article4.pdf
Journal of Economic Perspectives—Volume 18, Number 3—Summer 2004—Pages 47-70
Economic Policy and Prospects in Iraq
Christopher Foote, William Block, Keith Crane and Simon Gray
E conomic reform was central to the Coalition Provisional Authority's at-tempts to rebuild Iraq. Coalition Administrator L. Paul Bremer (2003)made this clear in his first speech before the international community, delivered on June 23, 2003, before a special meeting of the World Economic Forum held in Amman, Jordan. Noting that "the first joh of any government is to maintain law and order," Bremer began his talk with a pledge to confront the looters, saboteurs and street criminals that plagued Iraq after the war. Bremer also noted that a governing council of Iraqis would soon be established to help manage the country. But most of Bremer's speech focused on what he called his "third and most immediate priority," rebuilding the economy.
Bremer described a state where more than 60 percent of the population depended on government food rations to survive. After achieving middle-income status in the late 1970s, Iraq's economy imploded during its war with Iran in the 1980s and the UN sanctions that followed the Persian Gulf War in 1990-1991. The Iraqi government responded to the international sanctions by printing money to finance its operations, stoking inflation and debasing the currency. Other eco- nomic problems were strictly domestic in origin. The government controlled investment decisions throtigh its control of oil revenues, propped up money-losing state-owned enterprises and spent billions on wasteful consumer subsidies. Non-
• Christopher Foote is Senior Economist, Federal R£serve Bank of Boston, Boston, Massa-
chusetts. William Block is Senior Staff Economist, Council of Economic Advisers, Washington,
D.C. Keith Crane is Senior Economist, RAND Corporation, Arlington, Virginia office. Simon
Gray is Advisor to the Governor, Bank of England, London, United Kingdom. All four of the
authors worked at the Coalition Provisional Authority, Baghdad, Iraq. Their e-mail addresses
are ([email protected]), {[email protected]), ([email protected])
and ([email protected]}, respectively.
48 Journal of Economic Perspectives
Arab foreign investment was prohibited, and the Baathist regime was extraordinar- ily corrupt. "Put simply," Bremer (2003) said, "Saddam Hussein's regime devastated Iraq's economy from the inside out."
This paper describes the Coalition's attempts to stabilize and reform Iraq's economy along market lines. It argues that while security concerns remain serious, Iraq's economy has not been crippled by violence. Since the end of the conflict, small businesses have been able to grow and thrive despite domestic unrest. (By February 2004, a plurality of Iraqis believed that the employment situation in Iraq is better now than before the war.) Unemployment remains high, however, and a large majority of Iraqis believes that improved job opportunities would reduce violence. Reconstruction spending will create jobs and raise incomes this year, but sustained economic growth will depend on whether Iraq's future leaders pursue the pro-market approaches that the Coalition has advocated. If the Iraqi economy is to reach its potential, it will need to go even farther than the Coalition did, implementing some reforms that the Coalition did not pursue because of security concerns.
Iraq's Economy Before the War
Thotigh Iraq's ruling Baath party was socialist, die country had a mixed economy before the war. Most people worked in the private sector, though a majority of these jobs were in the informal economy. Many were engaged in trading or subsistence agriculture or some other form of self-employment. Probably no more than a fifth of the labor force worked for regular pay in a formally registered firm. About a quarter to a third of the labor force worked for the government, mostly in a government ministry, the army or in one of the 200 or so aging state-owned enterprises. The government did not set prices for private goods, but it controlled all oil revenues and the prices of refined oil products. It could force private firms to act in consort with the "national plan." and, after 1990, it directly distributed food rations to virtually everyone in the country.
Saddam Hussein created the food rationing system in response to a United Nations embargo imposed days after Iraq invaded Kuwait. The food hasket was increased after 1996, when the UN's Oil-for-Food program allowed Iraq to sell oil in exchange for humanitarian imports. Iraqis were free to stipplement their rations with purchases from the private market, but their ability to do so was limited by low incomes. Those at the bottom of the piiblic-.sector pay scale, like teachers, made less than $10 per month before the 2003 war. Moving up the income distribution, a branch manager at a state-owned bank made about $40 per month, and the owner of a private-sector food store in Baghdad might clear $60 a month. The country's Minister of Oil had an annual base salary of $20,000 (Oliver and McPherson, 2003).
