By Sabri Zire Al-Saadi
This article was written for MEESby economic advisor Sabri Zire al-Saadi, a UN former employee, who held senior economic posts in Iraq. Email: sabri_saadi@hotmail.com.
While the strategic role of oil in Iraq is well known, oil policy after the fall of the former regime became controversial in two aspects; first, because of the debate over public versus private ownership of the industry; and second, the allocation pattern of oil revenues1. The early call for privatization of the oil industry raised fears that the Iraqis might lose their oil wealth to foreign giants. But the issue faded because of domestic political pressure and terrorist attacks on the oil infrastructure. It is essential, therefore, that any new government has a clear position regarding privatization of the oil industry which, in our opinion, should be viewed as part of a long-term development strategy. Also necessary is that governments should be committed to a long-term policy
for the allocation of oil revenues to neutralize its political power. For obvious reasons, the policy of maximizing oil production and exports (revenues) has gained the support of all concerned parties.
Since the establishment of modern Iraq in 1921, successive governments have focused on the use of oil revenues to finance public development projects. However, until 1953, oil revenues were not significant in public finance. From 1953 to 1959, 70% of oil revenues were allocated to finance the country’s infrastructure projects. During 1960-73, oil revenues were the main source of public finance, distributed 50-50 between the annual budgets and financing for infrastructure projects. The period 1974-80 was Iraq’s golden opportunity for accelerating economic and social development, as available financial resources, mainly oil revenues, required for investment, increasing consumption and imports were abundant. Since 1980, Iraq has experienced the destruction of eight years war with Iran, followed by the invasion of Kuwait in 1990 and the subsequent Gulf war of 1991. Then came the devastating UN economic sanctions that lasted 13 years, as well as the mismanagement of oil revenues by the former regime. All these factors resulted in rapid economic deterioration, high unemployment, very low living standards and widespread poverty2.
Historical Factors
A quick glance at Iraq’s modern history sheds light on a major external factor behind the prevailing problems. In the early 19th century, under Ottoman rule, big powers began competing for strategic and trade interests. By the end of the century, the new energy source, oil, became an additional strategic element of foreign interests in Iraq. After World War I, the modern state of Iraq was established and foreign competition continued among the victorious powers – the UK, France, the Netherlands, and the US – to win the license for exploiting Iraq’s crude oil. In 1925, while Iraq was under the British mandate, fierce foreign competition resulted in the first oil agreement between a company that represented the interests of those great powers and the Iraqi government. Until 1950, however, oil revenues did not constitute an important source of public finance. As from 1953, oil revenues substantially increased and became an important source of public finance as well as a major factor of economic and social development3.
In utilizing oil revenues, subsequent Iraqi governments had a separate budget for public development projects. During the period 1927-80, many public works programs were implemented, along with economic and social development plans4.
At present, although the Iraqi government is under heavy pressure from prevailing economic, social and political problems, it should have clear policy for allocating oil revenues among government operational expenditures and investment in infrastructure. This must be consistent with fiscal and monetary policies. In particular, taxes on oil and gas production should be introduced and legal measures taken to allow more participation of indigenous private sector and foreign concerns in oil refining and products distribution, with at least 51% for government equity. The government also needs to implement economic reforms for promoting free market conditions, consistent with long-term economic strategy. Its main aim is to lessen the economy’s high dependence on oil revenue in terms of its contribution to GDP and to public finance, and as a source for financing imports. The contribution of oil’s value added to GDP should not exceed 20%, while non-oil revenues should be at least 80% of the government’s annual budget5. This objective can be achieved through three main policy components: diversification of economic activities and increasing private investment and non-oil exports; the application of intensive human development projects and rehabilitation programs for improving manpower skills and productivity; and the introduction by the state of advanced technologies in the fields of production, telecommunication and information.
Parallel to these policies, it is also essential for Iraq to have a new social security system (SSS) to enhance democracy and social development. The new SSS must be based on the existing experience of public education, health and social services. Public and private participation in these fields must be encouraged. In this regard, it should be noted that the present oil-for-food program and the social safety net, frequently suggested by the World Bank and UN organizations, can not be an alternative for the SSS. Iraq has a base of social infrastructure and public oil wealth, and Iraqis are socially conscious of their rights in having a SSS that is permanent, adequate and unbiased. Social welfare reform is another necessary condition to promote democracy in Iraq.
Market And Economic Policies: Pragmatism Not Rigid Ideology
Iraq’s experience during 1960-80 proved that highly centralized economic planning and the dominance of public enterprises were not efficient to utilize the available resources and caused serious structural problems, despite the realization of high rates of growth and substantial increases in living standards. Widespread government economic intervention was ill-practiced through the annual ordinary budgets, the annual public investment programs, and monopoly of foreign trade, financed mainly by oil revenues. Non-oil revenues contributed very little to public finance. Instead, the highly centralized decision-making processes enabled the government monopoly to exploit the power of oil for political objectives that eventually created the conditions for the rise of Saddam’s dictatorial regime.
