Lifting the resource curse : a case study on Iran and Malaysia

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Lifting the Resource Curse:

A Case Study on Iran and Malaysia

MSc Political Science: Political Economy

Master Thesis Project: The Political Economy of Energy

June 22nd₂₀₁₈

Tim de Ridder Supervisor: Dr. M. Parvizi Amineh

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Abstract

The topic of this thesis is the process of industrialization and economic diversification in relation to the resource curse. Countries have used their oil-revenues differently, resulting in different ways of industrialization and economic diversification. Therefore, the main research question is as follows: How can states shape the conditions to realize a transition from natural resource-dependence towards a diversified economy? In this thesis the cases of Malaysia and Iran are compared to understand their different processes of industrialization and how these countries have used their oil-revenues, in an attempt to draw a line between Malaysia and Iran and potential factors that obstruct or support industrialization and economic diversification. The main finding of this thesis is that the interrelations between politics and oil heavily influence the way countries use their oil-revenues. Countries require certain political and economic

conditions before they can properly address their oil-dependency: political stability, peaceful international relations, economic stability and leeway for the private market. Absence of these conditions hampers the industrialisation and economic diversification, as is the case with Iran; in Malaysia, these conditions were present, resulting in a fast industrialisation and economic diversification. Therefore, the presence of oil is not hampering the industrialisation and economic diversification of a country, but the absence of a solid economic and political foundation is.

Keywords:

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Acknowledgements:

I would like to thank dr. M.P. Amineh for his guidance throughout the process of writing this thesis. The guidance from Mr. Amineh was very thorough and interactive. I felt like I could ask any question at any time and you seemed just as enthusiastic and involved with my thesis as I was myself.

Furthermore, I would like to thank fellow MSc student Irene for her suggestions and feedback on my work. It was very valuable to be able to discuss academic matters in-depth with a fellow student.

Lastly, I would like to thank my family for their mental support throughout the process of writing this thesis.

Tim de Ridder,

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List of Maps

Map 1: Political Map of the Middle East

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Map 2: Political Map of the Islamic Republic of Iran

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Map 3: Political Map of Southeast Asia

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Map 4: Political Map of Malaysia

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List of Abbreviations

AIIB: Asian Infrastructure Investment Bank CBI: Central Bank of (The Islamic Republic of) Iran CPI: Corruption Perceptions Index

DAP: Democratic Action Party ECI: Economic Complexity Index EU: European Union

FDI: Foreign direct Investment FTZ: Free Trade Zone

FYDP: Five-Year Development Plan GCC: Gulf Cooperation Council GDP: Gross Domestic Product

ICAC: Independent Commission Against Corruption IMF: International Monetary Fund

IPE: Institutional Political Economy ISI: Import Substitution Industrialization ITT: Industry, Trade and Technology Policies MACC: Malaysian Anti-Corruption Commission MENA: Middle East North African

MNC: Multinational Corporation NEP: New Economic Policy

NOC: National Operations Council

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PIA: Promotion of Investments Act RBI: Resource-based Industrialization R&D: Research & Development

SAVAK: Organization of National Intelligence and Security (Sāzemān-e Ettelā'āt va Amniyat-e

Keshvar)

SEZ: Special Economic Zone SOE: State-owned Enterprise WB: The World Bank (Group) WTO: World Trade Organization

UMNO: United Malays National Organization US: United States (Of America)

List of Tables and Figures

Map i: Political Map of the Middle East

Map ii: Political Map of the Islamic Republic of Iran

Map iii: Political Map of Southeast Asia

Map iv: Political Map of Malaysia

Map 2.1: Malaysia’s geographical share in the Spratly Islands

Table 4.1: Iran’s total FDI-inflow in Million US$

Table 4.2: Iran’s Economic Sectors Value as % of Total Exports

Table 4.3: Rubber Exports as % of Malaysia’s Total Exports

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14 Table 4.5: Malaysia’s Economic Sectors Value as % of Total Exports

Table 4.6: Share of Malaysia’s Manufacturing Sector as % of total GDP

Table 4.7: Malaysia’s Economic Sector Value as % of Total Exports

Table 4.8: Foreign Share in Malaysia’s Manufacturing

Table 4.9: Malaysia’s Corruption Perceptions Index

Table 4.10: Malaysian Total External Debt in Million US$

Figure 3.1: Iran’s Export and Import Destinations as % of total export

Figure 4.1: Export Value of Natural Resources as % of Total Exports

Figure 4.2: Inflation Rate as % of Consumer Prices

Figure 4.3: Iran’s Unemployment Rate (%)

Figure 4.4: Global Oil Price per Barrel (US$)

Figure 4.5: Iran’s Population Pyramid

Figure 4.6: Unemployment as % of Labor Force in Iran

Figure 4.7: Corruption Perceptions Index (0 – Corrupt; 100 – Clean)

Figure 4.8: Malaysia’s Annual Gini-Coefficient

Figure 4.9: Economic Complexity Ranking (1 – most Complex; 120 – Least Complex)

Figure 4.10: Malaysia’s Total GDP in Million US$

Figure 4.11: Malaysia and South Korea Foreign Direct Investment as % of GDP (in US$)

Figure 4.12: Malaysia total FDI-inflows in Million US$.

Figure 4.13: Export Value per Sector

Figure 4.14: Machine Sector Exports Value

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Chapter 1: Introduction

1.1 Introduction

The objective of this thesis is to analyse how countries can deviate from a dependency on natural resources towards economic diversification. Hence, the overarching topic is the transition from natural resource-based economies towards diversified economies. The time-frame concerns the period between 1960 and 2018. The cases that will be analysed are Iran and Malaysia. More specifically, the state is the main unit of analysis in this research. Due to the authoritarian nature of Iran and (partly) Malaysia, the process of state-led industrialization and the role of the ruling political elite will be key elements of the analysis. Thus, this analysis will be focused on how the ruling political elite has utilized their oil-revenues and how their political climates shape the conditions for economic diversification.

Thus, the research question of this thesis will be: How can states shape the conditions to realize a transition from natural resource-dependence towards a diversified economy? The following sub-questions will be answered in order to find an answer to the main research question: What do the political contexts of industrialization in Iran and Malaysia look like? According to the literature, what kind of policies, development strategies and political circumstances may support or obstruct the process of industrialization? Which policies and political circumstances of Malaysia and Iran have contributed or obstructed their processes of industrialization? These three sub-questions will be answered, respectively, in Chapter 2, 3 and 4.