GDP Reliable figures for aggregate income before the war do not exist. Saddam
Hussein did not publish real GDP figures, and those that were calculated (and kept
Christopher Foote, William Block, Keith Crane and Simon Gray 49
hidden) were distorted by valuing international transactions at the official ex- change rale of 0.311 Iraqi dinars per U.S. dollar. By the late 1990s, inilation had caused the market rate of the dinar lo depreciate to around 2,000 to the dollar.
Figure 1 presents our rough estimates for real per capita GDP. Our approach is to use data from Iraq's Central Statistical Organization (CSO) to figure non-oil GDP, because the use of inaccurate exchange rates does not distort the non-oil figures from the domestic economy nearly as much as those for the oil sector. Nominal, non-oil GDP is first deflated into 2002 dinars using Iraq's consumer price index. Dividing the resulting constant-dinar series by the 2002 exchange rate (1955.25 dinars = 1 dollar) gives an estimate of real non-oil GDP in terms 2002 U.S. dollars. Output in Iraq's oil sector is estimated from data from the U.S. Energy Information Agency (which closely track data from the Iraqi government during the period when the two sources overlap). After 1991, the data do not include figures for the three northern Kurdish-dominated provinces, or "governorates." The Kurdish region became essentially autonomous after the Persian Ciulf War, protected by a no-fly zone established by the allies.
During the 1970s, both the oil and non-oil sectors grew rapidly. World oil prices were high, and Iraq's oil production rose from 1.5 million barrels per day (bpd) in 1970 to 3.5 million bpd in 1979. Soaring oil revenues allowed the government to conduct investment programs outside the oil sector, so the non-oil economy grew as well.
Iraq's economic meltdown began with the onset of its eight-year war with Iran in September 1980. Oil production virtually ceased the following month, and Iraq's Gulf port facilities were destroyed in November. Production averaged slightly more than 1 million barrels per day from 1981 to 1985, recovering tojust below 3 million bpd the year after the war. The second major interruption to oil revenues came during the Persian Gulf War. Allied attacks in January 1991 brought a complete halt to oil production; postwar exports were constrained by the ensuing UN em- bargo. Oil production was held Tiear tbe level of domestic consumption (about 500,000 bpd) until 1996, at which point Iraq agreed to the Oil-for-Food program. Both the oil and non-oil sectors recovered somewhat in the late 1990s, but re- mained severely depressed relative to the 1970s.
By 2001, GDP per capita at market exchange rates was about $960 per year, with oil output accounting for more than two-thirds of tbat amount. Outside of the Kurdish region, Iraq bad about 22 million people in 2001, so aggregate GDP was slightly more than $21 billion.
These real GDP estimates are constructed with constant base-year prices, including oil export prices. They therefore abstract from the decline in the relative price of oil after 1980. Oil prices averaged about $37 per barrel in 1980, falling to a low of $15 during the 1986 price collapse and rising to around $15-$20 for most of the late 1980s and 1990s. Since 2000, oil prices have generally fluctuated around $30 per barrel. One way to assess tbe combined effects of price and quantity declines on Iraq's oil export revenues is to deflate current-dollar oil export earn- ings into 2002 dollars using the U.S. GDP deflator. This exercise reveals that in
50 Journal of Economic Perspectives
Figure 1
Per Capita GDP in Iraq (1968-2001)
2000-
1500-
1000-
500-
0-
/
.. y Oil sector ' • « . •
Non-oil sector , '
\ \ Total
2002 dollars, per capita export earnings declined from a high of more than $4,100 in 1979 and 1980 to about $544 in 2002—a drop of more than 86 percent.
Employment Data from Iraq's 1997 census can be used to generate labor-force participation
rates and employment shares by industry. The results, which pertain only to civilian employees outside the Kurdish region, are displayed in Table 1. As of the census day (October 16, 1997), about two-thirds of Iraqi men aged 10 or older were in the labor force, though only 7.5 percent of women were. This rate of female partici- pation is low even among economies of the Middle East. Though oil accounts for most of Iraq's GDP, it is extremely capital intensive, accounting for less than 1 percent of aggregate employment. The largest employers for men are public administration, wholesale and retail trade and agriculture. For women, major employers are education, agriculture and public administration. Though women are less likely to be in the labor force, those who work are likely to be more highly educated than men, often working as teachers or government technocrats. Table 1 also shows that about 18 percent of men and 2 percent of women were unemployed when the survey was taken.
