The policy change on bank deposit rates is significant, both because of its magnitude — banks are free to offer deposit rates as high as they want — and because of the lesson it entails.  When President Ahmadinejad took office in 2005, he promised to lower both the interest rate and the exchange rate.  Seven years later, he has to live with higher rates for both.  The lesson to be learned from this fiasco is that a bit of economic logic can go a long way.  Ideologists inside and outside the government who view markets with suspicion and confuse understanding and respecting how markets work with defending neo-liberal and free-market policies, do themselves and the nation disservice.   In this particular case, the simple logic of markets says that you cannot control both the rate of interest and the exchange rate: if depositors cannot at least maintain the value of their money while it sits at the bank, among other things, they will turn to foreign currency, putting pressure on the exchange rate.

How have Iranian banks been rewarding depositors lately? If you put 100 rials in the bank ten years ago, today you would have 370 rials, which is worth only 91 rials because of inflation.  The real rate of interest on one-year bank deposits (nominal interest rate minus the rate of inflation) has been negative in 7 out of the last 10 years.  Real rates have averaged -1.7% per year for the period, and, significantly, reached minus 10% in 2011 (see the graph below).

It is not clear that the sharp negative turn in interest rates is responsible for the sudden collapse of the rial this month.  As inflation picked up in 2007, causing real interest rates to plummet, money first moved into real estate, which was already hot because of the oil boom, causing a housing bubble.  When the bubble burst, in 2008, people started looking for other stores of value, mainly gold and the dollar, pushing up their prices gradually.  The higher deposit rates will solve this part of the problem because they will attract money away from these risky and volatile assets into banks, but the larger problem, the sudden increase in the prices of gold and foreign exchange, is harder to solve.   This is because, in times of a crisis such as Iran finds itself in, bank deposits are not good substitutes for gold and foreign cash.

As I noted in my previous post, the latest crisis is caused in large part by the harsh US and EU sanctions that prevent not just ordinary traders but also Iran’s Central Bank from moving money around.  If sanctions worsen, as most people seem to expect, money in the local bank is of little use for paying for critical imports or for education or medical care abroad, no matter what the interest rate.  It is quite telling that the run on the rial started when the US sanctions against Iran’s Central Bank passed the Congress with near unanimity last December.  Once sanctions become law they are very hard to remove (the sanctions against Iraq were only removed in 2009).

An Iranian official said recently that the sanctions are good for Iran.  I am not sure if using the international financial system for  political reasons, as the US and EU have done, is good for anyone.  But we know of one good thing that the sanctions have done already — encourage more sound economic policy in Iran.

Financial sanctions against Iran, which intensified this week with the signing into law of the latest bill by President Obama extending them to transactions with Iran’s Central Bank, essentially create a segmented market for foreign exchange in Iran.  One market is for foreign currencies held in various accounts belonging to Iranian banks, and the other is for foreign currency notes or paper money.  Because of the sanctions, there is demand for paper money for certain transactions for which dollars or euros in foreign banks are of little use.  Iran has reportedly about $80 billion in bank accounts around the world, which it cannot easily spend.  So, for most transactions people are forced to buy paper currency in the Tehran market, or buy it in Dubai and have it shipped in.  For example, to send money to your daughter in Malaysia, these days you have to find a trustworthy traveler to take it for you because the Central Bank cannot make the transfer. So much for smart sanctions.

This market is relatively small, however, so its price can fluctuate rapidly.  Some of the increase in the value of foreign currencies reported in recent weeks is probably of this kind, reflecting the tightening of sanctions. As more people in need of dollars enter this market — manufacturers in need of imported parts, parents needing to send money to their children studying abroad — the price can shoot up quickly.

So, the two-tier exchange rate system that has recently emerged is in part the result of sanctions, not Iranian government policy.  It is therefore not to be confused with the policy-induced multiple exchange rate system that existed before 2000-2001.   At least a part of the current gap between the official and the free market rate is because there are two types of foreign currencies, paper money and electronic bank accounts. The government has little control over this gap, unless it can find a way to bypass the sanctions and enable Iranian importers to use its holdings of foreign currency.  We do not know what the equilibrium exchange would be if sanctions did not exist because we do not know the size of the market for paper currency.

The second reason why it is difficult to determine the right exchange rate lies at the heart of Iran’s oil-based economy.  Roughly speaking, and ignoring capital accounts, in a normal economy the exchange rate reflects two productivities, the productivity of workers producing for exports at home relative to the productivity of workers in countries from which imports originate.  Since in a balanced economy productivity in the export sector is close to the average level of productivity in the economy, the exchange rate reflects relative productivity levels in the two countries.  So, if in one country demand for imported goods expands in line with increase in productivity, its currency need not depreciate; higher productivity would help pay for the additional imports because it would make the country’s exports more competitive.

