The multitude of sanctions exercised on Iran in the past two decades have undoubtedly had a profound effect on US-Iran trade. They have also been instrumental in shaping Iran’s international trade policy, and its emerging economic partnerships in the region. This paper will therefore examine the policy measures taken by Iran in coping with economic sanctions initiated by the United States. We will review the history of these sanctions in post-revolutionary Iran, and examine relevant economic data to assess the effectiveness of Iran’s reactive and pro-active policy measures in combating them. The paper concludes with a discussion of business implications for firms operating in Iran..
 

Revolution and the Iran-Iraq War Years: This period which extends from 1979 to 1988 represents a difficult period for the Iranian economy due to the instabilities experienced following the revolution and the destruction inflicted by the war with neighboring Iraq. It is also a period during which American hostages were taken from the US embassy in Tehran, and is therefore characterized by a state of political and economic isolation, facilitated by a multitude of trade sanctions.

The Post-war Reconstruction Era: This period extends from 1989 to 1992. Iran’s economy focused on recovering local production capabilities lost during the Iran-Iraq war. Attracting international investments and technology, fostering foreign partnerships for developing the country’s infrastructure, and relaxing import restrictions characterize Iran’s major policy decisions. US trade sanctions were also relaxed during this period.

Dual Containment and Trade Sanctions Renewal: Starting in 1993, the Clinton administration exercised a series of restrictive trade measures on Iran. The ‘dual containment’ strategy was initiated in order to curb the economic development of both Iraq and Iran. US trade sanctions were revived and further intensified. During this period, Iran strengthened its regional partnerships through a series of long-term bilateral and trilateral economic agreements.

Iran-Libya Investment Sanctions: In 1996, dual containment took a special focus on Iran, through the implementation of the Iran-Libya Sanctions. The sanctions restrict non-US firms investing in Iran’s oil sector, thereby extending US foreign policy beyond American borders. Although the sanctions created a temporary slowdown in foreign investments in Iran, they have found little international support. Firms in Europe and the Far East have recently challenged the extraterritorial nature of the Iran-Libya sanctions.

In each of these time periods, Iran’s policy measures has evolved around specific themes and objectives. For example, in the years of the Iran-Iraq war, in order to reduce reliance on western suppliers, much emphasis was placed on diversification of international trade routes. However, following the end of the Iran-Iraq war in 1988 (and the instabilities experienced in international oil markets during the mid 1980's), expansion of non-oil exports became a primary objective. Since the early 1990's, and the breakup of neighboring Soviet Union, emphasis has been placed on developing regional economic partnerships, involving not only the former Soviet republics to the immediate north of Iran, but also regional neighbors to the east and west. Such long-term partnerships have also become critical in recent years as a mean for countering US investment sanctions, which specifically target Iran’s oil industry. In the following sections, we will examine the measures adopted by Iran in each of the above time periods, and assess their effectiveness. The business implications of the current sanctions are then discussed.

The first formal US economic sanctions against Iran were exercised in April 1980, following the break in diplomatic relations between the two countries. By introducing the 1980 sanctions, President Carter banned all US exports to Iran. Although the US was able to secure support among its allies for the sanctions, the sanctions were short lived and by early 1981, following the Algiers Accord which secured the release of the American hostages (Washington Post, 1981), the sanctions were lifted. A renewed series of sanctions were imposed by the Reagan administration in 1984. The Arms Export Control Act and Export Administration Act of 1984 restricted the permitted list of products which American companies could export to Iran. Export of goods such as certain types of aircraft and vehicles, as well as products with potential military applications was effectively terminated. US oil companies however continued to lift Iranian crude oil for import into the United States.

