As the Bush Administration and Iraqi opposition groups plan the
future of a post-Saddam Hussein Iraq without its menacing arsenal
of weapons of mass destruction (WMD), economic issues loom large.
Iraq's economy has been grossly mismanaged for 40 years, and its
people desperately need an alternative strategy to supplant the
failed policies of its dictator. Sound economics are needed to help
them rebuild their lives and their country after two decades of
wars and four decades of repression under the current regime.
Saddam Hussein's regime has succeeded in
bankrupting the country even though it boasts the world's second
largest oil reserves after Saudi Arabia. Gross domestic product
(GDP) for 2001, at the market exchange rate, is estimated to be
only about one-third the level in 1989. Iraq
also is hobbled by its $140 billion foreign debt. This devastation was wrought
by such policies as the nationalization of the country's chief
export commodity, oil; extensive central planning of industry and
trade; the 1982-1988 war against Iran; and the invasion of Kuwait,
which precipitated the 1991 Gulf War. And Saddam still stubbornly
refuses to meet the terms for lifting the economic sanctions that
the United Nations has imposed on his regime.
Saddam also has succeeded in diverting at
least $6.6 billion--primarily in revenues from smuggled oil and
kickbacks--to his program to develop nuclear, chemical, and
biological weapons and platforms for their delivery. He continues
to support terrorist organizations, such as Hamas and the Popular
Front for the Liberation of Palestine (PFLP), which the U.S.
Department of State includes on its list of state sponsors of
terrorism. Presumably, a post-war U.S.
military presence in Iraq and Iraq's future security forces will
ensure that the new Iraqi government does not continue to develop
WMD and support terrorism.
The
future of Iraq depends not only on the ouster of the repressive
regime, but also on the ability of the new Iraqi leaders to reverse
the damage through policies that will spur real economic growth.
The sooner the threat from Saddam's WMD programs ends and the Iraqi
economy recovers, the sooner the United States and the other
security forces will be able to depart.
A
double strategy of ensuring security and enabling economic growth
will need international support. The Bush Administration should
help Iraqi opposition leaders to develop an economic reform package
for their country. The new post-Saddam federal government should
develop a modern legal system that recognizes property rights and
is conducive to privatization; create a public information campaign
that prepares the people for structural reforms and privatization;
hire expatriates and Western-educated Arabic speakers with
financial, legal, and business expertise for key economic
positions; deregulate prices, including prices in the utility and
energy sectors; prepare state assets in the utility,
transportation, pipeline, energy, and other sectors for
privatization; keep the budget balanced and inflation, taxes, and
tariffs low; liberalize and expand trade; and launch an effort to
join the World Trade Organization (WTO).
The Tough economic Road Ahead
Iraq's
Lifeblood: Oil
As Chart 1 and Chart 2 show, the Iraqi economy is
dominated by the oil sector, which provides more than 60 percent of
Iraq's GDP and 95 percent of its hard currency earnings. The economic sanctions imposed
by the U.N. in the past decade to try to force Saddam to give up
his weapons of mass destruction not only have not worked, but have
helped to depress foreign trade.
According to the U.S. General Accounting
Office (GAO), however, oil smuggling and illegal surcharges of 25
cents to 50 cents a barrel on legal oil purchases bolster Saddam's
regime. These illegal activities during 1996-2002 have provided
unaccounted revenues of at least $6.6 billion, which
Saddam has been free to spend to develop WMD and support
terrorism. How much Saddam is actually
spending on his deadly arsenal is hard to tell. The lack of
information is so pervasive that the international financial
institutions (IFIs), foreign government agencies, and private
businesses that provide country economic analysis and data do not
publish any official economic statistics or estimates for Iraq.
This
means that no recent data on Iraqi government consumption of GDP
are available. In 1993, the most recent year for which data are
available, government consumption amounted to 13.9 percent of GDP.
According to the Economist Intelligence Unit,
Oil revenue has been the mainstay of
government income since the 1950s. In 1968 the oil-based nature of
the economy was reinforced by the introduction of a centralized
socialist system, with the government regulating all aspects of
economic life other than peripheral agriculture, personal services
and trade.... Meanwhile, the state's centrality to the economy has
increased because the vast majority of imports and foreign exchange
have been controlled by the government.
