Subsidy and natural resource curse: Evidence from plant level observations in Iran

Using plant level panel data of manufacturing firms in Iran from 2003 to 2013, we test the Dutch disease predictions, including the impact of a rise in oil prices on intensive and extensive margins of trade. Our findings indicate that during periods of high oil prices domestic currency appreciates, but contrary to resource curse theories, domestic firms export more, and new firms enter foreign markets. We reconcile this paradox by proposing a new channel, which we call “subsidy disease.” Despite rising oil prices, the government of Iran kept domestic energy prices at low levels, which increased the implicit subsidy accruing to energy intensive firms. In effect, these firms gain a competitive advantage in foreign markets because of the increased subsidy. We show that energy intensive plants export more when the oil price is high. Moreover, consistent with natural resource curse models, we show that the average wage increases during periods of high oil prices, but much less for exporting firms. We also find robust evidence that high oil prices reduce investments of manufacturing firms.