Could Iranian sanctions work? ‘yes’ and ‘no’, but not ‘perhaps’

Sajjad Faraji Dizaji, Peter van Bergeijk

01 June 2013

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Sanctions against Iran are closely monitored. In particular, academics and policymakers focus on the impact on Iranian exports and the potential for trade diversion (see Haidar 2013). But even if the sanctions bite, the question is whether these sanctions will change the political course of Iran. If one wants to evaluate the potential utility of economic sanctions against Iran then one should consider three key factors: the level of trade between sender and target of the sanctions, the speed of action and the political and institutional characteristics of the target nation (van Bergeijk 2012). The sanctions against Iran meet the economic requirements for success. Over 2007-2011 on average 83% of Iranian exports, 34% of Iranian government revenues and 24% of Iranian GDP directly relate to the main target of the sanctions: the Iranian oil industry.

The sanctions bite

Figure 1 is based on the most recent IMF estimates, showing substantially decreasing Iranian trade (thus, the sanctions are effective in an economic sense). The reduction of the imports-to-GDP ratio by a third and of the exports-to-GDP ratio by a quarter actually understate the impact of the sanctions as GDP according to the IMF data will contract for the second year in a row. The EU financial sanctions that accompany the oil boycott may explain why the sanctions are biting so hard. These financial sanctions exclude Iran from the SWIFT worldwide messaging system used to arrange international money transfers, which makes international payments very difficult and also constrains other bilateral economic flows, such as remittances and foreign direct investment. Clearly then the sanctions are working. The key question is whether this economic loss will induce a change in politics.

Figure 1. Export/GDP ratio and Import/GDP ratio, Iran, 1995-2013, constant prices and exchange rates

Sources: GDP, exports and imports at constant 2000 prices and dollars for 1995-2007 are from World Bank, World dataBank, http://databank.worldbank.org, accessed 5 December 2012 and calculated from their real growth rates for 2008-13 as reported and estimated in IMF, April 2013 World Economic Outlook database, http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/index.aspx accessed 10 May 2013.

Will behaviour change?

In order to answer this question we need to take both economics and politics into account (Dizaji and van Bergeijk 2013). We investigate this issue using a vector autoregression model for Iran that takes into account both key economic variables (oil and gas rents, government consumption, imports, gross capital formation, GDP) and political variables, that either measure the autocracy-democracy dimension or political competition and participation (note that while the formally stated goal of the sanctions against Iran is to stop nuclear proliferation, sanctions are clearly linked to democratisation; see Maloney 2010 and Farzanegan 2011).

We estimate the vector autoregression model on the basis of annual data for the period 1959-2006. Next, we introduce a shock in the system that mimics the sanctions and takes a look at the impulse response functions that show how economic and political variables react to that shock. Figure 2 focuses on the impact of the sanctions on the extent of democratisation; a positive impact implies that the sanction stimulates democracy. In the first two years the sanction has a significantly positive impact (confidence intervals are shown by dashed lines); but that effect wanes and in the long run the effect of sanctions is negative.

Figure 2. Impulse response function for the sanction’s impact extent of democratisation of Iran

Source: Figure 4f in Dizaji and van Bergeijk (2013).

This finding is in line with the general theory that acknowledges the importance of economic adjustment as a determinant of economic damage and thus the incentive to change political behaviour. Typically, this aspect has been ignored in the literature. By studying the dynamics of economic sanctions we are able to show why successful applications of economic sanction predominantly succeed in the early phase. For the Iranian, our research provides a clear answer: the sanctions can only help to soften the Iranian position in the short-run. Long-run, sanctions against Iran should not be expected to succeed.

References

Bergeijk, Peter AG van (2012), “Failure and success of economic sanctions”, VoxEU.org, 27 March.

Dizaji, Sajjad F and Bergeijk, Peter AG van (2013), “Potential early phase success and ultimate failure of economic sanctions: A VAR approach with an application to Iran”, Journal of Peace Research.

Farzanegan, Mohammad R (2011), “Oil revenue shocks and government spending behavior in Iran”, Energy Economics 33(6), 1055–1069.

Haidar, Jamal Ibrahim (2013), “Sanctions and trade diversion: Exporter-level evidence from Iran”, VoxEU.org, 9 April.

Maloney, Suzanne (2009), ”Sanctioning Iran: If only it were so simple”, Washington Quarterly 33(1), 131–47.

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Topics:  Politics and economics

Tags:  Iran

Central Bank of the Islamic Republic of Iran

Professor of International Economics and Macroeconomics, Institute of Social Studies, Erasmus University

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