THE ECONOMIC IMPACT OF AMERICAN SANCTIONS ON IRAN:

EFFECTS OF UNILATERAL SANCTIONS IN A GLOBAL ENVIRONMENT

By Patrick Frank

A nation that is boycotted is a nation that is in sight of surrender. Apply this economic peaceful, silent, deadly remedy and there will be no need for force. It does not cost a life outside the nation boycotted, but it brings a pressure upon the nation, which in my judgement, no modern nation could resist. President Woodrow Wilson, 1919

The recent electoral success of Iranian moderates has prompted the Clinton Administration to end several minor economic sanctions against Iran. As the United States attempts to foster a constructive political dialogue with Iran, specific legislative and private sector attention has been focused on the negative economic impact that unilateral sanctions impose on the United States. The ability of economic sanctions to achieve American foreign policy goals is increasingly difficult to accomplish within the integrated global market. In light of empirical evidence, a renewed diplomatic relationship with Iran would present tremendous economic advantages for both nations and may provide greater influence to US foreign policy objectives within the gulf state.

As President Wilson eloquently stated in 1919, economic sanctions represent a powerful instrument of national power. The term sanction is broadly defined as: "a collection of actions that the government can take directly to restrict the flow of goods, services, or capital between the United States and another country in order to promote foreign policies or enhance national security." In theory, the act of levying a sanction is meant to discourage objectionable activities through the imposition of higher costs on the targeted nation. However, as is the case with other instruments of national power (military, information, diplomacy), economic sanctions can infer negative costs to the US domestic economy. The use of economic sanctions in the pursuit of US foreign policy has increased dramatically over the last decade. A recent Congressional Research Service report by Dianne Rennack and Robert Shuey recorded 191 sanction related provisions in legislative statutes at the end of 1997. Despite the nation’s global leadership role, American diplomats are often unable to persuade the international community to invoke multilateral sanctions. Lacking broad multinational support US lawmakers have heavily relied upon unilateral sanctions to achieve policy objectives. Although the policy goals are laudable, unilateral sanctions often burden American consumers and businesses and restrict political engagement.

Economic Sanctions Imposed on Iran

Unilateral American economic sanctions were imposed against Iran during the hostage crisis following the Islamic Revolution in 1979. Additional measures have been enacted by the United States in an effort to curtail Iran’s support of international terrorism and acquisition of weapons of mass destruction. The dominant position of the United States in the international financial system has enabled Congress to integrate support for International Monetary Fund and World Bank assistance loans within American economic sanctions.

In 1995, President Clinton issued Executive Order 12957 and 12959 pursuant to the International Emergency Economic Powers Act. This declaration of a national emergency with respect to Iran banned commercial energy development contracts between Iranian and American corporations and imposed restrictions on Iranian imports, primarily oil and natural gas (Presidential renewal of act – March 2000). Furthermore, the United States Congress unanimously passed the Iran-Libya Sanctions Act (ILSA) in August 1996. The ILSA imposes mandatory and discretionary penalties on non-US companies, which invest more than $20 million annually in the Iranian energy sector. While enactment of the ILSA penalties against multinational corporations has been erratic due to international opposition, prohibitions on virtually all trade and investment activities by US citizens / corporations have been strictly enforced by the last four American administrations.

Impact of American Sanctions on the Iranian Economy

The ideological divide between the United States and Iran had its genesis in the 1979 Islamic Revolution. In an effort to end "western / capitalist" oppression, the government nationalized (constitutional Article 44) many sectors of economy. Despite the dramatic alterations of the nation’s economic structure, Iran remained heavily dependent on revenues from oil exports. Emboldened by large energy revenues, the Iranian leadership sought to expand the influence of the Islamic revolution beyond the nation’s geographic borders. Iran began to support (financial resources / training / equipment) ideologically aligned terrorist organizations and aggressively sought to acquire weapons of mass destruction. Additionally, oil revenues were funding the expansion of the Iranian armed forces.

Alarmed by the rapidly shifting balance of power in the strategic Persian Gulf region and the revolutionary regimes support of terrorism, the United States began to restrict exports to Iran in 1984 and banned most imports from Iran in 1987. The unilateral nature of these sanctions received broad support within the American executive and legislative branches, but lacked sufficient reinforcement from the international community. The commendable foreign policy objective of curtailing Iranian support for terrorist organizations and military adventurism viewed the abundant oil revenues as the key "enabler" for the gulf state’s international posture. Despite incremental escalations to the economic injunctions, the United States has experienced great difficulty in controlling Iran’s "economic enabler" in the fluid global market.

