Oil Revenue Shocks and Government Spending Behavior in Iran

Mohammad Reza FarzaneganResearch Fellow of the Alexander von Humboldt-Foundation

TU Dresden & ZEW Mannheim

Collaborative Conversations

22 June 2011, 34th IAEE International Conference, Stockholm , Sweden

Fakultät Wirtschaftswissenschaften, Lehrstuhl für Volkswirtschaftslehre insbesondere Finanzwissenschaft

Plan of Talk

1. Stylized Facts

2. Why I Did This Study?

3. How I Did It?

4. What Are My Findings?

5. Conclusion

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Stylized Facts

►On average, 60% of the Iranian government revenues and 90% of export

revenues originate from oil and gas resources.

► Increasing oil prices in the past years have boosted populist expenditures,

especially under the government of Ahmadinejad.

► Current international sanctions on Iran have mainly targeted the oil production

capacity of Iran and its exports to the global markets.

►Enjoying the high oil prices, Ahmadinejad reaction to the UN Security Council

resolutions: “…Today they (the Western countries) just aim to scare the Iranian

people with this piece of trash paper…"

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Sanctions & The Iranian Oil

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►In July 2010, the engineering and construction arm of the Revolutionary Guard

Corps, Khatam al-Anbia, which is also under new U.N. and U.S. sanctions,

unexpectedly withdrew from two key gas refinery projects in the world’s largest

gas field, South Pars. The reason given on their website is current sanctions.

►European Union leaders agreed on significant sanctions against energy related

investments in Iran on June 2010, prohibiting "new investment, technical

assistance and transfers of technologies, equipment and services related to

energy areas, in particular related to refining, liquefaction and liquefied

natural gas technology”.

►The Financial Times reports the reduction of oil production in Iran to be about

300,000 barrels per day due to international sanctions.

Share of Oil Revenues, Current & Capital Expenditures

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0102030405060708090

100

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

oil revenues/total revenuescurrent payments/total paymentsdevelopment payments/total payments

ShahIR-IQ War

Post- War

Absolute Spending of Government in Different Groups (US dollar) - current prices

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1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

0

2,000,000,000

4,000,000,000

6,000,000,000

8,000,000,000

10,000,000,000

12,000,000,000

Military spending (USD) Security spending (USD)Health spending (USD) Education spending (USD)

Government Expenditures in Different Functions (% of TGE)

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0

10

20

30

40

50

60

70

80

90

1001

95

9

19

61

19

63

19

65

19

67

19

69

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

General Services MilitarySecurity Services EducationHealth and Medical Services Social AffairsHousing CulturalEconomic Affairs Others

Why I Did This Study?

► Chun (2010) study from Strategic Studies Institute (SSI), part of the U.S. Army

War College, motivates me to do this investigation!

►Chun (2010) estimates the elasticity of demand of military spending in five oil

rich economies, namely Iran, Kuwait, Saudi Arabia, Venezuela, and Nigeria

►Using data of 10 years from 1997-2007, Chun suggests that each of these

countries shows a mainly inelastic demand for military spending.

►…“attempts to limit defence spending by tinkering with a producer of oil

revenues are likely to fail”.

►Opposing energy sanctions on Iran: “forcing oil exports may artificially pit

Washington against other oil importers”8 von 20

Sanctions & The Iranian Oil: Media & Iran Energy Project

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Sanctions & The Iranian Oil: Media & Iran Energy Project

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Sanctions & The Iranian Oil: Media & Iran Energy Project

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How I Did This Study?

► We examine the dynamic effects of shocks for Iranian oil revenues on different categories of government expenditures in Iran.

►Method: Unrestricted VAR, Impulse Response Analysis (IRF) & Variance Decomposition Analysis (VDC).

►Time period: 1959-2007, Annual Data.

►Endogenous variables: oil export revenues per capita (and/or oil prices, shock variable), military, security services, education, health and medical services, and cultural and recreational services expenditures (per capita and as a share of total EXP)

►Exogenous variables: Iranian revolution (1979), and the Iran-Iraq war (1980-1988) dummy variables.

►All variables in constant prices and in logarithmic form. Oil revenues and prices are transformed into Iranian rials to control for volatility of exchange rate.

►Source: expenditure variables from the Iranian National Account. Oil variables: BP, OPEC, Iran National Accounts.

►Specification:12 von 20

1 . .pt i i t i t ty A y B X e

Findings 1: Impulse responses to one standard deviation shock in oil export revenues per capita

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Findings 2: Impulse responses to one standard deviation shock in oil prices (oilp)- share in total spending

Folie 14 von 15

Findings 3: Impulse responses to one standard deviation shock in oil prices (oilp) - per capita spending

Folie 15 von 15

Findings 4: Impulse responses to one standard deviation shock in oil export revenues per capita (oilexppc)- per capita spending

Folie 16 von 15

Findings 5: Impulse responses to one standard deviation shock in negative changes of energy rents - per capita spending

Folie 17 von 15

Findings 6: Impulse responses to one standard deviation shock in negative changes of energy rents - share of spending

Folie 18 von 15

Findings 7: Variance decomposition

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Years ahead

oil revenues

Health Military Security Education Culture

Variance decomposition for Health 1 0.01 99.98 0 0 0 0 5 0.67 34.16 12.47 32.56 1.43 18.68 10 1.51 28.62 10.74 33.66 4.21 21.23 Variance decomposition for Military 1 7.60 6.65 84.74 0 0 0 5 17.09 25.82 44 7.08 2.84 3.14 10 15.29 22.88 32.35 15.29 5.84 8.31 Variance decomposition for Security 1 6.64 21.69 0.55 71.10 0 0 5 9.13 14.64 2.10 56.96 0.88 16.27 10 7.92 13.22 1.97 53.99 4.42 18.50 Variance decomposition for Education 1 0.71 30.60 0.34 16.867 51.46 0 5 0.33 17.86 4.69 7.51 50.11 19.47 10 3.60 13.36 5.20 6.72 48.28 22.82 Variance decomposition for Culture 1 0.89 3.04 3.54 6.29 1.52 84.68 5 5.70 5.33 5.63 9.62 7.04 66.66 10 7.75 6.21 7.17 19.69 5.90 53.25

Summary & Conclusion

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► Main Question: To what extent a shock in the Iranian oil export revenues affects different categories of Iranian government spending, and whether such shocks affect the military ambitions of the Iranian government or whether it only affects the government’s social, health, and education efforts.

►To answer this critical question, we have used an unrestricted VAR model and estimated the impulse response functions (IRF) and variance decomposition analysis, using annual data from 1959-2007.

►The main results show that the government’s military and security spending responds positively and statistically significantly to shocks in oil revenues (or oil prices).

►Other social spending of the Iranian government does not show a significant response to oil shocks.

►Policy implications: Those sanctions aiming to restrict the Iranian government’s oil export capacities and consequently oil export revenues may affect the military spending of Iran and not the social, education, and health efforts.