (8.2) (2.1) (2.1) 1.7 (0.8) (0.6) 1982 21.8 0.28 1.1 14.3 (2.7) (6.9) (2.3) (2.4) 1.5 (0.5) (0.8) 1983 21.2 0.36 1.3 20.6 (2.9) (10.8) (4.3) (2.6) 1.9 (0.6) (1.1)

aAll figures are in billions of current U.S. dollars and are from Balance of Payment Tables of Bank Markazi, except figures for "service payments," which are from Balance of Exchange Transactions of Bank Markazi. The line, "service payments of private sector," for 1977 is revised in the 1978 (1357) issue of Economic Report (cited below) from $3.9 billion reported in the 1977 issue of the same publication. The figure for total service payments is changed accordingly. Here the revised figures are reported. bParts do not add up to the total because interest payments are not included. Source: Bank Markazi, Economic Report and Balance Sheet (Gozaresh-e eqtesadi va taraznameh-e sal-e .. ), various issues.

exports and the resulting foreign-exchange income are independent of the exchange rate for the Iranian currency, mainly because the export price of petroleum does not reflect the production cost and price of petroleum in the Iranian market. Therefore, a change in the exchange rate of the rial will not have any effect on the 95 percent of Iran's foreign exchange earnings from oil. On the other hand, a change in the world price of petroleum and/or the volume of petroleum exports will affect the exchange earnings of Iran, and ceteris paribus, its equilibrium exchange rate. Iran has confronted serious difficulties in trying to maintain the prerevolutionary oil income flow as a result of, first, the war with Iraq that started in fall 1980, and later, the glut that appeared in the world oil market. It was only through aggressive oil price cutting-achieved in spite of OPEC's objections-that the oil revenues were brought close to the 1977 level in 1982 and 1983. In nominal terms, between 1978 and 1983 the total loss in oil revenues, compared to the 1977 level, has been $36 billion. If, however, a 5 percent annual increase in the dollar price of Iranian imports is assumed, the total loss is $63 billion (or a 60 percent overall decline) in the above-mentioned six years.3 The problem has been further aggravated in subsequent years, especially since 1985, by the steep decline in world oil prices and the ineffectiveness of IRI's price-cutting policy. Official figures for the Iranian oil revenues in 1984 and 1985 are not available, but they are unlikely to reach much beyond the $10 billion

Sohrab Behdad

level. In 1986 oil revenues are expected to fall even lower. That is a decline of about $15 billion from the 1977 level and $8 to $9 billion from the average for the 1978-1983 period (only in nominal terms). Because the oil export earnings are completely unaffected by a devaluation, what becomes relevant on the exchange-earning side are the potential effects of a devaluation on the non-oil export earnings of Iran. Non-oil exports (including hand-woven rugs, minerals, fruits and nuts, hides, and a number of manufactured goods exported according to bilateral trade agreements) have made up less than 5 percent of Iranian exports in the past decade (Table 1).14 A devaluation can cause an increase in the volume of non-oil exports because the price of these exports for foreign buyers will be reduced and each dollar earned by the exporters will fetch a larger amount of the domestic currency.15 The effect, however, will be a one-shot affair, although the increase may take place in the long run. That is, further increases in exports will require, ceteris paribus, further devaluations. The extent of improvements in the exchange earnings will depend on (a) the price elasticity of foreign demand for Iran's exports (this must be larger than one), and (b) the elasticity of domestic supply (the less elastic the supply the smaller the improvement). Although Iran's non-oil exports as a whole appear to have an elastic foreign demand, trade barriers of the OECD countries, the main potential markets for the primary export products of Iran, place serious limits upon the expansion of Iran's non-oil exports. The recent antidumping decision of the United States International Trade Commission against the exports of Iranian pistachio nuts is a clear case in point.16 Moreover, the structural constraints and the recent bottlenecks due to continuing interruptions in the production process, shortage of imported intermediate and capital goods, and war mobilization have set serious limits on the expansion of exports. Once the existing underutilized capacities in exporting activities are surpassed and the export level reaches its prerevolutionary level (about $0.5 billion in 1977), further expansion may be achieved by repeated devaluations. This is so because expansion of non-oil exports will be accompanied by sharp increases in the domestic price of export products17unless measures are implemented to increase productivity in these activities. Even if we assume a substantial expansion of non-oil exports in the existing conditions and an increase in their exchange earnings as the definite result of a devaluation, the overall effect on the foreign exchange gap of Iran is small or even negligible. A 100 percent increase in the value of non-oil exports from the 1983 level will bring the exchange earnings from these exports to only $0.7 billion. That is no more than 4.7 percent of a $15 billion import bill (average for 1978-1983). The IRI, since 1982, has devalued the Iranian rial within a system of multiple exchange rates in an effort to stimulate exports. Moreover, in an interesting confrontation between the export merchants (many from the bazaar) and the Central Bank (Bank Markazi) on the terrain of Islamic jurisprudence, the Central Bank liberalized its exchange controls on the foreign currency earnings of exporters.'8 The 1986 Export-Import Law provides for rates in excess of the

Foreign Exchange Gap in Iran

already established "preferential exchange rates" for non-oil export earnings. In addition, the exporters have the option of selling their foreign currency earnings to importers.19It is evident that the sale of foreign exchange by exporters takes place at the market exchange rate, implying a partial devaluation amounting to no less than a 300 percent increase in the value of foreign currency for many exporters.20 Although many exporters have been making handsome profits, the effect on the foreign exchange gap of Iran has not been significant. In the first nine months of 1985, Iranian non-oil exports increased 99 percent in volume and only 26 percent in foreign exchange value.2' That is only approximately a $0.1 billion dollar increase for the whole year. With further devaluation of the rial for exporters, the value of non-oil exports is expected to increase for 1986. However, it is doubtful that it can exceed much beyond the $1 billion mark.22 To complete the review of the exchange earnings of Iran, income from "services" must also be considered.23 The most important items in this category used to be tourism and interest earnings from foreign assets. The former declined sharply as the flow of European and American tourists to Iran came to a halt after the revolution. Interest earnings reached a peak of $1.2 billion in 1979 and have continued to fall in subsequent years as foreign assets have been depleted.24 Another source of Iran's exchange earning is the repatriated earnings of Iranian workers in Persian Gulf countries. The most substantial segments of these earnings have entered the black market for foreign currency. Moreover, because of the political reservation of the Persian Gulf countries about hosting Iranian workers and the general decline in employment in these countries resulting from the oil glut, the number, and thus the earnings, of these workers have declined in recent years.25 In sum, with the predominant position of oil exports in the foreign currency earnings of Iran, there is only limited potential in closing the foreign exchange gap from the export side. A devaluation, which in fact has taken place by providing preferential rates of exchange for exporters and allowing them to sell their export earnings to importers at a premium, has had only minor effects in the attempt to narrow the gap.
2. PRODUCTION, CONSUMPTION, AND IMPORTS OF CONSUMER GOODS