Iran is the second largest oil producer within OPEC, holding 9% of the world’s oil reserves (90 billion barrels) and 15% of the world’s natural gas reserves (812 trillion cubic feet). The Iranian economic cycle has a direct correlation to the world market for oil. The fundamentalist state suffered a recession during 1996 through early 1999, as the government controlled economy adjusted to record-low oil prices. Oil revenues constitute 50-75% of the national budget, presenting American policy strategists with an economic target of opportunity. However, Iran has foiled the United States attempt to cripple its command economy by seeking alternative markets for its energy resources: Japan, S. Korea, Britain, China, Turkey, Thailand, India, Brazil, and Taiwan. As the United States banned the practice of importing Iranian oil, a substitution effect occurred within the world energy market. Unwilling to participate in the American economic sanction, multiple industrialized nations replaced the US as Iranian energy consumers, rather than face potentially higher oil prices within a supply-constricted world market. Furthermore, Iranian oil was an acceptable energy alternative as most of the nation’s crude is low in sulfur (30-90 API / refinement cost factor). The developed world’s insatiable demand for oil proved to be a more significant factor than the global security concerns surrounding terrorism and weapons of mass destruction.

In concert with other OPEC nations, Iran reduced production limits, constricting the global supply (at a time of increased US consumption) and significantly raising oil prices. Presently, the Iranian economy is experiencing an expansion, corroborated in the 2.5% growth in gross domestic product for 1999 and a forecasted growth in GDP for 2000 of 4.2%. OPEC production agreements have established an Iranian quota of 3.359 million barrels per day. After allowances for internal consumption (1.2 million bbl/d), Iran exports 2.3 million bbl/d and projects to receive $21.9 billion in oil export revenues for 2000. Iran’s positive economic position enables it to service $16 billion in foreign debt and to adequately fund domestic and international policies favorable to the regime.

Iran-Libya Sanctions Act: Economic Impact on Iran

Proponents of the United States’ economic sanctions credit the ILSA penalties for Iran’s inability to attract foreign capital investment. Realistically, the uncertainty inherent within Iran’s nationalized economy was the primary factor in the lack of significant capital investment. The recent free-market initiatives and judicial reform proposed by President Khatami should promote investment security and attract foreign capital. A review of Iran’s major trading partners – Germany, Japan, Britain, France, Italy, Spain, and the Netherlands – acknowledges the significant pool of capital that is accessible to an "investment-friendly" Iran.

The recent discovery of an enormous oil field (26 billion barrels) in southwestern Iran has attracted considerable interest from foreign energy corporations. The ILSA barrier that denies US energy corporations access to Iranian oil and gas development contracts has "leveled the playing field" for major European and Asian energy corporations. The European Union disputes the imposition of ILSA penalties on its member states and passed a resolution (November 1996) directing members to disregard the American sanction. In May 1998 the US State Department granted a waiver to Total (French corporation), Gazprom (Russian), and Petronas (Malaysia) enabling the cooperative to accept a $550 million Iranian oil and gas development project that had originally been awarded to US based Conoco. Europe’s substantial economic ties with Iran, the environment of diplomatic/trade (ILSA) tensions with the American government, and a profitable Iranian energy sector absent the powerful US energy corporations, reflect the growing interest in investment opportunities within Iran and the failure of US sanctions to discourage economic support of the gulf state.

Sanctions: Barrier to Industry Leading US Technology

Iran’s flexible response to American sanctions has enabled the nation to continue to reap large oil revenues. However, Iran has experienced degradation in its production capability (efficiency) due to the nation’s exclusion from the US technology market. American energy corporations are the world’s leading proponents of harnessing sophisticated technology to ensure the greatest production yield from increasingly difficult and marginal fields (selective factor disadvantages). US energy corporations effectively used advanced technology to drive American production costs for discovering oil from $15/barrel in the 1980’s to $5/barrel by the late 1990’s. Iran does incur slightly higher costs for petroleum production equipment since its field of potential suppliers has been diminished (American barrier).

