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Foreign Exchange Gap, Structural Constraints, and the Political Economy of Exchange RateDetermination in IranAuthor(s): Sohrab BehdadSource: International Journal of Middle East Studies, Vol. 20, No. 1 (Feb., 1988), pp. 1-21Published by: Cambridge University PressStable URL: http://www.jstor.org/stable/163583 .

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Int. J. Middle East Stud. 20 (1988), 1-21. Printed in the United States of America

Sohrab BehdadFOREIGN EXCHANGE GAP, STRUCTURALCONSTRAINTS, AND THE POLITICALECONOMY OF EXCHANGE RATEDETERMINATION IN IRANForeign currency transactions have come under stringent controls in postrevolu-tionary Iran.' This is a relapse into the prevailing conditions in the yearspreceding 1974,2before the increase in oil revenues eliminated the foreign cur-rency gap.3 Initially, the Islamic Republic of Iran (IRI) imposed exchangecontrols to stop the postrevolutionary capital flight. Soon, however, exchangecontrols became an integral policy instrument of the government for rationingthe existing supply of foreign currency in the face of a widening foreign exchangegap.Recently, some economists and business circles have come to advocate devalua-tion policy as a means for coping with the existing foreign exchange problem inIran.4 The IRI has not let this view surface in the arena of public debate. Theissue, however, has been confronted in an informative and timely article byWolfgang Lautenschlagerin a recent issue of the International Journal of MiddleEast Studies.5

Lautenschlager has formulated what I call the "devaluation thesis." He assertsthat the Iranian "rial is one of the world's most overvalued currencies,"6which"has strongly affected" the Iranian economy,7 and that the inflow of cheapimports, resulting from the overvalued rial, has caused a decline in the marketshare of Iranian industries. Lautenschlager maintains that "[i]f Iranian industryhad not lost this market share, its output would possibly have been as much asone-third higher" (italics added).8 That is, according to the author, "[w]hile thewar, the oil glut and departure and purge of skilled personnel have certainly beenimportant influences on the economy ... [a]griculture and industry would bothhave fared better had it not been for the unrealisticexchange rate policy."9The "devaluation thesis" explains the seemingly irrational exchange policy ofthe IRI by pointing to the existence of a close alliance between the IRI and thepowerful bazaar merchants who benefit from the exchange control schemes. Inthe words of Lautenschlager, "the Islamic Republic has tailored its economicpolicies to meet the interest of bazaar merchants . . . [against] their majorcompetitor ... namely, modern industry managed by westernizedtechnocrats."1'I maintain that the "devaluation thesis," as represented in Lautenschlager'sarticle,1' understates the complexities of the Iranian economic structure and? 1988 Cambridge University Press 0020-7438/88 $5.00 +.00

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2 Sohrab BehdadIran's postrevolutionary economic conditions. I argue that Iran, as an oil-exporting economy,12 is heavily dependent on imports of industrial inputs,whereas the possibilities for any major expansion of its non-oil export earningswithin the existing economic structure are severely limited. A general devalua-tion, unless accompanied by a comprehensive economic plan aiming to overhaulthe existing industrial structure, will do little to increase the country's exchangeearnings, but can cause serious interruptions in industrial activities. Because theIRI has come to commit itself to the revitalization of the existing industrialstructure, it finds itself committed also to maintaining an overvalued rial toprovide the inflow of "cheap"industrial inputs, which constitute the most signifi-cant portion of Iran's import bill.Contrary to Lautenschlager's claim, Iran's industries have lost little of theirmarket share to cheap imports. Although the demand for imported consumergoods has increased in the postrevolutionary period due to interruptions indomestic production and changes in the distribution of national expendituresand the structure of demand, quantitative import restrictions have preventedimports from making up for the domestic supply shortages.I also maintain that because of the high black-market prices for many im-ported products, the burden of the external adjustment of a general devaluationwill merely fall upon those who receive the imported goods at their officialprices: mainly the protected large manufacturing establishments (public or pri-vate) and some consumers of certain politically sensitive items of mass consump-tion. Therefore a devaluation is most effective in achieving external equilibriumexactly where the IRI finds its effects, for economic or political reasons, leastdesirable. The IRI may continue to devalue the rial within the present system ofmultiple exchange rates in order to increase government revenues, to achievelimited reductions in imports of consumer goods, and to boost exports. The IRIwould not, however, want to close the foreign exchange gap fully by devaluationand/or import restrictions, for fear both of a negative impact on Iranian in-dustries and of intense public discontent. In the absence of a significant increasein oil revenues, external financing remains the only possible alternative. Asunpatriotic and reproachable as the IRI viewed foreign borrowing only a fewyears ago, overtures are being made toward external financing of Iran's importbill.In this article I will analyze the elements contributing to the present foreignexchange problem of Iran, and the effects of a devalution on the varioussegments of supply and demand for foreign exchange in the context of thepolitical economy of the postrevolutionary Iran. The structure of Iranian exportsis presented in Section 1, the demand for import of consumer goods in Section 2,and the demand for import of producer goods in Section 3. In Section 4 transferpayments and capital flight from Iran are discussed. Finally, conclusions of theanalysis and implications of the present conditions are discussed in Section 5.1. OIL AND OTHER EXPORTS OF IRAN

In every year in the past decade, income from oil exports has constituted atleast 95 percent of the Iranian export earnings (Table 1). The volume of oil

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Foreign Exchange Gap in Iran 3TABLE 1. Major Sources of Foreign Exchange Receipts andPayments (1977-1983)a

1977 1978 1979 1980 1981 1982 1983ReceiptsOil exports 23.5 15.6 24.2 11.6 10.6 21.8 21.2Non-oil exports 0.52 0.54 0.81 0.65 0.34 0.28 0.36Services 4.5 4.2 2.8 1.4 1.5 1.1 1.3PaymentsImports 18.9 13.8 10.0 13.4 15.5 14.3 20.6Consumer goods (2.7) (2.1) (2.6) (2.9) (3.1) (2.7) (2.9)Primary and intermediate goods (7.9) (5.3) (5.3) (6.2) (8.2) (6.9) (10.8)Capital goods (4.0) (2.9) (1.8) (1.7) (2.1) (2.3) (4.3)Nonclassified imports (mostlydefense related) (4.3) (3.5) (0.3) (2.6) (2.1) (2.4) (2.6)Servicesh 7.9 7.7 5.0 3.1 1.7 1.5 1.9Private (5.0) (4.8) (3.5) (1.9) (0.8) (0.5) (0.6)Government (2.6) (2.3) (0.7) (0.8) (0.6) (0.8) (1.1)aAll figures are in billions of current U.S. dollars and are from Balance of Payment Tables of BankMarkazi, except figuresfor "servicepayments,"which are from Balance of Exchange Transactions ofBank Markazi. The line, "service payments of private sector," for 1977 is revised in the 1978 (1357)issue of Economic Report (cited below) from $3.9 billion reported in the 1977 issue of the samepublication. The figure for total service payments is changed accordingly. Here the revised figuresarereported.bParts do not add up to the total because interestpayments are not included.Source: Bank Markazi, Economic Report and Balance Sheet (Gozaresh-e eqtesadi va taraznameh-esal-e .. ), various issues.

