Oil revenues, welfare policies, and uncertainty in Iran

By: Ingrid Krüger

Mahmoud Ahmadinejad won the Iranian presidential election for his first term in office in June 2005 on a populist economic agenda, promising to bring oil money to people’s dinner tables. His government later made some unpopular policy changes that affected Iranians’ daily lives – efforts to change gasoline consumption through rationing and cuts in gasoline subsidies in the following years sparked angry protests. It is well-known from economic theory that the gasoline underpricing seen in Iran is a waste of resources, but trust in and support of the president is essential in order to avoid future public protests and riots in Iran as further attempts are made to change domestic gasoline consumption.

Much of the debate on Iran’s economy today concerns how the citizens are ensured a share in Iran’s natural resource benefits. Iran is OPEC’s second largest oil producer and oil exporter after Saudi Arabia and has roughly 10 percent of the world’s total proven petroleum. Iran’s economic rent from its oil resource is the difference between the international market price and the cost of producing oil. Subsidizing gasoline domestically is a way of spending these oil revenues on the Iranians.

Gasoline was already heavily subsidized when Ahmadinejad entered his first term in office in June 2005. Ahmadinejad had made himself a popular presidential candidate during his campaign by promising a more equitable distribution of Iran’s oil revenues. Although welfare policies are naturally associated with taxation in representative democracies, it is not so that once you tax, you represent. The protests sparked by Ahmadinejad’s effort to change gasoline consumption patterns domestically after he was elected president might be explained by the Iranian citizens being uncertain about how they would benefit from the oil revenues unless the distribution was made directly through low prices. A move away from low prices might be interpreted as a move away from generosity. While trying to change gasoline consumption through rationing and cutting subsidies, it might have appeared to the Iranian president that he is damned if he does, damned if he doesn’t.

Although Iran is a large producer and exporter of crude oil, Iran’s refining capacity is insufficient to satisfy domestic demand for gasoline and Iran therefore has to import gasoline, making the gasoline subsidies very costly for the Iranian government. Two years after Ahmadinejad was first elected president, he reluctantly and out of necessity attempted to decrease domestic gasoline consumption by introducing rationing of gasoline through smart cards in Iran. The central government’s fiscal balance was in red ink the year before this move and Ahmadinejad feared the dependence on oil revenues. The president has argued that cheap fuel mainly benefit people with higher income, but Iranian citizens were used to unrestricted dirt-cheap gasoline supply at the filling stations and the rationing led to angry protests.

Gasoline is still heavily subsidized in the country. The rationed amount of gasoline was increased in March 2008 and gasoline sales above it was allowed at a higher price. The Energy Information Administration (EIA) reports that the majority of motorists are permitted a monthly ration of approximately 120 liters of gasoline at around 10 cents/liter and that, in addition to this, special allowances are given to commercial vehicles, part-time taxis and government vehicles.

IMF reported in its Regional Economic Outlook from May 2009 that Iran is planning to significantly reduce its expenditures to preserve fiscal sustainability, pointing out that Iran was in deficit in 2008. At the end of 2008, Ahmadinejad proposed a bill to eliminate subsidies on basic goods and make cash transfers instead, but the lawmakers omitted this article in March this year, when approving the budget for 2009-2010. Cutting gasoline subsidies further may again spark angry protests within Iran, but there is obviously a fiscal need to reduce expenditures and it is crucial how oil revenues will be distributed instead. Although Ahmadinejad calls the doubts about the elections being free and fair ‘a psychological warfare in the West, trying to deviate the nation from its clear and bright path’, the important thing is what the majority of Iranians themselves believe, because this will be decisive with respect to the support Ahmadinejad can expect within the country as he continues on his economic reform plan to change domestic gasoline consumption.

1 Response to “Oil revenues, welfare policies, and uncertainty in Iran”

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