By 1981 the imports of consumer goods and primary and intermediate products to Iran had increased 6.6 percent from the prerevolutionary level (Table 1), while gross national income had fallen 24 percent in the same period.26 Lautenschlager points to this as an anomaly27because imports are expected to rise and fall with the rise and fall of national income. One factor that might explain this anomaly, according to Lautenschlager, is the overvalued exchange rate that has made imports exceptionally more attractive than their domestic alternatives. If this is true, then the Iranian industries must have suffered from competition of "cheap" imports. In the words of Lautenschlager: Much attentionwas given in the U.S. in 1984to the damagingeffectsof a high dollar on than the dollar,has had a the U.S. industry; rial,whichis muchmoreseverelyovervalued

Sohrab Behdad
TABLE2.

Rates of Growth of National Output and Industrial Productiona

Total 1977 b. rials

1977 2.7 4.6 -1.7 11.9

1978 -18.6 -7.2 -15.2 -14.3

1979 5.4 4.8 -9.2 -0.5

1980 -13.5 -2.8 1.6 -6.3

1981 2.4 5.7 2.7 13.2

1982 15.1 6.2 10.5 14.2

1983 13.6 14.8 15.6 12.5

1984 - 1.7 2.8 3.2h 18.3

Gross national income 3934 Non-oil gross domestic product 2380 Value added in industry and mining' 592 Production in large manufacturing unitsd 410

aln constant prices (1974=100). bPreliminaryestimates. CExludingpetroleum. dEstablishments with 50 or more workers. There were 1,238 such manufacturing establishments in 1984. Source: Bank Markazi, Economic Report, various issues; "Preliminary Estimates of National Production and Expenditures in 1984 (Baravardha-ye avvali-ye tulid va hazineh-ye melli-ye keshvar dar sal-e 1363)," mimeographed (n.d.), and "National Survey of Large Manufacturing Establishments in 1983 (Natayej-e barresi-ye kargaha-ye bozorg-e san'ati-ve keshvar dar sal-e 1362)," mimeographed (November/December 1984-Azar, 1363) and the same publication for 1984-1363 (November/ December 1985).

proportionately stronger impact on Iranian industry. While Iran's inflation of 20 percent or more per annum has raised the price of goods made in Iran, the price of imported goods has been depressed by the official exchange rate, which has changed less than 5 28 percent per year.2

Consideration of the internal economic conditions of Iran, however, will

reveal that the "anomaly," to the extent that it is related to the demand for

imports of consumer goods, is caused by the decline in output and changes in the
distribution of expenditures and the structure of consumption demand. Furthermore, the consumer good industries have not lost their market shares to "cheap" imports because the increase in import demand has not resulted in an increase in imports. The share of consumption expenditures in the national expenditures of Iran increased sharply during the revolution and in subsequent years. This increase coincided with a decline in national output and in the production of industrial products. This trend, which was most pronounced until 1981, resulted in a substantial increase in demand for imported consumer goods. In 1978, during the revolutionary turmoil, gross national income declined 18.6 percent. Value added by industry and mining fell 15.2 percent and the output of large manufacturing establishments (with 50 workers or more) dropped 14.3 percent (Table 2). (All figures except for foreign transactions are in constant prices.) In the same year, however, personal consumption expenditures increased 6.8 percent (Table 3) as the salaries of government employees were augmented. The growth of personal consumption expenditures in the face of reduction in

Foreign Exchange Gap in Iran

TABLE3.

The Rate of Growth and the Share of Some Major Items of National Expendituresa
Total 1977 b. rials

1977

1978

1979

1980

1981

1982

1983

1984h

Private consumption expenditures Share in total Government consumption expenditure Share in total Gross domestic fixed capital formation Share in total Machinery

1684

14.4 (50.3)

6.8 (56.2)

-14.9 (45.3)

-4.3 (55.4)

6.1 (57.9)

6.1 (53.3)

9.9 (51.8)

2.4 (52.9)

836

-1.3 (20.8)

2.3 (26.7)

-16.9 (21.1)

-8.8 (22.0)

4.6 (22.7)

-3.8 (18.9)

-2.0 (16.4)

-4.2 (15.7)

1083

3.4 (23.4)

-20.8 (26.8) -34.4

-27.4 (18.5) 29.2

-3.8 (21.0) -22.6

1.6 (21.0) 51.9

9.9 (20.1) 11.0

39.0 (24.6) 73.4

-10.5 (22.0) -5.7

428

4.5

aln constant prices (1974= 100). bPreliminaryestimates. Sources: Bank Markazi, Economic Report, various issues; and "Preliminary Estimates... (1363)."

for 1984

national income was offset by a decline in capital formation (20.8 percent in 1978; see Table 3) and the stock of inventories (by about one quarter of the private consumption expenditures in 1978).29 In the following years, the increase in the legal minimum wage and the minimum salary of civil servants contributed to the growth of the share of personal consumption expenditures in the national expenditures. By 1981, this share had increased to 57.9 percent from 50.3 percent in 1977 (Table 3). This trend was accompanied with an improvement in income inequality,30 which raised the demand for certain articles of mass consumption. To the increase in demand for consumer goods the effects of the war on the consumption expenditures of the government must also be added. Although government consumption expenditures have declined almost continually in the postrevolutionary period (Table 3), it is expected that as a result of the war with Iraq the government demand for many items of mass consumption has increased. Production, however, was seriously hampered in the initial postrevolutionary years. By 1981, the gross national income was still 23.8 percent less than the 1977 value, whereas personal consumption expenditures had only declined 8.1 percent. Also taking into account the effects of the change in the distribution of household incomes and in the composition of government expenditures, an acute

