EVENTS

Date:	Thursday, July 26, 2007
Time:	9:45 AM -- 2:30 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

July 2007

Divesting from Iran: A Briefing from State and Federal Legislators

As shrill partisanship dominates Washington, there remains one vital security issue that unites rather than divides America's leaders: the growing threat posed by the Islamic Republic of Iran. While there are few ideal policy options, there has been a groundswell of state and national legislation to facilitate the divestment of funds from corporations working in the Islamic Republic. As Tehran continues to defy international demands, divestment may prove to be the most effective mechanism yet in curtailing Iran's nuclear and regional ambitions. But what barriers to divestment exist? Is divestment little more than a symbol, or will it drive business away from Tehran? And, ultimately, what will divestment mean for the Islamic Republic?

Representative Brad Sherman (D-Calif.), chairman of the House Committee on Foreign Affairs Subcommittee on Terrorism, Nonproliferation, and Trade, opened this AEI event with an overview of Congressional efforts to move divestment legislation this year. Patrick Clawson of the Washington Institute for Near East Policy, Ken Katzman of the Congressional Research Service, and Danielle Pletka of AEI addressed the public policy implications of divestment. Senator Jon Kyl (R-Ariz.), chairman of the Senate Republican Conference, delivered a luncheon keynote address on the Senate's view of the Iran threat and potential legislative responses. The day's last panel covered state legislation, pension fund divestment, and the new state activism. Panelists included Senator Ted Deutch (D-Fla.), sponsor of the Protecting Florida's Investments Act of 2007; Senator Craig Johnson (D-N.Y.), sponsor of the Iranian Economic Divestment Act of 2007; and Missouri state treasurer Sarah Steelman, architect of Missouri's terror-free fund.

Opening Remarks

The Honorable Brad Sherman (D-Calif.)
U.S. House of Representatives

Despite the many tools the United States has for altering Iran's behavior, the nuclear facility at Natanz remains operational. Iran must not be allowed to obtain a nuclear weapon. Action is necessary for three reasons. First, the United States has a stake in maintaining world order. If a rogue state is allowed to obtain a nuclear weapon, the Nuclear Non-Proliferation Treaty will be severely undermined. Middle Eastern nations will aggressively pursue nuclear weapons for their own security and other states, like Brazil, will likewise begin nuclear weapon programs as a matter of national pride. Second, allowing Iran to build a nuclear weapon will embolden it. It is likely that an emboldened Iran will come into direct conflict with the United States through its proxies and would act more aggressively to establish regional hegemony. Third, a nuclear Iran might use its weapons against the United States, resulting in mass casualties.

Divestment, then, is one way that the United States can alter Iran's behavior. Recent protests over gas rationing show that Iran's economy is vulnerable and that the country is dependent on multinational corporations, suggesting that a well-formed divestment policy can have big results. There are, however, three obstacles. First, the government must be willing to enforce the law. Currently, the president is not compelled to issue sanctions if companies violate the Iran Sanctions Act (ISA). Congress may be forced to amend the ISA to force the president to sanction companies in violation of the law. Second, legislators must convince investment managers that divestment is a good financial decision. To do this, legislators must protect institutional investors and investment managers who believe that they are fulfilling their fiduciary duties by avoiding the risk that investment in Iran poses. And third, Congress must ensure that states have the authority to enforce divestment bills by passing the currently pending Iran Sanctions Enabling Act.

Ultimately, divestment is only one way in which the international community can seek to alter Iran's behavior. Combined with aggressive measures to limit international loans from the World Bank (from which Iran receives $1.3 billion annually), divestment can persuade Iran that defying the world and building a nuclear weapon will come at the expense of a healthy economy.

Panel I: Divestment and its Policy Implications

Patrick Clawson
Washington Institute for Near East Policy

In the past five years, Iran's economic performance has been mediocre. Although the nation has little foreign debt and small government deficits, Iran's performance has paled in comparison to its neighbors in the Middle East and the expectations of Iranians. There are four main problems with Iran's economy. The first is cronyism, a policy whereby revolutionary institutions in the government make a profit through political connections and rent-seeking instead of through economic activity. The second problem is the poor use of government funds. The Iranian government has ample resources, but it uses them for subsidies. The third problem is youth unemployment. Even if Iran sustains 5 percent of its GDP growth, unemployment will rise. The fourth problem is declining oil output. The oil industry has experienced a dramatic decline in output and is in need of foreign technology and managerial skills. We can offer carrots and sticks to Iran to try to control its first three problems. Sticks can be used against cronyism to keep money out of the pockets of Iran's leaders. Carrots, such as joining the World Trade Organization, can be offered to provide an opportunity for job growth. Divestment addresses Iran's fourth problem: oil output.

