Iraq’s economy is based upon a contradiction. It has huge
natural wealth with its petroleum reserves that are being developed, and
provides most of the country’s revenues. At the same time that industry hardly
provides any jobs. That is a classic dilemma posed by the oil curse. To help
explain this issue and others that affect the country is Lehigh Professor of
Economics Frank Gunter. Previously Prof. Gunter was the lead economist to the
U.S. military in Iraq from 2005-2006 and 2008-2009. And he is the author of The Political Economy of Iraq: Restoring Balance in a Post-Conflict Society (Edward Elgar Publishing, 2013).
1. Iraq is a classic
example of the oil curse. Can you briefly explain what that theory is and how
it applies to Iraq?
The oil or natural resource curse – also known as the
paradox of plenty – concerns developing countries whose economies are dominated
by the production and export of a single natural resource. Such countries tend
to have worse economic and political outcomes then countries with more
diversified economies. Iraq is seriously vulnerable to the oil curse. Not only
is it the most oil-dependent country among the Middle East and North Africa
(MENA) countries, Iraq is the most natural resource dependent country in the
world. Oil production and exports account for roughly two-thirds of the
country’s GDP and provide almost 95% of government revenues.
One aspect of the oil curse is the Dutch disease where a
large value of exports leads to an appreciation of a country’s currency. In Iraq,
the dinar has appreciated about 20% since December 2005, which reduced the
competitiveness of the country’s non-oil exports and contributed to a flooding
of the Iraqi economy with cheap imports.
Also, the large and growing revenues from oil exports have
not only allowed the Iraqi government to increase the number and compensation
of government workers but also oil wealth has fundamentally changed the
relationship between the government and the people. Concentration of economic
power tends to lead to concentration of political power. If the party that
controls the government also controls the economy then those in power begin to
believe that choosing the national leadership is too important to entrust to
the voters.
There is also an important psychological effect. In most
long-lived democracies, the major source of government revenue is tax receipts.
People in such countries feel that they are “buying” government services and if
the government fails to provide, at reasonable cost, the services demanded by
the taxpayer-citizens then they will attempt to “fire” the government through
the ballot box. But in Iraq, the government doesn’t need to tax citizens.
Cynically, the primary role of Iraqi citizens is to receive - and be grateful
for – whatever level of service that the government decides is appropriate. In
this sense, Iraqi citizens are not independent entities that support the
government. Rather they are symbolically, and often in reality, clients of a
“beneficent” government. As Samuel P. Huntington stated in 1991: “’No taxation
without representation’ was a political demand; ‘no representation without
taxation’ is a political reality.”
Iraq might best be described as having partially evolved
from Saddam-era central planning to state-guided capitalism in which government
tries to guide the market by supporting particular industries that it expects
to become ‘winners’ or that are important sources of employment. But, if oil continues to dominate the
economy, there is a real danger that Iraq’s state-guided capitalism is only a
way station to becoming an oligarchic capitalistic state - like most of the
other countries in the Arab Middle East - in which the bulk of the power and
wealth is held by a small group of individuals and families. Despite wealth from
natural resources, such oligarchic capitalistic states tend to have great
income inequality, sluggish growth, large informal or underground sectors, and
massive corruption.
2. You’ve argued that
failure to develop the economy away from the oil industry is a national
security issue for Baghdad. What kinds of risks are involved if Iraq doesn’t
break away from its oil dependency?
In the absence of economic diversification, there are both
short-term and long-term threats to political stability. Due to the dominance
of oil revenues in the national budget, government capital expenditures are on
a roller coaster of world oil prices. When oil prices are high as in 2008 and
2011-2013 then the government can expand the number of civil service jobs,
increase wages and pensions, increase spending on the social safety net and
essential services, as well as accelerate infrastructure investment. However,
during years of lower oil export revenues such as 2009-2010 then the government
responds by slashing capital expenditures in order to preserve funds for
current expenditures such as the government’s wage bill.
Since public investment accounts for over 90% of total fixed
capital formation when the government cuts such investment in response to lower
oil prices, the effect is serious. Most infrastructure and other investment in
roads, electricity, schools, clinics, water supply, etc. slows or grinds to a
stop. Partially completed multi-year building projects are abandoned for months
or years until investment spending is restored in a future budget. When
projects are restarted, it is often discovered that previous work must be
redone due to looting, vandalism, environmental damage, or plan revisions. This
waste and delay tend to have the most serious impact on private sector firms
and workers resulting in increased unemployment. As discussed below in response
to another question, this rise in unemployment threatens political stability.
3. Baghdad says that
it is committed to diversifying the economy and promoting the private sector.
The country consistently ranks as one of the worst business environments in the
world however. What kind of regulatory barriers do entrepreneurs face, and how
might that be solved?
