Sanctions and Self-Sufficiency: The Evolution of Iran’s Manufacturing Sector

For decades, Western countries, especially the United States (U.S.), used sanctions as a common tool to promote democracy and prevent certain nations from developing nuclear or chemical weapons. Iran, due to its efforts to develop nuclear weapons and other advanced technological weapons, has become a prime example, facing one of the strictest sanctions regimes in the world since the 1979 Iranian Revolution. These measures including the U.N. Security Council embargoes in 2007 and 2015, have had a major impact on Iran’s economy. However, alongside the economic hardship, sanctions have also spurred the growth of a domestic manufacturing sector, especially in defence and military industries, demonstrating the country’s capacity to adapt to hardship.

Economic sanctions are sometimes a powerful policy tool that often blur the lines between diplomacy and economic warfare. Iran serves as a key case study, facing some of the most stringent sanctions globally, targeting sectors, entities, and individuals for their involvements in nuclear proliferation and terrorism. These measures have severely impacted Iran’s economy but have had limited success in achieving their goals. The limitations of sanctions in accomplishing comprehensive policy goals are even highlighted by the acknowledgement of U.S. Treasury Secretary Janet Yellen that the penalties caused economic suffering but did not result in behavioural change.

Sanctions have inflicted significant damage to Iran’s economy, contributing to a wide range of negative macroeconomic consequences. These include a rapid decline in the value of the Iranian currency, severe trade and fiscal deficits, high inflation, and rising poverty rates. Iran has been unable to mitigate the economic pressures exerted by sanctions. The World Bank reported that over 20% of Iran’s middle class has slipped below the poverty line where 9 million Iranians have dropped out of the middle class. This economic hardship has increased reliance on government aid, with 80% of the population now dependent on it. Experts like Nasr and Bajoghli argue that the middle class, who could drive change in the country, has been the most affected by these economic pressures​. Moreover, sanctions have reduced the affordability and availability of healthcare and medicine in Iran, severely impacting the healthcare system, citizens’ lives, and overall quality of life. Restrictions on the banking system have made importing medicines challenging, constituting a violation of fundamental human rights.

In addition, sanctions’ impact can be further illustrated by the estimated 15-20% contraction of Iran’s economy between 2012 and 2015, attributed to intensified sanctions, as noted by former U.S. Treasury Secretary Jacob Lew. This contraction resulted in an estimated $160 billion loss in oil revenue. Furthermore, over $100 billion in Iranian assets were frozen in overseas accounts, severely impacting the nation’s financial stability. This economic decline is reflected in the long-term trend of Iran’s GDP growth, which fell from 12.7% in 1970 to 5.5% in 2023. The oil embargo, coupled with reduced GDP, rising unemployment, and escalating prices, has further strained government revenues. Disruptions to essential supply chains for imports and domestic food production, compounded by subsidy cuts, high inflation, rapid population growth, urbanization, and limited agricultural resources, have collectively worsened food security within the country.

This inflationary pressure is further fuelled by the sanctions’ impact on oil revenues and access to hard currency, which has led to a sharp devaluation of the Rial. As a result, Iran recorded an inflation rate of 44.6% in 2023, ranking it 10th globally for rising prices. In response, the government introduced a currency rationing system to manage the Rial’s domestic demand, and mitigate inflationary pressures.

While these measures have effectively restricted Iran’s economic capabilities, they have not forced the country to abandon its nuclear ambitions. Instead, the country has focused on building self-sufficiency, particularly in industrial and military production.

While sanctions have severely constrained Iran’s economic growth, they have also contributed to the development of a self-reliant manufacturing sector. Indeed, certain sectors, particularly defence and military, have experienced growth in recent years, although the overall impact of sanctions on the manufacturing sector remains complex. These measures compelled the country to adapt and develop independent capabilities, despite higher production costs due to the lack of comparative advantage and foreign investment. Since the Iranian Revolution, the country has become proficient in producing cost-effective missiles, weapons, and advanced nuclear and technological solutions. Studies highlight a notable rise in the number of firms across various industries, with both private and public sectors driving growth rates in specific areas. Although Iran’s manufacturing sector has been the least negatively affected by sanctions, it has only partially offset the slower growth and reduced exports in the energy sector. Even with an overall increase in Iranian exports, persistent challenges, such as banking restrictions and dysfunctional customs arrangements have continued to hinder growth. These factors help explain why many Iranian manufacturing firms maintain a pessimistic outlook on export opportunities, as demonstrated by Javad Shamsi’s firm-level research. In addition to direct restrictions on access to technology and investment, sanctions have also negatively impacted Iran’s manufacturing sector by reducing energy efficiency. A study found that increased sanction intensity correlates with a 3.2% decrease in energy use efficiency across 24 industrial sub-sectors. This decline in energy efficiency further constrains manufacturing output and competitiveness.

Moreover, the sector encountered numerous challenges in recent years, including geopolitical uncertainty, supply chain disruptions, evolving consumer preferences, and intensified sanctions. Despite these hurdles, the sector continues to benefit from positive developments such as growing global demand, technological innovations, and increasing investment in automation and digitalization. Manufacturers embracing digital transformation and automation are positioning themselves for long-term success. By effectively managing cost pressures while maintaining a commitment to quality, these companies can navigate current crises and emerge stronger and more resilient. The outlook for manufacturing remains optimistic, driven by adaptability and a focus on innovation.

One key manifestation of this industrial growth has been the expansion of Iran’s arms industry. Data from the Ministry of Industries, Mine and Trade on manufacturing establishments indicates that most manufacture licenses issued after the Iranian Revolution were granted to the companies and industries heavily involved in weapons development, including missiles and other defence systems, as well as advancing its nuclear program. Additionally, industries such as chemicals and chemical product, rubber and plastic products, machinery and equipment, and computer related activities have seen significant growth under this framework.

