Middle East Research and Information Project: Critical Coverage of the Middle East Since 1971

Kaj dar-o mariz” (the jar is tilted but not spilled) describes how the Islamic Republic came stumbling through its first decade. Unlike Iraq, Iran fought the war between them entirely on its own resources, which enabled the state to maintain a sense of achievement and independence. [1] However, with the country deeply scarred and castigated as an international pariah, the economy in shambles and the population exhausted and disillusioned, the peace that was finally achieved was a bitter one. The makeshift economic management of wartime and the proliferation of competing centers of political and administrative power have presented the most serious obstacles to the task of reconstruction. Yet many Iranians are convinced that the long-term survival of the regime hinges upon its success in rationalizing the economy and improving living standards.

The ceasefire with Iraq provided the first real opportunity for the Islamic regime to put its house in order and formulate a social and economic model of development based on Islamic principles. [2] Ayatollah Khomeini shrewdly foresaw the necessity of such a transition and undertook a number of steps before his death to reduce the fractiousness and inherent instability of the regime he had founded. He established working relations with the Soviet Union, dissolved the Islamic Republic Party, accepted the resignation of his radical heir designate, Ayatollah Montazeri, enhanced the status of Ali Akbar Hashemi-Rafsanjani by making him commander-in-chief, and decreed the supremacy of the interests of the state over those of religion. Within weeks of Khomeini’s passing, the regime moved rapidly to insure a smooth transition of power to the team headed by Rafsanjani and Ayatollah Khamenei. It enacted a set of constitutional reforms aimed at strengthening the executive at the expense of a multitude of competing centers of power, and finally, it formulated an economic agenda in the form of a five-year (1989-1993) development plan.

The substance of these reforms made it clear that this pivotal period marked the transition not just to a new phase of the revolution, but to what might, with a bit of irony, be called a “Second Republic.” In their entirety, these reforms abandoned the search for a uniquely “Islamic” model of social and economic development in Iran. [3] The impetus for this change was the foundering economic and material legacy of the first decade of the Iranian revolution.

The First Decade

The war with Iraq resulted in a staggering $650 billion in damages and more than a million casualties for Iran alone. [4] In the final years, the war was consuming 70 percent of the country’s revenues. [5] The population had almost doubled over the previous decade. The pre-revolutionary structure of Iranian industry was such that it needed to import at least 60 percent of its parts and inputs from abroad, making the country extremely vulnerable to international sanctions. In 1988, the industrial sector was operating at barely 40 percent of its capacity. [6] Some 3.5 million international refugees had entered from Afghanistan and Iraq, in addition to 3 million internal refugees from war-torn towns and villages. Unemployment ranged from 14 to 40 percent, domestic production collapsed and income per capita declined by half. [7]

The revolution had led to capital flight and a serious brain drain. [8] In 1979 the Provisional Government nationalized banks, insurance companies and many large factories on the verge of financial collapse. Rising populist fervor led to monopolization of foreign trade, full nationalization of the oil industry, the breakup of private agro-industries and some confiscations of properties of the former elite. [9] While the private sector shrank, the public sector nearly tripled in size. [10]

By the end of the Islamic Republic’s first decade, non-military government expenditures were four times as much as investments in capital formation and development projects. Political insecurity and the unpredictability of the legal system pushed private capital away from productive sectors into more profitable speculative activities. [11]

The decline in the productive sectors and increasing war expenditures forced the country to rely more heavily on oil revenues, despite a constitutional obligation to reduce its dependence on petroleum exports. But Iranian oil production had dwindled from 6 million barrels per day (mbd) before the revolution to 2 mbd, and international oil prices fell sharply. [12] Faced with a crisis of falling revenues and rising expenditures, the state resorted to deficit spending. By the end of this period, the deficit had reached 52 percent of the budget, fueling official inflation rates of over 20 percent. The brunt of this burden fell on the working people, whose real incomes fell by a third between 1982 and 1990. To protect the needy and to avoid a popular backlash, the government implemented rationing, subsidies and price controls. [13]

