How the “Structural Adjustment Program” Led to External Debt and Hyperinflation in Iran
Inflationary pressure has persistently plagued the Iranian economy since the 1979 revolution. Throughout the 1980’s the government sought to contain this pressure by administrative means: strict laws against hoarding, price gouging, and speculative transactions, combined with government-sponsored distribution of essential goods and services at subsidized, affordable prices. Price controls were somewhat relaxed in the early 1990’s as President Rafsanjani sought to reduce the economic role of the government in favor of market mechanism. This was part of the broader package of the so-called “structural adjustment program,” designed to fight inflation by the World Bank/IMF/Monetarist policies: curtailment of government spending, constraint of credit, unification and devaluation of exchange rate, elimination of exchange and price controls, elimination of most of the consumer subsidies, and related measures. 
Far from tempering the inflationary pressure, the adjustment program and relaxation of price controls sparked new waves of price rises that can clearly be characterized as hyperinflation. The new waves of price rises became so strong by the early 1994 that the government, fearing social instability, was forced to backtrack on its drive toward the price mechanism and, once again, to try to fight inflation by bureaucratic means—since increasingly broadened and intensified.
What went wrong? Why did the Monetarist stabilization program fail to help mitigate the inflationary pressure? Why did it, indeed, aggravate that pressure? While continuing to blame government spending and excess liquidity, proponents of Monetarism (i.e., of unfettered market mechanism) have now targeted additional culprits or scapegoats. These include greedy speculators and hoarders who torpedoed the government’s anti-inflationary policies by subverting the price mechanism in order to fill their deep pockets. No doubt, speculation and price gouging activities have been very disruptive, but the fact remains that speculators are not born with speculative genes, and that these “economic parasites”, as they are aptly called in Iran, need favorable breeding grounds for nourishment and growth.
What are those breeding grounds for hoarding, speculation, and price gouging? They are none other than the structure and the institutions of the Iranian economy and the government policies of economic management. Could it be, then, that the anti-inflation strategy was inherently flawed? Or was the inflation problem essentially misdiagnosed when blamed on government spending and monetary imbalances rather than structural problems and external payments difficulties?
We will argue in this brief study that, while no doubt money creation and price inflation are related, the more important factors in the hyperinflation that ensued President Rafsanjani’s “structural adjustment program” were balance of payment problems and/or external payments difficulties. (Other important factors—such as the stagnation of production, political uncertainty, economic mismanagement and corruption, as well as economic restrictions and boycotts imposed on Iran by the U.S. imperialism—cannot be discussed in this brief survey.)
The Official Explanation: Government Spending and Excessive Money Supply
According to President Rafsanjani’s economic advisers (positioned largely in the Central bank, the Ministry of Plan and Budget, and the Ministry of Economics and finance), government spending and/or excessive money supply are the major cause for the hyperinflation in Iran. This is the Monetarist/World Bank/IMF’s standard diagnosis for the plague of inflation not only in Iran but almost everywhere else in the world. That the President’s economic policy makers are parroting this dogma should not be surprising considering the fact that the majority of them are trained in the Western academic institutions, and hence in the Monetarist school of economic doctrine. The essence of that doctrine can be summarized as follows.
(1) Excessive government spending contributes to the growth of the money supply. (2) The growth of the money supply will increase aggregate demand, but not aggregate supply, since real output is determined independently in the medium-to long-term by “supply-side” factors. This leads to a demand-supply gap, and hence to inflation—inflation is therefore a “demand pull” phenomenon. (3) Inflation will then hurt a country’s balance of payments position as it will encourage imports and discourage exports. (4) In fact, payments deficits could not have been sustained without surplus liquidity (i.e., without central banks creating the money to spend, or governments failing to tax incomes which are then spent on foreign goods and services); in other words, payments deficits are simply reflections of money surpluses. (5) Since both inflation and balance of payments problems are therefore caused by an oversupply of money, it is self-evident that the cure of these problems lies with deflation: rolling back government spending and the money supply, and hence income and price levels.
The Monetarist view of inflation is largely based on the notorious quantity theory of money which holds that price changes are directly caused by money changes. This “causal” relationship is shown by the rather neat mathematical formula MV=PQ (or, P=MV/Q), in which M stands for the quantity of money (currency outside banks plus demand deposits), V stands for the velocity of circulation (or the number of times per period or per year that an average money unit changes hands), P represents the general level of prices, or a price index, and Q is a measure of physical output. Since the Monetarist theorists assume that V and Q are constant—at least, in the short-to medium-term— and M is simply a means of exchange (i.e., money has no other usefulness or property than circulating commodities  ), it follows mathematically that any change in M will be automatically reflected in P.
The real economic world is very different from the Monetarists’ pure mathematical (indeed, mechanical) formulation. For example, once the dubious assumption of the constancy of Q is relaxed, assessment of the impact on P of a change in M becomes much more difficult. Depending on the magnitude and direction of Q, an increase in M, for example, may increase P, leave it unchanged, or even lead to a decrease of it. An oft-cited case in this context is the German experience of the immediate post-WW II period. Evidence shows that while the volume of cash and demand deposits rose 2.4 times and the volume of bank loans, both short and long term, rose more than tenfold in the 1948-54 period, this significant rise in liquidity not only did not lead to a rise in the level of prices but it was, in fact, accompanied by a decline in the general level of prices—the consumer price index declined from 112 to 110 during that period. Why? Because the increase in liquidity was accompanied by an even bigger increase in output (Q). 
The Monetarists’ disposition to discount the importance of output and exaggerate the role of money in determining the value of commodities, including the value of money as a special commodity, stems directly from their theory of price determination. According to this theory, commodity prices are determined purely by supply and demand conditions. In other words, commodity prices are simply scarcity prices: as a commodity becomes scarce relative to the demand for it its price will go up, and vice versa.
No doubt, supply and demand conditions greatly influence commodity prices, but they are not the sole determinants of those prices. More importantly, commodities have intrinsic values. (In Marxian economics the intrinsic value of a commodity is the labor embodiment of that commodity. In other economic theories this is vaguely called the cost of production.) Because major economic advisers of President Rafasnjani are trained in the Monetarist school of economic thought, they do not see, or acknowledge, the importance of the intrinsic value of commodities. For them it is only the supply and demand mechanism that determines prices. It is not surprising, then, that their only prescription for the problem of inflation is the old generic Monetarist one: curtailment of government spending and/or of the money supply. Whether money supply is actually the culprit or not matters less to these experts than does the dogma of Monetarism.
Likewise, from the declining rial, the Iranian currency, against the U. S. dollar they automatically concluded that the solution lay with increasing the supply of dollars and decreasing that of rials. To this effect, in the late 1992 and early 1993 they poured massive amounts of oil dollars into the market in an effort to raise the dollar supply and lower its price against the rial. Before realizing that this only made the business of foreign exchange speculators more profitable, billions of dollars were wasted. But, alas, this was not enough! They repeated the same prescription for the case of gold coins: as the price of gold coins rose sharply against the rial in the early 1995, the Central Bank tried to ‘saturate’ the market with gold coins by injecting them into the market at prices much lower than the unofficial market prices in the hope that this would stabilize the coin-rial relationship. Once again, the policy resulted in simply providing grist for the mills of speculators and hoarders. 
The claim that excessive government spending is the main cause of Inflation is also rendered dubious by facts. While it is true that the Iranian government has been spending a significant share of the national income in the post-revolution period, this share, measured in constant prices, is in fact smaller than the pre-revolution years, as shown in Table 1 below.
Table 1: Total Government spending (% of GDP) in Iran
G stands for total government spending and GDP for gross domestic product.
Source: Central Statistics of the of the Islamic Government of Iran (in Fars); as cited in K. Athari, “Afsoon-e pool bavari va afsaneh-ye naghdinaghi dar Iran,” Iran-e Farda, No. 11, January-February 1994 (Bahman-Isfand 1372, Iranian Calendar), p. 48; World Bank Development Report 1994, p. 181.
As this table shows, the Iranian government’s fiscal responsibility has consistently declined since the revolution of 1979. The Islamic Republic’s fiscal responsibility (in relative terms) is not only below that of the pre-revolution years; it is also below that of both the advanced capitalist countries (Table 2) as well as many less-developed countries that are roughly at the same level of economic development as Iran (Table 3).
Total Government spending (% of GDP) in Selected Industrialized Countries
Source: World Bank Development Report 1994, p. 181.
Total Government spending (% of GDP) in Selected Developing Countries
Source: World Bank Development Report 1994, pp. 180-181.
This brief look at government spending in Iran casts great doubt on the Monetarist claim that government spending is inordinately high, and that it is the major source of high inflation rates. We must therefore look for other explanations for the inflation problem.
While government spending as percentage of GDP has been steadily declining in the post-revolution period, the volume of money supply has been constantly rising; it has since 1979 gone up almost ten times, from 3550 million rials in 1979 to 36698 million rials in 1992.  This poses a dilemma for the Monetarist theory of inflation that maintains that changes in government spending and money supply move in the same direction. Without making any attempts to explain this incoherence in their theory—in fact, without even acknowledging it—the Iranian Monetarists simply point to the expanded money supply and insist that it is the major cause for inflation. 
Yet the apparently contradictory developments of a rising money supply accompanied by the declining government spending require an explanation. While a thorough explanation of this paradox will require longer treatment and space than can be provided here, a short-cut answer is that the simultaneous rise in liquidity and fall in government spending can only mean that the rising liquidity has not been translated into effective demand or actual purchases. This is similar to a person’s monetary income going up without a corresponding increase in his or her purchasing power (or, more precisely, while at the same time losing purchasing power and buying less). This can only mean that money increases have followed, not preceded, price increases: the government has regularly resorted to money creation in a race to offset the depreciating currency, or rising prices, in order to pay its bills and meet its financial obligations. In other words, the rise in liquidity has been more the effect than the cause of inflation. Let us examine this more closely—and this will bring us to the analysis of the major cause of hyperinflation that resulted from President Rafsanjani’s “structural adjustment program,” the external payments difficulties.
Balance of Payments Difficulties and Hyperinflation
A distinction must be made between an inflation that is prompted by domestic monetary ove-rissue, accompanied by a stagnant or declining output, and one that stems primarily from external factors such as balance of payments deficit and foreign debt. As Michael Hudson points out, it is usually the latter type of inflation that is difficult to contain, and thus often develops into hyperinflation. “For if the inflation was a purely domestic monetary or fiscal phenomenon, it could be stopped before it became hyper. However, when it stems basically from external factors it cannot be stopped nearly as readily.”  Hyperinflation is, therefore, characteristic of a situation where the inability of foreign exchange receipts to cover external payments leads to a depreciation of the currency which will, in turn, lead to the rise first of import prices and then domestic prices as domestic commodities become more attractive than the now more expensive foreign commodities. As the government is unable to meet its external obligation, it will also be forced to restrict imports, thereby further heightening the inflationary tide.
The sequence of price changes at work here is just the opposite of the sequence of price changes caused by domestic money creation. In the latter case, domestic products are the first to rise in price. This then will make import products more attractive and raise their demand and their prices. In both cases import prices and domestic prices rise, but the line of causation is reversed.
This distinction is not merely technical or pedantic. It is important because just as in medical science a correct diagnosis is crucial for an effective prognosis, so too in economics a proper identification of the sources of economic ills is necessary in order to remedy those ills. As noted earlier, the view that attributes any change in prices to a monetary cause reduces the problems of inflation and balance of payments to a simple monetary control/management: keep the supply of money at the “natural” or “desired” level—although such a level of money supply is never clearly defined—and your economy will be problem-free! On the other hand, the view that focuses on structural difficulties—both the structure of international trade as well as that of domestic production and institutional systems—in search for an understanding of inflation and balance of payments problems will call for rectification of the adverse structural conditions. The difference between these two views is rather well known in the trade and development literature: it is the long-debated difference between Monetarists and Structuralists, especially in the context of South America. At the heart of the Monetarist-Structuralist controversy, as Dudley Seers put it, “are two different ways of looking at economic development, in fact, two completely different attitudes toward the nature of social change, two different sets of value judgments about the purposes of economic activity and the ends of economic policy, and two incompatible views on what is politically possible.” 
In the case of Iran too a clear distinction can be made between the two types of inflation just discussed. The inflationary pressures that have stemmed from balance of payments problems have clearly been more severe than those that existed prior to the emergence of such problems. While inflation has persistently plagued the Iranian economy in post-revolution years, it is only since the emergence of the payments difficulties in the early 1990’s that it can be characterized as “hyperinflation.” Whereas the official annual inflation rates in the 1979-1992 period fluctuated between 4.6 and 26.6 percent,  after the implementation of the “structural adjustment program” and the emergence of payments and debt difficulties in the early 1990’s price rises have become much sharper. 
Following President Rafsanjani’s adoption of the “structural adjustment program” in 1989-90 and the resulting open-door policy, Iran went on a borrowing and spending binge. The opening of the country’s borders to almost unhindered foreign commodities was necessary, the Iranians were told, in order to (a) promote competition and harness inflation, and (b) import the badly needed means to reconstruct the war-ravaged economy. Government economic policy makers considered the role of imports in accomplishing these objectives so important that they actively promoted the flow of imports. This was done in two ways. The first way was through foreign-exchange subsidies: the government
heavily subsidized importers by providing them with dollars at only a fraction of their market value against Iran’s currency, the rial. The second way was through drastic tariff reduction. The weekly Kayhan Havai of 19 May 1993 (p. 18) showed that Iran’s import tariffs were among the lowest in the world. The official rate of import tariffs was about 15%, but because in the calculation of tariffs imports were valued at $1 = 70 rials, the old exchange rate that had long been obsolete, and not at $1 = 1600 rials, which was the prevailing exchange rate, the effective tariff rate was therefore about 0.7 percent, not 15%. This means that for a period of time in the early 1990s President Rafsanjani’s government subsidized both domestic importers, through subsidized foreign exchange, as well as foreign exporters by practically eliminating import duties!
The importers jumped on this opportunity and the rush to import was on.  Every individual, institution, or authority with any clout—and there are many of them in Iran—rushed to government-owned banks for cheap dollars. These included government ministries, state-owned enterprise managers, various clergy-run bunyads (foundations), military leaders, and influential merchants with ties to “proper” authorities who facilitated their imports and shared their gains. 
Eager to show some early positive results for the “adjustment” program, most of the government ministries and state-owned enterprises spent much more of the subsidized foreign exchange than had been earmarked to them in the first five-year plan (1989-1993). Citing the Central Bank statistics, Ahmad Keyani shows that fourteen such government entities went beyond their allocated foreign exchange quotas by 29% in the first four years of the plan, and that the Ministry of Industries and the Ministry of Heavy Industries alone exceeded their shares by 159% and 133%, respectively.  Driven partly by the lure of the cheap foreign exchange and partly by the anxiety to show positive results for the “adjustment” program, government ministers and managers were almost totally unmindful of the cost factor of their projects. When the time came to pay for the enormous amounts of foreign credit it had used, mostly short-term credit, the government found it difficult to meet the obligations it had accumulate. 
But while some money went into reconstruction projects (though, as just mentioned, in a very wasteful way), “much of it…was thrown away on consumer imports to earn quick profits and satisfy pent-up demand.”  To take advantage of the government’s policies of trade liberalization and import subsidization of this period, “A plastic company had imported 27 years’ worth of raw materials just so it could get more discounted dollars, a business consultant says. An electronics dealer bemoans a glut of calculators and computers imported by profiteering military units and ministries.” 
Coupled with the fall in the country’s oil revenue during this period, the import rush soon opened a wide gap between the country’s foreign exchange earnings and its external payments. As a result, barely four years after the inception of the open-door policy in 1989, Iranian Monetarists had managed to accumulate more than $30 billion of foreign debt, and by the late 1992 Iran was becoming unable to service its debt. 
The flood of foreign commodities did more damage than accumulating external debt; it also strangled domestic producers who could not meet the challenge of more competitive foreign producers. Although wasteful, the massive government expenditures on restructuring projects in the 1989-92 period led to an average annual GDP growth rate of seven percent during this period. While this came about largely as a result of capacity utilization (i.e., utilization of the existing but idle capacity) rather than capacity creation, it was nonetheless an economic upsurge. But this burgeoning economic surge soon came to a halt by the powerful foreign competition as the flood of better and cheaper imports saturated the domestic market, and as the country’s inability to meet its foreign obligations in the late 1992 made further importing of the manufacturer’s needs of capital goods impossible.
The government’s difficulty to service its external debt forced it to backtrack somewhat on its open-door policy, and in 1993 it moved to severely restrict imports. The country’s currency also lost about 250% of its value against the U.S. dollar early in that year as part of the government’s exchange rate unification and devaluation—from about 500 rials to 1750 rials to the dollar. As the currency plunged and imports were restricted, prices began to jump up, thereby ushering in the hyperinflation that began in the late 1993 and early 1994 and continues to this day.
The depreciation of the currency and the almost indiscriminate restriction of imports has done more damage than having brought about the brutal hyperinflation. Coupled with the reflexive decision to suddenly curtail credit to manufacturers, this has also paralyzed the country’s production system and precipitated a generalized economic crisis. Scarce and expensive foreign exchange has shut down many production plants and left many unfinished projects to gradually go to waste. The deflationary, tight monetary policy of the ‘adjustment’ program has created a crisis of credit that, in turn, has choked off productive investment and crippled production enterprises. This adds to the scarcity of goods and services and further aggravates the problem of inflation. In other words, the government’s inept and misguided policies to fight inflation have led to an even bigger problem: that of stagnation, hence the spiral of currency depreciation, inflation, and stagnation.
Contrary to the Monetarist claims, government spending and/or the overissue of money are not the main causes of inflation in Iran. To the extent that government spending has added to domestic liquidity, this seems to be more in response to the decline in the country’s external earnings and to currency depreciation, hence to inflation, than the other way around. This is especially true for the hyperinflation that followed Iran’s experiment with the World Bank’s “structural adjustment program.” in the early 1990s. As this program opened the country’s doors to massive imports during that period, it precipitated problems of balance of payments and external debt. This, in turn, led to the drastic depreciation of the country’s currency, and hence to the problem of hyperinflation. In other words, Iran’s hyperinflation is more a problem of balance of payment difficulties than the government spending and/or the overissue of domestic money.
In short, the major causes of inflation (and other economic problems) in Iran are structural, not monetary. These include both the structure of international trade, which was briefly discussed here, as well as that of the domestic economy, which could not be discussed in this brief study. (Most important among domestic structural problems are: stagnation of production, institutional paralysis, political uncertainty, economic mismanagement and widespread corruption, and the like.)
. Details of collaboration between the World Bank/IMF consultants and the economic advisors of President Rafsanjani will probably never be known, but there are strong indications that there was indeed such collaboration. One such indication is the fact that, starting in 1990, the Bank granted or facilitated credit to a number of government-sponsored projects in Iran. These included loans for irrigation improvements, flood control, earthquake relief, health, and drainage and sewer construction in Tehran. As a rule, the Bank grants or sponsors such loans only if the applying government accepts its conditions. Also, the Iranian government’s request of the IMF for credit approval and/or access to international capital markets in 1990-91 was approved on similar conditions: liberalizing foreign trade, privatizing much of the public sector, removing price controls and subsidies, tightening the money supply and credit, implementing wage and salary controls, raising interest rates and the like. See, for example, Kaveh Ehsani, “Tilt but don’s Spill: Iran’s Development and Reconstruction Dilemma,” Middle East Report, Vol. 24, No. 6 (November-December 1994), p. 18; K. Kakvand, “Roshd va Toufigh dar Barnameh-ye Aval-e?!” [Growth and Success of the First Plan?!]. Iran-e Farda, No. 10 (November-December 1993; Azar-Day 1372, Iranian calendar), p. 71..
. This assumption is not spelled out by the monetarists; it is made implicitly. Criticizing this assumption, and the quantity theory in general, as was formulated by David Ricardo, the grand mentor of Monetarists, Karl Marx wrote: “What should have been demonstrated was that the price of commodities or the value of gold depends on the amount of gold in circulation. The proof consists in postulating what has to be proved, i.e., that any quantity of the precious metal serving as money, regardless of its relation to its intrinsic value, must become a medium of circulation, or coin, and thus a token of value for the commodities in circulation regardless of the total amount of their value. In other words, this proof rests on disregarding all functions performed by money except its function as a medium of circulation” (A Contribution to the Critique of Political Economy. New York: International Publishers, 1976, P. 174).
. S. H. Samadi, Chegoonaghi-ye bazsazi-ye eghtesadi-ye alman-e federal (Economic reconstruction of the Federal Republic of Germany). Tehran: Tehran University Press, 1989; Athari, K. “Afsoon-e pool bavari va afsaneh-ye naghdinaghi dar Iran” (Monetarist Enchantment and the Myth of Liquidity in Iran), Iran-e Farda No. 11 (January-February 1994; Bahman-Isfand 1372, Iranian Calendar), p. 49.
. Iran Times, February 24, 1995, p. 11.
. K. Athari, 1994, p. 47.
. This is typical of the Monetarist intellectual tradition: ignoring (or camouflaging) what contradicts their theory while playing up what serves their purposes!
. M. Hudson, Trade, Development and Foreign Debt (London: Pluto Press, 1992), p. 319.
. D. Seers, “Inflation and Growth: the Heart of the Controversy,” in Werner Baer and Isaac Kerstenetzky (eds.), Inflation and Growth in Latin America (Homewood, Illinois: Richard D. Irwin, Inc., 1964), p. 89.
. Based on Bank Markazi (Central Bank) statistics as cited in Athari, 1994, p. 47; see also J. Amuzegar, Iran’s Economy Under The Islamic Republic (London & New York: I. B. Tauris & Co Ltd Publishers, 1993), pages 340, 348 and 357; Iran Times, February 3, 1995, p. 15.
. Depending on the source, unofficial rates vary significantly, but even the most conservatively estimated ones are much higher than the official rates. For example, while almost all unofficial accounts place the inflation rate for the year 1373 (1994-95) at three-digit figures, the Central Bank of Iran’s rate for this year is 60%. Even the 60% rate has not yet been declared publicly; it has leaked out through “Foreign economists…based on unpublished figures they had seen at Bank Markazi (Central Bank]), the Reuters said” (Iran Times, February 3, 1995, 15).
. The rush was further accelerated by the fact that the government let the importers know that the exchange rate would soon be unified and the rial would be drastically devalued–in effect, telling importers “import as much and as soon as possible because before long you will have to buy expensive foreign exchange”! (Athari, 1994, p. 48).
. While details and dimensions of scandalous deals related to foreign exchange and import policies of this period are not yet known, and may never be fully known, there is evidence that points to the occurrences of such deals. In fact the very policies that so irresponsibly promoted imports through foreign exchange and tariff subsidies, which led both to the stifling of the burgeoning domestic industries as well as the huge foreign debt, would have been considered scandalous in many countries with checks and balances on government policies. [see, e.g., Kayhan-e Havai, 21 December 1994, p. 32; Iran-e Farda, No. 11 (Bahman-Isfand 1372, Iranian calendar), p. 48; Arash, No. 38 (May 1994), pp. 7-8; The Wall Street Journal, 28 June 1994, p. A12; K. Kakvand, “Roshd va Toufigh dar Barnameh-ye Aval-e?!” (Growth and Success of the First Plan?!), Iran-e Farda No. 10 (November-December 1993; Azar-Day 1372, Iranian calendar), pp. 67-71].
. A. Keyani, “Roshd va Toufigh dar Barnameh-ye Aval-e Eghtesadi?!” (Growth and Success of the First Economic Plan?!). Iran-e Farda No. 9 (September-October 1993; Mehr-Aban 1372, Iranian calendar), p. 72.
. Despite the revolutionary chaos and the war economy, Iran had managed its economic needs without external borrowing until the inception of the “structural adjustment program.” Thus, it was considered quite creditworthy in the beginning of the adjustment program. This, coupled with the blessings of the World Bank and/or IMF, paved the way for the granting of a lot of external credit to Iran between 1989 and the early 1992.
. The Wall Street Journal, June28, 1994, p. A12.
. Statistics on Iran’s external debt vary significantly. The figure $30b. is cited here because it is the most frequently cited, and least disputed, figure. See, e.g., Resalat, 1371/10/14, Iranian calendar (01/04/1993, Western calendar); Athari, 1994, p. 44; Omeed, 1373/7/23, Iranian calendar (10/15/1994 Western calendar); Keyani, 1993, p. 71.