The imposition of higher costs for petroleum production equipment represents a "loss of consumer surplus" or "welfare loss" for Iran. The welfare loss reflects the cost that American export sanctions place on the gulf state. Within figure I, dQ represents the equipment sanction placed on Iran. However, since only US firms are barred from the Iranian market, competing world firms fill the American void, preventing the overall supply availability by falling to the full dQ level. The foreign companies are able to charge a premium for the petroleum equipment and a new equilibrium is established (p2). The original consumer surplus is represented by the triangle area of P1, P3, and e1. When the United States enacted sanctions on Iran, the trapezoidal area of P1, P2, e1, and e2 is subtracted from the initial consumer surplus. The higher cost imposed on the Iranian economy is referred to as a welfare loss ((Q1)(dP) = welfare loss).

Iran has recognized the American dominance in the oil-field technology sector and has been increasingly willing to develop commercial connections with US energy corporations. The Islamic government has consistently drawn a distinction between the US government and the American people. In fact, Conoco (US) received the first major petroleum contract awarded to a foreign corporation since the Islamic Revolution in 1979. The recent actions of the Iranian government reflect a meticulously calculated cost-benefit analysis, acknowledging the US technological advantage.

Currently, Iran’s production quota is 3.359 million bbl/d. Iran’s sustainable oil production capacity is estimated to be 3.7 – 4.0 million bbl/d. Industry experts have speculated that Iran was recently opposed to additional increases in oil production, as the nation does not have the ability (advanced technology) to exceed 4.0 million bbl/d. Unable to fulfill increased OPEC production levels, Iran would forfeit oil revenues and significant influence to other cartel members. The exclusion of US energy production expertise may have attributed to poor Iranian / foreign production practices; permanently damaging mature oil fields.

Peripheral Sanction Effects on the Iranian Economy

"The very foundation of our economy is sick…the right remedy is to create a fundamental change in the economy." President Mohammad Khatami

Although American sanctions have clearly been focused on the considerable oil revenues available to the Iranian government, the legislative barriers have negatively affected "less" robust sectors of the gulf states’ economy. Exclusion from the world’s largest market had a marginal impact on the Iranian oil industry, however the ability to re-establish trade in "substitute markets" proved to be extremely difficult for Iran’s major non-petroleum exports: carpets and pistachios. Effectively "locked-out" of the vast American marketplace, Iranian producers are unable to achieve a competitive advantage in any non-oil sector. The inability of Iran to diversify its economic foundation has linked the nation’s economic fortunes to the fluctuations of the global energy market.

American financial dominance has enabled US policy makers to deny IMF and World Bank loans to Iran. Listed by Washington as a state sponsor of terrorism, Iran is unable to secure capital for economic development projects. In effect the American sanctions have heightened economic conditions within the Iran, by constraining the market opportunities (IMF/World Bank projects) available to the large unemployed segment of the nation’s population. In 1998, Iran’s official unemployment rate was 13.3% (western analysts believe rate approx. 26%). State officials estimate that based on contemporary economic trends that the unemployment rate would reach 23% in 2007. Iran experienced a population expansion between 1987-1997 of 8.3 million. However, job development during the same ten years amounted to only 3.6 million.

Absent IMF / World Bank assistance, Iran could experience a dangerous trend towards a large segment of society that is young, restless, and unemployed. This potential "unemployment" factor stimulated by American sanctions poses an interesting dilemma to US policy makers: Could high unemployment rates in Iran destroy the political-reform efforts of moderate Iranian leaders, re-establishing the hard-line policies of conservative Islamic politicians and clerics? Treasury Secretary Lawrence Summers echoed this policy predicament during a recent appearance before the House Banking Committee, "From the experience of Germany in the 1930’s to Bosnia and Africa in more recent times, history teaches us that conflicts are most likely in situations of economic distress, when populations turn their frustrations to nationalist leaders because of a lack of a sense of economic opportunity."

Domestic Cost of Unilateral American Sanctions

Because the actions and policies of the Government of Iran continue to threaten the national security, foreign policy, and economy of the United States, the national emergency declared on March 15, 1995, must continue in effect beyond March 15, 2000. President Clinton

Since the seizure the American Embassy in Tehran in 1979 the United States has gradually intensified the economic sanctions against Iran. The restrictions on trade have limited imports from Iran, US exports to the gulf state, and have restricted American (attempted to restrict foreign) investment in Iran. Economic theory maintains that the net domestic costs will be negligible when imposed against nations that are not major trading partners. The market rapidly adjusts to government sanctions by introducing substitute goods, easing the impact to the vast national economy.