Sohrab Behdad

shortage of mass consumption items is to be expected. As the government attempted to control prices, the black market appeared. In spite of the pricecontrol efforts of the government, the official consumer price index (with a tendency to underestimate black market prices) indicates a threefold increase (20 percent annually) between 1977 and 1984.3' With shortages and the rapid increase in the price of domestic products, increase in demand for imports is inevitable but is not necessarily followed by increased imports if quantitative import restrictions exist. The figures in Table I show that between 1978 and 1983, imports of consumer goods fluctuated around the 1977 level. In fact, the value of consumer good imports, averaged over that five-year period, is exactly equal to the 1977 value. Again, if we assume a 5 percent price increase for imports, the real value of imports during that time, on the average, is for each year 15.7 percent less than the last prerevolutionary year. That is, even if domestic shortages had not developed, maintaining the nominal value of consumer good imports at the 1977 level would have caused an excess demand for these imports. It is clear that with the shortages in the domestic market, this excess demand has been even greater. The black market and the remarkably high price of imported consumer goods (relative to 1977) in the black market are the obvious indications of the excess demand, which reflects the existence of the potential market for the import-competing domestic industries. Therefore, the argument that Iranian industries have lost their market share to "cheap" imports does not hold. This argument would have been true if the consumption expenditure had fallen at a higher rate than production, while the imports had remained at a relatively constant level. It would have also been true if there were no significant import restrictions or foreign exchange constraints and the import flow had offset the decline of domestic output. But the postrevolutionary conditions in the Iranian economy do not come close to either situation. As long as there are effective quantitative restrictions, no matter what the exchange rate is, domestic industries enjoy a protected market. The extent of protection is determined by the restrictiveness of import barriers. The existence of shortages for the goods produced by domestic industries, their 20 percent average annual price increase, and the decline of the real value of imports from 1978 to 1983, all indicate that the loss of market share has not been one of the difficulties of the Iranian industries. The extent of the black market for imports and the very high prices in this market reflect the scarcity of imported products, as well as the ineffectiveness of the price control policy of the government. Because not all categories of imported consumer goods have confronted the same degree of import restrictions some industries have enjoyed more protection than others. The existence of black markets for almost all imported goods, and black market prices much higher than official prices (which are set higher than the official exchange rate would indicate) make it difficult to accept the "cheap" import argument for consumer good industries. On the contrary, the added quantitative import restrictions have, if anything, increased the protection of domestic industries and caused the price of the imported competing products to

Foreign Exchange Gap in Iran

increase beyond the level solely determined by internally induced market conditions. Whether or not the merchants benefit from the black market for imports is irrelevant to the market share issue. "Who benefits from the black market for the domestic products?" is, however, a theoretically relevant question. If the "[i]ndustrialists have more difficulty taking advantage of the black market than do merchants," as Lautenschlager argues,32 then most of the resulting benefits of the protection of domestic industries occur at circulation and not production of the commodities. However, the empirical validity of this assertion is questionable. Price control has been effectively imposed on goods produced by establishments under government ownership or management. Price control for the goods produced by private concerns has proven ineffective and, in most cases, has been abandoned. Moreover, Lautenschlager's assertion implies an assumption of high inflexibility of industrial capital and lack of common sense (not even ingenuity) on the part of industrialists to expand the sphere of their activity to control distribution as well. Iranian industries have faced two basic difficulties, unrelated to the competition of imports and the price control policy of the government: (1) the lack of security for capital and (2) the short supply of imported inputs, initially caused by an interruption in the relationship with Western economies and their multinational corporations, and later by the foreign exchange gap confronting the IRI. Continued uncertain political conditions, stemming from the inability of the political regime to resolve its internal crisis and to take an unequivocal position on protection of property rights, has jeopardized the position of capital. This has affected the activity of capital in the manufacturing sector most seriously. At the same time, this condition has provided an almost unprecedented possibility, not only for the merchants, but also for the industrialists who have established a close political alliance with the Islamic Republic to receive its protection and the valuable entitlements that it distributes. The market share issue aside, the widening foreign exchange gap requires some measures to reduce the import bill. Devaluation can be effective in reducing the import bill only to the extent that it results in an increase in the domestic price of imports. With the extensive black market for almost every imported consumer product, and nonofficial prices reflecting an implicit exchange rate 700 to 900 percent higher than the official rate, a devaluation that would bring the exchange rate to a level near these inflated rates will be effective only in eliminating or reducing the demand of those who manage to consume the imported products at their official prices. However, because a number of imported consumer goods (mostly food items) and a segment of the market that receives these goods at the official prices are considered politically sensitive, it is expected that a devaluation of the rial for consumer goods be limited to "nonessential" items, as defined by the IRI, and then only to a rate lower than those currently existing. (Such high rates of devaluation are simply shocking to the public.) Thus, partial devaluation will have little effect on the foreign exchange payments for consumer goods, yet it will have a significant positive effect on government revenues from sales of foreign exchange.33 This increase in government revenues is no more than a transfer of a portion of the windfall gain

10

Sohrab Behdad

of import merchants to government coffers. Given the huge budget deficit, this is a practical possibility, in spite of the close alliance of the regime with import merchants. Further quantitative import restrictions will, however, continue to be the main policy tool that the government uses to reduce the import bill because they are flexible and can be applied more discriminately to various products destined for different consumer markets.
3. IMPORT DEPENDENCE AND IMPORTS OF PRODUCER GOODS

The weak interindustry linkages in the Iranian economy34reflect the economy's dependence on imported industrial inputs. This dependence is more pronounced for the modern manufacturing industries than for the rest of the economy. These industries have been developed primarily by the multinational corporations and are integrated into their international network, with few linkages in the Iranian economy.35 The import dependence of the Iranian economy and its industries increased continually from the early 1960s to the mid-1970s. The following estimates reflect this trend:36Each 100 rials of the non-oil gross domestic product (GDP) produced between 1963 and 1967 required, on the average, 4.6 rials of imported capital and 10.4 rials of imported primary and intermediate inputs. These figures increased, respectively, to 5.5. rials and 13.3 rials in 1968-1972, and to 8.4 rials and 16.8 rials in 1973-1977. Taking into account the fact that the largest share of these imports (about 80 percent of the primary and intermediate inputs) was used by the industrial sector (no more than 30 percent of the non-oil GDP), the import dependence of Iranian industries becomes even more evident. The import dependence of the economy has not been reduced in the postrevolutionary period. The primary and intermediate import requirements for each 100 rials of the non-oil GDP and the value added in manufacturing are estimated for 1977-1983 (Table 4). Notwithstanding the fluctuations due to irregularities in the flow of imports in these years, the estimates show a trend toward the 1977 import requirement ratios after an initial drop in these ratios in 1978. The low ratios for 1978-1980 may be explained by the sharp decline in the industrial value added and in the value of output in the large manufacturing TABLE 4. Dependence of the Economy and the Manufacturing Sector on Imported Primary and Intermediate Inputs
1977 0.33 1.76 1978 0.23 1.38 1979 0.23 1.55 1980 0.28 1.42 1981 0.35 1.79 1982 0.27 1.37 1983 0.37 1.81

