Oil and the Rentier State
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Topics in Middle Eastern and African Economies Vol. 4, September 2002 OIL AND THE RENTIER STATE: IRAN’S CAPITAL FORMATION, 1960-1997 ¹ Sousan Badiei and Cyrus Bina California State Polytechnic University, Pomona and University of Minnesota, Morris [email protected] Keywords: Oil, Iran, Capital Formation, Rentier State JEL:O11, N5, Q4 1. INTRODUCTION The focus of this study is on the “rentier” character of state and economy in relation to capital accumulation during the period of 1960-1997 in Iran. The rentier character and structure of the Iranian State reflects the domination of the economy by the oil sector (Mahdavy 1970, Bina 1992a). The rentier nature of the Iranian economy is also potentially recognized through a strand of literature in economic development, known as Dutch Disease (Katouzian 1978, Corden and Neary 1982, Corden 1984, Romer 1985, Evans 1986). Such domination has continually been the common denominator of both the Shah’s, as well as the Islamic Republic’s regimes in Iran. For the analysis of oil rents theory, see Bina 1985 (Ch. 5), 1989, 1990, 1992b. It is shown through a simple but decisive econometric model that oil revenues had a positive and significant relationship with the long-term trend of gross fixed domestic capital formation (GFDCF) during the latter part of Shah’s regime in Iran. However, it is also shown that such a positive and significant relationship had suddenly become negative after the legendary oil price hike of 1973-1974, despite the fact that it brought an enormous windfall to the Shah’s treasury by 1975 (Bina 1985, 1988, 1990, Karshenas 1990). The situation under the Islamic regime has been somewhat different. Iran’s oil revenues have declined substantially, and were subject to much fluctuation during the period of 1980-1997 (Fesharaki 1985, Bina 1992a, EIU, various issues). It is shown that econometrically there is no significant relationship between the extent of oil revenues and the gross fixed domestic capital formation (GFDCF) during the period of 1980-1997 in Iran. Moreover, the Islamic regime in Iran does not appear to have paid much attention to capital accumulation and long-term investment. Instead, the government seems to have allocated the revenues from oil rents to politically motivated consumption expenditures and unproductive activities, presumably, to contain and ameliorate the potential internal political upheavals and external threats during the period under study (Mofid 1990, Yaghmaian 1992). The analogue of these activities is the fact that the Government of the Islamic Republic has consistently engaged in the allocation of various sorts of (formal and informal) subsidies to those areas and interest groups that provided sustained ideological and material support for the fortification of the regime in Iran (see Bina and Zangeneh 1992, Amuzegar 1993, Bina 1994a, 1999, Zangeneh 1997, 1999). Topics in Middle Eastern and African Economies Vol. 4, September 2002 2. THE HYPOTHESES, MODEL, AND DATA 2.1. The Hypotheses Given the weight of the literature concerning the dominant nature of oil revenues (rents) in the Iranian economy, the relationship between the level of oil revenues and that of the gross fixed capital formation is hypothesized as follows for different time periods: Null Hypothesis I: There is a significant relationship between the amount of oil revenues and the level of gross fixed capital formation (GFDCF) in the Iranian economy under the Shah’s regime. There can be two outcomes, Ia and Ib Null Hypothesis Ia: There is a positive (upward) shift in the above relationship (i.e., Null Hypothesis I) since the 1973-oil crisis during the Shah’s regime. Alternative Hypothesis Ib: There is a negative (downward) shift in the above relationship (i.e., null hypothesis I) since the 1973-oil crisis during the Shah’s regime. Alternative Hypothesis I There is no relationship between the amount of oil revenues and the level of gross fixed domestic capital formation in the Iranian economy under the Shah’s regime. Null Hypothesis II: There is a positive relationship between the amount of oil revenues and the level of gross fixed domestic capital formation (GFDCF) under the Islamic Republic in Iran. Alternate Hypothesis II: There is no relationship between the amount of oil revenues and the level of gross fixed capital formation under the Islamic Republic in Iran. These relationships are measured through the test of significance of the corresponding linear models indicated above. This would capture the hypothesized influence of oil revenues on capital investment during the two sub-periods under study in Iran. 2.2. The Model The entire period of the study extends from 1960 through 1997, spanning the Shah’s regime as well as the IslamicRepublic regime in Iran. This period is divided into the two