The Politics of Subsidy Reform in Iran

by Kevan Harris
published in MER254

Although most Iranians forget it today, Mahmoud Ahmadinejad was elected in 2005 on a platform of technocratic competence. The clique surrounding his rise to mayor of Tehran and beyond once called themselves Abadgaran, “the Developers.” In a column four months after Ahmadinejad’s election to the Iranian presidency, commentator Saeed Laylaz reminded readers of the sage advice of Deng Xiaoping, arguing that a hard-line conservative government could push through economic reforms where the reformist administration had failed. “The cat is finally catching mice,” Laylaz wrote, “and its color no longer matters.” [1] After the exhaustion of the reform movement’s momentum, Ahmadinejad presented himself to the people as the intrepid engineering professor, the humble, principled and no-nonsense expert who could get things done. “Expert,” in fact, is one of the good doctor’s favorite words.

What occurred was instead second-rate. The network of clients enveloping the new president set its sights on capturing the money and resources controlled by the ossifying bureaucracy of the Islamic Republic. Abadgaran men and assorted hangers-on replaced the aging first generation of post-revolutionary technocratic cadres. No sweet plum remained unpicked in the state agencies and ministries, not even in provincial offices and the development projects they oversaw. The rebellious tone with which this turnover was presented -- “throw the bums out” -- resonated with the lower social strata, who have rarely benefited from state largesse. In 2007, the president stuck a pitchfork of his own in the 60-year old Planning and Budget Organization, taking away its independent auditing power. But overall the Ahmadinejad administration has not exactly been distinguished by fiscal discipline and managerial efficiency. Ahmadinejad, for instance, has paid three rounds of highly publicized visits to the oft-neglected provinces. On his tours, he has been met with hundreds of thousands of handwritten letters asking for small favors -- resolving a quarrel with a local official, helping a son lacking sufficient connections for a state post, defraying the cost of an upcoming wedding or paying an overdue bill. The supplicants received personalized replies, and a few dozen thousand-toman notes (1,000 tomans equal $1) were stuffed into the envelopes for good measure. Ahmadinejad’s political vehicle was nothing less than a new patronage machine. It is an administration charismatic in appearance, but inconsistent in policy and practice.

In the spring of 2010, with the country still in political tumult over the dubious election of the previous June, and in economic pain due to global recession, the reinstalled engineer-president announced a plan that drew out critics of his competence in droves. The government proposed to enact the most sweeping economic policy change in over a decade: a phasing out of price subsidies for nearly all staple commodities -- bread, electricity, water and gasoline -- starting in March and continuing until 2015, when they would cease entirely. The plan provoked immediate protest and predictions of chaos, prompting parliamentarians to chop half of the cuts out of the budget bill they passed on March 9.

Easy Money No More

Ahmadinejad’s political opponents within the Islamic Republic, from reformists to pragmatic conservatives, and irrespective of their feelings about the Green Movement arising after the June election, were pleased to see the president on the economic hot seat at last. After 15 years of attempting to construct their own versions of a modernization project, they were aghast that this upstart had labeled them as the backward, out-of-touch cronies of an old elite. Whether they had sought to do so through a glasnost-style opening, like former President Mohammad Khatami, or through a top-down economic restructuring, like Khatami’s predecessor Akbar Hashemi-Rafsanjani, they had been equally disparaged. Infuriating them more was that Ahmadinejad liberally stole from their policy playbook, just as President Bill Clinton was etched into the pages of US history though the use of softened Republican Party talking points. Politically, the Islamic Republic’s bêtes noires in the Bush administration gave the Iranian regime easy targets with which to justify their position: a region in conflagration and blatant enforcement of double standards in nuclear geopolitics.

For most of Ahmadinejad’s first term, the money poured in, in the form of oil rents inflated due to the same regional crises. The government rode the heady boom in land prices and resplendent construction projects. In 2006–2007, many Iranians with capital jumped into the housing market, seeing dizzy gains of 100 percent every year. The resulting real estate bubble temporarily concealed the lack of a coherent development policy. [2] The benchmarks and proposals of the Fourth Five-Year Plan (2005–2009), passed in Khatami’s era, were discarded in favor of hundreds of bridges to nowhere, and most of these were not even completed. [3] The economy entered a liquidity trap, where over-accumulation of capital and a lack of profitable outlets for investment drove down the rate of return while sending prices into an upward spiral. Finally, Iran’s central bank reined in the easy money in mid-2008, months before the collapse of global financial markets (with much resistance from the president, who forced the two largest state banks to continue to hand out loans, resulting in the large debt burdens of today, as borrowers default). [4] Each block of every middle-class neighborhood in Tehran is now home to three or four real estate offices, all filled with jacketed agents listlessly huddled together.

