The Nationalizing of Iranian Oil – An
Economic Analysis
Ali
Memarsadeghi[1]
This paper examines the relevant events and apparent forces surrounding the nationalizing of Iranian oil and the subsequent CIA-induced coup of Prime Minister Mohammed Mossadegh. Using economic analysis integrating neo-classical forces with additional considerations, we will gain insight regarding the events, suggesting policy prescriptions that will reduce the chance of encountering such conflicts in the future.
Introduction
Mohammed Mossadegh was the leading representative of an Iranian interest that enacted the Oil Nationalization Act of March 15, 1951, expropriating the Anglo-Iranian Oil Company’s operations in Iran, in direct opposition to British oil interests. In reaction the British ultimately persuaded the United States to help orchestrate the August 1953 coup that restored monarch Mohammad Reza Pahlavi to power. While much has been written on the matter, modern economic theory has not informed the discussion. This paper attempts to apply theory to the matter, simultaneously advancing understanding of the events and building on a general framework for modern development analysis.
The framework used builds on Douglass North’s (1995) New Institutional Economics, adding detail to the considerations of power, rationality and optimal government. The events examined demonstrate the potential of economic interest to override moral considerations in government decision-making. Furthermore, they suggest that the first step in ensuring conflict-free development is to ensure that the institution-managing governments of the world are free from corruption and truly representative. Otherwise, decisions will be made which will eventually lead to unrest at perceived injustice.
In Section 2, excerpts from Wikipedia[2] summarize the relevant historical facts. While the accounts surely contain errors due to the nature of Wikipedia, they nonetheless shine light on certain unmistakable objective truths about the sequence of events. For example, no one can doubt that oil interests were central to the conflict or that the US and Britain influenced Iran’s political development. It is only these obvious facts that are used for analysis. The section is meant to give a sense of the relevant history to those unfamiliar with the subject. Those who are familiar with the history may proceed directly to Section 3, which presents an analytical framework building on the New Institutional Economics of Douglass North (1995). Section 4 applies the theory to the case at hand, shedding light on both the history and potential improvements to a general model of economic development. Section 5 concludes.
The following
is a brief overview of the development of the Iranian oil industry from birth
until the Oil Nationalization Act of 1951:
The
Anglo-Persian Oil Company (APOC) was founded in 1909 following the discovery of
a large oil field in Masjed Soleiman, Iran. It was the first company using the
oil reserves of the Middle East. APOC was renamed in 1935 to Anglo-Iranian Oil
Company (AIOC) and eventually became the British Petroleum Company (BP) in
1954, as one root of the BP Company today.
The
D'Arcy Oil Concession was granted to the British during the reign of Mozzafar
al-Din Shah Qajar, giving control of Iranian oil reserves to Britain for 60
years. William Knox D'Arcy had
negotiated a 60-year oil concession with the Shah of Persia in 1901 but within
a few years was almost bankrupted by the cost of exploration. He sold his interest to the Burmah Oil
Company Ltd., who created APOC as a subsidiary and also sold shares to the
public.
Volume
production of Persian oil products eventually started in 1913 from a refinery
built at Abadan. The British government, at the impetus of Winston Churchill,
First Lord of the Admiralty, partly nationalized the company in 1913 in order
to secure British-controlled oil supplies for its ships.
By
1927, Iranian popular opposition to the D'Arcy oil concession and royalty terms
whereby Iran only received 16 percent of net profits was widespread. Since
industrial development and planning, as well as other fundamental reforms were
predicated on oil revenues, the government's lack of control over the oil
industry served to accentuate the Iranian government's misgivings regarding the
manner in which APOC conducted its affairs in Iran. Such a pervasive atmosphere
of dissatisfaction seemed to suggest that a radical revision of the concession
terms would be possible. Moreover, owing to the introduction of reforms that
improved fiscal order in Iran, APOC's past practice of cutting off advances in
oil royalties when its demands were not met had lost much of its sting.
The
attempt to revise the terms of the oil concession on a more favorable basis for
Iran led to protracted negotiations that took place in Tehran, Lausanne, London
and Paris between Abdolhossein Teymourtash, Iran's Minister of Court from
1925-1932 and its nominal Minister of Foreign Affairs, and the Chairman of
APOC, John Cadman, 1st Baron Cadman, spanning the years from 1928 to 1932. The
overarching argument for revisiting the terms of the D'Arcy Agreement on the
Iranian side was that its national wealth was being squandered by a concession
that was granted in 1901 by a previous non-constitutional government forced to
agree to inequitable terms under duress. In order to buttress his position in
talks with the British, Teymourtash retained the expertise of French and Swiss
oil experts.
