Middle East Economic Survey

VOL. LI

No 28

14-July-2008

Iraqi Oil: Turning The Curse To A Blessing (2/2)

By Muhammad-Ali Zainy

Dr Muhammad-Ali Zainy is Senior Energy Economist and Analyst at the London-based Centre for Global Energy Studies. He holds degrees in engineering, law and mineral economics from England, Iraq and the US respectively; he is also the author of ‘The Iraqi Economy: Past, Present and Future Prospects’. This paper was presented to the Conference on Iraq Oil Policy: A Review on 25 February at the Center for Iraqi Researches Fondation Maison des Sciences de L’Homme, Paris. Part 1 was published last week.

The Case Of Iraq

If Iraq were resource poor, would it have developed a tradition of democratic government? The answer is definitely not! Since the founding of the present state of Iraq after the collapse of the Ottoman Empire, an oligarchy of Iraqi officers and functionaries from that defunct empire came to rule Iraq under the umbrella of a weak Hashimite monarchy established by the British in 1921. Iraq, then and until the early 1950s, did not enjoy any meaningful inflow of oil revenues in order to be afflicted with the alleged resource curse (see Figure 7). Although Iraq adopted a good constitution, perhaps even better than the present one, this constitution was almost always violated by a sectarian Sunni minority government, which had no regard to basic human rights, suppressing all sorts of freedoms provided by the constitution and rigging parliamentary elections every time they were held.

During the four decades from 1932, when Iraq gained its independence and became a member of the League of Nations, until 1972 when the Iraqi Petroleum Company (IPC) was nationalized, Iraq could not be considered as a resource-rich country, judging by the meager cumulative oil revenues of less than $10bn received during this period. Nevertheless, Iraq’s successive governments, whether monarchic or republican, were undemocratic and repressive. Iraq became relatively oil revenue-rich only in the aftermath of the oil price explosions of the 1970s, as illustrated in Figure 7. 

Despite the meager oil revenues Iraq was receiving, they were treated as a budgetary surplus to be allocated for infrastructure building. With the advent of the profit-sharing agreement with the oil companies as of the beginning of the 1950s, when oil profits began to be equally split between Iraq and the oil companies, the successive governments under the monarchy were able to utilize the country’s oil income prudently to finance a series of economic development plans, by allocating 70% (later to drop down to 50%) of the oil revenues for the purpose. Nevertheless, the Iraqi governments continued their tradition of repressive rule until the monarchy was overthrown by a military coup d’etat in 1958.   

In a nutshell, the inflow of large oil revenues did not cause the Iraqi governments to become autocratic, as they were already so since the founding of the present Iraqi state in the aftermath of the British occupation last century. The impact of the oil revenues, which became stupendous as of the mid-1970s, was to allow Saddam Husain, who grabbed power in a blood bath in 1979, to become even more stupid. Indeed, if there is truly a curse associated with resource-rich countries, then Iraq, during Saddam Husain’s rule, became its embodiment par excellence! What was built in Iraq with the help of the country’s oil revenues, in terms of advanced and adequate infrastructure, a generous health care scheme and a very good educational system, was wiped out within a short period of time, thanks to Saddam’s foolish military adventures.

To give examples of what happened, the successive Iraqi governments used most of the oil money, whose cumulative amount reached around $100bn by 1980, to finance the five-year economic development plans. As a result of those genuine endeavors, the Iraqi GDP almost quintupled over the period 1960-80, growing in real 1980 prices, from around $10.7bn in 1960 to around $53bn in 1980, with a remarkable average growth rate of 8% per annum (see Table 3 and Figure 8). The Iraqi per capita income increased in real 1980 prices about 2.6 times from $1,557 in 1960 to $4,000 in 1980, making a yearly real growth of 4.7% despite the high Iraqi population growth rate during that period of around 3.3% per annum. Furthermore, on the road of economic diversification, the Iraqi oil sector’s contribution to GDP decreased from 66% in 1960 to less than 62% in 1980.