Hence, Iraq needs an active role for the indigenous private sector and entrepreneurial initiatives as well as the state’s role for creating a favourable investment and business environment. Explicitly, Iraq at this stage requires a national project for radical economic changes that includes long-term vision, strategy and policies for liberalization, as well as a new non-political state entity to resume the reconstruction of infrastructure. Business initiatives and government capacity building are necessary but not sufficient to carry out such a far-reaching change. It is also essential that all concerned parties appreciate the importance of the three strategic elements that influence the country’s future: oil, democracy, and development.
Over the last three decades, Saddam’s totalitarian and repressive regime did not allow large-scale economic endeavors in the private sector. Small and medium-sized businesses operated, but with weak and limited roles, and subject to exploitation by the regime. In the past, private enterprises served in a subordinate role to large state-owned industries, and projects, and import licenses were awarded as concessions to Saddam’s supporters. At present, economic development needs private business resources and entrepreneurial initiatives. The challenge, however, is to maintain economic and regulatory conditions that allow new voluntary business initiatives under free, legal, and competitive market conditions.
It was anticipated that after the fall of Saddam’s regime the private sector would help in mobilizing resources for increasing economic growth and employment. But unfortunately such hope faded because of security problems, bad economic and fiscal policies, and corruption. However, the Iraqi private sector is capable of participating actively in the mobilization of resources for investment if the political and economic environment is improved.
Economic Liberalization
It is true that the role of the public sector has been associated closely with the increase of oil revenues and government expenditures. However, for defining the alternative, it is imperative to have a compelling vision, strategy and policies that would achieve, among other objectives, economic liberalization without diminishing the prospect of developing the indigenous private sector and infant domestic industries. Simultaneous and subsequent implementation of comprehensive economic structural reforms, ie the tax system, banking and insurance, the stock market and financial services, public administration, and social security, as well as the provision of infrastructure are necessary conditions for increasing private investment.
Experience has also shown that in order to reactivate the market mechanism, the government should not rely on oil revenues to retain political power. This is also valid for the federal government of Kurdistan, as the implementation of the oil-for-food program in Kurdistan's region during 1996-2003 revealed.
In theory, it is undisputable that economic efficiency can be realized by a free market mechanism. However, targeting only economic efficiency may not enhance the capacities of the indigenous private sector. Also, it may not ensure social justice, the provision of basic health and education services and public utilities, as well as better distribution of income and wealth resulting from oil revenues and economic activities. Therefore, a carefully defined and limited government role must be maintained. For this purpose, Iraq’s economic policies may be classified in three main integrated groups: the government’s macroeconomic fiscal and monetary policy that aims to maintain domestic economic stability and external balance through a flexible foreign exchange regime; the economic structural reforms that aim to provide the requirements for a free market; and the implementation by the government of a large scale program to build the economic (physical), social and environmental infrastructure.
IDRC: An Indigenous Entity
Since the early 1950s, Iraq has experienced fairly good institutional economic and social development programming. In 1951 and 1953, the Development Board (DB) and the Ministry of Development (MOD) were established. Both were responsible for the formulation and implementation of development programs. In 1959, the Ministry of Planning and the Planning Board replaced the MOD and the DB. Since then, the concept of development planning in Iraq has changed. First, centralization of programming and execution which prevailed in the 1950s was replaced by central planning of investment and decentralization of the execution of public projects. Secondly, during 1951-59, government authorities exercised limited intervention in the investment decision-making process of DB as compared to the period afterwards. Thirdly, economic planning since 1964 tended to be more comprehensive both in concept and practices, covering the objectives and activities as well as economic, social, and political implications. At the technical level, Iraq witnessed the most challenging and serious economic planning endeavors during the first half of the 1970s. In the second half of the decade, Iraq enjoyed an economic growth model characterized by unlimited financial resources. Afterwards, the role of Iraq’s economic institutions deteriorated rapidly as a result of the backward and destructive political agenda of Saddam’s regime6.
From the early 1950s, Iraq was a pioneer in implementing economic and social development programs7. Until the early 1970s, government institutions were reasonably efficient in regulating the annual budget and public investment in physical infrastructure, education and health services, and provision of public utilities. However, as government economic intervention increased – starting in 1964 – the importance of government development programs also increased. Parallel to this, government economic policies were not made through proper constitutional and institutional procedures, which resulted in the prevailing economic and financial problems before the fall of the former regime.