Dollar value of imported inputs Per 100 rials of non-oil GDPa Per 100 rials of manufacturing value addedh

aValue of imported primary and intermediate goods (in current U.S. dollars) is divided by the non-oil gross domestic product (in constant rials, 1974= 100). hValue of imported primary and intermediate goods used for manufacturing and mining (in current U.S. dollars) is divided by value added in manufacturing (in constant rials). Source: Bank Markazi, Economic Report, various issues.

Foreign Exchange Gap in Iran

TABLE

11

5. Share of Imported Primary Inputs in Total Inputs and Output of Large Manufacturing Establishmentsa (1983)
Activity Share in total inputs (%) 31.3 47.4 26.8 58.0 69.6 25.3 71.5
69.9h

Share in total output (%) 20.0 22.2 11.6 30.1 35.9 6.3 52.5 37.5 19.2 28.2

Food, beverages, and tobacco Textile, clothing, and leather Wood and wood products Paper, cardboards, printing Chemicals Nonmetalic products (excluding oil and coal products) Basic metal industries Machine tool, tools, and metal products Miscellaneous Total

45.1 54.0

aEstablishments with ten or more workers. There were 6,938 such manufacturing establishments in 1983. hThis figure was misprinted in the source for this table. The correction is found in the National Statistical Yearbook 1984 (Salnameh-ye amari-ye keshvar, 1363), published by the Statistical Center of Iran (1985/1364), p. 499. Source: Statistical Center of Iran (Markaz-e Amar-e Iran), Large Manufacturing Establishments' Statistics, Results of the 1984 Survey (Amar-e kargaha-ye baozorg-e san'ati, montaj az amargiri-ye sal-e 1363), (February/March 1985-Esfand 1363), p. 7.

establishments (Table 2). These ratios started to increase substantially from 1981 when production in the industrial sector, especially in the large manufacturing establishments, gained momentum. Thus, between 1980 and 1983, when non-oil GDP increased 29.0 percent and manufacturing value added 42.8 percent,37 imports of primary and intermediate products had to increase by 74 percent
(Table 1).38

Recent statistics published by the IRI show the extent of the import dependence of the "large" (with ten or more workers) manufacturing establishments (Table 5). Imported primary products accounted for 54 percent of total inputs of these establishments in 1983. For chemicals and basic metal industries, these shares were, respectively, 69.7 percent and 71.5 percent. Similarly, imported inputs constitute a large share of the output value, 28.2 percent for all "large" industries. The import of capital goods conforms closely with the rate of capital formation in machinery. The import of capital goods doubled between 1981 and 1983 (Table 1) as investment in machinery by the private sector and government increased, respectively, by 152 percent and 52 percent.39 The pattern of change in the imports of primary and intermediate products and capital goods thus coincides with the pattern of change in the level of output. When the fundamentalists in the IRI gained full control in the political regime by ousting the rival groups and succeeded in containing the revolutionary movement in 1981, the trend toward economic recovery and revitalization of the

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Sohrab Behdad

economic structure began. Contracts with the multinational corporations were renewed or reinstated. Some de facto guarantees were extended to protect property rights and the activity of capital, and revolutionary rhetoric was noticeably toned down. With increasing production since 1981, imports of producer goods have increased despite foreign exchange constraints and physical limitations arising from the war. It can be concluded, therefore, that the Iranian industries, in general, and large manufacturing enterprises, in particular, were not in the least hurt by imports. The overvalued rial has provided cheap inputs for industries while quantitative import restrictions on final products have added to the already high tariff barriers40that promoted the establishment and growth of the large, modern manufacturing industries between the 1960s and the mid 1970s. These industries have received generous exchange quotas and import licenses in the postrevolutionary period. Many of these enterprises are under "public management": 14.2 percent of manufacturing enterprises with ten or more workers, producing 70.9 percent of the total value added of these enterprises in 1983.4' The survival of the "publically managed" enterprises under the price control policy of the government depends on the continuation of the present exchange rate policy because direct subsidies to these enterprises will be strongly opposed by the powerful laissez faire faction of the IRI. On the other hand, the large privately owned manufacturing enterprises, which manage to buy their imported inputs at the official exchange rate and to sell their products at continually higher prices, are in the most privileged position. The small industries, deprived of the advantages enjoyed by the large establishments prior to the revolution, are again unable to receive these benefits, as well as the now valuable exchange quotas and import licenses. A devaluation in the order of magnitude required to cause any considerable reduction in the foreign exchange gap would put much of the large manufacturing enterprises (producing 86 percent of the output of the manufacturing sector)42 out of production. The resulting increase in production cost and the fall in output in the large manufacturing activities would cause a drastic increase in prices of these products and in the rate of inflation. In the absence of a plan to modify the industrial structure, it is highly improbable that the IRI will implement a general devaluation of the rial, but it is rather to be expected that the present exchange rate for this portion of imports (73.3 percent of the import bill in 1983) will be maintained while some further quantitative import restrictions are imposed. This will result in further deprivation of small industries. "Nonclassified imports" (Table 1) are imports not subject to customs inspection. They are primarily defense-related products. These imports (12.6 percent of the 1983 import bill) are paid for by the government. Devaluation will have little effect on the amount of these imports, as the government is the main recipient of foreign exchange earnings and its demand for these imports is insensitive to their rial prices. With the continuation of the war with Iraq, this portion of the foreign exchange payments is not expected to fall. It may even increase if the IRI can find new suppliers of arms.

Foreign Exchange Gap in Iran

TABLE

13

6.

