During the last 20 years, the Iranian economy has had to adjust to a revolution, an eight-year war with Iraq, economic isolation and the collapse of its oil revenues. As a result, Iran witnessed the complete undoing of its gains in per capita income from the boom years of the 1970s. The generation of Iranians who grew up before the revolution, at a time of steadily increasing incomes, view the last 20 years of decline and stagnation with disbelief. For the new generation, which came of age after the revolution, the pressing issue is not past losses but the current reality of stagnation and unemployment: One in four Iranian youths cannot find jobs. If current growth rates remain static, it will take 30 years before this generation’s standard of living can compare to that enjoyed by their parents.
President Khatami’s election two years ago was partly a response to the needs of the new generation and the disappointments of their elders. Although he has made progress toward establishing the rule of law and “civil society,” Khatami has struggled to create more jobs and to revitalize Iran’s economy. Each year approximately 800,000 new workers enter Iran’s labor market. Who will invest sufficiently to employ all these new job seekers?
Khatami’s political survival depends on his ability to answer this pressing economic question. Ten years ago he might have relied on government employment, but given the poor performance of the state-dominated economy in post-revolution Iran, the collapse of central planning in the Soviet Union and Eastern Europe and the success of the East Asian countries’ market-led growth, statist solutions are not Khatami’s first choice. While maintaining their ideals of social justice, new progressive forces — whether Islamic or secular — must accept the role of markets and private enterprise in economic growth more than their predecessors did during the Shah’s rule. 
In 1989, President Rafsanjani launched a pro-market reform program that had widespread support in Iran, largely because it did not involve the international financial institutions that usually champion the cause of free markets in less developed countries.  At the time that restructuring was being debated elsewhere, Iran’s foreign debt was too low to occasion visits by the IMF and the World Bank. Indeed, when these institutions did briefly appear on the scene in 1992-1993 in support of Iran’s reforms (before President Clinton halted their involvement in Iran), they proved a liability for Iranian reformers. Support for reforms among Iran’s top policymakers stems primarily from the state’s inability to continue underwriting the losses of a huge proportion of Iran’s enterprises while also paying for social programs it has shouldered since the revolution.
President Khatami’s political posture vis-à-vis market reforms provides further evidence of an evolution in economic thinking. As a founder of the leading leftist clerical group opposed to Rafsanjani’s reforms a decade ago, Khatami now promises to continue them, including the privatization of public enterprises.  So far, Khatami has managed to maintain a balance between his desire for reform and his commitment to social justice; he has spoken of the need for incentives for private investment and the primacy of social equity over growth. Khatami is trying to claim a middle ground that encourages growth without sacrificing “the dignity of the people.” Despite dire investment needs, he has promised to continue subsidizing food, fuel and medicine until reliable programs are developed to serve as a social safety net.
The real test of Khatami’s willingness to move in the direction of market reform will come if and when he tackles labor market reform. A large share of public sector workers (30 percent) and stiff regulations guaranteeing job security characterize Iran’s rigid labor market. To encourage the purchase of state-owned enterprises and new investments, the government must promote a more flexible labor market responsive to the logic of private enterprise. This will entail a further political shift for Khatami, since labor market rigidity stems from the revolution’s anti-capitalist tendencies, as well as from the political power workers gained during the revolution. The primary challenge will be the reformation of the existing labor law. Although labor issues did not figure prominently in Khatami’s initial statement of goals, they are certain to dominate coming legislative debates. 
The rigid structure of Iran’s economy rendered the country highly vulnerable to the oil shock of the 1980s. The shock caused a dramatic drop in real oil revenues per person to one tenth of their value twenty years earlier, representing a devastating blow to an economy that, at its peak, depended on oil revenues for 95 percent of exports and 80 percent of the budget. Economic restructuring would make Iran less vulnerable to volatility in world oil markets while increasing employment and promoting non-oil exports.
