Oil Market Efficiency: A Case Study for Iranian Economic Prosperity

Abstract
Iran is an energy superpower with the second largest reserves in the world that produced 5.1 percent of the world’s total petroleum output in 2004 (James, 2008). Oil is the main source of foreign currency and the engine of economic growth. Iran is rich in terms of natural resources but poor regarding total GDP, and this disparity has impacted social and economic development throughout the past three decades (Malek, 2017). In this article, the pivotal events in the history of oil policy in Iran will be used to demonstrate the origins of current problems in Iranian economy. The global importance of the role of Iranian oil will be analyzed through the application of rational choice theory within global petrochemical supply and demand. Then the current oil market efficiency will be assessed through an exploration of different proposals regarding the utilization of oil revenues and institution building in a democratic manner. Through an assessment of these proposals according to the Theory of Justice, some possible solutions will be discussed to improve Iran’s economic prosperity.

Contemporary pricing versus Salary in Iran

The social welfare of families is highly depended on their income levels and the proper distribution of income increases the level of welfare of the society as a whole. Therefore, equitable distribution of income is one of the important goals of the development plans of a country. By increasing inequality in a society, in addition to reducing labor productivity, the demand for domestic products and public confidence in economic agents will also decrease. For this reason, if the consumption level of people is similar and is in accordance with the distribution of income amongst them, the rule of ultimate utility is maintained. In this section, by mentioning salary and pricings, I will analyse whether or not Iran’s government has been able to maintain social justice.

Many of the policies of the Islamic government are based upon principles of social equality. The Islamic Republic of Iran has survived three decades and recently has been emerged as a major Middle Eastern power (Abrahamian, Why the Islamic Republic Has Survived, 2009). Although there is an intention for social redistribution in the ideologies of the Islamic Republic of Iran, the outcome is poverty and failure. This is due to inadequate and poorly managed structures of government, outdated legal frameworks, corruption and inequalities in wealth and income (Parsa, 2016).

According to the Supreme Labor Council (SLC) in Iran, the monthly national minimum wage is 1,566,882 IRR that equals almost 120 USD (Iran, Iran Data Portal, 2019). This cannot cover the basic costs of living and places workers below the poverty line (Average Salary Survey, 2019).

After the withdrawal of the United States from the Joint Comprehensive Plan of Action (JCPOA) on May 2018 and the placement of US economic sanctions, the Iranian Rial fell significantly and the national inflation rate increased to an all-time high. The sanctions are aiming to push Iran’s oil exports to zero and immediately after they were imposed, Iran’s oil exports started to shrink and dropped from more than two million barrels per day (BPD) in March 2018 to below 400,000 BPD a year later, the lowest since the 1980s.

It is worth mentioning that Iran’s gross domestic product, including oil production, shrank 4.9 percent in 2018-2019, compared with the previous year. Based on a report published by the Statistical Center of Iran (SCI), Iran’s overall GDP is 7,130 trillion Rials (almost 52 billion USD).

In the past month the people of Iran started protesting against a 300% sudden increase in domestic petrol price and got murdered by the government for the crime of peaceful protesting. This amongst the previous facts mentioned shows us that Iran’s economy is marked by statist policies and an inefficient state sector, which create major misrepresentations throughout the system and the reliance on oil provides a large share of government revenues. Significant corruption is widespread in the system. Private-sector activity is limited to small-scale workshops, farming, and some manufacturing and services (Parsa, 2016).

The problem of oil dependency:

Oil revenues started playing an important role in the economy of the country after 1960s. Oil policy affects both the macroeconomics of the global oil market and microeconomics at a regional level and within Iran. By summarizing the oil history below, I will search for roots of current social and economic underdevelopment and later will try to find solutions.

Perhaps one of the most important events in the history of Iran is the failed struggle for control and national autonomy of the oil market. In 1951, the government of Mohammad Mosaddegh, the prime minister of the time, formed the National Iranian Oil Company (NIOC). Mosaddegh was the prime minister of Iran from 1951 until 1953 when his government was overthrown in the 1953 coup d’état by orchestrated by the United States Central Intelligence Agency, and MI6 of the UK. He died in 1967 under house arrest and is remembered as the leading champion of secular democracy and resistance to foreign domination in Iran’s modern history (Britannica, 2019). After disputes between the Iranian government and the AIOC (Anglo-Iranian Oil Company that was a British company founded in 1908 following the discovery of oil in a large field in Masjed Soleiman), the Iranian oil industry was nationalized through a mandate given by the Iranian Parliament (or Majles) to Mosaddegh. The shock of nationalization caused oil production and government revenues to fall sharply. In 1951 British workers were removed by Mosaddegh with the intention of replacing them with workers from Iran and other nations. However, other European nations and the United States refused to assist and co-operate in the nationalization of the Iranian oil industry (Ferrier, 1982).