Iran’s arms industry has grown significantly, making the country a regional power in missile technology, while arms industry evolved due to the sanctions, they were not the sole factor driving its development. It is evident that a significant portion of vacancies in manufacturing establishments with exploitation licenses, has been concentrated in the production and development of weapons and other goods targeted by U.S. sanctions. The number of such vacancies in these sectors has been rising rapidly, reflecting the growing focus on industries directly impacted by sanctions.

Iran has allegedly succeeded in developing a growing global arms industry, particularly in the last decade. According to the Iranian regime, “5,000 knowledge-based companies are cooperating with its defence industry to develop innovative weapons.” This effort encompasses an estimated 200 to 240 production facilities located within Iran and in other nations like Syria, Tajikistan, and Venezuela. For some, this reflects Iran’s determination and capacity to enhance its military strength despite the international restrictions placed on it.

Regarding the types of arms that have been manufactured, recently, Iran have been specialized in developing cost-effective ballistic missiles and unmanned aerial vehicles (UAVs). Iranian UAVs are said to range in price from $20,000 to $50,000, which is much more affordable compared to Russian drones that can reach up to $3 million. The most notable Iranian UAVs include the Shahed and Mohajer series, with their latest models introduced in 2021 and 2023, respectively. In terms of ballistic missiles, the Fateh-110, Zolfaghar, and Qiam-1 stand out as significant examples of Iran’s heavy weaponry. This focus on domestic arms production, particularly in cost-effective technologies, is a key component of Iran’s broader sanctions mitigation strategies.

Following the imposition of sanctions, Iran implemented a range of economic strategies to mitigate their impacts. A key approach has been bolstering domestic production, pursued through a multi-pronged approach. While raising public sector wages may have contributed marginally, more impactful measures included the elimination of certain import subsidies, raised wheat purchase prices, and increased administered food prices and that these led to a sharp 25% month over month rise in food costs, with the overall results remaining unclear. In parallel with efforts to stimulate domestic production, Iran also diversified its trade partnerships, capitalizing on higher global oil prices, which are expected to improve fiscal and external balances and benefit the non-oil sector. This diversification also involved Iran establishing trade agreements and expanded trade partnerships with non-Western countries, including China and Russia, to bypass restrictions.

This strategy of trade diversification isn’t new phenomenon for Iran, it has a long history as a response to external pressures. During the Iran-Iraq War, Iran prioritized diversifying trade routes to reduce reliance on Western suppliers. After the war, Iran shifted its focus to expanding non-oil exports, especially due to the instability in oil markets. In the 1990s, following the Soviet Union’s collapse, Iran sought regional economic partnerships, particularly with former Soviet republics and neighbouring countries. These partnerships became essential in countering U.S. sanctions targeting Iran’s oil industry, demonstrating a pattern of using trade relationships to navigate economic challenges.

These historical examples illustrate a consistent approach to trade policy as a tool for navigating external pressures. The sanctions imposed in the 1980s, for example, led to a realignment of Iran’s trade policies, pushing Tehran to find new economic partners while avoiding traditional suppliers such as Germany, France, the U.K., and Japan, fearing U.S. political influence. Consequently, Iran strengthened trade relations with smaller European nations, Eastern Europe, and non-aligned countries. The post-revolution constitution allowed the Iranian government to exert tighter control over trade, requiring private importers to obtain prior authorization. This control was further reinforced through selective bilateral agreements, shifting imports of key commodities like wheat, meat, and iron to suppliers such as Australia, New Zealand, Sweden, Denmark, and Eastern bloc countries. Over time, Iran reduced its dependency on Western economies, cutting U.S. imports to zero by 1996.

Finally, specific instances of sanctions reveal consistent strategies employed by Iran to mitigate their impacts. To counter the Iran and Libya Sanctions Act, for instance, Iran considered several strategies. One approach was to develop domestic technology for its oil industry to reduce reliance on foreign investment, promoting self-sufficiency. Other options included engaging in diplomatic dialogue with the U.S. to ease sanctions, though it carried political risks and encouraging non-U.S. firms to violate sanctions, leveraging international opposition to their extraterritorial nature. To attract foreign investment, Iran offered lucrative terms for oil and gas projects, drawing major European, Russian, and Asian companies despite U.S. restrictions. Simultaneously, Iran focused on developing local manufacturing capabilities to support its oil sector, reducing dependency on international suppliers. Although they are unique to the Iran and Libya Sanctions Act, these strategies show the kind of steps Iran takes to lessen the effects of sanctions generally, such as strengthening its own capabilities and expanding its international alliances.

Iran’s experience under extensive sanctions highlights both its resilience and the challenges it continues to face. While sanctions have significantly strained the economy, reducing oil revenues, increasing inflation, and causing widespread poverty, they have also driven Iran to develop a more self-reliant economy. The manufacturing sector, despite facing supply chain disruptions and energy inefficiencies, has adapted by focusing on military and technological advancements, making Iran a regional power in arms production. However, this self-reliance has come at the cost of broader economic growth and social well-being, as sanctions exacerbate inequality, hinder innovation in non-military sectors, and strain public resources. Iran’s adaptability underscores its determination, but without addressing the structural challenges and external pressures, sustainable progress remains elusive.

This resilience, however, faces ongoing tests amid shifting geopolitical dynamics. The U.S. “maximum pressure” policy, particularly under President Donald Trump, has sought to intensify economic constraints on Iran, raising questions about the nation’s future economic trajectory. While these renewed sanctions aim to weaken Iran’s economy, their effectiveness remains uncertain, given Iran’s history of adapting to external pressures. The long-term impact will depend on how Iran navigates these challenges and whether it can mitigate the consequences of prolonged isolation.

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