The automobile industry in Iran is a telling example of how government interference pulls an industry out of economic reckonings and burdens it with political baggage. The result is an industry whose product is manufactured at a very high cost and sold to a special group, using uncommon gambits such as lottery, at a mandated price that does not cover the costs, but at a market price three times higher than the factory price. This equals to inefficiency, waste of resources and reduction of public welfare.
Hossein Abbasi, a lecturer in the Department of Economics of University of Maryland, prefaced his article for the Persian economic daily Donya-e-Eqtesad with this note. A translation of the text follows:
Let’s take a look at the features of Iran’s automobile market.
First: Carmaking is costly here. Several indicators can be surveyed but comparing the number of manufactured products with the number of workers is enough to show the inefficiency of the production process.
Iran Khodro, with 56,000 workers, currently manufactures up to 500,000 cars annually. Compare this with Kia Corporation whose 2,700 workers manufacture 250,000 cars in its factory in Georgia, USA. This means that every employee of Kia is more efficient than 10 employees of Iran Khodro.
Even if we accept that the optimal number of workers in Iran should be more than the number in the US, the ratio of workers to products in Iran is still so high that it cannot be blamed on anything but inefficiency. According to the former managers of the Iranian carmaker, a large number of workers in this industry have been employed on the basis of recommendation made by politicians, i.e., the dominance of political relations over economic calculations.
Second: The pricing of products also indicates the presence of other problems. A large number of institutions and government organizations are involved, officially and unofficially, in the pricing process. The price imposed on the factory is lower than its production cost, so that every year thousands of billions of rials are being added to the accumulated losses of this industry. The domestic carmakers are constantly facing losses and the interesting point is that these losses do not make them bankrupt. On the contrary, given that the government institutions are the cause of these losses, the carmakers force the government to pay these losses from the fiscal budget. The logic behind such mechanism cannot be justified by economic theories.
Setting the price of a car the world over is the exclusive business of the manufacturer. The only job that the government has in this regard is to remove market monopolies. When automakers are forced to comply with a mandated price, they will have many demands in return, the most important of which is securing government protection against potential and actual competitors. The fact that domestic carmakers seek to control imports or, under unusual pretexts, place hurdles in the way of imports is an example of such demands.
Third: The prices of cars in the market also reveal other aspects of the problems in this market. Iranian consumers have to pay multiple times the price of a similar car produced in other parts of the world. Given their subpar quality, the prices and costs of cars and services the consumers receive are very high in Iran. The basic principles of economics tell us that this is not possible, except by creating a monopoly that creates barriers to the import of better and cheaper products; it increases the price and survival of expensive and low-quality products.
Combine the above two features to come to the fourth feature. The price charged by the factory on the orders of the government is several times lower than the market price. The difference between these two prices is the rent given to those who get the car at the government price. In the case of the cheapest cars in the market, this rent is up to 20 times the salary of an ordinary individual; the corruption that such a rent can create is so obvious that it does not need further explanation.
Reversed Relationship
We all know that the root of the problems in the domestic automobile industry lies in the government’s interference. To better understand this matter, we need to analyze the relationship between the government and the industry.
The main problem is in the kind of relationship established between the carmaker and the supervisory body. Instead of monitoring and ensuring the improvement of quality and competition, the supervisory body extends unconditional support to domestic carmakers.
At present, there is a regulatory and supervisory organization for almost every industry in the world. The responsibility of these agencies is to ensure compliance with standards and prevent monopolies so that the market witnesses higher quality and lower prices. A prerequisite for this move is that the automaker constantly sees itself at risk of being struck out of the market by more efficient rivals. A competitive market does not only mean the presence of a large number of carmakers you see in the case of Iran. The centerpiece of a competitive market is that every carmaker has to offer a better product at a lower price through investment and innovation. The result of such competition is that if the automaker fails to be sufficiently innovative, it will go bankrupt and would be forced to cede the market to more efficient competitors.
The supervisory organization must be sure that no producer can avoid this competition through political and economic bargaining. This is the key to the success of this industry in the world and its failure in Iran. This relationship has been reversed in the Iranian car market. The watchdog seems to be very careful not to expose carmakers to competition. Bankruptcy and exit from the market are meaningless in Iran. The carmaker is allowed to operate at high costs without worrying about losing the market to more efficient rivals. The losses of the carmakers are ultimately transferred to consumers.
This support has another side. The carmaker is obliged to comply with the regulations of the supervisory organization and to act according to its wishes. The result of such a wrong relationship between the car manufacturer and the supervising organization is nothing but low quality and high priced products.
Spokespersons of supervisory organizations of this industry and similar industries repeatedly speak of the benefits of this industry for Iran’s economy and its ability to create employment, its relative advantages and its potential. However, the economic translation of all these comments is that thanks to the supervisory organization, competition will be absent in this industry.
The first principle of economics is that people operate based on motivations. There is no motivation for qualitative and quantitative improvement in the absence of competition. Even if you gather all the relative advantages in one place, if individuals and companies lack the motivation to use these advantages efficiently, the society will not benefit from it. In addition, motivation is not achieved by incentives and support; rather it is achieved by the fear of losing the market.
Only by changing the relationship between the supervisory organization and the carmakers for turning unconditional support into competition can we expect this industry and market to improve.