During the years 1952 and 1953, only 28 thousand barrels per day were produced on average, which was around 4 percent of previous production levels in 1950. Although this was partially due to the lack of technical skills, the main reason for the large slowdown in production was the British governments’ embargo on Iranian oil and the seizure of any oil tanker that wanted to do business with Iran. In 1952 the British Royal Navy blocked the interception of ships carrying Iranian oil (Heiss, 1994).

One of the reasons for the nationalization was that Mossadegh and the Majles believed that profits from the oil industry were not benefiting the Iranian economy, and national development was hampered by foreign ownership of the most valuable resource. This was due to the small percentage of the total oil revenues that the Iranian government actually received. In a speech to the United Nations Security Council on 15 October 1951, Mossadegh declared that “the petroleum industry has contributed nothing to the well-being of the people or the technological progress or industrial development of my country” (Mosaddegh, 1951).

In 1953 a military coup led by US and British intelligence agencies ousted the Mosaddegh government under an operation labeled as “operation AJAX”. This operation restored Mohammad Reza Shah to the throne (Elm, 1992).

If Mosaddegh was able to recruit engineers, equipment and spare parts from other European countries, we would see a different geopolitical configuration of the Middle East right now. The lessons we learn from this part of history is that national self-manifestation was perceived as a threat by foreign governments and investors. For this reason, the new nationalization project failed through a lack of human resources and the required technology (Elm, 1992). Ironically this means that Iranian economy could have fared better if it was never nationalized. However, the oil of one country belongs to the state and nationalization is not the reason of lack of economic growth in Iran, it is the wrong formation of institutions that has brought poverty and underdevelopment to a resource rich country.

The end of Mosaddegh’s government meant that new negotiations could start between the British and the American governments and the new pro-Western Iranian cabinet of prime minister Fazlollah Zahedi. The negotiations resulted in the formation of the Consortium Agreement in 1954 that gave the rights of extracting oil in the 100,000 square mile area covered by the 1933 Concession to a Consortium of eight European and American companies.

In 1954 AIOC became the British Petroleum Company (BP) and a new company was formed to manage the Iranian oil assets, termed the Iranian Oil Participants Ltd (IOP). The founding members of IOP included British Petroleum (40%), Royal Dutch Shell (14%), French Compagnie Française des Pétroles (6%) with the remaining 40 percent to be split equally between five American companies (Exxon, Gulf Oil, Mobil, Socony, and Standard Oil of California). This agreement gave Iran 50% of the net profit, which was the agreement that most Middle Eastern countries had with foreign oil companies. However, it did not allow the Iranians to control oil policy or join the board of directors (Dean, 2004). In addition, the contract stated that Iranians auditors were not allowed to see the company’s books.  With these terms, the Iranian revolution of 1979 should not have come as a surprise. By 1979, most oil countries have already nationalized and fully owned their own oil resources with full control of production and export decisions.

In 1955 oil production increased and by 1959 it reached the level of 951 thousand barrels per day, which was 50% more than the average level of production in the pre-nationalized period (Pesaran, 2012). Although oil exports formed 51% of total exports between 1936 and 1959, due to the royalty system, Iran’s share of foreign exchange receipts from oil export was disproportionately small, and non-oil exports were the dominant factor to balance Iran’s external account (Esfahani, 2009).

In 1960 and with the foundation of the Organization of the Petroleum Exporting Countries (OPEC), oil prices which had been falling since 1920, started to stabilize. OPEC was established by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. It was feared for its ability to impose economic pain on the West. Oil price was an important factor driving the Iranian oil export revenues and domestic output.

