Iraq: Construction Site of the Century

Iraq is a transition economy of the Middle East. The task is to transform the economy—dominated by central planning, price controls, and extensive state ownership—into a genuine market economy. The process will take years and billions of dollars. After security has been achieved and remnants of the former regime have been eradicated, a postwar economic strategy needs to be developed and implemented.

Iraq can be seen as the newest addition to the group of transition economies. Baathist Iraq modeled its economy on Eastern European communism, including central planning, price controls, and extensive state ownership. In the 1960s Iraq collectivized its agriculture. Just like the transition economies of the 1990s, Iraq faces immense economic challenges.

Iraq is endowed with abundant economic and human resources and has the second highest proven oil reserves in the world at around 112 billion barrels (after Saudi Arabia with 262 billion barrels). But the 35 years of Baathist rule; the nationalization of the country’s main export commodity, oil; the extensive central planning of industry and trade; the 1982–88 war against Iran; and the invasion of Kuwait, which precipitated the 1991 Gulf War, have devastated the economy. GDP has shrunk by 75 percent since 1979. According to World Bank figures, the number of underweight children soared from about 10 percent of children in 1990 to about 20 percent in 2000, while primary school enrollment fell from nearly 95 percent to about 75 percent during the same period. Child and maternal mortality have also worsened significantly. According to Yale University economist William Nordhaus, living standards have fallen by 90 percent in the last 23 years. About 60 percent of the population became dependent on humanitarian food aid, partly because of economic sanctions imposed after Iraq’s invasion of Kuwait in 1990.

Because of the lack of investment and access to the latest technology and the damage resulting from years of war and sanctions, Iraq’s infrastructure disintegrated. Before the war started earlier this year, this country of 23 million people had only 675,000 fixed telephone lines. Mobile phones were banned except for government officials and the army. As a result, Iraq has become one of the world’s least developed economies. Estimates indicate that an investment of around $1 billion will be required to repair and rebuild the telecommunications infrastructure alone. A country that could have been a model of development for the Arab world turned out to be one characterized by economic decline, mismanagement, and massive corruption.

Estimates of Iraq’s financial obligations vary widely, but the Center for Strategic and International Studies estimates that the figure could be as high as $383 billion. That includes $127 billion worth of debt, $57.2 billion in pending contracts, and $199 billion in actual and potential Gulf War compensation claims. Reconstruction bills could top $20 billion a year for the immediate future. Compare those figures with an annual economy that could generate anywhere between $29 billion and $59 billion per year, including $18 billion a year in oil sales, and it is obvious that any Iraqi government will have a hard time meeting these obligations. The United States has already has put out feelers suggesting that some of these obligations should be written off, others restructured.

Several blueprints are circulating in Washington that outline sweeping reforms of Iraq’s economy based on free market principles. The major points of these documents are as follows:

• Privatizing state-owned enterprises. Some insolvent Iraqi companies should be liquidated, others sold, partly by means of a broadly based mass privatization program. Ownership vouchers would be distributed to ordinary Iraqi citizens, similar to the program Russia used in the mid-1990s. According to the timetable in the documents, officials would spend a year building consensus for industry privatization, and would then transfer assets over the following three years. Privatization efforts in other countries demonstrate that privately held infrastructure, including oil production and service companies, attract modern technology and management expertise, result in greater efficiencies, improve production standards, and generate higher revenues than centrally planned and state-owned industries. Some experts on postcommunist reform efforts warn, however, that a policy of swift privatization met with mixed success across the former Soviet bloc. In many countries the rapid privatization of state-run enterprises led to severe disruptions in jobs and services as well as rampant corruption. In addition, many Iraqis interpret religious teachings as entrusting people to become guardians of the land’s natural endowments, including oil, and that profits from oil production should therefore be shared among the people. Some experts suggest applying the Alaska-model, whereby every resident of the state receives an annual dividend from the oil industry’s profits that often amounts to 10 percent of a family’s annual income.

• Reforming the central bank and the commercial banking system. Banks should clean up their nonperforming loan portfolios and jump-start the private sector by providing fresh credits; the traditional Islamic money transfer system should be incorporated into the banking system; special credit lines should be created for small and medium Iraqi businesses. The new Iraqi government will decide on the creation of a new currency. The U.S. occupying authority has already started to pay salaries to 2 million civil servants. Over a period of three months, almost $500 million were to be pumped into the economy, thereby strengthening the exchange rate of the Iraqi dinar against the dollar.)

• Revising the Tax Code and tariff system A comprehensive income tax system consistent with current international practice should be drafted by the end of the year.

• Modernizing the Baghdad Stock Exchange. Within a year the U.S. administration envisions converting Iraq’s rudimentary prewar stock market into a "world-class exchange" for trading the shares of newly privatized companies. The plans also call for setting up a tough securities commission to prevent abuses.

To date the U.S. Agency for International Development has awarded nine contracts for the reconstruction of Iraq worth $2.4 billion to American companies, including Bechtel, Halliburton, Motorola, MCI, and the Research Triangle Institute. Bechtel’s $680 million contract gives the American company the responsibility for designing, rehabilitating, upgrading, and reconstructing Iraq’s infrastructure, including one seaport, five airports, electric power plants, road networks, rail systems, municipal water and sanitation services, schools and health facilities, selected government buildings, and initial satellite communications systems. The U.S. Agency for International Development has allowed these American companies to subcontract up to half the value of their contracts to non-U.S. firms, with an eye to benefiting from the excess capacity available in the region. Furthermore, U.S. federal regulations prohibit American companies from supplying materials if the cost is more than 6 percent higher than local costs.

In a recent interview U.S. Chief Administrator Paul Bremer highlighted the need to encourage both foreign and domestic investors, another key element for stimulating growth. He has formed an advisory group of Iraqi business people, economists, and politicians to discuss the rebuilding of the economy, and is also being advised by large U.S. banks, including JP Morgan and Citigroup. With more than half the working-age population jobless, unemployment is a tremendous problem in postwar Iraq.

Transforming Iraq from a military dictatorship and a secret police state into a real market economy will take years and billions of dollars. An estimated $100 billion in reconstruction costs and more than $350 billion of debt and reparations far exceed what even a rehabilitated oil industry can generate in the next few years. The country needs to invest in education, health, infrastructure, public administration, the police and army, a new legal system, a new currency, a new central bank, a new constitution, the rule of law, and then democracy. However, the signs are encouraging. Iraqis remain relatively well educated, and the status of Iraqi women is better than in many Arab countries. In addition to huge oil reserves and sufficient water resources, 4 million Iraqis living abroad can contribute experience and money.

This article draws extensively from Ariel Cohen and Gerald P. O’Driscoll, Jr., The Road to Economic Prosperity for a Post-Saddam Iraq, published as a Heritage Foundation Backgrounder, no. 1633; available on http://www.heritage.org/Research/MiddleEast/loader.cfm?url=/commonspot/security/getfile.cfm&PageID=37452.