Payments for Services and Unilateral Transfers in the Balance of Paymentsa

1973 1977 626 1,897 680 2,281 1,420 6,904b 125 1978 100 1,649 780 2,264 3,095 7,888 15 1979 95 2,934 798 724 439 4,990 15 1980 60 1,700 398 823 87 3,068 2 1981 44 681 275 635 78 1,713 1982 38 400 227 761 70 1,496 1983 100 .464 184 1,062 71 1,881 68 240 671 310 64

Transportation Travel Investment profits Other services (government) Other services (private) Total Unilateral transfers

1,353 6

aIn millions of U.S. dollars. bThe difference between this and the corresponding figure in Table 1 is due to the revision referred to in the note to that table. The revised Balance of Payment Table is not available. Source: Bank Markazi, Economic Report, various issues.

4. TRANSFER PAYMENTS AND CAPITAL FLIGHT

An analysis of the foreign exchange market in Iran cannot be concluded without appropriate consideration of transfer payments and capital flight. These payments were disguised in the "service" items of balance of payments in the prerevolutionary years (Table 6). In more recent years, the foreign exchange demand for these payments makes up the most important part of the demand in the foreign currency black market.43 Generally, postrevolutionary capital flight diminishes after an initial surge in the midst of revolutionary confrontations and immediately following establishment of the new regime. The Islamic Republic has had the distinctive feature of continually alienating segments of the urban middle class on cultural, social, and religious grounds. This alienation, the continuation of the war, and the high rate of unemployment among intelligentsia and professionals have caused a continuing wave of emigration from Iran, accompanied by the outflow of assets. Therefore, the demand for foreign currency to transfer wealth abroad has not yet subsided and appears to continue, although at a lower rate than the initial surge of capital flight. The most important element of transfer payments is the living expenses of students and the expatriated Iranians without a foreign source of income. The flow of students abroad was reduced sharply after the revolution, once the IRI put stringent limits on sales of foreign exchange at the official rate for this purpose. Similarly, some expatriated Iranians returned to Iran because living abroad was becoming exceedingly expensive with the foreign currency price soaring in the black market. Many, however, have continued to liquidate and transfer their income-earning assets (mainly real estate). Those who do not want to take the risk of returning to Iran to liquidate their assets (the presence of the

14

Sohrab Behdad

owner is required by law for any large legal transaction) continue to receive income from Iran. On the other hand, the draft-evading young males (ages ten through eighteen) or upper-middle-class families, and those who have migrated to escape political repression in the past several years, have partially made up for the decline in the number of Iranians who receive their living cost fully or in part from Iran. The amount of official exchange provided by the government for these purposes has continually declined.44A substantial portion of these transfer payments are sent abroad through the nonofficial foreign exchange market. Foreign currency demand for these purposes has been the major determinant of the black market exchange rate, which has in turn affected the black market price of imported goods. Devaluation of the rial, to the extent that the official rate comes close to the black market rate, would have no effect in reducing these payments. In fact, if anything, the demand may increase as the risks and limitations of transacting in a black market are eliminated. A devaluation can, however, increase government revenues from selling foreign exchange for these and other purposes. The partial legalization of these transactions, allowing owners of foreign currency to sell their holdings in their Central Bank account at the market rate,45has brought such a profit for the owners of these accountsforeign trade merchants and others, who somehow manage to earn foreign currency from "sources abroad." Such gains can be appropriated by the government through a partial devaluation, increasing the price of foreign exchange for these purposes. Given that the expatriated Iranians, those who transfer their capital or wealth abroad, and the travelers to Europe and the United States (the main destinations of Iranian tourists) are the villains of the IRI, imposition of a higher exchange rate on them does not raise any concern in the regime. The difficulty, however, in the eyes of the IRI is in the legitimization of the capital and wealth transfers, and transfer payments for expatriated Iranians. Yet, it is highly probable that steps will be taken toward legalizing these exchange transfers while charging higher prices for foreign currency. Nevertheless, little decline in this segment of demand for foreign exchange can be expected for some years to come.
5. CONCLUSIONS AND IMPLICATIONS

The Iranian industries have not lost any market share to cheap imports and thus have not been hurt by the exchange rate policies of the IRI. The large, modern industries have, in fact, been the major beneficiary of the current exchange allocation system. The stringent import-licensing practices of the government have amounted to furthering the protection that these industries enjoyed during the Shah's rule. The policy that promotes industries with heavy dependence on imported inputs requires the maintenance of a continuous inflow of cheap imports. The Shah's industrial policy owed its "miraculous" achievements to the continual increase in the oil revenues that made increased inflow of imported inputs possible. The IRI has come to revitalize the same industrial structure,46only in a world confronted with a glutted oil market.

Foreign Exchange Gap in Iran

15

The unfavorable conditions in the world oil market have, however, turned into a blessing for the privileged industrialists in the IRI. The large manufacturing establishments have received generous exchange quotas to import their needed industrial inputs at the official exchange rate and to sell their products at continually higher prices. Small industries, unable to receive exchange quotas, must acquire their inputs from black markets. This was the lot of small industries in the Shah's period, too. The privileged industrialists have been, therefore, in a no less favorable position than that of the privileged merchants. The "privileged" are those whose property rights are protected and who receive valuable entitlements distributed by the regime. In the capitalist democracies protection of property rights is enjoyed by all property owners, in general, and the capitalist class, in particular, but the distribution of entitlements is a matter of conflict between different strata of capital and individual capitalists. In the dictatorial capitalist regimes, however, protection of property rights becomes less indisputable and distribution of entitlements less institutionalized and less subtle. These features are even more pronounced in the IRI. Although the regime has come to a de facto acceptance of industrial property rights, those who have closer alliance with the regime enjoy firmer protection of their property rights than others. The foreign exchange gap of recent years has added the foreign currency allocations to the myriad of entitlements that the regime distributes. The battles that the industrialists fought in the Ministry of Industries and Mining during the rule of the Shah to receive licenses for protective tariffs, tax holidays, and soft loans now have been extended to the various centers of distribution of import licenses and exchange quotas. It is, no doubt, too simplistic to consider the economic policies of the IRI merchant-pleasing, even though the Islamic movement in Iran has been nurtured and financed by the bazaar merchants. The imperatives of ruling a capitalist state necessitate formation of class alliances between the IRI and the industrialists, in spite of the original merchant mentality of the regime's leaders. The so-called antitechnocratic position of the regime is also a false perception on the part of those who continue to evaluate the IRI on the basis of its initial populist proclamations. On the contrary, the regime has found it difficult to conceal its fascination for the abilities of technocrats, westernized or otherwise.47A number of high-ranking positions, even at the cabinet level, have been held by westernized technocrats par excellence. On the other hand, bazaar merchants have not sworn to remain merchants. They are men of profit and much of their dissatisfaction with the Shah's regime reflected their inability to enter the fiefdom of large modern industries.48 The Islamic Republic has provided them with the opportunity they longed for, and they certainly are taking advantage of it. Some have already made advances in extending their activity into the industrial sector. Many others are struggling to make similar moves.49 The clamor for denationalization of industries is heard more clearly these days in the bazaar of Tehran than anywhere else. The IRI has few options to reduce its widening foreign exchange gap. A general devaluation, as attractive as it appears in the textbook model of exchange

