Trade Policy, Foreign Exchange Regime, and Industrial Development in Iran

Abstract

This chapter investigates the relationship between trade policy and industrial development in Iran with an emphasis on the postrevolutionary period through 2014. It suggests that Iran’s trade policy has been principally under the influence of oil shocks and government’s reactions to it through fiscal and exchange rate policies. The country’s trade regime has as a result experienced periodic shifts between import substitution and de facto import promotion. Furthermore, with the prevalence of significant energy subsidies, Iran’s largely unintentional industrial orientation has been toward large-scale and energy-intensive production such as petrochemicals, basic metals, and minerals. These same industries have become Iran’s main exporters. In the initial stages of an oil boom, domestic industry tends to benefit from the availability of inexpensive foreign exchange that eases access to imported machinery and intermediate goods. However, as significant amounts of oil money are circulated in the domestic economy, expansionary fiscal and monetary policies give rise to mounting inflation. Yet, the government and the central bank attempt to check inflation by anchoring the nominal exchange rate and rushing in imports with devastating results for the competitiveness of domestic producers. The government deals with negative oil shocks by devaluating the domestic currency and preventing balance of payments crises through raising tariffs and nontariff barriers to imports. These initiatives give rise to an important substitution regime that features unproductive rent-seeking activities and technological stagnation, as government protection provided to domestic producers is neither selective, nor contingent, nor time-bound. The chapter offers a set of recommendations as minimum requirements to place Iran’s economy on a more solid development and industrialization track.