But if exports are mostly oil or oil related products, this mechanism would fail to work.  (Iran’s non-oil related exports amount to less than 5% of total exports.)  The oil sector produces a lot of value with relatively few workers, as if these workers were much more productive than their fellow workers in the rest of the economy.  But “productivity” in the  oil and oil-related sectors such as petrochemical depends on the price of oil and on how much the government decides to extract from its reserves, two variables that have nothing to do with average productivity.   The world price of oil is beyond government’s control, but how much it decides to extract (or more precisely how much of its oil revenues it decides to inject into the economy) does affect the exchange rate.  The fact that governments of oil-exporting countries can influence the equilibrium exchange rate by merely selling more oil suggests that the textbook case of supply and demand is not all that relevant.  The market for foreign exchange is dominated by a monopolist –the government — which has to decide on its oil exports and the exchange rate simultanously.

I do not know how one would go about finding the optimal level at which the government should set the exchange rate (by extracting more or less oil or by brining more or less of the oil money into the economy).  But I do not need to know the optimal rate to know that, until a few weeks ago,  Iran’s currency was highly overvalued.  The oil boom of the last decade that brought $80-$100 billions a year in oil revenues prevented the rial from falling in value despite rising inflation in Iran.  As a result, imports became increasingly cheap, undermining domestic production.

The figure below shows that while Iran’s price level was rising fast (the line in green) its exchange rate remained rather steady (red), causing the real effective exchange rate (EER, in blue) to increase; that is, Iran’s currency appreciated relative to the currencies of its main trading partners.  Iran’s consumer price index more than doubled during 2005-2010 while the rial lost less than 15% of its value, causing the EER to increase by 50%.   If we take these numbers as our main guide for deciding how far is too far for the rial to fall, 50% would be about right.  This simple analysis then suggests a band between 15,000-16,000 rials per dollar.

This adjustment is long overdue and the impact of the real appreciation of the rial on the real economy has been quite severe.  Because Iran’s economy is rigid and workers move slowly between sectors, the shock to the tradable sectors has caused loss of output and increased unemployment in tradable sectors, such as textiles.  If the oil boom hurt Iran’s tradable sectors, can sanctions do the opposite by protecting domestic production from foreign competition?  The answer is yes and no.  Yes, because as Iran finds it increasingly difficult to pay for imports using its oil money deposited in foreign banks, and has to resort to barter and other special arrangements for tis import, domestic production will gain shelter from foreign competition.  No, because much of domestic production depends on imports of intermediate goods, which will be also cut as a result of tougher trade conditions.

The fall in rial is just one part of this process of adjustment.  As it falls it sets both forces into motion: the good (more protection) and the bad (costly inputs for industry and agriculture).  To answer the question that I posed at the outset for this post more accurately  – has rial fallen too much? – requires knowing which of these two factors is stronger.

It is not as if Iranians are living in calm times.  There are threats of war, deepening of sanctions, and very strange behavior from the monetary authorities to contend with.  The Central Bank governor, Mr. Bahmani, was recently quoted as saying that he had “ordered” the reduction in prices of gold and foreign currency.  Before ordering so he had engaged in selling the same things cheap in order to lower their market price.  It does not take a genius to figure out that if the Bank is selling from a limited stock, every day selling diminishes its stock and therefore its ability to continue.  After weeks of fighting the speculative windmill, the Central Bank governor sounded a serious tone by acknowledging that with low real rates of interest (that is nominal rates some 10 points below the rate of inflation), it is very difficult to restrain asset price increases.

There is method in the madness of the rial gyrations.  The instability in Tehran’s foreign currency market is in part the result of past inflation that has gradually pushed rials out of alignment with other currencies.  Iran’s price level has jumped by about 50% in the last two years (despite price controls during the last 12 months) while the currency hovered around 10,000 rials per dollar.  This has made foreign goods cheap in the Iranian market and Iranian goods uncompetitive at home and abroad.  Local businesses were suffering from real appreciation (caused and financed by rising oil money) even before subsidy reform added fuel to the fire by raising inflation.   Parity between rial and foreign currencies is thus long overdue.  So a 50% devaluation, which has occurred with the dollar hitting the 15,000 mark, a previous wrong has been put right.

The subsidy reform was expected to worsen this imbalance in the short run by increasing inflation.  However, in the long run it can help.  Higher energy prices should encourage producers to adopt technologies that use less energy and more physical and human capital, which would boost productivity.  The cure for the worsening of the competitive disadvantage of Iranian producers as a result of higher energy prices is depreciation of the rial, provided that it takes place in an orderly fashion and does not add to uncertainty and macroeconomic instability.   The vents of the past few weeks have been anything but orderly.