By 1961 over 1.2 million barrels of oil were being produced per day which was twice as much as the peak amount of pre-nationalization era in 1950 (0.6 million). The noteworthy increase in production meant that government revenues from oil exports started to rise notably and steadily. Consequently, the ratio of oil export revenues to GDP rose to 47 percent by 1974. Therefore, the role of oil production in the Iranian economy, although muted during 1908 and 1959, became slowly more important between 1960 and 1978 (Pesaran, 2012).

The Crisis of 1979

Since the Revolution of 1979, the economy of Iran has been caught between the ideological mandates of Islamic government and prevailing forces of global free market capitalism. The purpose of this section is to highlight a few key points in this long and complex process, and to establish a context for analysis of the contemporary situation. This is significant as the Iranian Revolution was a unique event in world history, with important implications that make the economy of Iran a special case study unlike that of any other country.

During the wake of Iranian Revolution, the 1979 oil crisis occurred that led to a decrease by almost 4% of global oil supply. This led to widespread panic and a significant sudden increase in the price of crude oil. The price of oil was doubled, and long lines appeared in gas stations.

From 1980 oil production almost stopped in Iran due to the Iran-Iraq war, and production was correspondingly slowed in Iraq. Economic recessions were triggered in many countries including the U.S and oil prices did not subside to pre-crisis levels until the mid 1980s. In November 1978, a strike by 37,000 workers at Iran’s nationalized oil refineries initially reduced production from 6 million barrels per day to about 1.5 million barrels. Foreign workers (including skilled oil workers) fled the country. (Philip K. Verleger, 1979).

In 1979 the new Iranian Regime, led by Ayatollah Khomeini, nationalized all IOP assets and nullified the 1954 agreement. Since then, everything is under the control of the NIOC.

By the time of the revolution, the five largest international companies that had agreements with the NIOC, accounted for only 10.4 percent of total oil production. During this period, the oil industry in Iran remained disconnected from other industries. This separation promoted inefficiencies in the overall industrial economy of the country (Amiri, 2010).

The leader of Islamic revolution of Iran, Ayatollah Khomeini, said once that “economics is a science for donkeys”, and that the economy could be managed by mullahs versed in Islamic jurisprudence. His ideological position is one of the factors explaining the inchoate performance of the Iranian economy since the 1979 revolution. Khomeini is also known for his ambiguous and contradictory attitudes on the role of the state in the economy (Abrahamian, Khomeinism, 1993). He made populist promises such as free water and electricity and government-provided homes for the poor, which could be fulfilled by massive government intervention in the economy in violation of traditional Shariah law (Moin, 1999). This populist side of his legacy is found in the government of Mahmoud Ahmadinejad, who followed the “donkey” science of economics wearing “his contempt for economic orthodoxy as a badge of honor”, which resulted in sluggish growth and rising inflation and unemployment under his administration (Tait, 2008).

However, Khomeini agreed with conservative clerics and the traditionalist bazaar merchants on the importance of Shariah law and respect for the sanctity of private property. After Khomeini’s death and until 1997, his legacy was predominated by his “Bazaari” side and with the government of president Akbar Hashemi Rafsanjani who supported a free market position domestically, favouring privatization of state-owned industries and a moderate position internationally, seeking to avoid conflict with the United States and the west (Ramazani, 1987). Akbar Hashemi Rafsanjani was an influential politician and the fourth president of Iran after the revolution from 1989 to 1997.

The relatively moderate government of Hassan Rouhani has been negotiating these historically generated tensions since coming to power in 2013 and it seems like Iran is in a loop of repeating its past mistakes by ineffective institutions and global misrepresentation.

World oil Supply and Demand

Paul Rivlin has examined Iran’s energy balance and the potential for this balance to be defeated by international sanctions. He believes that by subsidizing all energy products, Iran artificially raises demand while US sanctions limit the ability to increase energy supply. As a result of which Iran will rely on the export of gasoline and other products, and if oil continues to subsidize, oil exports will decline. Below, we will discuss the impact of Iran’s oil supply on the global oil supply and demand (Rivlin, 2006).

Crude oil price is determined by global supply and demand. The world’s transportation sector is almost completely dependent on petroleum and therefore crude oil. For many countries it’s also used for heating, cooking and generating electricity.

