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 112 billion barrels
of oil in reserves--the world's second largest after Saudi
Arabia's. According
to some experts, Iraqi reserves can be as large as 220 billion
barrels--equal to those of Saudi Arabia. Gross domestic product (GDP) for 2001,
at the market exchange rate, however, 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 country's
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 in an effort to force Saddam
to give up his weapons of mass destruction not only have not
worked, but also have helped to depress foreign trade.
According to the U.S. General Accounting
Office, however, oil smuggling and illegal surcharges of 25 cents
to 50 cents a barrel on legal oil purchases under the U.N.
oil-for-food program bolster Saddam's regime. These illegal
activities from 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 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 (estimated at from $60 billion-$140
billion) and compensation costs to Kuwait and other countries (over
$20 billion), the more realistic figure is $200 billion. However, as long as
structural economic reforms are undertaken, Iraq's vast oil
reserves and rebuilt economy, including the revamped oil sector,
are likely to provide the funds needed to rebuild and boost
economic growth.
Thus, the United States and the people of
Iraq have the same interest at heart: maximize Iraq's economic
performance. Without private ownership, however, oil will remain
politicized and mismanaged. A group of Iraqi-born oil experts
stated in December 2002, after a conference on the future of the
Iraqi oil sector sponsored by the U.S. State Department, that
The aspiration of the group is a
rehabilitated, globally connected oil and gas sector.... Oil will
remain the primary source of revenue and will play a pivotal role
in the country's economic reconstruction. The group recognized the
need to establish a favorable investment climate and attract
international and inward capital in the reconstruction and growth
of the industry. It saw the importance of introducing modern
technology, know-how and management skills.
Thus, the exiles fell short of calling for
post-Saddam privatization of the Iraqi economy.
Secretary of State Colin Powell has said
that "The oil of Iraq belongs to the Iraqi people.... [I]t will be
held for and used for the people of Iraq. It will not be exploited
for the United States' own purpose...." But this does not preclude
the United States from offering its guidance to the future
government of Iraq on establishing sound economic and trade
policies to stimulate growth and recovery. It would be counterproductive to
empower either U.N. bureaucrats or Iraqi officials loyal to the
Ba'ath party and Saddam to run the Iraqi oil industry.
The
Bush Administration, through its executive directors at such IFIs
as the IMF and World Bank, as well as other international
governmental and non-governmental organizations, should begin to
advise the future leaders of Iraq's next government 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 Organization 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 incentives 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. Estimates by Iraqi oil officials are
even higher: According to Oil Minister Amir Muhammad Rashad and Senior Deputy Oil
Minister Taha Hmud, the reserves could 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.)
Such
a surge in production may be opposed by OPEC countries, which would
like to keep its quota around the current 2.8 million barrels per
day, while historic market share is taken by the Kingdom of Saudi
Arabia, which currently is pumping close to 8 million barrels per
day. 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 again
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 these 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 limited to 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.