Rising Employment Casts Doubt on IMF’s Grim Forecast for Iran’s Economy

This article is republished from the author’s economics blog.

In October, the IMF downgraded its forecast of Iran’s economic growth for 2019 from -6 to -9.5 percent. The adjustment brought the IMF’s assessment of Iran’s economic performance closer to that of the World Bank (-8.7 percent) and is revising opinion regarding the ineffectiveness of sanctions in forcing Iran to renegotiate the 2015 nuclear deal. It has strengthened the hand of Iran foes who argue that sanctions are about to bear fruit and urge the Trump administration to stay the course and ignore appeals from Europeans to ease pressure on Iran.

The Financial Times, quoting an unnamed Iranian economist, added alarm to the downgrading by suggesting that Iran’s situation may be worse than it was during the Iran-Iraq war or the Anglo-Soviet occupation of Iran during World War 2. The idea that life in Iran is anything like the 1940s or the 1980s is nonsense, and the FT reporter who files her reports from Tehran can (but did not) attest to that. It is easy to dismiss this comparison as silly, but the dire predictions of sharp contraction by IMF and the World Bank for the year should be taken seriously. And by seriously I mean to ask why they are at odds with new employment data from Iran.

Surprising Growth in Employment

Earlier this month, the Statistical Center of Iran (SCI) release the latest results of its labor force (LFS) survey, for summer 2019. The summer quarter of 2019 (third quarter of the Gregorian year 2019) recorded the highest number of people employed ever, 24.75 million people, up by 3.3 percent relative to summer 2018, when sanctions first hit, and 1.5 percent relative to spring 2019. More than 795,000 jobs had been created since summer 2018, reducing the number unemployed by 430,000 and the unemployment rate to 10.5 percent.

Significantly, this was not due to lower participation in the labor force, which had actually increased by 1.1 percent, so this was not the case of discouraged workers leaving the labor force.  Also significant to note is the fact that employment grew in all sectors, especially in manufacturing, where employment expanded by 4.6 percent compared to the same quarter in 2018, even though is was the hardest hit by sanctions (except for oil).

A similar pattern existed after the first wave of sanctions in 2012, when the currency crashed and the economy entered negative growth, but employment seemed steady for a while before the effect of Rouhani’s austerity program to bring down inflation in 2013 began to show itself in employment (manufacturing employment, in particular,  was on the upswing till late 2013).

Divergent Narratives

What explains the strong discord between the international forecasts and employment figures in 2019?

Before answering this question I should first discuss an often-heard concern that Iranian data are somehow doctored and therefore unreliable, more so than data from other developing countries which form the basis of our understanding of the rest of the world. Many analysts (including me) have worked with the raw data for the labor force survey of Iran (LFS), which are all available on the SCI’s data portal. The LFS was designed by ILO experts to bring Iran’s employment data into line with the rest of the world. The old employment survey, which stopped more than ten years ago did not conform to international standards. For example, it classified a person as employed if he or she had worked at least two days in the week prior to interview. The new survey follows the ILO guidelines and defines the employed as those who have worked at least one hour in the past week. It is therefore disappointing that some so-called experts, inside and outside Iran, reject the SCI data for this very reason. On a recent BBC Persian panel, an expert questioned the criterion of a minimum of one hour in defining employment.  Responding to this type of criticism, a while back SCI published a report showing that defining employment more strictly increases the unemployment rate by one or two points only. Lack of trust in official data runs deep in Iran, and is at times quite healthy. However, in the case of SCI this is unwarranted because its surveys are publicly available in unit record and have become the workhorse for most economic research on Iran.

Now, to answer the question, there are two explanations for the difference in outlook offered by the employment data and the revised IMF forecast that seem plausible. First, the main reason for the lower revised estimate may be Iran’s falling oil exports. Since most United States waivers for buying Iranian oil have expired oil exports have dropped below half a million barrels per day—how far below I do not know. Arithmetics dictate to lower the growth projection for the year if the original projection assumed higher oil exports. However, the link between oil and the rest of Iran’s economy involves more than arithmetics and does not extend to employment. The oil sector employs less than half a percent of Iran’s workforce, so its contraction does not automatically bring down the rest of the economy. Had the IMF chosen to report growth of the non-oil GDP, as they should since it measures the level of economic activity in Iran much better than GDP including oil, they would have made a more moderate downward adjustment. On 2018/2019, as I noted last month, non-oil GDP fell by less than half the rate of the total GDP.

The second plausible explanation is that the IMF’s forecasting model, about which I know next to nothing, may fail to capture the possibilities for substitution in the Iranian economy.  The rise of the dollar brings a large change to the price structure in Iran, opening substantial opportunities for profitable production in the non-oil sectors that employ the 99 percent of the workforce. These are the sectors which are overwhelmed by cheap imports when oil income lowers their prices.