The classical theory of supply and demand is a good place to begin. In order to do so, we illustrate the relationship between the quantity of crude oil, that producers wish to sell at various prices and the quantity that consumers wish to buy. The price of oil is determined by the interaction of supply and demand in the global oil market. The resulting price is referred to as the equilibrium price and represents an agreement between producers and consumers of oil. In equilibrium the quantity of a good supplied by producers equals the quantity demanded by consumers.

The quantity of oil demanded depends on the price of crude oil and potentially on many other factors such as the price of other commodities, the incomes and preferences of consumers and so on. In a basic economic analysis, all factors except the price of crude oil would be held constant. The analysis involves examining the relationship between various price levels and the maximum quantity that would potentially be purchased by consumers at each price level. A demand curve, showing the price-quantity combinations, almost always reflects the willingness of consumers to purchase more at lower price levels. Any change in non-price factors would cause a shift in the demand curve, whereas changes in the price of the commodity can be traced along a fixed demand curve (Chappelow, 2019).

Developing countries are expected to account for a demand of nearly 67 million barrels per day, and OPEC is projected to demand 12.3 million barrels of oil per day in 2040. Iran is the second largest oil consuming country in the Middle East. Total oil consumption was approximately 1.87 million barrels per day in 2018 (McKinsey, 2019).

The quantity of oil that is supplied in the market depends on the price obtainable for oil, as well as other factors such as the oil production technology, and the cost and availability of labor. In basic economic analysis, analyzing supply involves looking at the relationship between various prices and the quantity potentially offered by producers at each price, again holding constant all other factors that could influence the price. 

Unlike the demand curve, a supply curve is upward sloping, usually reflecting the willingness of producers to sell more of the produced oil in the market with higher prices (McKinsey, 2019).

Global oil supply from OPEC countries fell to 30.2 million barrels per day after the imposition of sanctions by President Trump. According to data published by OPEC, Iran has 155,600 million barrels proven crude oil reserves, and is currently producing only 3,554 crude oil barrels per day (Countries, 2019).

It is the function of a market to equate demand and supply through the price mechanism. If buyers wish to purchase more of a product than is available at the prevailing price, they will tend to bid the price up. If they wish to purchase less than is available at the prevailing price, suppliers will bid prices down. Thus, there is a tendency to move toward the equilibrium price. That tendency is known as the market mechanism, and the resulting balance between supply and demand is called a market equilibrium. As crude oil is not completely substituted by any other product, the demand for it may be inelastic, which means that it will be less responsive to changes in the price. Basically, oil total revenue of each country can increase by raising prices.

When supply exceeds demand, the price of oil drops. When demand is higher than supply, prices rise. Each country and producer decide how much oil to produce, which is why alliances like the OPEC, can change the price of a barrel of oil by deciding to increase or limit production (Chappelow, 2019).

The world oil supply may increase if the pending Iranian nuclear program deal is approved. Iran has been under trade sanctions for years, with United Nations members agreeing to embargo all Iranian oil. This embargo limits the oil supply, and the nuclear deal may bring Iranian oil back into the market.

Influence of Iran’s Oil on Global Oil Pricing

Iranian oil exports have dropped due to sanctions and rising tensions with the United States. The U.S has removed nearly 2.7 million barrels of Iranian oil from the global market. Iran exported about 100,000 barrels per day of crude oil in July. In an interview with American cable news network MSNBC, the Secretary of State Mike Pompeo stated:

“We have managed to take almost 2.7 million barrels of crude oil off of the market, denying Iran the wealth to create their terror campaign around the world, and we have managed to keep the oil markets fully supplied”.

The Organization of the Petroleum Exporting Countries (OPEC), Russia and other producers have been cutting 1.2 million barrels per day to reduce global supply. OPEC in July renewed the pact until March 2020 to avoid a build-up of inventories as worldwide demand is perceived as weakening. Despite OPEC’s actions and US sanctions on Iran and Venezuela, Brent crude international oil prices have been relatively weak, falling to $59 a barrel from a 2019 high of $75, pressured by concerns about slowing demand (Lawler, 2019).

Iranian oil still has to be pumped to keep facilities viable and there is some export capacity, however limited this may be at the moment. Chinese companies have continued to import Iranian crude, but instead of reporting the crude imports, which would violate US sanctions, they are storing the oil in bonded storage tanks situated at Chinese ports.