Iran
demanded a revision of the terms whereby Iran would be granted 25% of APOC's
total shares. To counter British objections, Teymourtash stated that if this
had been a new concession, the Persian Government would have insisted on 50% of
APOC's total shares. In addition, he
specified that the company was to reduce the existing area of the concession.
The intent behind reducing the area of the concession was to push APOC
operations to the southwest of the country so as to make it possible for Iran
to approach and lure non-British oil companies to develop oilfields on more
generous terms in areas not part of APOC's area of concession.
Apart
from demanding a more equitable share of the profits of the Company, an issue
that did not escape Teymourtash's attention was that the flow of transactions
between APOC and its various subsidiaries deprived Iran of gaining an accurate
and reliable appreciation of APOC's full profits. As such, he demanded that the
company register itself in Tehran as well as London, and the exclusive rights
of transportation of the oil be cancelled.
In
the face of British preverification, Iran decided to demonstrate its misgivings
by upping the ante. Apart from encouraging the press to draft editorials
criticizing the terms of the D'Arcy concession, a delegation consisting of Reza
Shah, and other political notables and journalists was dispatched to the close
vicinity of the oilfields to inaugurate a newly constructed road, with
instructions that they refrain from visiting the oil installation in an
explicit show of protest.
In
1931, Teymourtash, who was traveling to Europe to enroll Crown Prince Mohammed
Reza Pahlavi at a Swiss boarding school, decided to use the occasion to attempt
to conclude the negotiations. The following passage, from 1st Baron John Cadman
confirms that Teymourtash worked feverishly and diligently to resolve all
outstanding issues and succeeded in securing an agreement in principle:
"He
came to London, he whined and he dined and he spent day and night in
negotiating. Many interviews took place. He married his daughter, he put his
boy to school [Harrow], he met the Secretary of State for Foreign Affairs, a
change took place in our government, and in the midst of all this maze of
activities we reached a tentative agreement on the principles to be included in
the new document, leaving certain figures and the lump sum to be settled at a
later date."
However,
while Teymourtash likely believed that after four years of exhaustive and
detailed discussions, he had succeeded in navigating the negotiations on the
road to a conclusive end, the latest negotiations in London were to prove
nothing more than a cul de sac.
Matters
came to a head in 1931, when the combined effects of overabundant oil supplies
on the global markets and the economic destabilization of the Depression, led
to fluctuations which drastically reduced annual payments accruing to Iran to a
fifth of what it had received in the previous year. In that year APOC informed
the Iranian government that its royalties for the year would amount to a mere
366,782 pounds, while in the same period the company's income taxes paid to the
British Government amounted to approximately 1,000,000. Furthermore, while the company's profits
declined 36 percent for the year, the revenues paid to the Iranian government
pursuant to the company's accounting practices, decreased by 76 percent. Such a
precipitous drop in royalties appeared to confirm suspicions of bad faith, and
Teymourtash indicated that the parties would have to revisit negotiations.
However,
Reza Shah was soon to assert his authority by dramatically inserting himself in
to the negotiations. The Monarch attended a meeting of the Council of Ministers
in November 1932 and after publicly rebuking Teymourtash for his failure to
secure an agreement, dictated a letter to cabinet canceling the D'Arcy
Agreement. The Iranian Government notified APOC that it would cease further
negotiations and demanded cancellation of the D'Arcy concession. Rejecting the
cancellation, the British government espoused the claim on behalf of APOC and
brought the dispute before the Permanent Court of International Justice at The
Hague, asserting that it regarded itself "as entitled to take all such
measures as the situation may demand for the Company's protection." At
this point, Hassan Taqizadeh, the new Iranian Minister to have been entrusted
the task of assuming responsibility for the oil dossier, was to intimate to the
British that the cancellation was simply meant to expedite negotiations and
that it would constitute political suicide for Iran to withdraw from
negotiations.
After
the dispute between the two countries was taken up at The Hague, the Czech
Foreign Minister who was appointed mediator put the matter into abeyance to
allow the contending parties to attempt to resolve the dispute. Ironically,
Reza Shah, who had stood firm in demanding the abolishment of the D'Arcy
concession, suddenly acquiesced to British demands, much to the chagrin and
disappointment of his Cabinet. A new agreement with the Anglo-Persian Oil
Company was agreed to after Sir Cadman visited Iran in April 1933 and was
granted a private audience with the Shah. A new agreement was ratified by the
Majlis on May 28, 1933 and received Royal assent the following day.
