Fakultät Wirtschaftswissenschaften, Lehrstuhl für Volkswirtschaftslehre insbesondere Finanzwissenschaft Oil Revenue Shocks and Government Spending Behavior in Iran Mohammad Reza Farzanegan Research Fellow of the Alexander von Humboldt-Foundation TU Dresden & ZEW Mannheim Collaborative Conversations 22 June 2011, 34th IAEE International Conference, Stockholm , Sweden

Plan of Talk Stylized Facts Why I Did This Study? How I Did It? What Are My Findings? Conclusion

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…"

Sanctions & The Iranian Oil 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. 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.

Share of Oil Revenues, Current & Capital Expenditures IR-IQ War Post- War Shah

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

Government Expenditures in Different Functions (% of TGE)

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”

Sanctions & The Iranian Oil: Media & Iran Energy Project

Sanctions & The Iranian Oil: Media & Iran Energy Project

Sanctions & The Iranian Oil: Media & Iran Energy Project

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:

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

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

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

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

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

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

Findings 7: Variance decomposition

Summary & Conclusion 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.