16

Sohrab Behdad

rate determination, is not an effective instrument in the case of an oil-exporting country with a heavily import-dependent industrial sector. Devaluation will do little to increase foreign currency earnings, given the very small share of the non-oil exports in the exchange earnings of the country. The potential of the non-oil exports is limited by the internal structural constraints and trade barriers in the export markets. Prices in the black market for consumer goods are exceedingly high for a devaluation within a conceivable range to have any considerable effect in reducing the demand for these products and thus for foreign currency needed to import them. A general devaluation will reduce the demand only for that portion of the imported goods that are purchased by final consumers at, or near, the official prices. This share is not only relatively small in the total import bill, but it also encompasses products and consumers of strategic importance to the IRI. With imported consumer goods making up only 14 percent of the total import bill, a 50 percent reduction in the value of these imports will be equal to a saving of no more than 7 percent in Iran's total foreign currency payments. The remaining portion of foreign exchange payments is for purposes that the IRI has no intention of putting in jeopardy. With continuation of the war, the imports of defense-related products will not be reduced. The most substantial portion of Iran's payments is for imports of producer goods. Even a slight devaluation, which in Iran's present condition is in the magnitude of a 100 or 200 percent increase in the value of foreign currency, will have a devastating effect on the large modern industries of Iran, and is, therefore, totally out of the question. One major reason that the presumed equilibrium exchange rate is far above the official rate is the large outflow of transfer payments and capital flight that is supplied from nonofficial sources. With the foreign currency price nearly ten times the official rate in this market, profit-seeking merchants and industrialists will continue to supply the foreign currency demanded. The effect is that an amount nearly equal to the size of this outflow is siphoned off by various schemes from the exchange earnings of the country and thus not available for covering the official foreign currency payments. Therefore, a general devaluation provides little attraction and only grave consequences for the IRI. Only further partial devaluation of the rial within the multiple exchange rate system, which the IRI devised soon after the revolution (not unlike that of many other countries), is what may be expected. The rial may be devalued for some categories of foreign currency payments. The existing categories may be expanded to allow for finer discrimination of payments and to include some that were not considered authorized in the past. A high foreign currency price for imports of "luxury" goods (with more goods falling into this category) and for travelers is to be expected. It is also highly probable that certain types of transfer payments and wealth transfers will be included in the official categories. Continually higher prices will be offered for the exchange earnings of exporters as an incentive to boost exports. With the exception of the latter measure, which will have a minor effect on reducing the foreign exchange gap, other measures can only increase government revenues without diminishing the foreign exchange gap.

Foreign Exchange Gap in Iran

17

Further quantitative restrictions will be applied to imports. Thus, the scramble for receiving import licenses and exchange quotas will intensify as these entitlements can bring higher windfall gains for the fewer privileged capitalists (merchants or industrialists) who receive them. These further restrictions will accelerate the process of oligopolistic formation that commenced in the postrevolutionary period and is replacing the oligopolistic structure that was formed between the 1960s and mid 1970s and became dysfunctional in the 1979 revolution. It is the specter of exclusion from this circle of privileged capitalists, particularly for those who have looser ties with the regime, that has generated an uproar among the merchants and industrialists in the past few months. Statements of Ayatollah Khomeini50and Ayatollah Montazeri5s addressed the issue in an effort to mediate in this confrontation with the slogan "Let Everyone Participate." If the position of the oil-exporting countries in the world oil market does not improve, external financing appears to be the only alternative available to the IRI. This is, however, a highly sensitive issue in Iranian politics. Borrowing from abroad is a severe blow to the political posture that the IRI has attempted to maintain. It is all the more so when the potential lenders are those whom the regime has put in the "satanic"category.52 The IRI has, however, revealed its exceptional flexibility in acceptance of pragmatic solutions. This latest dilemma will, nevertheless, have two important implications. First, in the domestic arena, external financing of the foreign exchange gap will be considered a victory for proponents of the free market (versus state control) within the regime. It will be counted as a reflection of the failure of the government to manage a large (much larger than in the Shah's period) segment of the economy and its control over many facets of the economic life. "Let Everyone Participate" has already transpired into what may be called Laissez Faire, Laissez Participer. Second, in the international arena, foreign borrowing will necessitate a substantial toning down of the belligerent foreign policy position of the IRI as well as some guarantee of progress toward a free market condition in the internal economy. Proponents of a free market in the regime are aware of the latter condition for borrowing and will not lose their chance to capitalize on it. The widening foreign exchange gap and the existing economic and political constraints are, therefore, ushering the IRI toward a new phase in the transformation of its politics. The recent rapprochement with France and the revealed secret arms deal with the United States are indications of IRI's new diplomatic disposition. Further acceptance of the free market relations in the domestic economy will be another important outcome of the present phase in the transformation of the postrevolutionary politics of Iran. The IRI is rapidly approaching the path of "moderation." It may come as a surprise to some observers of the Iranian political events that the coming of "moderates" to power was not the necessary condition for any of the phases in this transformation.
DEPARTMENT DENISON OF ECONOMICS