During the 1980s, Iran’s economic structure resembled that of a centrally planned economy (without the central planning). As a result of confiscation shortly after the revolution, nearly every major banking, industrial and service institution came under government control. These number about 2,000 firms, as well as 4,000 related enterprises.  As an indication of their size, the budget of the 404 largest public firms amounted to 38.3 percent of the GDP in 1996-1997,  representing a significant strain on the public purse since they regularly lose money despite subsidies.  Subsidy reductions following the Rafsanjani reforms of 1989 shifted these losses to the public budget and the banks. The share of public firms in the general budget increased from 53 percent in 1989 to 67 percent in 1996, and their borrowing from banks increased from 8 percent of all bank lending to 30 percent during the same period.
A significant portion of the property confiscated for political reasons in 1979 came under the control of the Bonyad Mostazafin (Foundation for the Disinherited), which is accountable only to the Supreme Leader, Ayatollah Khamenei, but not to the government. The extent of Bonyad’s ownership is unknown, leading many to exaggerate its power, even to the point of calling it a rival government. The Bonyad claims ownership of 400 companies in all sectors of the economy with annual sales of $3.5 billion.  As the largest conglomerate in Iran, it is a formidable economic force. Its opposition to many aspects of Rafsanjani’s reform program, especially those that aimed at raising the price of foreign exchange and credit to its holdings, slowed the pace of reform. The Bonyad is unlikely to oppose labor market reform because it stands to benefit from it.  The Bonyad reported that 80 percent of its companies lost money in 1997, but their losses were more than offset by their profitable ventures.  The Bonyad’s losses would be much greater were it not for the implicit subsidies it receives from access to official rates for foreign exchange and credit.
Economic restructuring also requires reducing direct subsidies while allowing market prices to influence demand. Food, medicine and fuel subsidies amount to about 8 percent of the GDP and 30 percent of the government budget. A few cents can buy a loaf of bread, a gallon of kerosene, or a bottle of antibiotics. Subsidies have been effective in containing poverty at a time of economic decline, so their removal would be politically sensitive.  As with all general subsidies aimed at the poor, though, Iran’s delivery system is very inefficient. Estimates indicate that at least half of all subsidies go to those who do not need them. The impact of subsidies is evident in figures indicating that per capita private consumption has remained steady despite a sharp drop in real wages. The decline in income per capita is mirrored in investment more so than in consumption: Investment’s share in GDP declined from about 25 percent in the mid-1970s to 15 percent in the 1990s. Thus, Iran’s post-revolution adjustment policy has protected private consumption at the expense of investment.
Following the war with Iraq, and after two years of very low oil revenues in 1988-1989, Iran’s rulers realized that the resource needs of reconstruction were completely at odds with the huge obligations shouldered by the government since the revolution — social expenditures and losses of state enterprises. The Islamic leadership was forced to reconsider its policies, from population to economy. The budget deficit had grown to nearly 45 percent of expenditures, up from 10 percent in 1979. In 1989 the Rafsanjani administration embarked on a program of structural reforms to reduce the role of government and increase the role of the market. 
The first Five-Year Development Plan (1989-1993) called for privatization and removal of price controls. The two parts of the reform program were finely intertwined: Privatization entailed market reform. The myriad of subsidies enjoyed by public firms made it impossible to determine their worth once cut off from the public purse. To better evaluate the worth of public enterprises, the reforms called for increased “transparency” of economic transactions, making implicit subsidies explicit (as in payments from the budget). The biggest step in this direction was the reform of foreign exchange and credit markets. In 1989, there was a twenty-fold difference between the black market rate and the official rate of exchange for the rial,  and real interest rates were around -5 percent.  Perhaps because of its far-reaching impact, the reform program came under increasing criticism and was practically abandoned in 1995. Privatization stopped and the system of multiple exchange rates was reinstated. Real interest rates, which had, for a brief period, been positive, turned negative again. President Khatami promised to continue the Rafsanjani reforms, so the third Five-Year Development Plan now being drawn up must find answers to the same questions raised in the first plan.