exports and the resulting foreign-exchange income are independent of the ex-change rate for the Iranian currency, mainly because the export price of pe-troleum does not reflect the production cost and price of petroleum in theIranian market. Therefore, a change in the exchange rate of the rial will not haveany effect on the 95 percent of Iran's foreign exchange earnings from oil.On the other hand, a change in the world price of petroleum and/or thevolume of petroleum exports will affect the exchange earnings of Iran, andceteris paribus, its equilibrium exchange rate. Iran has confronted serious diffi-culties in trying to maintain the prerevolutionary oil income flow as a result of,first, the war with Iraq that started in fall 1980, and later, the glut that appearedin the world oil market.It was only through aggressive oil price cutting-achieved in spite of OPEC'sobjections-that the oil revenues were brought close to the 1977 level in 1982and 1983. In nominal terms, between 1978 and 1983 the total loss in oil revenues,compared to the 1977 level, has been $36 billion. If, however, a 5 percent annualincrease in the dollar price of Iranian imports is assumed, the total loss is $63billion (or a 60 percent overall decline) in the above-mentioned six years.3The problem has been further aggravated in subsequent years, especially since1985, by the steep decline in world oil prices and the ineffectiveness of IRI'sprice-cutting policy. Official figures for the Iranian oil revenues in 1984 and 1985are not available, but they are unlikely to reach much beyond the $10 billion

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4 Sohrab Behdadlevel. In 1986 oil revenues are expected to fall even lower. That is a decline ofabout $15 billion from the 1977 level and $8 to $9 billion from the average forthe 1978-1983 period (only in nominal terms).Because the oil export earnings are completely unaffected by a devaluation,what becomes relevant on the exchange-earning side are the potential effects of adevaluation on the non-oil export earnings of Iran. Non-oil exports (includinghand-woven rugs, minerals, fruits and nuts, hides, and a number of manu-factured goods exported according to bilateral trade agreements) have made upless than 5 percent of Iranian exports in the past decade (Table 1).14A devaluation can cause an increase in the volume of non-oil exports becausethe price of these exports for foreign buyers will be reduced and each dollarearned by the exporters will fetch a larger amount of the domestic currency.15The effect, however, will be a one-shot affair, although the increase may takeplace in the long run. That is, further increases in exports will require, ceterisparibus, further devaluations. The extent of improvements in the exchangeearnings will depend on (a) the price elasticity of foreign demand for Iran'sexports (this must be larger than one), and (b) the elasticity of domestic supply(the less elastic the supply the smaller the improvement).Although Iran's non-oil exports as a whole appear to have an elastic foreigndemand, trade barriers of the OECD countries, the main potential markets forthe primary export products of Iran, place serious limits upon the expansion ofIran's non-oil exports. The recent antidumping decision of the United StatesInternational Trade Commission against the exports of Iranian pistachio nuts isa clear case in point.16Moreover, the structuralconstraints and the recent bottlenecks due to continu-ing interruptions in the production process, shortage of imported intermediateand capital goods, and war mobilization have set serious limits on the expansionof exports. Once the existing underutilized capacities in exporting activities aresurpassed and the export level reaches its prerevolutionary level (about $0.5billion in 1977), further expansion may be achieved by repeated devaluations.This is so because expansion of non-oil exports will be accompanied by sharpincreases in the domestic price of export products17unless measures are imple-mented to increase productivity in these activities.Even if we assume a substantial expansion of non-oil exports in the existingconditions and an increase in their exchange earnings as the definite result of adevaluation, the overall effect on the foreign exchange gap of Iran is small oreven negligible. A 100 percent increase in the value of non-oil exports from the1983 level will bring the exchange earnings from these exports to only $0.7billion. That is no more than 4.7 percent of a $15 billion import bill (average for1978-1983).The IRI, since 1982, has devalued the Iranian rial within a system of multipleexchange rates in an effort to stimulate exports. Moreover, in an interestingconfrontation between the export merchants (many from the bazaar) and theCentral Bank (Bank Markazi) on the terrainof Islamic jurisprudence, the CentralBank liberalized its exchange controls on the foreign currency earnings ofexporters.'8 The 1986 Export-Import Law provides for rates in excess of the

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Foreign Exchange Gap in Iran 5already established "preferential exchange rates"for non-oil export earnings. Inaddition, the exporters have the option of selling their foreign currency earningsto importers.19It is evident that the sale of foreign exchange by exporters takesplace at the market exchange rate, implying a partial devaluation amounting tono less than a 300 percent increase in the value of foreign currency for manyexporters.20Although many exporters have been making handsome profits, the effect onthe foreign exchange gap of Iran has not been significant. In the first ninemonths of 1985, Iranian non-oil exports increased99 percent in volume and only26 percent in foreign exchange value.2' That is only approximately a $0.1 billiondollar increase for the whole year. With further devaluation of the rial forexporters, the value of non-oil exports is expected to increase for 1986. However,it is doubtful that it can exceed much beyond the $1 billion mark.22To complete the review of the exchange earnings of Iran, income from"services" must also be considered.23The most important items in this categoryused to be tourism and interest earnings from foreign assets. The former declinedsharply as the flow of European and American tourists to Iran came to a haltafter the revolution. Interest earnings reached a peak of $1.2 billion in 1979 andhave continued to fall in subsequent years as foreign assets have been depleted.24Another source of Iran's exchange earning is the repatriated earnings ofIranian workers in Persian Gulf countries. The most substantial segments ofthese earnings have entered the black market for foreign currency. Moreover,because of the political reservation of the Persian Gulf countries about hostingIranian workers and the general decline in employment in these countries result-ing from the oil glut, the number, and thus the earnings, of these workers havedeclined in recent years.25In sum, with the predominant position of oil exports in the foreign currencyearnings of Iran, there is only limited potential in closing the foreign exchangegap from the export side. A devaluation, which in fact has taken place byproviding preferential rates of exchange for exporters and allowing them to selltheir export earnings to importers at a premium, has had only minor effects inthe attempt to narrow the gap.2. PRODUCTION, CONSUMPTION, AND IMPORTS OF CONSUMER GOODS

By 1981 the imports of consumer goods and primary and intermediate pro-ducts to Iran had increased 6.6 percent from the prerevolutionarylevel (Table 1),while gross national income had fallen 24 percent in the same period.26Lauten-schlager points to this as an anomaly27because imports are expected to rise andfall with the rise and fall of national income. One factor that might explain thisanomaly, according to Lautenschlager, is the overvalued exchange rate that hasmade imports exceptionally more attractive than their domestic alternatives. Ifthis is true, then the Iranian industries must have suffered from competition of"cheap"imports. In the words of Lautenschlager:Much attentionwasgivenin the U.S. in 1984 o thedamagingeffectsof a highdollaronU.S. industry;herial,which s muchmoreseverelyovervaluedhanthedollar,hashad a

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6 Sohrab BehdadTABLE2. Rates of Growth of National Output and Industrial Productiona