Economic relations between the two countries suffered further in 1987 and 1988, following the US re-flagging of Kuwaiti oil tankers in the Persian Gulf. During this period, numerous incidents involving US and Iranian naval forces, and the shooting down of an Iranian airliner with over 200 passengers on board by the American Navy increased the level of tension between the two countries. In October 1987, President Reagan issued an executive order banning the import of all goods and services originating in Iran - an amount totaling close to $1 billion. US oil companies were also prohibited from importing Iranian oil into the United States for local consumption. They were however allowed to continue purchasing Iranian oil for their non-US markets through their overseas subsidiaries. Moreover, additional export controls were put in place in 1987 (FFND, 1987; Washington Post, 1987).

The years following the 1979 revolution therefore witnessed a series of sanctions and trade restrictions exercised on Iran by the United States. This contributed to an early realignment of Iran’s trade. For example, the 1980 sanctions, while short in duration, heightened the importance of diversification of Iran’s import supply sources, forcing the administration in Tehran to more aggressively seek new economic partners. However, in diversifying the trade routes, traditional pre-revolution suppliers in Western European (Germany, France, and the UK), and Japan were intentionally avoided. It was believed at that time that the US political influence on Japan and Western Europe will limit their ability to freely conduct trade with Iran -- a critical issue at a time of a vicious war with neighboring Iraq. Plans were therefore developed to reduce the country’s overall dependence on these suppliers, and to forge relationships based primary on politics rather than pure economics (Amuzegar, 1993).

While the United States lost its pre-revolution position as Iran’s top supplier, trade and economic relations with smaller European countries, Eastern Europe, Islamic, and non-aligned nations grew significantly. The implementation of such a plan was further enhanced by an Iranian constitution, which had recently been rewritten. The revised 1979 constitution mandated the government to take tight control of Iran’s international trade. Private sector importers were thereafter required by law to obtain prior authorization from government agencies to proceed with their import activities, and as a result, the influence of the government in determining the sources and nature of Iranian imports grew substantially (Amirahmadi, 1990; Amuzegar, 1993).

Control over international trade was also facilitated by a series of selective bilateral agreements. For example, while the US had traditionally been Iran’s primary supplier of wheat, Australia and New Zealand quickly took on that role. Iran’s other commodity requirements - such as meat, sugar and iron - were met through small European countries such as Sweden, Denmark, Italy, as well as eastern block countries such as the Soviet Union, Yugoslavia, Poland and Romania. During this period, the Iranian government also undertook formal schemes, which attempted to limit the trade imbalance, which existed with some OECD countries. This was achieved by restricting the amount of permitted imports from specific countries - such as Japan, Germany, and the UK - to a predetermined proportion of exports to those countries (Amuzegar, 1993; Kavoosi, 1988).

Pre-revolution (1975-78)                   18.5          48.7         15.8          17.0
Revolution and Iraq War (1979-88)           1.8          47.8         13.0          37.4
Postwar Reconstruction (1989-92)            2.1          52.1         11.4          34.4
Dual Containment (1993-96)                  3.3          45.8          8.3          42.6
Iran-Libya Sanctions (1996)                 0.0          44.9          6.4          48.6

Source: Direction of Trade Statistics, International Monetary Fund, Washington, DC; years 1975-1997.
  

With unprecedented controls gained by the government through the new post-revolutionary constitution, a persistent pattern of diversification in Iran’s international trade has since become evident. As a result, the percentage of Iranian imports supplied by traditional suppliers in the US, Western Europe, and Japan declined substantially. Table 1 outlines the trend. While prior to the revolution, these sources typically accounted for more than 80% of imports, in the years following the revolution they accounted for only about 63% of Iran's total import bill. The share of Iran’s imports supplied by non-traditional suppliers more than doubled in this time period. This trend has continued till today, such that by 1996, following the latest round of trade and investment sanctions, the US share of Iran’s imports was nil, and Japan and Western Europe only accounted for half of Iran’s import bill. Between 1995 and 1996 alone, the volume of imports from Iran’s non-traditional suppliers grew by over 8%, as compared to 2% for its traditional suppliers.