 Possibly the strangest aspect of this whole arrangement is that the oil sits in the tanks, unused. So far, none of it has been cleared through Chinese customs, so the oil is still technically ‘in transit’ (Turak, 2019)

Right when the nuclear deal with Iran was announced, oil prices fell about 2%, but the decline was only temporary. While traders initially feared that Iran could flood the market, we believe that it does not have the ability to do so immediately. This is because oil production has grown in recent years in the United States, and Saudi Arabia and other OPEC countries have kept production at high levels despite falling oil prices. While Iran can make a modest impact, it cannot greatly lower prices on its own in the short-term.

Iran may be at a turning point in its relations with Europe and the United States, and the nation may be on the verge of rebuilding its aging and sluggish oil industry, but the oil exports are not enough to significantly shift the world oil supply. It can, however, affect the price and the market equilibrium as we learned from the 1979 crisis. World oil demand is increasing, and the supply is decreasing and if Iran’s oil enters the global market it can at least help the global supply in a small percentage.

Utilization of oil revenues and democracy

It is necessary to outline the main features of oil economies in the Middle East before proceeding. One of the main characteristics of petrochemical economies is extreme centralization. This is often demonstrated in one or a few densely populated urban centers, especially the capital which has the political power, being the beneficiaries of the expenditure of oil rents. This way the working age population is attracted to these urban centers and this prevents the social and economic development of other resources in the economy. One consequence is the current situation of Iran, where the country’s economy is mainly dependent on oil revenues and the state is perceived as creator and guarantor of jobs (Alnasrawi, 1987). This causes also inequalities and social and technological differences between the cities; as Tehran and other big cities are much more developed than farming areas.

Utilization of oil revenues has been an issue that almost all oil economies have been dealing with. A key question is related to the appropriate institutions that can reconcile a democratic and transparent polity in developing oil economy in a country like Iran where oil is a sizable source of income in the economy. Below we will discuss several proposals meant to reconcile the buildup of oil rents to the government with less centralized and more democratic modes and better economic outcomes. These proposals focus on the relationship between oil and politics and therefore ownership and the mechanism of distribution of oil revenues rather than their ideal mode of utilization (Hakimian, 2005).

Rawls’ Theory of Justice

Providing social justice and equitable distribution of the amenities and benefits of life should be among the most common value considerations of governments. The amount of attention given to these considerations varies across communities, and intervention in the allocation of resources resulting from the operation of prices in the market to promote social justice has typically been a concern of governments.

John Rawls follows Kantian philosophy and social contract theory to address the problem of distributive justice – this means the socially just distribution of primary goods in a society. If we consider oil revenues a socially primary good, we can follow the Rawlsian theory to see which proposal works out for the best. In Rawls’ theory the States will have a monopoly of power and will become a coercive institution if free and equal citizens are not given the opportunity to consent to an institutional arrangement. This is the current situation in Iran.

At the original position in Rawls’ theory, two main principles of justice will be chosen mutually: basic liberties (including political liberties and freedom of speech) and the fair distribution of social benefits and burdens, by which inequalities may be accepted as far as they contribute to the general welfare with the requirement of accessibility of position of authority to all. Accepting these two principles in the initial setting of institutions is favorable for all parties since no other possible alternative will provide the same level of utility.

In order to achieve this agreement, parties will stand behind a veil of ignorance meaning that no one will know their place in society, class, position or social status, as agents for the distribution of natural assets and abilities. Behind this veil of ignorance about the political and economic situation of the society, they will choose the principles they will be subject to. If they choose to distribute wealth in an unfair way, they could be victims of this injustice themselves. Thus, they will choose the principles that will ensure the maximization of utility levels even for the least wealthy person. The choice of the principles reached in the original position and under the veil of ignorance will shape the society and institutions that will determine each agent’s life expectations. These fundamental institutions will distribute primary social goods for each agent to pursue whatever goal they wish to; institutions will provide the means for it but not the ends. Rawls’ theory will choose the best option within all the worst possible outcomes, in order to ensure fairness and avoid risk. Therefore, this maximin guarantees the highest possible amount of goods for the least wealthy individuals even if it is economically less efficient.

