Iraq: Mixed Opportunities, Messy Outlook? (Part II: Not Quite A Dreamland Yet)

Isam al Khafaji

Last Updated: 15, February 2012

Please note that we are not authorised to provide any investment advice. The content on this page is for information purposes only.

In part two of our feature on the Iraqi economy, we look at how the downfall of Saddam Hussein’s regime, and the subsequent introduction of the US, managed to shape Iraq’s oil industry and political scenario. Finally, we ask what the Iraqi government needs to do to ensure the nation’s future, particularly with the fate of its citizens at hand.

Missed the first part of our feature? Read: Iraq: Mixed Opportunities, Messy Outlook? (Part I: The Road To Entrapment)

In 2003, an overly jubilant Paul Bremmer, the US administer of Iraq, proudly declared that Iraq “was now open for business”. Thirteen years of crippling sanctions – leading to soaring unemployment, the virtual disappearance of the middle classes and an unprecedented rise in the percentage of population living under the poverty line – had left Iraq with a severely battered economy, and the fall of the Ba’thist regime was supposed to promise a brighter outlook for the Iraqi people.

But a year later, Iraq found themselves under a façade of an international governing body called the Coalition Provisional Authority (CPA), which was effectively being run by the US. The American administrators pushed hard to liberalize the economy at the beginning; but they did this without any consideration to the prerequisites for such a dramatic move – especially coming from a situation whereby the state had been imposing a tight grip on private activities.

The US authorities’ stated motives behind the liberalization strategy – to allow market mechanisms to induce efficiency, to inject Iraqi private resources, and to raise the private sector’s share in the economy – were also compromised as they used Iraqi oil revenue to fund US firms and withheld financial resources from the Iraqi authorities. According to a study published by Open Society Institute’s Iraq Revenue Watch, the CPA had awarded US firms with 74 percent of nearly $1.5 billion in contracts paid for with Iraqi funds, while Iraqi firms received just 2 percent of the value.

In addition, no legal framework to enforce the rule of law was established; with no stock exchanges functioning properly, no laws enforcing transparent bidding and acquiring or buying privatized assets promulgated, and no property, investment or tax regulations to ensure the gradual transition to a market economy.

What The CPA did do was try to create a commission of integrity in order to monitor, report and bring corrupt individuals to courts. But given the dysfunctional justice system, the dominance of the militias and the government’s heavy hand due to its control of the oil revenues, this commission (as well as the justice system) was a toothless body with diluted authority.

[quote]In sum, Iraq was now moving along the path of “Yeltsin-type” liberalization or crony capitalism, which handed out the country’s assets to a few tycoons and left the vast majority striving for means of subsistence.[/quote]

Table of Contents

Not Quite A Dreamland

The country, as most would expect, had been, and still was, struggling to attract investors. While most investors had optimistic views of the future, they faced formidable obstacles that made them hesitate to enter that promising market. This is hardly surprising as the World Bank ranks Iraq 164 out of 183 countries in terms of ease of doing business – down five spots from last year – while Transparency International ranked it as the seventh most corrupt country in the world in 2011 – four grades up from 2010.

Furthermore, despite the World Bank’s condition that Iraqi authorities had to bring down inflation rates and put an end to the government subsidies for basic goods in exchange for cancelling 80 percent of Iraq’s debts, implementing the two tasks was impossible. Not only did the Iraqi government had to act swiftly to raise the salaries for medium level employees, which had dwindled to no more than $2 a month, they had to try and alleviate the suffering of the vast majority of the population as well – many of whom were facing extreme levels of poverty thanks to years of tyranny, wars and sanctions. Monthly incomes for Iraqis were raised by around 500 hundred folds, and the rush by Iraqis to satisfy their long awaited needs for durable goods led to spiraling rates of inflation. In 2006, the index of inflation was 132.3 percent – rising by almost 52.5 percent in one month during the same year.

But the Iraqis still had one trump card: its oil sector. Since 2008, the Iraqi government has been issuing bids for international oil companies to invest in its oil and gas fields; with the pre-condition that these companies work more as service providers, rather than taking a share of oil production. On January 18^th this year, the Iraqi oil minister also declared that the country had finished the first phase of its crude oil export capacity expansion project – a plan that would add five loading berths, each with 850,000 b/d of handling capacity, to Iraq’s southern export system; in what is the first expansion of Iraq’s export capacity for decades.

Consequently, the country’s oil export level managed to grow to 2.37 million barrels per day – a figure close to its prewar level of 2.58 million b/d – even in the face of terrorist attacks on its oil production, transport and refining facilities. By the end of 2012, Iraq would have added a further 400,000-500,000 b/d to its oil exports figure; while the country also believe that a massive increase in its oil production capacity over the next six years, to as much as 13.5 million b/d, is possible after Baghdad signed twelve technical services contracts for field development with some of the world’s largest oil companies. Accordingly, the World Bank estimates that Iraq’s oil sector could contribute up to 12 percent towards the growth of Iraq’s GDP in 2012 – a figure that is likely to contribute to a 16 percent growth rate for the entire economy.

Related: Iraq Economy

Related: Iraq Economic Forecast

Yet, some Iraqis remained doubtful. The political quagmire in the country, they say, could still threaten to bring the potential growth to a halt or even set it back.

[break]

Not Quite A Dreamland

The problem lied in the fact that the Iraqi society was effectively portrayed in an over-simplified way, as an amalgam of juxtaposed ethnicities and sects, following the fall of Saddam’s regime. A Shiite Arab had assumed the main post of Prime Minister; a Kurd now headed the largely symbolic post of presidency, while a Sunni Arab now was the speaker of the parliament. Rather than enhancing a horizontally stratified society following the fall of a despotic regime that favored certain sects and regions, the new regime soon become a sad alternative of its predecessor. Bitter rivalries emerged between the communities, which extended from squabbles in the political arena to arguments over the spoils of Iraq’s wealth – especially oil revenues.