The subsidy reform has survived its first year, and in a better shape than its critics were willing to admit.  Of all the programs introduced by the Ahmadinejad administration — marriage loans, quick returns projects, and low cost housing — this is the one that is most likely to outlast him and for which his administration will be remembered, at par with the reforms of the first Rafsanjani administration (1989-1993).  The latter hit the foreign exchange crisis of 1993-94 that forced President Rafsanjani to abandon his programs of economic reform during its second term.  Luckily, Khatami’s administration that followed (1997-2005) picked up the reforms where they had been left off, especially the reforms of the foreign exchange markets, banking. and foreign trade.

Saving the subsidy reform from the current turmoil should be easier because this time oil prices are high and at least this time the government is not broke.  But reliable information is in much shorter supply.  Governments tend to fight speculation by suppressing information or — worse — by supplying misinformation.  These tactics do not work well when investors are sophisticated and information flows fast.  Speculative bubbles are by definition the creation of bad information, rumors backed by no reliable data other than asset prices themselves.  While it is not at all clear to me that asset prices in Iran represent bubbles, or otherwise are unhinged from market fundamentals, I am willing to bet that reliable information about those fundamentals would calm the markets by reducing uncertainty rather than make them more unstable.  I also know that selling assets cheap or ordering their prices to go down is not what inspired confidence.

The government needs to come clean on the facts about the economy (publication of crucial data goes back to three  years ago), how external sanctions are affecting the economy and what it plans to do about them.  In terms of actions, unfortunately the government does not have all the cards; it has to contend with the parliament and other important players.  For example, even if it wanted to, it cannot decide on its own to raise the rate of return on bank deposits, something logical to do if interest rates are at record negative rates (minus 10%) and people are rushing to buy gold.  And then, if it did that, it would need to improve the business environment so that the funds that are redirected to banks can find their way into productive investments.  Interestingly, in this regard it is worth noting that the parliament is about to pass a bill, called behbood fazaye kasb o kar (improving business environment), that is surrounded by controversy and some in the private sector even claim they have not seen but are up in arms about.  The list of things to do is long and the place to start — increase transparency — is clear, but unfortunately, as always, not all policy actors are reading from the same script.

I reproduce below the old graph, which was for 2005 and used $PPP incomes, and a new one, which is for 2008 and uses the same base.  The picture for 2008, as Branko would hasten to add, is not yet complete.  So far he has 88 countries in his sample, but plans to increase it to 125.  He does have all the important ones, including China and India, so the new results are definitely worth a look.

Let me first explain what these graphs tell us.  Consider putting together the populations of all countries of the world, the entire 7 billion people into one giant bin arranged by their income or expenditure per day.  The place of each person in this global distribution is marked on the vertical axis.  The horizontal axis measures the position of the same person in her own country’s distribution.  So, for examples, in 2005 Figure 1a shows that the poorest person in the US was at the 60th percentile of the world distribution, the poorest person in Germany at roughly the 78th percentile, and the median person in Iran at about the 75th percentile, and so on.

In 2008 (Figure 1b), the poor in both Germany and the US were doing relatively worse than in 2005, perhaps because of the financial collapse and the Great Recession that started about then. The poorest person in the US had moved down the global income distribution to about the 55th percentile, from 60th.  Moving up were all the developing countries listed in this graph, including Iran and Egypt (Brazil, China and India are not shown in the 2005 graph, but you can look them up in his latest book, The Haves and Have-Nots, Basic Books, 2010).

The interesting feature of the change in Iran’s position is that it appears to have mainly resulted from increase in incomes of Iranians above their nation’s median income.  While the person with median income in Iran has stayed around the 75% percentile, those at the top 10% appear to have moved up quite a bit, joining the world elite at the top 1%.  In 2005 there were no Iranians at the very top, but by 2008 some had secured enviable positions at the top 1% of the world distribution, in good company with the richest Germans,  Americans, and Brazilians.

Figure 1a. The world distribution of income, 2005

Figure 1b. The world distribution of income, 2008

Figure 1b also shows, for 2008, the position of the two fastest growing economies of world, China and India.  There are super rich people in these countries that belong to the top 1%, but they are not included in their income and expenditure surveys because, as all surveys, they have poor coverage of the very top incomes.  As a result, the curves for these countries stay below the 95th percentile.

The difference between living standards in China and India seems more striking in this graph than in GDP per capita.  China’s GDP per capita is about 3 times that of India (and one-fourth of Iran’s).  The distributions here show that, thanks to rapid economic growth in the last two decades, in China a relatively large middle class has emerged (defined loosely as people above the 75th percentile line of the global income distribution).   India’s global middle class is by comparison very small as a proportion of its population, though it is large in absolute numbers.  Brazil is more of a middle class nation than either China or India, with about half of its population with incomes above the 75th percentile.

