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Iran’s Soft Economic Underbelly Lies Outside Its Borders

David Rosenberg
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A displaced Syrian man works at a makeshift oil refinery near the village of Tarhin in an area under the control of Turkish-backed factions in the northern countryside of Aleppo, February 25, 2021.
A displaced Syrian works at a makeshift oil refinery near the village of Tarhin, in an area controlled by Turkish-backed factions in the northern Syria, February 2021Credit: BAKR ALKASEM - AFP
David Rosenberg

The logic behind the sanctions Donald Trump’s slapped on Iran was pretty simple: By squeezing the economy, Tehran would either agree to negotiate a new, tougher nuclear agreement or the regime itself would fall in the face in mass protests.

Not only didn’t any of that happen, but Trump’s successor Joe Biden is having a hard time convincing the Iranians to come to the negotiating table to reach the more modest goal of reviving the original nuclear accord.

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Certainly, some of Tehran’s foot-dragging is tactical, the better to squeeze some advance concessions from the United States before the actual talks get underway. But the fact is the Iranian economy isn’t hurting nearly enough for its leaders to be overly anxious to get the sanctions lifted. The Islamic Revolutionary Guard Corps, the most powerful player in Iran, has a host of political and business reasons to be content with the sanctions regime. 

Iran’s economic soft underbelly isn’t at home, but with its client states – Syria, Lebanon and to a lesser degree Iraq – and that may be the opening that Washington needs to pressure Tehran.

Side by side with nuclear weapons, the quasi-empire Iran has been building in the Middle East is a critical part of Iran’s defense posture and a symbol of their regional-power status. They don’t want to see it evaporate in economic collapse. Let’s not overstate the degree to which Iran has withstood the Trump sanctions.

Oil exports have fallen sharply and the economy has shrunk, although the latter not as much as you might expect. The World Bank estimates that Iran's GDP dropped 5.4% in the 2018-19 year and 6.5% in 2019-20 (exacerbated by the coronavirus), but this year the decline may be as little as 3.7% – and that’s assuming no sanctions relief comes.

On the other hand, even without any major steps by the U.S., Iran is already seeing some pickup in oil exports because countries like China don’t believe the Biden administration will enforce the sanctions as seriously as Trump did.

The big problem with imposing sanctions on Iran is that it is a big country with a relatively sophisticated economy and a leadership practiced in the arts of sanctions-busting. Iran has a big industrial sector that has ratcheted up production, often making cheap knockoffs of internationally renowned products. Its manufacturers may not be globally competitive, but they don’t have to be because the sanctions mean there’s no global competition. Meanwhile, they create jobs and prevent shortages. 

The converse of sanctions is an open economy and foreign investment. But the Revolutionary Guards are no friends of either, which only threatens to create competition for its own businesses and kill off its big and profitable smuggling business.

Supreme Leader Ayatollah Ali Khamenei, right, greets Syrian President Bashar Assad, in Tehran, 2019Credit: Office of the Iranian Supreme Leader / AP

By contrast, Iran’s clients don’t have economies with that kind of depth.

Syria was ruined by a decade of civil war, but Bashar al-Assad’s government has yet to gain control of large parts of the country and has no resources to begin reconstruction. Food prices have doubled in the past year, electric power is sporadic and the value of the pound has collapsed.

In Lebanon, the misery isn’t appreciably less. Financial collapse, the Beirut port explosion, COVID and an indifferent political leadership caused the economy to contract more than 19% last year and will probably lead to another drop of more than 13% in 2021. A collapsing currency and triple-digit inflation have driven almost half of the country into poverty.

Iraq, meanwhile, is running out of money to pay its bills. Reliant as it is on falling oil profits for income, the government can no longer cover the cost of a bloated public sector workforce that keeps people employed. There’s barely a private sector to fill the gap. GDP probably fell 10.9% and will only show a small turnaround this year in the (highly unlikely) event Iraq’s leaders undertake reforms, says the International Monetary Fund.

All of these countries have held together in the most minimal sense of the word, i.e., no government has collapsed in the face of protests. But the situation isn’t sustainable.

Iran therefore faces an insurmountable problem. It isn’t really interested in its clients having strong governments and thriving economies because that would undermine its modus operandi of wielding power and influence through militias answerable to it. But if the situation becomes too desperate anything can happen, including the ousting of governments to Tehran.

Unfortunately for Tehran, it doesn’t have anything like the economic resources or technical knowledge to extract its client states from the morass. It needs help from somewhere, and only the West, China, and the Arab Gulf countries can provide it. The offer the U.S. and the other P5+1 partners to the nuclear accord should include not just sanctions relief for Iran but an offer of aid to Lebanon and Iraq, and perhaps Syria.

This won’t be easy to negotiate. In exchange, Iran will have to be made to pare back its military presence in all three countries and distance itself from its partners (Hezbollah, Assad and the Iraqi militias), something it will no doubt be loath to do even if it is free to maintain political influence.

But Tehran doesn’t have much of a choice. Its economy and military strength are not equal to its big-power pretensions. It would do well to get real and acknowledge that, just as Britain did after World War II, and come to terms.

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