Middle East Economic Survey
VOL. XLIX
No 16
16-Apr
IRAQ
Iraq’s Vicious Circles of Economic Priorities Distortion, Misuse of Oil Wealth, And Political Weakness
By Sabri Zire Al-Saadi
This article, written by economic advisor Sabri Zire Al-Saadi, a UN former employee who held senior economic posts in Iraq, summarizes a paper to be published in Arabic in the next issue of the Iraqi journal Al-Thakafa Al-Jadeeda. Email: sabri_saadi@hotmail.com.
The Purpose
This article has two aims. The first is to put the current views of those opposed to the proposed new “Oil and Gas Law 2007”1 – regardless of its commercial and administrative provisions – within a framework of economic strategy and policies needed to deal with Iraq’s acute economic problems and the historical misuse of oil revenues. The second is to highlight the prospects of liberal and social democrat groups playing a role in domestic politics. In the present extraordinarily difficult circumstances, that have reduced the bargaining power of the Iraqi government to a very weak level, it is rather strange and irresponsible on the part of Iraq’s decision-makers to rush through approval of the new “Oil and Gas Law 2007” which will greatly influence long-term economic and social development. It is also essential to question the future of liberalism and democracy if the elected government continues to resist a radical change to the present economic policies.
Despite all the present difficulties, Iraq has the necessary conditions to establish a successful democratic political system and a dynamic liberal economy: human resources, individual freedom, political will, diversified culture, natural resources, and the ability and desire for hard work2. The strategic geopolitical position and the abundance of crude oil and gas qualify Iraq to be a distinguished modern state in the Middle East. Indeed, the future of Iraq is bright. The main priority at this stage, however, is to reach political agreement and implement economic strategies and policies, including utilization of oil wealth, that deal effectively with the current acute economic and social problems and serve the long-term interests of Iraq.
Foreign/Iraqi Interest In Oil
The influence of oil power in domestic politics prior to the fall of the former dictatorial regime resulted in the accumulation of political, economic and social problems that led eventually to the collapse of Iraq’s modern state. The irrational government policy of allocating oil revenues among public enterprises and its biased socio-geographical criteria, especially after 1968, substantially restricted individual economic freedom and eliminated the prospect of democracy, agitated sectarian and national differences, and induced the rise of the dictatorial regime that also seeded the catastrophic demise of the state on 9 April 2003. The historical perspective shows how foreign interests in Iraq’s crude oil were behind the early conflicts among the victorious great powers of the First World War, the competition between Britain and the US in the Middle East before and after the Second World War, and the conflict between the West and East during the Cold War era3. Domestically, the implementation of the first oil agreement in 1932 that was signed in 1925 between the Iraqi government and foreign companies shed some light on the anxiety about the prospect of oil importance in the future economic and social development of Iraq. This was reflected by the government formulation of construction programs beginning with the first five-year (1931-35) public work program assumed to be financed by oil revenues. However, oil revenues were insufficient and were spent mostly on current government expenditures4. Since the early 1950s, oil revenues have exerted a significant influence on the economic and social development of the country.
Foreign conflicts over Iraq’s oil have motivated the Iraqis’ demand for oil production to be controlled by the state rather than being left to foreign companies and for oil revenues to be spent mainly on increasing economic growth and accelerating social development. In response, the major first step was taken by the government in 1953 to allocate 70% of oil revenues to finance the four development programs (1953-61). The second was the issuance of “Oil Law No 80” in 1961 by ΄Abd al-Karim Qasim, the then President and Prime Minister of the new Republic of Iraq, which was established after the fall of the Hashemite Monarchy on 14 July 1958. This law significantly limited the production and discovery concessions given to foreign companies. Furthermore, during 1972-76, the Ba΄th government, with massive public support, nationalized all the activities of foreign oil companies and established state ownership of oil industry and wealth. However, after that, the utilization pattern of oil revenues changed in a way that helped to increase political oppression, perpetuate the one-party political system, and create severe structural economic problems that in turn caused more political, economic, social, and environmental ones. Despite achieving high rates of economic growth in the 1970s in terms of GDP, high employment, manufacturing oil products, improving public education and health services, and building physical infrastructure, subsequent economic and living standards indicators showed significant deterioration, especially during the 13 years of UN sanctions (1991-2003)5.
Post-War Economic Strategy And Policies
Given the well-known economic problems of Iraq during 1980-2002, an objective assessment of the economic strategy of Paul Bremer, former head of the Coalition Provisional Authority in Iraq (April 2003- June 2005), could have easily predicted their failure. He dismissed advice calling for gradual economic liberalization reforms and dealing urgently with the main economic and social problems (sluggish growth, high unemployment and poverty, electricity and water shortages, failing public utilities and infrastructure). Instead, the hasty application of US policies based on neo-liberal economics had no chance of achieving its aim of establishing a free market economy and reconstructing the destroyed infrastructure.
