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The Political Economy of Credit Subsidy in Iran, 1973–1978

Published online by Cambridge University Press:  29 January 2009

Djavad Salehi-Isfahani
Djavad Salehi-Isfahani
Affiliation:
Department of EconomicsVirginia Polytechnic Institute and State University
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Extract

During the last decade of the Pahlavi rule in Iran, rising oil income financed a very extensive development program in which both the state and the private sector accumulated huge amounts of wealth in real and financial capital. Having no direct access to the oil riches, the private sector accumulated much of its new wealth by direct and indirect subsidies from the government. Through various mechanisms, the state channeled resources to the private sector in an attempt to foster capitalist development of the country. While the strategy was successful insofar as it resulted in massive investment by the private sector, it was not without its ill side effects. This article is a study of the consequences, both intended and unintended, of one specific conduit for resource transfer—credit subsidy.

Type
Articles
Information
International Journal of Middle East Studies , Volume 21 , Issue 3 , August 1989 , pp. 359 - 379
Copyright
Copyright © Cambridge University Press 1989

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References

NOTES

Author's note: For comments on an earlier draft of this article, I would like to thank, without implicating, Ahmad Ashraf, Houchang Chehabi, Vahid Nowshirvani, Hashem Pesaran, Arthur J. Vidich, the editor, and the referees.

1 This aspect of the shah's style of rule is emphasized in Zonis, Marvin, The Political Elite of Iran (Princeton, N.J., 1971), especially chs. 2 and 4;Google Scholar and in Fatemi, Khosrow, “Leadership by Distrust: The Shah's Modus Operandi,” The Middle East Journal, 36, 1 (1982), 48–62.Google Scholar In the context of economic planning, the shah's insistence on making detailed decisions himself is blamed for the unhappy outcome of planning in Iran by Razavi, Hossein and Vakil, Firouz, The Political Environment of Economic Planning in Iran, 1971–1983 (Boulder, Colo., 1984).Google Scholar

2 Katouzian, Homa, The Political Economy of Iran (New York, 1981), p. 266.CrossRefGoogle Scholar

3 Pesaran, M. H., “Dependent Capitalism in Pre- and Post-Revolutionary Iran,” International Journal of Middle East Studies, 14, 4 (11 1982), 501–22, here 510.CrossRefGoogle Scholar

4 Bashiriyeh, Hossein, The State and Revolution in Iran 1962–1982 (New York, 1984), p. 42.Google Scholar

5 Ibid., p. 48.

6 Looney, Robert, Economic Origins of the Iranian Revolution (New York, 1982);Google ScholarKeddie, Nikkie R., “Oil, Economic Policy, and Social Conflict in Iran,” Race and Class, 21, 1 (Summer 1979), 13–29.CrossRefGoogle Scholar

7 Looney, Economic Origins, ignores this important point when he argues that the government should have played a smaller role in investment. Taking a standard supply-side view, he asserts that public sector expansion had a “strong negative impact,” and blames the government for “bidding away… resources from the productive private sector” (p. 136).

8 To avoid repetition, unless otherwise noted, all data are from Bank Markazi Iran, Annual Report and Balance Sheet, various years.

9 Mahdavi, Hossein, “Patterns and Problems of Economic Development in Rentier States,” in Cook, M. A., ed., Studies in the Economic History of the Middle East (London, 1970), p. 441.Google Scholar See also Baldwin, George B., Planning and Development in Iran (Baltimore, 1967), p. 105 and pp. 121–22;Google ScholarAmuzegar, Jahangir, Iran: An Economic Profile (Washington, D.C., 1977), p. 247, who describes the economic system as “private enterprise assisted by the state.”Google Scholar

10 About 85 percent of the commercial bank lending was less than one year and almost all were less than five years in duration, according to Shirvani, Hassan M., “A Flow of Funds Model of the Iranian Economy and its Implications, 1961–1975,” Ph.D. dissertation, Dept. of Economics, Harvard University, 1978, p. 117.Google Scholar

11 Ibid., p. 100.

12 Ibid., p. 125.

13 For a history of development banking in Iran, see Benedick, Richard E., Industrial Finance in Iran (Cambridge, Mass., 1964);Google Scholar Baldwin, Planning; Shirvani, “Flow of Funds.”

14 Bank Markazi Iran, Annual Report, 1977/78, p. 53.

15 Benedick, Industrial Finance, p. 151 and Table 2.

16 Ibid., p. 126.

17 Shirvani, “Flow of Funds,” p. 100.

18 Bank Markazi Iran, Annual Report, 1974/75, p. 57 (in Persian). This was billed as an anti- inflationary measure, but a story told by Central Bank officials—which, if not more true, is certainly illustrative of economic decision-making under the shah—links the decision to lower interest rates at a time when demand for money was exploding to a similar decrease in European interest rates. The shah ordered the decrease, so the story goes, after a few top businessmen lobbied him for it, noting that following suit was fitting, given His Majesty's proclamation that Iran was about to catch up with Western Europe.