The economic hangover allowed political competitors to pin the label of ineptitude on the president’s dwindling faction and make it stick. If any theme permeated the televised debates between presidential candidates before the June 2009 election, it was competent governance. The intra-elite bickering was so intense that it arguably burned through the electorate’s apathy and ignited mass participation in the balloting.

Into this environment the president introduced his subsidy reform law, whose provisions were as follows: The government spent around 40 percent of its 2006 budget ($40 billion) on such subsidies and even more during 2008’s oil price peak. Of the revenue gained from the lessening of subsidy levels, the state would keep 20 percent, ostensibly compensating for increased costs in the public sector. Another 30 percent would be allocated to industries that rely heavily on subsidies and development of more energy-efficient infrastructure. The remaining 50 percent would be given back to Iranians in direct cash transfers or indirect welfare benefits, “targeting” the poorest strata of the population. After five years, the prices of the staples were to be close to regional market levels. The parliament wrote into the law that the government should gain no less than $10 billion and no more than $20 billion during the first year, which would have meant increasing prices for subsidized goods on average between 2.5 and 4 times their current levels.

Debate over the law was heated, even a bit melodramatic, with parties for and against seeming to believe equally in the awesome power of unregulated markets. The president identified this single reform as the solution to the country’s many economic, social and perhaps even cultural woes. On March 9, amid reports that Parliament would approve only half of the cuts, state news agencies relayed that Ahmadinejad was praying in the chamber for passage of them all. Critics of the law, including stalwart conservatives in Parliament, predicted hyperinflationary catastrophe and industrial collapse. Green Movement supporters hoped that an intensification of economic grievances would keep middle-class Iranians, some of whom see the plan as a government attack upon their livelihoods, coming into the streets. Labor activists foresaw a new surge of working-class unrest to fuel the Green fire.

The drama of the subsidy debate was all the higher for playing out against the backdrop of the post-election turmoil and the fragmentation of the political elite into so many temporary chiefdoms, with the accompanying fleeting wars and alliances. In this climate, no policy initiative on the scale of subsidy reform would proceed without the express approval of Ahmadinejad’s patrons, Supreme Leader Ayatollah Ali Khamenei and the Revolutionary Guards. Why, given the hubbub, did they permit the president to move forward with the subsidy-cutting plan? Have they gone nuts?

Toward Consensus

Lost in the coverage of the March 9 vote, which was represented as a major defeat for Ahmadinejad, was the fact that Parliament still approved $20 billion in subsidy reductions. Another question should be directed to the president’s opponents: If cuts would be so disastrous, why make any at all? Parliamentarians crafted the $20 billion compromise with an eye to the opinion of Ayatollah Khamenei, who had remained conspicuously quiet throughout the raucous debate. His continued silence was interpreted by the Western press as an effective vote of no confidence in the president, but it is more accurately seen as an endorsement of the concept of slashing subsidies. The fact is that, in proposing the cuts, Ahmadinejad and his supporters were not far outside the economic policy consensus within the Islamic Republic.

Over the last 20 years, every political faction in the Islamic Republic has undergone an intellectual transformation. Each by its own route, all of these groups came around to the same economic point of view: The state could not afford the current form of the extensive social safety net woven after the 1979 revolution. Subsidies on staples were but one thread of this web, replacing the ration cards that the Islamic Republic had issued during the 1980–1988 war with Iraq.

Already in the early 1990s, technocrats under Rafsanjani were arguing for a “rationalization” of subsidies, outright removal being impossible, because the subsidies were highly popular. [5] Subsidy reform was held to be the key to an efficient allocation of resources that could jump-start economic development. This view was quietly adopted across the reformist-conservative divide that developed in the later 1990s (though there were dissenters in both camps), and many commodity prices were floated at market rates. But subsidies of essential goods and services were untouched.

A reporter for the reformist daily Etemad was surprised, therefore, when Ali Shams-Ardakani, former secretary-general of the Chamber of Commerce, Industry and Mining and a cousin of Mohammad Khatami, professed unwavering support for Ahmadinejad’s subsidy reform law: “Introducing targeted subsidies is a move toward fixing a wrong policy that we have followed for many years.… If something is implemented badly, it does not mean that it was bad to begin with.” Shams-Ardakani added that poverty would likely increase if the bill passed, but held that without it, and indeed a package of economic reforms, Iran would be stuck with lackluster growth in perpetuity. [6] In other words: No pain, no gain. Since 2008, the analogy of “economic surgery” has been repeatedly used in op-ed columns and Friday sermons.

Many political liberals jumped on the subsidy reform bandwagon because liberalization of the economic sphere was believed to open up the political domain as well. The state would shrink, yielding the commanding heights of the economy to a private sector interested in meritocracy, transparency and accountability, leading to greater democracy. The population, meanwhile, would grow less dependent on the regime. Historically, the links between economic and political liberalization are rather tenuous, but reformist discourse presented the two processes as intertwined. [7] Their line was in keeping with the spirit of the times, and of course remains widespread. Much to the political liberals’ horror, this language is now employed to promote a subsidy reduction plan that in all likelihood will enlarge the state through still-to-be-designed cash-granting apparatuses, not break it up.

