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An Economist’s Fix to the Iran Deal

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Reza Ansari, Dalibor Rohac

Security, Middle East

Malta-flagged Iranian crude oil supertanker

The new sanctions regime would give much less leeway for Iran to act like a rogue state.

An Economist’s Fix to the Iran Deal

In his speech at the Heritage Foundation, the U.S. Secretary of State Mike Pompeo set out clear conditions under which the United States would lift its sanctions against Iran. After the withdrawal from the Joint Comprehensive Plan of Action (JCPOA), the thrust of U.S. strategy seems to consist of building up the pressure of re-imposed sanctions to change Iran’s behavior. It seems unlikely that will happen anytime soon. Fortunately, there is a better alternative, which does not require the United States to engage with Iran’s regime directly but to strike a grand bargain with other permanent members of the UN Security Council (UNSC).

But first, here is what’s wrong with the 2015 ‘Iran Deal’. Once the JCPOA’s restrictions on uranium enrichment and deployment of advanced centrifuges expired, the crisis was bound to re-emerge in a radically worsened form. With advanced centrifuges, Iran would be able to re-enrich its stockpile of uranium to weapons-grade levels in no time, reaching the brink of a nuclear breakout. Moreover, as the world learned painfully in Syria, the agreement did nothing to keep Iran’s regional ambitions in check, nor did it limit the country’s ballistic missile program, which would provide the means of delivery for a future nuclear arsenal.

The United States is now restoring sanctions established by the Iran Sanctions Act of 1996 and expanded later, including by the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010. Those include a ban against almost any activities by American and non-U.S. persons who facilitate foreign business with Iran, by providing shipping services, insurance, opening lines of credit, and processing payments.

The re-imposition of sanctions has prompted a strong adverse reaction from Europe. The European Union (EU) is now reactivating a “blocking statute” that aims to shield EU businesses from U.S. sanctions. In addition, the EU is enacting a measure to involve EU governments indirectly transferring money to the Central Bank of Iran, so that any U.S. sanctions against the processing of payments would necessarily have to be enforced against sovereign European states. That is unfortunate since Europeans and Americans agree that a change in Iran’s behavior, as outlined by Secretary Pompeo, is desirable. Here’s how that agreement can be translated into a common transatlantic strategy.

The United States could offer to recommit to the JCPOA in exchange for the P5+1 support for a U.S.-advanced resolution to the UN Security Council (UNSC). That resolution would lift of the bulk of U.S. unilateral sanctions against Iran’s economy and simultaneously set up a UN fund as the sole recipient of all proceeds of Iranian oil exports – call it the United Nations Fund for the Iranian Observance of International Law, or the OIL Fund.

The OIL Fund would have the following three characteristics.

First, there would be a limit on weekly repatriation of proceeds from Iran’s oil exports that would be set in advance on the principle of revenue neutrality. The repatriation rate would offset the estimated positive effect of the lifting of U.S. sanctions on the income of Iran’s government from domestic sources, resulting from an upward jump in long-term economic growth rates. As a result, the relief from the sanctions would be felt by Iran’s economy at large, but not by Iran’s government. The remaining proceeds would be invested in the international capital markets, following investment guidelines used by sovereign wealth funds.

Second, the OIL Fund would act as a deterrent mechanism. The UNSC would claim the power to suspend the repatriation of funds whenever and for as long as Iran refused to comply with any of its resolutions – past or future – including those concerning Iran’s missile program, which has been hitherto unenforceable.

Third, the OIL Fund would change incentives facing Iran’s government. The initially set repatriation rates could be increased by the UNSC, with the consent of the United States. That would provide the U.S. government with an additional mechanism to extract concessions from Iran on nuclear and non-nuclear issues through bilateral negotiations. In the future, the rising financial burden of Iran’s unfunded liabilities would provide a strong motivating force to meet U.S. demands in exchange for additional funds.

Although the Security Council would have the power to shut the OIL Fund down, its existence would be open-ended, unlike the JCPOA. Of course, as soon as Iran became a reliable, “normal” country and not a source of regional instability and aggressive revisionism, the need for the OIL Fund would disappear.

Until then, the new regime would be de facto permanent without the need for renegotiating the JCPOA, since in the aftermath of the sunset of any JCPOA provisions, if Iran came closer than the current twelve months to a nuclear breakout, the UNSC could simply pass a resolution and require Iran to change course. Under the threat of a sharp punishment against Iran’s oil-dependent treasury, Iran would practically have no choice but to comply. The same new deterrent could be used to change Iran’s behavior on any issue – nuclear-related or not. Symmetrically, the possibility of increasing the repatriation rate as a reward for Iran’s constructive behavior would act as a lever that was absent in the case of the ‘Iran Deal’, which provided all sanctions relief ex-ante.