Although it contradicts the idea of utilitarian efficiency by which the total sum determines welfare, Rawls’ theory is an egalitarian solution in which the worst-off player’s needs are maximized while benefiting other agents. In this theory each person would try to find a balance between the utility gains and the losses they would experience in the worst possible case. This is realized under the Rawlsian veil of ignorance in order to ensure equality and justice within the system. Choosing the best method of distribution of oil revenues amongst the worst possible outcomes is what can bring us close to fairness and equality and is a way of risk avoidance for both agents that are people and government in the case of oil (Rawls, 1971).

Privatization proposal

This proposal argues for privatizing the oil industry by either selling the assets and production rights to private companies or distributing marketable shares to people. Privatization is argued to help strengthen the private sector economy and civil society, turning the state into a more accountable tax state (Rotunda, 2004). The result is to be favorable to the development of a more democratic form of government.

The criticism to this proposal is that oil industry assets will be ultimately monopolized by a few domestic managers, similar to the rise of Russian oligarchs following its privatization plan, or it will fall into the hands of international oil companies. This can be the way capitalism works, and we can also argue that the political and economic outcome will be better anyways than the oil industry being monopolized by the state.

The main problem with this proposal however is lack of attention to the characteristics and nature of the oil industry and reserves in the Middle East. We should keep in mind that ownership of oil reserves is different from ownership of oil industry. In the Middle East, oil is mainly related to the issue to ownership of oil reserves that entitles the owners to economic rent, while the ownership of industry by firms entitles them to a return to their capital (Hakimian, 2005).

Ownership of the Oil Industry and the National Oil Companies

The oil industry from its early days has been dominated by a few large, vertically integrated companies due to its characteristics. These are large sunk costs and high capital intensity, high risk and substantial economies of scale especially in transportation and marketing.

It is important to note that the National Iranian Oil Company (NIOC), or any other national company in Iran, does not have the ownership of oil reserves. These companies develop the oil reserves on behalf of the State and their budget normally comprise a share of oil export revenues in return for their services. In the argument for privatization of these companies, it is important to recognise that no matter the nature of their legal ownership of the resource (or lack of ownership, as stated above) these companies are not protected from competition.

As integrated oil companies, the national oil companies should be given the same level playing field as foreign oil companies. That is, they have to be able to survive, in whatever legal or structural form, without resort to State subsidies. It is not possible to see an end of political patronage in oil economies in the Middle East and viable balanced economies in these countries, without the removal of State subsidies. Although this does not solve the problem of control and distribution if oil rents. Nor does it mean that the strategic decisions regarding production and exports can be left to private investors or the market forces (Hakimian, 2005).

Ownership of revenues and control of oil rent

Middle Eastern and Iranian oil reserves are situated in huge fields, and for this reason the cost of extraction is extremely low comparing to other regions. Regulation of Middle Eastern oil in the international oil market, and the nature of oil revenues and their implication for domestic economy will be treated in this section.

The international oil market, and the low-cost Middle East oil, has always been regulated (Alnasrawi, 1987). This began with the international oil cartel that ensured price stability in case of production increase. Since the 1970s this has been done by oil producing and oil consuming associations, where OPEC has played an important role in regulating the output of low-cost, high capacity Middle Eastern producers. Such regulation is very important because without it, oil prices become very unstable to the disadvantage of both the producers and the consumers. It is important to know that Middle Eastern oil should not be produced and exported within a free market framework as some think it should. Decisions regarding investment and pricing of oil need to be made within a national strategy to ensure the optimal extraction of oil resources and maximum revenues in the long run. The role of the national oil companies and the oil minister is critical in relation with the design and implementation of a unified national strategy. In order to protect the interests of the country in negotiations with large foreign oil companies, formation of unified, powerful and well-informed national oil institutions is necessary. Such ideal depletion of the Middle Eastern oil reserves, which cannot be ensured by short-term perspective of private investors, also helps the interests of the consumers in the long-term (Hakimian, 2005).

The second implication of the low-cost Middle Eastern reserves is that much of oil revenues take the form of rent or super-profits that cannot be easily divested by the government.