UNIVERSITY

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Sohrab Behdad

NOTES Author's note: The final version of this article was completed in May 1987. I would like to thank Richard Lucier, James Pletcher, and the anonymous referees for their helpful comments. I am responsible for the opinions and remaining errors. 'The Iranian currency, rial, is pegged to SDR (I SDR = 92.30 rials). For details of the exchange control measures in Iran, see International Monetary Fund, Exchange Arrangements & Exchange Restrictions, Annual Report 1986 (Washington, D.C., 1986), pp. 297-98. 2Although the Iranian calendar year starts on March 2, I refer to any particular year in this calendar by using the corresponding Gregorian calendar year. Thus I write, for example, 1974 for 1353 and not 1974/75, which some authors prefer. 3Some restrictive measures were applied to foreign currency transactions in the months before the fall of the Shah's regime. 41nitially the Planning and Budget Organization (now a ministry) proposed the devaluation policy in the intergovernmental debates in 1982. This view has been opposed by the Central Bank (Bank Markazi). 5Wolfgang Lautenschlager, "The Effects of an Overvalued Exchange Rate on the Iranian Economy, 1979-84," International Journal of Middle East Studies, 18, 1 (February 1986), 31-52. 6Ibid., 50. 'Ibid., 49. 8Ibid., 43. The article does not provide the basis of the suggested "one-third" potential growth in industrial output. 9Ibid., 49-50. "'Ibid., 50. '"Lautenschlager's analysis is based on a simplified version of the exchange rate determination model of international monetary theory. This model is explained in many international economics texts; see, for example, M. E. Kreinin, International Economics: A Policy Approach, fifth edition (New York: Harcourt Brace Jovanovich, 1983), chapters 3, 6, and 7. For a survey of literature and debates on balance of payments adjustments in the underdeveloped countries, see: Anne D. Krueger, Exchange-Rate Determination (New York: Cambridge University Press, 1981), chapter 8; and William R. Cline, "Economic Stabilization in Developing Countries: Theory and Stylized Facts," in John Williamson, ed., IMF Conditionality (Washington, D.C.: Institute for International Economics, 1983), pp. 175-222. Carlos F. Diaz-Alejandro's work on Colombia (with coffee as its main export) is an appropriate guide for the study of multiple exchange rates and the foreign currency problems of countries with a single important export commodity. See his Foreign Trade Regime and Economic Development in Colombia (New York: National Bureau of Economic Research, 1976). 2The oil dependence of the Iranian economy is examined in Patrick Clawson, "Capital Accumulation in Iran," in P. Nore and T. Turner, eds., Oil and Class Struggle (London: Zed Press, 1980), pp. 143-77; M. H. Pesaran, "The System of Dependent Capitalism in Pre- and Post-Revolutionary Iran," International Journal of Middle East Studies, 14, 4 (September 1982), 501-22, especially 50911; and Homa Katouzian, The Political Economy of Modern Iran, 1926-1979 (New York: New York University Press, 1981), especially pp. 242-53. '3Iran, similar to other oil exporting countries, benefited from the appreciation of the U.S. dollar prior to mid-1985. From then on, the depreciation of the U.S. dollar has accentuated the fall in the nominal price of oil by causing a decline in the real value of oil earnings. '4The sudden jump in non-oil exports in 1979 is explained by the fourfold increase in the noncommercial rug exports as a form of wealth transfer. In 1981, the IRI put a stop to the noncommercial exports of rugs. 15Forsome of the Iranian export items only the latter is true because, as a small source of supply, Iran does not affect the international price of these products. '6See United States International Trade Commission (USITC), News (July 3, 1986) and USITC, In-Shell Pistachio Nuts From Iran: Determination of the Commission in Investigation No. 731-TA287 (Final) Under the Tariff Act of 1930, Publication No. 1875 (Washington, D.C.: USITC, 1986). Between 1984 and 1985 the volume of Iran's pistachio nut exports to the United States increased by sevenfold, accompanied by a 43 percent price reduction (ibid., p. A-39).

Foreign Exchange Gap in Iran

19

7The increase in the domestic price of exports in the case of small exporting countries (which are price takers in the international market) limits the export expansion effects of a devaluation by reducing exporters' profits. For the analysis of the effects of domestic price increase on export performance in the Indonesian case, see G. Russell Kincaid, "A Test of the Efficacy of Exchange Rate Adjustments in Indonesia," IMF Staff Papers, 31, 1 (March 1984), 62-92. '8The export merchants, supported by most of the maraji'-e taqlid (sources of imitation) argued that there is no Islamic justification for the state to require exporters to surrender their exchange earnings to the Central Bank. The Central Bank gradually retreated by allowing exporters to use their export earnings for importing products (Official Notification no. T/7000 Bank Markazi, dated February 1, 1983-Bahman 12, 1361), and later, to sell them to importers (see note 19 below). Another element in this exchange-control liberalization measure was allowing the private owners of foreign exchange abroad to sell their foreign currency to importers or others at any price that they came to agree upon (Official Notification no. NA/11600/14 Bank Markazi, dated July 4, 1982-Tir 16, 1361). '9Articles 22 and 23 of the 1986 Export-Import Law, Kayhan (March 19, 1986-Esfand 28, 1364). This was the formalization of what has been taking place as an extension of the Central Bank's exchange-control liberalization for exporters. 2?Thepremium for "export foreign exchange" (arz-e saderati) fluctuated between 300 and 500 rials per dollar in 1985-1986. The official rate for the U.S. dollar has been about 80 rials. 21Kayhan(air edition, May 7, 1986-Ordibehesht 17, 1365). 22According to the latest estimate, Iran's export earnings reached 750 million dollars in 1986. Ettela'at (March 30, 1987-Farvardin 10, 1366). Iran has been negotiating to resume natural gas exports to Soviet Union, starting from "a small amount building up by 1990 to the former level of 350 billion cubic feet a year," New York Times, August 26, 1986. These revenues were 248.5 million dollars in 1978, Bank Markazi, Economic Report and Balance Sheet (Gozaresh-e eqtesadi va taraznameh) for 1978 (1357), p. 134. If potential earnings from exports of natural gas are added, the total non-oil export earnings will not exceed $1 billion. 23Capital inflows are not discussed because there has been practically no capital inflow to Iran in the postrevolutionary period, and the outflow of private capital takes place through the nonofficial market. 24SeeBank Markazi, Economic Report, various issues. 25Aneditorial in Kayhan ("Exports of Services," June 3, 1986-Khurdad 13, 1365) suggests that the "3 million unemployed" Iranian workers form a potential source of exchange earnings. According to this editorial Libya should be encouraged to "expel workers from reactionary countries and to attract revolutionary Muslim workers from Iran." This will cause the expelled workers "to become instruments of pressure and opposition against the reactionary regimes." Moreover, "with the unofficial decline in the value of the rial, Iranian workers will be ready to work at wages much lower than the wages that the South Korean, Pakistani, or Egyptian workers receive." 26BankMarkazi, Economic Report, for 1982 (1361) and 1979 (1358). 2Lautenschlager, "The Effects of an Overvalued Exchange Rate . . . " 38. 28Ibid., 43. It must be pointed out that the comparison between the "effects of a high dollar in the U.S. economy" and the situation in Iran is theoretically improper because (1) the U.S. dollar is a floating currency, therefore, its value is the market equilibrium price; (2) imports to the United States continued to increase in absence of general quantitative restrictions. In fact, the most staunch protectionists in the United States would be overjoyed by the implementation of a much milder import restriction measure than that enforced in the Iranian case. 29BankMarkazi, Economic Report, for 1979 (1358), p. 139. 30Based on author's estimates in a forthcoming study on income inequality in postrevolutionary Iran. 3'Bank Markazi, "Price Index of Consumer Goods and Services in the Urban Regions of Iran" (Shakhes-e beha-ye kalaha va khademat-e masrafi dar manateq-e shahri-ye Iran), mimeo February/ March 1986-Bahman 1365, Table 2. 3Lautenschlager, "The Effects of an Overvalued Exchange Rate . . . ," 45. 33In 1984, government revenues from selling foreign exchange at a rate above the "established" price amounted to 206 billion rials (5 percent of government revenues). The most important sources