However, the unilateral nature of recent American economic sanctions has a greater potential to impose negative costs on the domestic economy. While consumers within the United States may not experience higher prices at the pump, unilateral actions can place large burdens on domestic companies and worker employment prospects. Furthermore, economic sanctions have a cumulative effect on the domestic economy, reducing foreign confidence in US firms and decreasing opportunities for economic growth. Although the impact that sanctions may cause within the domestic market may seem inconsequential to lawmakers, the long-term negative economic effects and marginal policy influence must be carefully considered before implementation.

Sanction Impact on American Consumers

Recently, the dramatic rise in the price of gasoline and home heating oil has renewed debate over whether American economic sanctions on OPEC’s second leading exporter had a negative impact on domestic petroleum costs. Although Iran is a major supplier of energy products, oil is a relatively interchangeable commodity (API / sulfur / refinement costs) with multiple suppliers available on the world market. Short term cost increases may have been diverted to the consumer, as new transportation and contracting costs were incurred following the creation of US sanctions. However, American energy companies would most likely be unable to pass short-term costs to consumers. Thus, the American consumer has not experienced an increase in petroleum prices (short or long term) due to sanctions emplaced on Iran.

Sanction Impact on US Energy Corporations

The American energy corporations have a commanding influence within the world petroleum markets. Capital investment, exploration, an enormous domestic demand, and industry leading technology are key elements of the US energy companies. Despite the apparent negligible effect of sanctions on American consumers, US commercial interests may suffer adverse effects.

The 1995 Executive Order issued by President Clinton, which implemented restrictions on the import of petroleum products from Iran, imposed short-term costs on US refineries. Plants that were designed to refine Iranian crude had to adapt to alternative types of crude and experienced new transportation arrangements. Since the industrial practices of foreign refiners were not disturbed by the unilateral American sanctions, short-term costs were accepted by US firms (could not pass to consumers) in order to remain competitive in the market.

The Presidential decision to deny Iran access to the US commercial sector has had a dramatic impact on the domestic suppliers of oil field goods and services. The American energy industry has established a commanding technology advantage in the extraction of oil from mature fields and challenging geological formations. Over the last decade, Iran has experienced technical difficulties in maintaining oil production quotas from mature fields. Furthermore, Iran has irreparably damaged several oil fields in large part due to restrictions on the services of American experts.

Unable to purchase oil field equipment and services from US corporations, Iran is forced to contract with foreign competitors. American firms are able to recapture a portion of the world market for goods and services as foreign prices increase. Despite the ability to attract new customers, the unilateral economic sanctions create an "efficiency loss" by the lose of producer surplus. The loss of individual markets has a cumulative effect as foreign suppliers construct equipment systems / services in former US markets and embed life cycle costs (parts, maintenance, service) within plant and equipment.

Unilateral actions have a dangerous long-term impact on American suppliers. As an element of risk management, foreign investors deliberately avoid contracting goods or services from US suppliers due to the "unreliability" factor. Recently, Caterpillar failed to contract with a Canadian firm concerned with the ILSA penalties and General Electric lost an Airbus contract to rival Rolls Royce due to the unpredictability of receiving export licenses. Unilateral sanctions are an unacceptable risk in the high stakes arena of international commerce. Loss of market share due to "lack of confidence" in US corporations must be recognized as a negative impact on the domestic economy.

Unilateral Sanctions: Impact on Domestic Exports and Jobs

American policy-makers enacted initial export restrictions to Iran in 1984 and through subsequent legislation have dramatically restricted trade to the gulf state. A study by the Institute of International Economics (1995) determined that American companies lost approximately $15 billion of export business to foreign competition and 200,000 jobs due to unilateral sanctions. Gary Hufbauer estimated that the loss (1997) to US export business ranged from $15-$19 billion and that 260,000 jobs were sacrificed in the pursuit of economic sanctions.

While it is difficult to accurately, determine total US losses in exports and jobs as a consequence of sanctions on Iran, selected ILSA negotiations demonstrate the enormous influence on the American private sector. Recently, the Russian oil corporation Gazprom withdrew contracts for $163 million in compressor controls, $163 million in horizontal drilling projects, and $536 million in oil field equipment from American companies in response to ILSA punishments. The presence of an economic "multiplier effect" (domestic output and employment impact of exports) calculates the total US domestic losses from this single contract to be $1.8 billion in production (which would support 17,000 jobs – see Dept of Commerce employment table). The world’s growing energy demand presents a significant window of opportunity for US economic growth. Ineffective unilateral sanctions will continue to represent an albatross around the neck of American businesses and workers.