Infrastructure and Investment Even before the looting and sabotage of 2003, Iraq's infrastructure was fragile
due to a dearth of capital investment during the previous two decades. Figure 2 presents real gross capital formation in the private and government sectors from 1980 to 2001. The data are unadjusted figures from Iraq's Central Statistical Office,
Economic Policy and Prospects in Iraq 51
Table I
Labor Market Data from the 1997 Census
Men Women
Civilian labor force as percentage of populaiion aged 10 + Shares of rivilian lahui' hivct: trmployfd in:
Public administration Wholesale and retail trade Agriculture Manufacturing Education Mining and qtiarrying (including oil drilling) Other
Share of civilian labor force unemployed
66.8 7.5
20.1 19.3 18.3 4.3 2.6 0.6
16.9 17.9
8.6 4.5
24.1 6.4
37.4 0.7
15.9 2.4
Source: 2002 Annual Abstract of Statistics, Ministry of Planning.
Figure 2
Gross Capital Formation (1980-2001)
c
CO
OV
o
Socialist sector (government owned)
but because they measure domestic investment in real terms, they are less affected than the GDP figures by the overvahiation of tbe official exchange rate. The figure shows that both public and private investment collapsed during the Iran-Iraq war of the 1980s and was miniscult' during the 1990s.
Iraq's infrastructure also bears the scars of the 1990-1991 Persian Gulf War, when allied attacks hit the country's electricity grid and telecommunica- tions network particularly hard. According to a recent joint UN/World Bank assessment (2003a), peak electricity' demand before the Gulf War had been about 5,000-7,500 megawatts (MW), and generating capacity had been about 9,300 MW.
52 Journal of Economic Perspectives
Damage from allied attacks during the Gulf War reduced generating capacity tojust 2,500 MW.
During the 1990s, efforts to rebuild the infrastructure were thwarted by the UN embargo, which denied the country a source of spare parts. Iraqi engineers still managed to repair much of the electricity grid by cannibalizing parts from some generating facilities to rebuild others. Parts imported through Lhe UN Oil-for-Food program permitted generating capacity to climb to about 4,400 MW by 2002. While generating capacity remained below demand throughout the 1990s, not all of Iraq suffered eqtially from power shortages. The government regularly channeled elec- tricitv' to Baghdad al the expense of the much poorer southern part of the country, which had rebelled against the regime after the Gulf War.
The 1990s saw Iraq's stock of human capital stagnate along with its physical infrastructure. A comprehensive literacy campaign in the 1970s and 1980s had reduced illiteracy among 1.5- to 45-year-olds from 48 percent in 1978 to 20 percent in 1987 (UN/World Bank, 2003b). In 1991, all literacy programs outside the formal school system ceased, as did new construction and maintenance of school build- ings. By the time of the 200.S war, students were often going to school in double or triple shifts because of a lack of adequate buildings. According to the United Natiotis Htunan Development Report, about 59 percent of Iraq's females and 55 percent of its males aged 15-24 were illiterate in 2001, the highest such rates in the Arab world.
Government Finanee, Debt and Inflation When Uie han Iraq war and the UN embargo disnipted <jil sales, Iraq's
government was denied its main source of income. Funds raised through internal taxation typically totaled less than •} percent of GDP, as income from state activities, such as wages earned in state-owned enterprises, was exempt from taxation. Small firms paid taxes only if they did btisiness with the government, and all firms commonly reduced their tax bills by underreporting their incomes and employ- ment levels. The government collected some revenues from sales taxes, but these revenues were also a small sotirce of funds.
Iraq used international capital markets to cushion the immediate revenue effects of the Iran-Iraq war. Development programs drawn up during the late 1970s were continued until 1982, financed by borrowed funds. Imports rose by more than 400 percetu from 1978 to 1982, mostly due to an increase in noiimiUtary goods (Alnasrawi, 1994). By 1990, however, debt service payments were soaking up 55 percent of Iraq's oil revenues (Alnasrawi, 1994, 2002). Today, Iraq's debt is estimated to be about $120 billion, nearly six times GDP.