Total1977b. rials 1977 1978 1979 1980 1981 1982 1983 1984Gross national income 3934 2.7 -18.6 5.4 -13.5 2.4 15.1 13.6 - 1.7Non-oil grossdomestic product 2380 4.6 -7.2 4.8 -2.8 5.7 6.2 14.8 2.8Value added in industryand mining' 592 -1.7 -15.2 -9.2 1.6 2.7 10.5 15.6 3.2hProduction in largemanufacturingunitsd 410 11.9 -14.3 -0.5 -6.3 13.2 14.2 12.5 18.3aln constant prices (1974=100).bPreliminaryestimates.CExludingpetroleum.dEstablishments with 50 or more workers. There were 1,238 such manufacturing establishments in1984.Source: Bank Markazi, Economic Report, various issues;"PreliminaryEstimates of National Produc-tion and Expenditures in 1984 (Baravardha-ye avvali-ye tulid va hazineh-ye melli-ye keshvar darsal-e 1363)," mimeographed (n.d.), and "National Survey of Large ManufacturingEstablishments in1983 (Natayej-e barresi-ye kargaha-ye bozorg-e san'ati-ve keshvar dar sal-e 1362)," mimeographed(November/December 1984-Azar, 1363) and the same publication for 1984-1363 (November/December 1985).

proportionately stronger impact on Iranian industry. While Iran's inflation of 20 percentor more per annum has raised the price of goods made in Iran, the price of importedgoods has been depressed by the official exchange rate, which has changed less than 528percent per year.2Consideration of the internal economic conditions of Iran, however, willreveal that the "anomaly," to the extent that it is related to the demand forimports of consumer goods, is caused by the decline in output and changes in thedistribution of expenditures and the structure of consumption demand. Further-

more, the consumer good industries have not lost their market shares to "cheap"imports because the increase in import demand has not resulted in an increase inimports.The share of consumption expenditures in the national expenditures of Iranincreased sharply during the revolution and in subsequent years. This increasecoincided with a decline in national output and in the production of industrialproducts. This trend, which was most pronounced until 1981, resulted in asubstantial increase in demand for imported consumer goods.In 1978, during the revolutionary turmoil, gross national income declined 18.6percent. Value added by industry and mining fell 15.2 percent and the output oflarge manufacturing establishments (with 50 workers or more) dropped 14.3percent (Table 2). (All figures except for foreign transactions are in constantprices.) In the same year, however, personal consumption expenditures increased6.8 percent (Table 3) as the salaries of government employees were augmented.The growth of personal consumption expenditures in the face of reduction in

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Foreign Exchange Gap in Iran 7TABLE3. The Rate of Growthand the Share of Some Major Items ofNational Expendituresa

Total1977b. rials 1977 1978 1979 1980 1981 1982 1983 1984hPrivate

consumptionexpenditures 1684 14.4 6.8 -14.9 -4.3 6.1 6.1 9.9 2.4Share in total (50.3) (56.2) (45.3) (55.4) (57.9) (53.3) (51.8) (52.9)

Governmentconsumptionexpenditure 836 -1.3 2.3 -16.9 -8.8 4.6 -3.8 -2.0 -4.2Share in total (20.8) (26.7) (21.1) (22.0) (22.7) (18.9) (16.4) (15.7)

Gross domesticfixed capitalformation 1083 3.4 -20.8 -27.4 -3.8 1.6 9.9 39.0 -10.5Share in total (23.4) (26.8) (18.5) (21.0) (21.0) (20.1) (24.6) (22.0)Machinery 428 4.5 -34.4 29.2 -22.6 51.9 11.0 73.4 -5.7

aln constant prices (1974= 100).bPreliminaryestimates.Sources: Bank Markazi, Economic Report, various issues; and "Preliminary Estimates... for 1984(1363)."

national income was offset by a decline in capital formation (20.8 percent in1978; see Table 3) and the stock of inventories (by about one quarter of theprivate consumption expenditures in 1978).29In the following years, the increase in the legal minimum wage and the mini-mum salary of civil servants contributed to the growth of the share of personalconsumption expenditures in the national expenditures. By 1981, this share hadincreased to 57.9 percent from 50.3 percent in 1977 (Table 3). This trend wasaccompanied with an improvement in income inequality,30 which raised thedemand for certain articlesof mass consumption.To the increase in demand for consumer goods the effects of the war on theconsumption expenditures of the government must also be added. Althoughgovernment consumption expenditures have declined almost continually in thepostrevolutionary period (Table 3), it is expected that as a result of the war withIraq the government demand for many items of mass consumption has increased.Production, however, was seriously hampered in the initial postrevolutionaryyears. By 1981, the gross national income was still 23.8 percent less than the 1977value, whereas personal consumption expenditures had only declined 8.1 percent.Also taking into account the effects of the change in the distribution of house-hold incomes and in the composition of government expenditures, an acute

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8 Sohrab Behdadshortage of mass consumption items is to be expected. As the governmentattempted to control prices, the black market appeared. In spite of the price-control efforts of the government, the official consumer price index (with atendency to underestimate black market prices) indicates a threefold increase (20percent annually) between 1977 and 1984.3'With shortages and the rapid increase in the price of domestic products,increase in demand for imports is inevitable but is not necessarily followed byincreased imports if quantitative import restrictions exist. The figures in Table Ishow that between 1978 and 1983, imports of consumer goods fluctuated aroundthe 1977 level. In fact, the value of consumer good imports, averaged over thatfive-year period, is exactly equal to the 1977 value. Again, if we assume a 5percent price increase for imports, the real value of imports during that time,on the average, is for each year 15.7 percent less than the last prerevolutionaryyear. That is, even if domestic shortages had not developed, maintaining thenominal value of consumer good imports at the 1977 level would have causedan excess demand for these imports. It is clear that with the shortages inthe domestic market, this excess demand has been even greater. The blackmarket and the remarkably high price of imported consumer goods (relativeto 1977) in the black market are the obvious indications of the excess demand,which reflects the existence of the potential market for the import-competingdomestic industries.

Therefore, the argument that Iranian industries have lost their market share to"cheap" imports does not hold. This argument would have been true if theconsumption expenditure had fallen at a higher rate than production, while theimports had remained at a relatively constant level. It would have also been trueif there were no significant import restrictions or foreign exchange constraintsand the import flow had offset the decline of domestic output. But the post-revolutionary conditions in the Iranian economy do not come close to eithersituation.As long as there are effective quantitative restrictions, no matter what theexchange rate is, domestic industries enjoy a protected market. The extent ofprotection is determined by the restrictiveness of import barriers. The existenceof shortages for the goods produced by domestic industries, their 20 percentaverage annual price increase, and the decline of the real value of imports from1978 to 1983, all indicate that the loss of market share has not been one of thedifficulties of the Iranian industries. The extent of the black market for importsand the very high prices in this market reflect the scarcity of imported products,as well as the ineffectiveness of the price control policy of the government.Because not all categories of imported consumer goods have confronted thesame degree of import restrictions some industries have enjoyed more protectionthan others. The existence of black markets for almost all imported goods, andblack market prices much higher than official prices (which are set higher thanthe official exchange rate would indicate) make it difficult to accept the "cheap"import argument for consumer good industries. On the contrary, the addedquantitative import restrictions have, if anything, increased the protection ofdomestic industries and caused the price of the imported competing products to