Iran has an even larger middle class in relative terms, but to be accurate I should note that Iran’s middle class is more a product of rising consumption made possible by rising oil income than rising productivity.   In Brazil, joining the ranks of the global middle class means being as productive as a person in China or Germany with similar income and status, whereas in Iran (and other oil rich nations) it does not mean that at all.  This is why comparisons that some people in Iran make between Iran and with the much (oil) richer countries of the Persian Gulf is so misleading.  The real criterion for international comparisons is productivity, not GDP per capita which includes oil rents (even with the PPP correction).

I believe in some sort of folk theorem of economic and social development, according to which only a productive middle class can play its historic role of reorganizing society in ways that enables its people to live productive lives; that is, building democratic institutions, the rule of law, and so on.   When the rise of the middle class is from the fruits of other people’s labor and human capital, as reflected in higher demand (and therefore price) for oil, which has lately been the case for Iran, it does not have the same effect.  But that is a long story and for another post!

Before I get to the numbers, let me explain why the reported unemployment rate of 11.1% is hard to believe, and why the hasty questioning of the survey itself is misguided.

Although systematic GDP data are still lacking, it is no secret that, if growing at all, the economy is growing at half or a third of the rate it used to grow just a couple of years ago.  A decline of 2.5 percentage points in the unemployment rate one year in means that last year about 600,000 more jobs were created than new workers entered the labor market (estimated at about 800,000 per year).  That is 1.4 million new jobs.   (A similar calculation probably lies behind the government claim of 1.6 million new jobs reported in the news).  When the economy was growing at 6% per year, it  generated half as many jobs per year.  How can it produce 1.4-1.6 million jobs when it is stagnating?

The answer that seems most appealing these days is that the numbers are cooked.  It is commonplace for reporters to question Iran’s official data and for experts to claim that the unemployment numbers are twice what the government reports.  What is new this time is that the accusation of data manipulation came from a former SCI number 2 official, Mr. Khalil Saidi, claiming that the Ahmadinejad administration routinely questioned unfavorable numbers and on occasion ordered them changed.

This charge comes at a bad time for SCI, having already risked its reputation as an independent data collector (under the watch of the same official) by getting involved in the cash transfer program, which is part of the 2010 subsidy reform.  An institution charged to collect data under strict confidentiality rules for the purpose of generating information on average Iranians entered the political fray by helping the government identify individuals to see if they deserved to receive cash transfer.

The accusation of data manipulation ignores how difficult it is to do so.  For years now SCI has allowed researchers access to the raw survey data, which has become the reason why those of use who use the data have come to appreciate their quality and attest their credibility (mostly to deaf ears, I might add).  If you examine, as I have, consecutive surveys you will find a high degree of consistency. It would take a lot of effort and skill to mess with the raw data in such a way as to produce smooth series for unemployment by, for example, sex, age, and province over the years.  I certainly do not know how to do it and neither those who make this charge.  As I argued in an earlier post, the unemployment rates for young women could not be much higher than the 50% the labor survey has consistently reported.

Another source of doubts about the accuracy of unemployment data arose is the change of survey instrument to measure unemployment, from the old Employment Survey to the new Labor Force Survey, and with it the change in the criterion for being unemployed, from two days of work last week to one hour only.  A recent news report from the BBC Persian service claimed that change in the definition of the unemployed was initiated by the Ahmadinejad government and was politically motivated.  It is easy to show that this is nonsense.  The changeover from the old to the new survey happened before Mr. Ahmadinejad was installed in office, in summer 2005.  The spring and summer rounds of the new survey had been collected before anyone from the new administration had set foot in SCI.  The decision to change how labor force data is collected and how unemployment is measured was taken during President Khatami’s administration.  The survey was designed and field tested in 2004 while he was still in office.  The move to the new survey was encouraged by the International Labor Office in Geneva in order to make Iranian employment data conform to international standards.  A top statisticians from ILO helped design the new survey, in close similarity to the labor force survey in neighboring Turkey.

The one-hour cutoff, which seems restrictive and is the source of controversy in Iran is standard practice elsewhere.  I doubt that it makes as big a difference as people think, perhaps 1-2 percentage points lower unemployment.  In any case, this change has nothing to do with the accuracy of the 2.5 percentage point drop in unemployment last year because both numbers come from the same survey.

Now, to explain the mystery of the good survey producing misleading results: A closer look at the released report shows that, in addition to lower unemployment, the size of the labor force is surprisingly smaller, especially for summer when school leavers start seeking work  (SCI only reports the size of the 10+ labor force in its quarterly publications).  Or perhaps this is not so surprising once you take into account the fact that the economy has been sluggish for the last three years and there is no end in sight to its sluggishness.  The lower labor force is very likely the result of discouraged workers not rapid job creation.

The SCI report for summer 1390 (2011) puts the size of the active labor force at 23.4 million, lower than the same figure reported for spring 1390 (24.4 million).  Assuming a small growth rate of 0.5% in the population of the 10+ age groups over one quarter, if the participation rate had not decreased we should have seen a labor force of about 24.6 million for last summer.  This leaves a rather large gap of about 1.2 million ‘missing workers’ who could be safely assumed to have been discouraged and therefore in fact unemployed.  So, instead of 2.6 million unemployed counted in the survey we could have as many as 3.8 million unemployed, in which case the real unemployment rate would be — deep breath! — as high as 15.2 percent.