The
socialist Ba'ath government has demonstrated gross mismanagement of
the oil sector. During the 1960s, exploration stopped and the
sector was nationalized, which bred corruption and mismanagement.
Oil production has barely increased since 1980. In 2001, oil
production stood at approximately 2.8 million barrels a day. Today,
Saddam's regime controls oil exploration, extraction, refining,
pipelines, ports, and all utilities, but oil export prices are set
by the U.N. sanctions regime.
Taxing Imports,
But Not Smugglers
The Economist Intelligence Unit notes that direct taxation
has never been a preferred means of raising revenue in Iraq. As the International Monetary
Fund (IMF) reports, "imports are restricted by [U.N.] sanctions.
All imports subject to import duty are also subject to a customs
surcharge.... Imports of commodities are normally handled by the
public sector." Although the government of
Iraq inspects and regulates all imports, a small private sector is
involved in considerable smuggling and black market currency
exchange activities.
Tough Investment
Environment
Even though Iraq has permitted some foreign investment in
its oil industry and private sector, mainly to help it rebuild from
the damage of the Gulf War, it discourages most capital inflows.
The legal system does not guarantee contracts. Inflation in Iraq
remains high. From 1994 to 2001, Iraq's weighted average annual
rate of inflation was 80.4 percent; for 2001-2002, the rate has
ranged from 60 percent to 70 percent.
The
government controls almost all prices, and rationing is the norm
for items like food. The regime continues to distribute imported
goods in what is essentially a highly centralized command economy
structure, although it does retain the ability to skew the
distribution of food and other items as a way to favor cronies.
There is no application of modern property
rights protected by legislation and enforced through the courts.
The Revolutionary Command Council (RCC) of Iraq holds all
executive, legislative, and judicial authority. The RCC's chairman,
Saddam Hussein, appoints a council of ministers who are
theoretically vested with executive authority, but in fact they are
able only to rubber-stamp the decisions of the RCC and its
chairman. The judiciary is not independent; consequently, there is
no check on Saddam's power to override any court decision.
AFTER Saddam: The outlook for Iraq and
World Energy Markets
One
thing is clear: Saddam's regime, obsessed with control and
coercion, is destroying the wealth of the Iraqi people. After
liberation from this regime, it will be important for the Iraqi
people to rebuild their economy, especially the oil sector,
increase GDP and improve the standard of living, attract foreign
investment, and improve government services through
privatization.
The Cost of
Rebuilding
The cost of rebuilding the country will be high. If
Operation Desert Storm reconstruction costs are used as the basis
for estimation, the cost of rebuilding Iraq after Saddam's regime
falls will be in the $50 billion to $100 billion range. Together with repaying the
Iraqi foreign debt, the more realistic figure is $200 billion. However, as long as
structural economic reforms are undertaken, Iraq's vast oil
reserves are more than ample to provide the funds needed to rebuild
and boost economic growth.
The
United States, through its executive directors at such IFIs as the
IMF and World Bank, and other international governmental and
non-governmental organizations, should begin to advise the future
leaders of Iraq's three primary ethnic groups to establish policies
that will lead to a thriving modern economy. These policies should
be based on "best practices" developed around the world in the
1990s, when the largest government privatizations in history
occurred.
During the Iran-Iraq War and the post-Gulf
War sanctions period, Iraqi petroleum production declined
significantly. Saudi Arabia filled the void, generating a net
profit of $100 billion. The funds it generated represent monies
that should have benefited the Iraqi people. (See
Chart 3.)
Following the demise of Saddam Hussein, it
is unlikely that the Saudi kingdom would transfer a fraction of its
production quota under the Organisation of Petroleum Exporting
Countries (OPEC) regime to Iraq to compensate for those lost
profits and facilitate its rebuilding. Iraq will need to ensure
cash flow for reconstruction regardless of OPEC supply limitations.