The
terms of the new agreement provided for a new sixty-year concession. The
Agreement reduced the area under APOC control to 100,000 square miles, required
annual payments in lieu of Iranian income tax, as well as guaranteeing a
minimum annual payment of 750,000 pounds to the Iranian government. These
provisions, while appearing favorable, are widely agreed to have represented a
squandered opportunity for the Iranian government. The agreement extended the
life of the D'Arcy concession by an additional thirty-two years, negligently
allowed APOC to select the best 100,000 square miles, the minimum guaranteed
royalty was far too modest, and in a fit of carelessness the company's
operations were exempted from import or customs duties. Finally, Iran
surrendered its right to annul the agreement, and settled on a complex and
tediously elaborate arbitration process to settle any disagreements that would
arise.
The
Anglo-Persian Oil Company continued its large Persian operations although it
changed its name to the Anglo-Iranian Oil Company in 1935. By 1950 Abadan had
become the world's largest refinery. In spite of diversification the AIOC still
relied heavily on its Iranian oil fields for three-quarters of its supplies,
and controlled all oil in Iran. The Iranian government wanted to take a
significant share in the company, and would not negotiate when only offered a
larger share of revenues. This culminated in the nationalization of the oil
industry in 1951.
--Wikipedia[3]
The following is a summary of the response to
the Oil Nationalization Act of 1951:
Responding
to the act, the British government announced it would not allow Mossadegh's government
to export any oil produced in the formerly British-controlled refineries. A
blockade by British ships was established in the Persian Gulf to prevent any
attempts by Iran to ship oil out of the country. Furthermore, the AIOC withdrew
its British trained technicians when Mossadegh nationalized the oil industry.
Thus, many of the refineries lacked properly trained technicians that were
needed to continue production. An economic stalemate thus ensued, with
Mossadegh's government refusing to allow any British involvement in Iran's oil
industry, and Britain refusing to allow any oil to leave Iran.
Since
Britain had long been Iran's primary oil-consumer, the stalemate was
particularly hard on Iran. While the country had once boasted over a 100
million dollars a year in exports to Britain, after nationalization, the same
oil industry began increasing Iran's debt by nearly 10 million dollars a month.
The Abadan Crisis quickly plunged the country into economic difficulties.
Despite
the economic hardships of his nationalization plan, Mossadegh remained popular,
and in 1952 was approved by parliament for a second term. Sensing the
difficulties of a worsening political and economic climate, he announced that
he would ask the Shah to grant him emergency powers. Thus, during the royal
approval of his new cabinet, Mossadegh insisted on the constitutional
prerogative of the prime minister to name a Minister of War and the Chief of
Staff. The Shah refused, and Mossadegh announced his resignation.
Ahmad
Qavam was appointed as Iran's new prime minister. On the day of his
appointment, he announced his intention to resume negotiations with the British
to end the oil dispute. This blatant reversal of Mossadegh's plans sparked a
massive public outrage. Protestors of all stripes filled the streets, including
communists and radical Muslims led by Ayatollah Kashani. Frightened by the
unrest, the Shah quickly dismissed Qavam, and re-appointed Mossadegh, granting
him the full control of the military he had previously requested.
Taking
advantage of his popularity, Mossadegh convinced the parliament to grant him
increased powers and appointed Ayatollah Kashani as house speaker. Kashani's
radical Muslims, as well as the Tudeh Party, proved to be two of Mossadegh's
key political allies, although both relationships were often strained.
Mossadegh
quickly implemented more sociopolitical changes. Iran's centuries old feudal
agriculture sector was abolished, and replaced with a system of collective
farming and government land ownership.
The
government of Britain had grown increasingly distressed over Mossadegh's
policies and was especially bitter over the loss of their control on the
Iranian oil industry. Despite Mossadegh's repeated attempts to negotiate a
reasonable settlement with them they refused outright the same terms, and later
total control over Iranian oil.
Unable
to resolve the issue single-handedly due to its post Second World War problems,
Britain looked towards the United States to settle the issue. The United States
was led to believe by the British that Mossadegh was increasingly turning
towards Communism and was moving Iran towards the Soviet sphere at a time of
high Cold War fears.
Acting
on the opposition to Mossadegh's of the British government and fears that he
was, or would become, dependent on the pro-Soviet Tudeh Party at a time of
expanding Soviet influence, the United States and Britain began to publicly
denounce Mossadegh's policies for Iran as harmful to the country.
