Iran has a mixed economy that is heavily dependent on export earnings from the country's extensive petroleum reserves. Oil exports account for nearly 80 percent of foreign exchange earnings. The constitution mandates that all large-scale industries, including petroleum, minerals, banking, foreign exchange, insurance, power generation, communications, aviation, and road and rail transport, be owned publicly and administered by the state. Basic foodstuffs and energy costs are heavily subsidized by the government. Although economic performance improved somewhat during 1999 and 2000 due to the worldwide increase in oil prices, performance is affected adversely by government mismanagement and corruption. Unemployment was estimated to be as high as 25 percent, and inflation was an estimated 22 percent. Iran's gross national product (GNP) is the highest in the Middle East, although its GNP per capita is comparatively low because of Iran's large and growing population.
From medieval times until the 20th century, the socioeconomic structure of Iran remained almost unaltered. Only half of the population was settled; the remainder were tribal nomads, mainly engaged in the herding of grazing animals. A system of land assignment was in place, similar to the medieval European system of feudalism, under which the ruler, the shah, granted land to loyal subjects who became absentee landowners, collecting taxes from the peasants on their land. Economic activity further suffered from the handicaps of topography and climate, as well as prolonged political and social insecurity (with constant pressure by foreign powers). Things began to change when Reza Shah Pahlavi, a colonel in the Persian army and founder of the Pahlavi dynasty, seized the throne in 1925 and initiated a modernization of Iran's political and economic system, while also changing the country's name from Persia to Iran.
Following World War II the new shah, Mohammed Reza, guided the economy through public planning, urbanization, industrialization, and investment in the infrastructure , and achieved sustained growth, all supported by substantial oil revenues. Compared with other third world countries during the period from 1960-77, Iran's annual real growth rate of nearly 9.6 percent was about double the average. Therefore, one explanation for the Islamic revolution of 1979 is that the modernization program imposed by the shah was too rapid for the Iranian people, who wished to hold on to their traditional values and ways. Another view suggests that in fact, the shah failed to modernize rapidly enough. The Iranian economic and social infrastructure was found increasingly inadequate to meet expectations, despite rising oil revenues that produced a superficial modernism. The standard of living did increase in Iran during the early 1970s, when per capita income rose from US$180 per year just before the massive oil price increase to US$810 in 1973-74, and up to an estimated US$1,521 just one year later. During the last years of the shah's reign, per capita income rose less rapidly and living costs soared. By 1978, the typical rent for a house in Esfahan had risen from about US$70 per month in 1973 to over US$500 a month, while a typical salary was still below US$2 per hour. In addition, corruption had become widespread.
In 1979 an Islamic revolution ousted Shah Mohammed Reza Pahlavi from power and placed the Shiite clergy in control of the government of the country. The revolution was followed by trade sanctions and the freezing of Iranian assets in the United States after radical Iranian students stormed the American embassy in Tehran and held embassy staff as hostages. These measures and the war which broke out between Iran and Iraq in September 1980 and lasted for 8 years harmed the development of the Iranian economy considerably. Since that conflict, efforts to resume broad economic development and diversification have been hindered by volatile world oil prices, by internal structural weaknesses and rampant inflation, and by persistent political tensions with the West, especially with the United States, which still considers Iran to be the most active state sponsor of terrorism, supporting extremist groups such as Lebanon-based Hezbullah and the Palestinian Hamas.
The most remarkable features of the post-revolutionary Iranian political and economic scene are the influence of the so-called bazaar and the bonyad . The bazaar refers to Iran's traditional import-export markets, the leaders of which wield considerable influence over economic policy. These leaders, known as bazaaris, showed their power in 1978 by calling a series of strikes, paralyzing Iran's economy and speeding up the departure of the shah. Since the revolution the bazaaris have enjoyed a close relationship with the Islamic regime, benefiting from lucrative business contracts in exchange for funding individual mosques and conservative parliamentary and presidential candidates. The bazaar also provides an informal banking service to the private sector and is responsible for much of the black-market trade in currency; as a result, bazaaris tend to oppose exchange-rate reunification. In broad terms, they also oppose wider economic reform, the reduction of tariff barriers, and the greater participation of foreign investors in the economy.
The bonyad (religious foundations) were created after the revolution to safeguard the Islamic Republic's revolutionary principles and to attend to the plight of the poor. While providing much-needed welfare support for the families of those killed or wounded in the Iran-Iraq war, the bonyad have exploited their position to become multi-billion dollar conglomerates controlling large portions of the Iranian economy, especially properties and businesses taken from the Pahlavi family and individuals associated with the monarchy. The larger bonyad, such as the Bonyad-e Mostazafan (Foundation of the Oppressed) and Bonyad-e Shahid (Foundation of the Martyrs), oppose better relations with the West and the liberalization of the economy, fearing that foreign investment in Iran could threaten their economic empires.
In the early 1990s, Iran faced a huge foreign debt and other serious economic dislocations stemming from the nearly decade-long Iran-Iraq war (1980-88), while its population continued to grow at a rapid pace. Most of the economic resources were allocated through the vast public sector , widespread price controls , extensive trade and exchange restrictions, heavily subsidized energy and petroleum products, and protective labor and business practices. With oil prices changing considerably during the 1980s, planning became difficult and resulted in inflation, since the government did not want to borrow on international markets, but financed war-related and other expenses through the central bank. Between 1981-82 and 1984-85, the real GDP had grown by about 8 percent annually, which reflected oil production and export recovery after the low-point during and in the immediate aftermath of the revolution. But when oil prices fell to a historic low in 1987-88, this drop was also reflected in the economy at large, and Iran witnessed a negative growth rate of 10 percent.
After the war, efforts were made to revive oil exports and to shift the economy onto a peacetime basis. Through the 1990s, attempts at privatizing public enterprises, liberalizing prices and the exchange system, removing tariff barriers, and lowering income taxes to encourage investment were made. During the First 5 Year Development Plan (1989-94), these measures worked well and the economy grew in real GDP terms at an average annual rate of 7 percent. While the First 5 Year Development Plan focused on infrastructure development and reconstruction programs, the Second 5 Year Development Plan (1994-99) concentrated on Iran's financial problems. The sharp drop of oil prices in 1998-99 forced the government to abandon structural reforms and brought about a budget deficit of US$2.1 billion, which was financed by monetary expansion, thus accelerating inflation from 17 percent in 1997-98 to 25 percent in 1998-99.
The reformist president Khatami, elected in 1997, has continued to follow the market reform plans of his predecessor, President Rafsanjani, and has indicated that he will pursue diversification of Iran's oil-reliant economy, although he has made little progress toward that goal so far, mainly because of Iran's dependence on oil and the decline in oil prices in the first 2 years of his government. A broad program of economic adjustment and reform was issued in August 1998 to form the Third 5 Year Development Plan (2000-05). It involves restoring market-based prices, reducing the size of the public sector and encouraging private sector investment. As a result, domestic petroleum prices were raised by 70 percent in 1999, and a more market-based official exchange rate was introduced on the Tehran Stock Exchange (TSE).
The recovery of oil prices during 1999-2000 significantly strengthened Iran's external and financial position. Although annual GDP growth remained weak at 2.4 percent and the inflation rate remained almost unchanged at 20 percent, the government incurred a large budget surplus of about US$4.7 billion and hurried to pay external debt , reducing outstanding debt to about 10 percent of the GDP. The Third 5 Year Development Plan aims at accelerating growth to an average annual rate of 6 percent in order to create sufficient employment opportunities for the rapidly growing labor force , which currently increases by an estimated 5 percent every year.