Does Iraq Suffer From The Oil Curse?

Iraq is the most oil dependent country in North Africa and the Middle East. More than half of its Gross Domestic Product and almost all of its foreign exchange come from petroleum. That has led to major difficulties with its economy. Some would explain this through the resource curse. That theory holds that countries that are natural resource dependent usually underperform, lack productivity in other parts of the economy, suffer from poor social indicators, poor governance, authoritarianism, and corruption. Having oil does not automatically mean that a nation will run into these problems. There are plenty of countries that have petroleum such as the United States, Canada, and Norway that have prospered. The deciding factors are trying to base development solely upon exploiting that resource, and then how the wealth generated is used and distributed. The resource curse definitely helps explain many of Iraq’s current economic difficulties.

There are several different versions of the resource curse. The four main ones are the rentier thesis, the repression thesis, the rent seeking thesis, and the Dutch Disease. The rentier thesis argues that oil creates regimes, which are not dependent upon their publics. Petroleum brings in so much money that taxes are not necessary to fund the government. That makes countries dependent upon oil, and less accountable and representative of their publics. The result is that there is no social contract formed between the people and the authorities. Petroleum dependence also leads to booms and busts in the economy and government spending. When oil prices are high, public expenditures not only go up, but countries usually over spend, causing inflation. Likewise, when prices go down as they traditionally have, spending has to be dramatically cut. Oil is also capital and technologically intensive, and employs few people. Not only that, but petroleum producing countries usually lack the skilled labor force to work on the industry, and have to import foreign workers meaning there are even fewer jobs available. The huge amount of wealth generated from hydrocarbons, and the large government projects that are started with it open up ample opportunities for corruption. The repression thesis is based upon the idea that oil leads to authoritarian governments. Oil money is used to fund large security forces to keep the elite in power. The rent seeking thesis believes that oil becomes the spoils that factions within countries compete over. Political parties then use the petroleum wealth to create patronage systems to stay in power. For example, they start government programs that are about distributing goods and services to hold onto their followers rather than ones that are about producing things. Finally, the Dutch Disease is based upon the experience of the Netherlands. In the 1960s, it found natural gas in the North Sea, and went on to emphasis it over other industries, which distorted its economy. Nations afflicted by the Dutch Disease see the value of their currency driven up by oil profits, which makes their other exports less competitive as a result. Businesses then start focusing upon sectors that are not affected by the appreciation, and that usually leads to less innovation. The government then steps in by creating high protective tariffs to try to preserve those sectors, which are struggling. The net results it that the agriculture and manufacturing sectors most often get pushed out, and the countries become even more oil dependent. The growing strength of the domestic currency also drives up demand for imports as they become cheaper. The overall affects are countries that on the surface appear rich, but are actually economically hollow, corrupt, have weak bureaucracies, and ruling elites that are intent upon staying in power.