Confronted by one predicament after another — many of its own making — the Islamic regime went through a series of ad hoc strategies to take control of the economy. The only attempts at meaningful structural change took place in the first two years of the revolution, but were effectively frustrated by political struggles and infighting, and the war. Initial lame attempts at long-term planning were soon abandoned for annual budgets. As the war raged on, controls on imports and consumption were further tightened. An austerity plan cut the budget and foreign expenditures by one third in 1986. [14] The Islamic Republic defiantly resisted Western economic pressure by diversifying its sources of trade and by promoting barter and pre-sales of oil to get around international sanctions.

By 1988, the situation had deteriorated to such a degree that the government was running the economy on a day-by-day basis. Khomeini was ready to accept UN Security Council Resolution 598 calling for a ceasefire with Iraq, and the regime started thinking about peacetime reconstruction and long-term development planning.

The Second Republic’s Choices

No coherent vision of a distinctly “Islamic” political economy emerged from the revolution. The ruling clerical elite was too heterogeneous and inexperienced to reach consensus on fundamental economic issues. Nevertheless, the revolution had generated enormous popular and local initiative in both rural and urban areas. The war and international embargo had forced the country to rely primarily on its own resources, thus giving a great deal of autonomy and confidence to farmers, managers, workers, researchers and a numerically small but vibrant class of small industrialists.

The war’s end and the beginning of the five-year plan marked a new transitional era. The question was — and to some extent remains — a transition to what? The first priorities were to jumpstart and expand the productive sectors, especially industry, and to reduce the size of the public and service sectors. But the magnitude of these problems demanded much more than a five-year plan. What was needed was a long-term industrialization strategy supported by comprehensive political and legal reforms that would enable Iran to replace oil as the income generating basis of the national economy. Such a long-term strategy required not just planning, but institutional preparation. The issue was not simply to import hardware and technology, but to build the social consensus necessary to mobilize available resources for a structural transformation. In short, greater pluralism, national reconciliation and some form of participatory democracy needed to be as much a part of the development strategy as strictly economic factors.

To date, no such long-term strategy has emerged and the present economic crisis is the consequence. Development policy has been reduced to a set of macro-economic administrative and fiscal reforms shaped by two documents: the five-year plan and the set of structural adjustment policies recommended by the International Monetary Fund. The result is an eclectic version of a “mixed” economy which rhetorically emphasizes the leading role of the private sector.

The last few years have seen numerous heated debates about planning in the mass media and in the parliament. But experts outside of the regime were never invited to participate. The plan opted to increase domestic production and reduce costs and inefficiency, giving priority to utilization and modernization of existing idle capacities and the completion of current projects. This required the regime to reduce restrictions on imports, and to pay for them with revenues to be raised by promoting exports and improving domestic tax collection. The need to reduce the deficit moved the regime to privatize assets and transfer the burden of social services to the population by cutting subsidies.

Since domestic resources were insufficient to finance growth and reconstruction on the scale of the plan, the “Second Republic” did not hesitate to challenge two of the shibboleths of the revolution by seeking international loans and direct foreign investments. The deadly 1990 earthquake in Gilan and Zanjan provided an opportunity for the Iranian government to request, and for the World Bank to extend, a $250 million emergency relief loan. This signaled Iran’s official return to the international capital markets, after an absence of nine years. Rafsanjani’s government began sending out feelers to international lending agencies. But efforts to clean up Iran’s image abroad were offset by assassinations of opposition figures abroad, the death sentence against Salman Rushdie and continued support of movements such as Hizballah in Lebanon.

The government also sought IMF credit approval and technical assistance. The IMF response was a predictable ensemble of price and market reforms. It included proposals for unifying the currency exchange rates, removing price controls and subsidies, raising interest rates to encourage savings and reduce liquidity, liberalizing foreign trade, privatizing much of the public sector, reforming tax structures and implementing stiff wage and salary controls.