With Saddam sitting behind Iraq’s steering wheel (1979-2003), what was built during three decades of sweat and toil and expenditure of over $100bn was all but wiped out (see Figure 8). With the start of the Iran-Iraq war in 1980 until the collapse of Saddam’s regime in 2003, the Iraqi economy suffered horrendously. The destruction of Iraq’s oil infrastructure at the beginning of the Iran-Iraq war, coupled with a precipitous decline in oil production, caused the Iraqi GDP, which was growing at 8% per annum in real terms, to lose one-third of its value in just one year (1980-81), and continue at a stagnant level during most of the war years (see Figures 7 and 8). With the invasion of Kuwait and the consequent Gulf war, which precipitated almost the entire destruction of Iraq’s infrastructure including that of oil, Iraq’s economy almost collapsed, with the GDP losing 75% of its real value during 1990-91.

The loss of domestic production was only one facet of the economic destruction that befell Iraq. The brutal sanctions years brought about hyper-inflation and the collapse of the Iraqi currency, wiping out in the process the savings of a large portion of the Iraqi middle class and causing its impoverishment. Since the 1991 collapse, the Iraqi economy never recovered, but continued limping at a level far below its peak in 1980.

To express that in figures, the Iraqi GDP in real 1980 prices averaged around $13bn during the period 1991-2007 compared with around $53bn in 1980, which should have continued growing in real terms at 5% per annum at least (see Figure 9). Associated with this low level of production and virtually no real growth were the lack of opportunities for gainful employment and the spread of poverty as a consequence. This is exemplified in the drastic decline, by 2007, of the Iraqi per capita income, to $500 in real 1980 prices after peaking in 1980 at $4,000, which was viewed at the time as one of the highest among the developing countries, with Iraq itself being considered by the United Nations as one of the most promising among emerging markets of the time (see Figure 10).

Can The Curse Be Turned Into A Blessing?

The answer is a definite yes. The horrendous Iraqi decline, in almost all aspects, be it as a result of a resource curse or the doings of inept and unscrupulous politicians is, at the end of the day, man-made. Anything man-made can be changed for the better as, the old adage says, if there is a will there is a way and, in the case of Iraq, a good will it must be.

The tragic story of Iraq tells us that, although foreign exchange generated from resource exports – oil in the case of Iraq – should be maximized to the extent possible, revenue maximization is not an end in itself or, in other words, it is not the end of the game, but only part of it. The end-game should be to utilize prudently the oil revenues for the benefit of the country. Iraq now needs a lot of rebuilding efforts which, in turn, need a lot of money. Since the Iraqi economy got destroyed, the only source of money to finance Iraq’s rebuilding efforts must come from the oil sector. This process might have to continue for a couple of decades until the Iraqi economy becomes sufficiently diversified and broad enough to act as a tax base to finance the government budgets. Furthermore, the revived economy should be vibrant and successful enough to create a state of self-sustained economic growth without any heavy dependence on oil, as it is the situation of the Iraqi economy right now.

Conditions For A Blessing

The blessing we envisage cannot happen unless two conditions are fulfilled. One condition is for the country to have enlightened governance, if not a full-fledged democracy from the outset. What we mean by enlightened governance is a form of benign rule where the citizens’ human rights are secured and respected and, in parallel with that, the means of a decent material living are provided. There is now a semblance of benign rule in the smaller GCC states of the Arabian Peninsula, meaning Kuwait, Bahrain, Qatar, UAE and Oman.

In the case of Iraq, and after all of what the Iraqi people went through, a democratically elected government is the only form of government that can be accepted. Furthermore, such Iraqi government would have to be enlightened enough to realize and act upon the goal that a political solution to the present Iraqi predicament, acceptable to all Iraqi players, based on the key tenet of inclusion and not exclusion, should be attained – and sooner rather than later. This solution is absolutely essential for the political stability and domestic security of Iraq, both of which should act as the bedrock supporting and allowing the other required condition to work ‒ that is the realization of a state of sustained economic development, necessary to provide decent material living for the people.

