Domestic Economy

Free Trade: Pitfalls and Prospects

Free Trade: Pitfalls and ProspectsFree Trade: Pitfalls and Prospects

Goldman Sachs was not only the author of the term BRICS, but it has also introduced the Next Eleven. The N-11 is a set of countries with strong potential of becoming the largest, fastest growing economies of the 21st century.

Alongside Pakistan, Nigeria, Egypt, Mexico, Turkey and the Philippines, sits Iran in the grouping.

Assuming that globalization will play a crucial role in the development of all these economies, what relationship should Iran have with the outside world to realize its potential? How important is free trade in the country’s successful development?  

Many economists believe that the industrial sector tends to be more instrumental than services and agriculture in economic development, particularly in its early to mid-stages. Influential development economist Albert Hirschman argues that due to its extensive linkage to other sectors, the manufacturing industry can spur growth in a variety of directions.

The failure of import substitution in many developing countries has also taught that manufacturing should be oriented to foreign markets to survive and grow. Export-oriented industrial development can bring in the foreign exchange and investment to kick-start a mechanism of viable long-term increases in living standards. Over the past two decades, China has been the best example of this trend, while the four so-called Asian Tigers, namely Hong Kong, Singapore, South Korea and Taiwan, did so at an earlier stage.

Ha-Joon Chang, a Cambridge economist, believes uncontrolled free trade can “kick away the ladder” of socioeconomic development, pointing out that developed countries have reached their privileged position through strategic protectionism. Their export markets were opened only step by step and with a look on their global comparative advantage.

Indeed, emerging markets like Brazil, Indonesia, South Africa and Turkey have not as successfully claimed a front-seat position in the fiercely competitive global industrial export market. This has made these countries much more vulnerable to currency exchange fluctuations, financial and debt-driven crises and mostly speculative, short-term investment flows.

In Iran, pro-free trade policy has increasingly been accepted as the way forward, although at times inflicting damage on domestic industries. For example, President Hassan Rouhani’s economic team has had to confront cheap rice imports from India and steel dumping from China, as both were wreaking havoc on two important sectors of the economy.

Economists are mostly in agreement that free trade could increase low productivity rates in Iran and improve the effective use of human capital and technologies.

The main barrier against successful trade liberalization has been sanctions (imposed by the West against Iran over its nuclear energy program). The sanctions regime has prevented the country from negotiating trade contracts that could profitably orient domestic industries to the outside world.

This does not imply that sanctions have had an exclusively negative impact on Iranian exports. When the tightening of sanctions in 2012 fueled inflation, lower real wages and a weaker rial turned a range of Iranian export products in globally competitive assets.

Now investors fear that an appreciating currency and wages will cause exports to drop again. However, these fluctuations only led to a relative and temporary strengthening, and are often seen as less “real”. A smart and strategic opening of Iranian export markets can instead lead to higher productivity and living standards.

Defying sanctions, successive governments have still pushed forward with liberalizing trade. Most recently, the Rouhani administration lowered import tariffs for various basic materials. The government also wants to scrap preferential currency rates if nuclear negotiations turn out to be successful.

 Iraq Market Potential for Trade Liberalization

Although many foreign traders stopped doing business with Iran during years of sanctions, the Iran-Iraq Chamber of Commerce has been noticeably active.   

Valiollah Afkhami-Rad, deputy minister of industry, mines and trade, believes free trade could help Iran and Iraq attain a target of $25 billion in bilateral trade.

Non-oil exports to Iraq have grown from $3.7 billion in 2010 to $4.6 billion in 2013, making it the second largest export market after China, according to data released by Tehran Chamber of Commerce, Industries, Mines and Agriculture.

Bilateral trade stood at $12 billion in 2013. Exceptional for Iran’s foreign trade relations is that up to half of this trade is unrelated to the oil industry, according to comments made by Jaafar al-Hamdani, head of the Iraqi chamber of commerce.

Iranian car manufacturers, particularly Iran Khodro, have been beefing up their production in Iraq to respond to the growing demand in the neighboring country. Iran exports an average of about 100,000 cars annually to Iraq. Other large export markets in Iraq include cement, construction materials, tiles and ceramics.

Nevertheless, adventures in trade liberalization with Iraq have remained limited to easing the flow of border traffic. Turkey, which unlike Iran is not affected by sanctions, has better chances of concluding free trade agreements with neighboring markets. Turkish exports to Iraq reached $11.9 billion in 2013, more than three times exports from Iran, according to the Turkish Statistical Institute.

Nevertheless, Turkey and Iran are not completely in competition. Turkey exports more to the Autonomous Kurdistan Region, while Iran is more focused on southern Iraq. Iran has also profited from the worsening security situation in Iraq’s north and west. As Nora Salem, a member of Iraq’s Parliamentary Economic Committee told Al-Hayat, “Iranian products will thrive this season in the local markets and the Turkish industry will be the most prejudiced as they lost the Iraqi market due to the security situation.”

Recent decisions by the government threaten to nullify the hard-earned advances of producers in securing market share in Iraq. The government has recently lowered tariffs on ceramics, tiles and rubber, all of which are among Iran’s main exports to Iraq.

Now, the rapidly growing wave of cheap imports from China endangers Iran’s fledgling export-oriented ceramics industry, which booked revenues of $179 million in 2013 to Iraq alone. If similar policies are pursued in other industrial areas, like the car or cement industry, Iran’s export-oriented industrial engine, which is hard hit by years of economic sanction, might soon lose steam.

The government should work closely with manufacturers to analyze the comparative advantages of Iranian products to neighboring countries. If Iraq is one market where Iran’s competitiveness is obvious, the country should attempt to imitate such strategic trade liberalization with other markets.  

However, the realization that trade liberalization should be rolled out gradually and strategically, and not as a policy, might be an even bigger priority if the government does not want to turn around the small and arduous advances made in Iraq by some of Iran’s largest industrial producers.