The relevance of this thesis is based on a research puzzle regarding lifting the resource curse, whereas most research is based on investigating how this curse comes into existence or how it may differ between various cases. Yet, the actual method for economies to diversify and deviate from oil-dependency is heavily under-researched (Sachs and Warner, 1990: p. 20-21). The solution of this curse can potentially influence not only the energy studies, but societies as well. Another more specific research puzzle regards the fact that Iran is still very dependent on oil and facing the consequences of the resource curse. Meanwhile, Malaysia has managed to lift this curse by diversifying its economy. This thesis will therefore attempt to explain why this difference exists. This thesis concerns questions on the development of countries, therefore addressing their economic, political and societal issues. This thesis can potentially show how countries can successfully diversify their economies, lifting the resource curse. This could then heavily benefit a country’s development and therefore also the entire welfare and wealth of its society.

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1.2 Literature Review

The goal of the literature review is to analyse the current literature on the topic of the resource curse, development theory and the cases of Malaysia and Iran. The first academic debate to be addressed is the debate on the resource curse. The second section will be about

industrialization and development.

1.2.1 The Resource Curse Theory

There have been many publications on the resource curse. The first few publications in the late 1980s were mainly focused on a broader picture, such as the work of Richard Auty (1990) and Alan Gelb (1988). Auty introduced the term Resource-based industrialization (RBI) and claimed that RBI is capital-intensive and dependent on economies of scale and therefore doomed to fail. This is due to the high rate of rent-seeking and short-term political focus of most oil-rich

countries. Thus, the characteristics of resource-dependent countries impede the method of RBI (Auty, 1990). On the other hand, Gelb mainly blames the activities of the state. Gelb claims that countries with a dependency on a single resource can industrialize and develop properly, however, this requires the right policies. These policies are often lacking, Gelb claims: ‘(…) most

of the resource-rich countries have poor macroeconomic management and often ineffective political institutions.’ (Gelb, 1988: p. 321-322).

Both of these well-known publications come together in the work of Lane and Tornell, who introduced the idea of a vicious cycle of revenue-absorption, which basically means that the short-term political goals, along with a high rate of rent-seeking, places these countries in a cycle of a high absorption of oil into their domestic economies. This is often called a feeding

frenzy, meaning that these countries instantly consume and spend their oil revenues on a

domestic level. Practically, most of the revenue is spent on importing goods that the country cannot produce efficiently, usually all kinds of commodities. Furthermore, in regard to rent-seeking, the remainder of the revenue then disappears into all kinds of subsidies to –often hardly efficient or shady- industries (Lane & Tornell, 1995).

Sachs and Warner apply this argument to the manufacturing sector, in an attempt to analyse how resource-dependence can impede growth in the manufacturing sector. An important building block for their analysis comes from Matsuyama, who introduces the learning-by-doing argument. This argument is heavily interlinked with economies of scale and mainly stresses the importance of investing and producing in the manufacturing sector. However, Matsuyama claims that resource-dependence often impedes the possibility to focus on the manufacturing sector. This is because selling resources like oil does not require a lot of technological skill or long-term investments, however, the global demand for natural resources results in an almost instantaneous gain without much effort (Matsuyama, 1992).

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17 Selling resources like oil is efficient and lucrative to the extent that it draws all the attention to this natural resource sector. This is because it requires much less investments, takes less time to develop and generates profit in a much smaller timespan. This results in a neglect of the

manufacturing sector. Sachs and Warner’s claim in their economic linkages approach that a successful manufacturing sector leads to a much more complex division of labour and a more diverse economy (Sachs & Warner, 1995: p. 20-21).

Altogether this means that resource-rich countries have a tendency to depend heavily on their own natural-resource sector, mainly due to short-term political goals, infinite global demand and rent-seeking behaviour. However, it is rather difficult to deviate from using natural resources once they are embedded into a country’s economic structure. Thus, this reliance on natural resources comes with all kinds of problems, which is something Ross focuses on. He claims that The Curse of Oil takes place in most resource-rich countries and impedes their overall development, both in wealth and welfare (Ross, 2013: p. 5-6). This logically brings us to the question: How can one avoid this curse?

This part of the resource curse has been investigated quite a bit as well. Most of the research focuses on Norway, the Netherlands and the US, which gives us an idea on why these countries do not suffer from this curse. This introduced two terms; the Dutch Disease and Sovereign

Wealth Funds.

The concept of the Dutch Disease offers more insight on how resource-dependency can impede the functioning of an economy. This argument is very similar to the argument of Sachs and Warner and basically means that an abundance of resources results in a focus on the natural resource sector. This focus will have two consequences. First of all, this is a zero-sum game, meaning that there will be effectively less focus on the other two sectors; manufacturing and the non-tradeable sector. This first part of the Dutch Disease is known as the resource

movement effect. The second part is known as the spending effect, which means that the

currency of a country quickly appreciates due to its extensive resource-exports. This is problematic for the two other sectors that the country has neglected entirely, meaning that both the manufacturing and non-tradeable sectors will be low on labour and investment.

The appreciation of the currency then entirely destructs the potentials of these sectors, because they have to trade in a currency that is very expensive, yet they do not have the efficiency to actually sell or buy with such an expensive currency. Hence the other two sectors become a victim of the growth of the natural resource sector (Cordon, 1984: p. 359-360).

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18 Sovereign Wealth Funds were seen as a viable solution to this problem, proven successful in both Norway and the Netherlands. The idea was that the spending effect of the Dutch Disease could be drastically decreased by moving capital abroad, freezing it in a foreign fund. This way, the currency would not appreciate as fast, which then results in the spending effect to be much less prominent (Fini, 2011: p. 74-75).

However, this solution is based on the Netherlands and Norway. Both countries already had functioning non-tradeable sectors and manufacturing sectors. So, one may wonder, is this really a fair a comparison? Norway and the Netherlands are drastically different from most of the other resource-rich countries that face the resource curse. The problem here is that the one remedy that has been given is focused on reducing the spending effect, however, both the Netherlands as well as Norway will experience the resource movement effect much less. Hence, it is no surprise that there is no real remedy to this part of the Dutch Disease. In that sense, the Netherlands and Norway already had somewhat established economies before they found their natural resources. This is very different for the countries that were not as economically

successful. A country like Saudi-Arabia is very much built on oil, and the resource movement

effect has been in full effect (Cammett et al., 2015).

The problem with the cases of the Netherlands and Norway is that both these countries did not have to realize this transition at all, because they were already economically diverse before their natural resources entered the equation. So, what about countries that did not diversify before they found their resources? This is where this thesis adds to the academic debate: How exactly can states transition from an oil-led economy towards an economically diversified economy? This is why Malaysia and Iran have been selected as cases, in order to analyse how countries can actually lift this resource curse and what they can do to promote their economic diversification, decreasing their oil-dependency. This then brings us to the debate on

development theories.

1.2.2 Development Theory

Thus, my research also enters the academic debate on general development and

industrialization. However, development is a very broad term, therefore development theories have traditionally been split in several different theories: The modernization theory,

dependency theory, the neo-classical theory and structuralist theories.

