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Saudi Arabia, Iran, and perils of military involvement in the economy

The IMF’s April 2019 Regional Economic Outlook for the Middle East and Central Asia offered some positive news for the Saudi economy, revising its 2019 growth estimate for the economy upward from 1.8 percent due to improvements in the non-oil sector. In contrast, the Iranian economy was set to contract by six percent, accompanied by inflation of nearly 40 percent, following a contraction of 3.9 percent in 2018.

While the IMF report emphasizes US sanctions as the proximate cause of the difficulties faced by the Iranian economy compared to the relative success of the Saudi economy, there are in fact deeper structural factors at play. The role of the military in the Iranian economy is one of the most important forces that has prevented it from realizing its potential.

Iran’s Revolutionary Guard Corps (IRGC) – the military branch in charge of protecting the country’s Islamist system – controls arguably as much as 20 percent of the gross domestic product. It is involved in a wide range of industries, including construction, infrastructure, telecommunications, and petrochemicals. The last 40 years have shown that the IRGC is good at military activity, but not very good at serving consumers. It undermines competition via extortion and has become a serious obstacle to foreigners doing business in Iran.

One of the most famous illustrations of this is the government’s decision to award the license for operating the main terminal of Tehran’s airport to a Swiss-Turkish consortium, only to have to renege once the IRGC closed the airport in protest. The IRGC – whose own bid was initially defeated in the tender – classified the decision as a threat to national security, and had a series of economic and political interests in securing the deal. The Basij, which is a subsidiary of the IRGC, has been able to purchase stock in state-owned enterprises at artificially low prices, distorting the functioning of capital markets. It also provides preferential employment opportunities for its wide array of members, distorting labor markets.

The IRGC’s propensity to take actions that serve its own interests rather than those of the general public are arguably reflected in its financial support for foreign militias, such as those in Lebanon and Syria. Thus, in addition to exposing Iranians to bad quality services, military involvement in the economy also diverts scarce resources (on the order of hundreds of millions of dollars) to foreign ventures with questionable economic returns.

Most recently, the IRGC’s involvement in the economy has been a contributor to the deployment of wide-ranging economic sanctions against Iran, and is a reason why the Iranian economy has been forced to be inward-looking, despite the fact that it would benefit immensely from foreign investment and trade. In fact, in the brief aftermath of the Joint Comprehensive Plan of Action, the economy grew at 12.3 percent as Iran re-engaged the global economy, compared to contractions in three out of the four years prior, including a decline of almost eight percent in 2012.

In the case of the Gulf economies, including Saudi Arabia, military engagement in the economy has been virtually nil, beyond its role as a standard purchaser of goods and services in the market. This has been an important contributor to the attractiveness of the Gulf economies to foreign investors, and in turn to the countries’ high living standards.

This is because military involvement in the economy makes engaging with the global economy much more complex. Prospective foreign economic partners become much more wary of the political consequences of trade and investment, as they inevitably empower the military.

Moreover, the military has access to special resources which can completely undermine the competitive process, such as the de jure power to designate competitors as security concerns and the de facto power to extort competitors via its armed personnel. This can lead to market concentration – and even monopolization – with consumers suffering from higher prices, decreased choice, and low levels of innovation.

When a company such as Italian oil giant Eni wants to explore for oil in Saudi Arabia, it doesn’t have to worry about its personnel being physically threatened by a Saudi military contractor who is competing for control of the oil, nor does it have to buy off generals who might otherwise designate it as a security threat and remove its access to any oil it discovers.

Respect for property rights – especially those of foreign investors – and openness of markets has been critical to the rapid advancements in human development in the Gulf. Moreover, despite the geopolitical challenges that the Saudi government has been facing, it has continued to be able to secure critical foreign investment, because the economy and the government are relatively independent from the perspective of foreign diplomatic relations.

In light of the uniformly negative consequences of military involvement in the economy, why would a country even permit it? The military itself will support such an expansion as it allows it to diminish its financial dependence on the state, and frees it from civilian oversight. Moreover, it will support any broader political aspirations of the military. From the perspective of the government, it may allow such expansion as a defensive tactic if it feels threatened by other groups in the economy, such as civilians or other military branches, or it may simply be powerless to prevent the military’s gradual encroachment.

But military personnel are trained for combat, not for managing production and satisfying consumer needs. Putting the army in charge of the economy is in principle the same as putting a regional supermarket manager in charge of air defense, which would naturally lead you to worry about the integrity of your country’s airspace. Naturally, there are some shared managerial skills, but for the most part, when it comes to performance, there is no substitute for dedicating oneself to one’s craft for 30 years.

While economists disagree on the best growth model for development economies, one area of consensus is that the military should stay away from the economy. The Gulf countries have been able to harness their oil wealth in a much better way than their regional neighbors for a variety of reasons, with one of them being keeping the military away from the organization of commercial activity. Until countries such as Iran heed this lesson, they will continue to perform significantly below their potential.

 

Last Modified: Friday، 10 May 2019 12:22 PM
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