¹ Sectors such as health and education where the government spent heavily and created large numbers of jobs during the 1980s and 1990s are now experiencing excess employment.

² The government has had a privatization program since the First Development Plan (1988–92) that has been carried onto the Second and Third Development Plans. However, the actual number of companies privatized has fallen short of the quantitative targets set by the government in each of the above plans.

³ In recognition of the importance of a more friendly macroeconomic environment for economic growth, the Second and Third plans called for credible fiscal and monetary policies but the gap between policy and practice is significant.

⁴ The morphology of growth undertaken by Chenery and Syrquin studied structural changes for a large sample of countries. The rise in per capita income was associated with “normal patterns” of development and structural change, in particular a decline in the share of agriculture and an increase in the share of industry and services. There was initially a presumption that predicted changes in the sectoral composition of output were indicative of a more balanced growth path or that following the “normal” pattern could generate some growth momentum on its own. Obviously, for primary commodity-oriented economies (also oil exporters) changes in the sectoral composition of output deviated from the “normal” path. In the primary-oriented economies the service sector was found to be larger and the manufacturing sector smaller than the average for non-primary developing countries. See Chenery, H. B., Syrquin, Moses, The Patterns of Development 1950–1970 (London, 1975)Google Scholar.

⁵ The basic result in the theory of business investment is that, the optimal stock of capital is a function of the rental or the real cost of capital. In the simplest version, we assume a representative competitive firm maximizes the present value of its profits (Π), with a discount rate equal to r. See further Romer, P., “Increasing Returns and Long Run Growth”, Journal of Political Economy, 94 (1986)CrossRefGoogle Scholar.

Where K is the industry-wide capital stock, κ, is the firms' own capital stock, and κ_t+1 = rq_t + I_t, and C(I) is investment adjusted cost. It is possible to form a Hamiltonian,

The first order conditions of interest is π(K(t)) = rq(t) − q˙(t). This implies that demand for capital will rise until the marginal revenue product of capital (with p = 1 here) is equal to its marginal cost. In the above q_t is equal to the purchase price of capital (assumed here to be 1) plus the marginal adjustment cost, and r is the interest rate. With a fixed real cost of capital, the amount of investment is proportional to the increase in output and that proportion is given by ICOR. For a Cobb-Douglas production function, output (Y) is obtained from capital (K) and labor (L), the optimal capital stock is K* = αY/ψ, where α is the elasticity of output with respect to capital and ψ is the cost of capital. With a constant ψ normalized to unity, ΔK = αΔY, ΔK is net investment and is equal to K_t − K_t−1. Gross investment is ΔK + δK_t.

⁶ An initial capital output ratio of 1.8 and a depreciation rate of 5 percent.

⁷ The MENA figures are based on World Development Index C-D ROM, World Bank, 2001.

⁸ It is a tax system that combines features of a global and a schedular system. The former applies a unitary rate to income from all taxes and the latter taxes the principal sources of income flow at different rates.

⁹ Two major types of tax reforms, concerning corporate and value added taxes, have been on the policy agenda in Iran in recent years.

¹⁰ A close substitute for bank and equity financing for large corporations, mostly government owned entities and enterprises, is called “Participation Shares”. The basic “profit” rate charged on “Participation Shares” is 17.5 percent. This medium-term financial instrument is supposed to be a certificate of equity participation in specific projects between the issuer and the public. However, the financial market views them more like a medium term bond with limited risks because they are usually backed by bank guarantees.

¹¹ See A. Sendadji, “Sources of Economic Growth: An Extensive Growth Accounting Exercise”, IMF Working Papers, WP/99/77 (Washington DC, 1999)

¹² Aghion and Howitt draw distinction between knowledge-based endogenous growth models and Schumpeterian interpretations of endogenous growth models. The empirical evidence have not been supportive of the first generation of endogenous growth models. See Aghion, P. and Howitt, P., Endogenous Growth Theory (Cambridge Mass., 1998)Google Scholar.

¹³ Mankiw, Romer and Weil argue that by adding HC, a better explanation of per-capita income differentials between industrial countries and DCs can be obtained from the traditional growth models. Their Solow-augmented model did in fact obtain much better empirical results than the earlier convergence tests. See Mankiw, N.G., Romer, D. and Weil, D.N. (1992): “A Contribution to the Empirics of Economic Growth”, Quarterly Journal of Economics, 107 (1992): 407–437CrossRefGoogle Scholar.

¹⁴ Pritchet (1996) raises a challenging question as to “where all the education has gone in MENA”? This is an important policy issue, since a large fraction of government resources in Iran (and also in MENA) is spent on publicly funded education. See Prichett, L., Has Education Had a Growth Payoff in the MENA Region? (World Bank, 1999)Google Scholar.

