Monday, March 25, 2013

Iraq’s Economy At A Crossroads, Interview With USAID’s Vladimir Halama and Thomas Doherty

The Tijara Provincial Economic Growth Program is run by the United States Agency for International Development (USAID). Its goal is to help Iraq develop a market economy. At the end of 2012, it released a report, “Assessment of Current and Anticipated Economic Priority In Iraq.” The paper went over Iraq’s National Development Plan, and the difficulties it is facing in diversifying its economy. The report claimed that Iraq was at a crossroads over whether it would be able to escape the oil curse and its state-led economy. Below is an interview with Thomas Doherty and Vladimir Halama who helped put the document together.

Vladimir Halama, an Australian economist with experience in working in transitional economies, has worked in Iraq from 2005 until February 2013 in a number of advisory assignments, most of which involved working with Iraqi government bodies. From September 2011 until November 2012 he led a team of specialists in putting together “An Assessment of Current and Anticipated Economic Priorities in Iraq” for the USAID-Tijara project.  

Thomas Doherty is a U.S. lawyer who has worked on a number of assignments in Iraq at various times since October 2003, including with the Coalition Provisional Authority, the State Department, and USAID. Until December 2012, he was the regulatory advisor of the Business and Investment Enabling Environment Component of USAID-Tijara project.        

USAID said that Iraq is at a “crossroads” over whether it will be able to escape the resource curse and its state-run economy (AP)

1. The Tijara report said that Iraq was at a crossroads between its past of being a state-run system and its future of developing a market economy. Can you explain what role the government plays in employment?

Vladimir Halama: The government is the main employer as well as the employer of choice for most Iraqis. Of those employed for 40 hours per week or more, an estimated 60% are on the payroll of the government, the security forces or state owned enterprises. They enjoy security of tenure, generous pension provisions, and other advantages such as grants of land or loans on favorable terms. This distorts motivation on the supply side of the labor market. Much effort and bribery is expended in trying to get onto the government payroll, and resignations are unheard of. Employment in the private sector is less sought after. In, for example, construction and services, some employers resort to employing workers from Turkey or South East Asia.

Thomas Doherty: I agree, and add that often times the main purpose of government in Iraq seems to be to provide perquisites for government workers. For example, recently the Ministry of Housing and Construction announced a new housing development in Wasit province only for employees of the Ministry of Housing and Construction. The reservation of state-owned land for largesse to workers in government and state-owned enterprises also makes it more difficult for private investors to obtain land for housing, industrial, and retail developments.

2. How about the state-run banks?

Vladimir Halama: Lending by state banks is under the direction of the government, and is mostly at concessional interest rates. Even the repayments of the principal are often waived, for example in the case of loans to the agricultural sector. As can be expected under such circumstances, the loans usually go to those with lobbying power. State banks have been directed to make loans covering the payroll costs of many state-run enterprises where revenues fail to cover operating costs. The backlog of unrecoverable loans in state banks is large, and the banks are de facto bankrupt. However, Iraqis still place their savings with them, as they are confident that the government will keep these banks operational.  

Thomas Doherty: The concessionary terms given out by the state banks crowd out private sector banking. In this regard, the recent enactment by the Council of Representatives to establish a state-run Islamic bank is troubling, as it will probably make it more difficult for the private Islamic banks now operating in Iraq to grow. There have been orders from the Council of Ministers directing Iraqi government agencies to only do their banking at the state banks, so this is another drag on the private sector.

3. Can you talk more about what’s happening with the state-run enterprises (SOEs)?

Vladimir Halama: Many of them are barely making ends meet, despite receiving hidden subsidies through low energy costs and through being the supplier-of-choice to the government. The traded goods sector is particularly badly off as Iraq is uncompetitive in every product market with the exception of minerals. In other sectors, the state enterprises are doing better. However, overstaffing is rife everywhere. Workers have the same security of tenure as public servants, and everyone is kept on the payroll, even in factories that were totally destroyed during the military campaigns against Iraq in 2003 and before. Since 2003, several attempts to reform the SOE sector have been announced, but they have not yielded any results as yet. Despite occasionally claiming efforts to the contrary, the politicians are very reluctant to initiate any reform, which would lead to redundancies for fear of political backlash and losing the benefits of patronage, which control over SOEs brings to the various political parties controlling different ministries. Instead, the creation of another 130,000 jobs in the state sector had been heralded in February 2013.