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Foreign Exchange Gap in Iran 9increase beyond the level solely determined by internally induced market con-ditions. Whether or not the merchants benefit from the black market for importsis irrelevant to the market share issue."Who benefits from the black market for the domestic products?"is, however,a theoretically relevant question. If the "[i]ndustrialists have more difficultytaking advantage of the black market than do merchants," as Lautenschlagerargues,32 then most of the resulting benefits of the protection of domesticindustries occur at circulation and not production of the commodities. However,the empirical validity of this assertion is questionable. Price control has beeneffectively imposed on goods produced by establishments under governmentownership or management. Price control for the goods produced by privateconcerns has proven ineffective and, in most cases, has been abandoned. More-over, Lautenschlager's assertion implies an assumption of high inflexibility ofindustrial capital and lack of common sense (not even ingenuity) on the part ofindustrialists to expand the sphere of their activity to control distribution as well.Iranian industries have faced two basic difficulties, unrelated to the competi-tion of imports and the price control policy of the government: (1) the lack ofsecurity for capital and (2) the short supply of imported inputs, initially causedby an interruption in the relationship with Westerneconomies and their multina-tional corporations, and later by the foreign exchange gap confronting the IRI.Continued uncertain political conditions, stemming from the inability of thepolitical regime to resolve its internal crisis and to take an unequivocal positionon protection of property rights, has jeopardized the position of capital. This hasaffected the activity of capital in the manufacturing sector most seriously. At thesame time, this condition has provided an almost unprecedented possibility, notonly for the merchants, but also for the industrialists who have established aclose political alliance with the Islamic Republic to receive its protection and thevaluable entitlements that it distributes.The market share issue aside, the widening foreign exchange gap requiressome measures to reduce the import bill. Devaluation can be effective in reducingthe import bill only to the extent that it results in an increase in the domesticprice of imports. With the extensive black market for almost every importedconsumer product, and nonofficial prices reflecting an implicit exchange rate 700to 900 percent higher than the official rate, a devaluation that would bring theexchange rate to a level near these inflated rates will be effective only ineliminating or reducing the demand of those who manage to consume theimported products at their official prices. However, because a number of im-ported consumer goods (mostly food items) and a segment of the market thatreceives these goods at the official prices are considered politically sensitive, it isexpected that a devaluation of the rial for consumer goods be limited to"nonessential" items, as defined by the IRI, and then only to a rate lower thanthose currently existing. (Such high rates of devaluation are simply shocking tothe public.) Thus, partial devaluation will have little effect on the foreign ex-change payments for consumer goods, yet it will have a significant positive effecton government revenues from sales of foreign exchange.33 This increase ingovernment revenues is no more than a transfer of a portion of the windfall gain

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10 Sohrab Behdadof import merchants to government coffers. Given the huge budget deficit, this isa practical possibility, in spite of the close alliance of the regime with importmerchants. Further quantitative import restrictions will, however, continue to bethe main policy tool that the government uses to reduce the import bill becausethey are flexible and can be applied more discriminately to various productsdestined for differentconsumer markets.3. IMPORT DEPENDENCE AND IMPORTS OF PRODUCER GOODS

The weak interindustrylinkages in the Iranian economy34reflect the economy'sdependence on imported industrial inputs. This dependence is more pronouncedfor the modern manufacturing industries than for the rest of the economy. Theseindustries have been developed primarily by the multinational corporations andare integrated into their international network, with few linkages in the Iranianeconomy.35 The import dependence of the Iranian economy and its industriesincreased continually from the early 1960s to the mid-1970s. The followingestimates reflect this trend:36Each 100 rials of the non-oil gross domestic product(GDP) produced between 1963 and 1967 required, on the average, 4.6 rials ofimported capital and 10.4 rials of imported primary and intermediate inputs.These figures increased, respectively, to 5.5. rials and 13.3 rials in 1968-1972, andto 8.4 rials and 16.8 rials in 1973-1977. Taking into account the fact that thelargest share of these imports (about 80 percent of the primary and intermediateinputs) was used by the industrial sector (no more than 30 percent of the non-oilGDP), the import dependence of Iranian industries becomes even more evident.The import dependence of the economy has not been reduced in the post-revolutionary period. The primary and intermediate import requirements foreach 100 rials of the non-oil GDP and the value added in manufacturing areestimated for 1977-1983 (Table 4). Notwithstanding the fluctuations due toirregularities in the flow of imports in these years, the estimates show a trendtoward the 1977 import requirement ratios after an initial drop in these ratios in1978. The low ratios for 1978-1980 may be explained by the sharp decline in theindustrial value added and in the value of output in the large manufacturing

TABLE. Dependence of the Economy and the Manufacturing Sectoron Imported Primaryand Intermediate InputsDollar value of imported inputs 1977 1978 1979 1980 1981 1982 1983

Per 100rials of non-oil GDPa 0.33 0.23 0.23 0.28 0.35 0.27 0.37Per 100 rials of manufacturingvalue addedh 1.76 1.38 1.55 1.42 1.79 1.37 1.81aValue of imported primaryand intermediategoods (in current U.S. dollars) is divided by the non-oilgross domestic product (in constant rials, 1974= 100).hValue of imported primaryand intermediate goods used for manufacturing and mining (in currentU.S. dollars) is divided by value added in manufacturing(in constant rials).Source: Bank Markazi, Economic Report, various issues.

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Foreign Exchange Gap in Iran 11TABLE 5. Share of Imported Primary Inputs in Total Inputs and

Output of Large Manufacturing Establishmentsa(1983)Share in total inputs Share in total outputActivity (%) (%)Food, beverages, and tobacco 31.3 20.0Textile, clothing, and leather 47.4 22.2Wood and wood products 26.8 11.6Paper, cardboards, printing 58.0 30.1Chemicals 69.6 35.9Nonmetalic products (excluding oil and coal products) 25.3 6.3Basic metal industries 71.5 52.5Machine tool, tools, and metal products 69.9h 37.5Miscellaneous 45.1 19.2Total 54.0 28.2aEstablishments with ten or more workers. There were 6,938 such manufacturing establishments in1983.hThis figure was misprinted in the source for this table. The correction is found in the NationalStatistical Yearbook 1984 (Salnameh-ye amari-ye keshvar, 1363), published by the Statistical Centerof Iran (1985/1364), p. 499.Source: Statistical Center of Iran (Markaz-e Amar-e Iran), Large Manufacturing Establishments'Statistics, Results of the 1984 Survey (Amar-e kargaha-ye baozorg-e san'ati, montaj az amargiri-yesal-e 1363), (February/March 1985-Esfand 1363), p. 7.

establishments (Table 2). These ratios started to increase substantially from 1981when production in the industrial sector, especially in the large manufacturingestablishments, gained momentum. Thus, between 1980 and 1983, when non-oilGDP increased 29.0 percent and manufacturing value added 42.8 percent,37imports of primary and intermediate products had to increase by 74 percent(Table 1).38Recent statistics published by the IRI show the extent of the import depen-dence of the "large"(with ten or more workers) manufacturing establishments(Table 5). Imported primary products accounted for 54 percent of total inputs ofthese establishments in 1983. For chemicals and basic metal industries, theseshares were, respectively, 69.7 percent and 71.5 percent. Similarly, importedinputs constitute a large share of the output value, 28.2 percent for all "large"industries.The import of capital goods conforms closely with the rate of capital forma-tion in machinery. The import of capital goods doubled between 1981 and 1983(Table 1) as investment in machinery by the private sector and governmentincreased, respectively, by 152 percent and 52 percent.39The pattern of change in the imports of primaryand intermediate products andcapital goods thus coincides with the pattern of change in the level of output.When the fundamentalists in the IRI gained full control in the political regimeby ousting the rival groups and succeeded in containing the revolutionary move-ment in 1981, the trend toward economic recovery and revitalization of the

