A computable general equilibrium model of international sanctions in Iran

• Author: Mohammad Reza Gharibnavaz,Robert Waschik
• Published date: 01 January 2018
• Date: 01 January 2018
• DOI: http://doi.org/10.1111/twec.12528

ORIGINAL ARTICLE

A computable general equilibrium model of

international sanctions in Iran

Mohammad Reza Gharibnavaz

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Robert Waschik

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KPMG, Melbourne, Vic., Australia

2

Centre of Policy Studies, Victoria University, Melbourne, Vic., Australia

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INTRODUCTION

International sanctions have become an important tool for use against a target country to pursue

various foreign policy goals. According to Marinov (2005), there were only five countries affected

by economic sanctions in the 1950s. This number increased to 47 in the 1990s. Advocates of sanc-

tions believe that economic pressures can be effective in altering the target country’s policies with-

out military intervention (Baldwin, 1985; van Bergeijk, 1989). However, others argue that

sanctions on a target country have not resulted in anticipated outcomes while imposing consider-

able costs on citizens who have little influence on the behaviour of their governments (Dixon,

Giesecke, Rimmer, & Rose, 2011; Drezner, 1999; Elliott, 1998; Hufbauer, Schott, & Elliott, 1990;

Pape, 1997).

According to Hufbauer, Schott, Elliott, and Oegg (2007), economic sanctions “mean the delib-

erate, government-inspired withdrawal, or threat of withdrawal, of customary trade or financial

relations.”International economic sanctions are regarded as a less expensive alternative to milit ary

intervention (Kaempfer & Lowenberg, 2007). While broad economic sanctions can be used as a

tool for achieving specific policy objectives such as altering a target country’s political and mili-

tary behaviour through interrupting its economic and diplomatic relations, these measures are

increasingly being employed against weaker and more dependent nations without full consideration

of their impact on the welfare of citizens in these countries, particularly vulnerable groups of

households. The literature of sanctions argues that broad economic sanctions unintentionally dam-

age the well-being of citizens in targeted countries, by deteriorating the quality and access to edu-

cation and public healthcare services and worsening their economic conditions (Cortright, Millar,

Lopez, & Gerber, 2001; Drury & Li, 2006; Weiss, 1999; Weiss, Cortright, Lop ez, & Minear,

1997). As a dramatic example, Pape (1998) cites evidence that suggests that comprehensive UN

sanctions imposed on Iraq in the 1990s had devastating humanitarian consequences, causing the

deaths of as many as 567,000 Iraqi children while significantly reducing Iraq’s GDP.

There is considerable evidence that economic sanctions aimed at imposing hardships on the

economy of a target country can severely disrupt economic activities in sanctioned sectors and

The authors would like to thank participants at the 18th Annual Conference on Global Economic Analysis, Melbourne,

Australia, 2015, two anonymous referees and the editor for helpful comments.

DOI: 10.1111/twec.12528

World Econ. 2018;41:287–307. wileyonlinelibrary.com/journal/twec ©2017 John Wiley & Sons Ltd

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consequently restrict economic growth in the sanctioned country (Andreas, 2005; Crawford &

Klotz, 1999; Dizaji & Van Bergeijk, 2013; Hufbauer et al., 2007; Jacobson, 2008; Neumeier &

Neuenkirch, 2015). Kaempfer and Lowenberg (2007, p. 870) note that there is “no doubt that

embargoes or restrictions on flows of goods and capital impose welfare costs on the target econ-

omy.”While some studies have estimated the aggregate effects of sanctions on target countries,

few if any have employed economic models to estimate the welfare losses imp osed by economic

sanctions on different economic agents and households in sanctioned countries.

Over the past three decades, considerable effort has been expended by the United States (ar-

guably the most prominent actor on the sanctions scene) to induce the international community to

develop a sanctions policy against Iran due to concern over attempts by Iran to develop weapons of

mass destruction and humanitarian concerns. Since 2011/2012, strict economic sanctions have been

imposed by the US, the European Union (EU) and others on Iran’s economy in an attempt to dis-

courage the government of Iran from continuing to engage in the development of a nuclear weapons

capability (Abrams et al., 2012; O’Sullivan, 2010; Schott, 2 012). These recent sanctions have effec-

tively targeted Iranian oil exports, which make up a significant source of revenue for the government

of Iran. In this paper, we seek to analyse the impact of comprehensive economic sanctions on Iran’s

economy in general, on the government of Iran and on households of different socio-economic back-

grounds, especially those from the lower and middle classes of society. But the recent sanctions

against Iran were applied over a period when the government of Iran undertook a major reform of

large domestic subsidies on heavily distorted food and energy products. An examination of the

recent economic performance of Iran would conflate the effects of this significant subsidy reform

with those of the international sanctions against Iran. This problem motivates our use of a compara-

tive static computable general equilibrium (CGE) model to simulate the effects of international sanc-

tions, where we generate counterfactual results which mimic as closely as possible the changes in

Iranian exports and imports of sanctioned commodities. The comparative static “what-if”simula-

tions allow us to model only the effects of international sanctions absent any confounding effects

which would be due to other policies like the subsidy reform undertaken by the government of Iran.

The paper proceeds as follows. Section 2 gives a summary of international sanctions against Iran,

including a description and recent performance of the sectors of the Iranian economy which have been

most strongly affected. This information, particularly the observed decreases in Iranian production

and exports of oil since the strict US and EU sanctions were enforced, is used to validate the perfor-

mance of the CGE model in simulating the effects of international sanctions against Iran. The data

set, production technology and utility functions which comprise the CGE model are described in

Section 3. We populate the CGE model with data on production, consumption and trade from the

Global Trade Analysis Project (GTAP), a popular CGE model used extensively in such exercises. We

augment the GTAP8 data set with information from the Statistical Centre of Iran (SCI) which enables

us to disaggregate private demand to 10 urban and 10 rural consumer groups, and to accurately allo-

cate ownership of factors of production between urban and rural households and the government in

Iran. The latter is of fundamental importance, since international sanctions primarily target Iran’s oil

exports, and the rents derived from the ownership of all capital and natural resources employed in the

production of energy products in Iran accrue to the government of Iran.

The CGE model uses endogenous trade taxes to simulate the effects of sanctions on Iranian

exports and imports of sanctioned commodities. Section 4 reports and interprets quantitative esti-

mates of the effects of economic sanctions on Iranian government revenue and on the well-being

of Iranian rural and urban households. Results suggest that international sanctions could reduce

aggregate welfare in Iran by 14%–15%. To put this result in context, in the 43 cases of sanctions

involving modest changes in target-country policies reported in table 4A.1 of Hufbauer et al.

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