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Where Washington's Iran Policy Went Wrong

The notion that sanctions will cripple the Iranian economy and cause the government to give up its nuclear program is a fallacy. While increasing labor unrest and economic unease make the country more vulnerable to international sanctions, the Obama administration should not expect constructive results from these policies. Sanctions rarely achieve their ultimate political goal, particularly in the case of Iran, which has withstood U.S.-led sanctions for the last thirty years. Rather than imposing further punitive sanctions, integrating Iran into the international community through trade and empowering its private sector is more likely to result in gradual change in the regime's behavior and could create a mutually beneficial environment of gains from trade.

As a result of economic mismanagement at home, Iran is currently experiencing high levels of unemployment and inflation. Some analysts argue that Iran's current economic instability makes it more vulnerable to further economic sanctions. Sanctions that would hinder direct investment, however, would actually help Iran contract its economy in the short run and reduce it's inflation rate (which is essentially the first step in combating supply-sided recessions). When a central bank increases interest rates to contain the inflation rate, the initial increase in interest rates puts a damper on investment spending, which causes a drop in direct investment. With or without further economic sanctions, Iran's economy is going to get worse before it gets better.

Meanwhile, U.S. officials have initiated a set of targeted sanctions on members of the Islamic Revolutionary Guard Corps. These target individuals who were heavily involved in the post-election crackdown and maintain a stake in the country's nuclear program. While the IRGC's role in the Iranian government and economy make it an ideal target, the addition of targeted sanctions is more likely to hurt the broader Iranian public.

Initially established to protect the ideologies of the Revolution from foreign and domestic threats, the Revolutionary Guard eventually emerged as a dominant player in large infrastructure development projects and entered the consumer goods market at the expense of private enterprises. It's monopolization of key sectors displaces traditional business elites and compromises incentives in the marketplace that would otherwise increase efficiency and long term growth. Today, the Revolutionary Guard reaches into nearly every sector of the economy; it manufactures cars, runs laser eye-surgery clinics, builds roads and bridges, develops gas and oil fields, constructs pipelines, and controls black market transactions.

Since President Mahmoud Ahmadinejad took office in 2005, companies affiliated with the Revolutionary Guard have been awarded hundreds of no-bid government contracts in oil, gas, and construction projects. Their dominance over the country's most advanced technological undertakings impedes private-sector growth. They do not face many of the costs that their private-sector competitors face. They run their own trade ports and are not subject to import or export tariffs. Companies affiliated with the Guard are large enough to underbid competitors and are generally favored in the bidding process for large contracts. A lack of transparency creates room for widespread corruption, compromises consumer welfare, and creates economic inefficiency.

Because of the Guard's heavy involvement in the Iranian economy, imposing targeted sanctions on the IRGC risks hurting the broader Iranian public (as long as the private sector remains weakened by existing sanctions). On the other hand, lowering costs for Iran's private sector would facilitate the process of subverting the IRGC's monopoly in the Iranian economy. While a successful sanctions approach that entails broad adherence could further damage Iran's already fragile economy, a targeted sanctions approach against an entity that holds a monopolistic grip in many sectors is more likely to hurt the broader Iranian public and unlikely to achieve the ultimate goal of moderating the regime's behavior.

Iran's convoluted political and economic situation requires an innovative policy approach by Washington. While many U.S. officials insist the current sanctions regime targets government and military personnel, they often forget to address more general trade sanctions, such as those that prevent U.S. and foreign firms from investing in Iran's private sector. These trade sanctions create barriers to entry for the private sector and ultimately strengthen the IRGC's monopolistic grip on the economy. To remedy this, the U.S. should drop existing sanctions against Iran's private sector and instead consider a more constructive policy approach centered on engagement and economic integration.

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