19 According to Shirvani, “Flow of Funds,” p. 99, the announced reason for interest rate ceilings was not subsidy but to fight inflation.

20 For a brief account of the operation of the unofficial credit market in Iran, see Amuzegar, Economic Profile, pp. 137–38.

21 More precisely, the real rate equals (i — p)/(1 + p), where i is the nominal rate and p is the rate of inflation.

22 This is consistent with other information which indicates that specialized banks often lent at interest rates below the maximum. For example, interest on loans to agriculture were sometimes as low as 2 percent (ADB, Annual Report, 1976/77, p. 13).

23 Benedick, Industrial Finance, p. 154, reports interest on IMDBI loans in the early 1960s to have been 7.5 percent, which with the addition of a 2.5 percent service charge brings it to 10 percent.

24 According to Bharier, Julian, Economic Development in Iran 1900–1970 (London, 1971), pp. 81–82, in comparison to the earlier period, the late 1960s was a period of cheap credit. He notes that Iran has always been a country of “dear money” because, “short term rates were rarely granted at annual rates of less than 10–15 percent for the first-class signatures, and long term loans at less than 15–20 percent. Less reliable signatures were charged three to four times these rates.” These observations further underline the low cost of credit in the 1970s.Google Scholar

25 Selowsky, Marcello, Who Benefits from Government Expenditure? A Case Study of Colombia, World Bank Research Publication (London, 1979), pp. 144–46.Google Scholar

26 The 1977/1978 figure is from Basseer, Potkin A., “The Role of Financial Intermediation in Economic Development: The Case of Iran, 1968–1978,” Ph.D. Dissertation, Graduate School of Business Administration, George Washington University, 1983, p. 189, who also quotes Bank Markazi as the source.Google Scholar

27 These estimates of grant values are indications of potential rather than actual transfer because the actual profitability of the projects may have turned out to be different from what is indicated by the market (bazaar) rate of interest.

28 The existence of political influence in the lending process is, by its nature, difficult to document, but it has been confirmed to me in interviews with several officials of the previous regime, including the general managers of two development banks.

29 Bank Markazi, Annual Report, 1977/78, p. 54.

30 ADB, Annual Report, 1977/78, pp. 5–6.

31 Economists ascribe this to imperfection of the credit market due to asymmetry of information. The probability of default is known better to the borrower than to the lender. The lender knows that the risk involved in a particular loan increases with the interest rate charged on it. This prevents the lender from increasing the rate of interest on a risky loan indefinitely without affecting the risk of default. As a result, some loans, or some individuals, would be judged as ineligible for credit. Banks routinely screen candidates to evaluate the risk, but if a project is found too risky, rather than charge a higher rate they often decide to refuse credit altogether. For more details see Stiglitz, Joseph and Weiss, Andrew, “Credit Rationing in Markets with Imperfect Information,” American Economic Review, 71, 3 (07 1983), 393–41.Google Scholar

32 See, for example, Abrahamian, Iran Between Two Revolutions, p. 498; Looney, Economic Origins, goes so far as to say, “the anti-profiteering campaign… sowed the seeds of distrust and resentment of the government by the bazaar” (p. 167).

33 The link between granting of credit to enterprises and the social position of the owners is based on the fact that, unlike in the industrialized countries, there was (and still is) very little difference between ownership and management of the firm. Even the largest private firms were family owned. See Richardson, P., “Understanding Business Policy in Iran,” Journal of General Management, 4, 3 (Spring 1979), 42–53.CrossRefGoogle Scholar

34 Here are some examples: Ashraf, “Historical Origins,” ‘traditional’ vs. ‘modernized’ or ‘comprador’ Bill, The Politics of Iran, ‘bourgeois middle class’ vs. ‘industrial upper class’ Pesaran, “Dependent Capitalism,” ‘traditional’ vs. ‘dependent’ (in the sense of being dependent on the court and the bureaucracy); Abrahamian, Iran Between Two Revolutions, pp. 432–34, ‘upper class’ and ‘propertied middle class’ idem, “The Constitutional Revolution,” p. 394, ‘national’ vs. ‘comprador’. The Iranian Left has generally used the terms ‘national’ and ‘petty bourgeois’ vs. ‘comprador’ and ‘dependent’.