The OIL Fund would not be another version of Iraq’s failed Oil for Food Program started in 1996. The latter invited waste, corruption, and fraud by giving discretionary power to UN officials over how country’s oil revenue was spent. Our proposal does nothing of the sort – it merely sets an initial ceiling on the amount of oil revenue that can be repatriated to Iran and enables the Security Council to increase or decrease it based on Iran’s behavior. Likewise, ensuring that the Fund’s balance is invested in a responsible and transparent manner is a straightforward exercise – one extreme, though probably unnecessary, solution would consist of delegating the task to the management of one of Norway’s sovereign wealth funds.

Iran could increase its disposable oil income beyond the revenue neutral ceiling in three ways, all of which could be blocked by the UNSC resolution establishing the OIL Fund. First, Iran could try to smuggle oil outside of the UN mechanism. That could be deterred by setting prohibitively high penalties in the form of reduced repatriation rates, proportionate to the value of the smuggled oil. In addition, to incentivize detection, the United States or the UN could offer a substantial financial reward to whistleblowers, payable from the reserves of the OIL Fund – as well as guaranteed U.S. permanent residency for them and their families. Second, Iran could try to impose special levies on its oil companies. That pathway could also be blocked explicitly by the UNSC resolution. Third, Iran could sell its oil at artificially discounted prices and ask for a fraction of the discount back through a side contract. That pathway could also be blocked by making the OIL Fund the sole authorized entity to broker the sale of Iranian oil for export markets to the highest bidder. Commodity brokerage firms – whose fee schedules are generally transparent – would be contracted for that purpose through open competition and made accountable to the OIL Fund. That would also eliminate Iran’s ability to provide in-kind support to its allies, such as Syria, in the form of free oil.

Of course, as a designated terrorist organization, Iran’s Islamic Revolutionary Guard Corps (IRGC) would remain under U.S. sanctions. So would the Execution of Imam Khomeini’s Order (EIKO), the economic conglomerate controlled by Iran’s Supreme Leader with around $95bn in assets. EIKO originated mainly from the confiscation of real estate or extracting large payments from their politically disfavored private owners. Another sanctioned entity would be the Mostafazan Foundation, whose holdings are a result of the confiscation of the property of the royal family and its associates following the 1979 revolution. Finally, there is also the Astan-e Quds-e Razavi, the wealthiest Shia temple in the world, whose holdings mostly originate from control over land in Eastern Iran.

Applying sanctions to such entities would be essential to reduce their grip on Iran’s economy and society. Earlier this year, Iran’s Defense Minister announced that Iran’s armed forces had been instructed by the Supreme Leader – also Iran’s Commander-in-Chief – to start the process of divesting from the economy and selling commercial holdings “irrelevant” to their main function. The targeted sanctions and the international control of the state-dominated oil industry would strengthen incentives to accelerate that process.

It is true that future decisions to reduce or suspend payments- if Iran found itself in breach of Security Council’s resolutions- could be blocked by Russia or China. In that case, the United States could always threaten Iran by leaving the JCPOA while voting to conserve the infrastructure of the OIL Fund. Alternatively, from the outset, any of the permanent members of UNSC may reject the U.S. proposal to establish the OIL Fund in exchange for the United States’ return to the JCPOA – or they might waver later in its implementation and enforcement down the road. But that would effectively leave the responsibility for the future of the ‘Iran Deal’ and Iran’s actions on the shoulders of America’s partners, not of the U.S. administration. The same is true of Iran’s refusal to abide by the OIL Fund resolution – in that case it would be Iran, not the international community, who would bring down the JCPOA and who would be held responsible for it.

The new sanctions regime would give much less leeway for Iran to act like a rogue state. There is no need to negotiate with Iran’s government directly and wait for it to comply with the U.S.-UN sanction swap. With bold U.S. leadership and determination to act, the international community can make that call for Iran and push the country towards a better, less belligerent future.

Reza Ansari is an Iranian economist based in Washington DC. You can follow him at @TheRezaAnsari.

Dalibor Rohac is a research fellow at the American Enterprise Institute. You can follow him at @DaliborRohac.

Image: Malta-flagged Iranian crude oil supertanker “Delvar” is seen anchored off Singapore March 1, 2012. Western trade sanctions against Iran are strangling its oil exports even before they go into effect, a U.S. advisory body has found, amid warnings that any shortages will only push up crude prices and strain a weak global economy. REUTERS/Tim Chong (SINGAPORE – Tags: ENERGY BUSINESS MARITIME TRANSPORT)

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