Tracing the Sources of Sluggish Local Production

EghtesadOnline: Misguided forex policies, lack of commercial and financial ties with the world, ineffective system of local businesses and decades-long unhealthy macroeconomic environment are the main factors sapping the strength of the domestic production sector.

News ID: ۷۸۲۳۰۶

10 April 2018

The above statement was made by Special Presidential Aide for Economic Affairs Masoud Nili in an article published by Iran Chamber of Commerce, Industries, Mines and Agriculture. According to Financial Tribune, excerpts from the article follow:

Iranian officials have always promoted, in good faith, the idea of supporting local production and curtailing imports. There were periods of time when there were no imports, except for products that the country was unable to produce within its borders. Cheap energy and water, zero-interest loans and guaranteed local market without any foreign rivals were concessions made by policymakers for local producers.

How have these policies shaped Iran’s economy and where does the country stand now in comparison to other economies?

Unwavering support is being provided for domestic production. As exports are mostly raw materials while the country is the importer of the items made by the same raw materials, Iran’s economy is facing a rare phenomenon called smuggling of consumer goods, including home appliances and clothing whereas in other countries the term “smuggling” is restricted to illegal transportation of weapons, drugs and human beings.

By and large, poor quality and pricier Iranian products compared to those of foreign rivals are the main reasons behind the unappealing local products and the current sad state of domestic manufacturing.

> Forex Policies

Forex policies over the past four decades were always designed with no regard for inflation. When resources allowed, currency rates were kept fixed for certain periods of time, only to be followed by sudden bouts of sharp increases.

Such a regulation of forex market only fuels the flames of instability. Had we taken the different course of gradual rate hikes, the results would have been totally different today.

The best service that could be provided for foreign manufacturers and the worst harm that could be inflicted on local producers are to hold the foreign exchange prices steady against a rising inflation rate.

Higher inflation is synonymous with price growth at home, but when you keep forex rates unchanged, you are keeping the prices of foreign-made goods unchanged as well, given the fact that inflation rates of Iran’s trading partners are close to zero.

Costlier local production naturally makes it less competitive than foreign production. Iranian consumers tend to choose cheaper imported goods of better quality and that makes production economically unviable, threatening the factories with closure and workers with unemployment.

Under the circumstances, decision-makers of the country dutifully follow currency stability policy and also stress the importance of lending support to local producers. They tend to impose high tariffs on imports to ease the concerns of local producers while reinforcing the motives of people to bring in goods illegally.

Such policies are to blame for practices such as smuggling by cross-border couriers, referred to as kulbaran in Kurdish.

Border couriers are people of mainly Kurdish-dominated provinces of West Azarbaijan, Kermanshah and Kurdestan who carry contraband on their backs through mountainous areas to earn their livelihood. They usually carry the goods from areas bordering Iraq and Turkey to the nearest villages in Iran and from there the goods are transported to cities by road.

In an ideal economy, Iranian border couriers could have been skilled workers of factories that manufacture the same items they smuggle into the country. As such, the insistence on following wrong policies invigorates smuggling.

Likewise, the right to duty-free imports when the tariff rates are high becomes a trump card only a select few can hold. These special interest groups become ardent advocates of currency stability policy.

> Trade Relations

Over the past 15 years, Iran's annual imports ranged between $30 billion and $85 billion, of which around 85% were intermediate and capital goods. It is surprising that a large share of Iran’s trade with the world is not recorded under a long-term contract and there is no organized connection with trading partners with regard to wholesale or after-sales services.

A bigger fraction of consumer goods enter the country unofficially and ultimately in the retail sector, therefore the consumer cannot enjoy the most rudimental rights of after-sales services.

Such a situation does not give a clear idea of global competition to local producers. Industrial goods enter the country at different prices and this denies domestic producers the opportunity of making an accurate comparison.

> Inefficient Large-Caps

There is no doubt that local production is pricy. Studies show only about 3% of Iranian economic enterprises are large-cap companies, accounting for 70% of all industrial goods produced inside the country.

The overall productivity of manufacturing has a negative correlation with the size of the enterprises, suggesting that the bigger a business, the lesser its productivity.

The ownership structure of major economic entities in Iran is strongly intertwined with politics. The number of employees of a public enterprise is far from the optimal standards. The directors of these economic entities are appointed based on political criteria. When it comes to pricing of products, political expediencies play different roles.

In short, the structure of economic enterprises in Iran has become more politicized, particularly after the implementation of Article 44 of the Iranian Constitution and the whole thing has affected the competitiveness of large-cap companies’ products negatively.

> Macro Environment

The macro-financial environment of the country, including trends in inflation, forex market, interest rates, budget volume, taxation system and monetary policies, has not been healthy over the past decades.

Transaction costs are greater in an unfavorable macro environment. When a business fails to make predictions about the economy and international relations, it would hoard raw materials more than it requires.

Investment declines when uncertainty rises. An unfavorable macro environment adversely affects production, increases transaction costs and erodes competitiveness of local products.