Ken Katzman
Congressional Research Service

The economy in Iran is poor and mismanaged, and the government will never reach its ambitious goals of increasing production. There are two power centers in Iran's economy. Ahmadinejad represents the first. He advocates government control of the economy and the state. His constituency is the rural working class, which does not care about trade agreements with the United States or the European Union. This political base does not buy luxury items or cars produced in the West. The pressure on the government comes from the Bazaaris (merchant-capitalists). This group is the source of Iran's employment, and its members makes money by importing goods and raising the price for domestic buyers. The Bazaaris are fearful of international sanctions and the threat of economic isolation. Without markets they will starve. The Revolutionary Guard is less fearful of economic sanctions, because its members will receive the contracts given to the international companies that leave Iran.

Danielle Pletka
AEI

At the state level, two divestment bills have been passed relating to Sudan and Darfur. It is not clear whether the Iran Sanctions Act will become law. Most U.S. companies are not dealing with Iran, but there are many foreign companies that are. It has not been easy to get Great Britain, France, Russia, or China to agree with the recent United Nations resolutions about Iran. Now we are negotiating a third resolution. The Bush administration has tirelessly made the argument that Iran is going forward with uranium enrichment. Now there is reluctance in the banking industry to do business with Iran. Iran is looking to divide Europeans and Asians over sanctions. There will be serious repercussions if we sanction European countries' investments in Iran.

Keynote Address

The Honorable Jon Kyl (R-Ariz.)
U.S. Senate

A look at U.S. foreign policy before World War II and during the latter stages of the Cold War is instructive for U.S. policy towards Iran today. Like Nazi Germany, Iran has made bold threats, plainly revealing its revisionist intentions. Rather then wait for the threats to carried out, as we did in World War II, the United States should take a number of steps at the margins to contain Iran, with the ultimate goal of long-term behavioral change, as the United States did during the Cold War.

Iran is vulnerable both politically and economically. The regime in Tehran is incredibly unpopular, primarily because it has mismanaged the economy. A recent survey revealed that a majority of Iranians would trade the recognition of Israel, nuclear weapons, and influence in Iraq for the normalization of U.S.-Iranian relations. Moreover, Ahmadinejad has lost a significant amount of political capital. He has lost popularity for failing to deliver on his reformist platform, and his supporters fared poorly in the last round of municipal elections. There is speculation that Supreme Leader Khamenei is upset with his aggressive handling of the nuclear issue as well. The Iranian economy is weak. It is experiencing high unemployment and rising inflation, despite the bullish oil market of the past five years. Its oil production is declining, primarily due to its poor facilities, and it is possible that Iran will cease oil production by 2015.

Divestment is aimed at these economic vulnerabilities. An effective divestment campaign, however, must be widespread (become money is fungible) and immediate (because time is limited). A good policy would begin with robust enforcement of the Iran Sanctions Act, even if strict divestment results in trade disputes. The United States should also exert diplomatic pressure on China and Russia to make divestment work. Effective policy also includes preventing money from reaching Iran's elite, the prime movers of the economy. Finally, the United States must take advantage of the pro-American sentiment of the Iranian public through robust public diplomacy.

It is critical that the United States and the international community combat the Iranian threat now, while its policy options are more open. If they do not, then it will be more likely that force will be necessary to stop Iran's nuclear program.

Panel II: State Divestment

The Honorable Sarah Steelman
Treasurer of Missouri

There is no question that Iran is one of the United States' most dangerous enemies in the world today. It was shocking, therefore, to find out that Missouri was indirectly funding Iran's transgressions through its public pension investments. This was the impetus for Missouri's divestment program. The important aspect of this program was that Missouri was able to affect companies' behavior without infringing on investors' fiduciary duty. In fact, the public pension funds affected improved their long-term rate of return.

Missouri used Congressional resources to identify companies that do business in Iran, then removed them from the state's broker-dealer list. The program has sought to reward companies that cease operations in Iran. For instance, the investment bank UBS pulled out of Iran partly as a result of being removed from Missouri's public pensions funds. Missouri then reinstated UBS to its broker-dealer list.

The Honorable Ted Deutch
Florida Senate

The Florida divestment bill was passed unanimously, but it faced serious opposition nonetheless. Opponents argued that because other investments offered a lower rate of return, the government was forcing pension funds to violate their fiduciary duties. This argument does not stand up to scrutiny. As the Missouri example demonstrates, divestment does not necessarily lower long-term rates of return. Indeed, the risk of investment in Iran due to government corruption and its unstable international situation means that there are better investments available. Additionally, many pensioners were unaware that their money was being used to finance business in Iran. Once they found out, they strongly supported divestment.

In terms of affecting behavioral change, divestment has a proven history. South Africa and Sudan offer instructive case studies. The Iran divestment bill in Florida affects thirteen companies and accounts totaling $830 million. Combined with the efforts of other states, this can amount to a significant amount of money--perhaps enough to make divestment effective.

Divestment and sanctions are serious measures and must be reserved for only the gravest cases, such as Iran, which is the most egregious state sponsor of terrorism, has visions of destroying Israel, and is pursuing nuclear weapons in defiance of the international community. Bipartisan divestment is an important method for preventing Iran from realizing its nefarious goals and ensuring national security.

AEI interns Phil Alito and Lorna Schadeberg prepared this summary.