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12 Sohrab Behdadeconomic structure began. Contracts with the multinational corporations wererenewed or reinstated. Some de facto guarantees were extended to protectproperty rights and the activity of capital, and revolutionary rhetoric was notice-ably toned down. With increasing production since 1981, imports of producergoods have increased despite foreign exchange constraints and physical limita-tions arising from the war.It can be concluded, therefore, that the Iranian industries, in general, and largemanufacturing enterprises, in particular, were not in the least hurt by imports.The overvalued rial has provided cheap inputs for industries while quantitativeimport restrictions on final products have added to the already high tariffbarriers40that promoted the establishment and growth of the large, modernmanufacturing industries between the 1960s and the mid 1970s. These industrieshave received generous exchange quotas and import licenses in the postrevolu-tionary period. Many of these enterprises are under "public management": 14.2percent of manufacturing enterprises with ten or more workers, producing 70.9percent of the total value added of these enterprises in 1983.4'The survival of the"publically managed" enterprises under the price control policy of the govern-ment depends on the continuation of the present exchange rate policy becausedirect subsidies to these enterprises will be strongly opposed by the powerfullaissez faire faction of the IRI. On the other hand, the large privately ownedmanufacturing enterprises, which manage to buy their imported inputs at theofficial exchange rate and to sell their products at continually higher prices, arein the most privileged position. The small industries, deprived of the advantagesenjoyed by the large establishments prior to the revolution, are again unable toreceive these benefits, as well as the now valuable exchange quotas and importlicenses.A devaluation in the order of magnitude required to cause any considerablereduction in the foreign exchange gap would put much of the large manufactur-ing enterprises (producing 86 percent of the output of the manufacturingsector)42out of production. The resulting increase in production cost and the fall inoutput in the large manufacturing activities would cause a drastic increase inprices of these products and in the rate of inflation. In the absence of a plan tomodify the industrial structure, it is highly improbable that the IRI will imple-ment a general devaluation of the rial, but it is rather to be expected that thepresent exchange rate for this portion of imports (73.3 percent of the import billin 1983) will be maintained while some further quantitative import restrictionsare imposed. This will result in furtherdeprivation of small industries."Nonclassified imports" (Table 1) are imports not subject to customs inspec-tion. They are primarilydefense-related products. These imports (12.6 percent ofthe 1983 import bill) are paid for by the government. Devaluation will have littleeffect on the amount of these imports, as the government is the main recipient offoreign exchange earnings and its demand for these imports is insensitive to theirrial prices. With the continuation of the war with Iraq, this portion of the foreignexchange payments is not expected to fall. It may even increase if the IRI canfind new suppliers of arms.

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Foreign Exchange Gap in Iran 13TABLE 6. Paymentsfor Services and Unilateral Transfers

in the Balance of Paymentsa1973 1977 1978 1979 1980 1981 1982 1983Transportation 68 626 100 95 60 44 38 100Travel 240 1,897 1,649 2,934 1,700 681 400 .464Investment profits 671 680 780 798 398 275 227 184Other services

(government) 310 2,281 2,264 724 823 635 761 1,062Other services(private) 64 1,420 3,095 439 87 78 70 71

Total 1,353 6,904b 7,888 4,990 3,068 1,713 1,496 1,881Unilateral transfers 6 125 15 15 2 - - -aIn millions of U.S. dollars.bThe difference between this and the corresponding figure in Table 1 is due to the revision referred toin the note to that table. The revised Balance of Payment Table is not available.Source: Bank Markazi, Economic Report, various issues.

4. TRANSFER PAYMENTS AND CAPITAL FLIGHTAn analysis of the foreign exchange market in Iran cannot be concluded

without appropriate consideration of transfer payments and capital flight. Thesepayments were disguised in the "service" items of balance of payments in theprerevolutionary years (Table 6). In more recent years, the foreign exchangedemand for these payments makes up the most important part of the demand inthe foreign currencyblack market.43Generally, postrevolutionary capital flight diminishes after an initial surge inthe midst of revolutionary confrontations and immediately following establish-ment of the new regime. The Islamic Republic has had the distinctive feature ofcontinually alienating segments of the urban middle class on cultural, social, andreligious grounds. This alienation, the continuation of the war, and the high rateof unemployment among intelligentsia and professionals have caused a continu-ing wave of emigration from Iran, accompanied by the outflow of assets. There-fore, the demand for foreign currency to transfer wealth abroad has not yetsubsided and appears to continue, although at a lower rate than the initial surgeof capital flight.The most important element of transfer payments is the living expenses ofstudents and the expatriated Iranians without a foreign source of income. Theflow of students abroad was reduced sharply after the revolution, once the IRIput stringent limits on sales of foreign exchange at the official rate for thispurpose. Similarly, some expatriated Iranians returned to Iran because livingabroad was becoming exceedingly expensive with the foreign currency pricesoaring in the black market. Many, however, have continued to liquidate andtransfer their income-earning assets (mainly real estate). Those who do not wantto take the risk of returning to Iran to liquidate their assets (the presence of the

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14 Sohrab Behdadowner is required by law for any large legal transaction) continue to receiveincome from Iran.

On the other hand, the draft-evading young males (ages ten through eighteen)or upper-middle-class families, and those who have migrated to escape politicalrepression in the past several years, have partially made up for the decline in thenumber of Iranians who receive their living cost fully or in part from Iran. Theamount of official exchange provided by the government for these purposes hascontinually declined.44A substantial portion of these transfer payments are sentabroad through the nonofficial foreign exchange market.Foreign currency demand for these purposes has been the major determinantof the black market exchange rate, which has in turn affected the black marketprice of imported goods. Devaluation of the rial, to the extent that the officialrate comes close to the black market rate, would have no effect in reducing thesepayments. In fact, if anything, the demand may increase as the risks andlimitations of transacting in a black market are eliminated. A devaluation can,however, increase government revenues from selling foreign exchange for theseand other purposes. The partial legalization of these transactions, allowingowners of foreign currency to sell their holdings in their Central Bank account atthe market rate,45has brought such a profit for the owners of these accounts-foreign trade merchants and others, who somehow manage to earn foreigncurrency from "sources abroad." Such gains can be appropriated by the govern-ment through a partial devaluation, increasing the price of foreign exchange forthese purposes. Given that the expatriated Iranians, those who transfer theircapital or wealth abroad, and the travelers to Europe and the United States (themain destinations of Iranian tourists) are the villains of the IRI, imposition of ahigher exchange rate on them does not raise any concern in the regime. Thedifficulty, however, in the eyes of the IRI is in the legitimization of the capitaland wealth transfers, and transfer payments for expatriated Iranians. Yet, it ishighly probable that steps will be taken toward legalizing these exchange trans-fers while charging higher prices for foreign currency. Nevertheless, little declinein this segment of demand for foreign exchange can be expected for some yearsto come.5. CONCLUSIONS AND IMPLICATIONS

The Iranian industries have not lost any market share to cheap imports andthus have not been hurt by the exchange rate policies of the IRI. The large,modern industries have, in fact, been the major beneficiary of the currentexchange allocation system. The stringent import-licensing practices of thegovernment have amounted to furthering the protection that these industriesenjoyed during the Shah's rule. The policy that promotes industries with heavydependence on imported inputs requires the maintenance of a continuous inflowof cheap imports. The Shah's industrial policy owed its "miraculous" achieve-ments to the continual increase in the oil revenues that made increased inflow ofimported inputs possible. The IRI has come to revitalize the same industrialstructure,46only in a world confronted with a glutted oil market.