In
October 1952 Mossadegh declared that Britain was "an enemy", and cut
all diplomatic relations with the United Kingdom. In November and December 1952
British intelligence officials suggested to American intelligence that the
prime minister should be ousted. The new US administration under Dwight
Eisenhower and the British government under Winston Churchill agreed to work
together toward Mossadegh's removal. In March 1953 Secretary of State John
Foster Dulles directed the US Central Intelligence Agency, which was headed by
his younger brother Allen Dulles, to draft plans to overthrow Mossadegh.
On
4 April 1953 CIA director Dulles approved $1 million to be used "in any
way that would bring about the fall of Mossadegh". Soon the CIA's Tehran station
started to launch a propaganda campaign against Mossadegh. Finally, according
to The New York Times, in early June, American and British intelligence
officials met again, this time in Beirut, and put the finishing touches on the
strategy. Soon afterward, according to his later published accounts, the chief
of the CIA's Near East and Africa division, Kermit Roosevelt, Jr. arrived in
Tehran to direct it.
The
plot, known as Operation Ajax, centered on convincing Iran's monarch to use his
constitutional authority to dismiss Mossadegh from office, as he had attempted
some months earlier. But the Shah was uncooperative, and it would take much
persuasion and many meetings to successfully execute the plan. Meanwhile, the
CIA stepped up its operations. According to Dr. Donald N. Wilber, who was
involved in the plot to remove Mossadegh from power, in early August, Iranian
CIA operatives pretending to be socialists and nationalists threatened Muslim
leaders with "savage punishment if they opposed Mossadegh," thereby
giving the impression that Mossadegh was cracking down on dissent, and stirring
anti-Mossadegh sentiments within the religious community.
Mossadegh
became aware of the plots against him and grew increasingly wary of
conspirators acting within his government. He set up a national referendum to
dissolve parliament. Some purport that the vote was rigged, with Mossadegh
claiming a 99.9 percent victory for the "yes" side. Allegations that Mossadegh was resorting to
dictatorial tactics to stay in power were in turn cited by US- and
British-supported opposition press as a reason to remove Mossadegh from
power. Parliament was suspended
indefinitely, and Mossadegh's emergency powers were extended.
Inside
Iran, Mossadegh's popularity was eroding as promised reforms failed to
materialize and the economy continued to suffer due to heavy British sanctions.
The Tudeh Party abandoned its alliance with Mossadegh, as did the conservative
clerical factions.
In
August 1953 Mossadegh attempted to convince the Shah to leave the country. The
Shah refused, and formally dismissed the Prime Minister, in accordance with the
foreign intelligence plan. Mossadegh refused to leave, however, and when it
became apparent that he was going to fight, the Shah, as a precautionary measure
foreseen by the British/American plan, flew to Baghdad and on from there to
Rome, Italy, after hesitantly signing two decrees, one dismissing Mossadegh and
the other nominating General Fazlollah Zahedi Prime Minister, subsequent to
pressure from the US and UK intelligence agencies. The choice had fallen on
Zahedi, whom in the months before, Roosevelt and Wilbur had identified as
perfectly suitable to carry out strong-armed tactics, during and following the
coup. Fazlollah Zahedi was to prove that they had backed the right horse, after
all he had fallen out with Mossadegh and resigned from his post as minister of
the interior, as well as having been briefly detained already on suspicions of
planning a coup of his own, by Mossadegh's orders in February of 1953. Fearing imminent re-arrest, Zahedi went into
hiding, with another affair, the torture death of Tehran's chief of Police,
General Afshartus being blamed on him by the authorities.
Once
again, massive protests broke out across the nation. Anti- and pro-monarchy
protestors violently clashed in the streets, leaving almost 300 dead. Funded
with money from the U.S. CIA and the British MI6, the pro-monarchy forces, led
by retired army General and former Minister of Interior in Mossadegh's cabinet,
Fazlollah Zahedi, gained the upper hand on 19 August 1953 (28 Mordad). The
military intervened as the pro-Shah tank regiments stormed the capital and
bombarded the prime minister's official residence. Mossadegh managed to flee
from the mob that set in to ransack his house, and, the following day,
surrendered to General Zahedi, who had meanwhile established his makeshift
headquarters at the Officers' Club. A tearful Dr. Mossadegh was received in
dignity however and placed under arrest in a comfortable apartment at the
Officers' Club and transferred to a military jail shortly after.