¹⁵ See A. R. Jalali-Naini Jalali-Naini, Economic Growth in Iran: 1950-2000 (Global Research Project, Global Development Network, 2003) and A. R. Jalali-Naini, and H. Karimi (2003), “Budgetary Rent-Seeking and Economic Growth” (paper presented at the 10th Annual Conference, ERF, Marrakesh, 2003). The inputs in the production function were the physical capital stock and the employed workers weighted by their human capital, as measured by their average years of schooling. The homogeneity condition was not imposed but the estimated elasticities were very close, though less than unity. A time dummy variable is included to capture the effects of the revolution, the war, and foreign exchange scarcity on the economy during the 1977–2000 period.

¹⁶ The Phillips-Hansen method is appropriate for estimation when a single cointegrating vector exists between a set of I(1) variables. A number of studies estimate the sources of growth using first difference form to account for the existence of a unit root in output, capital stock, and labor force variables. Differencing has the disadvantage of removing long-run information in the data. The issue of unit root can be handled on two different levels. First, if we impose a theoretical identification, the aggregate production function must have one cointegrating vector; hence we can confirm the existence of a long-run equilibrium relationship using the Engle-Granger method. Secondly, we can estimate a cointegration regression to deal with the issue of non-stationary variables using the Johanson-Juselius (1990) method and to estimate the sources of growth. If there is a single cointegrating vector, the two procedures are different in so far as the estimation methods are different. Moreover, in this case the use of the Phillips-Hansen estimation method is appropriate. See Johansen, S. and Juselius, K., “Maximum likelihood estimation and inference on cointegration—with applications to the demand for money”, Oxford Bulletin of Economics and Statistics, 52 (1990): 169–210CrossRefGoogle Scholar.

¹⁷ The production function specification here is of the following form

where f(.) measures the factors that cause a shift in the production function, aside from productivity shocks. It has a general functional form; the specific form is ascertained through empirical estimation.

¹⁸ The growth rate of energy consumption in Iran, particularly in the transportation sector, is very high and this is partly due to the low relative price of energy.

¹⁹ See A. R. Jalali-Naini, “The Sturcture and Volatility and Taxes in Selected MENA Countries” (www.worldbank/mdf3, 1999).

²⁰ Easterly and Rebelo maintain that government expenditures do not affect growth in the same way and certain categories of government expenditures may have a stronger effect on growth. They find that government investment, especially in transportation and communication, is positively correlated with growth. To capture the effect of different types of public investment on growth, government investment may be divided into strategic and non-strategic sectors. The former consists of government investments in transportation, communications, water, and electricity, and the latter is non-strategic investment. Public spending on education may be used as a proxy for government investment in human capital. The estimated coefficient for this variable has the expected sign but is not statistically significant and therefore not reported here.

²¹ Jalali-Naini and Karimi, 2003.

²² See Jalali-Naini, A. R., Review and Reform of Monetary and Exchange Rate Policies, Plan and Budget Organization (Tehran, 2000)Google Scholar.

²³ For more details see, Jalali-Naini and Nazifi, 2002.

²⁴ See for details Jalali-Naini, 2003.

²⁵ See Jalali-Naini, A. R. and Nazifi, F., “Inflation-Ourput Tradeoff and Asymmetric Effects of Monetary Stocks”, Plan and Development Quarterly, 3(2002)Google Scholar.

²⁶ However, a change in the composition of saving such as increasing holdings of the existing equity can have the opposite effect.

²⁷ Since the mid-1990s a new financial instrument called “Participation Shares,” a security for medium-term financing of investment projects, has been introduced. Although there have been instances where private companies have used these shares to raise investment funds, they are primarily issued by the government agencies and government corporations for investment finance. Since a couple of years ago the Central Bank has also occasionally issued these shares for conducting monetary policy. See Jalali-Naini, A. R. and Toloo, M., “Participation Shares and Monetary Policy”, Proceedings of the Ninth Annual Conference on Monetary and Exchange Rate Policies (IRI Central Bank, 2001)Google Scholar.

²⁸ Data on non-oil exports are based on the figures for non-oil exports, Central Bank of Iran, and the OECD CPI price index from the IMF data bank.

²⁹ See for details, Jalali-Naini, 2003.

³⁰ The real exchange rate is defined as EP^w/P, where E is the nominal exchange rate, P^w is the world price level, P is the domestic price level. Alternatively, the real exchange rate can be defined as the ratio of tradable to non-tradable prices.