Thomas Doherty: There was an announcement some time back that the Ministry of Trade was going to privatize the State Company for Automobiles and Machinery and the State Company for Markets, two SOEs that sell cars and operate retail stores.  These would seem to be able to be easily privatized or just dissolved in favor of the private sector.  Well, it turned out that the reforms were rolled back, and now they are just talking about granting some contracts to foreign investors to operate shopping malls. This is another problem, the SOEs becoming required “partners” to any private sector enterprise.

In other sectors, the SOEs don’t have any picture of what their bottom lines really are, because of the complicated subsidies they receive. Some operate like spendthrifts who believe that as long as there are blank checks left in the checkbook or there is enough political capital they can hire and spend more. On the other hand, the managers of commercially viable SOEs, who really do want to operate better, have no discretion to hire, fire or purchase without tortuous bureaucracy through their own ministries and the Ministry of Finance. The United Nations Development Programme has provided a roadmap for eventual commercialization of the SOEs, but it’s going to be a gradual process.

Of course, the SOEs do provide needed employment, even if it’s often not productive employment. Paul Brinkley’s Task Force on Business Stability Operations, and other donors spent a lot of money on the SOEs in the hope that increasing employment would decrease the insurgency, which is recognition that employment is important to social peace. This is something the U.S. also recognized with the auto industry bailouts.

We talked to the Iraqi Railways people, and I was glad that they have an ambitious program to build an expanded cargo and passenger network, including a Baghdad commuter rail network, and cargo rail lines from the new Al Fao port. Railways are a worthy SOE for investment right now, in my opinion. Why not build a Baghdad Metro, too? The plans are supposedly on file from the 1970s. Unfortunately, the announcement of a Baghdad monorail to be built by Alstrom does not appear to have advanced much in the almost two years since that project was announced to great fanfare. 
4. Another issue is the role of the oil industry in the development of the country, and the oil curse. What problems could Iraq be heading for with the growth of the petroleum business?

Vladimir Halama: The symptoms of the oil curse already permeate the Iraqi economy, and are more acute than in other resource-based economies. Currently, all development depends on crude oil export revenues, as it is almost the sole source of income for the government. Large sums are spent on investing in the oil industry to increase the output levels as fast as possible, based on the view that much larger oil revenues will then adequately fund the development in areas that are currently underinvested, for example health, education, and labor-intensive productive sectors. This approach ignores the possibility that, in the meantime, social unrest could reach explosive levels as a result of, for example, the large numbers of young people reaching working age each year. Alternative approaches, suggested in the USAID-Tijara Assessment, would see an increase of investments in other areas at the expense of oil sector investments, a distribution of a portion of oil revenues through direct payments to Iraqis, and the setting up of a wealth fund for future generations that would invest in assets abroad.

Thomas Doherty: The report notes how little employment the oil industry actually provides relative to Iraq’s need for jobs. The oil money has to be cycled back into the economy in a way that provides jobs, and the education that provides future capacity for the health, education, and other sectors of the economy.

5. What kind of affect does the large oil-funded public sector have upon investment?

Vladimir Halama: As regards private sector investment, competition from subsidized SOEs has crowded out many areas of potential private sector economic activity. An exception to this is Kurdistan, which is experiencing a construction boom financed by Turkish capital, the telecommunication sector (mobile phones), and the recent crude oil service contracts awarded to oil multinationals, which are expected to finance the expansion of production and recoup their investment afterwards. While data is hard to come by, the volume of private sector investment so far appears to have been considerably lower than the forecasts that were made in the NDP.

Thomas Doherty: In Baghdad, the Ministry of Communications is seeking more and more of a role in the market. They are seeking to control 100% of the bandwidth in and out of Iraq, and the mobile phone operators are required to eventually use these government-controlled gateways as a condition of their licenses. Whether this will eventually lead to the banning of private-sector satellite gateways for internet services and other data, with the political and cultural implications this could mean, time will tell.