Effects from the second interruption to Iraq's oil revenues, the UN embargo, could not be papered over with debt. The government then began to finance its operations by printing money. Until then, Iraq had not been a high inflation country. Between 1945 (the first year for which data are available) and 1989, inflation usually stayed in the single digits. But rapid rates of monetary growth after the Gulf War caused inflation to rise from 6 percent in 1989 to nearly 500 percent
Christopher Foote, William Block, Keith Crane and Simon Gray 53
in 1994. The Iraqi dinar depreciated from around 4 dinars pt-r dollar in 1990 to more than 1,700 in 1995.
The rate of inflation exceeded the rate of money growth during this period, as Iraqis fled the dinar as a store of wealth and held gold or foreign cunency instead. Because interest rates paid on deposits weie capped in the single digits, holding dinars in a hank account was also a losing proposition. One top Coalition budget oHicial snmiised that most Iraqis had never seen the inside of a bank when the 2003 war started. More than 85 percent of Ml was held as currency throughout the late 1990s.
Microeconomics and Markets Because oil is so central to Iraq's economy, understanding Iraq's microe<(>-
nomic climate in the 1990s begins with understanding the Oil-for-Food program, through which oil revenues flowed from 1996 to 2003. By relaxing the embargo, the program no doubt improved the lives of Iraq's people, particularly its children. But the program adversely affected private economic activity in a mnnber of ways.
Before the Oil-for-Food program, Iraq's food-rationing system supplied only about 1,300 calories per person per day, about 40 percent less than the level recommended by the World Health Organization. The Oil-for-Food program per- mitted the government nearly to double the average caloric intake in the monthly food ration, to 2,200 calories by 2002. According to the United Nations (2003), childhood malnutrition rates dropped hy haU from 1996 to 2002, while the number of underweight children dropped from 23 percent to 10 percent. The macrocct> nomic picture hrightened as well, as the return of oil revenues reduced the government's need for seignorage revenue. Monetaiy growth and inflation re- mained relatively tame in the late 1990s—that is, typically less than 20 percent.
But the Oil-for-Food program reduced incentives for private economic activity. By augmenting the existing rationing system with imported food, the program discouraged the local production and distribution of food and otlier consumer items. Some agricultural sectors, such as the poultry industry, were helped hecause they could import feed. But small grain farmers experienced extraordinaiy declines in incomes, because they could not compete with subsidized grain from abroad. Moreover, because the program allotted virtually the same basket to every family, most households sold part of their rations in secondary markets for cash, because they needed different things or because they preferred bettcr-qualit)' items. The prices that consumers received in secondary markets were generally less than lialf the purchase cost of these goods, further depressing prices for local producers. Finally, by distributing food through the government's original food-rationing program, the program maintained the link between each family and their existiug food distrihution agent, typically a food store or baker). This discoiuaged the entry of new retail firms.
Corruption The Oil-for-Food program also exacerbated government corruption. .Aiter
1999, the UN removed the previous ceiling on permissihle oil sales and relaxed the
54 Journal of Economic Perspectives
oversight of certain humanitarian imports. Iraq's leaders used the new flexibility to pocket illegal surcharges for oil sales (on the order of 10 percent) and demand kickbacks when purchasing imported goods.
Some elements of Oil-for-Food corruption were known even before the 2003 war. A 2002 report from the General Accounting Office of the United States conservatively estimated that Iraq's government received about $2.3 billion in illegal surcharges on oil and commissions on commodity contracts during the preceding five years. This was on top of $4.3 billion earned through smuggling oil out of the country. Additional details about Oil-for-Food corruption came to light after the war. When preparing budgets of various Ministries in mid-2003, Coalition budget officials were surprised to discover that goods imported through the pro- gram would sometimes be awarded to state-owned enterprises for no consideration at all. The state-owned enterprises were then free to sell the imported good (a car, for example), with all revenues recorded as "profit," entitling the managers of the state-owned enterprises to hefty bonuses. In March 2004, the GAO upped its estimate of theft through the Oil-for-Food program to $4.4 billion.