First of all there is the modernization theory. This theory was rather popular in the 1950s and 1960s, however its popularity has only declined ever since. Most of the ideas of this theory were established by Weber and worked out by Parsons later in the 20th_{century. Modernization}

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19 theory attempts to analyse how countries can transition from a traditional society to a modern society, drawing upon the idea that there is a linear process of development. This means that developing countries can easily develop by using the same methods of the developed countries, albeit with a bit of assistance. The main idea here is that there is only one road to success. This is also apparent because the concept of a modern society is very much based on the western perspective of what it means to be modern. The biggest issue of this theory, arguably the reason of its downfall, is the emphasis on the internal factors of a country to explain why it has failed to modernize. This theory is therefore often criticized to neglect international relations and external factors.

The most well-known theory of this perspective is the stages of growth theory by Rostow (1971). This theory shows the ideas of a linear process of development. This linear process is indicated by the specific stages that a country will go through, no matter which country this is. These stages are as follows: (1) traditional, (2) conditions for take-off, (3) take-off, (3) maturity and (5) the age of mass consumption. This model assumes a specific sequence of stages which is also the basis of its critique; it is too focused on a linear process and neglects external factors entirely.

Another perspective on development theory is dependency theory. The difference that set these two theories apart from one another is that dependency theory is much more focused on the international relations between countries and the dependency that comes with it. The idea of dependency is best explained here in terms of core and periphery countries. According to the most well-known theory of dependency theory, the World Systems Theory by Wallerstein, the world consists out of a myriad of economic relations. This world is held together by the

dependent relations between the core and the periphery, where the core-nations exploit the periphery by the use of its cheap labour and its natural resources. This is because the core countries are on ‘(…) a never-ending quest for more profit.’ (Jackson & Sørensen, 2013: p.173). This leads to the exploitation of the periphery which obstructs them from developing, this traps these countries in their periphery while the core flourish at their expense. This idea of core versus periphery is related to the ideas of Marxism and neo-Marxism on friction between classes (Elwell, 2006). The main critique on this theory comes from the supporters of the free-market. They claim that there is no such exploitative world system, rather, free trade will ultimately benefit every society. Indicated by this critique, this brings us to the following perspective; Neoclassical theory, often called Neo-liberalism as well.

The neoliberalists are highly in favour of the world-market and especially in favour of free trade, meanwhile, they are firmly against state intervention. Being against state intervention in

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official approach, for it is used by both the World Bank and the IMF in their development

policies. The Washington Consensus can be seen as the height of neoliberal influence. The neo-liberal part of development theories is mainly focused on market freedom. The reason some countries remain underdeveloped is due to oppression or the lack of freedom for businesses to become successful in a country’s economy. The main road to success, according to

neo-liberalism, is by letting capitalism generate development. As stated earlier, the idea here is that free trade eventually benefits everyone. These ideas are prominent in Structural Adjustment Programmes (SAPs). Which are programmes initiated by the World Bank or the IMF that give loans to countries conditional to implementing neo-liberal policies. This means that these SAPs require countries to deregulate, lower protectionism, increase privatisation and cut taxes. All of these points come together in one idea: a big market and a small state. This is of course a broad overview of Neo-liberalism while there are many more differing perspectives within

neo-liberalism (Jackson & Sørensen, 2013: p. 165).

However, this neo-liberalist view is basically the opposite of what structuralism claims.

Especially the work of Chang in Kicking Away the Ladder clearly opposes the neo-liberal ideas of development. Thus, structuralism is on one of the biggest challengers of neo-liberalism. This paradigm arguably starts with Prebisch in 1950 and focus mainly on the structural aspects that impede the economic development of countries. These structural aspects are mainly focused on the action of the state to initiate the process from a agriculturally focused country towards a service and manufacturing based country. The main idea here is that states have to promote industrialization to become more self-sustaining, the key element of development according to structuralism. This will be discussed more thoroughly in the theoretical analysis in Chapter 3.

The theory on Import Substitution Industrialization (ISI) is one of the most well-known examples of how a state can promote industrialization where imports are replaced by domestic

production. Additionally, ISI is also related to the infant industry theory, based on the ideas of Hamilton. Alexander Hamilton (1757 – 1804) argues that infant industries need to be protected by tariffs and subsidies until they become internationally competitive. Once competitive, these industries can take part in the benefits of economies of scale but require some help in taking-off, which is also related to the ideas of Chang. This is often also called a neo-mercantilist approach because structuralism tends to be very broad (Chang, 2002). However, it is important to note, despite borrowing some ideas from structuralism, Chang claims not to be a structuralist himself. Instead, he focuses on the term ‘Institutional Political Economics’ (IPE). According to Chang, this is a kind of institutionalism based on traditional works from Schumpeter, Veblen and Simon. This tradition is known as old institutional economics. In this regard institutions are not merely constraints but have influence on individuals themselves.

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21 Furthermore, Neo-Marxism is also a part of structuralism, it is a structuralist theory whereas structuralism itself encompasses more theories than just the Neo-Marxist class-based theories (Jackson & Sørensen: p. 165-167). In this thesis the term structuralism will be used, to avoid terminological confusion. Structuralism in relation to the ideas of Mercille (2008) will be the main academic approach of this thesis. This structuralist perspective is based on the idea that phenomena can only be truly understood when taking their position within an overarching structure into account. For example, if one would attempt to understand China’s rapid rate of growth, structuralism would imply that it is necessary to first understand the domestic and international political structures of China. In a sense, this means that the political climate in which a country acts needs to be understood. In this thesis, Chapter 2 will be analyzing the political climate and the role of the state in Iran and Malaysia.

When explaining structuralism, its forefather cannot be left unmentioned; Antonio Gramsci (1891 – 1937). Gramsci’s theory of passive revolution is particularly relevant within the topic of industrialization and development,. A passive revolution is about a massive change in a society that happens gradually over time; passively. The idea of this passive revolution is to gradually change a society without an explosive revolution. Essential to the idea of the passive revolution is that this is not about a revolution from below, thus, excludes strong social forces. Rather, it is often a revolution from above, such as economic catch-up processes and state-led development (Amineh & Guang, 2017: p. 16; Forgacs, 1988: p. 245-246). This is specifically important due to the nature of analysis of this thesis being the state and the top-down processes of state-led industrialization.

Another notable author of structuralism is Robert Cox. The ideas of Cox draw more of a line to Marxism, especially regarding his ideas of class and production. Cox argues that production is the foundation of international and domestic politics. Production itself is dependent on how states organize it, whereas states influence what is produced, how production is organized, how the roles within production processes are assigned and how wealth is allocated and generated. However, the states are not as powerful as it may appear. Given that the economy is becoming more globalized, so do the production processes. This takes away power from states to

influence their own production processes. The idea here is that the global political and

economic structure of the world influences the behavior of states, which is what sets Cox apart from neo-realism. Additionally, these influenced states then influence their own production processes based on how they are positioned in this global structure (Cox, 1987).