With Iran being the second largest producer of OPEC, and its vast oil and gas reserves, the country had historically been dependent on crude oil export revenues as the primary source of foreign exchange. However, during the war, many of Iran’s oil fields and petrochemical facilities -- highly accessible to neighboring Iraq -- were severely damaged. Dependence on the international oil market and the 1986 collapse of crude oil prices further highlighted Iran’s excessive dependence on oil. Expanding non-oil exports was considered as an appropriate strategy in securing the long-term economic health of the country. Therefore, following the war, expansion of industries with strong export potential became a prime objective (Amuzegar, 1993).

Oil and Gas                 94.9%                89.2%                82.3%
Carpets                      1.8                  3.9                  6.6
Fresh & Dry Fruits           1.0                  2.3                  3.3
Leather Products             0.4                  0.4                  0.5
Copper & Metals              0.2                  0.3                  0.7
Caviar                       0.2                  0.2                  0.2
Textiles                     0.1                  0.1                  0.2
Chemicals                    0.1                  0.2                  0.1

 Source: Country Report - Iran, Economist Intelligence Unit, London; years 1980-1997
  

To promote non-oil exports, production in industries with strong export potential - such as handmade carpets and dried fruits - was supported by various government programs. In this period, foreign exchange and customs restrictions on exporters were relaxed, income taxes for non-oil exporters were reduced, and bureaucratic processes were simplified to improve the flow of exports. Since the end of the Iran-Iraq war in 1988, non-oil exports' share of export revenues has therefore been on a rise, as evident by Table 2.

Carpets have been a notable area of growth. Between 1989 and 1992, Iran's carpet exports - the second largest source of export revenues - experienced a three-fold increase from $345 mil per year to $1.2 billion. Similarly, exports of fresh and dry fruits almost doubled, and refined copper and textile exports grew by almost five times. Moreover, in the early 1990's, trade liberalization measures, and the privatization of state owned businesses helped fuel economic activity and significantly increased production in non-oil industries. The net effect was increased flexibility given to private sector exporters, improved local productivity, and special incentives for export oriented business activities. As a result, while in 1989 non-oil exports accounted for less than $1 billion. in annual exports, within three years the number had more than doubled.
 

To slow the momentum of dual containment, during the early and mid 1990's Iran attempted to offer lucrative contracts to American companies, and to improve trade relations with the West. As a result, by 1994, the United States had become Iran’s fifth largest supplier of imports, and American oil companies had become the primary purchaser of its crude oil. However, during this period an emphasis was also placed on developing long-term regional economic partnerships with neighboring countries. For example, a long-term economic cooperation agreement with Russia which had been signed few years earlier made Russia the primary supplier of combat aircraft for Iran's air force, and the suppliers of three diesel powered submarines for the Iranian navy (Defense Daily, 1997). Despite US concerns, Russia also began construction of an $800 mil. nuclear power reactor in southern Iran, and the two countries agreed to set up joint companies to explore and produce Caspian Sea oil.

Iran’s regional partnerships were also facilitated by the breakup of the former Soviet Union, and by the common economic interests shared by its former republics in the region. As a result, Iran assertively developed economic relationships with the republics of the former Soviet Union neighboring it to the north. Many of these relationships were a result of Iran's strategy of wanting to become a regional transit point for gas and oil from Central Asia (Hunter, 1996). Due to unique geographical conditions, much of the oil and gas extracted from Central Asia would be more cost efficiently exported if shipped via Iran through pipelines or swap agreements. As a result, relations with neighbors such as Turkmenistan and Kazakhstan have pivoted primarily on these grounds. One notable agreement is the one reached with Turkmenistan and Turkey for a natural gas pipeline. The 900 mile pipeline will link Iran to Turkey and is to be extended northward to Turkmenistan in order to help export Turkmen gas to Turkey, and eventually to Europe by early next century (Economist, 1996a). Iran and Kazakhstan have also agreed to an oil swap deal, whereby Iranian refineries in the north are supplied with Kazakh oil, in return for shipments of crude oil in the Persian Gulf to Kazakh customers, thereby facilitating Kazakh oil exports through Iranian territory.