The Role of Labor in Restructuring
Iran’s working class has much at stake in privatization, a larger role for the market, the removal of subsidies and the reorientation toward exports, both because of the potential loss of real wages as well as the promise for economic growth. Because workers lack an independent and unified voice, however, it is difficult to determine labor’s stance toward restructuring. The semi-official organization, Khaneh Kargar (House of Workers), which acts as a labor lobby and publishes the daily newspaper, Kar va Karegar (Work and Workers), supports Khatami, yet remains adamantly opposed to any changes that might diminish job security. Although workers have lost much of the power they gained at the time of the revolution,  anti-capitalist sentiments prevail inside and outside the government. Workers’ desires for job security and the economy’s need for flexibility constitute the horns of the political and economic dilemma confronting any progressive force in Iran.
Rapidly rising wages in the 1970s were the result of an increase in the price of oil rather than an increase in productivity. The same figure also shows that the real wage index for the large industrial establishments, where one would expect more rigidity, fell in harmony with wages in the more competitive construction labor market. In contrast, employment in the formal sector is more rigid. Following the oil price collapse of 1986, industrial output fell by 32 percent while employment declined by only 6 percent. To achieve a new production structure in accordance with the reduced inflow of foreign exchange, some firms must be able to cut their workforce while others expand. This requires that appropriate market signals, especially the foreign exchange rate, guide reallocation of resources while a flexible labor market permits the necessary reallocation of labor.
Due to heavy government intervention, in the form of direct employment and regulation, Iran’s labor market lacks this flexibility. In 1995, government employees numbered 1.6 million (excluding oil and defense), or roughly 12 percent of all employment, i.e., twice as many as in 1979. The state employment law guarantees lifetime employment. Other workers, whether employed in public or private enterprises, fall under the protection of the labor law of 1990.  Relative to the 1959 law, the new law increased job security and is more rigorously enforced.
The labor law is progressive in its recognition of workers’ rights to organize (Article 131) and to bargain collectively (Article 139). It outlaws employment of workers under the age of 15 (Article 79), allows for paid maternity leave and stipulates feeding time and daycare services at the workplace (Article 76). It also requires major employers to provide workers with housing, sports facilities and training. However, by shifting the burden of employee welfare to employers, the law increases labor costs and discourages employment, particularly of women. If the law’s provisions were to be fully enforced, labor costs would rise to such high levels as to deter all investors. In most other countries some of these costs are borne by the government and others by workers themselves.
The main drawback of the labor law is its attempt to legislate job security. Dissolution of the work contract without cause is only possible within the first month for unskilled and the first three months for skilled workers (Article 11). In particular, the law does not recognize poor performance as grounds for dismissal, but employers can obtain permission for dismissal on such grounds from the government-appointed labor councils (Article 27). Employers who fail to obtain prior approval risk fines and will be forced to reinstate the employee if his or her appeal is successful.
Jobs of fixed duration are exempt from this provision of the law. To prevent employers from turning permanent jobs into a series of temporary contracts, the law requires ministry approval before any job is classified as fixed term. However, the difficulty of enforcing this rule permits many employers to offer their workers contracts of 29 or 89 days in duration. Some employers — among them some government ministries and the Tehran municipality — maintain contract flexibility by encouraging workers to sell their labor through a service company or a cooperative.  Ironically, by attempting to increase job security, the labor law has in fact done the opposite: Even employers who would otherwise prefer long-term contracts (which encourage workers to invest in job-specific human capital) may opt instead for short-term contracts.
These provisions constitute the greatest obstacle to privatization in Iran. The law stipulates that no change in the legal status of the firm can void the labor contract, so buyers of public enterprises will be stuck with the excess labor force, which could be as high as 30 percent. 
Successful restructuring does not require unfettered labor markets free of all regulations. Government regulation of the employer-employee relationship is important for social, moral and economic reasons. Because the poor are usually highly risk-averse, asking them to shoulder the entire burden of job displacement may lead them to withdraw from the labor market entirely. Publicly administered social safety nets and employment insurance programs can therefore promote economic restructuring and growth. Direct supervision of the employment relation, though it may increase the job security of those already employed, does not benefit all workers equally and, more importantly, creates adverse incentives for worker effort and human capital accumulation.