Illicit funds earned through the program help explain why Saddam Hussein was able to embark on an ambitious program of palace building even as many in Iraq struggled to survive. These building programs were no doubt at least partially financed by illicit earnings, but government revenue might also have been used. One government official told tis that budget authority for an "irrigation" improve- ment, for example, might have been used to build a private lake behind one of Saddam Hussein's homes.*
In talking with members of Iraq's business community, we were told of another of Saddatn Hussein's favored techniques of self-enrichment. He would purportedly encourage the formation of businesses that he believed would become profitable, then nurture their growth through various channels of favored treatment. After a while, Saddam would suddenly close the firm and confiscate its bank accounts and assets, while the owner would "disappear." We were told this was "Saddam's f;: i- ing of the lamb before its slaughter."
Corruption extended far below Saddam Hussein's inner circle. Starting a new business required an application to the Ministry of Trade that might take a year to complete. Worse, applications also attracted the attention of other parts of the government, like the secret police. Applicants were typically investigated to deter- mine whether they had any relatives who belonged to opposition groups, who had deserted or avoided service in the army or who had belonged to the regional militia in the restive Kurdish part of the country. "Even the involvement of relatives would
' Coalilion advisers also learned to take Central Bank of Iraq figures with a grain of salt. Under the previous regime, the Bank often used opaque accounting procedures so as to hide transactions, such as transfers of central bank funds to commercial bank accounts controlled by Baath part)' officials or the transfer of foreign currencies to secret bank accounts abroad. The central bank also masked the real value of transactions in its reports by using the out-of-date official exchange rate, then failing to denote consistently tlie items that were denominated in foreign currency.
Economic Policy and Prospects in Iraq 55
cause the government to not let the applicant start any kind of business, and may lead to very serious charges," one official said. "That is why not many people would dare start any business" (Kader Hussein, 2003). One Iraqi auto parts dealer, like other business people, simply avoided registration of his business to escape the attention of the government or organized crime. "If you go to the Trade office, everyone will know," the dealer said. "So one way to keep a low profile is not to register your company. One year after opening my shop, a government inspector came, and I just had to pay him a bribe" (as quoted in Braude, 2003, p. 118).
Iraq's Economy after the War
After the end of hostilities, the greatest effect of the 2003 war on Iraq's economy was the subsequent decline in oil and electricity production. Oil produc- tion had been running at 2.5 million barrels per day before the war. It dropped to near zero in April; exports ceased until June 2003. Electricity generation fell by about 25 percent, regaining pre-war levels in October 2003. Based in part on these figures, the International Monetary Fund {2003, p. 22) estimates that Iraq's GDP fell by about 22 percent in dollar terms for 2003.
Both of Iraq's main statistical organizations, the Central Statistical Office and the Central Bank of Iraq, were heavily looted after the war and both were slow to recommence operations. As a result, no data measure the effect of the war on private economic activity. It was undotibtedly negative. An August 2003 suiTey of 393 small firms in Iraq sponsored by the Iraqi-American Chamber of Commerce revealed that the average size of firms in the survey dropped fixnn slightly more than 16 workers before tbe war (median size of seven workers) to an average of slightly more than 12 workers (median size of five workers) (Ommar and Khesbak, 2003). Public employment also fell after the war, due largely to the Coalition's controversial decision in late May to disband the army. When the war ended, the army consisted of ahotit 500,000 people, or about 7 percent of the current lahor force. The Coalition would later pay stipends to former soldiers, but the decision to put them back on the streets without jobs has been blamed for worsening attacks on Coalition forces. In defending this decision. Coalition officials pointed otit that much of the army had essentially melted away during the war. They also noted that the army has been a destabilizing political force tbroughout Iraq's history, dating back to the army's overthrow of the British-installed monarchy in 1958. Another group of public employees losing their jobs was the 25,000-30,000 persons who had belonged to the top four levels of the Baath party. Outside of these changes, government employment levels were generally maintained. In particular, the 500,000 employees at state-owned enterprises continued to be paid after the war, even if electricity shortages, looting or a lack of demand gave them little to do.
