The Sanctions Conundrum

To the surprise of many economists, sanctions seem to be having a serious impact on the Iranian economy. With the unofficial exchange rate of the Iranian rial down by more than two-thirds since the beginning of the year, inflation approaching 30 percent, and demonstrators appearing again on the streets, the crunch is apparently awakening opposition within the ruling elite to the lame duck president (and perhaps his nuclear ambitions.)

But it doesn’t quite follow that the sanctions are succeeding. The Iranian economy was a mess before the sanctions began to bite, which makes it difficult to untangle their effects from the impact of ongoing mismanagement. Moreover, success requires a negotiated end to Iran’s nuclear ambitions, and it’s unclear whether sanctions will weaken the regime’s resolve or serve as a rallying point for anti-Western paranoia. Last but not least, it’s important to remember that trade and investment sanctions are, by their very nature, scattershot weapons. They will be felt less by Iran’s military-ecclesiastical complex than by ordinary people.

Social scientists have generally been skeptical about the value of international economic sanctions. And for good reason: Their track record is mixed, at best. The classic analysis, made by 1997 by Gary Hufbauer and colleagues at the Peterson Institute for International Economics, concluded that sanctions were successful roughly one-third of the time, with better odds if the goals were modest — i.e. if the goal was practical policy change rather than regime change. But that figure was considered too conservative by Robert Pape, a political scientist now at the University of Chicago, who reviewed the Hufbauer findings and decided that only four percent of the cases had been successful.

Note, moreover, that "success" is a term of art, with ideology, politics and economic interest muddying the waters in most cases. Take the example of U.S. sanctions against Cuba. Though in place for more than half a century, they have obviously not toppled the Castro government. Nor, with hindsight, did they ever have much chance of felling Castro, since Cuba never lost its ties with Europe, Canada, and most of Latin America. Indeed, sanctions may have entrenched hardliners by making it easy to blame Cuba’s economic woes on outsiders.

Sanctions have a way of making both the left and right uneasy. The Left object because sanctions are often directed against anti-Western popular governments, and are likely to produce a lot of collateral damage. The Right doesn’t like sanctions because trade and investment are thought to be liberalizing influences in the long run, and because they often hurt Western exporters. That’s why Richard Nixon opened the door to China — or at least how conservatives rationalized the policy reversal after the fact.

That said, what do we know about the impact of sanctions on Iran? In many ways, the country seems the ideal target. More than 80 percent of its exports consist of oil. And while petroleum is an anonymous commodity that is typically shipped on supertankers registered under shadowy flags of convenience (Panama, Liberia, and even Tuvalu), the West does have the means to disrupt the trade. Supertankers need insurance to operate, and, in the wake of the European Union’s decision to enforce sanctions, the only insurers willing to cover tankers transporting oil from Iran seem to be an Iranian company with modest financial credibility and, for the moment, government-backed insurers in Asia.

Probably more important, as a practical matter purchasers must use electronic means to transfer the tens of millions of dollars needed to buy a single tanker’s-worth of oil. And with the European Union on board, they can no longer use the dominant Brussels-based SWIFT bank consortium to facilitate those transfers.

Good, but not perfect. Iran did manage to sell 1.2 million barrels per day in August, mostly to Asian countries tempted by the price discounts and easy credit offered by Tehran. That’s up from 940,000 daily barrels in July, the month the European Union’s embargo went into effect — though way down from the 2.5-3.0 million barrels that Iran has the physical capacity to export after accounting for domestic use. What’s still unclear is whether Iran can build on that 1.2 million barrel figure. There’s never been a shortage of customers for the oil in Asia (and Latin America), provided it’s sufficiently discounted. The big question is whether Iran can patch together robust mechanisms that bypass both SWIFT and Western insurers.

All this, it is important to remember, is taking place in the context of an Iranian economy that has been underperforming for decades. GDP per capita (in terms of purchasing power) exceeds $13,000, and it has grown at an average rate exceeding four percent for two decades. But those seemingly ample numbers mask a host of problems.

Oil revenues have (at least until a few months ago) sustained a decent standard of living, and poverty is down sharply since the era of the Shah. However, the Islamic Republic has not been able to diversify its exports or to build an efficient industrial base. Nor has it been able to employ the flood of youth entering the job market: Double-digit unemployment seems to be a permanent fact of Iranian life.

Privatization of state-owned enterprises, begun in earnest after the 2009 elections, might have led to competition among large businesses, and perhaps an industrial sector efficient enough to hold its own against imports. But market efficiency didn’t mesh with President Mahmoud Amadinejad’s plans to reward his allies in the Republican Guard with sufficient shares to control most of the privatized businesses. Socialism has merely been replaced by a form of state capitalism in which the groups with real power — the mullahs and the military — have a big stake in preserving business as usual.

The economy is also suffering from the inefficient means chosen by the mullahs to redistribute income to the bottom half of the population: loosely targeted food and fuel subsidies that keep domestic prices far below world prices and encourage profligate consumption. As a result, Iran is burning one-third of its oil production on its own. Sweeping reforms, imposed by the Ahmadinejad government in 2010, that raise fuel prices (while holding the poor harmless) should increase productive efficiency in the long run. But for now, they have only given the urban middle class more to be angry about, and added to inflationary pressures already building thanks to jolting declines in the exchange value of the currency.

That suggests some interesting comparisons with Cuba. Both the Cuban and Iranian economies are badly mismanaged. And the autocratic governments of both claim that the problems are the work of foreign enemies, offering them a way to build popular support for not-very-popular regimes. But there are two big differences: The Iranian administration has far more to lose than Cuba by hanging tough, and far less to lose by negotiating change.

Much, then, turns on the way the politics play out within Iran — and on the pressure the United States and the European Union are prepared to direct against energy-short Asian governments that are always in the market for cheaper oil. For better or worse, it’s also a striking opportunity to test whether global financial integration is making it easier to enforce sanctions.