Will Iran Crack?

Sanctions May Help, but Economic Pain Can't Be the Sole Pressure Point

The latest Iran sanctions came into full effect this week, adding to a byzantine array of unilateral and multilateral measures that prohibit Iranian oil imports, other trade and financial transactions, and freeze Iranian assets by countries concerned that Tehran's nuclear program is intended for military purposes, not civilian ones.

The international community is now on watch for cracks in Iran's defiant stance: Will increased sanctions compel Tehran to make real concessions and allow for a diplomatic solution to the standoff? This characterization is too simplistic, however, and the record suggests there may be some reasons to be optimistic that current sanctions on Iran will deliver.

Sanctions generally get a bad rap, with many declaring that they don't work. First, sanctions against Iran are today just one tool in a larger strategy. In other cases — in South Africa, Serbia and Libya, for example — where sanctions have worked, they were not stand-alone instruments. In past decades, sanctions against Iran have constituted the entirety of the U.S.-led strategy against Tehran's nuclear ambitions. Today, in contrast, the U.S. approach involves not only sanctions but also diplomatic talks, and at least some threat of military force.

Perhaps more important, sanctions against Iran have already had a real economic impact. Some reports assess that Iranian oil imports have dropped by as much as 1 million barrels a day since the end of 2011. This puts pressure on Iran's budget, nearly 70% of which is funded by oil revenue. Moreover, the value of the Iranian rial has dropped dramatically since September 2011 on account of Iran's growing isolation from the international banking system and the need to resort to barter arrangements. As a result, inflation is on the rise.

But the real test of sanctions is not whether they are part of a nicely crafted strategy, or whether they create economic hardship, but whether they induce a change in the behavior of Tehran's leaders. Anticipating whether the pain from sanctions is sufficient to force this shift is always difficult, and even more so in a country like Iran where decision-making is opaque. After all, leaders from every country will insist they are impervious to the pressure — right up until the moment they make the sought-after concession.

The latest round of talks in Moscow between Tehran and the five permanent members of the U.N. Security Council, plus Germany, provide us with some clues, and the news isn't good. Given the economic pain Tehran was already feeling, and the then-looming threat of increased sanctions, one might have expected Iran to respond positively. Unlike the U.N. or the International Atomic Energy Agency's board of governors, those negotiating in Moscow did not demand a complete cessation of enrichment but allowed for a continued low level of this activity.

But the Iranians didn't seize the opportunity. Instead, they demanded recognition of their right to enrich. This tough stance hardly indicates they perceived themselves to be under the sword of Damocles. Instead, it suggests that Tehran had decided to weather any and all economic pressure, seeing it as an unwelcome but possibly necessary cost of pursuing its nuclear ambitions.

The transmission belt between economic pain and political change is, of course, dynamic. As policymakers and market watchers evaluate the new sanctions, the economic barometer may not be the best predictor of whether Iran's leaders are going to make a strategic shift. Here's what else to focus on:

Whether the negotiation track remains alive. Absent negotiations, intensified sanctions are likely to reinforce Tehran's perception that the West is only interested in regime change, which could prompt an acceleration of the nuclear program rather than an abandonment of it.

Whether the threat of military force becomes more credible. Thus far, Tehran probably dismisses both the damage that Israeli military strikes could achieve on their own and the likelihood the United States would use military force. If the latter were perceived to be a real possibility, Tehran might change its calculations.

Internal developments inside Iran. Sanctions are envisioned as driving the Iranian regime to the negotiating table, but they could "succeed" by working in another manner. Although there is little indication this scenario is on the horizon, sanctions-induced economic problems could combine with indigenous political tensions to challenge the survival of the regime.

Global oil markets. Iranian leaders are no doubt hoping that new sanctions will drive up oil prices, allowing Iran to maintain revenue through higher prices even though it sells less oil. But should a breakup of the Eurozone, or slower Chinese growth, or even an increase in the amount of oil OPEC produces, dampen oil prices, the magnitude of economic hardship Iran experiences could far exceed that which Tehran is anticipating.

It is perhaps inevitable that as negotiations faltered last month, focus returned to sanctions and the new July 1 strictures. But a closer look at how sanctions work, and how the Iranians have reacted to economic pressure thus far, suggests caution, and should be a prompt to the international community to intensify its efforts to combine existing economic duress with other forms of pressure, if it hopes to see a shift in Tehran's behavior.