Iran stands at a pivotal moment. If political change brings institutional reform, the country could break decades of stagnation and return to sustained growth. But without credible governance, any transition risks replacing one failed equilibrium with another.
Iran’s recent nationwide protests, which were met with a deadly crackdown unmatched in the country’s modern history, stem directly from five decades of Islamic Republic rule.
More than half the population lives near or below the $3-a-day abject poverty line. The national currency is in free fall, with hyperinflation and famine in sight. The state seeks to control every aspect of citizens’ lives. Add to this systemic corruption, international isolation, apocalyptic environmental devastation, and a catastrophic brain drain that has driven more than 5% of Iranians to live outside the country.
During a period when most developing countries achieved major gains in living standards, Iran’s GDP per capita under the Islamic Republic has remained below its pre-revolution level for nearly half a century. Once competitive among middle-income nations, Iran’s per capita income has fallen behind war-torn Iraq and now more closely resembles that of low-income neighbors such as Pakistan.
The rulers in Tehran have proven unable to address urgent and mounting economic challenges: soaring inflation, a bankrupt financial system, a shrinking capital stock, and non-viable state-owned enterprises (SOEs).
Beyond these immediate crises, Iran faces deep structural problems that will persist for decades. The population is aging and the demographic window is closing. Soon, ever-larger cohorts will reach retirement with little or no savings. The water crisis is also unlikely to improve, constraining agricultural output and heightening food security risks.
These compounding crises, especially under external pressure, could trigger the Islamic Republic’s collapse—or at least force fundamental changes in its governing structure. Regardless of what political system emerges, Iran’s institutions must be aligned with both political and economic development objectives.
We believe any strategy capable of generating a virtuous cycle of change must prioritize one core objective: building a credible, stable, and legitimate state. Without this foundation, prescriptions for “sound” macroeconomic policy or state-capacity reforms will remain technocratic exercises that fail to take hold, endure, or deliver.
At the highest level, these political transformations can be summarized as follows:
1. State: scaling back
While Iran’s formal central government budget is relatively small (about $50 billion), the state’s true economic footprint is far larger, encompassing well over half of economic activity through para-statal foundations (bonyads), state-linked banks, and SOEs. Some efficiency gains may be possible through spending cuts, including transfers to ideological or religious bodies. But the core challenge is to rationalize and properly govern this broader quasi-state sector.
This requires consolidating and privatizing SOEs, gradually strengthening tax collection, and integrating off-budget entities into a transparent and accountable fiscal framework, while addressing longer-term structural challenges.
2. Democratic accountability
While democracy is an end in itself, strengthening democratic accountability plays a vital role in providing the legitimacy needed for the state to implement painful economic reforms and address short-term dislocations. A political leader elected through a free and meaningful process can better shield technocratic reformers from political pressures and enable difficult but necessary policy decisions.
3. Rule of law
Reforming the rule of law is the slowest and most complex task. While formal legal rules can be changed rapidly, transforming institutional practices and cultural norms is far more difficult. It is unlikely that any future judicial system will immediately apply the law equally to ordinary citizens and elites. But even a “good enough” system—as seen in countries such as China—could be sufficient to support sustained economic growth.
A successful transformation of political institutions could launch a new period of sustained growth. Optimism about a post-Islamic Republic Iran rests on its human capital, natural resources, and a highly capable diaspora able to invest and reconnect the economy to global markets.
Under a stable and legitimate system, near- to medium-term gains could come from lifting sanctions, activating underused capacity—especially in energy—attracting domestic and foreign investment, improving productivity, and expanding tourism and trade.
We estimate these channels could add $100–150 billion to output over five years, raising average incomes by only $3–5 per person per day. Claims of a trillion-dollar economy, as stated by some commentators, are as unrealistic as the Islamic Republic’s long record of unfounded projections.
History offers wide variation in the outcomes of institutional reform in post-authoritarian states. In the post-communist transition, for example, Russia endured a severe contraction of more than 40% of GDP, while Poland pivoted relatively quickly toward sustained growth. A decisive factor in Poland’s success was the prospect of joining the European Union, which provided a powerful external anchor for reform.
Unfortunately, Iran’s trajectory of political and economic transformation appears more likely to resemble Russia’s experience than Poland’s.
In the MENA region, Tunisia and Iraq have undergone post-authoritarian institutional reforms in recent decades. Tunisia, initially viewed as the Arab Spring’s only democratic success, has since regressed into authoritarianism, and its per-capita GDP remains roughly at pre-revolution levels.
Iraq, following the 2003 invasion, has seen per-capita GDP rise from about $1,500 to over $6,000, largely driven by increased oil production, while inflation has generally remained stable. Yet progress in controlling corruption has been limited, with only modest improvements in corruption perceptions.
A post-Islamic Republic government may initially enjoy high legitimacy, but that window will be brief. It must deliver tangible results quickly while managing overlapping crises and unavoidable distributional conflicts over who gains, who loses, and who must wait. Economic recovery and political stability will be tightly linked—and failure in one will undermine the other.
Experience from other transitions is sobering. Beyond early gains, post-authoritarian growth is often slow, fragile, and reversible. Stagnant living standards can create fertile ground for populist politicians who promise shortcuts.
Iran therefore needs a development strategy that integrates political and economic reform. Without it, the country risks remaining trapped in its current low equilibrium.
