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What Iran will really do with its sanctions relief windfall

- November 4, 2015
Iranian Foreign Minister Mohammad Javad Zarif gave a press conference in Tehran on Oct. 17. (AP Photo/Ebrahim Noroozi)

Critics of the Joint Comprehensive Plan of Action (JCPOA) deal continue to assert that sanctions relief will primarily be used for nefarious purposes by the Iranian government. They claim the windfall will be used to improve Iran’s military capabilities and increase support for proxies, fomenting instability in the region and raising the prospects for conflict between the United States and Iran.

However, past and recent statements and policies by the Iranian government indicate it will apply sanctions relief more to the economy than the military or proxies.

Sanctions relief will allow Iran to reconnect to international financial markets, import previously restricted goods, expand export markets and receive greater foreign direct investment (FDI). Estimates of the sum of unfrozen assets range from $30 billion to $180 billion in an economy valued at approximately $400 billion. Analysts have not only tried to project the deal’s exact windfalls but also to what ends they will be used and to what extent they will alter Iran’s regional conduct.

In the short term, sanctions relief will not radically transform Iran’s regional behavior but will likely trigger incremental change. Recent political science research – which focuses primarily on the effects of imposing economic sanctions rather than alleviating them – demonstrates that they further empower entrenched elites within targeted states like Iran and fail to modify their behavior. Thirty-six years of sanctions did not lead to regime change; they did not drastically alter, but even worsened, Iran’s regional conduct. Reversing this trend will likely require engaging and inducing Tehran with fewer sticks and more carrots or – to borrow David Balwin’s phrase – “positive sanctions” comprised of economic statecraft and soft market power in the form of foreign aid, investment, trade, and technology transfers.

Since signing the agreement, the Iranian government has sought immediate and maximum sanctions relief to alleviate external pressure and stabilize the economy before upcoming elections for the parliament and Assembly of Experts. While the Guardian Council will vet the candidates, Iranians will cast their votes based on perceptions of whether citizens directly benefit from the deal. To promote economic stability and raise voter confidence, the Iranian government says it will channel sanctions relief, in a targeted manner, into specific economic sectors to which it has already dedicated significant attention and resources.

The government’s stated top priority is attracting FDI and importing machinery and technology to expand and modernize the oil and natural gas sectors, which are by far the country’s largest. Iran contains the world’s second-largest natural gas reserves and fourth-largest petroleum reserves. Oil export revenues account for nearly half of the government’s budget. Economic sanctions curbed oil and natural gas exports as well as restricted imports of machinery and technology. This reduced the efficiency and productivity of upstream and downstream operations, leading, at times, to rising imports of refined and processed fuel.

The government’s second priority is economic diversification. This is essential given the economy’s susceptibility and vulnerability to petroleum price shocks and foreign exchange shortages. To counter recent price drops, the government seeks to strengthen secondary industries, beginning with the automobile sector. After oil and natural gas, this sector is the country’s second-largest and contributes up to 10 percent of GDP.

During the administration of former president Mahmoud Ahmadinejad, automobile and tractor manufacturers opened factories in Africa to produce and export taxis, buses, tractors and other commercial vehicles. Sanctions relief will enable companies such as these to attract FDI and upgrade machinery and parts to maintain and expand operations on the continent and beyond. Beyond improving economic diversification, these operations will increase export revenues and alleviate an official national unemployment rate of 11.4 percent in 2014.

Based on preexisting priorities and policies, the Iranian government will also likely direct the funds, investment and inputs that accompany sanctions relief to the following economic sectors:

  • Agriculture: With sagging oil prices, Supreme Leader Ali Khamenei and Minister of Agriculture Mahmoud Hojjati have been committed to achieving agricultural self-sufficiency. Since 2013, the government guaranteed wheat purchases from farmers, and, for the first time in its history, the Islamic Republic ceased being a net importer of the grain;
  • Human development: To improve national health care, Minister of Health Hassan Hashemi introduced a plan similar to Obamacare that would provide affordable and quality health care to all Iranians, especially those from lower socioeconomic backgrounds. Sanctions relief would allow the government to further improve health care by alleviating shortages of medical supplies and upgrading medical research reactors.
  • Citizen subsidies: The government will likely continue spending billions of dollars on cash transfers to citizens to compensate them for subsidy cuts and rising prices of fuel, food and other basic goods. This policy — which began under Ahmadinejad in 2010 — created sizable budget deficits. While President Hassan Rouhani cut back on transfers to the wealthy, he refrained from substantially cutting or reducing them for the rest of the population. With declining oil prices, the government may seek to attract FDI and technology to upgrade civilian nuclear reactors. This would enable the government to meet rising domestic energy demand and further cut cash transfers and fuel subsidies – which remained the highest in the region between 2014 and 2015 at five percent of GDP.

Compared to the economy, the government will likely dedicate fewer resources from sanctions relief to the military. To a limited extent, the government will allocate funds toward improving and expanding conventional military and defense capabilities, such as missiles, tanks, naval vessels and fighter jets. The Iran-Iraq War cost Iran an estimated $450 billion – one-third of the national budget in just eight years – in infrastructural damage and destruction and precipitous declines in oil production and revenues, not to mention between 150,000 and 300,000 casualties. After such major losses, the government reduced military spending from 17 percent to 2 percent of GNP. Since then, Iran’s official military spending — excluding the Revolutionary Guard and other paramilitary groups — has ranged between 1.4 percent and 3.9 percent of GDP. In 2014, this trend continued as Iran spent about $15.7 billion or 3.75 percent of GDP, and will likely continue so long as international oil prices remain low.

In fact, previous sanctions had done little to curtail its military ambitions as Iran has managed to successfully advance its geopolitical aims in the region through proxy warfare on the cheap. Iran apparently funds its Lebanese proxy, Hezbollah, several hundred million dollars per year. By offering similar support to the Houthis in Yemen, Iran has provoked its GCC rivals – which spend significantly more on defense (Saudi Arabia alone ranked fourth in the world at $80.8 billion or 10.4 percent of GDP in 2014) – into expending considerably more. The GCC’s military campaign in Yemen has also tested the unity of member states, tarnished their image and created tension with the United States.

In the immediate future, sanctions relief will not cause Iran’s regional conduct to change significantly. Nevertheless, sanctions relief could yield positive, incremental results over time. Irrespective of the total financial gains, the symbolic act of sanctions relief would signal to Iran that the United States is a serious, reliable and credible negotiating partner.

As trust between both sides builds, constructive engagement can materialize around common geopolitical interests, including fighting the Islamic State and resolving conflict in Afghanistan, Iraq, Syria and Yemen. This precedent was already set in 2003 with Iranian-American cooperation in Afghanistan.

Given that Tehran’s support of Syrian President Bashar al-Assad costs billions per year – not to mention the lives of military advisers, specialists and operatives – ending the conflict remains in its interests. Engaging Iran grants the United States strategic flexibility to solve issues, stabilize the region and push for collective security between Iran and traditional allies.

More broadly, the JCPOA could mark a significant step toward integrating Iran into the international community and strengthening ties with the West. The deal has already opened the door for European and American trade delegations and educational exchanges, connections that sanctions relief would accelerate and reinforce. Since the negotiations and agreement, Iran is preparing to join the World Trade Organization and establish preferential trading with the European Union.

While Iranian and Western interests and identities will continue to clash and diverge in key areas, greater economic interdependence and trade relations would not only increase interactions and build trust, but also raise the costs of diplomatic defection, escalating conflict and nefarious deeds. Today, the onus of achieving economic cooperation, attracting foreign investment and improving the lives of ordinary Iranians has shifted from American-led sanctions to endemic corruption and recalcitrant hardliners inside Iran itself.

Eric Lob is an assistant professor in the Department of Politics and International Relations at Florida International University. His research focuses on the intersection of development and politics in the Middle East. Lob is currently working on a book project entitled “Construction Jihad: Rural Development and Regime Consolidation in Revolutionary Iran (1979-2013).”