After more than three decades of political repression and corruption, wars and sanctions, Iraq badly needed a comprehensive reconstruction program. At present, the complete collapse of economic institutions, the implementation of irrational policies, political instability and terrorist attacks after the occupation have made this task even more difficult. In particular, Iraq’s post-war experience showed that the externally imposed Development Fund for Iraq (DFI) was not able to perform the reconstruction tasks, despite the availability of financial resources and the advice of international experts8. Also, the Ministry of Planning and Development Cooperation (MOPDC) lacked the capacity to cope with the new economic environment and continued Iraq’s old practices with more emphasis on external financial resources. The suitable alternative is the establishment of the Iraq Development and Reconstruction Council (IDRC) as an indigenous, independent and professional apparatus for taking the responsibility of designing and implementing the required reconstruction program. Based on Iraq's experience and the constitution of federalism and decentralization principles, the objectives of IDRC may be defined to include the following:
a. Identification of investment opportunities in public infrastructure.
b. Preparation of guidelines and investment criteria for project evaluation.
c. Selection of main public investment projects.
d. Mobilization and allocation of financial resources.
e. Preparation of nationwide development plans.
f. Implementation of structural reform programs.
g. Initiation of Iraqi thinking on long-term future vision for the country.
To achieve these objectives, the IDRC must carry out the following activities:
a. Commission feasibility studies for public infrastructure projects.
b. Conduct investment promotion conferences and negotiations.
c. Implement an investment capacity building program.
d. Follow up the implementation of the public investment program.
e. Submit annual progress assessment reports to the government.
The IDRC financial sources would be oil and public enterprise revenues, and contributions from international, regional, and Arab financial institutions, and from Iraqi private sector and foreign financial institutions. The IDRC should consist of at least four main departments: a decision-making board, technical secretariat, financial directorate, and administration department.
Conclusions
The oil sector will continue to have a huge impact on the Iraq’s economic growth and social development for a long period. However, to maintain economic liberties and neutralize the political power of oil in domestic politics, the current piecemeal and heterogeneous policies must be changed. The aim of reconstruction and transforming the stagnant economy into an efficient market economy (where an enterprise culture dominates and the private sector contributes more than oil to GDP and public finance), can be realized by effective application of consistent policies guided by a long-term economic strategy and nationwide vision that inspire hope and promise opportunities. In the short run, urgent measures such as the implementation of labor-intensive public works programs have to be implemented to deal with the severe unemployment and poverty problems.
Iraq needs the IDRC as an indigenous state entity for the construction of public infrastructure in order to sustain social and environmental development and to facilitate the activities of the private sector as well. For this purpose, most of the anticipated oil revenues must be allocated to the IDRC’s budget. Smaller amounts could be allocated to finance the annual budgets. Utilization of oil revenues independent from the direct control of the central government and FG(s) would also contribute to political stability, combating corruption and win the confidence of foreign concerns.
As experience has revealed, not all the current misfortunes of Iraq originate from oil wealth, nor will all future virtues emanate from it. However, successful efforts to promote democracy, and maintain civil liberties and economic freedom can not be separated from the rational use of oil revenues. If these continue to finance increasing public spending without the expansion of domestic non-oil production capacity, then the “virus” for a new form of political authoritarianism and economic corruption will be born. Economic governance in Iraq must prevent the economy being trapped by oil.
1. During the former regime's period (1967-2003) neither public debate nor discussions among government ministries and officials on oil policy (production and exports) were permitted. The policy was only Saddam's daily decisions which were technically supported by very few professionals.
2. Quantitative assessment of economic hardship in this period in terms of Iraq's GDP data was given in: Sabri Zire Al-Saadi, Oil Wealth and Poverty in Iraq: Statistical Adjustment of Government GDP Estimates (1980-2002), (MEES, 18 April).
3. The details on the long competitions between Great Britain and the big foreign powers for the exploitation of Iraqi oil and oil’s agreements with the Iraqi governments as well as various political interests and economic implications were intensively discussed by: Penrose, Edith, & H F Iraq: International Relations and National Development, Ernest Benn, 1978.
4. Financial details of the annual budgets and development programs for the period prior to 1950 were given by Sassoon, Joseph, Economic Policy in Iraq 1932-1950, Frank Cass & Co Ltd, London, England 1987. Development assessment and related details of the period 1950 and afterwards were researched by the author on the bases of government documents, Economic Liberalization and Oil Policy: Vision and Priorities (MEES, 21 July 2003.)
5. See Sabri Zire Al-Saadi, Economic Liberalization and Oil Policy, ibid.
6. Analytical and statistical summery of economic crises during the period (1980-2003) was given in the author’s unpublished study: Sabri Zire Al-Saadi, Economic Project For Change: Economic Policies and a Program of Action for the New Democratic Regime, presented to the economy and infrastructure group, Future of Iraq Project, US Department of State, 23 October 2002.
7. See, Penrose, Edith & H F, ibid.
8. The DFI was established by the UN-SC resolution 1483 dated 21st May 3003 and operates under the control of UN, IMF, WB, and Coalition forces, playing the role of treasury for both the government and the Central Bank of Iraq. Since the implementation of UN-SC resolution 1546 dated 8 June 204, Iraq became full member of the DFI board of directors. However, the Advisory and Monitoring Board for Iraq (IAMB) was established as an audit for the DFI and aims to ensure that; the DFI is used in a transparent manner for the benefit of the people of Iraq, and export sales of petroleum, petroleum products, and natural gas from Iraq are made consistent with prevailing international market best practices.