Combined with the potential privatization of the oil industry, such
measures could provide incentive for Iraq to leave the OPEC cartel
down the road, which would have long-term, positive implications
for global oil supply.
Potential
Benefits of Leaving the OPEC Regime
An Iraq outside of OPEC would find available from
its oil trade an ample cash flow for the country's rehabilitation.
Its reserves currently stand at 112 billion barrels, but according
to the U.S. Energy Information Administration, it may have as much
as 200 billion barrels in reserve. Iraqi
officials estimate even more: According to oil minister Amir
Muhammad Rashad and Iraqi Senior Deputy Oil
Minister Taha Hmud, the reserves can be as high as 270 billion to
300 billion barrels, making them equal to Saudi Arabia's.
Iraq's 1990 output prior to the beginning
of the Gulf War stood at 3.5 million barrels a day, while oil
discovery rates on a few new projects in the 1990s were among the
highest in the world: between 50 percent and 75 percent. Given
Iraq's own output projections, it may be capable of pumping as much
as 6 million barrels (by 2010) to 7 million barrels (by 2020) a
day, more than doubling current production levels. (See Chart 4.)
Depending on the dynamics of global
economic growth and world oil output, Iraq's increase in oil
production capacity could bring lower oil prices in the long term.
An unencumbered flow of Iraqi oil would be likely to provide a more
constant supply of oil to the global market, which would dampen
price fluctuations, ensuring stable oil prices in the world market
in a price range lower than the current $25 to $30 a barrel.
Eventually, this will be a win-win game: Iraq will emerge with a
more viable oil industry while the world will benefit from a more
stable and abundant oil supply.
PRIVATIZATION:
Learning from the past
Boosting oil exports and oil industry
privatization by itself still may not be sufficient for growth over
the long haul. To rehabilitate and modernize its economy, a
post-Saddam government will need to move simultaneously on a number
of economic policy fronts, utilizing the experience of
privatization campaigns and structural reforms in other countries
to develop a comprehensive policy package.
Several lessons from other countries'
privatization experiences are particularly relevant to Iraq's
situation. Specifically:
LESSON #1:
Privatization works everywhere
Between 1988 and 1993, 2,700 state-owned
businesses in 95 countries were sold to private investors. In 1991 alone, $48 billion in
state assets were privatized worldwide.
Privatizations led to higher productivity, faster growth, increased
capacity, and cheaper services for consumers.
In one study, the World Bank reviewed 41
firms privatized by public offerings in 15 countries. This review
demonstrates that privatization will increase the return on sales,
assets, and equity. As privatized firms grow, they often increase
their workforces. In another study, the World Bank reviewed 12
privatization efforts in four countries, and its findings also
demonstrate why privatization is good for the economy as a whole,
no matter where it is implemented.
LESSON #2:
Privatization works best when it is part of a larger structural
reform program
Privatization needs to be accompanied by reforms
to open markets, removal of price and exchange rate distortions,
reductions in barriers to entry, and elimination of monopoly
powers. In addition to these policies, governments should enact
legislation that protects consumer welfare. Such
successful structural reform and privatization programs were
implemented in the 1990s in Poland, Hungary, the Czech Republic,
and the three Baltic States, particularly Estonia.
LESSON #3:
Privatization of large enterprises requires
preparation
Successful privatizations of large enterprises
may necessitate such advance actions as breaking them into smaller
competitive units, recruiting experienced private-sector managers,
adopting Generally Accepted Accounting Principles (GAAPs), settling
past liabilities, and shedding excess labor.
LESSON #4:
Transparency and the rule of law are critical
Opaque privatization and allegations of
corruption and cronyism provide political ammunition to the
opponents of market-based policies. To eliminate those problems and
be successful in its privatization efforts, the government must
adopt competitive bidding procedures, objective criteria for
selecting bids, and protocols for hiring independent privatization
management firms, and establish a privatization authority with
minimal bureaucracy to monitor the overall program.
LESSON #5: A
minimal safety net is necessary to support laid-off workers and
prevent social unrest
Buyouts of the state-owned enterprise's
management and labor force, as well as distribution of some of the
privatized firm's shares to its management and labor force, can go
a long way toward alleviating social tensions that might undermine
public support for privatization.