There were at least two main reasons for this assessment. First, the implemented policies, especially the monetary ones, could only have been effective in developed countries where physical and social infrastructure and production capacities maintain economic growth and employment with a reasonable increase in private demand. That is to say, while economic stability has been the major concern of the fiscal and monetary policies in advanced countries like the US, in Iraq the expansion of production capacities, building the required infrastructure, and increasing employment are the main priorities of economic policy. Secondly, effective demand in Iraq has been dominated by public expenditures, current government expenditures and public investment. It is well known that the value added of the oil sector constitutes the major contributor to GDP, and oil revenues have been the major source of government budget and foreign currency required for imports. Thus, in order to transfer the oil-rentier economy into a dynamic free market one it is essential to adopt certain ad hoc measures to support the indigenous private sector, especially small farmers and industrialists, and promote non-oil exports. Therefore, the US policies aimed at liberalizing the Iraqi economy (unconditional liberalization of foreign trade and flow of foreign capital, artificially imposed independence of monetary policy from fiscal policy, and abandonment of proper economic and social development plans to be replaced annual budgets) were bound to fail6. Even the changes made to these policies have had no effect, despite frequent claims that economic stability is being achieved, along with a slight improvement in the income of a small segment of the population. Today, aspects of Iraq’s acute economic crisis are apparent: zero-growth of industry, agriculture, non-oil mining, transportation, services; low growth of trade and construction, and some private services; high unemployment; widespread poverty; low living standards in terms of income, public education and health services; and lack of essential public utilities and infrastructure. Also, the chronic economic structure problem – the high dependence on the oil sector – has worsened. But clear and realistic alternatives could be implemented immediately if there was a serious review of policies on the part of the US, the most influential authority in Iraq7.
Politics, Oil, Indigenous And Foreign Investment
It has been rightly argued that privatizing the public sector is part of economic structural reforms aimed at liberalizing economic activities, ie maintaining the freedom of property ownership, labor, trade, and competition. Obviously, the assumption is that the market mechanism is more efficient in mobilizing and distributing the available resources than the public sector. Indeed, Iraq’s centralized economic planning experience supports such important policy suggestions. However, the required major economic reforms that Iraq needs should consider the salient economic, social, and political features of Iraq’s stage of development. For example, subsidies in terms of income support and exemption of agriculture equipment from import duties to small farmers are necessary to increase agricultural production on which about 30% of population depends. Also, the earlier calls for the privatization of the oil industry during Mr Bremer’s period, the fantasy of distributing oil revenues in cash among Iraqi citizens, and the hasty call to adopt the proposed “Oil and Gas Law 2007” to facilitate long-term concessions to exploit the huge reserves of Iraq’s crude oil and gas, are unrealistic. As Iraq’s past experience shows, especially during the last four years, public opinion will not accept a new oil agreement with foreign companies unless the economic situation and living standards substantially improve – even if such an agreement is judged commercially and technically sound by professional criteria. If one were imposed, such a move would only aggravate the current fragile political and security situation and maintain social upheaval. Equally important, any economic agreement with foreign partners should be delayed until the required radical change in the fiscal, monetary, trade, investment policies is made.
The same goes for revising the economic planning apparatus as part of a capacity building process. It is wrong to suggest that economic conditions in Iraq permit a workable and efficient free market benefiting from free competition. Unless Iraq succeeds in substantially reducing the economy’s dependence on oil revenues, ie generating value added, financing the government expenditures and public investment from non-oil and private sector activities, the imposed policy measures to liberalize the economy will have a devastating impact. Therefore, reformulation of the macroeconomic policies is needed to achieve both economic growth and stability, and the gradual liberalization of foreign trade and flow of foreign capital. Limited protection and subsidies should also be given to industries and small farms, and a package of investment incentives (revision of the Investment Law) for the private sector should be introduced.
At this stage, with the physical infrastructure lacking, it is misleading to suggest that foreign investment would be promoted by the newly adopted “Investment Law” regardless of its clear shortcomings. It is also misleading to assume that lack of available financial resources for the expansion and modernization of oil industries necessitates the urgent approval of the proposed “Oil and Gas Law 2007”. In fact, neither the limited absorptive capacity of the economy nor the available huge reserves of oil revenues justify the urgency of securing oil agreements with international companies8.
As past experience showed, foreign (contracting) companies are ready to implement public projects that are financed by oil revenues. However, indigenizing foreign technology in industry, agriculture, and services through the targeted inflow of foreign investment is constrained by the lack of physical, institutional, social, and environmental infrastructure. Therefore, the mere issuance of the “Investment Law” would change nothing.
Envisaged Economic Role Of The Liberal And Social-Democrats
The aim of the violent political struggle for power in Iraq today is to control the utilization of the country’s abundant resources and set the criteria for distributing the economic surplus – oil revenues – among the people. The experience of the former regime showed that the misuse of oil revenues was politically motivated; and when the regime failed to maintain indigenous support the national and sectarian differences (mainly Arabs versus Kurds and Sunnis versus Shi΄a) were exploited. Also there was, of course, the shameful waste of Iraq’s oil wealth during the 1990s as the regime sought to buy foreign support.