Economic Effects of Violence Street crime has been a serious problem since the war ended. In the late
summer of 2003, a World Bank assessment team reported that crime was among the
56 Journal of Economic Perspectives
top four obstacles to private-sector investment, along with poor access to finance, telecommunication problems and macroeconomic instability (UN/World Bank, 2003c). Ha.ssan Fattah, an American journalist of Iraqi descent, started an English- language newspaper in Baghdad soon after the war ended. "Wbat sets Iraq apart from most other nations in transition," he writes, "is the level of risk. For us, tbe lesson came early. A day before we published our first issue on 7̂"̂ July 2003,1 woke up witb a gun barrel in my face. Seven men were standing over me, bolding Kalasbnikovs and demanding money. Tbey bad notbing against tbe newspaper; tbey just saw us as westerners with cash. Tbey tied me up and took our $12,000 stasb of money" (Fattab, 2004a).
Fattab's paper, Iraq Today, sbook ofFtbis initial setback. By Marcb 2004, it bad expanded its initial press run, its online version was reaching thousands of people via tbe Internet, and tbe paper'.s managers were considering a new Arabic edition. But then tbe paper suspended publication. A mortar rotind landed outside Iraq Todays office, prompdtig Fattab to send tbe staff bome for a montb wbile be considered bow to deal witb tbe security situation. Tbe paper's financial backers witbdrew support in part because of fears of ongoing violence in tbe cotintry. A close friend and colleague of Fattah's was killed. Fattab bimself received enotigb death tbreats tbat be left Iraq in early April 2004 (Fattab, 2004b). Tbe paper bas yet to resume publication.
Despite tbe difficult commercial environment, a drive around Bagbdad reveals large numbers of new sbops, manufacturing firms and even Internet cafes doing business under a skyline laced with construction cranes. One of Iraq's new small businessmen is Nader Hindo, wbo grew up in Iraq but left tbe country after be finisbed bigh scbool in 1992. Along witb bis fatber (a businessman once jailed by Saddam Hussein), Hindo now runs Neareast Resources, a firm involved in con- struction, security, information tecbnology and trade. "Basically," be said, "we bave witnessed tremendotis growtb in our size, staff, and business volume." One way in whicb Hindo's firm bas bandied security problems is to break large jobs up into pieces, then try to finisb cacb functional piece of tbe project in "bours and days rather tban weeks or montbs," be said. "We believe tbat by reducing tbe lifetime of a project, you reduce tbe number of uncertainties that can affect you. Next week tberc might be protest, an electrical grid shutdown, or your laborers in Sadr City can't get out because tbere are Coalition roadblocks." Security problems bave raised tbe firm's costs, but markets are clearing. "People wbo are bold and aggres- sive are rewarded," Hindo said. "A laborer would cost you %1 a day, but ifyou take bim to tbe Green Zone or bire bim dtiritig turbulent times, tbe price goes up by two to tbree times. Witb tbat kind of financial reward, tbere is always a supply" (Hindo, 2004).
Regional levels of violence are closely correlated with bow residents assess Iraq's ctinent economic situation. Figure 3 reports tbe results of polls taken in early 2004 tbat asked Iraqis bow tbey viewed Iraq's economy in general and tbeir own family's situation in particular. In Baghdad, 62 percent of respondents felt tbat Iraq's economy is doing better tban before the war, witb 59 percent viewitig tbeir
Christopher Foote, William Block, Keith Crane and Simon Gray 5 7
Figure 3
Fractions of Poll Respondents Reporting Economic Improvement for Iraq as a Whole (1st percentage) and for Respondent's Own Family (2nd percentage)
Sulamaniyah: (in Kurdish region)
98% & 68%
Tikrit: 3% & I I %
Diyala: 43% & 40%
Sources: Figures for Karbala, Tikril, and Sainarra from Jantiai"y ^004 poll. All Febmary 2004 poll.
cities from
own family's fortunes as improving. Similarly sanguine results Wf re ibund in Iraq's second largest city, Basra; the northern Kurdish city of Sulamaniyah; and in Babylon. Opinions were far less favorable in the "Sunni Triangle," where most attacks on Coalition forces have taken place. In Tikrit, Saddam Hussein's home- town, only 5 percent of respondents said the country's economy had improved. Views were even worse in nearby Samarra.
