Bourse and Bazaar | Djavad Salehi-Isfahani: 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).
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.