Publication Details

This article was originally published as Verma, R, Wilson, E and Pahlavani, M, The role of capital formation and saving in promoting economic growth in Iran, Middle East Business and Economic Review, June 2007, 19(1), 8-22.


This paper estimates the interdependencies between capital formation, saving and output for Iran. The analysis is complicated because of the conflicting theoretical and empirical findings of their relative roles in other studies, the lack of research on Iran whose turbulent history makes it difficult to disentangle the complex and changing interrelationships between output, saving and investment for the period of our study, 1960 to 2003. The analysis uses Lee and Strazicich (2004) procedure to endogenously determine that structural breaks occurred in 1979 for real output, 1983 for saving and 1977 for investment. These dates coincide with the effect of the Islamic revolution in 1979 and Iran-Iraq war, 1980 to 1988. The relationships were estimated using Johansen’s FIML procedure which is appropriate for estimating the effects of non-stationary variables in a simultaneous setting. The estimates indicate a Solow style relationship where a one percent increase in saving will be associated with a 0.55 percent increase in the long run equilibrium level of output. This also implies the share of income that is paid to capital in the form of saving in Iran is higher at 0.55 than the average for developed countries of around 0.35. The role of investment was found to be imprecise in the long run. The short run estimates show that saving has a short run equilibrating effect on output with elasticity −0.13, which further supports the Solow model whereby changes to saving have only transitory effects on the growth in output. The other important result found that investment dynamically Granger causes output growth with a short run elasticity of 0.17, consistent with the endogenous growth explanation. The structural change parameter estimates that the effect on the growth in output fell by around 10 percent after 1979. These findings have two important policy implications for Iran. First, there is scope to reduce the reliance of saving as the domestic source of economic growth. Second, saving needs to be better targeted to the long run strategic provision of capital (including infrastructure) in the structurally transforming economy of Iran.