MENA countries are not known for their friendliness towards
private businesses, Iraq is one of the worst in the region. It ranks 176th
in the world with respect to the World Bank’s Ease of Doing Business survey. It
is particularly difficult in Iraq to legally start a business, get credit, or
engage in international trade. And in one category, closing a business, Iraq
ranks dead last. Considering the competition from sub Saharan Africa, this is
quite a dismal achievement.
Ever since the first port-Saddam National Development Strategy of 2005, the importance of diversifying
the economy has been recognized. Unfortunately, while the economic necessity of
diversification is strong, the political will to make the difficult decisions
is weak. It is important to recognize that the regulatory hostility towards the
private business sector in Iraq is not an unloved artifact of the Saddam era
but rather is carefully maintained by the leadership of the bureaucracy. The
great regulatory complexity and expense provides strong incentives for
businessmen to offer bribes to helpful government officials. Also, harsh
regulation of private businesses reduces competition for the state owned
enterprises. These state owned enterprises tend to be high cost/low quality
producers.
What can be done? Iraqi government efforts to rewrite its own
commercial code will probably take more than a decade and will provide multiple
opportunities for officials to extract bribes in return for inserting clauses
favorable to one group or another. The World Bank and other international
organizations can provide a “model” commercial code that Iraq could adopt.
However, there is Iraqi concern that to adopt a “western” code would be
inconsistent with the business strictures of Islam. Probably the most practical
option would be for Iraq to adopt with minor modifications, the commercial code
of another Islamic state such as the UAE.
4. If Iraq were ever
able to build up a vibrant private sector how would that contribute to
stability in the country?
In the long-term, Iraq must deal with a severe demographic
challenge. Unlike Iran, its neighbor to the east, which is experiencing a
demographic collapse; Iraq still is a young country with a high fertility rate.
As a result, even after adjusting for the low labor force participation rate of
women in Iraq, the number of new job seekers is expected to grow by at least
250,000 this year and even more in the future. And this is in a country where
the combined unemployment and underemployment rate among the young is already
an estimated 80%! The experience of other low-income countries is clear: a
rising number of permanently unemployed young men is politically destabilizing.
Therefore, Iraq must create enough jobs to not only absorb
this annual increase but also shrink the pool of current unemployed and
underemployed. It is unlikely that increased public sector employment will be
sufficient. Public sector entities are already severely overmanned. In
addition, in the absence of a sharply higher oil export earnings, the public
sector will be hard pressed to achieve its current infrastructure investment
goals much less substantially increase government employment.
In developing countries, most jobs are created by new small
private businesses engaged in services and light manufacturing. Of the three
institutional requirements for such job creation – favorable regulatory
environment, available small business finance, and widespread literacy – Iraq
only has the third. In addition to regulatory hostility, the banking system is
moribund while microfinance still reaches relatively few Iraqi businesses.
5. You’ve argued that
the new Iraq has led to “entrepreneurial corruption.” Can you explain what that
means?
If corruption is the abuse of public power for private gain
then, under Saddam, corruption in Iraq was controlled from the top in a classic
case of “state capture”. It was expected that Saddam, his family, or his
supporters would financially benefit from every public and private economic
activity. As a result, corruption under Saddam differs in at least two ways
from that in post-Saddam Iraq. First, Saddam’s family and his immediate ring of
supporters captured a large proportion of the total gains from corrupt
activities. While lower levels of
government were corrupt, they captured a smaller proportion since Saddam and
his immediate supporters were careful to ensure that lower levels of the
bureaucracy didn’t divert flows of corrupt money from reaching the top. Second,
under Saddam corruption was more “honest” – honest in the ironic sense of the
old Chicago joke about an “honest judge” who, when he accepts a bribe, actually
performs the service that he was bribed to perform!
In post-Saddam Iraq, gains from corruption are more widely
distributed. While the top levels of the Iraqi government tend to be very
corrupt, they seem to be less able or willing to constrain corruption at lower
levels of government. Post-Saddam corruption is more widespread and competitive
- more “entrepreneurial”. Government officials at all levels are creatively
engaged in sometimes cooperative, sometimes competitive efforts to extract
maximum rents from not only private persons but also from other branches of the
country’s bureaucracy. As a result of this entrepreneurial corruption, bribe
takers tend to be less “honest”; corrupt members of the bureaucracy are often
unable to actually provide the services for which they accepted bribes.
It is likely that, although Saddam and his supporters were
able to steal a larger proportion of the nation’s income; current
entrepreneurial corruption imposes a more serious burden on the Iraqi people
because of the increased uncertainty resulting from entrepreneurial corruption.
6. Another side
effect of the bureaucracy and corruption is the growing and vibrant underground
economy. What is that sector like?
