Economic growth in capacity constraints

Iranian economy:

From this point of view, there is a fundamental difference between economic growth and sustainable economic growth. The production of an economy may increase in a year due to an increase in exports, a temporary improvement in external conditions or the growth of a certain sector, but such an increase does not necessarily mean that the production capacity of the economy has also increased to the same extent. Sustainable growth is formed when, along with increasing production, the necessary capacities for its continuation are also created; That is, investment, productivity, workforce, technology, infrastructure, energy and access to production inputs should be developed enough that the economy can create more production in the following periods.

In other words, today’s production is largely dependent on the capacities that have been created in the past years, and tomorrow’s production is also dependent on the decisions that are made today about investment and development of production capacity. Therefore, the assessment of the economic growth situation is not complete only by observing the growth rate of a period. One should ask where this growth came from, what factors have supported it, and whether a new capacity for future production has been formed behind it. This question is more important in Iran’s economy; Because the experience of the past years shows that the country’s economic growth is significantly affected by the performance of the oil sector, foreign exchange earnings, foreign trade conditions and investment.

The growth of the oil sector and the increase in its exports, in addition to the direct effect on production, also affects other sectors of the economy by increasing foreign exchange earnings and making it possible to import capital and intermediate goods. For this reason, oil in Iran’s economy is not just one of the components of production, but in periods it has been one of the most important channels for transferring growth to industry, services and other economic activities. On the other hand, when this channel is weakened, its effects are not limited to the oil sector itself. The decrease in foreign exchange earnings can limit the import of machinery and inputs required for production, affect the activity of the industry and at the same time affect the service sector through the reduction of income and demand.

Therefore, to analyze the growth of Iran’s economy, it is necessary to pay attention to the sectoral structure of production and the link between the oil sector, foreign trade, investment and the activities of other sectors. The year 1404 was a clear example of this situation. The country’s economic growth, including oil, was recorded at about 0.2%; While the growth in 1403 was about 3.1%. This year, oil and natural gas extraction, despite the positive growth, could not alone create a base for the extensive growth of the economy. On the other hand, the decrease in the added value of agriculture and industry and weakness in some energy-related sectors neutralized an important part of the positive effect of oil. As a result, the positive growth of 1404 was the result of the unbalanced performance of several limited sectors rather than the coordinated movement of different sectors of the economy. According to chart 1, the seasonal trend of growth also shows that even the limited growth of 1404 did not have sufficient stability and continuity. The seasonal growth reached from minus 0.2% in spring to around 0.5% in summer and 2.7% in autumn, but it decreased again to around minus 2.2% in winter. This path shows that the positive annual growth of 1404 was not the result of a uniform and stable trend, but was accompanied by significant fluctuations throughout the year.

However, the main significance of the chart becomes apparent in 1405. In the spring of this year, economic growth, including oil, reached negative 10.1%. In separating the share from the growth, the decrease in oil and natural gas production alone is about 6.74 percent of the growth; But services, water supply, electricity and gas, industry and construction all had a negative contribution and agriculture had only a limited contribution in the positive direction. From this point of view, the drop in the spring of 1405 cannot be considered as an oil drop only; Rather, we are facing a contraction that covers different sectors of the economy at the same time. This point becomes more important considering the negative growth of 4.6% of the economy without oil. In other words, even after removing the direct effect of oil, a significant part of the economy has been on the path of contraction.

Therefore, the issue of spring 1405 should be analyzed beyond the fluctuations of oil production and in the framework of simultaneous weakness of production sectors and factors affecting demand and investment. This situation has been formed in a situation where Iran’s economy has faced accumulated restrictions in the fields of investment, energy, foreign trade and uncertainty. The outbreak of war and the escalation of geopolitical risks in the spring of 1405 could also have intensified the pressure on the economy through trade, transportation and disruption of some production activities. However, since the war covered only part of the season and national accounts do not allow disentangling the causal effect of each factor, the entire decline in growth cannot be attributed to this event.

Part of this reduction is based on the weaknesses that were previously accumulated in the economy. For this reason, uncertainty in the current situation is not just a mental or behavioral variable; Rather, it can directly affect the growth capacity by postponing investment decisions, shortening the planning horizon of companies and changing the direction of resources from long-term investment to current needs. In an economy where investment is already weak, the escalation of uncertainty can reveal its effects not only in current production, but also in the production capacity of the coming years. One of the most important signs of such a situation is investment behavior. The formation of gross fixed capital has decreased by 8.4% in the spring of 1405. In the same period, investment in machinery has dropped by 9.7% and construction investment by 6.4%. The importance of this reduction is not only due to its effect on today’s demand; Capital formation determines how much capacity the economy will have for production in the coming years. Therefore, the decline in investment should be considered simultaneously as a factor weakening current growth and a warning about future growth capacity.

