Threshold Effects of Oil Rents on Non-Oil Economic Growth under Varying Levels of Financial Development in Iran

Document Type : Research Paper

Authors

1 PhD student, Department of Economic Sciences - Economic Development, Faculty of Economics and Management, University of Tabriz, Tabriz, Iran.

2 Professor, Department of Economic Development and Planning, Faculty of Economics and Management, University of Tabriz, Tabriz, Iran

3 Professor, Department of Economics, Faculty of Economics and Management, University of Tabriz, Tabriz, Iran

4 Department of Economics, Faculty of Economics and Management, University of Tabriz, Tabriz, Iran.

10.22034/epj.2026.23323.2716

Abstract

Abstract
This study examines the threshold effects of oil rents on non-oil economic growth in Iran across different levels of financial development using the annual data for the period 1995-2023. To this end, three indicators of financial development were employed as threshold variables in the model, namely the ratio of credit extended to the private sector to gross domestic product (GDP), the ratio of liquidity to GDP, and the ratio of financial credit provided by the banking sector to GDP, along with a composite index. The results indicate that fixed capital formation and labor exert a positive and statistically significant effect on non-oil growth in all the model specifications. Significant threshold effects were identified for three financial development indicators -liquidity, bank credit, and the composite index- suggesting that the impact of oil rents depends on the level of financial development. At low levels of financial development, oil rents are found to have predominantly insignificant effects; however, at higher levels, their impact varies by indicator, becoming either negative (due to inefficient resource allocation) or positive (in the case of the composite index, owing to a more coordinated financial system). In addition to confirming the role of capital and labor in line with the Solow growth model, these findings reveal that the effect of oil rents deviates from the predictions of this model at low levels of financial development and underscore the need to strengthen the financial system in order to achieve sustainable growth. Overall, the findings highlight the importance of institutional reforms, improved resource allocation, and financial system strengthening to transform oil rents into sustainable non-oil growth.
 
Extended Abstract
Purpose: This study investigates the threshold effects of oil rents on non-oil economic growth in Iran, considering financial the moderating role of development. In resource-rich economies like Iran, oil revenue dependence presents a double-edged sword: providing substantial public income while potentially causing resource misallocation, institutional weakening, and economic volatility. The "resource curse" phenomenon has been extensively debated with reference to mixed empirical evidence regarding whether natural resource abundance promotes or hinders long-term development.
Iran, as one of the world's largest oil exporters, provides a compelling case study. The economy has experienced significant volatility tied to oil price fluctuations, sanctions, and varying financial sector development over three decades. Understanding how oil rents interact with financial development to influence non-oil growth is crucial for policy formulation and diversification strategies.
This research addresses the literature gaps by examining whether threshold levels of financial development exist beyond which oil rents transform from neutral/harmful to beneficial for non-oil growth. The study employs nonlinear threshold regression to detect regime shifts and provide insight into how financial deepening can serve as a transmission channel for positive oil rent effects or buffer against adverse rentier dependence consequences.
 
Methodology: The research adopts a quantitative approach grounded in an extended Solow growth model, incorporating oil rents and financial development indicators. The theoretical foundation builds upon the endogenous growth theory, emphasizing financial intermediation's role in capital accumulation and technological progress. The production function uses augmented Cobb-Douglas form including capital, labor, and oil rents.
The core hypothesis is that oil rents-non-oil GDP growth relationship is nonlinear and contingent on financial development level. When financial systems are underdeveloped, oil rents may be misallocated toward consumption or rent-seeking. Conversely, sophisticated systems may facilitate transformation of oil windfalls into growth-enhancing investments.
The analysis uses annual time series data from 1995-2023, covering oil price cycles, reforms, and sanctions. The dependent variable is the real non-oil GDP growth rate. Financial development is modeled using four threshold indicators including private sector credit, broad money, bank-based intermediation, and a composite index via Principal Component Analysis.
Hansen's (1999) threshold regression methodology estimates differential oil rent effects across financial development regimes, along with endogenous threshold determination and statistical significance tests.
 
Findings and Discussion: The capital accumulation and labor indices show consistent positive impacts on non-oil growth, with 1% increase in capital contributing 0.33–0.47% growth and 1% labor increase resulting in 2.3–3.8% growth increment. The threshold effects for oil rents are statistically significant in three models using liquidity, bank credit, and composite index as threshold variables.
Model 1 (Private Sector Credit): The oil rent effects are insignificant in both regimes, suggesting that credit access alone cannot transform oil rents without efficiency improvements and institutional quality enhancements.
Model 2 (Broad Money): The oil rents are insignificant in low development but significantly negative above the threshold (4.287). Higher liquidity without adequate intermediation may amplify misallocation and fuel inflation, undermining non-oil sector growth.
Model 3 (Bank Credit): A similar pattern with oil rents is insignificant at low levels but significantly negative in high-development regime, reflecting credit allocation inefficiencies and the crowding-out of productive investments.
Model 4 (Composite Index): Most promising results show oil rents have no effect in low-development but a positive significant impact in high-development regime. Well-balanced financial systems can successfully convert oil windfalls into growth-enhancing non-oil investments.
 
Conclusions and Policy Implications: The study provides evidence for threshold effects in oil rents-non-oil growth relationships, mediated by financial development. Without mature financial systems, oil rents have no contribution to non-oil growth and may impede it through inflation and rent-seeking. However, well-coordinated financial development transforms oil rents into sustainable growth catalysts.
The policy implications of this study include a) enhancing financial sector efficiency through improved credit allocation and transparency, b) strengthening institutional frameworks against rent-seeking, c) establishing stabilization funds and fiscal rules, d) promoting financial inclusion and capital market development while reducing state-bank dependence, and e) linking oil revenue management to strategic industrial policy for non-oil exports and innovation enterprises. The research contributes the empirical evidence of nonlinear relationships between resource rents and growth, highlighting the critical role of financial system maturity.

Keywords

Main Subjects

References

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The Journal of Economic Policy
Volume 18, Issue 36
September 2026
Pages 361-403

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