Economic Development

Although respect for human rights in a country is absolutely necessary, it is not sufficient in itself for the citizens of that country to enjoy a decent living standard; a vibrant and successful economy is needed. The key to turning the curse to a blessing in the case of oil-rich Iraq is to utilize the country’s oil riches to rebuild Iraq’s battered infrastructure, provide for good healthcare and education systems, and use the surplus money as a stop-gap finance source for government budgets until a state of diversified tax-based self-sustaining economy is reached.

This desired state of the Iraqi economy, or the state of sustainable economic growth, would not just happen by itself. Good planning and sincere efforts are needed to reach this state. There are good examples of successful economies attained in a myriad of developing countries that Iraq can emulate. One must caution, however, that a successful economic development paradigm in one country may not be fully suitable for another, and economic development planners in a certain country must, somehow, tailor their development plans to fit the specific needs and peculiarities of the country in question in order to launch it on a path of successful economic development¹.

There are, nevertheless, generally agreed-upon conditions and steps that Iraqi politicians and planners can incorporate in a national development strategy to revive the Iraqi economy and send it on the course of a development trajectory. Some of these steps would be to redress past mistakes committed by former Iraqi regimes, and some of them can be viewed as necessary ingredients of a recipe needed for creating the conducive environment for economic development and self-sustaining growth².

Adopting A Market Economy

From the beginning of the formation of the modern Iraqi state, the Iraqi economy grew under a market environment dominated by the private sector. With the increase in the country’s oil revenues, the Iraqi government, through acts of direct investment, created an expanding public sector engaged in all sorts of economic activities, including mining, manufacturing and provision of services. This public sector obtained a big boost with the nationalization, in 1964, of private sector enterprises worth around $200,000 and larger, and then became the dominant sector in the aftermath of Iraq’s skyrocketing oil revenues as of the mid-1970s and the ensuing heavy public investments in industry and other sectors of the economy.

Needless to say, socialist and public-sector dominated economies proved to be a failure all over the world, and Iraq was no different. Consequently, the Iraqi authorities need to get rid of these loss-making public enterprises and keep the government away from economic activities normally mastered and efficiently carried out by the private sector. The role of the government would, then, be confined to that of an honest broker and not a major economic player. Under this role, the Iraqi government should adopt a market-friendly approach and, at the same time, let the efficient private sector work, and only intervene where the market fails.

The market (the private sector) most likely fails in areas where the government is expected to be the major provider at low – often subsidized – cost, where the private sector cannot realize acceptable level of profits without making heavy charges. Such charges, however, are normally viewed by the public as exorbitant, thus causing the private sector to shun such activities, or restrict them to such areas where acceptable levels of profits are realized. The areas where the private sector fails – for lack of profits – and where government should assume the major provider role would be building the country’s infrastructure, protecting the environment and providing such public services as education, health care and social security.

Economic Restructuring

For the Iraqi economy to be successful it needs to undergo several steps of economic restructuring. Although adopting a market economy is, indeed, the major step in the direction of economic restructuring, there are other necessary steps which need to be taken to create a proper environment for a successful emerging economy. These steps include providing an independent legal system for the protection of property rights and resolving commercial disputes, a high level of transparency, a corruption-free environment, minimum bureaucracy, a reasonable tax regime, a skilled labor force and adequate infrastructure. These, in turn, will open up the domestic environment for foreign direct investment (FDI), with its associated inflow of capital, technology and management expertise.

Sustainable Growth

The ultimate aim in the case of Iraq’s present dual economy (ie the case of being oil dependent) is to reach a state of economic diversification whereby this duality is abolished and dependence on the oil sector is eliminated. Coupled with this would be a situation of self-sustained economic growth whereby the Iraqi economy grows, in real terms, by at least 2-3% per annum over and above the population growth rate, thus securing a continuous improvement in the people’s standard of living. This cannot, of course, be brought about, without securing the conditions that support such ultimate goal. These conditions would be:

• Macroeconomic stability: controlling fiscal and current account deficits, keeping inflation in check and securing a stable exchange rate for the country’s currency.