sub-periods of 1960-1979 and 1980-1997, corresponding with the above respective regimes. The period under study is limited to the availability of the time series data for the variables utilized in the model. The model in its functional form is as follows: It = ƒ(Rt), where, correspondingly, Rt and It stand for time series of oil revenue (oil rent) and gross fixed capital formation, assuming that It is a linear function of Rt.Given the structural Topics in Middle Eastern and African Economies Vol. 4, September 2002 differences between the Shah’s regime and the regime of Islamic Republic, the entire period of 1960-1997 has been divided into two sub-periods, each of which relates to the appropriate regime. The models utilized in the estimation of parameters for the two sub- periods are as follows: α β ε (1) It = + Rt + Dt + , α β ε (2) I't = ' + 'R't + ', where It and I't are designated as dependent variables in time t, and Rt and R't as independent variables for oil revenues (oil rents) for the two sub-periods; α, α', β, and β' are vectors of parameters in the equations (α and α' constants, and β and β' coefficients of independent variable), and ε, and ε' are the residuals, and D is a binary variable (see Pindyck and Rubinfeld 1998a, Kennedy 1998). 2.3. The Data The time series data on the gross fixed domestic capital formation (GFDCF) for the entire period of 1960-1997 are obtained from the Central Bank of Iran (Bank Markazi, Annual Report, various issues, EIU, various issues, IMF, International Financial Statistics). These data are nominal and kept in Iranian currency. As a result, one of the shortcomings of the data is the lack of adjustment for inflation. However, while it would have been desirable to utilize a real trend for a more accurate year-to-year comparison, due to the lack of information on the actual inflation rate in Iran, the authors had no choice except to utilize what was available. The time series data on Iranian oil revenues is in US dollars. Although problematic in terms of exchange rate, the revenue has been converted to Iranian rials for both sub-periods. These data are obtained from OPEC (Annual Statistical Bulletin, various issues). The conversion of the oil revenue data for the sub-period of 1960-1979 has been made at 760 rials per US dollar. This rate was consistently utilized by the Central Bank under the Shah (Pesaran 1992, Bina 1994b, EIU, various issues). However, due to the unprecedented and unusual controls by the Islamic Republic— particularly the policy of holding multiple exchange rates—the oil revenue data for the period of 1979-1997 are kept in its original (US dollar) denomination. Despite these shortcomings, the time series are rather up-to-date and complete relative to what had been available previously on Iran’s economy (Bank Markazi 1998). Topics in Middle Eastern and African Economies Vol. 4, September 2002 Figure 1 shows the trend of the gross fixed domestic capital formation (GFDCF) for the period of 1960-1997 in Iran. This trend reflects the growth of the Iranian economy in the long run, and overlaps the two regimes. While the shape of GFDCF somewhat resembles an inverted "V" during the 1960-1979 period, it is nearly "N"-shaped during the 1980-1997 period. GFDCF figures include gross capital investment in agriculture, oil and gas, mining and manufacturing, commercial and residential structures, and services. During the Shah's regime, in the period under study, GFDCF has increased steadily-except in the mid-1960s- through mid-1974, and then exhibited its sharpest increase ever in the Iranian economy during the 1974-1975 period. This period coincides, with a small lag, with the oil crisis of early 1970s, and the worldwide oil price hike of 1973-1974 (Bina 1985, 1990). However, GFDCF declines sharply from 1976 through 1979, when the Shah's regime was overthrown. The trend of GDFCF during the regime of Islamic Republic is similarly moving with the trend of Iran's oil revenues. Even though the trend of GFDCF shows a brief decline, the new regime benefited from a sharp increase in the global oil prices in 1986, and reversed its direction. As can be seen from Figure 1, GDFCF shows a sharp increase from 1981- 1983 when it levels off first and begins to taper off intensely from 1984 to 1987, a period of precipitous decline in the oil prices. The period of 1987-1995, however, can be divided into the two periods of sharp and (subsequent) moderate increase, which levels off thereafter during the period under study (see Figure 1). As for the oil revenues in Iran, given the Iranian Revolution (1979), the period under study has been divided into the two sub-periods of 1960-1979 and 1980-1997. As can be seen from the comparison of the corresponding trends of oil revenues during the Shah's period, they are nearly mirror image of each other in both US dollars and Iranian rials (see Figures 2 and 3).