In 2004, the first post-Saddam Husain government was formed by a liberal prime minister, and many liberals held important ministerial positions. The experience, however, failed to highlight the promising prospects of liberalism and democracy because it solved none of the prevailing political, security, and economic problems. Significantly, several liberal ministers were accused of corruption. Such a poor performance has greatly reduced the credibility of the liberal and democratic groups, and influenced the outcome of the general election of 2006.
Four years of military efforts to re-establish security, against background of a stalled political process and crippled economic efforts have resulted in the dominance of new political powers. At present, the Shi΄a coalition is dominant, followed by the Kurds’ coalition, and then the coalition of Arab Sunnis and nationalist. The liberal and democratic groups are fourth in terms of the number of parliamentary representatives. Unfortunately, the political significance of the general election of December 2006, in which more than 12mn people participated willingly despite the risks of terrorist attacks and violence as well as the burden of economic difficulties, was not matched by subsequent political and economic progress, nor by the return of security.
Based on the apparent failure of the present government in dealing with the economic problems in particular and its attempts to pursue a dogmatic policy such as marketing the vague idea of equal distributions of oil revenues among citizens, the liberal and social democrats could seize the new opportunity to return political power at the next general election.
Conclusions
After four years of immense loss of human life and huge cost of resources, Iraq still needs a radical change in economic vision and strategy. At present, the adopted new “Investment Law” and the proposed new “Oil and Gas Law 2007” would not stimulate economic growth, increase employment, support the indigenous private sector, or facilitate the reconstruction of infrastructure. Significantly, the current economic policies have failed to establish an efficient market economy and sustain the indigenous private sector. The alternative, however, must be formulated in a well-defined economic strategy and policies to be guided by a long-term vision. Such professional endeavor is essential to diversify the economy and lessen its dependence on oil, promote economic structural reforms, including privatization of public enterprises, through clear and timely policies, programs, and projects. As part of the suggested strategy, allocations of oil revenue should be made in favor of increasing the contribution of non-oil sectors and the private sector to GDP, as well as to annual budget and exports.
Politically, since the dominant Islamic parties and to a certain extent the main Kurdish parties have no unified and clear vision of contemporary economics, liberal and social democratic political groups should take the initiative in adopting an economic program that aims specifically to increase economic growth and employment, alleviate poverty, and support the Iraqi private sector, while embarking on a huge public investment program for building the physical, social, and environmental infrastructure.
1. The given views are based on the Arabic version of the Law approved initially by the government on 15 January 2007 and published by Iraqi media.
2. Elaboration on Iraq’s future vision and the economic model for Iraq was given in; Sabri Zire Al-Saadi, “Iraq’s National Vision, Economic Strategy, and Economic Policies”, Centre for Contemporary Conflict, Strategic Insight, Vol 5, Issue 3, March 2006 (www.ccc.nps.navy.mil/si/2006/Mar/saadiM06.asp). Also, Al-Saadi, “Iraq’s Needs a Radical Change in Economic Strategy and a political Commitment to National Criteria for Oil Wealth Utilization”, Center for Contemporary Conflict, Strategic Insight, Vol 6, Issue 1, January 2007. (www.ccc.nps.navy.mil/si/2007/Jan/al-saadiJan07.asp).
3. On the history of foreign interests in Iraq’s oil see; Penrose, Edith & H F, Iraq: International Relations and National Development, Ernest Benn Ltd, 1978.
4. For details of these programs, see: Joseph Sassoon, Economic Policy in Iraq 1932-1950, Frank Cass & Co Ltd, London, 1987.
5. On these indicators, see Sabri Zire Al-Saadi, “Oil Wealth and Poverty in Iraq; Statistical Adjustment of the Government GDP Estimates (1980-2002), MEES, 18 April 2005.
6. Earlier assessment of post-war economic policies was given in; Sabri Zire Al-Saadi, “Iraq’s Post –War Economy: A Critical Review”, MEES, Vol 47 Issue No 14, 5 April 2004.
7. See: Sabri Zire Al-Saadi, “Liberalization Strategy for Iraq’s Oil-Hostage Economy: Alternative to Oil Power Dominance and Subordinate Neo-Liberal Economic policy”, MEES, Part 1 & 2, 16 & 23 October 2006.
8. The annual government budget of 2007 estimated total revenues at about ID42,065bn ($33.360bn) of which 93% are revenues from oil exports and 1.2% from the increase of prices oil products and only 5.3% are from other sources; ie taxes on reconstruction, income tax, excise duties, public enterprises. Total government expenditures was estimated at about ID51,727bn ($41.053bn) of which ID12,665bn; ie 24.5% allocated for investment in public projects. Estimated deficit amounted to ID9,663bn ($7.669bn). Oil exports revenues of 2007 have increased by 10.5% compared to oil revenues of 2006 mainly due to price increase. The 2007 annual budget was approved by the Iraqi Presidency on 22 February 2007.