[quote]The country was now fragmented along a multiplicity of stakeholders, compared to highly centralized Ba’thist regime with one body of decision makers. The so-called national accord government – that has been in place since 2004 – looked like a division of spoils among warlords rather than a coalition among political parties who agreed on a common program or plan for action. [/quote]

This situation has serious repercussions for the future of the country and its potential to achieve socio-economic development. A cohesive and strong government, which has the ability to take decisive measures, simply cannot exist when the ministers are only answerable to the factions that nominated them. Cronyism and corruption lie at the heart of such a political system as each faction strives to pass government contracts to its followers, create a base of supporters by promising jobs, and divert huge sums into their own pockets. During the period 2006 -2010, the total allocation for the president, prime minister and speaker of the parliament amounted to $11 billion, more than the allocations for the manufacturing, agriculture, environment communication and science sectors combined. The total take home salary of a minister or a parliament member per month was a tax-free $10,800 and upon retirement they would receive eighty percent of that amount. This means that members of the parliament were earning forty times as much as the average Iraqi per year.

That Resource Curse

With rivalries, cronyism, corruption and waste afoot, a long-awaited oil and gas law, which was due for discussion in the parliament in January this year, is not expected to be laid on the table, let alone approved, for months. This is a cause for the several delays of the bidding rounds for a dozen of oil and gas blocks due in April this year, in which more than forty international oil companies have been qualified for competition.

Another serious consequence is that the loosely formulated constitution approved six years ago contained many loopholes that need amendments before a national strategy for the exploitation of Iraq’s natural resources can be implemented. The constitution states vaguely that oil revenues are to be distributed fairly and proportionately with the country’s population distribution. Moreover, the relevant articles indicate that the new fields will be under the jurisdiction of the regions and provinces. In practice however, this has proved to be a major contentious issue between the central government and the Kurdish autonomous regional authorities. Within its officially defined borders, Kurdistan contains only three percent of the total oil reserves of Iraq. However, the Kurds insist that the province of Kirkuk, which Saddam’s regime carved out of their region and lies over some twelve percent of the total reserves, must be brought back to their authority. To this there is the no less thorny dispute over the way that oil fields and reserves that straddle across more than one province, especially between Kurdistan and the rest of Iraq, should be handled.

It is thus not an exaggeration to state that Iraq is now at a historical crossroad: either it proceeds to create the long fought for strong, modern and democratic state or it disintegrates into rival despotic statelets each under the protection of a regional power. For the past six decades when the country was transformed into a rentier state, a central dictatorial executive in one form or other laid its firm grip on the oil revenues and used them to buy off supporters and punish opponents. The situation is no more given the multiplicity of political actors and pressure groups as was shown in the previous paragraphs.

Until now, Iraq’s quasi-total dependence on oil revenues, which account for 92 percent of the government budget finance and afford the foreign exchange for the country’s imports, is replicating the patterns of a rentier state and society that constituted the basis for the rise and perpetuation of dictatorial regimes and it is highly unlikely that the economy will deviate from that pattern in the foreseeable future: the total workforce employed or contacted by the state is 2.6 million individuals, manufacturing and agriculture contribution to the GDP are at all time low with 1.7 percent and five percent respectively.

Related: Iraq Oil and Gas Industry

Apart from the government sector, no significant job creating sectors are able to provide jobs for the 39 percent unemployed and 57 percent of those between the ages of fifteen and twenty-nine. And despite all the wealth provided by the oil bonanza, Iraq still ranks 159 out of 227 countries in per capita income.

Practically all of the Iraqi governments emphasized the objective of diversifying the economy and lessening dependence on oil. However the temptation to recourse to the easy venue of collecting rents was hard to resist. But following 2003, many plans as to how to pull Iraq out of the “resource curse” have proposed which are admittedly easier said than done.

In my view, the first necessary (and formidable) task is to transform Iraq into a “normal” tax state whereby the government would be accountable to the tax payers and in the meantime has strong motives to enhance economic growth in order to boost its tax base. This cannot be implemented without exerting public pressure to force the political leaders to acquiesce to distributing oil revenues among the population and collecting a fixed proportion of these revenues in the form of income taxes. This proposal, it must be emphasized, is entirely different from that of diverting oil assets into the hands of the people which would eventually lead to a handful of tycoons laying their hands on them as happened in post-communist Russia. Oil revenues in the hands of people would eradicate, or at least ease, the tragic levels of poverty as well as providing a source of investment in small scale and cooperative projects by ordinary citizens.

By Isam al Khafaji

Isam al Khafaji is a special advisor and consultant on the social and economic affairs of the Middle East. After being forced to leave teaching at Iraqi universities in the late 1970s, he proceeded to become a senior expert for the UNDP for launching Syria’s first Human Development report in 2000, and an advisor to the World Bank on issues of political reform in the Middle East in 2001. In 2002, he actively joined the US State Department’s workshops on the “Future of Iraq” and later served as an advisor to the Coalition Provisional Authority in Baghdad until July 2003 when he resigned in protest at the US policies in handling Iraq.

Missed the first part of our feature? Read: Iraq: Mixed Opportunities, Messy Outlook? (Part I: The Road To Entrapment)

Get more special features from the world’s top economists in your inbox. Subscribe to our newsletter for alerts and daily updates.

About Isam al Khafaji PRO INVESTOR

Adjunct scholar at the Middle East Institute in Washington DC and contributing editor of Middle East Report, Washington DC.

View all posts by Isam al Khafaji