The labor law recognizes two types of worker organizations: Islamic societies (anjoman eslami), whose purpose is to further Islamic culture in the workplace (Article 130), and guild societies (anjoman senfi), which serve workers’ interests (Article 131).  Although the law does not explicitly call the latter “unions” (etehadieh), they can function as such. Guilds can organize nationally, but their duties are limited to enforcing the law and any disputes between employees and employers must be mediated through the Ministry of Labor and regional labor councils. The labor law does not address workers’ right to strike, except to state that in the case of a dispute, the government intervenes to resolve it or, failing that, administers the unit at the employer’s expense (Articles 141-142). Trading legal protection for autonomous worker organizations will not only benefit workers, it will also further Khatami’s objective of moving toward “civil society.”
The Islamic revolution began 20 years ago espousing anti-capitalist and pro-government ideologies and benefiting from abundant foreign exchange. The regime moved quickly to control the economy and institute expensive social programs. It has taken more than ten years, since the oil price collapse, for the regime to realize that the economy cannot grow beyond its present impasse unless the state loosens its control of the economy and reduces its social spending. The political obstacle to privatization, replacing the general subsidy program with a social safety net and reducing labor market rigidity, is formidable but not insurmountable. President Khatami enjoys considerable popularity because of his bold social agenda for a more open society. The question is whether he can forge a winning strategy that advances his social objectives while instituting economic reforms.
 The most popular and anti-establishment Tehran newspapers, Hamshahri and Salam (as well as Jameeh and Tous, before they were closed down), appear to favor pro-market reforms. During the early years of the revolution, anti-imperialism and anti-dictatorship implied anti-market and anti-capitalist sentiments, but this is no longer true.
 Tabibian, an architect of the reforms, rejects the charge leveled by reform critics that they were inspired by the IMF and the World Bank. See Mohammad Tabiban, On the First and Second Development Plans (Tehran: Institute for Research in Planning and Development, 1996). [Persian] This article was serialized in the Tehran daily Hamshahri in 1996.
 Khatami’s political dilemma is reflected in his choice of cabinet posts for economic affairs: The Plan and Budget Organization is under the control of the pro-market reformists, while the Ministry of Economic Affairs is controlled by his “leftist” associates.
 A high official of the Plan and Budget Organization has called the labor law “the largest obstacle to creating employment,” Iran Times, November 6, 1998.
Iran Times, October 16, 1998.
 Hassan Khoshpour,“An Analysis of the Performance of Public Firms and Privatization Policies,” in M. Nili, ed., The Iranian Economy (Tehran: Institute for Research in Planning and Development, 1997). [Persian]  A high official of the Plan and Budget Organization, quoted in Iran Times, October 30, 1998.
 See the Bonyad’s web page.
 In 1993 the manager of a luxury hotel owned by the Bonyad, complained of overstaffing but could not lay off any workers for fear of the labor law. In one instance, he had agreed to pay a disgruntled employee his salary on the condition that he would only show up once a month to collect it!
 Hamshahri, November 30, 1998.
 Since the revolution infant mortality has decreased from 122 per thousand in 1976 to 36 in 1996, and consumption of bread and rice per head are up by 50 percent and 95 percent, respectively.
 Masoud Nili, “An Analysis of the Performance of the Structural Adjustment Policies” in Nili, op cit, pp. 361-444.
 M. H. Pesaran, “Economic Trends and Macroeconomic Policies in Post-Revolutionary Iran,” in P. Alizadeh, ed., State and Development: The Case of Post-Revolutionary Iran (London: I. B. Tauris, forthcoming).
 Seyyed Ahmad Reza Jalali-Naini, “A Look at Inflation and Monetary, Foreign Exchange and Credit Policies” in Nili, op cit.
 See Asef Bayat’s “Workers’ Control After the Revolution” MERIP Reports 113 (1983) and Workers and Revolution in Iran (London: Zed Books, 1987).
 The conservative Council of Guardians opposed this controversial ruling after Parliament had approved it; the law was eventually passed in the adjudicating Expediency Council.
 To close this loophole, the labor law requires employers “to write their service contracts in such a way as to commit the contractors to treating its workers according to the law” (Article 13).
 Buyers were willing to pay only the book value of a company because, anticipating its continued lack of profitability, they would not lose if they declared bankruptcy and sold off its assets.
Each unit must decide on one of these two options (not both), or simply elect a representative, then register its choice with the local labor office.