During this period, Iran also strengthened its regional partnerships to the east. With the visit by President Rafsanjani to New Delhi in 1995, and the launch of the India-Iran chamber of commerce in that year, economic activity between Iran and India has since increased. The two countries have also formed a joint shipping company, and have finalized plans for a $400 mil. fertilizer project in Iran. Iran has also proposed an extensive pipeline project to both India and Pakistan, which would facilitate the export of Iranian gas using an undersea pipeline passing through Pakistan.

Iran’s relations with its neighbors in the Persian Gulf and with Turkey have also proven to be an effective means for dodging western trade sanctions. These countries have played an instrumental role by becoming re-export centers for Iranian imports. For example, the volume of exports from U.A.E. to Iran between 1978 and 1996 has grown by over five times, most of which consists of re-exports of western-made products. Iran’s relations with Turkey have also pivoted on common regional interests. While both countries share security concerns with their respective Kurdish communities, and although Kurdish intrusions into each others’ territories and internal skirmishes have resulted in diplomatic tension for decades, the common economic interest in the energy resources of the area have often dominated bilateral relations. This was later demonstrated in 1996, where shortly after the announcement of the Iran-Libya sanctions -- to be discussed shortly -- Turkey proceeded to sign a $23 billion. natural gas supply agreement with Iran despite warnings from Washington (Economist, 1996a).

Other countries with which Iran developed closer partnerships during this period include China, Malaysia, and South Africa. China is cooperating with Iran in building Tehran's subway system and is also a key supplier of military hardware, and Malaysia has played a pivotal role in Iran's petroleum industry, by becoming a partner with France's Total in developing two Iranian off-shore oil and gas fields in the Persian Gulf. Relations between Iran and South Africa have also significantly improved in the past few years, as evident by high level visits on both sides. South Africa, which in 1994 began its purchases of Iranian crude for the first time in over a decade, now sources most of its crude oil from Iran.

While the Iranian constitution does not allow production sharing with foreign investors in the oil sector, by the mid-1990's mechanisms for encouraging foreign involvement in petroleum projects were developed as an alternative. In 1995 a buy-back production sharing system was developed by NIOC (National Iranian Oil Company). Under this system, foreign oil companies would be able to invest in an Iranian oil field and recover their investments and associated profits though the sale of the produced oil from the project. In what some analysts consider as an olive branch extended from Iran to the United States, such a contract worth $600 mil. was agreed upon between NIOC and Conoco - a subsidiary of Dupont Corporation - for the development of two offshore oil and gas fields in the Persian Gulf (Project and Trade Finance, 1995). Although the Conoco deal was later canceled, from a symbolic point of view, it could have created a significant shift in US-Iran relations. The deal would have been the first contract awarded by Tehran since the 1979 revolution, involving a foreign entity in both exploration and development of Iranian oil. With Conoco being an American firm, improved economic relations between the two countries was a conceivable outcome.

However, the Conoco deal would have also created a contradiction in US foreign policy of dual containment, at a time when the US was itself persuading its allies to restrict their business dealings with Iran. The Conoco deal not only would have made dual containment hard to sell to American allies, but it also helped raise policy differences between the administration and the Republican dominated congress. These differences further accelerated the momentum of trade sanctions, such that in early 1995 an executive order prohibiting all American companies from any involvement in developing Iran's petroleum industry was issued, and shortly after a total trade ban on Iran went into effect. American companies were prevented by law to conduct any kind of trade with Iran - oil or non-oil - with criminal penalties for violating corporations ranging up to $500,000. Moreover, the export of American goods and services to Iran, and brokering or financing of such trade has since been prohibited (MEED 1995a; 1995b; Oil and Gas Journal, 1995).