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Foreign Exchange Gap in Iran 15The unfavorable conditions in the world oil market have, however, turned intoa blessing for the privileged industrialists in the IRI. The large manufacturing

establishments have received generous exchange quotas to import their neededindustrial inputs at the official exchange rate and to sell their products atcontinually higher prices. Small industries, unable to receive exchange quotas,must acquire their inputs from black markets. This was the lot of small industriesin the Shah's period, too.The privileged industrialists have been, therefore, in a no less favorable posi-tion than that of the privileged merchants. The "privileged" are those whoseproperty rights are protected and who receive valuable entitlements distributedby the regime. In the capitalist democracies protection of property rights isenjoyed by all property owners, in general, and the capitalist class, in particular,but the distribution of entitlements is a matter of conflict between different strataof capital and individual capitalists. In the dictatorial capitalist regimes, how-ever, protection of property rights becomes less indisputable and distribution ofentitlements less institutionalized and less subtle. These features are even morepronounced in the IRI. Although the regime has come to a de facto acceptanceof industrial property rights, those who have closer alliance with the regimeenjoy firmer protection of their property rights than others. The foreign ex-change gap of recent years has added the foreign currency allocations to themyriad of entitlements that the regime distributes. The battles that the indus-trialists fought in the Ministry of Industries and Mining during the rule of theShah to receive licenses for protective tariffs, tax holidays, and soft loans nowhave been extended to the various centers of distribution of import licenses andexchange quotas.It is, no doubt, too simplistic to consider the economic policies of the IRImerchant-pleasing, even though the Islamic movement in Iran has been nurturedand financed by the bazaar merchants. The imperatives of ruling a capitalist statenecessitate formation of class alliances between the IRI and the industrialists, inspite of the original merchant mentality of the regime's leaders. The so-calledantitechnocratic position of the regime is also a false perception on the part ofthose who continue to evaluate the IRI on the basis of its initial populistproclamations. On the contrary, the regime has found it difficult to conceal itsfascination for the abilities of technocrats, westernized or otherwise.47A numberof high-ranking positions, even at the cabinet level, have been held by west-ernized technocrats par excellence.On the other hand, bazaar merchants have not sworn to remain merchants.They are men of profit and much of their dissatisfaction with the Shah's regimereflected their inability to enter the fiefdom of large modern industries.48TheIslamic Republic has provided them with the opportunity they longed for, andthey certainly are taking advantage of it. Some have already made advances inextending their activity into the industrial sector. Many others are struggling tomake similar moves.49The clamor for denationalization of industries is heardmore clearly these days in the bazaar of Tehran than anywhereelse.The IRI has few options to reduce its widening foreign exchange gap. Ageneral devaluation, as attractiveas it appears in the textbook model of exchange

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16 Sohrab Behdadrate determination, is not an effective instrument in the case of an oil-exportingcountry with a heavily import-dependent industrial sector.Devaluation will do little to increase foreign currency earnings, given the verysmall share of the non-oil exports in the exchange earnings of the country. Thepotential of the non-oil exports is limited by the internal structural constraintsand trade barriers in the export markets.Prices in the black market for consumer goods are exceedingly high for adevaluation within a conceivable range to have any considerable effect in re-ducing the demand for these products and thus for foreign currency needed toimport them. A general devaluation will reduce the demand only for that portionof the imported goods that are purchased by final consumers at, or near, theofficial prices. This share is not only relatively small in the total import bill, butit also encompasses products and consumers of strategic importance to the IRI.With imported consumer goods making up only 14 percent of the total importbill, a 50 percent reduction in the value of these imports will be equal to a savingof no more than 7 percent in Iran's total foreign currencypayments.The remaining portion of foreign exchange payments is for purposes that theIRI has no intention of putting in jeopardy. With continuation of the war, theimports of defense-related products will not be reduced. The most substantialportion of Iran's payments is for imports of producer goods. Even a slightdevaluation, which in Iran's present condition is in the magnitude of a 100 or 200percent increase in the value of foreign currency,will have a devastating effect onthe large modern industries of Iran, and is, therefore, totally out of the question.One major reason that the presumed equilibrium exchange rate is far abovethe official rate is the large outflow of transfer payments and capital flight that issupplied from nonofficial sources. With the foreign currency price nearly tentimes the official rate in this market, profit-seeking merchants and industrialistswill continue to supply the foreign currency demanded. The effect is that anamount nearly equal to the size of this outflow is siphoned off by variousschemes from the exchange earnings of the country and thus not available forcovering the official foreign currency payments.

Therefore, a general devaluation provides little attraction and only graveconsequences for the IRI. Only further partial devaluation of the rial within themultiple exchange rate system, which the IRI devised soon after the revolution(not unlike that of many other countries), is what may be expected. The rial maybe devalued for some categories of foreign currency payments. The existingcategories may be expanded to allow for finer discrimination of payments and toinclude some that were not considered authorized in the past. A high foreigncurrency price for imports of "luxury" goods (with more goods falling into thiscategory) and for travelers is to be expected. It is also highly probable thatcertain types of transfer payments and wealth transfers will be included in theofficial categories. Continually higher prices will be offered for the exchangeearnings of exporters as an incentive to boost exports. With the exception of thelatter measure, which will have a minor effect on reducing the foreign exchangegap, other measures can only increase government revenues without diminishingthe foreign exchange gap.

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Foreign Exchange Gap in Iran 17Further quantitative restrictions will be applied to imports. Thus, the scramblefor receiving import licenses and exchange quotas will intensify as these en-