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22 Lastly, I will discuss the structuralist ideas of Harvey and Mercille.. According to Harvey, cross-border activities are based on two principles: geo-political principles and geo-economic

principles. The geo-political principles are about territorial, spatial and more politically-oriented power. Additionally, geo-economic principles regards the creation and accumulation of wealth and capital flows (Harvey, 2006). Mercille adds to this that these principles are very often interconnected, whereas certain territorial expansion comes with geo-economic benefits as well, such as specific exporting locations or resources. Additionally, as a critique on Harvey, Mercille adds that geo-political and geo-economic orientations of foreign policy need to be seen strictly as causes of policy, not the nature of the policy itself. This stresses the idea of

structuralism and how geo-political and geo-economic events in the world system affect a country’s policies. In Chapter 2 the influence of geo-political and geo-economic activities will be specifically relevant when discussing Iran (Amineh & Guang, 2017: p. 16, Mercille, 2008, p 576). Altogether, the ideas of Gramsci, Cox, Harvey and Mercille add onto each other.

The ideas of a top-down passive revolution (Gramsci) and the relation between production priorities and states (Cox) will be the main perspective to analyze the authoritarian and top-down processes of industrialization. The international factors and policies that play a part in this process will be analyzed based on the perspective of Mercille regarding economic and geo-political orientations. This ideas come together in Chang’s perspective on IPE. In this perspective policies are seen as a reaction to political events. Furthermore, markets can be understood based on the institutions that act within a market. These perspectives combined will form the analytical perspective at which the ruling class and the top-down industrialization of Malaysia and Iran will be analyzed.

Altogether, this research is placed in the debate on the resource curse as well as the debate on development. The contribution of this thesis to these academic debates is as follows: To address the remedies of the resource curse while most of these remedies are based on the problems of western countries. This resulted in remedies that are not entirely effective for the non-Western world or countries that have –historically- much less successful non-oil sectors, countries such as Malaysia and Iran. Therefore, it is also necessary to discuss the body of research that has been written on Iran and Malaysia. In this literature review the most cited works will be

addressed and briefly outlined, however, most of the topics mentioned here will be much more thoroughly explained in Chapter 3 and 4.

Regarding Iran, a lot of research has been done on the Revolution in 1979 and what kind of consequences this may have had. Most of these works are very broad in terms of its unit of analysis, taking many aspects of the Iranian society into account. This is no surprise given the fact that the Revolution in 1979 is a very complex matter and requires a very eclectic analysis:

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23 ‘Revolutions are complex phenomena. They are structured in the societies that give birth to

them.’ (Amineh & Eisenstadt, 2007: p. 130). Given the array of factors that have to be analyzed

to understand the structure of a society, this literature focuses mainly on the history of economic and social factors that have led to the Revolution. Some of the most cited works on this topic are Halliday (1978), Abrahamian (1982), Karshenas (1990), Bakhash (1991), Feron (2003), Katouzian (2000), Hooglund & Curtis (2008), Marsh (2009). Altogether these works result in an impressive body of literature mainly focused on the historical socio-economic factors of Iran, often in relation the Revolution in 1979. These works all share the idea that the revolution has a very extensive historical build-up and is a consequence of economic

backwardness, political and economic polarization, foreign interventions and the everlasting tension between Iranian tradition and modernization. These elements will be more thoroughly discussed in Chapter 3.

Other works on Iran often regard very specific elements of Iran, such as unemployment and specifically on its economic backwardness. Examples of this are works of Esfahani & Pesaran, who write about Iran’s position in the global economy in the 20th_{century. Hakimian has several} works on Iran’s ability to attract FDI and MNCs and why this has been difficult. Salehi-Isfahani wrote a prominent work on Iran’s unemployment, focusing on the causes and consequences of this unemployment, specifically youth unemployment. Arjomandy (2014) wrote about the difficult international relations of Iran, from both the Iranian and the Western perspective. All of these elements will be more thoroughly discussed in Chapter 3 and mainly in Chapter 4.

The literature on Malaysia is obviously somewhat less extensive, simply because Malaysia is a much younger country than Iran. Malaysia has only been united and independent in the late 1950s after becoming independent from the British colonization. Up to that moment, Malaysia and most of its surrounding countries were mainly very fragmented and secluded societies, geographically dispersed by the immense amount of islands. Therefore, no surprise, the national motto of Malaysia is ‘Unity is Strength’. In terms of general historic literature on Malaysia the most prominent works are of Kheng (2002), Cavendish (2007), Jeong (2007) Yusoff et al. (2000) and Zakariah (2012). Most of these works describe the rapid modernization of Malaysia, mainly in relation to its foreign relations and rapid process of industrialization. Especially Rasiah is one the most-cited scholars on Malaysia, having written about a variety of topics, such as: FDI-attraction, corruption, financial crises and specific industrial sectors in Malaysia (1995, 1998, 2010, 2014). Most of these works are about the success of Malaysia in combatting its political and economic issues but also contain critique on Malaysia’s neglect for home-grown technology as a result of its excessive reliance on foreign technology. This problem will be thoroughly discussed in chapters 3 and 4.

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24 In terms of literature, Malaysia has a lot of literature on its racial issues regarding the Sino-Malay tensions that have been prominent in Sino-Malaysia since its birth. The most cited works on this topic are from Horowitz (2003) and Koh et al. (2016). Both describing the problematic Sino-Malay relations and how Sino-Malaysia has successfully used economic means to solve these political issues. Although, these problems still remain relevant in linguistic, specifically in education.

Other than this, a lot of literature on Malaysia is about the economic performance of Malaysia. Most of these works regard the high level FDI-attraction or the successful way in which Malaysia combatted the Asian Financial Crisis. In most of these works Malaysia is often discussed in comparison with the Asian tigers or the BRICS-nations. Especially the way in which Malaysia has attracted a lot of FDI to support its industrialization in one of the key elements in these works. (Winters, 1999; Shari, 2000; Lee, 2004).

This short analysis of Malaysia’s and Iran literature, albeit somewhat limited, provides an overview on the body of literature that has been written on both these cases. Specifically for Iran my thesis can add to the academic debate with much more recent data, given that most of the prominent works on Iran tend to be somewhat old. In the light of recent events regarding the JCPOA (the nuclear deal and lifted sanctions of Iran) make a recent analysis of Iran all the more relevant. In terms of Malaysia’s academic debate this thesis will add to the body of literature by offering a much more overarching analysis of Malaysia, mainly using academic literature on very specific topics which will be connected in this thesis. In the next paragraph the reason for choosing these two cases will addressed.