Private businesses in Iraq must choose between seeking to
become a legal enterprise, which due to regulatory hostility is a difficult and
expensive process, or operating in the underground economy with all of the
associated inefficiencies. One characteristic common to both options is the
necessity of paying bribes to a long line of corrupt officials. One survey of
corruption in Iraq showed that one-fifth of private businesses reported paying
40% or more of their firm’s total
revenues in bribes.
Excluding agriculture, an estimated 6% of the labor force is
employed by private legal enterprises while 20% is employed in the underground
economy. Firms in the underground economy tend to be small-scale, engaged in
services or light manufacturing. In many cases, underground entities are
engaged in illegal activities such as selling black market fuel or smuggling
across Iraq’s long open borders. However, other underground firms are engaged
in other wise legal activities that are concealed to avoid the choice of
meeting arduous regulations or paying bribes to inspectors to ignore
violations. As expected, workers in the underground economy lack legal
protections and there are stories of workers being denied pay or even
physically abused. Generally firms in Iraq’s underground economy are very
inefficient. This inefficiency arises not only from the usually small-scale
production but also from the necessity of operating in such a way so as to
avoid coming to the attention of rapacious officials.
7. Iraq’s economy
also suffers from political interference. How have politicians attempted to
manipulate and control the economy for their own gain?
Most politicians in Iraq – like everywhere else – seek to do
the right thing for their country as long as it doesn’t injure their own
self-interest. Just because a person has been elected or appointed to a
responsible government position, doesn’t make him or her more virtuous. And
like in other countries, politicians in Iraq manipulate the economy to achieve
a better life for themselves in at least two ways.
First, as discussed above, politicians engage in corrupt
activities and some have succeeded in stealing vast amounts for themselves and
their families through such illegal activities.
Second, politicians can personally benefit through
activities that, although they are not illegal, have an adverse effect on Iraqi
economic development. A major source of status and political influence for
politicians in Iraq is their control of large numbers of government jobs. It is
irrelevant that a ministry in incredibly ineffective or that a state owned
enterprise is a low quality/high cost producer of a good or service; what is
important for the status of a high level government official is the number of
jobs that they control. As a result, the ministries and state owned enterprises
tend to be seriously overmanned. As one example, the Iraqi publicly owned
railroad industry has over 10,000 employees running a system that in other
countries would require one-fourth to one-tenth as many. And that is true with
other state owned enterprises, these workers can not be fired for failure to
perform their assigned tasks to expected standards or even have their pay
docked for failure to show up for work.
Proponents of excessive ministerial and state owned
enterprise employment argue that it reduces political instability by providing
jobs for unskilled young men. However, expanded government employment in Iraq
may actually be destabilizing. It is not uncommon for a state owned enterprise
or ministry to be “captured” by a religious sect, party, sect or tribe as a
means of providing funding for the organization as well as jobs for its members.
Thus government employment can be destabilizing by supporting - with government
funds - members of political parties or other groups that may be in opposition
to the rule of law.
8. Iraq has huge
needs in terms of its infrastructure and services, and that is drawing in
increasing amounts of foreign investment. Do you think that those foreign
companies can help diversify the economy and help the private sector grow?
To date, almost all of the foreign direct investment (FDI)
flowing into Iraq has been associated either with one of the ministries or one
of the almost 200 state owned enterprises. In other words, very little of this
investment is purely private. Association with a government agency has both
advantages and disadvantages. A government partner can help cut through
bureaucratic red tape especially with respect to bringing capital equipment and
key personnel into Iraq. In addition, having a government partner can reduce
the demands for bribes.
However, the government partner probably expects to benefit
from the relationship with the foreign investor in ways that may not be clearly
delineated in a partnership agreement. Several examples might illustrate this
expectation. One European corporate investor agreed not to fire any workers in
a severely overmanned Iraqi factory. Apparently, the foreign firm thought that
it could gradually reduce the workforce through attrition until it reached
efficient levels. However, the Iraqi government partner not only demanded that
a new worker should be hired to replace each one who departs but also that the
government agency alone should select the new workers. As discussed above, this
demand reflected what the government agency saw as political reality that the
agency’s influence in Baghdad was a function, in part, of the number of jobs
that it provided for Iraqis. Another example involved a foreign hotel
management company that was informed rather late in contract negotiations that
the rooms on one floor of the hotel would be reserved for the sole use of the
Iraqi government partner without payment although it was expected that the
foreign management company would be responsible for maintaining these rooms.
As long as most foreign investment continues to take the
form of partnerships with public entities, it will have little effect on the
degree of economic diversity in the Iraq economy.
9. What direction do
you see Iraq moving in the future? Will its private sector eventually start to
grow or will it remain oil dependent with a large state-sector or something in
between?