Shortly
after the return of the Shah on 22 August 1953 from the brief self-imposed
exile in Rome, Mossadegh was tried by a military tribunal for high
treason. Zahedi and the Shah were inclined,
however, to spare the ailing man's life (the death penalty would have applied
according to the laws of the day). Mossadegh received a sentence of 3 years in
solitary confinement at a military jail and was exiled to his village, not far
from Tehran, where he remained under house arrest until his death, on 5 March
1967.[4]
In return for the US support the Shah agreed, in 1954, to allow an international consortium of British (40%), American (40%), French (6%), and Dutch (14%) companies to run the Iranian oil facilities for the next 25 years, with profits shared equally. The international consortium agreed to a fifty-fifty split of profits with Iran but would not allow Iran to audit their accounts to confirm the consortium was reporting profits properly, nor would they allow Iran to have members on their board of directors.[5]
Neo-classical economic theory “destroys its relation with the
real world” (Gallbraith 2), as a result of certain assumptions. When making this statement, Gallbraith was
specifically referring to assumptions “eliding power” (Gallbraith 2). However, there are many other significant
forces in the modern world which neo-classical theory fails to properly
consider.
This section will review theories that enrich the neo-classical
foundations of economics, in an attempt to relate economics to the real
world. Specifically, we will give
further consideration to institutions, government, power, and rationality. We will start with the New Institutional
Economics (NIE) of Douglass North and expand the framework to incorporate
additional “real world” considerations.
North (1995) provides a good summary of the NIE. According to North the NIE recognizes that
“we have incomplete information and limited mental capacity by which to process
information,” and so we “impose constraints on human interaction in order to
structure exchange” (North 1). We call
these constraints institutions.
“Institutions are the rules of the game of a society or more formally
are the humanly-devised constraints that structure human interaction. They are composed of formal rules (statute
law, common law, regulations), informal constraints (conventions, norms of
behavior, and self imposed codes of conduct), and the enforcement
characteristics of both” (North 5-6).
“Organizations
are the players: groups of individuals bound by a common purpose to achieve
objectives. They include political bodies (political parties, the senate, a
city council, a regulatory agency); economic bodies (firms, trade unions,
family farms, cooperatives); social bodies (churches, clubs, athletic
associations); and educational bodies (schools, colleges, vocational training
centers).” (North 6)
So the NIE is an analytical approach
that looks at the interplay between the organizations of the world and the
regulating institutions.
As North mentions, “there is no
implication that the consequent institutions are efficient” (North 6). “Institutions are not necessarily or even
usually created to be socially efficient; rather they, or at least the formal
rules, are created to serve the interests of those with the bargaining power to
create new rules” (North 3).
Less developed countries tend to have institutional structures that don’t properly reward entrepreneurship and hence economic development. “The institutional framework dictates the kinds of skills and knowledge perceived to have the maximum pay-off” (North 6). Often, knowing the right people can have the best payoff.
Furthermore, “the individuals and organizations with bargaining power as a result of the institutional framework have a crucial stake in perpetuating the system. … once an economy is on an ‘inefficient’ path that produces stagnation, it can persist (and historically has persisted) … since the [successful and therefore powerful] organizations owe their existence to the institutional matrix, there will be an ongoing interest group to assure the perpetuation of that institutional structure-- thus assuring path dependence” (North 3, 6).
In order to
follow an efficient path of development, it is clear that the government plays
a crucial role. Ideally it is the
government representing the interest of its people that has the greatest
power. In such a situation, the
resulting institutions are efficient because they serve the interests of the
people at large. However, the decisions
of the polity in the modern world are affected by organizations of power besides
the will of the general people, so we must consider the details of how and why
polities are influenced by forces outside of the interest of the general
people. The subsection on power
investigates further.
As North asserts, “a dynamic model of economic change entails as an integral part of that model analysis of the polity, since it is the polity that specifies and enforces the formal rules” (North 5). In the reality of the world today, “the state can never be treated as an exogenous actor in development policy and getting the prices right only has the desired consequences when you already have in place a set of property rights and enforcement that will then produce the competitive market conditions. … It is polities that shape economic performance because they define and enforce the economic rules of the game. Therefore the heart of development policy must be the creation of polities that will create and enforce efficient property rights” (North 5, 7).
Important to note is that the distribution of wealth dictated by the
property rights are crucial to efficiency.
We will address in the subsection on fairness the requirement that the
allocation of wealth be deemed fair.
“Political institutions will be stable only if they are supported by organizations with an interest in their perpetuation. Therefore an essential part of political/economic reform is the creation of such organizations” (North 7). A successfully operating democratic political institution is stable because the organization of the population at large has a general interest in its perpetuation, as the polity is efficiently providing the social infrastructure. Other polities are less stable, as they do not serve the general interest, and therefore face organizations that would like to challenge the political structure.