Lastly, the old-guard conservatives, many of whom resisted liberalization of foreign investment in the Khatami era, settled on a decidedly less nationalist position. [8] Hence the battle in Parliament between Ahmadinejad supporters and their conservative opponents concerned questions of oversight and implementation rather than the idea of removing subsidies as such. Comparisons with Turkey and South Korea -- two lodestars with regard to development -- were rolled out when needed. While the “China model” of economic opening without political opening is often identified as Iran’s self-chosen third way, Iranian elites do not really understand China’s gradual, selective embrace of the market very well. Instead, “China” is invoked as a place marker for the Iranian status quo, often as a defense mechanism against highbrow attacks on economic policy by Western-trained academics. The real models for Iran have continued to be those few economic successes among middle-income states that inspire the fairy tales of development. [9]

After taking up the “targeting” or “rationalizing” of subsidies as an issue in the middle of his first term, Ahmadinejad rarely missed a chance to promote it in a speech, often (accurately) saying that 70 percent of the nation receives only 30 percent of the subsidies, and vice versa. He even brought up the matter in his February 11 oratory at Azadi Square, when he announced that Iran had enriched uranium to 20 percent and was now a “nuclear state.” “God willing,” he intoned, “with the implementation of the targeted subsidies plan, the Fifth Five-Year Plan and the policies of Article 44 [the privatization of Iran’s state-owned enterprises], we will be the twelfth-largest economy in the world within five years.”

Many labeled the subsidy reform plan as a long-planned “shock therapy” that would ravage the Iranian economy and solidify a state-linked oligarchy at the expense of all other sectors. This view is inaccurate, if only because Ahmadinejad’s first administration showed few signs of a coherent economic policy beyond the short-term thinking of any political machine: Muscle your friends into power and keep them there. The reality seems to be that Ahmadinejad, having realized his limited economic vision, had no answer of his own when these initial gambits ran their course. So he embraced the set of ideas most available to him at the moment, and spoke of them as if he had come to these conclusions entirely on his own. Parroting such unobjectionable phrases as “getting the prices right” lent the appearance of technical knowledge. Meanwhile, if his government could enact and implement subsidy reform, he could point to a substantial achievement where past administrations had failed, thereby countering the accusations of bumbling that had been turned back against him. The cat would be catching mice.

If short-term political gain spurred Ahmadinejad and his backers to embrace of the market, they will surely be disappointed. Even at the lower levels approved on March 9, for the subsidy reform plan to be effective, it will require a state apparatus akin to the one he attacked upon entering office in 2005. The professionals who could have taken on the task have quit, been fired or been sidelined. Ahmadinejad may be stuck with a white elephant.

See What Sticks

In the lead-up to the parliamentary vote, it was difficult to predict the outcome of subsidy reform because the details were elusive. Indeed, the plan’s gelatinous form changed shape on a weekly basis as the administration reacted to complaints and criticisms from various sectors. The process was eerily similar to the raising of gasoline prices in 2007, when the government would tease the public with a new price and ration structure to test sentiment and then deny that these details had been determined yet. The eventual enactment of price hikes in the summer of that year, with very little advance warning, resulted in a few hurled Molotov cocktails and an armed guard next to every pump until things settled down. The conflict was actually less than had been expected, but the elimination of price supports for essential goods and services will presumably be a more serious matter.

In 2010, the subsidy reform discussion would have been farcical if it were not so troubling. The government announced that it already possessed income information for a majority of Iranian families and would rank them in deciles to determine the size of cash payments. Everyone was encouraged to update the family profile on a government Internet site; the rush of traffic crashed it. The Statistical Center of Iran then clustered the population into three groups from poorest to wealthiest, placing 18 million in cluster one, 30 million in cluster two and the remaining 23 million in cluster three. The data used to compile the clusters, however, were two years old, prompting many who were classified in cluster three to argue that inflation had eaten away their incomes in the interim. [10] It seems a large number of these citizens complained to their MPs, who passed the gripes on to the government, who then denied that the clusters were even to be used.

Confusion reigned. As of late February, government spokesmen were on record saying that 70 percent of Iranians would receive aid and also that 100 percent of Iranians will receive aid. The president had suggested that aid checks would be deposited in private bank accounts each month. In Iran, however, as in most middle-income countries, huge swathes of economic activity are hidden from the government’s view. Those millions of Iranians who earn their sustenance in the informal economy, and the petty bourgeoisie and small-time bazaaris who fear the tax man, are unlikely to subject their accounts to government scrutiny. [11] Many people on Tehran’s streets professed incredulity that the plan would go forward. According to interviews at Iran’s welfare agencies, there barely exists a centralized system of data sharing that could create a reliable gauge of family income and need. Instead, cash payments may be funneled through the various welfare institutions, between which there are notorious bureaucratic turf battles.

