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In the 1920s the majority of Iran’s population was rural, transportation was primitive, and large, modern industrial plants were few. Production and trade were aimed at local markets, with the exception of the developing petroleum industry, which was increasingly producing oil for the international market.
From 1925 onwards, Reza Shah Pahlavi set out to rapidly modernize Iran. He sought to develop a strong central government and enter Western markets. Industrialization was stepped up, roads and the Trans-Iranian Railway were built, and regulations on foreign oil companies were changed in order to secure more of the revenues for Iran.
The number of industrial plants, excluding those involved in processing petroleum, increased from 20 to 346 during Reza Shah’s reign. Between 1926 and 1941, the oil-industry labour force increased from 20,000 to 31,000. Rapid industrial growth caused rapid urbanization: Tehran’s population increased from approximately 196,000 in 1922 to about 700,000 in 1941.
In those two decades Iran’s national budget grew from approximately USD 15 million to USD 166.5 million, but investments focused mostly on the development of capital-intensive rather than labour-intensive enterprises, and the majority of Iranians, who were still living in rural areas, did not immediately benefit from these developments.
After assuming power in 1941, Mohammad Reza Shah Pahlavi continued his father’s modernization programmes. Governmental development planning was initiated in 1947 as a seven-year programme. The White Revolution that was begun in 1963 aimed to transform Iran into a global economic and industrial power. It included land reform, the construction of expanded road, rail, and air networks, dams and irrigation projects, and support of industrial growth.
The centralization of the economy coincided with an increase in oil revenues. During the 1970s, oil and gas exports remained Iran’s main source of foreign exchange. In the 1960s and 1970s Iran developed rapidly, but progress was uneven. A lack of skilled technical Iranian personnel meant that foreign workers were increasingly brought into the country.
Using revenues from the oil boom in 1973 and mid-1977, the Shah pushed industrialization and the establishment of a modern military, but the process went too rapidly, resulting in increased inflation, corruption, and extreme rural-to-urban migration.
After the Islamic Revolution of 1979, self-reliance in place of Westernization became the focal point of development. In the First Development Plan (1983-1988) the new government proclaimed its goals to be self-sufficiency in foodstuffs, employment for all, better standards of living, and reduction of the country’s dependence on oil exports.
Because of unresolved land-reform issues, lack of incentives, and rapid urbanization, however, the agricultural sector deteriorated. While Iran had almost achieved agricultural self-sufficiency in the 1960s, it had to import 65 percent of its food in 1979. Moreover, dependence on oil actually increased, with the price of oil peaking at USD 40 per barrel. Earnings from oil exports remained high until the mid-1980s.
The war with Iraq (1980-1988) did great damage to Iran’s economy. In the mid-1980s half of Iran’s revenues was spent on arms imports; industrial and petroleum development decreased, and the agricultural sector deteriorated further. At the same time, oil revenues began to fall. By 1985 revenues totalled only USD 1 billion per month, approximately the equivalent of the cost of the war with Iraq. Non-military spending was cut, further damaging the national economy. Basic food supplies, such as meat, rice, sugar, and dairy products, were rationed, and black markets flourished.
After the war with Iraq the government set out to reform the economy. Presidents Hashemi Rafsanjani (1989-1997) and Khatami (1997-2005) aspired to make Iranian industry more competitive internationally. They sought to reduce subsidies, create an equitable income-tax system, and privatize government enterprises, but opposition was strong, and many reforms were blocked. While diversification of the economy has been a goal since the early 2000s, little progress has been made.
Running on a populist election platform, President Ahmadinejad promised to improve the lives of the poor. He introduced higher minimum wages – soon reversed after industries had to fire employees because of the higher costs – promised higher pensions, and took other popular measures, such as loans for small enterprises in underdeveloped regions.
The spending has, however, contributed to further inflation, which reached 17.1 percent in 2008 and exceeded 15 percent in 2010. Critics say that while the country’s economy is pressured by sanctions, the government is spending money as though there were abundant resources. Subsidy-reform policies further increased the inflation rate to over 20 percent in 2011.
Iran’s economy faces many serious challenges. Most economic activity is controlled by the state. The Iranian government is one of the largest employers, and the state-run companies weigh heavily on the national budget. Necessary privatization has been stalled since Ahmadinejad became President.
In a liberal economy revenues come mostly from investments and taxes, covering most of the government’s budget. Iran’s economy, however, is not transparent, knowing who earns what is difficult, and many economic players (such as certain foundations) are exempt from government audits and taxes. The Third Economic Development Plan (2000-2005) aimed to reduce the government’s dependence on oil revenues to less than USD 12 billion, but it actually rose to more than USD 40 billion in 2006.
Another major problem is the subsidies, especially in the energy sector. In 2008 Iran imported nearly 40 percent of its domestic petroleum needs because of its limited refining capacity. In 2009 Iran spent USD 11 billion on imported fuel. In 2010, oil imports declined to 30 percent of its market needs, at 25 million liters of gasoline and 11 million liters of diesel fuel per day. Furthermore, Iran’s economy is extremely inefficient. While computerization is being developed, most administrative work is still paper-based. State-owned industries are especially infamous for their bureaucracy.
The only way the Iranian economy can improve is by comprehensively restructuring itself, but it is unlikely that this will happen soon, as many special-interest groups and powerful economic entities oppose it. Investment conditions in the country remain unattractive for foreign companies, and many projects are postponed or slowed down. As a result of lower oil prices and, in 2009, declining oil output, Iranian real GDP growth is likely to decline considerably.