How can we insure that the government represents the interests of its people? The best example we have of successful and efficient government is that of the United States as outlined by the Constitution. Even though the US has problems of corruption (for it is the nature of at least a portion of the population to sacrifice morals for personal gain), the institutions created by the Constitution are meant to minimize this corruption.
Ideally members of government are above monetary influence, allowing them to make decisions in the best interest of the people. From an economic viewpoint, the government corrects market imperfections. This requires viewing the market from outside, otherwise, an individual will be tempted to suggest policy which will give him the best payoff, not society at large.
Also contributing to the minimization of the abuse of power in government is the separation of power. As Thomas Jefferson recognized, “the first principle of a good government is certainly a distribution of its powers into executive, judiciary, and legislative" (Jefferson ME 6:321). Jefferson also recognized the dangers of concentrated power and the influence of money: "Mankind soon learn to make interested uses of every right and power which they possess or may assume. The public money and public liberty, intended to have been deposited with three branches of magistracy but found inadvertently to be in the hands of one only, will soon be discovered to be sources of wealth and dominion to those who hold them; distinguished, too, by this tempting circumstance: that they are the instrument as well as the object of acquisition. With money we will get men, said Caesar, and with men we will get money" (Jefferson ME 2:164). According to this viewpoint, a monarchy can never optimally serve the interest of the public, unless all political actors withstand pecuniary temptation from influencing their decisions.
Recognizing the first best system of regulating government and the
barrier of power/money interests preventing this first best leads us to examine
how these interests prevent the first best.
Who are the organizations (besides the general interest) with the power
to affect the institutions and rules of the game? The social theory of Michael Mann (1986) recognizes the four ways
in which power manifests itself in modern society. According to Mann, “the four sources of social power” are
“ideological, economic, military and political (IEMP) relationships” (Mann
2). The government is the political and
normally manages the military, but economic and ideological interests can
influence the government, should they have sufficient power. So as North highlights, “bargaining strength
… shapes the direction of long run economic exchange” (North 3), but, as an
example, the strength of an economic interest is limited by any conflicts it
has with ideological interests in influencing institutional structure. The general understanding of people at large
falls under the ideological category of power.
Political parties and interest groups are ways in which people with
shared ideologies organize their power to have a voice in shaping
institutions.
As already mentioned, government ideally acts as the aggregated
interest of the people at large. This
leads us to ask what determines individual choices and behavior. There is the utility maximizing component of
individual rationality, which neo-classical economics captures, but there is
much more to individual rationality than this.
Let us examine our limited mental capacity in greater detail, in order
to understand how these limitations factor in development.
North recognizes that “individuals
possess mental models to interpret the world around them. These are in part culturally derived--that
is produced by intergenerational transfer of knowledge, values, and norms which
vary radically among different ethnic groups and societies. … there is immense variation in mental
models and as a result different perceptions of the world and the way it
‘works.’ … Individuals do learn, and changes in mental models stem from
outcomes inconsistent with expectations; but in Frank Hahn’s words ‘there is a
continuum of theories that agents can hold and act upon without ever
encountering events which lead them to change their theories.’ … In consequence
… multiple equilibria can occur” (North 1-2).
So each individual has an understanding of the way in which the world works which guides his behavior. Part of this understanding is a notion of what is “right” and “wrong.” Choices made factor in this moral consideration. Akerlof and Kranton (2000) formalize this as identity. Individual utility is affected by how an action compares to what one should do, given their identity. So “identity reveals a new way that preferences can be changed. Notions of identity evolve within a society and some in the society have incentives to manipulate them … Politics is often a battle over identity. Rather than take preferences as given, political leaders and activists often strive to change a population’s preferences through a change in identity” (Akerlof and Kranton 3, 14).
As North acknowledges, “religions have clearly been a basic component of belief systems” (North 8), helping to shape one’s identity and therefore behavior. Furthermore, science and the notion of objective truth play a large role in decision-making, for religion and ideology are not all encompassing. A specific situation needs to be understood logically before the principles of ideology can be applied, if they can be applied at all. Logical reasoning, discourse and information communication help evolve and expand individual understanding. Objective truth is assumed in society, and though individual beliefs can vary tremendously, all would like to know the “truth.” People will believe new truths if it makes sense to them. Furthermore as Shleifer, Mullainathan, and Schwartzstein (2006) have formalized, people may be persuaded to believe that which is not true. Propaganda and marketing are examples of systematic attempts to influence the beliefs and therefore preferences of people towards the interest of an organization. They demonstrate, as Gallbraith recognized that “power depends extensively not on force but persuasion” (Gallbraith 9). The understanding of the people at large is the most influential power in our social structure, for it affects both the behavior of the government and economy.