Taking the zeros out makes sense because of the sheer difficulty of working with a currency one thousand of which cannot buy you a chewing gum.  Iranian national account data show up in Microsoft excel as a bunch of # signs because the program can’t fit the numbers in its regular cell size.  Turkey took out 6 zeros out of the Lira in 2005, and did not suffer any adverse consequence.  The name change has less to recommend it.  Parsi, the name that apparently has won the Central Bank poll, sounds awkward for a word people will be repeating all day because of its long syllable, but then it might just be able to chase out the word Iranians (mainly those abroad) use for our language– Farsi. They  never hear any Germans say “I speak Deutsch,” but they prefer to say that they speak Farsi instead of Persian).

But, more seriously, is this a good time to re-denominate the rial?  The answer is no.  Re-denomination is not something a country can do very  often, so it is better to wait until high inflation is behind us.  In 2005, when Turkey re-denominated its currency, it had reduced its inflation rate steadily from over 100 percent in 1994 to less than 10 percent in 2004. And, more importantly, it was able to keep it there.  Iran’s inflation at this time is surging, not falling.  Inflation did reach below 10 percent last year temporarily, but is now running at over 20 percent, and no one is sure when it will peak. Until the inflation pressures arising from the subsidy reform have abated, changing the currency unit can wait.  It is best to save this last arrow for a time when tranquility is in sight, which could be a while given the many sources of uncertainty that fog our vision of the future of Iran’s economy, including international sanctions.

Added to the fog is the government’s own decision to freeze the release of new economic data.  We do not know what is the rate of economic growth, inflation, or unemployment. If the powerful head of the Parliament Research Center is complaining about lack of access to data (link is in Persian), you can imagine the situation for the rest of us.

The immediate trouble with rial is the rapid printing of money, which has been the instrument of choice to finance budget deficits in the past.  Is the Central Bank talking about a new currency because the government is finally gaining a handle on its obligations?  There is no way to tell.  There is fear that the money it is collecting at the pump and from its subsidy free gas and electricity bills are not enough to pay out the cash it has promised.  So, there is fear that more inflation is on its way.  Hopefully, these fears are unfounded.  But, with lack of transparency over basic indicators and the budget numbers, economic actors are not able to see the light at the end of the inflation tunnel even if we have already cleared it.

Rial’s troubles may not end soon, and certainly not until macroeconomic stability returns in the aftermath of the subsidy reform program. When it does, to make sure that a decade later we will not be looking to drop more zeros from the currency, future governments should keep follow the rules that they have known all along: that oil income should not be spent every time it surges, that improvements in living standards should follow increase in productivity and not redistribution, and that the government should focus on its main mission to build the infrastructure of productivity — in health, education, and communication.  Making cash transfers to help the subsidy reform succeed was a great idea, but it should not become the main business of the government of a country in which millions of educated youth are unable to find their first job.

The old reasoning was based on the fact that university educated women participate in the labor force only half as much as men, so they should not take up valuable spaces for those who are more likely to put their education to use.   The new reasoning is that these educated women will have difficulty finding educated men to marry.  The argument has thus moved from the labor to the marriage market.

Proponents of this view, who I am certain are many beyond those listed in the Alef post, point to the rising age at marriage and spinsterhood to support their argument.  The policy-minded among them then take the next logical step to charge the government to save these women from themselves.

But there are serious problems with these arguments.  Their key assumption that the gap in university education between men and women is the main cause of the rising age at marriage does not survive close scrutiny.  There are at least two other more important reasons.  The first is a general trend worldwide of delay in marriage associated with economic development and the changing role of women in the family.  To have eight children  a woman would do well to start early, at age 15, but to have two children she could wait till age 25.  This is precisely what has happened for the vast majority of Iranian women: in one generation they have switched from 7 or 8 children to 2.

The second reason for the delay in marriage in Iran is an acute age imbalance in the marriage market.  Since the mid 1980s,  the ratio of marriage-age men to women (the sex ratio) has been falling, resulting in a shortage of men of about 25%.  This phenomenon is not limited to those with university education, it is for all young men and women.  This graph, taken from a forthcoming paper of mine, shows the ratio of men ages 25-29 to women 20-24.  The 5-year age gap is a rough approximation of the Iranian norm in marriage and a convenient way to capture  the imbalance in the marriage market.  In reality, this gap can change in response to the imbalance in the marriage market (and that is indeed what seems to have been happening in recent years).

