Special Report

2009 Failed States Index - Trouble in Tehran

Trouble in Tehran

Iran jumped 11 ranks in the Failed States Index this year. What went wrong?

BY DJAVID SALEHI-ISFAHANI

When the U.N. Security Council slapped a third round of sanctions on Iran for its nuclear program in March 2008, the country's economy, bolstered by record crude prices, still looked set to roar. Oil revenues had helped Iran grow at a healthy 6.9 percent clip during the previous year. Even poverty levels were down, according to the World Bank. So how could the country jump 11 ranks in the Failed States Index this year?

The index correctly penalizes Iran for macroeconomic mismanagement. Inflation doubled in annual terms from 15 to 30 percent in 2008 after President Mahmoud Ahmadinejad boosted social spending to "bring the oil money to people's dinner tables." As demand expanded, prices for nontraded goods such as housing rose sharply, squeezing the poor and the middle class. A flood of cheap imports kept inflation from going even higher, but jobs were lost as imports undercut local industries. The central bank restricted credit sharply to reduce inflation, hurting businesses further and putting more people out of work. Inflation did come down to below 20 percent by December, but unemployment probably increased. Iran's jobless rate hovers around 12 percent, with three out of four unemployed Iranians under age 30.

Festering discontent about inequality helped inspire Ahmadinejad's drive to redistribute the oil cash. But on this score, the results were also disappointing. Between 2005 and 2007, the income of the top 20 percent rose more than four times as fast as that of the bottom quintile. The influx of oil revenues, which trickle down Iran's unequal structure of access to power and position, always seems to worsen the distribution of income.

But Iran's economic weakness should not be exaggerated. The Failed States Index, for instance, too harshly critiques Iran for deficit spending and price controls. The government's 2008 budget was tied to a predicted oil price of $39.70 a barrel, far lower than the actual price for much of the year—meaning that "deficit spending" was probably well paid for. And though Iran began to limit purchases of subsidized gasoline, plenty of fuel was available at a higher—but still well below market—price. Finally, any rise in poverty will be cushioned by Iran's free education system, universal basic health insurance, and income assistance.

What the index claims happened in 2008, however, may already be occurring in 2009. Much lower oil prices will cause a massive deficit. If the government tries to keep up its expenditures, inflation will return with near certainty. If the government gives in to the temptation to control key prices, the exchange rate, or interest rates, it would hurt exports. Unless a new administration reverses some of the worst policies of recent years, it is unlikely that the private sector will revive in time to help the economy this year.

Djavad Salehi-Isfahani is professor of economics at Virginia Tech.

Photo: BEHROUZ MEHRI/AFP/Getty Images

Special Report

2009 Failed States Index - The Whiplash Effect

The Whiplash Effect

The ups and downs of 2008 took their greatest toll on the weakest states.

BY HOMI KHARAS

It was only a matter of time before the global financial crisis—now ravishing developed economies—hit the world’s poorest. In April, the World Bank predicted that 50 million people could be driven into poverty in coming months. But the point of impact won't be high-powered modern finance so much as old-fashioned commodities, just like in 2008. During the first half of last year, commodity prices jumped off the charts, rendering food and other necessities unaffordable. Then, beginning in the third quarter of 2008, many major commodities, including crude oil, aluminum, copper, nickel, and corn, took a nose dive, with the largest price decreases in percentage terms since 1970. The whiplash in prices left failed states reeling, and it might not be over yet.

Before 2008, the world's fragile states were already precariously dependent on commodities. Some, like Sudan, are vulnerable because they have commodities to export, encouraging a corrosive pattern of bribery, corruption, and rent-seeking that rewards those in power. Others, like Bangladesh, are fragile because they lack commodities and must import food, oil, and minerals for the population at market prices. With weak institutions unable to cushion the blow, such states suffer tremendously from commodity-driven booms and busts.

For the exporting countries, early 2008 brought high revenues as commodity prices spiked. Oil and gas producers such as Azerbaijan, Nigeria, Turkmenistan, and Yemen enjoyed double-digit income gains. Food producers, like Burundi and Sierra Leone, also did well. Populist governments in Bolivia and Iran rapidly expanded social spending.

The party came to a painful end when oil prices collapsed; many producer countries faced massive budget shortfalls, and 2009 looks just as tough. Twenty fragile states (out of the 56 for which data exist) are likely to suffer declines in real per capita income through 2010 as a result of the global recession and commodity price declines. Oil-rich Equatorial Guinea and Nigeria could see drops of 13.5 percent and 9.5 percent, respectively.

Major commodity importers such as Bangladesh, Ethiopia, and Pakistan felt a pinch even before 2008 began. Some, including Pakistan, felt compelled to go hat in hand to the IMF. Luckily, the other side of the whiplash brought the economy back from the brink. Pakistan lost 1.8 percent of GDP from higher import prices in 2008, but in 2009, it stands to gain 2.4 percent of GDP in purchasing power, an amount that will allow the economy to expand 2.5 percent in real terms. Absent lower crude oil prices, Pakistan—and others like it—would be having a much rougher 2009.

The whiplash effect matters to failed states not just for their bottom lines. The connection between economic instability and political turmoil is real. Economist Paul Collier estimates that the risk of conflict goes up 1 percentage point for each percentage-point decline in economic growth rates. Countries that were stable thanks to commodity windfalls in 2007 and 2008 will become less stable, while importing countries will become more stable.

This is good news for strategically important countries such as Afghanistan and Pakistan, where global price changes will add an extra boost just as new U.S. policies are kicking in. Iran, now facing revenue shortfalls, might be more accommodating to dialogue as its economy weakens and discontent simmers. One notable exception is West Africa, where an oil-dependent and increasingly unstable Nigeria could spread its contagion. We'll be treating these future whiplash victims for months to come.

Homi Kharas is senior fellow at the Brookings Institution.