This means that even if one offers the Iranian oil reserves in a wholesale manner to competitive bids by international oil companies, the offer price or rental which goes to the government will be still the bulk of the revenues. In theory, we can say that by issuing marketable shares to all Iranians we can get rid of the public ownership of the reserves. But this is not practical or justifiable, as such shares will most probably be concentrated in the hands of a few large shareholders whose interest may be different from the long-term strategic considerations regarding investment, output and pricing of oil. Various problems can rise from this option such as safeguarding the interests of the future generations, environmental issues, lack of incentive structure to discover new reserves, etcetera. One way to deal with these problems of course, is to distribute non-marketable shares to people, which can change as the population grows and new reserves are discovered, and with the state in charge of strategic decisions regarding investment, production and pricing, on behalf of people. We will discuss this below under Rawls’ theory of justice after a brief explanation of this theory.

The Oil to People Proposal

This proposal tendered for Iran and Iraq and suggests the distribution of oil revenues equally across the whole population. It is based on an idea of building a liberalized free market economy by reducing the size of the public sector and letting the people decide how they want to utilize the oil revenues within this liberalized market economy. The direct distribution of oil revenues to the citizens would supposedly have these long-term systemic effects:

1. Create the conditions for a strong civil society and a democratic polity.

2. By getting part of the oil revenues directly to the poorer sections of society, this proposal helps leading to faster poverty reduction.

3. Prevents the concentration of the revenues in the hands of a few

4. Leads to better income distribution and a more just distribution of benefits of oil (Bagherzadeh, 2002)

The oil to people proposal might be the only proposal that might work by taking Rawls’ theory of justice into account. However, none of the above arguments stand the test of careful scrutiny. We will discuss below why the third proposal seems more just.

Starting with the long-term economic arguments, the following question arises: would the distribution of oil revenues across the population create the conditions for a liberalized market economy or not? To achieve a well-functioning economy in Iran, there are a number of important preconditions, most of which have the character of public goods requiring collective action. A well-functioning public administrative system with adequately paid civil servants, long-term investments in infrastructure, the creation of a flexible labor market which will require well run social security and pensions systems, financial system and the banking sector. Also, consolidating minimally required social services such as education and public health. These types of activities are normally financed by taxation in non-oil economies. In the long run it is desirable that this happens also in Iran, but it requires the overhaul of the taxation system and improvements in the collection system.

Once these expenditures are taken care of, the next best use of oil revenues to construct a market economy is to set up investment funds to reinforce private sector investment in small sector enterprises which are barred from access to formal capital markets. Only the additional profits from such investment funds can be used for distribution across the population, but even then, very selectively and for worthy causes rather than blanket distribution to all the population. Another argument against the distribution idea is related to savings, and how the distribution of oil revenues to the population can lead to saving rates which may be socially sub-optimal.

In the long run, and even after overhauling the taxation system, it would still be more beneficial to deposit oil surpluses in investment funds to strengthen private investment than to distribute them between people. Apart from the private sector, the surplus can help to finance a general social security and pensions system. This ‘oil to the people’ model will not help the development of a civil society, and therefore democratic institutions. The Iranian context requires careful attention to institution building and socio-economic development, which will not be produced simply by distributing oil revenues to the population. The Sovereign Wealth Fund of Norway is a good example of this argument, where the surplus wealth produced by petroleum income is deposited to ensure responsible and long-term management of the resources (Norway, 2019).

In Iran, issues of poverty, inequality and social justice aspects are directly relevant. Iran has a young and rapidly growing labor force, and the long-term solution to combat poverty is the creation of productive jobs on a sustainable basis rather than oil revenues distribution. It is even arguable that oil handouts reduce the potential development of the economy and have a counterproductive effect in the long run. The immediate impact of the distribution of an equal sum of money to people, would be a one-time reduction in relative income inequality. This does not constitute sustainable economic advancement. It is also not a very just proposal when as we all do not have the same situation and opportunities in our lives.

At a more general level, there is no moral justification for people who were born in Iran to receive handouts simply because their country happens to have oil resources. On the other hand, access to oil revenues must be provided for social and economic development of the country that owns the oil. It is with such considerations that we discuss below our third alternative regarding the utilization of oil revenues, that was proposed by Karshenas and Hakimian in their article titled Oil, Economic Diversification and Democratic Process in Iran(2005) 

The Decentralized or Regional Option

Since in the case of Iranian oil market we do not have sufficient statistics in order to provide an initial probability distribution, it is better to use a principle of assurance and risk avoidance such as Maximin principle of Abraham Wald. According to this principle, for each alternative we should consider the worst outcome and choose the alternative with the best outcome amongst all (Hakimian, 2005).