Considering Iran’s dependence on oil exports, the focus of the Iran-Libya Sanctions seems to be a logical choice. Iran is OPEC’s second largest producer of crude oil with about 9% of the worlds’ oil reserves. With oil revenues being the biggest contributor to exports, the country has historically been highly dependent on oil production as the primary driver of the economy. Therefore appropriate maintenance of the existing oil and gas fields, exploration and development of new fields, and the construction of pipeline networks are essential. To facilitate such developments, Iranian plans call for billions of dollars of foreign investment. This exactly is where the Iran-Libya Sanctions attempt to strike. By prohibiting US firms' involvement in Iran's oil industry, and restricting that of non-US firms to an investment cap of $20 mil. per year, the policy aims to prevent international assistance in developing Iran's oil sector.

In responding to the Iran-Libya Sanctions, Iran has been faced with several strategic options. One possible strategy has been to focus on local development of the technology required in Iran’s oil facilities, and to not engage foreign partners in investment tasks . This would not only help avoid triggering the sanctions, but also be beneficial in the long-run as it will help create a self-sufficient petroleum industry. Clearly, such an approach would require the know-how an infrastructure needed for manufacturing, and service highly sophisticated petroleum and petrochemical projects. A second option - one, which would pose numerous political risks to the Iranian administration - has been to initiate a dialogue with the United States. Such a dialogue could aim at removing the two countries’ differences, and potentially lead to the removal of the sanctions. Finally, a third possible strategy has been to directly confront the United States. This could be achieved by persuading non-American firms to violate the terms of the sanctions. Such a strategy would capitalize on the international reaction to the extraterritorial nature of the Iran-Libya Sanctions.

While Iran has exercised each of the above strategies to some extent, the strategy of choice seems to have been one of direct confrontation. Following the 1996 announcement of the Iran-Libya Sanctions, only two countries expressed support for the policy, and expressions of concern were voiced by countries such as Japan, Canada, Australia, China, and member countries of the European Union (Economist, 1996b). By restricting the annual investment amount of non-American companies in Iran’s oil industry, the sanctions are dictating US policy beyond American borders, and it is no surprise that the European Union has already drafted retaliatory legislation should the Iran-Libya sanctions be exercised on an EU-based company. Support for the existing sanctions has also been limited by the state of Iran’s international debt. Following the end of the 1980-88 war, Iran underwent an economic revival, reflected by a period of rapid industrial development and its highest import bills in history. To facilitate this growth, a substantial amount of borrowing from international sources took place, such that by the early 1990's the country had accumulated close to $30 billion. of international debt. A series of negotiations have since lead to the restructuring this debt, and as a result, Iran has been committed to billions of dollars of annual loan payments till the turn of the decade. For countries such as Germany, France, Italy, Belgium, and Japan, any policy which targets Iran’s oil production capabilities may also lead to difficulties in recovering billions of dollars worth of Iranian loans.

To further motivate non-US firms to invest in Iranian oil, the authorities have been heavily promoting a dozen lucrative oil and gas development projects. Iranian plans call for a 10 percent increase in oil production capacity by the turn of the decade, and a three-fold increase in the next three decades. To achieve such objectives, the government has offered exceptional terms for companies who invest and participate in these projects. This strategy has successfully attracted large European, Russian, and Far Eastern firms in investing in such projects, thereby directly violating the terms of the Iran-Libya Sanctions. For example in 1997 the French company Total agreed to a $2 billion. project to develop an offshore Iranian gas field. Russian and Malaysian firms have since participated as partners in this project (Oil and Gas Journal, 1997). Other direct challenges to the sanctions have been made through a Canadian-Indonesian joint venture also involved in developing an offshore Iranian gas field, and a German bank financing an Iranian oil development project. In all cases the respective governments have strongly warned Washington against any possible actions, and the White House has been hesitant to enforce the sanctions (Amuzegar, 1997).