A view of the age imbalance in the marriage market

Source: United Nations, World Population Prospects, 2008 edition

The age imbalance in Iran, which is more exaggerated than for any other country that I looked at, is not due to “missing men” as a result of the war with Iraq.  That war was bloody enough to worsen the imbalance, but not by much.  By far the largest influence is from to the baby boom that occurred right around the revolution, about 1979-83, when new birth cohorts were larger (by about 60%  compared to those born 10 years earlier).  Because of the social norms in Iran regarding the age gap between husbands and wives, the larger cohort of men reached marriage age a few years ahead of the same cohorts of women, thus causing a shortage of men.

Looking at this graph, you cannot help being struck by how fast the situation will be changing in the next ten years — from a shortage of men of about 25% to a surplus of about 40%!  The policy of affirmative action for men would seem quite silly from the vantage point of 2020 when the age at marriage will be under serious pressure to come down.

When the diagnosis is wrong, what chance has the remedy?   The question that should be asked at the outset is why do women seek university education if that is not to their advantage?  We have to understand why people do something before dispensing prescriptions.  To assume that as experts we know more about the value of university education to women than women who seek the education takes quite a bit of hubris.

The classic rationale for policy intervention is the tragedy of the commons, as in a common pond, when individuals left to their own devices will deplete the pond of fish.  In such situations it is not the superior knowledge of  policy makers but their ability to restraint individual action that is the reason for policy to ration fishing rights.  There is no resemblance of the situation women face with respect to dwindling number of men in universities and situations like the tragedy of commons.  Why should we presume that policy makers know more about what women want from a university education, what would be their alternative (sit at home and cook for their brothers who go to university?) if they did not go to university, and how they evaluate that relative to going to university and having to marry someone with less education?

If women are going to university to improve their chances of marriage, in the face of the general demographic imbalance in the marriage market, restrictions in meeting men in public spaces, and unfavorable marriage and divorce laws, how can experts decide that they are making a bad calculation?  What if staying home is inferior to marrying later,  marrying someone with less education, or even not marrying at all?

But, you may ask, are public universities not common resources that should be put to their best social use, educating those who are more likely to join the labor force?  First, I should say that I am against subsidizing higher education.  Like energy subsidies, it tends to be regressive because the children for better off parents have a great chance to take advantage of it.  I prefer charging those who can afford it the full cost and for those who cannot, offer loans to be repaid when they are employed or scholarships based on need.  Second, the value of a university education is not just in the labor market; educated women provide better health and education for their children, a value that the market wage may not be able to match.

Given all the things we need to know that we don’t before we can decide where and how to intervene, there is a lesson in modesty to draw.  Without the knowledge of why people do something and how particular outcomes arise, designing and implementing policies to alter those outcomes is a fool’s game– looking for solutions to imagined problems.  That knowledge comes from solid policy analysis and does not come cheap; it requires good social science research.

This is my first trip to Cairo since the uprising that toppled the Mubarak regime.  The airport was unusually quiet and all Mubarak pictures are gone, but otherwise there are few signs of a country that has just experienced its most dramatic social upheaval since the 1952 revolution. Egyptians like to think of the uprisings as Revolution (“al thawrah”) which in Arabic signifies deeper social change than “enghelab,” the word Iranians use for revolution.  But what has transpired in Egypt’s first six months of “revolution” pales in comparison to Iran’s 1979 Islamic Revolution.  There have been no executions or mass exodus of the rich, and not even an overhaul of the high echelons of the bureaucracy, as happened in Iran. Egypt’s judicial system has taken the lead in calling the members of the ancien regime to account. So far it is moving cautiously; only 45 individuals are currently in jail or standing trial for their alleged crimes, including Mubarak and his two sons.  If the judiciary can satisfy popular demands for justice, Egypt has a good chance for a soft landing on this side of the uprisings, and its judicial system may emerge as a strong pillar of its future democracy. If it fails to do so, revolutionary justice may take over and all bets would be off about democracy and restoring the economy to its previously robust growth path. No one seems certain how Egypt’s revolution will end.  As de Tocqueville has said, “in a revolution, as in a novel, the most difficult part to invent is the end.”

In post-revolution Egypt, as in 1979 Iran, the overriding popular concern is with the economy rather than democracy, so it would seem that unless the former is fixed it will be difficult to achieve the latter.  A recent poll taken in April found that only 19% of Egyptians joined the protests because of lack of democracy whereas 64% joined it for lack of “low living standards/lack of jobs.”  Egypt is quite a bit poorer than Iran, with about 20 percent of its population under $2 per day, compared to less than half that in Iran.  Of course, that is not a surprise once you know that per capita GDP in Egypt is less than a third of Iran’s. Distribution of income is worse in Iran (the Gini index is about 0.42, compared to 0.34 in Egypt). In both countries the feeling of the general population is that inequality is much worse than these numbers from survey data indicate.  They maybe right, survey data in developing countries do not report wealth, which is far less equitably distributed than income or consumption, and are notorious even for under reporting the latter at the top.