Oil revenue utilization has to comply with a set of requirements in order to avoid the repetition of the economic and political mistakes in the past, especially for Iran as its economy will be dominated by oil sector for a long time to come.

Firstly, oil revenues should not inhibit the full development and utilization of all other resources like human resources and other natural resources. Rather, they should be made to provide a positive inducement for such development. Ultimately, oil reserves are finite and will end at some time in the future. Without diversification of the economy a catastrophic collapse is inevitable when oil runs out, as has been the case in Yemen.

Secondly, such development in the non-oil sector should be based on decentralized market-based principles in line with the comparative advantages of the economy. A basic precondition for this is that the State should refrain from engaging in economic activities that can be conducted on a commercial basis by the private sector. Oil revenues should be used to strengthen such activities in a manner which does not advantage special interest groups with political influence.

Thirdly, an accountable government subject to democratic checks and balances. In a society like Iran, the availability of oil revenues creates the tendency for the state to overstep democracy. There is always a pressure from people to utilize oil revenues to create jobs, and there is intense competition within the State to gain access to huge oil rents. This causes an authoritarian state’s dominance over the economy and the society.

The regional option tends to create a balance between centralizing and centrifugal forces in order to resist this. The main precondition for this proposal to be effective, is the balance between the regional political powers and the central government. To reconstruct the local economies and to reconstitute the current total centralization of power, oil revenues will be totally allocated to the local government according to a pre-set formula. The formula can be created according to the existing land/population ratios, and later they can be replaced by variables that can act as incentives for the development of the local private sector economies such as employment, productivity, etc. The central government will decide on the strategic issues of the oil sector such as pricing, investment and output, through the oil ministry or a reconstituted national oil company, also managing the macroeconomic side of oil revenue management. The local governments decide on the share of their oil revenues distributed between the central government budget and their own budget dedicated to education, health, policing and other local infrastructures.

The short- fall in the budget will be filled by taxation. Apart from being responsible to people, the mutual oversight of each other’s activities by the two layers of government will result in greater transparency and openness of government.

If the constitutional details are arranged in a manner that ensures an efficient division of tasks and roles by the central and local governments, and the regional option is implemented properly, we will have all of the advantages of other proposals without the mentioned disadvantages. By redistributing oil revenues more towards deprived regions we can improve poverty and income distribution without handicapping the potential development of oil revenue expenditures.

Once the institutional basics for this proposal are in place, the efficient use of oil revenues to reinforce private sector activity and export will not be blocked by the interest groups at the center, like it is now (Hakimian, 2005).

By building economic progress across all sections of the Iranian population, much of the tensions associated with regional and ethic jealousies can be minimised. One example of this is the Arab separatist movement in Khuzestan province which is driven by the belief that the government of Iran is appropriating oil resources of the region without adequately compensating the native inhabitants of the province.

Conclusion

One of the major goals of economic policymakers is to improve the quality of life and social well-being in society. In developing countries, not only is economic growth a target, but along with developed countries, increasing social welfare is both a major goal and a benchmark for development. Oil revenues play an essential role in the political economy as an independent variable and not merely as an economic factor. Iran is no exception. The dependence of governments in Iran on oil and oil revenues has made it less important to consider increasing non-oil revenues.

Contrary to popular opinion, expanding oil revenues will not necessarily lead to economic growth and improvement of social justice and welfare in society. The model of inefficient and poorly managed government passed from the Pahlavi era into the Islamic government. Furthermore, these underlying systemic problems are amplified through economic pressure from sanctions.

In this paper, we found a lack of a positive relationship between the price of oil sales and the improvement of social justice in Iran, which means that the increase in the price of oil sales in Iran does not increase justice and social welfare, but rather indicates a negative relationship between them.

Furthermore, economic growth will not increase with the oil sector in mind. Therefore, it can be concluded that Iran’s GDP is highly dependent on oil, while it has not improved social welfare and justice in society.

To increase social justice and prosperity and reduce the dependence of GDP on oil, precise planning must be achieved through a strategic management plan. We have reviewed several proposals to reconcile the buildup of large oil rents to the state with a democratic polity and diversified economy. Of course, a regionally specific plan needs a great deal of refinement. Yet better alternatives may be identified in the future. The hope is that these issues will be taken seriously by future policymakers.