titlements can bring higher windfall gains for the fewer privileged capitalists(merchants or industrialists) who receive them. These further restrictions willaccelerate the process of oligopolistic formation that commenced in the post-revolutionary period and is replacing the oligopolistic structure that was formedbetween the 1960s and mid 1970s and became dysfunctional in the 1979 revolu-tion. It is the specter of exclusion from this circle of privileged capitalists,particularlyfor those who have looser ties with the regime, that has generated anuproar among the merchants and industrialists in the past few months. State-ments of Ayatollah Khomeini50and Ayatollah Montazeri5saddressed the issue inan effort to mediate in this confrontation with the slogan "Let EveryoneParticipate."If the position of the oil-exporting countries in the world oil market does notimprove, external financing appears to be the only alternative available to theIRI. This is, however, a highly sensitive issue in Iranian politics. Borrowing fromabroad is a severe blow to the political posture that the IRI has attempted tomaintain. It is all the more so when the potential lenders are those whom theregime has put in the "satanic"category.52The IRI has, however, revealed its exceptional flexibility in acceptance ofpragmatic solutions. This latest dilemma will, nevertheless, have two importantimplications. First, in the domestic arena, external financing of the foreignexchange gap will be considered a victory for proponents of the free market(versus state control) within the regime. It will be counted as a reflection of thefailure of the government to manage a large (much larger than in the Shah'speriod) segment of the economy and its control over many facets of the economiclife. "Let Everyone Participate" has already transpired into what may be calledLaissez Faire, Laissez Participer. Second, in the international arena, foreignborrowing will necessitate a substantial toning down of the belligerent foreignpolicy position of the IRI as well as some guarantee of progress toward a freemarket condition in the internal economy. Proponents of a free market in theregime are aware of the latter condition for borrowing and will not lose theirchance to capitalize on it.The widening foreign exchange gap and the existing economic and politicalconstraints are, therefore, ushering the IRI toward a new phase in the trans-formation of its politics. The recent rapprochement with France and the revealedsecret arms deal with the United States are indications of IRI's new diplomaticdisposition. Further acceptance of the free market relations in the domesticeconomy will be another important outcome of the present phase in the trans-formation of the postrevolutionary politics of Iran. The IRI is rapidly approach-ing the path of "moderation."It may come as a surprise to some observers of theIranian political events that the coming of "moderates" to power was not thenecessary condition for any of the phases in this transformation.DEPARTMENT OF ECONOMICSDENISON UNIVERSITY

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18 Sohrab BehdadNOTES

Author's note: The final version of this article was completed in May 1987. I would like to thankRichard Lucier, James Pletcher, and the anonymous referees for their helpful comments. I amresponsible for the opinions and remainingerrors.'The Iranian currency, rial, is pegged to SDR (I SDR = 92.30 rials). For details of the exchangecontrol measures in Iran, see International Monetary Fund, Exchange Arrangements & ExchangeRestrictions, Annual Report 1986 (Washington, D.C., 1986), pp. 297-98.2Although the Iranian calendar year starts on March 2, I refer to any particular year in thiscalendar by using the corresponding Gregorian calendar year. Thus I write, for example, 1974 for1353 and not 1974/75, which some authors prefer.3Some restrictive measures were applied to foreign currency transactions in the months before thefall of the Shah's regime.41nitially the Planning and Budget Organization (now a ministry) proposed the devaluation policy

in the intergovernmental debates in 1982. This view has been opposed by the Central Bank (BankMarkazi).5Wolfgang Lautenschlager,"The Effects of an Overvalued Exchange Rate on the Iranian Economy,1979-84," International Journal of Middle East Studies, 18, 1 (February 1986), 31-52.6Ibid., 50.'Ibid., 49.8Ibid., 43. The article does not provide the basis of the suggested "one-third"potential growth inindustrial output.9Ibid.,49-50."'Ibid.,50.'"Lautenschlager's analysis is based on a simplified version of the exchange rate determinationmodel of international monetary theory. This model is explained in many international economics

texts; see, for example, M. E. Kreinin, International Economics: A Policy Approach, fifth edition(New York: Harcourt Brace Jovanovich, 1983), chapters 3, 6, and 7. For a survey of literature anddebates on balance of payments adjustments in the underdeveloped countries, see: Anne D. Krueger,Exchange-Rate Determination (New York: Cambridge University Press, 1981), chapter 8; andWilliam R. Cline, "Economic Stabilization in Developing Countries: Theory and Stylized Facts," inJohn Williamson, ed., IMF Conditionality (Washington, D.C.: Institute for International Economics,1983), pp. 175-222. Carlos F. Diaz-Alejandro's work on Colombia (with coffee as its main export) isan appropriate guide for the study of multiple exchange rates and the foreign currency problems ofcountries with a single important export commodity. See his Foreign Trade Regime and EconomicDevelopment in Colombia (New York: National Bureau of Economic Research, 1976).2The oil dependence of the Iranianeconomy is examined in Patrick Clawson, "Capital Accumula-tion in Iran," in P. Nore and T. Turner, eds., Oil and Class Struggle (London: Zed Press, 1980), pp.143-77; M. H. Pesaran, "The System of Dependent Capitalism in Pre- and Post-RevolutionaryIran," International Journal of Middle East Studies, 14, 4 (September 1982), 501-22, especially 509-11;and Homa Katouzian, The Political Economy of Modern Iran, 1926-1979 (New York: New YorkUniversity Press, 1981), especially pp. 242-53.

'3Iran, similar to other oil exporting countries, benefited from the appreciation of the U.S. dollarprior to mid-1985. From then on, the depreciation of the U.S. dollar has accentuated the fall in thenominal price of oil by causing a decline in the real value of oil earnings.'4The sudden jump in non-oil exports in 1979 is explained by the fourfold increase in thenoncommercial rug exports as a form of wealth transfer. In 1981, the IRI put a stop to thenoncommercial exports of rugs.15Forsome of the Iranian export items only the latter is true because, as a small source of supply,Iran does not affect the international price of these products.'6See United States International Trade Commission (USITC), News (July 3, 1986) and USITC,In-Shell Pistachio Nuts From Iran: Determination of the Commission in Investigation No. 731-TA-287 (Final) Under the Tariff Act of 1930, Publication No. 1875 (Washington, D.C.: USITC, 1986).Between 1984 and 1985 the volume of Iran's pistachio nut exports to the United States increased bysevenfold, accompanied by a 43 percent price reduction (ibid., p. A-39).

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Foreign Exchange Gap in Iran 197The increase in the domestic price of exports in the case of small exporting countries (which areprice takers in the international market) limits the export expansion effects of a devaluation by

reducing exporters' profits. For the analysis of the effects of domestic price increase on exportperformance in the Indonesian case, see G. Russell Kincaid, "A Test of the Efficacy of ExchangeRate Adjustments in Indonesia,"IMF Staff Papers, 31, 1 (March 1984), 62-92.'8The export merchants, supported by most of the maraji'-e taqlid (sources of imitation) arguedthat there is no Islamic justification for the state to require exporters to surrender their exchangeearnings to the Central Bank. The Central Bank gradually retreated by allowing exporters to usetheir export earnings for importing products (Official Notification no. T/7000 Bank Markazi, datedFebruary 1, 1983-Bahman 12, 1361), and later, to sell them to importers (see note 19 below).Another element in this exchange-control liberalization measure was allowing the private owners offoreign exchange abroad to sell their foreign currency to importers or others at any price that theycame to agree upon (Official Notification no. NA/11600/14 Bank Markazi, dated July 4, 1982-Tir16, 1361).'9Articles 22 and 23 of the 1986 Export-Import Law, Kayhan (March 19, 1986-Esfand 28, 1364).This was the formalization of what has been taking place as an extension of the Central Bank'sexchange-control liberalization for exporters.2?Thepremium for "export foreign exchange" (arz-e saderati) fluctuated between 300 and 500 rialsper dollar in 1985-1986. The official rate for the U.S. dollar has been about 80 rials.21Kayhan air edition, May 7, 1986-Ordibehesht 17, 1365).22Accordingto the latest estimate, Iran's export earnings reached 750 million dollars in 1986.Ettela'at (March 30, 1987-Farvardin 10, 1366). Iran has been negotiating to resume natural gasexports to Soviet Union, starting from "a small amount building up by 1990 to the former level of350 billion cubic feet a year," New York Times, August 26, 1986. These revenues were 248.5 milliondollars in 1978, Bank Markazi, Economic Report and Balance Sheet (Gozaresh-e eqtesadi vataraznameh) for 1978 (1357), p. 134. If potential earnings from exports of naturalgas are added, the