So, in reverse order, and as economic textbooks read, when oil income drop and prices of imports increase, demand shifts from foreign to home goods, encouraging firms to hire workers and expand production. For example, in the past visits to Iran I might have bought a box of Kellogg’s cereal because it tasted better than the Iranian brand and was only twice as expensive. But this past summer, with devaluation having increased the price ratio to four or five, I decided to buy the Iranian brand. Surprisingly, it tasted better, either because the quality had improved or because prices determine taste for Isfahanis!

The engine of this shift in demand and employment is shown in the chart below, which depicts the dramatic change in the real effective exchange rate (EER) in the past two decades. (EER here is the exchange rate deflated by the difference between the inflation rates of Iran and the OECD). The EER fell by more than half during the oil boom of the 2000s, which saw the oil price rise 8 times. This explains why during this period imports flooded Iran’s markets and employment stagnated. Tellingly, during the five years between the censuses of population 2006 and 2011, the economy produced only 14,000 jobs each year, compared to nearly 800,000 jobs since the return of sanctions over a year ago.

The tightening of sanctions in 2011-2012 lowered oil exports and forced a similar realignment of the rial against foreign currencies in early 2012, which was followed by a modest increase in employment and output, as the graph in this post shows.

Dark Clouds on the Horizon

The World Bank has noted that rial’s depreciation can help with economic recovery, and the Iranian economic press have published stories of how responsive is Iran’s private sector to improved incentives for production. But, I would advise caution in becoming too optimistic.  The biggest improvement in incentives in production has come in producing for export markets (saffron and pistachios prices are pegged to the US dollar), but sanctions limit how far (beyond its neighbors) and how much Iran can export. Even meeting local demand faces limitations as most goods produced in Iran use some foreign-produced inputs. About 45 percent of Iran’s imports are of this type.

Other dark clouds on the horizon that no doubt have influenced the lower forecasts of international organizations include the possibility of the return of UN sanctions and resumption of high inflation in Iran. The return of the UN sanctions would make it harder for Iran’s remaining trade partners to work with it, or at least they would exact a higher price for working with Iran. The current impasse with Europeans over INSTEX does not bode well in this regard.

Even without the return of the UN sanctions, Iran’s narrow window of trade can close if organizations such as FATF downgrade the credibility and security of Iran’s banking system, thus discouraging existing partners from handling money flow in and out of Iran for fear of being penalized elsewhere. Regulations to assure the rest of the world that Iran’s bank are being watched and regulated with respect to money laundering have passed Iran’s parliament but face stiff opposition on their way to become law.

As for inflation, it has been falling in Iran for the past six months, which indicates that, as in the 2012 episode, the economy may be on its way to return to normalcy (meaning below 20 percent!). What threatens this trend is the budget deficit, that the government is running out of ways to pay its workers and for the services it provides (it has given up building anything new). The government appears to have managed well so far, delicately balancing the need to keep its services going and to assure the private sector that inflation is under control. How long it can do this with parliamentary elections approaching and Iran’s polity divided as ever, is anyone’s guess. But, any attempt to increase incomes without producing more goods—i.e., populist money printing—will derail the path to recovery that new employment data seem to promise.

High inflation will destabilize the economy by making the exchange rate volatile and less predictable, which is bad for producers. Equally bad is if the government decided to keep the exchange rate constant in nominal terms, which it to let it depreciate at the rate of inflation, as was done after the currency collapse in 2012 when the EER gradually fell and lost nearly all the gain as a result of the devaluation.

Photo: IRNA

7 Charts That Challenge the Distorted View of Iran's Economy

Recently, a number of people have insisted to me that Iran has squandered its chance to joint the ranks of the BRICs—Brazil, Russia, India, and China—which count as the great emerging markets of the world. As sanctions return, as the rial sheds value, and as protests become routine, Iran is increasingly portrayed as an economic basket case where state collapse is just around the corner.

But even a cursory look to the recent experiences of BRIC markets makes it clear that Iran’s pains are not unique. In particular, Brazil has been in a near constant state of political and economic crisis since 2014, when an investigation called Operation Carwash uncovered massive corruption within Petrobras, a state-owned energy company, which was at the center of a “corruption machine” enriching allies of then President Dilma Rousseff. Since these revelations, millions of Brazilians have participated in protests around the country, their anger only increasing as a recession brings higher inflation and rising unemployment.

As I relayed in an interview with Brazilian newspaper Folha de S.Paolo, in January of this year, the slogans of the protests then emerging across Iran and still visible today, echo those of the protests that have been roiling in Brazil. The reason for this is simple. From a developmental standpoint, Iran’s economy is very similar to those of the BRIC countries, especially Brazil.

The policy failures of the Iranian government have garnered much attention in light of the recent protests. But they are not unique. They are the same failures that can be observed in Brazil, as well as other upper-middle income economies undergoing complex economic transitions. The frustrated cry of the Iranian protestor is the same cry as that of the Brazilian protestor. Sure, there is some local political and economic dialect. But the language of corruption and inequality is the same.

