Iran’s shortages crisis rooted in mandatory price setting
By Davoud Danesh-Jafari
Iran's former economy minister
Shortages in the Iranian economy are tied to its deep dependence on oil revenues. Approximately 80% of Iran’s GDP is directly linked to oil income, making fluctuations in global oil prices a key catalyst for economic crises.
For instance, between 2010 and 2014, the average oil price was $100 per barrel, but it dropped to $50 in 2015–2017 and has hovered around $70 in recent years.
For oil-dependent economies like Iran, such drastic changes in revenue create significant challenges. Compounding this issue are international sanctions, which have cut Iran’s oil revenues by half or even two-thirds, exacerbating the economic deficits.
Despite awareness of oil revenue volatility, Iran’s economic planning has failed to provide sustainable solutions. Mechanisms like the National Development Fund and Foreign Exchange Reserve Account were introduced to stabilize the economy by saving oil revenues during boom periods to cushion shortfalls during lean times.
However, these efforts have largely failed because these funds were often depleted even during periods of high oil income. Rather than serving as a safety net, these reserves became an auxiliary budget, leaving the country unprepared for economic crises and perpetuating the imbalance.
The COVID-19 pandemic further deepened Iran’s economic shortages. The combination of reduced oil revenues and pandemic-related disruptions led to a 9% contraction in GDP.
Socially oriented businesses shut down, and countless households lost income. The government, already grappling with falling revenues, was forced to increase spending to support vulnerable populations and fund vaccination efforts, which added pressure due to their foreign currency costs. This scenario exacerbated the budget deficit and worsened the economic imbalance.
One of the primary causes of Iran’s persistent economic shortages is government intervention in price-setting. According to basic economic principles, equilibrium prices emerge when supply equals demand, maximizing producer profits and consumer welfare.
However, when governments artificially lower prices, demand surges while supply diminishes, creating a gap that leads to shortages. This interference often stems from systemic decision-making beyond the executive branch, further worsening structural economic problems.
The costs of these shortages are enormous. For example, the government purchases wheat from farmers at high prices but sells flour at heavily subsidized rates, resulting in significant fiscal burdens.
Similarly, mandating exporters to return foreign exchange earnings at below-market rates diminishes their incentives. These policies not only deepen shortages but also strain financial resources and increase the budget deficit.
Electricity is an evident example of this imbalance. The government provides free gas to power plants, buys electricity at 500 tomans (approximately 0.8 dollar cent) per unit, and sells it at a mere 75–150 tomans.
This mismatch has led to a 100 trillion toman ($1.6 billion) debt to power plants, half of which are privately owned, discouraging further production. Policymakers, wary of burdening citizens with higher costs, maintain artificially low prices.
However, experience shows that such approaches are unsustainable and ultimately lead to higher prices. Instead, boosting household incomes is a more sustainable solution than price manipulation.
While price controls may seem appealing initially, as they offer consumers temporary relief, they ultimately lead to supply shortages and reduced production, culminating in price hikes and economic shocks.
For instance, in foreign exchange markets, excess demand over supply causes price surges. The solution lies in increasing supply, not artificially controlling prices.
When price adjustments adversely affect consumer welfare, the additional revenues generated should be redistributed to consumers to maintain their standard of living. Ultimately, prices should reflect economic realities, not short-term political strategies.
The root cause of economic imbalance lies in supply shortages. This issue spans sectors, from fuel to electricity and water. When the government steps in to cover costs, it often resorts to borrowing from the central bank or other financial institutions, leading to budget deficits and inflation.
Unless this vicious cycle is broken, the economic imbalance will persist. Addressing the core issue of supply shortages and reducing reliance on artificial price controls are crucial steps toward achieving economic stability.