LESSON #6:
Privatization is taking place in the Middle East
Privatization is no longer an affair of affluent
or middle-income countries. From Margaret Thatcher's Great Britain,
privatizations of state-owned assets and structural reform policies
spread to many countries in Africa, Asia, and Latin America,
including the Philippines, Malaysia, Jamaica, and Sri Lanka. An
internal study of World Bank managers in the Middle East and North
African department found that many were enthusiastic in supporting
privatization efforts in their regions. A
number of Middle Eastern states, including Iraq's neighbors
Turkey and Kuwait, are pursuing privatization of
their telecommunications, transportation, utilities, and oil
sectors and services, while others, such as Iran and Saudi Arabia,
have declared their intentions to privatize assets and are in the
policy discussion stage.
Lessons from Oil and Gas
Privatizations
Oil
privatization remains a politically painful issue in many
countries. Economic nationalists claim oil is a "national
patrimony," whereas socialists and
radical Islamists call private and foreign ownership of natural
resources "imperialist" and other such pejoratives. Such rhetoric
has one goal: to keep a precious and profitable resource in the
hands of the ruling elite, be it a communist party politburo, a
dictator, or a group of mullahs.
In
fact, oil is a commodity and should be managed according to the
laws of economics and best business practices. Even a country as
fiercely nationalist as Russia recognizes this and is undertaking
the largest oil sector privatization in history. The lessons from
past experience in oil privatizations are also positive.
Specifically:
ENERGY SECTOR
LESSON #1: First "entitize," then privatize
The Conservative government of Margaret Thatcher
successfully privatized some British oil assets in the 1980s. In
the early 1990s, Russia carved up its state-run oil ministry into
regional monopolies. It created joint stock companies, later
selling stock to the Russians, first, and then to foreigners. The
Ministry of Privatization distributed some stocks to managers and
workers in order to smooth the path to privatization. Since
privatization, many of these stocks, such as in LUKoil, Tyumen Oil
Co. (TNK), and Yukos, have risen in price considerably.
The Russian government did not go all the
way, however. For example, it did not privatize Transneft, a
company that controls its pipeline infrastructure, or fully
privatize some oil companies, such as Slavneft and Zarubezhneft and
GAZPROM, the giant natural gas monopoly that boasts the world's
largest natural gas reserves and controls a 90,000 km pipeline
network. The partial privatization
effort has led to friction between state-controlled entities and
the privatized-publicly held companies over pipeline access.
ENERGY SECTOR
LESSON #2: Oil privatization generates high economic efficiency and
market capitalization
The results of Russian oil privatization are
fascinating: While the privatized Russian oil companies
significantly expanded their production and exports and
significantly increased market capitalization, GAZPROM did not. The
government-controlled pipeline operator also has had difficulty
providing adequate pipeline capacity to the quickly developing oil
sector.
Meanwhile, privatized Russian companies
not only have attracted Western portfolio investment, but also have
been more successful than GAZPROM in attracting capital for foreign
direct investment. Several leading Russian publicly traded oil
companies also transformed their antiquated, Soviet-era accounting
practices to the GAAP standard, hired Western managers, and became
centers for dissemination of Western management and accounting
skills across Russia's industrial sectors. Moreover, Russia's
largest oil companies, such as LUKoil and Yukos, are fast becoming
major global oil players. LUKoil recently purchased 1,300 Getty gas
stations in the United States, and LUKoil and Yukos are selling
American Depository Receipts (ADRs) on the New York Stock
Exchange.
ENERGY SECTOR
LESSON #3: Keep it clean, and keep it profitable
The major problem with the Russian oil
privatization effort has been its relative opacity, especially in
the early 1990s. Scandals included the oil-for-shares debacle in
which Boris Yeltsin's government took loans from banks in exchange
for shares of the oil companies. The government never repaid the
loans, and the companies became the property of politically
connected banks. The insider dealing provoked
a political row that discredited privatization in the public's
eyes.