20

Sohrab Behdad

of these revenues were from sales of foreign exchange for imports of "special goods." Revenues from oil constitute 11.6 percent of government's income in 1987 (53.6 percent in 1979). The Parliament (Majles-e Shoura-ye Eslami), The Budget Law of 1985 (Qanun-e budje-ye sal-e 1354 koll-e keshvar) (1985-1364), and Kayhan (air edition, March 18, 1987-Esfand 27, 1365). Any devaluation of the rial will increase the oil revenue component of the government's budget. Because a large proportion of exchange earnings are, however, used by the government (62 percent in 1983) the full budgetary impact is less than it initially appears. 34See Manouchehr Parvin and Amir N. Zamani, "Political Economy of Growth and Destruction; A Statistical Interpretation of the Iranian Case," Iranian Studies, 12, 1-2 (Spring 1979), 64-65. 35Farhad Daftari, Multinational Enterprises and Employment in Iran (Geneva: International Labour Office, 1976). 36Sohrab Behdad, "The Pattern of Structural Transformation in the Iranian Economy (1953-79): A Historical Review," mimeo, 1985, 20. 37BankMarkazi, Economic Report, for 1982 (1361) and 1983 (1362). 3Instead of looking at this general trend, Lautenschlager (p. 45) attributes the industrial output growth in 1982 to a decline in the value of imports in that year. Much of the fall in imports of primary and intermediate goods in 1982 (16 percent) was compensated for by the inventory buildup of these imports in the previous year (32.0 percent increase in imports of these goods) and the increase in imports of primary and intermediate products in the following year (57 percent). If Lautenschlager's reasoning were correct, the industrial output in 1983 must have declined sharply as the imports of primary and intermediate products and consumer goods increased 42.7 percent. It did not. In fact, in that year the non-oil GDP and all indicators of industrial output show a significant growth (Table 2). According to my analysis, however, the 56.5 percent increase in imports of primary and intermediate products was a necessary condition for the impressive growth rates. "Bank Markazi, Economic Report, for 1983 (1362), pp. 156-57. 40On the nominal and effective tariff rates of Iran, see Mahnaz Fahim-Nader, "Import-Substitution Industrialization in Iran," unpublished Ph.D. thesis, Department of Economics, University of Maryland, 1978, p. 68. 41Statistical Center of Iran (Markaz-e Amar-e Iran), National Statistical Yearbook 1983 (Salnamehye amari-ye keshvar 1362) (1984/1363), pp. 434-35. 42Estimatedfrom the value added by enterprises with ten or more workers in 1982 (ibid., p. 401) and total manufacturing value added in Iran in that year (Bank Markazi, Economic Report, for 1982 [1361], p. 134). 43For a formal analysis of foreign exchange black market, see Michael Nowak, "Quantitative Controls and Unofficial Markets in Foreign Exchange: A Theoretical Framework," IMF Staff Papers, 31, 2 (June 1984), 404-31. 44Total official sales of foreign exchange for travel, medical, and student expenses in 1983 was $460 million (Economic Report, for 1983 [1362], p. 206; compare with $1897 million in 1977, Economic Report, for 1977 [1356], pp. 232-33). According to the prime minister's 1987 budget report to the Parliament, official payments of foreign currency for travel in 1985 were $337 million. This figure was reduced to $90 million in 1986. Student expenses in 1984, 1985, and 1986 have been reported to be, respectively, $155 million, $132 million, and $110 million. See Ettela'at (December 28, 1986-Day 7, 1365). 45Seenote 18. 46See Sohrab Behdad, "Political Economy of Islamic Planning in Iran, 1979-1986," in H. Amirahmadi and M. Parvin, eds., Post-Revolutionary Iran (Boulder, Colo.: Westview Press, forthcoming). 47The biographical sketches given at the time of presenting new cabinet members to the Parliament often exaggerate the educational backgrounds and technocratic abilities of the candidates. 48Somedid enter this privileged position. Haji Barkhordar, Yasini, and Khayyamis, among others, were merchantsof bazaarorigin who became industrialists.Obviously, not all merchantscould enter this highly monopolistic realm. 49Thisassertion is based on my own observations. No empirical study has yet been conducted on this issue.

Foreign Exchange Gap in Iran

21

50Ayatollah Khomeini's speech on the occasion of 'Id-e Fitr, Kayhan, June 10, 1986-Khordad 20, 1365. 5'Ayatollah Montazeri's speech in a meeting with newspaper editors, Kayhan, June 25, 1986-Tir 4, 1365. 52Thefew political allies of the IRI are in no position to extend financial assistance to Iran. Syria itself is a borrower with debts to Iran, and Libya's foreign exchange reserves have been depleted in the oil glut of the past few years.