There are also various exclusive agencies written into Iraqi law for SOEs. For example, the Ministry of Transportation’s State Company for Land Transportation has the exclusive concession to move cargo overland out of Iraqi ports. Another of these exclusive agencies, one which the Ministry of Transportation through Iraqi Airways granted a Sharjah company, RUS Aviation, actually stopped other air cargo services from flying into Iraq, at least for a while. This is just another burden on business and job growth for the sake of a little rent collecting.

6. Can you explain how the oil industry affects the social contract between the citizens and the government?

Vladimir Halama: Personal and corporate taxes yield very little, and that blunts government’s sense of accountability towards citizens. The oil industry, massive in comparison with the rest of the economy, is government owned and controlled, and gives politicians ample scope for self-dealing and favoritism.

To avoid a misconception on part of the readers, it is necessary to digress here and stress that while terms like 'state-run' and 'government-controlled' suggest a unitary system of the Soviet kind, this is far from being the case. An uneasy truce among a number of gangs running protection rackets would be a closer analogy. Iraq has been listed for a number of years now among the ten most dysfunctional countries in the world, according to the Fund for Peace index, and it is not difficult to see why. Neither the parliament nor the cabinet are worthy of their name. Iraq's inclusive government contains political groupings, which are mutually hostile. Any proposed activity requiring cooperation among Ministers from different political, religious and ethnic affiliations engenders suspicion, and results in inaction. In turn, officials within the ministries, belonging as they often do to differing groups, do not cooperate with each other. Thus the Ministers do not carry out the decisions of the Council of Ministers, Directors General do not carry out the wishes of their Ministers, and officials, particularly at the provincial level, disregard the instructions of their Directors General, with killings not being an unknown form of resistance, particularly in areas which give rise to substantial kick-backs and bribes. True, many investment projects are embarked upon behind the facade of established institutions, but their effectiveness is highly dissipated by the cuts taken at all levels by prime contractors, and the numerous bureaucrats whose approvals are needed. Additionally, those in the vicinity of the projects want to be paid for not destroying them. For example, tribes living in the vicinity of oil pipelines want their members to be paid as members of oil pipeline protection forces, and carry out attacks on the pipeline to make their point. Such universal brigandry does spread the wealth around, but in a very unsystematic way. In fact, even the tribesmen employed in the oil protection force are not particularly well off when, as is so often the case, they have to give a share of their income to the local powerbrokers. In other words, there is no social contract between citizens and the government because people are primarily beholden to those immediately above them in the food chain.

Efforts by international institutions and aid agencies and diplomats and politicians of foreign powers to bring a measure of order and sanity to the situation have amounted to a little more than a spit in the ocean. However, you would hardly get that impression from reading pronouncements and 'success stories' published by these organizations.

Thomas Doherty: As Vlad and the report say, the oil fosters conflict over revenues, and also a sense of entitlement among elites and government employees. 

7. Baghdad came up with a National Development Plan for 2010-2014. The Tijara report found some major flaws with its strategic goals. Can you explain some of those?

Vladimir Halama: Actually, the goals of the National Development Plan cannot be faulted. They include all manner of desirable outcomes: balanced development of regions, overcoming gender imbalances, reducing maternal mortality, improving private sector enabling environment, and so on. Rather, the problem is that the NDP is not an actionable plan. Actions needed to achieve the goals are not listed or costed, so there are no benchmarks against which the outcomes could be monitored and evaluated. The few quantitative guidelines in the NDP, which relate to the allocation of the investment budget, have not been reflected in the budget. In practice, little heed is paid to the Development Plan.

Thomas Doherty: Agree with Vladimir, the NDP’s worthy, but broad goals have to be supplemented with specific actions needed to achieve those goals. It’s long past the time where the Iraqi government should just be saying it wants to “develop the private sector.”  It’s time to do some of the things, which numerous USAID, World Bank, and other donor programs have recommended to allow diversification of the economy. An Iraqi businessperson should be able to operate without checking with the government every day, which would be the case with a growing enterprise seeking to diversify its activities – the company would need approval from the Companies Registrar for increasing its capital and operating new lines of business.