While a strategy of direct confrontation seems to have been highly effective for Iran, in recent years a coordinated effort to develop the local infrastructure for supporting the needs of the oil sector has also been evident. This is especially important since the development and maintenance of Iran’s oil industry requires roughly $2 billion of annual imports of parts and services. Iran has therefore setup a series of manufacturing companies, which locally manufacture a wide range of parts heavily used in the oil sector, such as special pipes, valves, and gaskets. The technology for manufacturing such products is either developed locally, or obtained through joint ventures with foreign firms. Moreover, for parts, which could not be locally produced, sourcing has been systematically diverted away from the West. In this effort, considerable assistance has been obtained from the Chinese and Eastern Europeans, who now account for the bulk of imported supplies in the oil industry. The Chinese also have the advantage of holding licenses for western technology, and can therefore provide many of the sophisticated equipment required to build modernized petrochemical plants (Petrossian, 1998).

The final strategy, which has been far less successful, both domestically and internationally for Iran, has been one of reconciliation with the West. With close to two decades of tensions between the US and Iran, efforts to reopen lines of communication have become more evident since mid 1997. President Khatami has begun to recreate Iran’s international image, and in this effort, expressions of a potential dialogue with the "people of America" have been voiced. Although this has helped tone down the position of the White House with respect to Iran (Mossavar-Rahmani, 1998), internal differences in Tehran on how to approach the West have plagued such an effort. A direct dialogue with the US administration is considered unacceptable by many in Iran, and is therefore unlikely to materialize in the near future.

The intensification of trade and investment sanctions since the early 1990's has significantly affected the nature of international competition for Iranian business. The effects of the trade and investment sanctions have however been felt more so by American companies than non-Americans. This is primarily due to the practical difficulty of enforcing US laws beyond US borders, and as a result, in numerous occasions significant business has been lost to non-American firms, immune to the terms of the sanctions. Boeing, Conoco, and BP America are prime examples. In 1993 the US administration turned down a request by Boeing to sell Iran civil aircraft needed for expanding Iran Air’s level of operations. Up until that point, most of Iran Air’s fleet consisted of Boeings, and Iran Air had in the previous year negotiated the purchase of 16 Boeing 737-400's. As a result of the refusal, Boeing lost a $900 mil contract, and Iran Air has since proceeded to purchase from the European aerospace consortium Air Bus. Similarly, in 1993 BP America had negotiated the sale of a chemical fertilizer plant with Iran. The sale was prohibited by the administration on the grounds that the technology may be of a dual purpose nature, resulting in a $100 mil. sales loss to BP America.

The most publicized loss over the economic policy on Iran has been Conoco - a subsidiary of Dupont Corporation . Conoco and the National Iranian Oil company had in early 1995 agreed to a $600 mil. contract for developing two off-shore Iranian oil and gas fields. However, Conoco was forced to withdraw from the contract due to pressure from the administration, and subsequent investment sanctions. This opened the way for France’s Total, which has since commenced work on the project. Total has also proceeded to challenge the latest round of investment sanctions by engaging in a separate $2,000 mil. investment in Iran involving Russian and Malaysian firms.

What is perhaps most disturbing about the current state of the sanctions is that despite their extremeness, they have in practice been unable to achieve their primary objective of halting international involvement in Iran’s oil industry. The Iranian oil industry is in a state of restructuring and development - Iranian oil and gas fields need to be appropriately maintained and developed, and petroleum refining capacity needs to increase in order to keep up with growing local demand. While these projects represent attractive business opportunities, American firms have not been allowed to compete in this market. Meanwhile, violations of the sanctions by firms from Europe and the Far East have remained unchallenged, primarily due to potential retaliatory measures that could result by punishing violating firms. Therefore, while the existing sanctions have locked out American firms from competing in Iran, they clearly represent significant business opportunities for non-American companies operating in Iran’s lucrative oil industry.