Iraq appears to have many of the characteristics of a nation struck by the resource curse. First, according to a 2010 study by the International Monetary Fund (IMF), Iraq is the most oil dependent country in the Middle East and North Africa. 60% of its Gross Domestic Product (GDP) and 95% of its foreign exchange comes from petroleum. In comparison, Saudi Arabia, which is the large producer in OPEC, depends upon oil for less than 30% of its GDP and approximately 78% of its revenue. Second, Iraq does not rely upon taxes. They only account for 2% of the government’s income. That means the government is not dependent or connected to the public. Third, public spending and the GDP are directly correlated to oil revenues. For instance, in 2008, Iraq earned $58.79 billion in oil receipts, and had a $72.18 billion budget. That year, its GDP was $86.53 billion. The next year, oil revenues went down to $37.02 billion, driving down the budget to $58.61 billion, and the GDP declined to $65.84 billion. Then in 2010, oil prices went back up, and so did the budget and GDP. That’s a classic example of the boom and bust that oil dependent countries experience. Not only that, but much of the public spending goes towards salaries, pensions, and goods and services provided by the government with only around a quarter being for infrastructure and investment. The Food Ration System for instance, takes 7% of the budget, and is the largest in the world. The state is also the largest employer in the country. Fifth, the reason why the public sector employs so many is because the country’s largest industry, oil, only provides 1% of jobs. The government therefore has to step in, and uses jobs as a form of social service to keep the public content. They are part of vast patronage systems run by the ruling parties, so that they can stay in power. Sixth, Iraq has been ranked one of the most corrupt countries in the world since 2003. In 2012, it was eighth from the bottom of 174 countries in Transparency International’s Corruption Perceptions Index. Seventh, there is a huge pent up demand for products in Iraq after years of wars and sanctions. Most of this spending goes towards imports, and is fueled by government salaries, which are in turn, paid for by oil profits. Those all point to Iraq suffering for the resource curse, but there are some differences. For one, Iraq’s dinar has not seen a large increase in value as the Dutch Disease argues. While there was high inflation in the mid-2000s, the Central Bank has now gotten that under control. It now wants to revalue the currency upwards, but Prime Minister Nouri al-Maliki is opposed. Iraq does not have many tariffs either. There are few protectionist barriers, and those that exist have just been implemented, because the Americans got rid of most of them when it ran the country after the 2003 invasion. That’s a major reason why Iraq’s agriculture and industry have regressed. Iraq has been flooded by cheap imports, which have put out of business many of Iraq’s farmers and factories. Last, Iraq is predicted to be one of the fastest growing economies in the world over the next several years. Bank of America and Merrill Lynch estimated that Iraq’s GDP would grow 10.5% in 2012 and 8.2% in 2013. That’s due to the massive government spending that is going into affect with high oil prices. That is the opposite of most oil dependent countries that have traditionally underperformed compared to others that do not rely upon natural resources. There are far more characteristics of the oil curse apparent in Iraq than not. Oil affects the economy, government, and society. It has created a country that depends upon oil for growth and a large public sector that is responsible for goods, services, and jobs. It also helps keep the ruling parties in power, and provides them with plenty of money to pocket as well.

There are many ideas on how to solve the oil cruse, but they would be very difficult for Iraq to implement right now. Transparency is being pushed by international organizations such as the World Bank in Iraq. Baghdad recently singed on to the Extractive Industries Transparency Initiative for example, which will make the authorities open up some of its books on the oil industry. That could help reduce the amount of theft going on, and give the public more confidence in the authorities. Privatization could get the government out of the oil business. It would in turn, force the government to set up a taxation system, and re-connect it with the public. Iraq could follow other countries that have set up oil funds. That would limit public spending, and provide a means for escaping the booms and busts that afflict it right now. Smart investing using those funds could also help diversify the economy. Oil profits could be directly distributed to the public as well. That could increase private spending, and provide an incentive for the growth of businesses. This was included in the 2012 budget, but has not been followed through with. Still, Iraq would face many problems trying to follow any of these policies. A big one is that Iraq’s government lacks skilled staff, and has weak institutions to carry out reforms. The oil money not being distributed to the public is an example of this. Second, the ruling parties and the public would oppose privatizing the oil industry. Iraqis are very nationalistic about oil, and would not want to turn it over to businesses especially if that meant foreign control. The political parties would lose a huge source of money to steal and spend, and therefore would be against the idea as well. Finally, even in developed countries, some of these ideas don’t work out. Setting up oil funds for example require difficult decisions about how much money should be taken out of the budget, and requires smart investing both of which can go wrong. Transparency can only go so far, as many of the energy companies that have joined the Oil Ministry, as partners do not want to divulge their business. Iraq also has bad bookkeeping, and many of its records are incomplete even if wanted to make all of them public. For the foreseeable future then, Iraq is likely to remain under the resource curse. Changes in the economy and governance could very well take place, but they’re likely to take a generation, because Iraq is coming out of such a problematic past.

Iraq seems a fitting example of the resource curse. It is an oil dependent country, and that has caused distortions in both the economy and government. Everything from the budget to jobs to food to investment are largely driven by the petroleum industry. Not only that it has created a public that relies upon the state rather than the other way around. Baghdad has talked a lot about diversifying the economy with all the money it is generating, but there have been very few concrete steps in that direction. That doesn’t mean it can’t happen, but right now the status quo seems pretty much set as there would be political and public opposition to many of the ideas on how to reform things.

SOURCES

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