8. Has the Development Plan helped Iraq move away from relying upon the state for managing the economy and delivering services?

Vladimir Halama: Iraq is still a state-run economy. The operations of the private sector are hemmed in by onerous regulations. The population receives subsidies, like the food distribution scheme, low utility charges, and has a strong sense of entitlement. The existing system enables those in charge of administration to appropriate for themselves considerable amounts of public money, and they have been successful in blocking any reform efforts. The inventiveness of the bureaucracy and political leaders in coming up with reasons and mechanisms for delay is breathtaking.

Thomas Doherty:  I don’t think the goals of the NDP were internalized by many Iraqi government officers. Some of the recent enactments of the Council of Representatives, like the establishment of a state-owned Islamic bank I mentioned above, seem to be moving towards more state involvement in the economy. There is also a lot of railing against “low quality imported goods,” which is partly true and partly a stalking horse for a return to autarky.

9. Iraqi law is also a barrier to developing a private sector. With regards to jobs for example, what kinds of difficulties are there to control the rapid expansion of the number of public workers?

Thomas Doherty: With the oil revenue available, public employment isn't so bad unless the workers are put to work thwarting private sector growth in bureaucracies or establishing monopolies. Iraqi law enables government bureaucracies to do that. For example, the Law of Transportation of 1983 says that “the socialist sector leads the transportation sector.”  This allows the Ministry of Transportation’s SOEs like Iraqi Airways and the State Company for Land Transportation to claim exclusive agencies, which crowd out private sector transportation enterprises. In other words, it’s not that bad that Iraqi Airways employs a lot more people than it would need if it were efficiently run: it’s bad if Iraqi Airways is preventing private sector competition in air cargo and passenger services. Same thing with the Ministry of Communications and its claim of a monopoly on international bandwidth.

The Coalition and subsequent donor activities did very little to change Iraqi law, which still contains numerous clauses subjecting private sector activity to state economic planning. A generation of Iraqis grew up with a statist political and legal philosophy, and it will take a generation to change. Although many Iraqi government officials now understand that the bureaucracy is overly burdensome, others believe that security or the need to prevent anyone from doing anything wrong justifies the control they exert over businesses.

This burden of bureaucracy falls most heavily on Iraqi businesses. Iraq has a tradition of contracting out for large government projects with foreign companies. Foreign companies with government contracts have glided into Iraq easily, exempted from the import and export, and other controls which Iraqis are subject to, because the Law of Major Development Projects of 1985, and other regulations exempted them from these rules.  This is one reason why there aren’t large Iraqi construction and engineering companies to build the infrastructure Iraq needs. It would be a good thing if the Iraqi government encouraged, and allowed the formation and growth of Iraqi companies, but that’s not going to happen under the current company law, where an Iraqi company has to run to the Companies Registrar every time it wants to raise its capital. 

10. Iraq needs good schools to train and prepare future workers, and help with development. How is the country’s education system doing?

Vladimir Halama: The intention to match the syllabus of technical schools with the demands of the labor market is still at the planning stage. School attendance and literacy levels have been falling in recent years. To improve the very low computer literacy in Iraq, schools need to be equipped better. Corruption infects the education system as well, and employers cannot be confident that graduates are competent in the field in they have received their diplomas.  

Thomas Doherty: Until Iraqi educational capacity is fully developed, it would be a good investment of both the Iraqi and American governments to fund Iraqis to study overseas, preferably in partnership with Iraqi universities. A generation of isolation and deprivation takes a generation to overcome. The Ministry of Higher Education also needs to liberalize its bureaucracy. For example, an Iraqi who has a bachelor’s degree in engineering or science field needs to jump through hoops to have a foreign MBA or MPA recognized in Iraq.


Tijara Provincial Economic Growth Program, “Assessment of Current and Anticipated Economic Priority In Iraq,” United States Agency for International Development, 10/4/12

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