The good news is that 77% of the Egyptians polled expressed confidence that their new government can address the main issues facing Egypt.  The bad news is that this confidence may be for the wrong reasons.  Just after the revolution, the new finance minister, Samir Radwan, asked for people without a job to send their resumes to him.  It is reported that 7 million people did so, of which one million were told they would be hired!  This is the last thing Egypt’s bloated and underpaid bureaucracy needs.

The poll also shows that only 28% of the Egyptians participated in the revolution, and most do not regard Iran as a model for which direction to go: when asked which of two countries they preferred Egypt to be close to, only 15% picked Iran over Saudi Arabia and 23% over the United States.

While these preferences might indicate that Iranian-style populism has low appeal in Egypt, the recent negotiations with unions and political parties and other opposition groups over the minimum wage suggest otherwise.  Nothing like a debate over the minimum wage to reveal lack of economic literacy. Ordinary people rarely acknowledge a relation between wages and productivity, and often think that governments can raise living standards by raising the minimum wage.  Egypt has a minimum wage only for its public employees, which was ridiculously low at LE 160 (Egyptian pounds) per month (less than $1 per day) and was raised to LE 400 last November, presumably to head off protests inspired by events in Tunisia.  Political parties and unions had asked for the minimum wage to be raised to LE 1500 (about $300), which is unsustainable given low productivity in Egypt. (Iran’s minimum wage is about $330 but then Iran has oil money and productivity is slightly higher in Iran.) The Egyptian government has announced a compromise at LE 700 per month (~$120), but who knows if it will last.  Demands for change continue in Tahrir square, pulling policy makers in different directions. The most widely attended are the protest to raise the minimum wage, but last week there was even a protest against “difficult questions in the secondary school examinations” (I am not making this up; it was reported in the Daily Egyptian, June 11, 2011, in Arabic).

The increase in minimum wage will have little real consequence for the Egyptian economy because it does not affect the informal sector where most low-wage workers are employed. It will affect the government salaries, which may be a good thing because very low public sector wages are a recipe for petty corruption.  Paying its public sector workers — those who actually work– a living wage will reduce such corruption.

The challenge facing the government at present is to find the money to pay for higher wages.  With tourism all but dead, and construction apparently slowed to a halt, government revenues are down substantially and foreign exchange is depleting fast.  One possible source of new money is removing subsidies for food and energy, estimated at about 10% of the GDP (about $20 billion).  Whenever I mentioned Iran’s (so far!) successful experience with subsidy reform to colleagues in Egypt, and heard a sigh –Egypt will never be able do that!  Perhaps Egypt and other Middle Eastern countries with heavy energy subsidies are the reasons why the IMF is giving Iran an easy pass on its subsidy reform, to encourage them to take the plunge.  It is interesting that most Iranian commentators are advising Egyptians otherwise.

Iran’s bold experiment with subsidy reform may not be easy to replicate in the Arab world, especially where revolutionary fervor and distributive sentiments run high.   But having an accurate account of what has happened in Iran and its impact on the poor is more important than ever.

The merger between the Ministries of Labor (MOL) and Welfare (MOW) raises important questions that go beyond the turf issues that are being hotly debated.  Work and welfare are intrinsically bound in laws and institutions of a country as they are in people’s lives. Economists have recognized the link between supply of labor and the level of welfare not working.  The idea is very simple: the higher the level of welfare while not working (the “reservation wage”), the lower the incentive to work.  The British colonial authorities in Africa discovered as much a long time ago when they imposed a hut tax to “persuade” African subsistence farmers to work in their mines.

Classical economists believed that in the early part of the Industrial Revolution labor supply was determined by population growth, which, because of diminishing returns, kept living standards in the rural areas (the reservation wage) low, and sent large numbers of people looking for work in industry.  Gradually, as the Industrial Revolution passed its Dickensian phase of low wages and worker misery, most industrial societies adopted programs to care for the unemployed, the elderly, and the disabled.  Today the tradeoff between effort and social protection is now recognized as a central issue in economics and in public policy.  On the tradeoff between work and welfare conservatives stress personal responsibility and are generally against publicly provided welfare of any kind because it reduces the incentive for people to work, while liberals seek a compromise between taking care of those in need and work incentives. The welfare reform of the 1990s in the United States under Clinton was a liberal compromise between these two tendencies in American politics.

In Iran, our entire approach to balancing the incentives for work and provision of welfare is very different from that of the industrialized countries.  The way our political dialogue has been conducted since the Constitutional Revolution is that the responsibility for individual welfare lies with the government, not the individual.  The rise of oil revenues has further tilted this debate in the direction of government responsibility.  Oil revenues thus not only raise the reservation wage directly, by providing benefits to people not working, they also raise it indirectly because they shift the responsibility for welfare from the individual to the state.  Before the subsidy reforms of 2010, various forms of subsidies affected the reservation wage, after the reform cash payments do it more effectively.

