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June 2021, No. 97


Endeavor

The Return of Populism!


We are holding the presidential election this year. Elections have always been associated with the promise of increased prosperity.


By: Dr. Hossein Abbasi 

Irans economy has been in recession for about a third of the last half century. The only decade in which all the years of economic prosperity took place was the decade of 1378 (1999) to 1387 (2008), when the Iranian economy grew by an average of eight percent per year. Although many effective policy making reforms have taken place in various sectors of the economy, perhaps the most important thing that has happened in this decade has been the avoidance of major policy mistakes. We owe the increase in relative prosperity that continued for many years to the economic growth of those years.

In some years of the recent half-century, factors such as war and sanctions have been instrumental in creating recession, but in almost all cases the traces of major policy making mistakes in creating or deepening recessions can be clearly seen. In most cases, foreign exchange policy has been at the forefront of these mistakes, which have appeared in Iran in the form of nominal stabilization of the foreign exchange rate in the context of inflation, i.e. the reduction of the real price of foreign currency. The dangers of lower real currency prices have been talked about time and time again, and economists and non-economists alike are familiar with them. As a result, the subject of this article, rather than describing the effects of this policy, is a renewed warning about the overwhelming interest of Iranian economic decision-makers in repeating this mistake, especially in the new year. Two factors make this policy more likely to be repeated next year.


Countless factories have been shut down since the second half of the 1380s following the devaluation of the real exchange rate, and many jobs have been lost.


First, we are holding the presidential election this year. Elections have always been associated with the promise of increased prosperity. Given the steady decline in the well-being of Iranian families in recent years, it is expected that in this period a competition will be launched among the presidential candidates to make the greatest possible welfare promises. Cash payments, commodity price controls, low-interest loans to various groups, wage increases, and all kinds of sponsorships and payments are some of the programs that will be promised to the people for voting. Some of these may be challenged by some competitors because they require a lot of budget resources. Promises to lower the exchange rate, however, will probably not be challenged.

The price of the US dollar in the same three years ago was about 42,000 rials. The insistence on keeping the price low, which led to a sharp increase in demand for the dollar, along with a lack of supply, led to a jump in its price. The sharp rise in the exchange rate in recent years came at a time when all political groups and all components of the government were in agreement that, firstly, its rise is harmful and, secondly, the government can and must prevent its rise. The governments failure to keep the exchange rate low was interpreted by government friends and rivals as the governments inability to manage the affairs.

The usual explanation for the need to prevent the exchange rate from rising is to preserve the value of the national currency, which is a populist translation of increasing the purchasing power of foreign goods. Given these cases, it is very likely that the presidential candidates will compete with each other in the promise of lowering the rate. Even if a candidate disagrees with the harmful consequences of stabilizing or depreciating the exchange rate, they will not have the courage to raise and defend it in the hot market of election race, which is exacerbated by the second factor I will explain below.

Second, there is a very small likelihood of some sanctions being lifted, as a result of which the current or future government may have access to Irans accumulated dollar resources in other countries. This makes it easier for dollars to flow into domestic markets. The government has consistently cited sanctions as the main reason for the rise in the exchange rate, and has naturally led to the expectation that by removing some of the sanctions, the obstacles will be removed and part of the increase in the exchange rate in previous years will be offset. As a result, almost any political group that has access to these dollars will give up restraint and use this precious opportunity to spread the dollars in the markets. But why are politicians so interested in this wrong policy? The cause must be sought in two kinds of effect on the economy: the effect that wins votes and the effect that destroys the economy.

The first effect, which is immediate and everyone immediately sees and feels it, is to increase consumer welfare. Low price currency increases the welfare of consumers because by making foreign goods and services cheaper, it increases consumers purchasing power of foreign goods. In the late 1380s (2000s), after the exchange rate remained stable for nearly a decade, consumers were reminded of foreign trips to dozens of distant and near destinations, a variety of inexpensive foreign appliances, fresh and colorful fruits, and even studying abroad.

Of course, different groups in society do not benefit equally from this increase in consumption. High-income groups, which spend a larger portion of their income on non-food and high-quality foreign goods, benefit far more than low-income groups, which spend a larger portion of their income on cheaper, lower-quality food and goods. The bitter irony of this policy is that it is executed in the name of justice and equality. The second effect, which is a gradual and hidden impact, is that it expels domestic goods from domestic and foreign markets in favor of foreign goods. When foreign goods gradually become cheaper, neither their similar domestic production nor their exports will be profitable.

Countless factories have been shut down since the second half of the 1380s following the devaluation of the real exchange rate, and many jobs have been lost. One of the facts that severely questioned the foreign exchange policies of the ninth and tenth governments was the revelation on a television program that the average job production during the eight years of these governments was almost zero. This result was by no means unexpected for those familiar with the literature on the effects of foreign exchange policy, but it greatly angered the demagogues who saw cheap currency a gift to the Iranian economy. The increase in production of some goods, including household appliances, over the past year, despite the sanctions crisis and the spread of the corona virus due to declining imports of similar goods, is further evidence of the exchange rate effect on domestic production.

The key point is that the first effect is quickly apparent after the exchange rate change, everyone sees it and feels it in their lives, but the second effect, which gradually erodes the foundations of domestic production over the years, is hidden and gradual. As a result, people in society do not immediately see it in their daily lives, and when its effects appear in the form of reduced employment and production and, consequently, a chronic and continuous decline in purchasing power, they cannot identify its roots.

That is why politicians, even if they are aware of these hidden effects, prefer to gain popularity by insisting on lowering the exchange rate and not to bother to prevent the destruction of production, the effect of which will be revealed years later. Not surprisingly, the low price of the currency is so much the qibla of politicians (and some economists) demagogues. The new year may be the arena for this populist policy.

 

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  June 2021
No. 97