Over the next decade, Iraq’s future will be determined to a
great extent by the degree to which the civil war in Syria on Iraq’s western
border and the dispute over nuclear sanctions between Iraq’s eastern neighbor,
Iran, and the west affect Iraq. So far these two disputes have had an adverse
impact on Iraq’s political stability as well as greatly complicated economic
policymaking but – surprisingly – these ongoing conflicts seem to have a
favorable effect on Iraq’s real economy. However, the price of oil will remain
the dominant determinant of economic development and political stability in
Iraq for the next decade.
In 2012, the U.S. Energy Information Administration
estimated three price scenarios for 2025: a high scenario where the world price
of oil is $180 per barrel (pb), a reference scenario of $120 pb, and a low
scenario of $50 pb.
The impact on Iraq of $180 pb in 2025 will probably be
mixed. If Iraq is able to raise its exports to 10.0 mbpd then Iraq’s export
earnings would reach $657 billion (in 2010 dollars) compared to $50 billion in
2010! With an expected 2025 population of 47 million, average per-capita income
would reach about $16,000 (in 2010 dollars) – seven times greater than in 2010.
This is about the same level of per capita income as Saudi Arabia had in 2010.
With this massive increase in oil export earnings, everything would be
possible: increased government employment and higher wages for government
workers, sharp rises in investment, generous provision of free essential
services, agricultural restoration, accelerated construction of homes, factories,
and government offices. New soccer stadiums would appear in every town. The al
Rahman Mosque in Baghdad would finally be completed. However, there would also
be negative effects. There would be an explosion in corruption. Efforts to
diversify the Iraqi economy away from its dependency on oil would probably
grind to a stop. And, as discussed above, without diversification, Iraqi
nascent democracy would be threatened.
At the other extreme, how likely is $50 pb oil? Increased
petroleum and natural gas production from Iraq, the USA, and other countries;
reduced energy demand from Brazil, Russia, India, and China; further
improvements in energy conservation; and peaceful resolutions of the conflicts
in Syria and Iran resulting in a reduction in oil risk premium could lead to a
return of $50 pb oil. After all, adjusting for inflation, average oil prices
were below this level for almost two decades from 1986 through 2005. The
adverse impact on Iraq’s political stability of an extended period of $50 pb
oil would be severe. The Iraqi government must earn at least $55 pb (in 2010
dollars) in order to pay its salary, pension, food assistance, and security
commitments. There would be no funds available for infrastructure investment or
expanded spending on internal or external security. If world oil prices fall
below this level for a year or two then the government of Iraq would be able to
pay for its basic expenditures by exhausting its Development Fund for Iraq
reserves, about $18 billion at the end of 2012; by persuading the Central Bank
to substantially revise its international reserves policy to make some of its
$70 billion available for fiscal purposes and by taking advantage of the
country’s limited access to world capital markets.
However, if there are more than two years of low oil prices
then not only will there be rising levels of unemployment and underemployment
but also the government will be forced to cut salaries and pensions. If Iraq’s
past is any guide to its future, cuts in wages and pensions will cause the
bureaucracy to turn against the government – undermining its policies,
participating in street protests, and possibly engaging in violent action.
Losing the support of government workers and pensioners will increase the
likelihood of a return of an authoritarian government – another Saddam or
Saddam-lite.
To insure against this outcome, Iraq must defuse the
resource curse by restoring balance – diversifying – its economy. Achieving
such economic diversification will not only require difficult economic choices
but also entail serious political risks. More than in any period since 1958,
the future of Iraq is in the hands of the Iraqis. Over the next decade, Iraq
will make - or fail to make - critical irrevocable decisions. Rich countries
with long histories of stable government can afford to make stupid decisions.
Iraq cannot.
SOURCES
Flintoff, Corey, “Iraq’s Shaky Economy Poses Threat To
Future,” National Public Radio, 12/9/09
Gunter, Frank, The
Political Economy of Iraq: Restoring Balance in a Post-Conflict Society.
Northampton, Massachusetts: Edward Elgar Publishing. 2013.
-“Corruption In Iraq: Poor Data, Questionable Policies,” EEA
Meetings, 3/7-9/08
- “Economic Development During Conflict: The
Petraeus-Crocker Congressional Testimonies,” Strategic Insights, December 2007
- “Entrepreneurship, Corruption, And Economic Development In
Post-conflict/Post-disaster States,” 5/13/11
- “Liberate Iraq’s Economy,” New York Times, 11/16/09
McArdle, Megan, “When Freedom Is Bad for Business,”
Atlantic, March 2011
O’Brien, Andrew, “Professor Gunter previews upcoming book
about Iraq economy,” Leigh Valley Live, 11/29/12