How is this related to the merger of ministries?  The policies pursued by the Ministry of Welfare affect the reservation wage while a separate Ministry of Labor is concerned with the incentives to work.  The coordination of policies dealing with work and welfare may work well in two separate ministries in societies in which the relationship between work and welfare are widely acknowledged, but in Iran a single ministry might just be what we need to take seriously the tradeoff between work and welfare. The current division of tasks between MOL and MOW reinforces the expectation that MOL’s task is to generate jobs while MOW attends to their welfare.

Whatever its original motive in merging the two ministries, the government has a unique opportunity now to use it to make a statement about the need to balance the provision of public welfare with the incentives for work, and the role of public policy in mediating the tradeoff between individual incentive to work and the desire for comfort.  Affirming the role of personal responsibility in determining life outcomes is particularly important in view of the progressive redistribution of incomes that has taken place as a result of the subsidy reform program, The low income and the lowly employed Iranians have doubtless interpreted the monthly deposit of cash in their bank accounts as the first installment of their share of the oil wealth, sending a strong message contrary to personal responsibility, that their standard of living can increase without any increase in their expenditure of effort and any change in the national employment picture.

Last December, when he announced the start of the subsidy reform, President Ahmadinejad promised to make employment his top priority in the coming year.  The merger of MOL and MOW offers him an opportunity to make it clear that his promise to improve employment prospects was not to create public jobs, that the government’s responsibility to employment is not to create jobs but rather to prepare the conditions that would encourage private employers to do so.  The most important task in this regard is to engage the public in the debate on the balance between the individual incentives to work and the public provision of welfare.  There are positive lessons the  government can draw from its experience in selling the subsidy reform program to the public. International experience on the subject is, as always, invaluable, but in the end this is a problem that requires local solutions designed by people familiar with the local conditions and the national mood.

In my reply, I tried to argue two points: First, most of the people the study in question considers poor are actually middle class (by standards of access to basic services and household amenities), a point that I addressed in an earlier post. Second, ignoring or denying the difference was to fundamentally misunderstand Iran’s economic and political dynamics. A country in a “sea of poverty” after the expenditure of some $300 billion of oil revenues is fundamentally different from one with a rising middle class. One is a fertile ground for populist politics and craves redistribution, the other receptive to policies that promote economic growth. Forty years ago, a misunderstanding of similar magnitude had led groups on the Left to believe that Iran was ready for a peasant or a proletarian revolution.

The Islamic Revolution of 1979 was a tectonic shift in Iran’s class structure, displacing the old social classes, demoting the nobility while offering those at the bottom, especially the rural poor, significant upward social mobility through education, sacrifices made in the war effort, or mere political connection (I develop this point further in a short article published in the Radical History Review). A large section of the middle class is the product of this upward mobility. For the most part they like to think of their gains in education and economic status as personal achievement rather than a gift from some bureaucrat. I realize the temptation of some to use extravagant claims of poverty as a political tool, but, besides being untrue, calling this rising middle class poor is condescending and unfair because it denies their achievements and portrays them as helpless bystanders unable to pull themselves out of poverty when their country was inundated with oil money. It is also misleading because it shifts attention from a serious problem that is being neglected –jobs for youth – and focuses attention on a problem that is relatively under control.

As for the future, exaggerating the extent of poverty implies that the populist and redistributive turn in Iran’s politics is what the country needs. Poor people are more likely to favor redistributive policies than push for pro-growth reforms. The middle class, on the other hand, is more likely to favor such reforms because reforms improve the return on its huge investments in education. It is important to know where in the process of social change Iran stands.

Back to methodology. I have tried to reproduce the results of the study in question using the same data they use– the expenditure survey for 2009. So far I have not been able to reproduce their results, so I rather doubt that in urban Iran in 2009 a person with less than $12.55 (58,035 rials converted at the PPP rate published by the World Bank) is unable to get decent nutrition (2300 calories per person per day according to the study). Choosing a poverty line based on calorie intake is problematic for Iran because Iran’s average calories consumption is high and the relationship between income and calories is not precise. You will find in the survey data many people with different income levels — rich and poor — consuming the same amount of calories, or persons with the same income consuming different amounts of calories. In other words, the distribution of calories conditional on income has a large variance. So, it’s hard to pick a calorie-based poverty line and be sure that everyone below that line is actually poor.

In the end, choosing a poverty line is rather arbitrary, like choosing a minimum level of height to calculate what percentage of a population is short. Poverty lines are useful in comparing the incidence of poverty across countries or track it for the same country over time. Most of the studies that come out of Iran do not do either of these. With survey data more widely available to researchers, it is ever so important that the results of studies that use such data be more closely scrutinized by peer reviewers so the data and the studies based on them inform us about how the poor in Iran live rather than turn into political football.