March 2010, No. 55

Spotlight

Reallocation of Subsidies Will Not Lead to Business Boom

The present structural problems and the severe fluctuations in economic growth rate during the past 30 years have been due to overreliance on oil revenues instead of increasing productivity.

Dr. Ghaninejad and Dr. Nili address 7^th int'l conference on management

What effect will reallocation of subsidies have on production companies? Will the government plan to allocate 30 percent of revenues earned through phasing out subsidies to the industrial sector lead to prosperity of that sector?

Dr. M. Ghaninejad, Senior Economist

Before the plan to reallocate subsidies enters into force, many questions have been raised by producers and economic experts. Dr. Mousa Ghaninejad maintains that the plan to reallocate subsidies will face companies with low funds, increase the costs of companies consuming subsidized products and increase budgetary share of subsidized goods consumed by families. Fars news agency reported that Dr. Ghaninejad addressed the 7^th international conference on management and talked about theoretical framework of the plan. He added that the first issue to be discussed is theoretical paradigm on which the government has based the plan.

Ghaninejad noted that according to the government, seven economic areas should be first corrected which include banks, taxation, customs, evaluation of the national currency, reallocation of subsidies, distribution of goods and services, and productivity. Ghaninejad, a faculty member of Oil Industry University then pointed to the subsidies reallocation plan and noted that the plan offered by the government aimed to oversee rectification of the government’s economic policies instead of reforming its economic structure. As for the position of economic development plan in the country’s economic system, he added that the pan should be in line with the policies of Article 44 of the constitution and correcting economic structure should be done through correction of economic policies and use of modern technologies in order to help the country achieve goals of the 20-Year Vision Plan.

He added, “The present structural problems and the severe fluctuations in economic growth rate during the past 30 years have been due to overreliance on oil revenues instead of increasing productivity. Another problem with the government plan is a two-digit inflation rate. Growth in liquidity as a result of oil dependence and imported inflation should be addressed by the government.”

The university professor also said the third reason offered by the government for the implementation of the plan was unequal distribution of income, excessive inflation, and other structural problems. He noted that the main paradigm in the plan was unequal distribution of oil revenues and added: “Despite the viewpoint of those who think that the plan stressed on correcting economic structure and policies, it has just criticized state-run economy without proposing anything as substitute but a state-run economy.”

Ghaninejad stated that the main goal of the plan is to reallocate subsidies, saying, “Introducing new prices for oil products according to FOB price of the Persian Gulf, increasing price of gas according to price of exported gas, increasing price of energy, water and other utilities and considering a tax on energy consumption has been considered in line with international standards of price management.”

“None of these changes entail price correction on the basis of the market mechanism. That is, the government is the main authority which sets prices and the cost price will not be based on the market price and is not based on supply and demand,” he added.

Ghaninejad said, “What we understood from the plan is that correction of prices has been considered by the government as a tool to increase its revenues, and new prices will not lead to increase in production. In this plan, the government sets the energy price. If the market was supposed to set the price, the government should have no part in it and producer should set prices according to market conditions.”

The economist stated that the plan was in contradiction to Article 44 of the Constitution and energy producing companies will not be transferred to the private sector. “Therefore, changing the energy price will not improve the structure of energy companies and is incompatible with true privatization.” He added that due to continued control of the government over the economy, achieving 20-Year Vision Plan goals will also become more difficult. 

Production will be in danger

Dr. Massoud Nili, dean of Sharif University of Technology’s Management and Economics Faculty, then took to the podium.

Dr. Massoud Nili, Senior Economist

Referring to general outlines of the plan to reallocate subsidies, he said that the plan allows the government to earn 10000-20000 billion tomans by introducing free energy prices. Nili noted that the amount of increase in and composition of prices is not clear and nobody knows what will happen in reality. The economist stated that the government should take four approaches when reallocating energy prices.

“The first approach is to increase efficiency of the market and micro economy. The second approach is to create the balance in macroeconomy, budget, inflation and unemployment. The third approach is to liberalize prices in order to reallocate subsidies to stakeholders and target groups. The third approach is to protect the environment and prevent further contamination,” he said.

The university professor stated that energy prices send a signal to people in order to measure their needs and regulate their consumption accordingly while producers will also have to think twice when producing a good or consuming energy.

The economist stated that inflation in Iran has been on the rise since 2005, adding, “Oil price has been relatively constant in those years. Therefore, retail and wholesale prices have been dissociated. The government should repair that dissociated financial relationship and invest in producing crude oil, building refineries and gas stations and making other forms of useful investment.”

“Since government investments have not been productive, they have not increased government revenues and the administration is spending a lot on education and health. As a result production is not increased and the country’s foreign exchange revenues only reduce growth of production and employment. On the other side, lack of efficient production in the oil sector and government investment in that sector leads to budget deficit and inflationary recession,” he said.

Nili stated that production companies in Iran use excessive amounts of inexpensive energy and since salaries are proportionate to inflation they are not willing to employ more workers.

“Since 70 percent of energy is consumed by the industrial sector like basic metals, cement and chemical plants and 60 percent is consumed by production plants, this orientation has led to reduced efficiency of energy and decrease in workforce. Since interest rate in banks is low, there is high demand for bank facilities and share of workforce is low. Average share of production institutions from total expenditure has stood at 46.2 percent for workforce, 42.8 percent for capital and 11 percent for energy from 1995 to 2005,” he said.

The economist stated that liberalization of prices of energy carriers will make micro-economic sectors inefficient, adding, “This is due to incorrect policies in the country in the process of annual production of 4 million barrels of crude oil. Here, the government is still facing a budget deficit and imbalance between revenues and expenses which will destabilize macroeconomy.”

Nili noted that the third aspect of reallocation of subsides was related to redistribution of revenues, adding, “Every economic policy will be beneficial for a group and hurt the interests of others. In this plan, stakeholder groups in relation to energy and gasoline prices change place. On the other hand, energy consumption and environmental contamination have brought the country to the brink of a human disaster and caused many diseases.”

Nili then turned to understanding the reason behind reallocation of subsidies and noted that if the main goal of the plan was the first reason, surplus resources should be allocated to companies in order to increase production, but this is not on the government agenda.

“If the plan aims to do away with imbalance and deficit in the budget, the resultant revenues should be entered into annual budget act to solve budget deficit problem, but the government and the Majlis have taken different approaches towards this issue,” he said.

Nili added that the main goal pursued by the government through reallocation of subsidies is to change stakeholders and target groups. The university professor noted that increased prices as a result of the reallocation of subsidies will cause short-, medium-, and long-term shocks to the society.

“In the first stage, demand for energy will decrease and high-consumption machinery will be shut down reducing production and increasing unemployment. If competition governs the market, domestic production will fall and the market will become more receptive to foreign goods,” he said.

Nili stated that in the long run and based on signals sent by companies, the country should move to streamline technologies, and this calls for selling old machinery and buying new ones.

“If, due to the sanctions, we failed to purchase high-tech machinery, domestic production and employment would be in danger,” he added.

Dean of Sharif University of Technology’s Management and Economics Faculty stated that the same theoretical paradigm which has reached the conclusion to increase price of energy carriers, should also find a solution to this problem.

As for the impact of increased price of energy carriers on the economy, he stated that if the plan were successful in correcting foreign exchange rate, bank interest rate, and energy prices as well as interaction with the world, then it can be assess totally successful.

“However, if only one factor improved with no improvement in other factors, it would be detrimental to national economy,” he said.