1.3 Delineation of Research

The geographical focus of this research is based on the two cases that will be analysed: Iran and Malaysia. The selection of my cases has been aimed at solving the research puzzle and therefore contained Malaysia and Iran: in which Malaysia has managed to transition from an emphasis on natural resources towards a diverse economy. On the hand, for Iran this has been a much more difficult task and still has not managed to diversify its economy.

Sachs and Warner argue that Malaysia is one of the very few exceptions to the theory of the resource curse, because it was able to deviate from an emphasis on natural resources. On the other hand, countries like the Netherlands and Norway were not entirely dependent on it in the first place. Sachs and Warner claim that more contextual research on Malaysia can give us more insight on how this country managed to lift the curse (Sachs and Warner, 1995: p. 20-21). Hence Malaysia is chosen as a success story, due to its success in diversifying its economy over a fairly short period of time. Additionally, Malaysia’s biggest export sector is machinery, which shows the economic functionality of its manufacturing sector (OEC, 2018). On the other hand, Iran has

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25 failed to diversify its economy. For example, Iran’s total export still exists for 81.5% out of

natural-resource exports, 68% of which is solely petroleum (OEC, 2018). Furthermore, Iran does not really have a sector within its economy that comes even close to the revenue its oil exports offer while Malaysia’s biggest export sector is machinery. Choosing Iran and Malaysia is also related to the fact that these are better-known countries. As Chang argues: ‘(…) it should be

pointed out that there is still great value in looking at the experiences of the supposedly better-known countries, particularly because there exist many myths and misconceptions about their histories’. (Chang, 2002: p. 8).

1.3.2 Time-frame

The time-frame in which these countries will be analysed is from 1960 till 2018. For Iran, the reason the timeframe starts at 1960 is to include the build-up of the Iranian revolution, as well as the aftermath. Furthermore, the year 1960 is one of the worst performing years for Iran resulting in an IMF stabilization programme, which marks the start of the story of Iran’s development (Karshenas, 1990: p. 136-137). For Iran this story will then continue through its revolution and its aftermath, along with recent years, in which Iran has slowly started

diversifying its economy. Especially the chemicals sector has been seeing a gradual rise relative to its oil exports over the past few years (OEC, 2018).

For Malaysia the timeframe itself starts in 1960 to discuss some historic fundamentals but most of the analysis is based on 1969 and onwards. This is because in 1969 the 13 May Incident take place. The 13 May incident is a revolt which was put down by the government, followed by a very strict curfew. As a consequence, Malaysia implemented the New Economic Policy (NEP), which initiated Malaysia’s process towards economic diversification (Horowitz, 2003: p.14-15). So, how can one analyse the differences between these cases? The next section contains the theories that will be used to analyse these differences.

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1.4 Theory and Concepts

To find answers to the main research question, theories are necessary to construct hypotheses for this question. In chapter 3 these theories will be more thoroughly discussed.

The state-led development theory of Chang is very much based on List’s infant industries

argument. Friedrich List (1789 – 1846) was a German economist who based his ideas on

historical and economic elements. His most notable work is called ‘Das nationale System der

politischen Ökonomie’ published in 1930. In short, when industries are not at the desired

technological level, thus infant, they require interventionist policies to stimulate the

technological growth. State intervention is necessary here because investments tend to be very low in a sector that is not performing very well. Thus, rather than market actors it is the state or ruling elite that needs to invest here, because the latter does not necessarily have a preference for returns on investments. This allows states to invest in infant industries, simply to increase their performance. While market actors only invest in sectors that will offer profitable returns on the investments (Chang, 2002). According to Chang most developed countries have used a form of state-led development. Yet once these countries achieved enough confidence in their manufacturing sectors they forcefully opened up the global market to reap the benefits of market expansion. This led to developed countries kicking away the ladder; the ladder being state-led development, which they used to climb to their current developed position in the first place. Thus, according to Chang, developing countries require infant industry promotion

policies, which is a form of state-led development. Yet the current global system obstructs this path of development (Chang, 2002). This theory will be used to evaluate to what extent Iran and Malaysia focused on their infant industries. For Iran and Malaysia this specifically means how much they have focused on sectors other than their petroleum sector or natural resource sectors. Furthermore, it also adds to the scientific debate by using this theory specifically on resource rich countries, rather than the broad cross-country analysis by Chang. However, the petroleum sectors in these countries remain very relevant, which logically brings me to the question: How have these countries used their oil revenues?

Karshenas (1990) offers a broad framework to analyze the usage of oil revenues. He seems to agree with Chang, that state-interventionist policies are highly necessary for the early stages of economic growth: ‘(…) the sluggish growth of new industries due to the liberal trade policy of

the government, had created an immense gap between the structure of domestic demand and supply for industrial products.’ (Karshenas, 1990: p. 167). Karshenas claims that especially

import substitution industrialization (ISI) is very important when utilizing oil revenues. The main idea of ISI is to invest in domestic production of products that would otherwise be constantly imported, often this results in a focus on simple commodities. However, Karshenas does make

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27 some claims about the risks of state-led industrialization. As he argues that some of the

attempts of Iran to industrialize were in fact so forceful that they impeded industrialization more than actually promoting it, usually because of non-synergetic policies or conditions. To analyze the relation between policies and conditions, Auty’s framework of RBI offers a more practical set of indicators (Auty, 1990).

In 1990, Auty published a work titled: Resource-based industrialization: Sowing the oil in Eight

Developing Countries. Resource-based industrialization (RBI) is a way in which countries can

promote their industrialization based on the revenue from natural resource exports. The question is rather, how does one achieve this? According to Auty this is very difficult and acquires a so-called big-push approach. This is because industrialization is very dependent on economies of scale, and therefore requires investments and attention in its manufacturing sector (Auty, 1990). However it is often very difficult for countries to successfully place their oil revenues into other sectors than the oil sector itself. Karshenas also mentions this and names this phenomenon perverse growth (Karshenas, 1990: p. 21). The high revenues from oil lead to a neglect of other sectors, politics to be solely focused on oil and its huge gains and

macroeconomic policies to be entirely absent or neglected. This makes RBI almost a paradoxical form of industrialization because the very presence of these resource may impede a country’s industrialization. This theory practical indicators of this theory will be more thoroughly

discussed in Chapter 3.

