Macroeconomics and Industries

A new era has begun for Iran’s economy. Isolated from the West, and operating in relative autarky, it has an opportunity to reconnect with the global economy following the January 2016 easing of international sanctions. Expectations of rapid growth are running high within the Iranian government, among ordinary Iranians, and in the domestic and international business community.

 

In this report we gauge Iran’s growth opportunity to 2035 through a sector-by-sector examination of the economy’s potential and challenges.

  • As Iran emerges from the sanctions era, it has six core strengths on which to build future growth. Its diversified economy, strong tradition of scientific education, and fast-growing consumer class, along with a high degree of urbanisation, a deeply rooted culture of  ntrepreneurship, and the country’s geographic location between East and West, could all contribute to Iran’s reconnection with the global economy and its future prosperity.
  •  Iran’s very substantial oil and gas reserves will be essential drivers of economic growth, but the country also has many other sectors with the potential to contribute to GDP growth and employment. They include other resource-based industries such as petrochemicals and mining; sectors including automotive, fast-moving consumer goods, and tourism that could become internationally competitive; information and communications technology, banking, insurance, and professional services that will be essential if Iran is to become a knowledge-based economy; and infrastructurerelated industries such as transport, utilities, and construction that would enable growth.
  • Our “micro-to-macro” approach, building a comprehensive picture from sector-by-sector analysis, finds that Iran has the potential to grow GDP by $1 trillion and create nine million jobs by 2035. This implies an economic growth rate of 6.3 percent per year in projected real exchange rates gradually increasing over the next two decades. Such growth would require investment of about $3.5 trillion and would increase global GDP by more than 1 percent.
  • To realise this opportunity, Iran will need to improve productivity and upgrade its industrial infrastructure with an economy better able to attract and absorb domestic and foreign investment, new technology, and modern management practices, a financial system that efficiently channels savings to productive investment and is well connected to international systems, a labour market with greater flexibility and workplace skills and higher labour participation, and a business environment that encourages more dynamic competition and innovation. Transparency, the rule of law, corporate governance, and pace of reforms will also need to be improved.
  • Alongside Iranian firms, international companies could have a significant role to play in building a stronger and more globally competitive Iranian economy. Foreign direct investment dried up during sanctions but is already starting to flow again. Since the implementation in January 2016 of the international nuclear agreement with Iran, many representatives of foreign companies have travelled to Iran to begin talks and, in some cases, sign commercial agreements.
  • Realising Iran’s potential for growth and its full reconnection to the global economy will take time and considerable effort. Not all international sanctions have been lifted, and Iran’s government, whilst expressing its intent to introduce widespread reforms, will need to accelerate its reform agenda. Stability at home and in its international relations will be essential if Iran is to meet the high aspirations of its people for a flourishing economy in the two decades to come.

As Iran now seeks to reconnect with the global economy, accelerate its GDP and employment growth, and meet the aspirations of its young, urban, and upwardly mobile population, it will be able to draw on six core strengths. These are:

  • Economic diversification. Iran has the largest proven gas reserves in the world and the fourth-largest proven oil reserves, and production costs for its oil and gas fields are among the lowest among its peers. These are key assets that will enable the economy to grow. At the same time, Iran’s economy is highly diversified and not overly dependent on oil and gas, which in 2014 accounted for just 23 percent of gross value added, less than many other oil-producing countries in the region. 

 

 

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A thousand years ago, a Persian scholar named Ibn Sina (known also in the  atinate form as Avicenna) wrote The Book of Healing, which became a standard medical text in medieval universities for almost seven centuries. That scientific tradition continues today: 36 percent of Iran’s university graduates in 2013 earned an engineering-related degree.42 Iran ranks in the top five in the world for the total number of engineering-related graduates, almost level with the United States, and ahead of Japan and South Korea . Two Iranian universities rank in the Shanghai list of leading global academic institutions, compared with one in India. Iran also has the world’s fastest-growing scientific output, measured by the number of peer-reviewed papers published in international journals, albeit starting from a low base.

 

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From Brazil to Thailand, one important predictor of rapid economic growth in emerging economies is a rising consuming class with ever-greater spending power—and the aspirations that go with it. Iran has an abundance of that.

Some 56 percent of Iranian households already have annual income exceeding $20,000, a level we define as “consuming households”. The current proportion of consuming households is already more than twice the share in China (24  ercent) and India (21 percent).

Of the BRIC economies of Brazil, Russia, India, and China, only Russia matches Iran, with 55 percent of households having an income above $20,000.

 

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Eight cities in Iran have more than one million inhabitants, the biggest of which—the capital, Tehran—has over eight million residents. With three-quarters of the population living in cities, Iran is more than twice as urbanised as India, and its urbanisation share is also higher than that of several European nations, including Austria, Ireland, Italy, and Portugal. It is far ahead of China, whose urbanisation level is percent.

 Tehran has a bigger GDP than Berlin, Hamburg, Melbourne, Rio de Janeiro, and Rome, when adjusted for purchasing power parity. MGI research has shown how important vibrant cities are to economic growth, so Iran’s degree of urbanisation is an asset.

 

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Spanning from as far north as Armenia or Turkmenistan, the same latitude as New Jersey, to as far south as the Persian Gulf, about the level of mid-Mexico, Iran is the 18th-largest country by area in the world. The country’s size and position historically made it an important stop on east-west and north-south trade routes. The same features could again give rise to a range of benefits, including the potential to be a regional hub for commerce, a centre of diversified trade, and an attractive tourist destination.

Iran borders seven countries with a total population of 430 million. The neighbouring countries represent nearly 40 million consuming households projected to grow at 5.2 percent by 2025.

Even though Iran has among the lowest stock and flows of foreign direct investment in the Middle East, its economy is surprisingly open and it has managed to remain in the global flow of trade despite sanctions.

The pattern of its trade has changed markedly. The United States was Iran’s second-largest trading partner before the 1979 Revolution, with total trade volume as high as $3 billion annually. Trade with the United States and with Western Europe has since dried up, and today the number-one trading partner is China, which accounts for almost 40 percent of all of Iran’s trade. India and Turkey also have boosted their commercial ties, with each taking a 16 percent share of overall trade.

Overall, Iran’s exports have fluctuated in recent years but still amount to about one-third of GDP. That is on a par with Japan and Australia. In absolute terms, Iran exports more than Egypt, Morocco, and Pakistan combined.

 

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Mckinsey Global Institute Report on Iran Economy June 2016

 

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