The US Department of Agriculture recently responded to policymakers’ requests to quantify the impact of US sanctions on American agricultural trade. The USDA review of the sanctions imposed on Iran revealed a $2.74 billion agricultural market that has been denied to American farmers. Before the enactment of sanctions, Iran had been a major importer of several US agricultural products. The USDA has recognized that American farmers have exported agricultural products to substitute markets, but estimates that a resumption in normal trade relationships could increase US agricultural trade between $433-$650 million.

Unilateral Sanctions: Impact on American Investment Opportunities

Unilateral sanctions on Iran have a significant impact on the investment opportunities for US energy corporations. Recent modifications to investment procedures within the Iranian petroleum industry and the vast oil/nature gas reserves in the country represent sound investment instruments. The absence of US companies unfairly benefits foreign competitors in regards to short-term investments and strategically positions foreign firms to dominate future opportunities.

Investment prospects in the Caspian Basin offer tremendous growth potential for American energy corporations. Industry experts state that the region is approaching "critical commercial mass" and that initial investors stand to be profitably rewarded if the substantial political and economic conflicts can be resolved. Presently, there is a direct correlation between the Clinton Administration’s economic sanctions on Iran and Washington’s proposal for a Caspian pipeline. In an attempt to exclude Iran from benefiting through development of the region’s petroleum resources, the proposed pipeline route (Baku-Ceyhan) would direct crude oil towards Turkey. However, the route requires the construction of several hundred miles of additional pipeline. Although the Administration views the Baku-Ceyhan route as the most strategically sound alternative, the major US oil companies remain unconvinced that the proposed route is economically sound. Furthermore, the Caspian reserve is bordered by five nations, (Russia, Kazakhstan, Turkmenistan, Iran, and Azerbaijan) that are entertaining commercial proposals from foreign energy companies. Iran’s geographic position and the potential ILSA punishments threaten American investment opportunities within a region poised for dynamic growth.

Conclusion

"As the government has announced, we want relations with all nations, and parliament will consider a policy of détente." President Mohammed Khatemi

In this era of expanding free trade and the globalization of world markets, economic theory implies that the United States faces only marginal domestic cost when it imposes sanctions. The current trend in the American political arena is towards the increased use of economic sanctions. Often, the United States does not receive the support of the international community and is forced to unilaterally pursue policy objectives. When reviewed in the context of the vast American economy, the cost of unilateral sanctions seems minor. However, the long-term effects of unilateral sanctions impose dramatic costs on American corporations and workers.

The United States has pursued a foreign policy objective towards Iran that seeks to punish the gulf state economically for its support of terrorism and pursuit of weapons of mass destruction program. The policy has removed all instruments of dialogue between the two nations. American policy makers focused on Iran’s petroleum revenues as the regime’s key enabler. Despite denying Iran access to the world’s largest market, the US policy of confining the Islamic regime’s petroleum revenues has failed. Within a relatively short period, Iran was able to locate substitute markets for its energy products. Although the Iranian economy has endemic problems, the nation’s GDP has continued to rise and total economic collapse is not even considered a remote possibility. While Iran has escaped the full impact of US sanctions, the American economy has suffered financial damage from the errant foreign policy. The negative influence on US job production, exports, and investment opportunities has been the legacy of unilateral sanctions.

The time has arrived for senior American policy makers to develop a new strategy towards Iran: a policy of engagement. The recent electoral victory of President Khatemi, provides a signal to the United States that a cooperative relationship could be fostered. The relaxation of sanctions on several Iranian imports (caviar, pistachios, dried fruit, and carpets) is a positive gesture by the Clinton Administration. The ability of President Khatemi to gain economic relief from the United States enables the moderate government element to secure authority in Iran.

The Clinton Administration should foster a bold new initiative towards Iran with the immediate relaxation of the majority of economic sanctions (imports, exports, and investment). The restrictions on IMF/World Bank loans and frozen Iranian assets should remain in place. A policy of engagement along diplomatic, military, social, educational, and commercial avenues has the greatest potential for positive change within Iran. Restoration of relations would strongly aid the United States in guiding Iran into the global community of responsible nations. The powerful ability of the American commercial sector to foster constructive change within a country is an essential segment of the policy revision. The engagement of American citizens and corporations with their Iranian counterparts may potentially be the nations greatest policy instrument for fostering revolutionary change within Iran and stability in the volatile Middle East.

Patrick Frank is a Major in the U.S. Army. He recently earned a Master of Arts in National Security and Strategic Studies from the United States Naval War College and completed the Master of Public Administration program at Syracuse University's Maxwell School of Citizenship and Public Affairs.