Other problems in Russia have been
privatization through vouchers and the denial of access to
foreigners in early privatization stages in order to assuage
nationalists in the parliament. These policies resulted in much
lower revenues (by as much as a factor of 10) than the government
could have received for the privatized assets.
AN ECONOMIC REFORM PLAN FOR POST-SADDAM
IRAQ
The
Bush Administration should provide leadership and guidance for the
future Iraqi government to undertake fundamental structural
economic reform. This process should include a massive, orderly,
and transparent privatization of state-owned enterprises,
especially the restructuring and privatization of the oil sector.
These steps would greatly enhance needed access to global capital
markets.
U.S.
political commitment will be needed to motivate international
organizations to provide appropriate expertise and technical
assistance. Inter alia, these organizations could include IFIs such
as the International Monetary Fund and the World Bank, and would
likely encompass such diverse non-governmental organizations (NGOs)
as the National Endowment for Democracy, the Center for
International Private Enterprise, the American Bar Association, and
the AFL-CIO.
In
particular, the Bush Administration should convince the future
federal government of Iraq to come to an agreement on how oil
revenues are taxed and proceeds are distributed to the country's
three distinct ethnic regions--Shiite Arabs, the Kurds, and the
Sunni Arabs. Successfully privatizing the country's oil fields,
refining capacity, and pipeline infrastructure will mean higher
efficiencies and higher tax revenues in the oil sector.
What a New Iraqi
Government Must Do
The Administration, the IFIs, and other economic
decisionmakers should prepare and provide support for a future
federal Iraqi government to:
- Develop a modern
legal environment that recognizes property rights and is conducive
to privatization. Protection and enforcement of property
rights and access to successful alternative dispute resolution
mechanisms are vital policies for fostering economic growth and
foreign investment. Iraq also will need to build modern and
well-functioning regulatory and supervisory frameworks and
institutions in the oil and gas, banking, securities, and financial
services areas. Such a legal and business environment should be
equitable and non-discriminatory, and it should not distinguish
between Iraqi-Arab nationals and foreigners.
The U.S. government,
its allies, and international organizations should be ready to
provide technical assistance in the legal, economic policy, and
public administration areas. Working cooperatively with the United
States, the European Union, and the IFIs, the post-Saddam
government of Iraq will need to boost the court system and the rule
of law. It will need to provide legislation to allow the use of
broad alternative dispute resolution mechanisms outside of Iraq, as
the local laws may change too quickly (and the local court system
too slowly) for local judges to be able to follow and apply new
legislation. Education for judges about the latest legal
developments in the economic area will also be important. The
courts will have to boost the enforcement of court rulings
independent of the executive branch. The central government will
need to pay judges and court employees adequate salaries to keep
corruption in check.
- Educate and
prepare the Iraqi population for structural reform and
privatization through a public information campaign.
Only when the public, including key stakeholders, elites,
and the population at large, understand the goals of economic
reform will they become more receptive to change and less likely to
succumb to the anti-Western demagoguery that undoubtedly will
emanate from the remnants of the discredited Ba'ath establishment
and Islamic fundamentalists. The new Iraqi government will need to
use the media and the educational system to explain the benefits of
privatization and the changes to come in order to ensure broad
public support.
- Hire Iraqi
expatriates, as well as other Western-educated Arabic speakers with
financial, legal and business backgrounds, for key positions in
government.
Examples of this approach in Eastern Europe demonstrate that
Western-educated experts can implement economic reforms better than
a former socialist bureaucracy can. Younger, well-educated
technocrats have an advantage in their ability to communicate
effectively with both locals and Westerners, including
international providers of technical assistance. In implementing
structural reform, the best results are achieved by teams of local
and Western experts working together.
- Deregulate
prices in Iraq, including prices in the utilities and energy
sector.
Quick price deregulation will be key to ensuring an adequate
supply of goods for consumers and ending rationing. It will
contribute to increased exports of oil and gas, which in turn will
provide additional earnings and tax revenues for the government to
share among the regional and local governments.
- Prepare to
privatize assets in the industrial, utility, telecommunications,
banking, transportation, port and airport, and pipeline and energy
sectors.