While a “monetarist” Central Bank and Ministry of Finance have enthusiastically backed these reforms, another more “statist” faction, led by the ministries in charge of industry, energy and transportation, has advocated that the state take responsibility for rebuilding damaged infrastructure, for investing in strategic industries, for attaining self-sufficiency in food production and for maintaining a welfare safety net.

Far from constructing an alternative “Islamic” model of development, the Islamic Republic has officially embraced a conventional liberalization-privatization-export promotion model. In practice, the eclectic and often contradictory vision pursued by the Iranian state combines a modish faith in the corrective power of free markets with the import-substitution approach of continued protection and direct state involvement in the economy. Since 1990, the IMF guidelines, which the Iranian government calls the “Economic Adjustment Policy,” have been enthusiastically appropriated as a streamlining supplement to the first five-year plan, and as the guiding principle underlying the preparation of the second five-year development plan (1994-99). [15]

Economic Performance

The economic history of the “Second Republic” falls into two distinct periods. The first, from 1988 to 1991, saw a sharp upswing as the war-damaged economy, boosted by relatively favorable international circumstances, reached many of the targets of the five-year plan. But this did not solve the myriad problems resulting from deep-set structural distortions and neglected sectors. These problems were complicated by the country’s sudden opening to the world market. As soon as the economic engine started running, it overheated dangerously. In the second period, beginning around the end of 1991, the lack of social reforms, coupled with poor management and unfavorable international circumstances produced a massive foreign debt, inflation and stagnation. The regime saw lack of access to capital and technology as the main obstacle to growth. The quickest source of revenue for Iran was oil, and in 1991 alone the government directed some $5 billion in investments to enhance the dilapidated oil sector to maximize production and revenues. [16] But the oil markets have been in a state of chronic depression. Iran’s revenues in 1991 were $16 billion but this dropped to $14 billion in 1993. Increased competition among OPEC members to maintain both their revenue and their production quotas has obligated producers to invest ever greater sums in the industry, further reducing their profits. As a result, Iran has had to continuously reduce its expectations about oil revenues, while the investment requirements — $2 billion in 1993 — for maintaining and expanding output continue to be an unavoidable burden. [17]

The export of non-oil products, especially industrial goods, was another planned source of revenue. Since 1988, restrictions on foreign trade have been increasingly liberalized and revenues from non-oil exports, negligible until then, now constitute 17 percent of the foreign exchange earnings. [18] By 1992, total exports reached $19 billion, up from $11 billion in 1988. But imports increased even more dramatically, from $11 billion in 1988 to $28 billion in 1991, responding to the need for capital investments as well as bottled-up domestic demand. This led to the enormous and sudden trade deficit that has become Iran’s current debt problem. [19]

Much of this growing revenue and importation has been invested in infrastructure and the productive sector, especially government-owned heavy industry. Since 1988, the number of new telephone subscribers has increased fivefold, to nearly a million. Commercial port capacity has doubled to 25 million tons. Road, railroad and airport capacities have significantly expanded. Some 200 cities have been equipped with natural gas extension services. Electricity production has increased fourfold since the revolution; Iran now has the largest power sector in the Middle East. [20] Refineries, petrochemicals, metallurgy, steel and aluminum plants are especially favored for export sectors and investments. [21] As more of the demand for metals and refined hydrocarbons is supplied domestically, the country is turning from a major importer to a net exporter of these products, albeit on a small scale.