The term perverse growth by Karshenas (1990) is only one way in which oil can impede growth. According to Ross, who further explains this idea of perverse growth, oil can result in a curse,

The Curse of Oil. The theory of Ross (2012) here is based on how oil can impede development in

its broadest sense. Other than perverse growth, Ross coins the following term: the Irony of oil

wealth. This means that the countries who need the revenues from oil the most are the ones

who suffer the most from the resource curse. Ross attempts to analyze the consequences of the oil curse in more aspects of society, such as authoritarianism and civil war. He claims that oil-states are about 50% more likely to be authoritarian and twice as likely to experience civil warfare. However, solving these issues is often difficult because these countries are trapped in their oil-based status-quo, making it very difficult to leave oil behind and the problems, but also the befits, that come with it. The argument of Ross is a counter-argument against the statist and economic focus of this thesis. In fact, Ross claims that oil is very influential for a country as a whole, not only its economic development but its stability as a whole. So according to Ross oil affects many more variables which then affect development, making oil-led development more problematic and more multi-faceted in its consequences.

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28 Another argument to be discussed here is the argument of economic linkages by Sachs and Warner. They state that a focus on natural resource exports has had an inverse effect on economic growth, with the only exceptions being Malaysia and Mauritius. They claim that the division between tradeable manufacturing goods and natural resource exports are a crucial indicator for economic growth. This problem of sector-preferences is heavily interlinked with the Dutch Disease problem and its resource movement effects. So in order to diversify an economy, the resource movement effect has to be combatted to acquire a focus on the

manufacturing sector. In this paragraph most of the concepts that will be used throughout this thesis have been discussed and explained. In Chapter 3 some other theories with more practical indicators will be discussed as well.

Most research that attempted to look for remedies was based on Western success stories, countries that already had functioning economies. But that is exactly what makes them hard to compare with a country like Iran, whose development is entirely drenched in oil. How can countries actually deviate from this dependence on oil, like Malaysia? Thus, this research proceeds with the works of Karshenas and Chang, with more recent data, new cases and more analytical methods to analyse state policies and political and economic structures.

1.5 Hypotheses & Argumentation

The main hypotheses are based on the ideas of Chang and Karshenas. As Chang explains, a country’s development should be supported mainly by intervention of the state, furthermore, promoting infant industries is a crucial element of this. Thus, for the hypotheses this means that is to be expected that countries who focused on other sectors than its oil sector, inherently infant due to the sheer size of the petroleum sectors of my cases, will be more likely to solve the

resource movement effect. Solving this problem means that a country managed to focus on

other sectors than its petroleum sector, which then leads to a more diversified economy (Chang, 2002; Karshenas 1990; Cardin, 1984; Sachs & Warner, 1995).

Given that Malaysia is seen as a success story, the hypotheses suggest that Malaysia’s policies were properly focused on its private market and manufacturing sector, allowing it to diversify its economy. Additionally, for Iran this is the opposite, where the policies of Iran were too focused on its petroleum sector which has been holding this country back from diversifying for such a long time. This brings me to the following two hypotheses:

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i) Malaysia’s policies focused on its private market and its manufacturing sector which resulted in the diversification of its economy, lowering its emphasis on oil-exports.

ii) Iran’s policies focused too much on its natural resource sector which left its other sectors underdeveloped, increasing its dependence on oil-exports.

The argumentation that lays at the basis of both these hypotheses is as follows: In order for countries to shape the conditions towards economic diversification they need to focus their oil-revenues on their non-oil sectors. This is a difficult task but necessary to lower a country’s dependency on oil. If the revenues of the oil-sector simply flow back into the oil-sector it means that the oil-sector will remain relative the most lucrative economic sector. This means that non-oil sectors will be neglected and, as a consequence and a cause, experience low investments and growth. This requires the state to implement policies to stimulate the non-oil sector. The reason this is necessary to be based on state-led development is because this requires

investments in underdeveloped or infant industries. Therefore, it requires an investments approach not inherently focused on the return of the investment. This is why the state itself needs to invest or legally enforce investments towards non-oil sectors in order to allow non-oil sectors to thrive relative to a country’s oil sectors (Karshenas, 1990; Sachs & Warner, 1995; Chang, 2002).

The third and fourth hypotheses are alternative explanations. First of all, the first two

hypotheses do not take regional relations into account. According to Fong and Kinyanjui, this is rather important for Malaysia due to the bamboo network; a network of Chinese businessmen who seek to increase their influence throughout Asia, this was especially prevalent in the 1970s. This led to an influx of Chinese entrepreneurs into Malaysian, which then greatly strengthened its private market (Fong, 1990; Kinyanjui, 2011). This was a great stimulation for the process of economic diversification, thus, suggesting the following hypothesis:

iii) Chinese influence in Malaysia led to an influx of Chinese entrepreneurs which strengthened Malaysia’s private market, in turn, this improved its economic diversification.

The last hypothesis is based on the ideas of Ross and Davis, both of which stress the volatility of oil for a country. Given that Iran has used much more of its oil-export than Malaysia, who also sold a lot of rubber and tin, this could mean that Iran suffers more from the volatility of oil itself. This volatility regards higher fluctuation of prices, more dependence on global prices and

uncertainty about constant commodity imports (Davis, 2011; Ross, 2013). This leads me to the following hypothesis:

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iv) Oil-exports are more volatile than rubber and tin exports, given that Iran has been more dependent on oil this explains its difficulties to utilizing the revenue of this volatile resource.

1.6 Method & Data

In this research a structuralist approach based on Chang will be used. Chang’s approach based on the German Historical School and entails the following: ‘(…) Searching for persistent historical

patterns, constructing theories to explain them (…) while taking into account changes in

technological, institutional and political circumstances.’ (Chang, 2002: p. 6). This thesis contains

such a long timeframe in order to be able to recognize such historical patterns and develop theories to understand them while also being able to analyse the different contexts throughout the timeframe. Therefore, chapter 2 will focus on the political contexts of the state and the process of industrialization in Iran and Malaysia. The ‘state’ in this thesis means the ruling political elite in relation to state-led industrialization. This chapter takes into account the

political context in which Iran and Malaysia have developed and implemented their policies. The main question of this chapter is therefore: What do the state and industrialization in Iran and Malaysia look like, between 1960 and 2018?

In Chapter 3 the actual method of evaluating the policies of Malaysia and Iran will be discussed. This is focused on the theories of Chang (2002), Epshtein (2016), Bresser-Pereira (2005), Auty (1990), Karshenas and Hakimian (2005). The main question of this chapter is: According to the literature, what kind of policies, development strategies and political circumstances may support or obstruct the process of industrialization? The concepts and theories derived from this chapter will then be used as theoretical leverage to compare Iran and Malaysia. These theories offer several concepts that will be used to evaluate the processes of industrialization in Malaysia and Iran. This evaluation will take place in Chapter 4. Which starts with discussing the policies of Iran and Malaysia in their processes of industrialization, followed by evaluating these policies based on the concepts from chapter 3. The evaluation of these concepts then allows for a more structured comparison between Malaysia and Iran. In chapter 5 the actual

recommendations based on the comparison of Iran and Malaysia will be discussed, focused on shaping the conditions to realize economic diversification.