The post-Saddam Iraqi government should prepare to privatize
government assets by creating government-held companies instead of
ministries, issuing stock for these companies, and implementing
guidelines that allow for the introduction of modern management
practices and GAAP standards. The central government should hire
consulting firms to execute comprehensive assessments of companies
it wishes to privatize in order to itemize inventory, to take stock
of assets and liabilities, and possibly to settle some of their
debts in preparation for privatization.
In particular, the Oil Ministry and
regional oil companies should be restructured to transform them
into attractive government-owned oil companies as an intermediary
stage before initial public offering (IPO). For example, one
company may focus its work in the southern portion of the country,
another in the central region (around Baghdad) and the Western
desert, and the third around Kirkuk in the North. Three more
companies may be created, one to operate the pipelines, the second
to operate the refineries, and the third to develop natural
gas.
The stages of preparation for
privatization could include:
- Taking
inventory of assets and liabilities;
- Exercising necessary
efficiency-improvement steps, such as retraining and layoffs (with
compensation);
- Introducing GAAP and other modern
financial and management practices;
- Signing
international conventions against nationalization of foreign
investments, such as the Convention on the Settlement of Investment
Disputes between States and Nationals of other States (the
Washington Convention), the World Bank's Convention on the
Multilateral Investment Guarantee Agency (MIGA), and the New York
Convention on Recognition and Enforcement of Foreign Arbitral
Awards (1958);
- Issuing
company stock;
- Running
the companies under new, transparent, and efficient management for
at least two years; and
- Taking
companies on road shows and completing IPOs in major financial
centers such as New York and London, and floating stock in
international markets.
Given adequate implementation of each of
these stages, the time frame for this privatization effort could be
four to five years after the new government is installed by the
people of Iraq. During this time, the U.S. government and the IFIs
would have to ensure that the political will for privatization
remains intact. Management and accounting consultants hired by the
new Iraqi government would have to ascertain that the program is
transparent and on track.
Moreover, after privatization, Iraq must
demonstrate that it is not losing tax revenue and that the
government's oil revenue is distributed among the regions equitably
and efficiently, allocated to the worthy causes, and not wasted,
looted, or abused, which could undermine the entire economic reform
program.
- Keep the budget
balanced and inflation, taxes, and tariffs low.
International experience demonstrates that lower and flatter taxes
(in the range of 20 percent or less), applied uniformly and in a
non-discriminatory fashion, are an important investment magnet,
especially for a country like Iraq that is rich in natural
resources. Moreover, oil revenues will allow Iraq to keep the
budget balanced and import tariffs low. Such a stable macroeconomic
policy is likely to attract massive investment from a variety of
sources, including the Middle East and Asia, not just the West, and
boost income and employment.
- Liberalize and
expand trade, and launch an effort to join the World Trade
Organization.
A study by the Council on Foreign Relations has
demonstrated that a majority of Middle Eastern countries suffer
from high import tariffs, red tape, and corruption--problems that
depress GDP growth.
Elimination of import taxes and tariffs and implementation of trade
liberalization would provide an additional economic development
engine for Iraq. The Bush Administration should provide technical
assistance for trade liberalization and support Iraq's eventual
membership in the WTO.
Conclusion
For
the Iraqi people, structural economic reform and comprehensive
privatization of government assets is necessary to stimulate
recovery and provide stability after years of disastrous economic
policies under Saddam Hussein. The winning strategy of structural
reform and privatization also would benefit the industrial world,
the United States and its allies, countries of the Middle East, and
the developing world.
Iraq's return to global markets would
allow for a more abundant and stable energy supply, a higher cash
flow for the Iraqi people, and numerous business opportunities for
the region and the world. Iraq's restructuring and privatization of
its oil and gas sector could become a model for oil industry
privatizations in other OPEC states as well, weakening the cartel's
influence over global energy markets.
Ariel
Cohen, Ph.D., is Research Fellow in Russian and Eurasian
Studies in the Kathryn and Shelby Cullom Davis Institute for
International Studies, and Gerald P. O'Driscoll, Jr., Ph.D., is
Director of the Center for International Trade and Economics, at
The Heritage Foundation.