Related to identity in that it
affects how one behaves is the notion of fairness. Rabin (1993) formalizes the fact that “if somebody is being nice
to you, fairness dictates that you be nice to him. If somebody is being mean to you, fairness allows-and
vindictiveness dictates-that you be mean to him” (Rabin 1). Specifically, a person will make a decision
that is to his detriment, if that decision has a negative effect (that serves
as just punishment) on another who behaved improperly. The loss in direct utility of a lower payoff
is compensated by utility gained from administering justice. Fairness is a factor when people consider
distribution of wealth, as North acknowledges.
“Efficient policies that are perceived to be inequitable will
engender political reactions which can stall or reverse effective reforms” (North 8).
The fair way to split a pie is into 2 pieces of equal size. Any other way requires rationalization.
Given that the aggregated preference of the people is a tremendous power and that these preferences can be influenced, information communication plays a crucial role in managing the balance of power. In general, one is better off knowing more. Akerlof (1970) was the first to model “the economic costs of dishonesty,” starting the field of information economics. The greater the stock of public information is, the less scope there is for dishonestly persuasive behavior. Society is more efficient with less uncertainty.
With the theory of the previous section in mind, this section presents
a historical analysis. Specifically, we
will identify the specific institutional and organizational characteristics
that explain the decisions made and their subsequent results.
Of relevance for our analysis is
Iran’s comparative backwardness in Political and Economic development at the
beginning of the 20th century.
Iran was much weaker and therefore subject to the influence of Western
powers. Recognition of this weakness
sparked the Iranian Constitutional Revolution[6],
which began the slow progression of Iran towards representative democracy, culminating
with Mohammed Mossadegh rising above the Shah of Iran in power in 1951.
Economic backwardness is best
evidenced by Iran not discovering and producing its oil wealth on its own.
As evidenced by the many
regime changes in the 60 years preceding the 1953 coup of Mossadegh, Iran was
politically unstable. This can be
attributed primarily to the sub optimality of the ruling regimes. None were fully representative, and so there
was always organizations of opposition maneuvering for greater influence for
more just practices as identified by the organizations. Furthermore, all regimes were subject to
Western influence and could not develop independently. Despite all this, representation did finally
prevail, when Mossadegh rose to prime minister, with power greater than the
Shah.
Oil was and still is the “best” source of energy. Iran was endowed with a great oil wealth, which attracted world interest.
Mohammad Reza Shah’s rule would not
have weakened to the point where Mossadegh overtook him in power, had he truly
represented Iranian interests. The
common perception of the Shah as a puppet of the West became most magnified and
unavoidable because of oil. While most
political issues are debatable, the terms of the oil concession became so
skewed in Britain’s favor that all could unite behind Mossadegh based on the
issue of oil nationalization alone.
Here, the general population can be
understood to unite behind the “truth” that the terms of the oil concession
were unjust. Britain was also to blame,
for they simply acted to maximize their oil profits, without giving
consideration to the power of popular reaction. The bully listened not, resulting in the weak uniting against it. Only when Britain saw that it could not
maintain its extremely favorable position did it offer a fairer split of the
oil pie. However, by this point,
principles of fairness dictated that Iran would no longer accept.
Now we can simplify the history into
a sequence of strategic moves surrounding economic developments.
The story begins with the initial D’Arcy oil agreement. At the time no oil had been discovered, so
the terms of the deal were fair (or at least not obviously unfair), given the
uncertainty. If we move 30 years ahead
to the period around 1930, the relevant state of the world has changed. Oil was found and has been exported
profitably. The terms of the deal are
such that Britain gets near 85% of profits, while Iran gets 15%. This is thought of as unfair. Iran wants to renegotiate.
This highlights the need for institutional considerations. If the rules of the game were fixed, then
Iran could not even consider a renegotiation, since a contract had already been
signed. In reality, if a rule is seen
as unfair, then people will try to change it, potentially revolting to incite
the change.
Britain, when presented with the request for renegotiation, acted as a
rational profit-maximizer. It would not
make sense to “gift” Iran a better deal, when the terms were already in place. Unfortunately, this profit maximizing rationale
failed to consider the reaction it would stir.
Moving ahead to the period around the Oil Nationalization Act, a
political movement had grown, centered on the perceived unjust oil deal. Iran at the time had a representative
government. The people’s interest
dictated that the oil deal be fixed.