The government has also pursued, with unexpected resolve, two politically sensitive targets. One was an impressive reduction in the population growth rates from 3.2 to 2.3 percent. The second was the unification of the multiple currency exchange rates in March 1993, which entailed a 95 percent devaluation and made the rial fully convertible. [22]

The GDP increased by a third but much of the growth in domestic production was a result of raising idle capacity from 30 percent in 1989 to 90 percent in 1992. In 1991 Islamic Iran finally reached the same volume of GDP as in 1977, the year before the revolution. [23] But over this same period, the population has increased by two-thirds, with the result that income per capita has fallen from $1,500 in 1977 to $700 in 1988. [24]

Turning Point

Iran’s grace period came to a sudden end in the spring of 1992, when a series of urban riots and anti-government demonstrations rocked the country. Oil revenues stayed below forecast, while the trade deficit and foreign debt reached alarming levels. The US put pressure on its allies not to reschedule Iran’s debt or issue new credits. Criticism of the state’s development policies from outside of government and elite circles became more vocal. The crisis of 1992 exposed seriously neglected structural problems at home, a significant misreading of the global economic situation and the degree of Iran’s isolation internationally.

The optimistic revenue forecasts allowed the government to liberalize its import regulations. Domestic firms rushed to put in orders for raw material and capital imports. [25] When the currency reunification program took place in March 1993, fledgling industries, which had enjoyed subsidized credit suddenly found themselves in an almost insurmountable bind before investments had time to take root. The combination of falling oil revenues, currency devaluations and reduced credit subsidies increased costs immediately by 25 to 100 percent. [26] These firms were not yet ready to compete on an international level, and their products became even too expensive for a seriously depressed domestic market glutted with cheaper, better-quality imports.

A combination of serious misjudgments, inadequate information and the inherent contradictions in the government’s monetarist and industrialization policies neutralized the steps taken toward industrialization. This was the consequence of a development strategy that emphasized growth over employment, and export-oriented, government-owned industry over a privately-owned, grassroots national industrial base. According to the minister of industries, between 1989 and 1992 some 35,000 agreements of principle had been signed in response to applications for industrial permits. These figures reflect the dynamism and the scale of earlier enthusiasm in the private sector which was jeopardized by later currency reform policies. Only 4,000 industrial projects were completed, creating 90,000 jobs at a time when 3 million people had joined the workforce. [27]

It was at this point that Iran’s inability to repay its accumulated short-term foreign debts intervened. The country’s alarmed leaders slammed on the breaks, hurriedly reducing imports by half and launching a series of austerity measures. They also gained some breathing space by successfully renegotiating most of the country’s repayment schedules despite Washington’s opposition. [28] But the impact of this radical contraction on the economy and on the population has been devastating. With the industrialization program and domestic production at an impasse, unemployment and inflation have accelerated by leaps and bounds, while the value of the rial has plummeted to half of what it was in mid-1993. [29]

This combination of economic instability and the insecurity of an unreformed and oppressive political system has neutralized both the tepid privatization program and free-trade zone schemes set up to attract foreign investments. No rational investor would commit capital for long-term investments under such circumstances. The worst structural distortions of Iran’s rentier economy have been exacerbated. The most important of these are, first, an ineffective taxation system which punishes the working population and private industry while practically excluding the enormous service and informal sectors. [30] The second is an industrialization strategy that continues to focus Iran’s limited investment resources on mammoth state-owned, capital-intensive industries. Nowhere has the continued affinity and shared rationality of the Islamist and monarchist states been better demonstrated than in white elephant mega-projects such as the Mubarak Steel project which, after 17 years and the equivalent of $5 billion in investments, is still incomplete; the phenomenally costly plans to turn the deserts of Khuzestan into sugarcane plantations; and the ambitious schemes to turn Iran into a major exporter of steel and aluminum, at a time when international markets for these products are in severe recession. [31] The alternative would have been to facilitate completion of more than 5,000 mostly private manufacturing and rural industry projects.


Far from encouraging national reconciliation, the economic policies of the Second Republic have led to the immiseration of the population, accelerating the delegitimization of a revolutionary state that claims to represent the interests of “the disinherited and the downtrodden.” Over the past two years, Iranian society has been increasingly divided between an isolated clerical elite entrenched within state institutions, and an increasingly disaffected population. The effective bankruptcy of the economy may even lead the Clinton administration to reconsider its “silent embargo” policy. [32] Any such reassessment would most likely be based on the realization of the grave dangers and consequences of political implosion and chaos in Iran.

