The Lifting of Economic Sanctions on Iran: Global Effects and Strategic Responses

This paper quantifies the global economic effects and strategic responses to the lifting of economic sanctions on Iran. The proposed lifting of sanctions, following its July 14, 2015 nuclear agreement with the permanent members of the UN Security Council and Germany (“P5+1”), will have consequences for the global, regional, and Iranian economies. The global effects will be felt mostly through the oil channel. The resumption of Iranian oil exports to pre-2012 levels could eventually add one million barrels per day on the world oil market, bidding down world prices. There will also be regional effects on Iran’s major trading partners, including the United Arab Emirates and other countries in the Middle East and Central Asia, through an expansion of oil and non-oil trade, as sanctions-induced trading costs come down. Finally, there will be effects on Iran’s economy as barriers to trade are relaxed, the production mix shifts in favor of goods that fetch high prices abroad and its consumption towards cheaper imports, with attendant effects on economic growth, efficiency and household welfare. This paper quantifies the economic effects of the lifting of sanctions on Iran using a modified version of the GTAP 9 database (Narayanan et al., 2015) and a global, computable general-equilibrium (CGE) model, GTAP, documented in Hertel (1997). CGE models capture the interaction between producers and consumers in the economy, mediated through the price mechanism. The global CGE model also captures the trade flows between countries and solves for a set of world prices that equilibrate global supply and demand. We use the model to simulate the effect of a “shock”, such as the removal of a trade embargo, on the market-clearing prices at the global and national levels. We are therefore able to isolate the consequences of the lifting of sanctions from other ongoing developments in the economy. Since the model captures the new equilibrium of an economy that has been perturbed, the time horizon of a simulation is best thought of as medium term, i.e. three to five years. In our simulations, the lifting of economic sanctions on Iran has three components. The first is the lifting of the EU oil embargo. The 2012 restrictions on imports of Iranian oil by the EU were the most far-reaching of the sanctions as they curtailed the volume of exports of Iran’s most important export commodity. Thus, the removal of the EU oil embargo is expected to have the largest macroeconomic impact on Iran and the rest of the world as oil accounts for about 64 percent of Iranian export revenue and Iran has a relatively large share (8 percent) of total world exports. The second component is the removal or significant reduction of the cargo inspections on Iranian exports and imports that were imposed as part of the sanctions regime. Transport costs on trade with Iran are expected to decline. This in turn will have an effect on Iran’s merchandise trade and boost in particular exports and imports of bulky goods and other goods with large transport margins, such as agricultural and industrial products and machinery. The third component is associated with improvements in non-tariff barriers affecting Iran’s cross-border imports of financial and transport services. As the US and other partners lift restrictions on financial transactions and transport services, Iran’s imports of these services are expected to rise. Simulations with the model show that gains from the embargo removal are the largest for Iran, resulting in a welfare gain of about $18 billion to the economy, or an increase in per capita welfare of 3.7 percent. Almost half of these gains (1.7 percent or approximately $8.2 billion) stem from the lifting of the EU oil embargo, while the reduction in trade costs and improvements in conditions for cross-border services trade result in additional gains of $2.0 billion and $7.5 billion, respectively. The gains to Iran will be 22 percent lower if Iran’s oil exports to the EU do not recover completely but reach only half of their pre-sanction levels. This may be a more likely outcome since a full bounce back may not be possible in the medium term due to various impediments to oil production and exports, including a range of technical constraints on crude oil extraction and high domestic oil demand, to name a few. In the global economy, net oil importers gain and net oil exporters lose as the world price of oil declines by about 13 percent due to the additional amount of oil sold on the global market. The gains to the EU and the US, both net oil importers, are sizable in absolute terms $67 billion and $34 billion but small in relative terms as per capita welfare increases by slightly less than a half of a percent in the EU and a quarter of a percent in the US. The losses are steepest for OPEC members, especially the GCC, which are expected to lose 3.9 percent in per capita welfare (equivalent to $55 billion in 2011 prices). Per capita welfare for other OPEC members and Russia declines by 2.9 percent ($19 billion) and 1.6 percent ($30 billion), respectively. The rest of the world is not significantly affected by the reduction in Iran’s trade costs because Iran is responsible for a negligible share of the world’s non-oil exports. Overall, the removal of Iran’s economic sanction translates into a gain for the world economy of $53 billion. Iran gains the most in per capita terms, while the losses of oil exporting countries are large and of similar absolute magnitude to Iran’s gains. The paper also considers the strategic responses of different trading blocks to the lifting of the sanctions. Major oil exporters may limit their own oil output and exports in order to stabilize world oil prices. We assess the effect of such a strategic move in combination with the lifting of Iran’s sanctions. Recognizing that Iran’s policy responses will have a substantial effect on the country’s ability to benefit from the lifting of sanctions, we consider the effects of two policy reforms: (i) unilateral reduction of tariffs on imported capital goods and (ii) reforms intended to boost automobile production. Finally, we assess the effects of improved market access for Iranian exports in western markets in response to credible signs of successful implementation of the nuclear agreement. We find that if major OPEC members limit the quantity of oil produced and exported in order to leave the world price of oil unchanged, the global welfare gains from the removal of the EU oil embargo would be significantly reduced. Compared to the baseline scenario, world-wide welfare gains decrease by 70 percent, from $54 billion to $16 billion. Iran’s welfare gains are enhanced and the losses to oil exporting countries reduced, but not by enough to compensate for the oil importers’ reduced welfare gains. The benefits to Iran will also increase if the lifting of the embargo is accompanied with national economic reforms that strengthen the supply response. With a reduction of tariffs on imports of capital goods, welfare gains are expected to be $1.8 billion larger for Iran than in the baseline scenario. Policies that encourage the expansion of automobile production to pre-sanction levels would translate into even higher gains. Given the importance of this industry to the Iranian economy, these reforms translate into a 40 percent boost to welfare or $7 billion. Exports of automobiles are found to increase by more than two-fold benefiting all factors of production but most significantly the returns to capital and skilled labor. Finally, improved market access to the west benefits not only Iran, but also the market-access-granting countries. The supply response will be stronger and the welfare effects larger if investment in general, and foreign direct investment in particular, picks up.