Mossadegh became the leader of this movement. He overtook the Shah in power, thanks to the power he had gained
by representing the Iranian people’s oil interest. He reacted to the British unwillingness to renegotiate by
nationalizing oil.
This was a move with tremendous impact. Britain had not considered this reaction as a possibility when it
had previously rejected requests for a better division of wealth. If maintained, Britain stood to lose a
tremendous amount of wealth that it had previously assumed it would
realize.
So Britain reacted by offering the 50-50 split. This would have been agreeable previously,
but not possible because of Mossadegh’s perception of the best direction for
Iran. There was bad will towards
Britain, and the Iranian decision was for no negotiation with Britain, even
though a deal could have been mutually beneficial. Perceived bad will caused a punishment equilibrium with lower
monetary payoffs for both sides.
Next, Britain encourages the US to stage the coup. While there were other reasons for US
intervention, we will focus on the fact that the oil was a significant
influence. Given Iran’s weak political
setup, the immediate monetary cost of causing regime change was much less than
the benefit of returning to a better oil deal.
Moral considerations must have been valued at an amount that would not
overcome the value of oil.
Once the decision was made, the money put in to the effort was enough
to both buy the behavior of some, and influence the behavior of many others
with propaganda. Here the power of
persuasion is demonstrated. The
propaganda was able to alter the beliefs of the people, weakening the
regime. After the coup, the Shah, who
was cooperative with the US, returned to power, establishing the better oil
deal for the West.
Once Mossadegh was overthrown and
the Shah restored to power, the freedoms that Mossadegh implemented were taken
away and replaced with dictatorial rule.
The SAVAK formed to repress any dissidence.[7] The 50-50 split of oil profits strengthened
the regime’s power, and democracy hasn’t been a possibility since.
5.
Conclusion
In summary, power and riches have fundamentally affected Iranian development. Iran’s weakness of power allowed its institutions to be affected from abroad. One of the fundamental motivations in affecting Iranian polities was the allocation of oil wealth. Bargaining didn’t yield a mutually beneficial solution, so force was used to make sure the terms were satisfactory for the actors with the most power. A significant negative consequence of this for Iran was that it’s political development took a huge step back in development. Government went from representative to dictatorial.
Without our expanded framework, we could not analyze these events realistically at all. The events demonstrate the central role of institutions and power in affecting development. They also demonstrate the nature of individual rationality as an evolving belief system, which can be altered by persuasion.
As North summarizes:
“Economic change is a ubiquitous, ongoing, incremental process that is a consequence of the choices individuals and entrepreneurs of organizations are making every day. … some [decisions] involve altering existing "contracts" between individuals and organizations. Sometimes that recontracting can be accomplished within the existing structure of property rights and political rules; but sometimes new contracting forms require an alteration in the rules. Usually existing informal norms of behavior will guide exchanges, but sometime such norms will gradually be modified or wither away. In both instances institutions are gradually being modified. Modifications occur because individuals perceive that they could do better by restructuring exchanges (political or economic). The source of the changed perceptions may be exogenous to the economy--for instance a change in the price or quality of a competitive product in another economy that alters the perceptions of entrepreneurs in the given economy about profitable opportunities. But the fundamental source of change is learning by entrepreneurs of organizations.” (North 6)
The situation examined shows that the entrepreneurs of organizations that North refers to may be profit maximizing for their organization, but act with great negative externalities. A regulating force is necessary to make sure these externalities are properly considered. In international relations we need a regulator. But the regulator must have the power to enforce decisions and be free from influence in decision-making. Such international regulatory power does not exist. The closest hope is that the US, which has the greatest power of all nations, acts as this regulator. However, when the US system is also subject to corruption, problems arise. One of the greatest challenges of our time is maintaining the integrity of the US as a world actor. As we reviewed, organizations of power will always attempt to influence polities in their favor, but we must make sure to maintain and modify the modern institutional structure to ensure that these influences occur only where they are supposed to. All politicians’ finances should be public information to ensure integrity in political affairs.
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[1] Department of Economics, University of California, Berkeley.
[2] http://www.wikipedia.org/
[3] http://en.wikipedia.org/wiki/Anglo-Iranian_Oil_Company
[4] http://en.wikipedia.org/wiki/Mohammed_Mossadegh
[5] http://en.wikipedia.org/wiki/History_of_Iran
[6] http://en.wikipedia.org/wiki/Persian_Constitutional_Revolution
[7] http://en.wikipedia.org/wiki/SAVAK