In fact, when the economy does not invest enough for a long period of time, the problem goes beyond a short-term fluctuation and becomes a capacity problem. The economy may be able to maintain a level of production for some time by using existing capacities, but without equipment modernization, capital development and productivity improvement, continued growth will be limited. On the other hand, the expenditure side also shows that the spring of 1405 was accompanied by the simultaneous weakening of several growth engines. According to chart 2, in the spring of 1405, private final consumption cost decreased by 4%, government final consumption by 1.7%, and gross fixed capital formation decreased by 8.4%. At the same time, the export of goods and services decreased by 35.7% and the import decreased by 14.8%. Among the expenditure components, net exports have decreased by 7.55 percentage points from growth; Private consumption around 1.69 percentage points, machinery investment around 0.95 percentage points, construction around 0.39 percentage points and government consumption around 0.2 percentage points also had a negative effect.

This combination provides a clear picture of the state of the economy: in the spring of 1405, the economy has not faced the weakening of one growth engine, but the simultaneous weakening of several main growth engines. Domestic consumption has decreased, investment has decreased, and at the same time, the foreign trade channel has become one of the main factors of growth reduction instead of supporting growth. This situation is significantly different from 1404. In that year, net exports were able to partially compensate for the weakness of some domestic components; But in the spring of 1405, this component has become the biggest factor reducing growth on the expenditure side. As a result, the recent drop is not the result of a single factor, but the result of the interaction of external shock, weak domestic consumption, investment decline and supply side constraints.

In such a situation, the question about the role of financing becomes more important. If one of the basic issues of the economy is the weakness of investment and the reduction of production capacity, it is natural that the increase of financial resources is one of the considered policies. However, the experience of 1404 shows that there is an important gap between “equipment of financial resources” and “realization of economic growth”. In such a situation, the issue of financing becomes more important. It is natural that when investment decreases, the policy maker seeks to equip more resources for investment.

Pursuant to paragraph “a” of article (3) of the law of the 7th five-year plan of progress, the formulation of the financing plan for targeted economic growth for the next year and the determination of how to provide financial resources from different paths have been taken into consideration. In the same framework, a program was formulated for the year 1404 with the aim of supporting 8% growth, and a set of capacities of the banking network, capital market, government resources, foreign investment, national development fund and other sources were considered to finance the required investment. But the experience of 1404 revealed a fundamental point: equipping and allocating financial resources, even on a significant scale, by itself does not mean the realization of economic growth. In the year when several financing capacities and mechanisms were designed to support the targeted growth, the output of the economy was still a very limited growth and the annual growth rate reached about 0.2%. This experience cannot be attributed solely to insufficient financial resources.

The more fundamental problem is that the financial resources are not the same as the real resources of the economy. Investment requires machinery, raw materials, energy, labor, technology and market. A part of these resources should be released from domestic production and if they are not available inside, they should be provided through foreign trade and access to foreign currency and capital. Therefore, even if financial resources are provided, if there are no necessary conditions to convert them into real investment, its effect on growth will be limited. For this reason, in a situation where uncertainty has increased, foreign trade is facing restrictions, energy is facing disharmony, and investment has decreased, more financial resources may be used to maintain existing production, provide working capital, and overcome current conditions, instead of creating new capacity.

In such a situation, an increase in financing does not necessarily lead to an increase in production capacity. From this point of view, the experience of 1404, along with the developments of the spring of 1405, puts an important issue in front of the growth policy: Iran’s economy is not only facing the problem of lack of financial resources; It faces the problem of converting financial resources into productive investment and converting investment into real production capacity. Sustainable growth is formed when there is compatibility between financial resources and real resources of the economy, between investment and production capacity, and between production and the possibility of selling it in the domestic and foreign markets. Otherwise, the economy may grow at times depending on a certain sector, a positive external shock or an increase in demand, but this growth may not be sustainable.

From this point of view, the spring of 1405 is more than just a negative number in the national accounts, it is a warning about the future growth capacity of the economy. The simultaneous drop in production, investment, consumption and foreign trade shows that the issue of growth now exceeds the level of short-term fluctuations and is tied to production and investment capacities. Therefore, the main question about economic growth is no longer simply how much financial resources can be mobilized? Rather, under what conditions can Iran’s economy increase its real production capacity with equipped resources? The gap between the answers to these two questions is the same gap between financing and economic growth, and finally, between short-term growth and sustainable growth.

Seyyed Amirhossein Mousavi / PhD student in monetary economics