• Deep financial markets: organizing the country’s financial system, encouraging domestic savings, inviting foreign capital and increasing banking competition.

• Openness to trade: lowering import barriers, improving efficiency of domestic industry and encouraging transfer of technology.

• Quality of government: providing adequate infrastructure, enforcing a proper legal system for doing business and resolving disputes and providing a vast array of other services.

• New economy: propagating the use of information and communication technology and use of the internet.

• Education: placing less emphasis on rote learning and dependence on memory, and more emphasis on scientific research and analysis and the practical application of knowledge.

• Fulfilling such other conditions as providing good and adequate infrastructure, enforcing the rule of law, minimizing red tape and insuring a non-corrupt environment.

The conditions as listed above are necessary but not sufficient in themselves to create a state of self-sustained economic growth. There must also be what some economists call engines of economic growth. Some of these engines can be summarized as:

• Easy start-ups and friendly environment for entrepreneurs.

• Low tax rates and small government.

• High rate of capital accumulation.

• Innovation and inward transfer of technology.

• Export promotion of non-natural resources.

Conclusion

The resource curse effect can occur in many ways. One is the production of spoiled governments and spoiled peoples. Spoiled governments are produced in the sense that, having secured a large source of unearned income (oil rent in the Arab case) sufficient – and often more than sufficient – to finance its activities, the government of a rentier state has a propensity to become autocratic, unaccountable and dissociated from the interests and aspirations of its people. Additionally, such a government will keep dragging its feet and will not sincerely endeavor to build a successfully diversified tax-based economy as long as its unearned income keeps flowing. Also, in a rentier environment, spoiled peoples are produced in the sense that, enjoying the overflow of a natural resource bounty and, at the same time, not having to pay taxes, the people of a rentier state become inclined to be lax and tolerant of autocratic traditions, and sometimes even complicit with their government by looking the other way when transgressions against the people and the state are committed.

In the case of Iraq, however, to use the word spoiled is to be most charitable. From the beginning of the formation of the modern state of Iraq, the successive governments of this country, regardless of when Iraq was resource-poor or after it became resource-rich, had always been undemocratic and often ruthless, and when Saddam came to power his government became criminal in the full sense of the word.

When Saddam took over absolute power in the summer of 1979, he presided over a rich country with wonderful infrastructure and good public services, a strong and healthy economy expanding at a fast rate of 8% per annum in real terms, and a treasury of foreign exchange reserves of $35bn. All of that was dissipated in a matter of two decades of tyrannical rule and foolish military adventures, which left Iraq under a huge burden of $120bn foreign debts, and with battered infrastructure, rampant unemployment, a collapsed services system and a crippled economy.

All of this tells us that, yes, it is quite prudent to have a proper oil law whose mandate would be to protect the country’s oil riches and maximize their monetary value to the Iraqi people. However, maximization of the value of oil revenues to the country is not an end in itself but a means to an end. The end, broadly speaking, is to build the country. In order to achieve this noble cause, those Iraqis in charge must devote their sincere efforts to preparing the conditions for a blessing, in the way described above.

________

Notes:

1. See Muhammad-Ali Zainy, ‘The Iraqi Economy: Past, Present And Future Options’, Al-Rafid Publishing, London, 2003 (Arabic), Chapters 1 and 16.

2. See Muhammad-Ali Zainy, ‘The Iraqi Economy: Present State And Future Challenges’, Emirates Lecture Series 54 (English) and 103 (Arabic), The Emirates Centre for Strategic Studies and Research, UAE.

Figure 7: Iraqi Oil Production, Export And Oil Revenues Over The Period 1960-2007

Source: OPEC, IMOO.

Figure 8: Iraqi Real GDP Index During 1969-2007 (2007 = 100)

Figure 9: Iraqi GDP In Real 1980 Prices (1960 – 2007)

Source: Iraqi CSO, Others.

Figure 10: Iraqi Per Capita Income In Real 1980 Prices (1960-2007)

Source: Iraqi CSO, IMF, Others.

Table 3: Real Annual Growth Of The Iraqi GDP During 1960-80 (%)