35 For more detail on the characteristics of these strata see Bonine, Michael, “Shops and Shopkeepers: Dynamics of an Iranian Provincial Bazaar,” in Bonine, M. E. and Keddie, N. R., eds., Continuity and Change in Modern Iran (Albany, N.Y., 1981);Google ScholarFischer, Michael M. J., “Persian Society: Transformation and Strain,” in Amirsadeghi, Hossein, ed., Twentieth Century Iran (New York, 1977), 171–95;Google Scholar Abrahamian, Iran Between Two Revolutions, pp. 432–33; the interview with Ashraf, Ahmad, “Bazaar and Mosque in Iran's Revolution,” MERIP Reports, 13, 3 (03–04 1983), 16–18.CrossRefGoogle Scholar

36 The extent of this proximity is difficult to ascertain, but most authors think that the relationship was close and cultivated: “Almost all major industrialists in the private sector were hand-picked for their loyalty to the Pahlavi regime and were backed by members of the royal family and the court either directly or indirectly through the machinery of the Pahlavi Foundation,” Pesaran, “Dependent Capitalism,” 510. See also Bill, James A., The Politics of Iran: Groups, Classes and Modernization (Columbus, Ohio, 1972), pp. 10–11.Google Scholar

37 According to Bashiriyeh, State and Revolution, p. 40, the “upper bourgeoisie” consisted of no more than 150 families, and out of 473 largest private enterprises 370 were owned by only 10 families. Bill, The Politics of Iran, also states that “the so-called ‘thousand families’ have at no times totaled more than one or two hundred” (p. 9). Abrahamian puts the number of the upper class at one thousand individuals, Iran Between Two Revolutions, p. 432.

38 This is echoed in Ashraf, “Bazaar and Mosque,” p. 16.

39 Abrahamian, Iran Between Two Revolutions, p. 60.

40 Bashiriyeh, State and Revolution, p. 40.

41 As exemplified by his official campaigns to unveil women and make men wear European-style hats, and by the building of avenues through the bazaars. See Bonine, “Shops and Shopkeepers,” p. 205.

42 Ashraf, Ahmad, “Historical Obstacles to the Development of a Bourgeoisie in Iran,” in Cook, M. A., ed., Studies in the Economic History of the Middle East (London, 1970), p. 331.Google Scholar See also his extensive treatment of the development of the bourgeoisie during the Qajar period in Ashraf, , Mavan-e tarikhiy-e roshd-e sarmayedari dar Iran: Dowreh e Qajar (Tehran, 1980).Google Scholar

43 For a detailed account see Ashraf, A. and Hekmat, H., “Merchants and Artisans and the Development Processes of Nineteenth Century iran,” in Udovitch, A. L., ed., The Islamic Middle East, 700–1900: Studies in Economic and Social History (Princeton, N.J., 1981), 725–50.Google Scholar

44 Abrahamian, Iran Between Two Revolutions, pp. 58–61.

45 See, for example, the original paper by Krueger, Anne, “The Political Economy of a Rent- Seeking Society,” American Economic Review, 64, 3 (06 1974), 291–303;Google Scholar extensions by Bhagwati, Jagdish, “Directly Unproductive, Profit-seeking (DUP) Activities,” Journal of Political Economy, 92, 5 (1982), 988–1002.CrossRefGoogle Scholar

46 This situation can be described as differential cost of rent-seeking for these social groups.

47 Looney, Economic Origins, p. 6.

48 Keddie, “Oil, Economic Policy,” pp. 20–21.

49 Bashiriyeh, The State and Revolution, p. 47.

50 Baldwin, Planning and Development, pp. 17–18.

51 Keddie, Roots of Revolution, p. 172.

52 Bashiriyeh, State and Revolution, pp. 47–48, believes that the court, where “economic policy making originated … was the center of all clientelistic relations”; Zonis, Political Elite, p. 30, states that “Few industrial or commercial undertakings are launched in Iran without the blessing of the Shah.”

53 According to Graham, Robert, The Illusion of Power (New York, 1980), p. 164,Google Scholar “It was a practice in Iran for those establishing industrial and commercial ventures to offer small stakes to members of the Royal Family or to the Pahlavi Foundation direct.” Bashiriyeh, The State and Revolution, p. 78, states that industrialists offered the court shares to benefit from the “discretionary powers of the royal family, such as the provision of credit and tax exemption.”

54 IMDBI, Annual Report, 1977/78.

55 Benedick, Industrial Finance, p. 212.

56 A very interesting discussion of these issues in the case of India is in Bardhan, Pranab K., The Political Economy of Development in India (London, 1984). Bardhan considers the peaceful resolution of conflict between the dominant classes in India to be closely linked to the democratic political system.Google Scholar

57 Keynes, John Maynard, The Economic Consequences of the Peace (New York, 1920), p. 19.Google Scholar