Iran’s economic woes have continued and even worsened since the first five-year plan was completed in 1993. Poor political and economic leadership and management, a lack of willingness to implement meaningful political and structural reforms, and the absence of a creative vision for a long-term development strategy have led the society to a seeming impasse.


[1] It has generally been accepted that Iran had virtually no foreign debt. It was therefore quite a surprise when recently the head of the Majles Budget and Planning Committee declared that at the end of the war, the country had a $12 billion outstanding foreign “obligation.” Resalat, January 26, 1993. See Patrick Clawson, “Islamic Iran’s Economic Politics and Prospects,” Middle East Journal 42/3 (1988).
[2] The difficulties and dilemmas facing the Islamic Republic resemble those faced by other post-revolutionary societies. See Tim McDaniel, Autocracy, Modernization and Revolution in Russia and Iran (Princeton, NJ: Princeton University Press, 1991).
[3] The expression “second republic” is from Anoushiravan Ehteshami et al, War and Peace in the Gulf (London: Ithaca Press, 1991).
[4] The estimates of war casualties and damage vary enormously. For casualties see A. Cordesman and A. Wagner, Lessons of Modern War, vol. 2 (Boulder, CO: Westview Press, 1990), p. 3. The figures for material damage are from Houshang Amirahmadi, “Economic Costs of the War and the Reconstruction in Iran,” in Cyrus Bina and Hamid Zangeneh, eds., Modern Capitalism and Islamic Ideology in Iran (New York: St. Martin’s Press, 1992), pp. 260-262.
[5] President Rafsanjani quoted in Iran Times, July 21, 1989.
[6] On the industrial sector, see Houshang Amirahmadi, Revolution and Economic Transition in Iran (Albany: State University of New York Press, 1990), pp. 145-146.
[7] Amirahmadi (1990), p. 188, puts the unemployment rate at 39 percent in late 1980s. The semiofficial Iranian Higher Institute of Research in Development and Planning puts the figure at 20 percent (Iran Times, April 9, 1993), while Rafsanjani has declared the figure to be close to 11.4 percent (Iran Times, April 30, 1993).
[8] In 1978, the recorded flight of capital abroad amounted to $5 billion. See Amirahmadi (1990), pp. 23-24. In reference to the brain drain, see Shaul Bakhash, Reign of the Ayatollahs (New York: Basic Books, 1984). Iran’s foreign assets, estimated at between $11-14 billion, had been confiscated by the US government and major international banks following the seizure of US hostages in Iran.
[9] See Mansoor Moaddel, Class, Politics, and Ideology in the Iranian Revolution (New York: Columbia University Press, 1993), pp. 223-54.
[10] There are currently more than 2 million government employees (excluding the security forces), up from 800,000 in 1977 (Keyhan, May 12, 1992). According to the Organization of Employment Affairs, the productive labor of each government employee is less than one hour per day. Iran-e Farda 5 (1993).
[11] M. H. Pesaran, “Iranian Foreign Exchange Policy and the Black Market for Dollars,” International Journal of Middle East Studies 24/1 (1992), p. 105.
[12] The fall in production was due partly to nationalization of the oil industry and the subsequent loss of technical assistance and expertise, as well as serious damage to facilities caused by the war. Cyrus Bina, “Global Oil and the Oil Policies of the Islamic Republic,” in Bina and Zangeneh, pp. 126-129.
[13] Between 1978 and 1990 the consumer price index went up 600 percent while wages and salaries increased only 120 percent (Iran Times, October 16, 1992). Official subsidies formed 3-5 percent of the government budget during this period.
