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5 obstacles to Khamenei’s call for ‘boost in domestic production’

While the Iranian supreme leader’s emphasis on domestic production in the face of external sanctions makes a certain amount of sense, the question is how such a strategy should be implemented — and in which sectors of the economy.
An Iranian technician works at a production line of carmaker Iran Khodro, west of Tehran February 6, 2016. REUTERS/Raheb Homavandi/TIMA  ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY. FOR EDITORIAL USE ONLY.   - GF10000298282

 Supreme Leader Ayatollah Ali Khamenei says this is the Iranian year for “boosting production.” This is a welcome slogan for an economy facing numerous challenges, particularly unemployment and pressure on its export performance due to external sanctions. There is no doubt that an expansion of domestic production capacities would have a positive impact on the Iranian economy. However, when looking at some of the realities of how the country’s economic activities are governed, it becomes clear that the planned increase in production is easier said than done.

In his annual Nowruz speech March 21 in the holy city of Mashhad, Khamenei acknowledged some of the impediments, but none of the top leaders in Iran have ever offered genuine remedies for actually removing these obstacles. In order to understand what reforms are needed to address these issues, it is necessary to review the realities the country is facing in the Iranian year that began on the day of the supreme leader's speech.

The first question is what specific areas of domestic production should be boosted. Iran does not have a clear plan as to which sectors to concentrate on in order to benefit from the country’s competitive advantages. In his speech, Khamenei said, “Industrial and agricultural production, stockbreeding, developing large, medium-sized and small industries and even developing handicrafts, homemade products and animal husbandry — breeding livestock in villages — will greatly help the expansion of public welfare in societies.” He added, “Of course, knowledge-based companies play a big part in this regard. They should receive due attention.”

One of the country’s largest sectors is the automotive industry. However, it produces low-quality vehicles that cannot compete against imported cars. This does not seem the place to start.

Step one in a serious strategic plan to boost domestic production would be to decide which sectors authorities should concentrate on. In fact, in terms of employment, Iran would almost certainly be better off promoting services (especially tourism), agriculture and construction rather than wasting massive resources on low-efficiency industries. In the past decade, there has been a focus on promoting natural gas-based industries, which is a logical extension of the country’s massive natural gas resources, but such policies mainly benefit the governmental and semi-state sectors, whereas the government’s stated goal is to create additional employment opportunities by promoting the private sector.

Second, a healthy and balanced development of domestic industry requires a sustainable set of government policies, including exchange rate, trade and taxation policies. The track record of the Iranian government in sustaining related policies is very poor. A recent survey of the business climate points to the instability of government policies as a major impediment in doing business. Khamenei did acknowledge that parts of the current economic difficulties stem from “our internal shortcomings and our own managerial weaknesses.” This is an important admission that should pave the way for introduction of reforms. He said the US sanctions regime offers opportunities for reform because when “countries that benefit from natural resources such as oil see their revenues decrease, they think of implementing economic reforms.” This indicates that major reforms relating to the business climate are needed.

Third, expanding the private sector requires financial resources; while these should come from a dynamic banking sector, at present Iran’s banks are under severe stress and too busy catering to the state and semi-state companies, thereby neglecting the private sector. Khamenei, saying “the problem related to the banking system” is one of the country's economic challenges, added, “If liquidity does not receive attention, this will deliver a blow. However, if it is managed efficiently and guided toward investment, … it will develop the economy.” The core issue is that capital resources are not used efficiently, mainly because the opaque political structure and economy of patronage both waste resources on rent-seeking. As such, serious reforms in the banking sector will have to be accompanied by political and structural reforms, especially addressing corruption and rent-seeking.

Fourth, private entrepreneurs need to feel safe in their economic activities. The fact is that the opaque political and economic structures in Iran present a major risk to genuinely private businesses. The feeling among private entrepreneurs is that there is a threshold up to which they can grow. Beyond that threshold, private businesses have to be taken over by semi-state institutions. Unfortunately, a large number of private entrepreneurs have either been forced to leave the country or have landed in prison facing fabricated charges. Mohammad Reza Nematzadeh pointed to this limitation in a 2017 speech when he was minister of industries, mining and trade. Such uncertainty limits the potential in building capacities by the private sector. Addressing this impediment will require major judicial and political reforms and a genuine push against corrupt networks. In his speech, Khamenei listed a number of corrupt practices and urged the “executive branch, the judiciary and other supervisory organizations” to “watch over the matter.” However, it is important for the supreme leader to appreciate that political reforms are a prerequisite for the “support of honest entrepreneurs.”

Fifth, one of the issues plaguing the Iranian economy is smuggling, which severely undermines domestic production. Unfortunately, the level of smuggling increases when the country is put under severe external sanctions. Khamenei refers to “curbing unnecessary imports” as one of the needed instruments. However, one fact driving unnecessary imports as well as smuggling is the existence of powerful networks whose entire business concept is based on imports, and especially on taking advantage of the massive differential between the official exchange rate and the free market rate. Experts have no doubt that the current foreign exchange policies are only feeding corrupt practices. The question is why the authorities are taking so long to do something about it. At the same time, the push for imports is so strong that even the unavailability of hard currency for imports won’t stop such interest groups. For decades, whenever the official sources of hard currency were tight, Iranian importers used the export of carpets and basic commodities to generate hard currency for their lucrative imports. By doing so, they not only did not stop imports, but also ruined export markets for some key Iranian products such as Persian carpets. Therefore, as long as such opaque interests are not addressed, domestic production will be exposed to the risk of cheaper imports and smuggled goods.

There is little doubt that Khamenei genuinely wishes to see an expansion of domestic capacities. In his own way, he admitted that reforms are needed when he said, “If there is a need for certain laws, the [authorities] should ask the parliament to take action. If there is a need for the presence of the judiciary branch and other supervisory organizations, they should ask them to take action and to cooperate.” However, the Islamic Republic would be better off to name this year as the one “to fight corrupt networks” and then get down to serious political and structural reforms. Otherwise, the economy will continue to suffer and remain well below its potential. 

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