The data that will be used in this thesis is mainly from databanks, policy documents and academic literature. The databanks mainly regard institutions like OEC, the World Bank or Indexmundi. All of which offer economic and statistical data such as economic complexity, growth rates, unemployment rates and FDI-inflows. The policy documents that will be used mainly regard the actual policy documents that have been used by Malaysia and Iran in their

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31 processes of industrialization. These were mainly gained through searching on Commonlii or the OECD databases (both of which have databases for policy documents). In the case of Iran, some policy documents were more difficult to retrieve, however, these were often discussed or translated in academic works. Lastly, there is an extensive body of academic literature used in this thesis for the entirety of the analysis, statistical data and theoretical perspectives.

1.7 Structure of the Thesis

In total, this thesis will consist of five chapters. The first chapter will serve an introductory purpose: explaining the research objectives, the research question, relevance, the delineation of the research, literature review, theory and concepts, hypotheses and a section on methods and data. The second chapter will discuss the political climates, the state and industrialization of both my cases in a historical manner. In this chapter I will chronologically discuss the political backgrounds of industrialization of Iran and Malaysia between 1960 and 2018. The main question of this chapter is: What do the political contexts of the state and industrialization in Iran and Malaysia look like, between 1960 and 2016?

The third chapter will be about the theories and concepts aimed at explaining the success and failure of industrialization. These will be used to evaluate the processes of industrialization in Chapter 4. The main question of this chapter is: According to the literature, what kind of policies, development strategies and political circumstances may support or obstruct the process of industrialization?

The fourth chapter will be the biggest part of the analysis and contains the analysis of Iran’s and Malaysia’s policies and attempts at industrial development. These will also be analyzed

chronologically, followed by a theoretical evaluation based on the concepts and theories from chapter 3. The main question of this chapter is: Which policies, political circumstances and development plans of Malaysia and Iran have contributed or obstructed their processes of industrialization? The fifth chapter is the conclusion. This chapter will discuss the hypotheses, conclusions, recommendations and suggestions for future research.

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Chapter 2:

The State and Industrialization in Iran and Malaysia

2.1 Introduction

This chapter will be an analytical evaluation of the political context of the state and process of industrialization in Iran and Malaysia. In this thesis, the term state will be used to describe the ruling political elite and their relation with state-led industrialization. The objective of this chapter is to analyze and indicate the political and social backgrounds at the time of

industrialization. The political context regard the domestic and international political structures and events that have shaped the political state of affairs in Iran and Malaysia. The main

question of this chapter is as follows: What do the political contexts of the state and

industrialization in Iran and Malaysia look like, between 1960 and 2018? The sub-questions of this chapter are the same as the research question.

In order to answer this question this chapter will be structured as follows: In paragraph 2.2 the political context of the state and process of industrialization of Iran will be discussed. This will be done chronologically, starting with paragraph 2.2.1 on the historic foundations in the 1800s and 1900s, paragraph 2.2.2 till 2.2.7 will respectively discuss the 1960s up to the 2010s. A similar chronological method will be used in paragraph 2.3 on Malaysia. However, given that Malaysia is a much younger country, the analysis on Malaysia will start in the 1960s in paragraph 3.3.1, up to the 2010s in paragraph 3.3.6. At the very end, in paragraph 3.4, this chapter will be finalized with the conclusion.

First, some basic statistics regarding Iran and Malaysia will be discussed. Iran has a population size of about 81 million people, spread over an area of 1.648 km 2_{. Currently its GDP per capita} is about 20.000 US$ and its total GDP at about 1.631 trillion US$. Malaysia’s population size is about 32 million, spread over an area of 330.8 km 2_{. Currently its GDP per capita is about 28.000} US$ and its total GDP at about 926 billion US$ (CIA World Factbook, 2018a; 2018b).

In the case of Malaysia especially the machinery and electronics sector have proven very successful. In 2017, 52% of Malaysia's export derives from its machinery sector. Therefore, Malaysia is no longer suffering from a dependency on natural resources. This is rather impressive when taking into account that in 1972 the electronics and machinery sector of Malaysia was only accountable for 0.6% of the total exports, throughout the 80s and 90s this sector grew immensely fast (OEC, 2018a).

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33 Currently Iran's natural resource sector takes up about 68% of its total exports. However, this value used to be far above 80% between the 1960s and 2000s. Only later in the 2010s there is a gradual decrease in the export value of Iran's natural resource sector. Specifically the sectors of medical and chemical products have relatively grown in Iran's total export value. So, what political contexts of the Iranian state were at the background of this oil-dependent path of modernization?

2.2 Iran:

‘Independence, Freedom and the Islamic Republic’

In this paragraph the political context of Iran’s state and its industrialization will be analyzed. Focusing mainly on the challenges Iran faces along with policies that relate to Iran’s process of industrialization. Iran’s industrialization is often described as a process that went back and forth, where both growth and backwardness are continuously returning topics. As Karshenas and Hakimian describe: ‘ (…) The agenda for economic reform has often been put on the back

burner, postponing the largely overdue modernization of Iran’s ailing economy.’ (Karshenas &

Hakimian, 2005: p. 67). To understand the historical background and political context of the Iranian state in Iran’s industrialization, this will be discussed chronologically starting in the early 19th_{and 20}th_century.

2.2.1 – 1800s and early 1900s:

Two different phases of Iran’s state-led development will be discussed: the reforms under the Qajar empire and the industrialization under Reza Shah. To understand the structure of the state in Iran it is important to briefly discuss the role of the Shia Islam in Iranian power

structures. Twelver Shi’ism is the dominant form of Shi’ism in Iran which includes the idea that leadership is based on how the Prophet Muhammad passed on his leadership to twelve imams. The twelfth of these imams is known as the Mahdi, the hidden Imam or the Lord of the Age. This twelfth imam is said to have removed himself from this world and will supposedly return to: ‘…Establish the government of truth and justice.’ (Bakhash, 1991: p. 1479). Until that time, the

mujtahids (the Shi’i jurists or vice-regency of the Imam) will be the ones to claim the position of

leaders of the Iranian community. However, until Khomeini in 1979, the idea of mujtahids’ leadership was mainly a theoretical claim rather than an actual mandate to assume political power.

