Since 1995, the US has enforced a total embargo against Iran, prohibiting American firms from routine business with the Islamic Republic. The $536 million settlement with Credit Suisse shows that the Obama administration is keen on pressuring companies active in Iran.
These sanctions, however, have not weakened Tehran. While sanctions have increased the cost of conducting business in Iran, cutting a nation of 70 million people out of the international economy has proven difficult. Indeed, where the US and Britain have cut ties, Tehran has found other suitors for its precious resources. Chinese, Russian, Indian, Malaysian, Italian, Turkish, and South Korean energy companies are active in Iran, enabling it to continue to expand its all-important energy sector.
With Iran close to having enough fissile material for a nuclear weapon, American policy stands at a precipice. To many, the choice is stark: Accept the "Persian bomb", with all the potential regional consequences that might follow, or attack Iran's nuclear facilities. Military exercises by Israel and Iran show that both countries are preparing for war. There is however, one last chance that American-led sanctions might work.
Tehran is fully aware that Iran's economy is chronically unstable and inefficient. As the House passed the Iran Sanctions Act, in the Majlis and Guardian Council, Iran grapples with the toughest piece of economic legislation since the revolution - the battle over energy subsidies.
President Ahmedinejad's government seeks to eliminate the energy subsidies that are a staple of Iran's domestic economy. These subsidies keep the price of a gallon of gasoline at only 40 cents and indirectly subsidize nearly every domestically produced good in the country. But, according to the IMF, subsidies on petroleum products cost Tehran nearly $85 billion a year, a full 15 percent of Iran's GDP. As Tehran is aware, this economic manipulation is unsustainable and harms Iran's ability to invest in vital sectors of the economy. Considering that the Oil Ministry cites the need for $85 billion for investment in the energy sector over the next decade, Iran could use the extra cash.
To mitigate expected opposition, the government hopes to distribute much of the savings as cash payments to the poorest Iranians. The business daily Sarmayeh estimates that each Iranian who qualifies would receive $17 a month, or $1000 per year for a family of five. Ahmadinejad hopes to marry free-market reform with populist redistribution.
Unsurprisingly, the plan is anathema among the upper and middle class Iranians. Little wonder as to why Iran's urbanized, educated middle class families gain disproportionately from energy subsidies, nearly ten times more than a poor family by some estimates. The growth of the domestic automobile industry in Iran is testament to that fact, with nearly one million new cars produced every year. Political figures popular among urban, middle class Iranians, including Mir Houssein Mousavi and Ali Larijani, have voiced dissent with the plan.
There is a real possibility that eliminating subsidies could lead to domestic instability; the last attempt to reduce energy subsidies in 2007 led to street riots. Furthermore, those most harmed by subsidy reforms are precisely already opponents of the regime - the urban, educated, middle classes. If recent street protests at the funeral of Grand Ayatollah Hossein Ali Montazeri are any guide, Iran's cities already tread a fine line between order and chaos.
Economically, the effect of eliminating subsidies will be profound. Many Iranian analysts fear that inflation, officially at 13.5 percent but likely to double that figure, will skyrocket if subsidies are eliminated. The increased cost of energy would not only affect the price of petroleum products, but would severely raise the price of all domestically made goods in Iran as industries pass the costs onto the consumer. Considering that the average Iranian family makes roughly $4,800 a year, if inflation rose by 20 to 30 percent, even a family receiving $1,000 in cash handouts would see a loss of real income. Across the class spectrum, rapid inflation would be a heavy burden. Finally, the domestic industries that profited from Iran's subsidy scheme, like the automobile industry, which employs nearly 3 percent of the country's work force, would face reduced demand and be forced to lay off workers. Since the entire Iranian economy is structured around cheap energy, the elimination of energy subsidies will be a painful process.
For the US, the looming crisis over energy subsidies presents a final window of opportunity for economic sanctions to work. The administration should closely watch this domestic issue and impose new sanctions to maximum political and economic effect. Iran's supply of refined petroleum is still heavily dependent on just a handful of companies: Trafigura, Vitol, Reliance, British Petroleum, and Total, to name a few. Even if sanctions were only able to halve the number of barrels of refined petroleum exported to Iran, coupled with the elimination of domestic subsidies, the economic and political effects would be painful. In what may be the last chance for American economic sanctions to put pressure on Tehran, timing is everything.
— Adam Kemal works on Iran's economy at the American Enterprise Institute. He is also a student at Georgetown University. He can be contacted at:
