Law of Unintended Consequences: US Sanctions and Iran’s Hardliners

In the aftermath of the earthquake which devastated the Iranian city of Bam on December 26, 2003, and killed perhaps 41,000 people, many Americans were appalled to learn that they were technically barred from sending donations to Iranian-run relief efforts by unilateral US trade sanctions in place since 1996. Realizing the problem, the United States quickly relaxed some of the restrictions on US-Iranian transactions for a period of 90 days. To cope with the earthquake damage, Iran also accepted direct US aid for the first time in a quarter-century of hostility between the two countries. Coming on the heels of Iran’s signature of the Additional Protocol to the Nuclear Non-Proliferation Treaty and just before Iran’s move to resume full diplomatic ties with Egypt, a long-time US ally, the temporary relaxation of sanctions led some to hope for an emerging thaw in relations between Washington and Tehran.  

But important forces on both sides remain threatened by the prospect of constructive US-Iranian dialogue. On the Iranian side, factions within the conservative camp feel that a full opening to the West could undermine their grip upon political power. These forces rejected the proposed high-level US delegation including Sen. Elizabeth Dole (R-NC) and, in the conservative newspaper Keyhan, called the partial suspension of sanctions a "deceitful" gesture and criticized the government for accepting US humanitarian aid. On the American side, a group of Iranian expatriates around the son of the former Shah, coached by think tank conservatives and Congressional hawks, have effectively blocked all avenues of potential improvement in relations and helped to keep sanctions in place.  

Advocates of punitive economic policies toward Iran point toward the power of unelected anti-American ayatollahs in Iranian politics, and the apparent determination of these hardline conservatives to pursue weapons of mass destruction and continue bankrolling groups on the State Department’s terrorist list. But as dramatized by the Bam disaster and its political fallout, the US policy of isolating Iran through economic sanctions has not only failed to achieve its intended objectives, but has also prolonged the dominance of Iran’s hardliners at the expense of reformists and other democratic forces.  


US sanctions on Iran began on November 12, 1979, seven months after the revolution that overthrew the Shah, when Washington banned the import of Iranian oil. President Jimmy Carter followed up with an executive order in 1980 that froze all Iranian assets in the US. After the Algiers agreement in January 1981, these measures were revoked in the spirit of "normalization of relations between the United States and Iran." But in October 1987, President Ronald Reagan designated Iran as a state sponsor of terrorism, and by executive order imposed a more restrictive regime of trade sanctions blocking the import of all goods and services of Iranian origin. The Iran-Iraq Arms Non-Proliferation Act of October 1992 further restricted the export of missile technology, commercial arms sales, sales of dual-use items and nuclear technology, and provided for secondary sanctions against foreign countries that supplied the prohibited items to Iran or Iraq. This legislation, particularly its provision for secondary sanctions, became a model for the Iran-Libya Sanctions Act (ILSA) of 1996, the most comprehensive of the laws passed by Congress.  

A report published in 2000 by the Atlantic Council of the United States, a Washington think tank co-chaired by former National Security Adviser Brent Scowcroft, notes that "many of the US policies that are found troublesome by Iran can be traced to the Congress that took office in January 1995." In that year, prompted by Israeli allegations of an Iranian nuclear program, the American Israel Public Affairs Committee (AIPAC) circulated its recommendation for a comprehensive embargo on commerce with Iran. Shortly thereafter, Sen. Alphonse D’Amato (R-NY) introduced the Comprehensive Iran Sanctions Act, which was followed by the introduction of Iran Foreign Sanctions Act on March 15, 1995. Two months later, D’Amato’s bill was renamed as the Iran-Libya Sanctions Act. ILSA, still in effect, penalizes any American company that invests even a dollar in Iran. It further considers secondary penalties for any non-American company that invests more than $20 million in the Iranian oil industry. In October 1997, more moderate legislators introduced two bills that would have required the president to terminate all sanctions within two years of initiation unless they were reauthorized. These bills were co-sponsored by 38 percent of senators and 26 percent of House members, but strong opposition from Sen. Jesse Helms (R-NC) prevented them from coming to a floor vote. The Clinton administration did eventually lift some prohibitions on trade in agricultural products, carpets and handicrafts.  

After the fall of Saddam Hussein’s regime and the occupation of Iraq by US troops, the hawkish Congressional campaign against Iran was reinvigorated. In May 2003, Sen. Sam Brownback (R-KS), a long-time supporter of exiled Iranian opposition groups, including the front organization of the cultish Mojahedin-e Khalq, introduced a bill called the Iran Democracy Act which would declare US support for an "internationally monitored referendum" to achieve peaceful regime change. Brownback later told the press that top Pentagon officials backed funding for covert operations as part of the legislation, but the bill was not so amended and remains in committee. Tougher companion legislation in the House of Representatives, the Iran Freedom and Democracy Support Act sponsored by Rep. Brad Sherman (D-CA), was proposed in June. Sherman’s bill would roll back the Clinton administration’s partial trade allowances and discourage the World Bank from giving loans to Iran. The ILSA Enhancement and Compliance Act, yet another measure introduced by Rep. Ileana Ros-Lehtinen (R-FL) in October, would also tighten the existing sanctions.  


The effectiveness of economic sanctions as a tool of foreign policy, particularly when they are imposed upon authoritarian regimes, became increasingly controversial over the course of the 1990s. In December 1998, the Overseas Development Institute (London) held an international conference funded by Britain’s Department for International Development which produced a consensus of experts on the question: "Can Sanctions Be Smarter?" Among their other conclusions, the experts stated that unilateral sanctions such as US sanctions upon Iran do not work in today’s highly integrated global economy. The US has come under significant international pressure, particularly from its European allies, to reevaluate its trade embargo on Tehran. On May 18, 1998, the Clinton administration waived the application of secondary sanctions proscribed by ILSA when the European energy conglomerates Petronas, Gazprom and Total signed a contract with Iran for the development of the South Pars gas field.  

The divide between the US and almost all other industrialized nations over sanctions has allowed Iran to succeed in attracting foreign capital into its oil and gas industry. In the year 2000, the French company TotalFina/Elf wrapped up a $2 billion deal to develop the South Pars oil and gas fields, Royal Dutch/Shell scored an $800 million contract to develop the Soroush and Nowrooz offshore oilfields, ENI-Agip acquired a 38 percent share in the Balal fields and Norway’s Statoil signed a series of agreements with the National Iranian Oil Company to explore for oil in the Strait of Hormuz. In late 2001 and early 2002, Shell brought part of the $1.1 billion Soroush-Nowrooz development online. More recently, a consortium of three Japanese companies bought a 20 percent share in the Soroush-Nowrooz project. Russia’s Lukoil indicated that it had received approval to prospect along the border with Iraq in September 2003. From 1995 to mid-1999, Iran attracted about $5 billion of investment in the form of joint ventures and buyback contracts in the oil and gas companies. According to the Middle East Economic Digest, the country is expected to lure an additional $20 billion to its petrochemicals industry by 2013.  

Iran’s recent progress in acquiring nuclear technology is another example of ILSA’s failure on its own terms. Indeed, without the diplomatic intervention of the European Union, Iran probably would not have signed the Additional Protocol that calls for full inspection of known nuclear sites. Iranian hardliners’ continued support for the Lebanese Shiite group Hizballah and the Palestinian militant group Hamas, and their hesitancy in extraditing suspected members of al-Qaeda who are reportedly detained in Iran, are further testament to ILSA’s limited accomplishments in realizing its stated objective of containing the extremist activities of the conservative leadership in Iran.  


In addition to failing on their own terms, US sanctions on Iran have two main sets of unintended consequences: direct and indirect costs to the American economy, and extension of an economic lifeline to the hardliners at the expense of the rest of the population.  

As non-American oil companies penetrate the Iranian market, there are significant economic losses to the US because of the lack of bilateral trade. One can roughly estimate the scale of these losses by combining the gross domestic products of Iran’s five main trading partners in 2002, Germany, France, Italy, China and South Korea. Calculated on the basis of purchasing power parity, together these GDPs amounted to over $12 trillion, about 15 percent more than the 2002 GDP of the United States. Iran’s imports from its five largest trading partners added up to nearly $4.3 billion in 1999-2000. Though disaggregated figures are not yet available for 2002, Iran’s total imports in that year rose from almost $12.7 billion in 1999-2000 to almost $21.2 billion in 2002-2003, according to the Central Bank of Iran’s latest data. If one assumes that the largest trading partners’ percentage shares did not change, then they exported over $7.1 billion of goods and services to Iran in 2002-2003. If one further assumes that Iran would have imported a similar dollar amount, as a percentage of GDP from the US, then the US is foregoing $6.2 billion dollars in exports per annum by maintaining trade restrictions. This extrapolated figure seems reasonable, given that the US did in fact export $747 million of goods and services to Iran in 1992, prior to passage of ILSA. After ratification of ILSA, the volume dropped to almost zero, though US exports to Iran have recently started to go up again, topping $93 million for the first eleven months of 2003.  

The burden of lost exports to Iran has fallen mainly on the wheat producers of midwestern states, aircraft manufacturers such as Boeing and McDonnell-Douglas, power generation companies such as General Electric and Westinghouse, and banks and insurance companies. Before the 1979 revolution, the US was Iran’s largest supplier of wheat to Iran, sending more than 1.8 million tons a year. In 2001, a year of drought, Iran became the largest wheat importer in the world by bringing in 7 million tons of wheat valued at over $1.5 billion. But by this time Iran had replaced its main supplier of the grain, the US, with Argentina, Canada and Australia. The hardliners, in spite of intense demand for American wheat from owners and managers of flour mills, continued to block the purchase of wheat from the US even after the Clinton administration allowed its export, because the issue is highly charged politically. On Washington’s side, ILSA has also blocked financing of wheat exports to Iran by American financial institutions.  


As for their effect on Iranian politics, US sanctions have not only left the anti-Western policies and sentiments of the powerful conservative minority intact, but have themselves become a potent weapon against the democratic forces that are struggling to blossom within Iranian society. Furthermore, the embargo gives the hardline clerics a ready scapegoat for their own economic mismanagement, which began well before the 1997 elections ushered reformist leader Mohammad Khatami into the presidency. With or without sanctions, the conservatives will continue to pursue their present course against opening to the West, not only because of their deeply rooted anti-modernist interpretations of Islam, but also because of their vested interest in keeping control over monopolies in the economy.  

The direct political impact of US sanctions on Iran boils down to the fact that by retarding the growth of the private sector and competition, the disproportionately large public sector, kept afloat by state subsidies, will continue to prevail in the economy. The industrial sector, for instance, is dominated by over 1,100 nationalized industries that produce over 60 percent of the total value added in this sector. In Iran, extensive involvement of the regime in direct production has distorted prices and conspired to cheat consumers. For example, the price of a Samand, an 80 percent locally manufactured car that hardly matches foreign-made cars of the early 1970s in quality, was over $17,300 until recently. Iranian consumers could have bought a brand new Toyota Camry or Nissan Maxima for that amount if the Japanese car was directly imported. But the government, under pressure from corrupt interest groups, did not allow the private sector to import foreign cars. This meant that the Iranian consumer had to pay over $48,000 to purchase a locally assembled Nissan Maxima. Only after recent economic reforms did the regime permit private import of cars — with hefty 170 percent import duties.  

Economic gains resulting from this price distortion have mainly benefited the ruling conservatives, who directly or indirectly have a claim on any activity that involves large profits. It is a common understanding among the business community that, without paying kickbacks to local or national political figures or government administrators, there is little chance of establishing a profitable large-scale enterprise. In the absence of competition, rent-seeking activities, speculation, bribery, monopolistic pricing and nepotism have thrived. Government subsidies for gasoline and food have been another major source of super-profits for the economic elites and their conservative allies. Because one needs special privileges to obtain permits in order to purchase, process, distribute and market the subsidized commodities, there are many hands who illegally take a share of these transactions. According to Mohammad Hossein Adib, an Iranian economist, in 2002 special permits to import rice were sold in the black market at 1,000 rials per kilogram. A permit to import 100 tons of rice would have been sold at 100 million rials, or over $12,500.  

A significant percentage of public-sector economic activities are controlled by shadowy semi-public "revolutionary organizations" such as the Mostazafan Foundation. While the scope of these organizations’ power has been exaggerated in the West, nonetheless they constitute a major economic power base for the conservatives, who use some of their proceeds to further political agendas. According to its director, the book value of the Mostazafan Foundation was about $2.1 billion in 2000-2001. Assuming an 80 percent increase in value over the last two years, and adjusting for inflation, a conservative estimate of the current market value of the Foundation’s assets is about $4.4 billion. According to the same source, the Foundation’s exports amount to $180 million a year, most of which is in construction of roads, bridges, ports and refineries, as well as technical assistance, engineering and design. These foundations have certainly benefited from closed-door policies and lack of competition in the economy.  

The impact of 20 years of US sanctions therefore has not been borne by their ostensible targets, that is, the conservative clerics and their allies among the managers of public-sector enterprises or the owners of the various private monopolies in Iran. The sanctions have not made a dent in the financial aid such players send to groups like Hizballah or Hamas. The Revolutionary Guards and the security apparatus of the regime have not suffered from the embargo either, as the Iranian military relies heavily on vast numbers of readily available conscripts who, in the absence of jobs, have had little choice but to spend years away from their families. There is no doubt that sanctions, combined with the US policy of actively opposing Iranian membership in the World Trade Organization and Iran’s attempts to obtain major foreign loans, have all impeded the pace of economic recovery and technological advancement. These impediments to growth have generally come at the expense of the Iranian populace and their struggle against clerical rule.  


Upon resumption of economic relations with the US, and on the back of major market liberalization reforms, one could expect a more rapid and equitable pattern of economic growth that would better benefit the middle classes and the deprived segments of the population. Indeed, research published by Mahmood Tavassoli in the Iranian Journal of Trade Studies in 1999 indicates that for every percentage point of increase in the rate of exports growth, the rate of growth of GDP increases by 0.16 percent. In order to roughly gauge the impact of the resumption of exports to the US, one can use the 1987 estimate of the US Census Bureau that Iranian exports to the US reached a post-revolutionary high of $1.67 billion in 1987. Assuming that everything else remains constant and that this amount did not come at the cost of decreased Iranian exports to other countries in that year, it would appear that had Iran exported an equal amount to the US in 1999, the rates of growth for 2000 and 2001 would have increased by 0.64 and 2.08 percent, respectively. These are significant numbers indeed.  

Khatami’s government and its allies in Parliament have been able to carry out serious market liberalization reforms that have consolidated the institutional basis of a more open and competitive economy. Among these reforms are the unification of the foreign exchange system, the creation of an oil reserve fund, passage of the New Foreign Investment Law, reform of the fraud and bankruptcy laws, the opening of pilot private banks, issuance of private bonds with flexible interest rates, mandatory taxation of the revolutionary organizations, introduction of a value-added taxation system, substitution of import quotas and licensing with tariffs, revitalization of the Tehran Exchange Market, the creation of exchange markets for metals and agricultural products, privatization through stock offering of the nationalized industries and privatization of the communication industry, to name a few.  

Combined with sustained high oil revenues, Khatami’s reforms have recently helped to strengthen the Iranian economy. For example, there has been a significant increase in the volume of non-oil exports, which reached $6 billion in 2003. This rate of growth has been accompanied by notable progress in technological know-how and quality in such areas of domestic production as shipbuilding, high-rise buildings and automobile manufacturing. There are signs of more fiscal discipline as the tax revenues showed a 24 percent increase during the last fiscal year. On the employment front, for the first time in seven years, the rate of unemployment was lowered. US sanctions and other measures designed to prevent Iran from joining the global economy have not prevented this growth, but were they absent, it is safe to assume that the growth would be greater. Meanwhile, only the hardliners benefit from the widespread resentment of the embargo among ordinary Iranians.  

The mass disqualification of reformist candidates in Iran’s upcoming parliamentary elections by the conservative-controlled Council of Guardians is a prime example of the hardliners’ opposition to the democratic process. The US and the European Union have correctly condemned this maneuver, which has been only very slightly reversed so far. However, if after inclusive and fair elections, a new parliament is voted into office, the Bush administration and the Congressional hawks should have a closer look at the merits of the ILSA sanctions regime, and revise their ideas about what policies might offer a boost to the democratic aspirations of the Iranian people.