Iranian industry, suffering from competition with a flood of imports over the last four years, was vocal in its opposition to the plan. The economic weekly Barnameh released results of a study on the effects of subsidy removal for various industrial sectors, predicting 50 percent inflation of input costs in transportation, 45 percent in chemicals and 25 percent in construction and mining. Iran’s Chamber of Commerce demanded industry-specific protection from hikes in prices, and the House of Labor, through its surprisingly vociferous Secretary-General Ali Reza Mahjoub, predicted “three-digit inflation” and waves of layoffs to hit the working class. [12] The president again replied, in pseudo-expert tones, that “tens of committees” were working on the problem and would submit their findings shortly.

Now What?

Few doubt that the long-standing subsidy policy has contributed to highly distorted consumption patterns in Iranian society. Keeping gasoline relatively cheap, the 2007 hikes notwithstanding, contributes to Iranian cities’ growing problems with congestion and air pollution. But why, many ask, should the pain of “economic surgery” be borne by consumers first? Commuters who may now find gasoline prohibitively expensive or may want to exercise an environmental consciousness do not have good fallback options in public transportation. Tehran’s subway system, for instance, is well behind schedule, again because of bureaucratic turf battles. The subway agency is run by Rafsanjani’s son and is under the control of Tehran mayor Mohammad Baqer Qalibaf, a critic of the hardline conservatives. As a result the government has withheld millions of dollars in funding, making it likely that progress in construction will remain sluggish.

There are other dilemmas. If inflation, which Ahmadinejad insists will remain manageable, gets out of control, how will the government maintain its loose peg of the highly overvalued rial to the dollar? Given that the subsidy plan already seems like a conspiracy against the Green-sympathetic middle class, a devaluation of the rial would only confirm their suspicions, since it would hurt their purchasing power more than that of the poor, who have very little to begin with. Yet the preservation of the currency peg may require the reimposition of currency and import controls if oil prices move lower, equally anathema to middle-class Iranians who remember the economic strictures of the war with Iraq.

As for waged workers, the utter absence of industrial policy has led to months of non-payment of arrears in segments of the steel, construction and other durable goods sectors. Protests remain sporadic and mostly spontaneous, but unrest is on the rise. Given that wage increases traditionally occur after the Persian New Year, the government will find it hard to blame the usual middlemen -- the bazaar merchants who imported their way into the ranks of the wealthy -- if the plan goes forward.

Yet economic distress never automatically generates political dissent. Those on the outside who gleefully watch Iran’s economy sink forget that there are alternatives to broad social protest in economic crises -- reliance upon extended family, xenophobia and avoidance of any and all interaction with the state. Mir-Hossein Mousavi, the titular head of the Green Movement, astutely questioned the plan in his official statements, calling attention to the effect on Iran’s poorer families. But it remains to be seen if the cuts, at the lower levels approved by Parliament, will have a galvanizing effect in Iran’s highly class-conscious society. Embarrassingly for the government, the details of how big the subsidy payments will be and who will receive them are still unclear, even after passage of the budget on March 9. One thing is certain. The hardline troika of Khamenei, the Revolutionary Guards and Ahmadinejad will be held responsible for whatever subsidy reform may do to Iranians’ standard of living. While, at one time or another, all of the Islamic Republic’s political factions have advocated subsidy reform, in the eyes of the population, it is now “owned” by the president who prayed for it.

Endnotes

[1] Sharq, October 13, 2005.
[2] See the interview with Kamal Athari in Etemad, January 18, 2010.
[3] Sarmayeh, January 19, 2009.
[4] The banking sector’s woes are outlined in Iran Dokht, January 23, 2010.
[5] See, for example, Jaleh Shadi-Talab, “Subsidy and Its Social Effects,” Farhang-e Towse’e (October-November 1992). [Persian]
[6] Etemad, February 1, 2010.
[7] Mehran Kamrava, Iran’s Intellectual Revolution (Cambridge: Cambridge University Press, 2008).
[8] Evaleila Pesaran details the battle over foreign investment in the Khatami period in her working paper, “Negotiating Iran’s Economic Reform: Factional Contestation Over the Foreign Investment Act of 2002.”
[9] See Kevan Harris, “Did Iran Lose Its Chance of Catching Up With the West?” in English at kevanharris.com and in Persian at alborznet.ir.
[10] Iran Dokht, February 6, 2010.
[11] Etemad, February 8, 2010.
[12] Mardom Salari, October 17, 2009.

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