[14] See Sohrab Behdad, “The Political Economy of Islamic Planning in Iran,” in Houshang Amirahmadi and Manoucher Parvin, eds., Post-Revolutionary Iran (Boulder, CO: Westview Press, 1988); and Amirahmadi (1990).
[15] Under the second plan, demand and supply and market forces are expected to determine prices, interest rates, imports and exports, currency exchange value, and the value of government services. Iran Times, December 25, 1992 and March 5, 1993.
[16] Middle East Economic Digest, November 5, 1993.
[17] In February 1994, the Majles lowered expected oil revenues in the second five-year plan from $78 billion to $64 billion (MEED, February 2, 1994). In the same period, Iran will have to invest $12 billion to raise its output to 5.5 mbd. Agence France Presse, June 23, 1993 and Iran Times, July 2, 1993.
[18] Iran Times, January 8, 1993.
[19] In 1990, raw materials and intermediate goods formed 63 percent of imports, capital goods 23 percent, and consumer goods 13 percent (Ministry of Economics and Finance and IMF data).
[20] Iran Times, September 9, 1992; “Special Report: Power,” MEED, August 20, 1993; Iran Times, November 12, 1993; Ettelaat, September 4, 1993.
[21] Iran Times, September 25, 1992 and January 22, 1993. Industrial exports are projected to provide half of total export earnings within five years, according to the director of Chamber of Commerce. Iran Times, May 7, 1993.
[22] On population see Homa Hoodfar, Middle East Report 190 (September-October 1994). For a chronicle of the exchange rate “shock therapy” see Iran Times, December 4, 1993, April 16, 23 and May 7, 1993; and MEED, April 23 and 30, 1993.
[23] Iran Times, December 4, 1992; Ettelaat, October 18, 1992.
[24] Saeed Leylaz, “Nazari bar Amalkard-e Eqtesadi Jomhuri-e Eslami,” in Iran-e Farda 5 and 6 (1993).
[25] The annual number of new industrial permits issued between 1989 and 1992 were 530, 804, 1,131 and 978. These numbers show a 41 percent rise during the US-Iraq war and the temporary oil price hikes of 1990-1991, followed by a 14 percent fall when the price situation and Iran’s foreign obligations took a turn for the worse. See the Central Bank’s “Kholase-i Tahavolat-i Eqtesadi Keshvar 1371 [1993].”
[26] San‘at-e Haml-o Naql, “Tahavolat-i San‘at-i Sangin dar Ma‘raz-i Davari,” (May 1993).
[27] Salam, February 14, 1993.
[28] The Bank for International Settlement estimates Iran’s total obligations at $16.1 billion. MEED, March 4, 1994. The rescheduling of debts to Germany, Japan, Italy, France, Belgium and Russia have been reported in MEED, April 30, 1993, September 10, 1993, March 4 and 18, 1994; Agence France Presse, April 3, 1993; Iran Times, June 25, 1993, November 12, 1993 and April 8, 1994; and Resalat, April 9, 1994. Iran even obtained some new but small development loans, including a $360 million loan from Japan (Iran Times, June 4, 1993), and a total of $800 million from World Bank (Iran Times, May 21, 1993), both approved despite strong opposition by the US (MEED, April 9, 1993).
[29] “Tied economy, tied president,” Economist, July 16, 1994; and Cyrus Bina, “The Foreign Exchange Crisis and the Fragility of the Iranian Economy,” Mehregan 2/4 (Winter 1994), pp. 117-131 [Persian] [30] The service sector controls 60 percent of the GDP and consumed 41 percent of total investments in 1991, but provides only 4 percent of total taxes.
[31] “Boosting the Aluminum Market,” The Middle East (April 1993); Economic Intelligence Unit, Iran Country Study 1 (1993); Resalat, January 26, 1993; Ettelaat, October 14, 1992 and May 17-19, 1993.
[32] New York Times, July 5, 1994.

How to cite this article:

Kaveh Ehsani "“Tilt but Don’t Spill”," Middle East Report 191 (November/December 1994).

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