from Follow the Money

Iraq: What happened to US plans for an extreme makeover of the economy?

August 19, 2005

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I agree with Mark Thoma more often than naught.   I certainly share his concern about the shifting sectoral composition of output (translated from economese to English, more jobs in housing), and, like Mark, worry that if the US continues to rely (almost) exclusively on the housing sector for job growth, it may face big problems in the future.

But I have a slightly different take than Mark (citing Antonia Juharsz) on the US economic policy legacy in Iraq.

What is striking to me is not that the US started out with dreams of creating a conservative's idealized version of a market economy, something that would serve as an economic as well as political model for the region.  Think a flat tax, no barriers to trade or foreign investment (2003 was before CNOOC), no more oil-for-food welfare, immediate privatization of all state owned firms outside the oil sector, if not the oil sector itself.   Think of an oil sector would partner up with the big international oil firms, not keep them out and reserve production for the national oil company. 

Rather what is striking to me is how quickly those dreams got scaled back.


An oil bonaza?  Oil production remains well below the 2.5 mbd Iraq produced before the war.

Privatization - or even partial privatization -- of Iraq's oil industry?   Not likely.   Iraq's leaders cannot even agree which part of the country should get the existing oil revenues, let alone how to divvy up a privatization windfall. 

End subsidies that keep the price of "premium" gasoline in Iraq at 13 cents a gallon, and keep the price of diesel at under 5 cents a gallon?  Well, when conditions permit.  The IMF estimates those subsidies cost Iraq about $8 billion, or about ¼ of total government spending. Some of the loss is revenue foregone by giving away oil inside Iraq rather than selling it abroad; but Iraq also has to import refined gasoline because of a lack of domestic refining capacity.

Wean Iraq's state from its dependence on oil?  Non-oil revenues are expected to provide less than 2% of Iraq government's total funding in 2005.

Reduce the role of the state in the economy?   2005 government spending is estimated to be bigger than Iraq's GDP.   Oil revenues do not cover the government's current spending, making it hard to do innovative things like set up an Alaska style oil fund that gives some of the oil revenue back to the people.

Open Iraq to foreign investment? Yes, laws that leave Iraq open to foreign direct investment remain on the books.  But it is pretty clear that those laws are meaningless when private militias are in de facto control of much of the country (see Shadid and Fainaru in the Washington Post), and no doubt control much of the economy as well.   The IMF optimistically estimates that Iraq's liberal foreign investment laws will help Iraq attract $300 million in foreign investment in 2005.  "Communist" China - with one of the most regulated capital accounts in the world - attracts about $1 billion of foreign direct investment a week.

Iraq's banking system?  Not worth talking about.  Iraq is a cash economy, and an informally dollarized economy.

Enough electricity to keep the lights on all day long?  Make sure Baghdad has more electricity than it did when the Iraqi economy was crippled by sanctions? That was something that was supposed to happen last summer.  I gather we are still waiting.    Electricity shortages remain endemic.   Electricity production (per Brookings) is about three quarters of the US goal for the summer of 2004 (4,500 MW v 6000 MW).

An Iraq that could pay for its own reconstruction?  That got abandoned back in 2003.   But the initial low-balled estimate of the cost of rebuilding Iraq still had an impact.   There was no aid (OK, not much aid) in the pipeline when the war ended, and it took time to push up reconstruction spending.  Actual grant aid disbursed in Iraq in 2004, according to the IMF (see table 3 of the Article IV): $3.4 billion.   2005 will be a bit better - the IMF now estimates there will be $8.9 billion in grant aid for Iraq.

But compare the $3.4 billion in grant aid in 2004 to the $5 billion a month cost of maintaining the US economy in Iraq - or to the $1.3 billion Iraq pays Kuwait in reparations for the first gulf war and $4.8 billion Iraq paid to import refined gasoline.   Right now, money flows from (poor) Iraq to (rich) Kuwait, not the other way around. 

Moreover, the US scramble to find funds to spend in Iraq in the early stages of the occupation meant drawing on a whole bunch of different pots of money - frozen Iraqi assets in the US, dollars cash that US troops seized in Iraq, the leftover funds in the UN's oil for food program, you name it (see box 4 in the IMF report).    The result: Iraq's budget is a mess.   The IMF of course does not put it in quite that way, but it does note: "Budgetary management remained weak in 2004, although some improvements were made in 2005." Best I can tell, "weak" means the ministry of finance has no real idea how much the rest of the government is spending.   That makes "timely and accurate assessment of the fiscal and monetary stance in 2004 and 2005 has been problematic."   

It is not just in the political realm where the US has scaled back its ambitions.   And to be honest, it was not just in the political realm where the US started out with unrealistic goals.  

The initial phase of shock therapy involves a lot of shock - workers at state owned firms get laid off, domestic products sheltered by sanctions face international (or even Iranian) competition, redundant workers in make work state jobs get laid off.    Markets do adjust.    But the process is not always pleasant.  Wages fall as old industries are shut down, and only start to rise when new industries are created.     In an economy with low wages and high unemployment even with bloated state payrolls, the US military (wisely) insisted that the US economic planners hold off on the shock.   That has not changed.  Best I can tell, the US is busy trying to add to the state's payroll (an army, a police force), not to reduce it ...

A market economy requires a functioning state - something that those who emphasize only the barriers the state places in the way of a market economy sometimes forget.   It often seemed to me that the initial economic planning put too much emphasis on eliminating state interference in the Iraqi economy, and too little emphasis on maintaining a functioning state.  

It is hard to create a modern market economy without a state that works.   You cannot carry off a massive privatization campaign without a functioning state either.  Competing private militias rarely produce a free-market nirvana, even with a flat tax and no (legal) barriers to trade and investment.

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