Despite this, the economic crisis in Iran has been characterized as a uniquely Iranian phenomenon, resulting from a set of political circumstances which can be traced back to the 1979 Islamic Revolution. Looking to Iran and Brazil in a comparative framework offers an important corrective to this characterization. Similar combinations of macroeconomic conditions produce similar political manifestations—protests against corruption, anger at social injustice, even calls to overthrow the government.

Put in its proper context, what is most unique about the crisis in Iran is not the economic reality, but the political reaction. Despite the clear parallels between the cases in Brazil and Iran, we do not see foreign powers “reaching for a regime change strategy” to alleviate the frustrations of the Brazilian people. No doubt, the failures of the Iranian government to create a robust economy are partially political failures. The country has an antagonistic relationship with the world’s superpower and its political elites are continually embroiled in needless scandal.

But as the seven charts below show, Iran is not an outlier when it comes to its economic performance. Governments of very different political persuasions and institutional frameworks—like those of Brazil and Iran—routinely fail to solve the fundamental challenges of economic development precisely because economic growth is difficult to achieve, harder to sustain, and insufficient to improve living standards. This is the context in which we ought to objectively understand and grapple with the idea of economic reform in Iran.

1. Struggles with Inflation

Both Iran and Brazil have long tried to keep inflation in check. Brazil suffered from extreme inflation in the early 1990s, hitting nearly 3000 percent. Iran also went through a period of chronic inflation, hitting an official rate of 50 percent in 1995. By the later part of the decade, both countries began to bring inflation under control. In 2016, the inflation rates in Brazil and Iran converged. Both are back on an upward trend, contributing to public frustration over the cost of living.

2. Stubborn Unemployment

One of the main drivers of recent protests in both Iran and Brazil has been anger over chronic unemploument. In Brazil, unemployment has risen sharply due to the recent economic downturn, and is now approaching levels seen in Iran. Revelations of deep-seated corruption in government have led Iranians and Brazilians to share the belief that their government officials are more concerned about their personal economic wellbeing than about creating jobs and tackling inequality.

3. Ease of Doing Business Rankings

Weak rule of law and the lack of transparency which enable corruption also serve as barriers to investors and entrepreneurs. Iran and Brazil are ranked 124th and 125th respectively in the World Bank’s Doing Business rankings. While the performance of Iran and Brazil varies across the constituent parts of the overall score, it is clear that conducting business in the two countries is similarly onerous and risky.

4. The Role of Foreign Direct Investment

However, despite the fact that Brazil is just as difficult a place to do business as Iran, the Brazilian economy has attracted nearly 25 times more net foreign direct investment (FDI) than Iran in the period from 1980 to 2016. Brazil’s economy has been burnished with over USD 1 trillion dollars in FDI, while Iran’s economy has secured just USD 44 billion in the same period. Brazil’s success in attracting foreign investment began around 1995, when the country was coming out of its hyperinflation crisis and when a new class of emerging market investors began to finance the new wave of globalization. Iran missed out on this emerging markets gold-rush. The passing of the Iran Libya Sanctions Act in 1996 by the U.S. Congress and the intensification of sanctions in 2008 at a time when global investors sought elusive growth in emerging markets in the aftermath of the global financial crisis, saw Iran’s FDI inflows stagnate.

5. Similar Growth, Differing Volatility

Despite missing out on FDI inflows, Iran has not been a growth laggard. Over the period of 1980 to 2017, Brazil and Iran achieved the exact same average annual GDP growth: 2.45 percent. The key difference is that Iran’s growth has been more volatile given that it is principally driven by oil revenues and is therefore tied to fluctuations in the global oil price. International sanctions have also frustrated economic growth in Iran.

6. Brazil’s Debt-Fueled Growth

But if Iran’s growth has been fueled by oil, Brazil’s growth has been fueled by its own global market—the debt market. Brazil’s external debt has skyrocketed, exceeding 70 percent of GDP, as the country has repeatedly turned to international bond markets and IMF loans in order to counteract domestic economic fragility and soften the impact of recessions. The recourse to debt allows Brazil to reduce economic volatility. While Iran’s oil buyers can be fickle, creditors are always ready to offer Brazil more financing.

7. GDP Per Capita

Iran and Brazil have seen similar overall levels of economic growth in the last four decades and standards of living, as measured by purchasing power, have likewise been improving at a similar rate. But this is all the more remarkable given that Brazil has enjoyed much greater access to international investment and financing. Even so, the average Iranian today enjoys greater purchasing power than the average Brazilian. The gap in GDP per capita widened during Brazil’s recent economic downturn, but it will likely narrow again as Iran enters its own economic crisis, marked by returning inflation and a devalued currency. Nonetheless, Iran can be said to have delivered greater economic dividends to its population than one of the vaunted BRICs, even without the stimulus of international finance.

Photo Credit: Bourse & Bazaar