total non-oil export earnings will not exceed $1 billion.23Capital nflows are not discussed because there has been practically no capital inflow to Iran inthe postrevolutionary period, and the outflow of private capital takes place through the nonofficialmarket.24SeeBank Markazi, Economic Report, various issues.25Aneditorial in Kayhan ("Exports of Services,"June 3, 1986-Khurdad 13, 1365) suggests that the"3 million unemployed" Iranian workers form a potential source of exchange earnings. According tothis editorial Libya should be encouraged to "expel workers from reactionarycountries and to attractrevolutionary Muslim workers from Iran." This will cause the expelled workers "to become instru-ments of pressure and opposition against the reactionary regimes." Moreover, "with the unofficialdecline in the value of the rial, Iranian workers will be ready to work at wages much lower than thewages that the South Korean, Pakistani, or Egyptian workers receive."26BankMarkazi, Economic Report, for 1982 (1361) and 1979 (1358).2Lautenschlager, "The Effects of an Overvalued Exchange Rate . . . "38.28Ibid.,43. It must be pointed out that the comparison between the "effects of a high dollar in theU.S. economy" and the situation in Iran is theoretically improper because (1) the U.S. dollar is afloating currency, therefore, its value is the market equilibriumprice;(2) imports to the United Statescontinued to increase in absence of general quantitative restrictions. In fact, the most staunchprotectionists in the United States would be overjoyed by the implementation of a much milderimport restrictionmeasurethan that enforced in the Iranian case.29BankMarkazi, Economic Report, for 1979(1358), p. 139.30Based on author's estimates in a forthcoming study on income inequality in postrevolutionaryIran.3'Bank Markazi, "Price Index of Consumer Goods and Services in the Urban Regions of Iran"

(Shakhes-e beha-ye kalaha va khademat-e masrafi dar manateq-e shahri-ye Iran), mimeo February/March 1986-Bahman 1365, Table 2.3Lautenschlager, "The Effects of an Overvalued Exchange Rate . . . ," 45.33In 1984, government revenues from selling foreign exchange at a rate above the "established"price amounted to 206 billion rials (5 percent of government revenues). The most important sources

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20 Sohrab Behdadof these revenues were from sales of foreign exchange for imports of "special goods." Revenues fromoil constitute 11.6 percent of government's income in 1987 (53.6 percent in 1979). The Parliament(Majles-e Shoura-ye Eslami), The Budget Law of 1985 (Qanun-e budje-ye sal-e 1354 koll-e keshvar)(1985-1364), and Kayhan (air edition, March 18, 1987-Esfand 27, 1365). Any devaluation of the rialwill increase the oil revenue component of the government's budget. Because a large proportion ofexchange earnings are, however, used by the government (62 percent in 1983) the full budgetaryimpact is less than it initially appears.34See Manouchehr Parvin and Amir N. Zamani, "Political Economy of Growth and Destruction;A Statistical Interpretationof the Iranian Case," Iranian Studies, 12, 1-2 (Spring 1979), 64-65.35Farhad Daftari, Multinational Enterprises and Employment in Iran (Geneva: InternationalLabour Office, 1976).36Sohrab Behdad, "The Pattern of Structural Transformation in the Iranian Economy (1953-79):A Historical Review," mimeo, 1985, 20.

37BankMarkazi, Economic Report, for 1982(1361) and 1983(1362).3Instead of looking at this general trend, Lautenschlager (p. 45) attributes the industrial outputgrowth in 1982 to a decline in the value of imports in that year. Much of the fall in imports ofprimary and intermediate goods in 1982 (16 percent) was compensated for by the inventory buildupof these imports in the previous year (32.0 percent increase in imports of these goods) and theincrease in imports of primary and intermediate products in the following year (57 percent). IfLautenschlager's reasoning were correct, the industrial output in 1983 must have declined sharply asthe imports of primary and intermediate products and consumer goods increased 42.7 percent. It didnot. In fact, in that year the non-oil GDP and all indicators of industrial output show a significantgrowth (Table 2). According to my analysis, however, the 56.5 percent increase in imports of primaryand intermediateproducts was a necessary condition for the impressive growth rates."Bank Markazi, Economic Report, for 1983 (1362), pp. 156-57.40On the nominal and effectivetariff rates of Iran, see Mahnaz Fahim-Nader, "Import-SubstitutionIndustrialization in Iran," unpublished Ph.D. thesis, Department of Economics, University ofMaryland, 1978, p. 68.41Statistical Center of Iran (Markaz-e Amar-e Iran), National Statistical Yearbook 1983(Salnameh-ye amari-ye keshvar 1362) (1984/1363), pp. 434-35.42Estimatedfrom the value added by enterprises with ten or more workers in 1982 (ibid., p. 401)and total manufacturingvalue added in Iran in that year (Bank Markazi, Economic Report, for 1982[1361], p. 134).43For a formal analysis of foreign exchange black market, see Michael Nowak, "QuantitativeControls and Unofficial Markets in Foreign Exchange: A Theoretical Framework," IMF StaffPapers, 31, 2 (June 1984), 404-31.44Total official sales of foreign exchange for travel, medical, and student expenses in 1983 was $460

million (Economic Report, for 1983 [1362], p. 206; compare with $1897 million in 1977, EconomicReport, for 1977 [1356], pp. 232-33). According to the prime minister's 1987 budget report to theParliament, official payments of foreign currencyfor travel in 1985 were $337 million. This figure wasreduced to $90 million in 1986. Student expenses in 1984, 1985, and 1986 have been reported to be,respectively, $155 million, $132 million, and $110 million. See Ettela'at (December 28, 1986-Day 7,1365).45Seenote 18.46See Sohrab Behdad, "Political Economy of Islamic Planning in Iran, 1979-1986," inH. Amirahmadi and M. Parvin, eds., Post-Revolutionary Iran (Boulder, Colo.: Westview Press,forthcoming).47The biographical sketches given at the time of presenting new cabinet members to the Parliamentoften exaggerate the educational backgrounds and technocratic abilities of the candidates.48Somedid enterthis privileged position. Haji Barkhordar,Yasini, andKhayyamis, among others, weremerchantsof bazaarorigin who became industrialists.Obviously, not all merchants ould enterthis highlymonopolistic realm.49Thisassertionis based on my own observations. No empiricalstudy has yet been conductedon thisissue.

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Foreign Exchange Gap in Iran 2150Ayatollah Khomeini's speech on the occasion of 'Id-e Fitr, Kayhan, June 10, 1986-Khordad 20,1365.5'Ayatollah Montazeri's speech in a meeting with newspapereditors, Kayhan, June 25, 1986-Tir 4,1365.52The ew political allies of the IRI are in no position to extend financial assistance to Iran. Syriaitself is a borrower with debts to Iran, and Libya's foreign exchange reserves have been depleted inthe oil glut of the past few years.