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34 Therefore, the relation between the jurists and the Iranian state has always been a controversial and complex relation. On the one hand, the jurists would oppose the ruling elite, modernization and foreign encroachment. On the other hand, some jurists would cooperate with the ruling elite, either to gain more personal power or because this cooperation was seen as a necessary evil. Either way, the individual positions of the jurists towards the state varied heavily. Following on this short introduction of Shi’i Islam will be the analysis of two waves of state-led

development and modernization, starting with a brief overview of the Qajar empire. In some of the literature these waves of modernization are split in several more, such as the three steps of 19th_{century modernization as argued by Shahriari (2017: p. 270).}

The Qajar empire ruled Persia from 1785 till 1925. The ruler of the Qajar empire was the

Shah-in-Shah, which translates to the King of Kings, the absolute ruler of the Persia. A British emissary

who visited Iran in the nineteenth century, Sir John Malcolm, wrote: ‘The Monarchy of Iran is

one of the most absolute in the world’ (Abrahamian, 1974: p. 10). However, most striking about

the Qajar rule was the fact that it had next to no physical instruments to enforce its rule, such as a massive military force. Therefore, its power was very limited in most cities and the far-out countryside. According to Abrahamian this has to do with Iran’s internal geography, which exists out of a very rugged terrain full off deserts, mountains and barren soils. This meant that most of the Iranian population has been traditionally isolated and secluded in small villages or nomadic clans, which led to a very geographically fragmented population. This geographical

fragmentation then resulted in even more fragmentation due to different languages and different religious interpretations, which lead to the rise of many different factions (Abrahamian, 1974: p. 9-11).

In 1848 Naser o-Din Shah became the new rules of the Qajar empire and is often seen as the most successful of the Qajar rulers. Under Naser o-din Shah Iran was introduced to Western forms of education, technology and science which initiated Iran’s first phase of modernization. Another important actor of Iran’s modernization was the advisor of Nasser o-Din; Mirza Taqi, who is also known under his title Amir Kabir, Iran’s wave of modernization in the 19th_{century is} often credited to Amir Kabir rather than the Shah. Between 1848 and 1851 Mirza Taqi

implemented many essential reforms in Iran’s society: Cutting government expenditures, modernizing central administration, promoting foreign trade and central responsibility for the national bureaucracy. While all these elements of modernization were in effect, Iran was enjoying a rather low rate of foreign encroachment. In this successful period of modernization Iran saw the rise of Tehran’s bazaar and Iran’s first university (Shahriari, 2017: p. 269-270) .

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35 However, this was about to change in the late 1800s. while Naser o-Din Shah and Mirza Taqi tried to modernize Iran, the amount of foreign encroachment rapidly increased, especially Britain was becoming more active in Iran. Countries like Iran and Afghanistan played an important role in Britain’s colonial politics because these were seen as a buffer-zone between British-India and the increasing control of Russia throughout the Middle-East. As a consequence, in the 1880s most of the Iranian economy came under British control. On top of this, in 1896 Naser o-Din was assassinated and his son became the new ruler of Iran; Mozaffar o-Din. However, Mozaffar o-Din proved a very unsuccessful ruler. He brought about many financial problems in Iran due to the lack of revenues and popular dissatisfaction due to his corrupt relations with Europeans. This led to the overthrowing of Mozaffar o-Din and the constitutional revolution in 1907. However, the signed promises of the constitution never came into existence because Mohammad Ali Shah abolished the parliamentary government and the constitution with Russian aid, such as the Russian Persian Cossacks Brigade. As a consequences this led to even more popular dissatisfaction and another revolution in 1909 which resulted in Mohammad Ali Shah to be exiled in Russia. Despite the eventual success of the Constitutional Revolution, the tumultuous period leading up to this revolution lead to a rapid decline in stability and trade. In 1909 Ahmad Shah became the new ruler at an age of 11 and proved to be an ineffective ruler. On top of this, Mohammad Ali, the previous Shah, attempted to regain control with help of Russian troops in 1910. Meanwhile, the Anglo-Russian agreement from 1907 divided Iran in Russian and British spheres of influence. Both these developments would severely obstruct the ideals for a constitutional revolution. Then in 1914 the occupation of Iran during the first World War by British, Russian and Ottoman troops increased the instability in Iran. On top of this, in 1919 the United States and other Western countries saw an increase in their oil demand as a result of the First World War. All of these foreign interventions heavily undermined the

authority of Ahmad Shah. However, in 1921 this is about to change when through a coup d’état Reza Khan, known as Reza Shah Pahlavi, rises to power and becomes the new Shah in 1925, initiating the second phase of modernization (Amineh, 1999: 165).

Modernization under Reza Shah was mainly based on state-led development and import substitution. This wave of modernization contained many Western influences, in education, market structures and the financial sector. Between 1925 and 1933 Reza Shah mainly focused on domestic modernization, such as improving the general infrastructure, education and

jurisdictional system. Between 1933 and 1941 Reza Shah increased his absolute control in order to realize reforms in secularization and adopting more Western policies (Abrahamian, 1982: p. 140-141).

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36 Furthermore, under the rule of Reza Shah Iran’s international relations were increasingly more aimed at Germany rather than its usual colonial or intervening countries, such as Great Britain or the US. This was, amongst other reasons, due to Germany’s excessive anti-US and anti-British propaganda that it was using in Iran. This meant that Iran became part of the Axis powers, also known as the Third Power, opposing the Soviet and Allied power spheres (Amineh, 1999: p. 198-199).

In 1939 the economic relations between Iran and Germany also improved, with a high export of industrial goods from Iran to Germany. At the time, about 32% of Iran’s exports were going to Germany, while in the early 1920s this was between 0% and 2%. However, the Iranian-German relations will prove very problematic when the Second World War starts in 1939 because the Iranian state-class had aligned itself with Nazi Germany. This turned Iran into a battleground in the Second World War, facing both Great Britain and the Soviet Union. In 1941 this led to the exile of Reza Shah, while his son Mahammad Reza Pahlavi were to be his successor. Iran under Mohammad Reza faced a problematic period. After the Second world War, Iran became entangled in the Cold War between the Soviet Union and the United States. Once again, Iran was seen as a buffer-zone against the threat of rising communism in the Middle East (Amineh, 1999: p. 163, 164, 200-201).

Under the rule of Mohammad Reza, Iran’s modernization slowed down, although it still progressed. Iran’s 1950s mainly contained industrial modernization and improvements in infrastructure. However, proper infrastructure was also necessary to deal swiftly with potential tendencies and revolts in Iran’s countryside. Therefore, the modernization under Mohammad Reza was very controversial: ‘For some, the shah attempted to modernize Iran too quickly,

touching off strains that society could not absorb and thus resisted. For others, he did not achieve results quick enough, leaving the country underdeveloped, despite promises of creating an industrial power and a great civilization.’ (Foran, 2003: p. 309). In this period, the presence of

the United States and the Soviet Union also become more prevalent in Iran as a result of the increasing tensions of the Cold War. This led to the use of the Truman-doctrine, which was the basis of the US’ politics in the Middle East throughout the Cold War (Amineh, 1999: p. 215-216). The US attempted to preserve the status quo in Iran through economic and military aid, which led to an intensive relationship between the US and Iran.

Lifting the resource curse : a case study on Iran and Malaysia