Why the regional discrepancy? No doubt part of it is dtic to the effect of political violence (as opposed to street crime) on economic activity. Responses probably also var)' with local support for the Coalition's presence and the level of government favors that residents enjoyed under the old regime. F.ven in the Sunni city of Ramadi, though, more than 40 percent of Ramadi residents said that their own family is doing better, even though only 15 percent of these rcsideiiLs said the same for the country as a whole. The pattern of answers to national versus family-specific questions is reversed in areas where political support for the Coali- tion is stronger, like Sulamaniyah.
Iraqis remain concerned about the health of the labor market no matter where
58 Journal of Economic Perspectives
they live. The first official postwar look at joblessness from the Central Statistical OfBce reported an tinemployment rate of 28. f percent for the countiy as a whole in October 2003. This rate is about 75 percent higher than the rate recorded in the 1997 censti.s. It is unclear whether unemployment concepts in the two surveys are the same, however, and a separate, private poll taken in late February revealed that a plurality of haqis think the labor market is better now than before the war (Oxford Research International, 2004). The poll found that 38.9 percent of re- spondents believed the availability of jobs was either "much" or "somewhat" better thati before the war, with 25.3 pcrcetit answering that the job situation was much or somewhat worse. The remainder said there had been no change (30.9 percent) or had no answer (4.9 percent).
Whatever the quantitative state of Iraq's labor market, there is widespread agreement that Iraq needs jobs. The late February poll also found that 96 percent of Iraqis believed that tnore employment opporttmities would be effective in reducing violence (Oxford Research International, 2004). Today, there is a "chicken-and- egg" relationship between jobs and security. Reductions in crime and violence wotild tmdoubtedly improve the emplovTnent climate, btit these improvements are difficult in a poor job market. One frustrated job seeker from Sadr City (a poor, predominately Sh'ia area of Baghdad) put it this way: "I haven't been working at all for the last two weeks. If I stay like this for another week my family will starve, and if someone comes along with $50 and asks me to toss a grenade at the Americans, I'll do it with pleasure" (Banerjee and Cushman, 2003).
Coalition Economic Policy
Although the Coalition Provisional Authority (CPA) enjoyed sweeping powers to make economic policy, policymakers were not free to pull out their textbooks and recast Iraq's economy as they saw fit.̂ They faced three constraints in reform- ing Iraq's economy: one legal, one political and one logistical.
Legal autfiority to reform the country was circumscribed by international
^ The Office of Economic Policy of" the Coalition Provisional Authority consisted mostly of employees from national Coaliiion governmt-nLs, central baiiLs and civil affairs units of the Coalilion armed forces, an Anieriran consulting Hrni railed Bearing Point, Inc. that won a USAID economic reconstruction contract and private institutions. The staff worked alongside representatives of the World Bank, Inicrnationiil Monctar)' Fund and L'nitt̂ d Nations. CPA economists were supported by Treasury em- ployees in Washin(Tton assigned to a special task force. Peter McPherson was director of the Office of Economic Policy from May to St-ptcmber 2003. He had served as the director of the U.S. Agency for Inieniatioiial Development and as Deputy Treasury Secretary in the 1980s. He later worked in the international banking division of Bank of America before becoming president of Michigan State University in 1993, returning to that position when his time in Iraq ended. McPherson was succeeded on an interitn basis by tieorge Wolfe, the t..'.S. Treasury's Deputy General Counsel. In November 2003, the office came under the direction of Marek Bclka, a transition economist from Poland who had served as that country's dcpuiy prime minister and finance minister as well as heading CFA's international coordination bodv.
Economic Policy and Prospects in Iraq 59
treaties. Article 64 of the Geneva Convention of 1949 stipulates that ati occtipying power can make changes needed "to fulfil! its obligations under the present Convention, to maintain orderly government of the territory, and to ensure the security of the Occupying Power." These powers have been liberally interpreted to allow eeonomic reforms that would improve living standards in the occupied country. But there is much less precedent for enacting irreversible reforms that could not be undone by future governments, such as selling off immovable government-owned property. Whether Iraq's state-owned enterprises would fall into this category of assets is open to debate.
The fact that Coalition reforms could be reversed led to the second constraint: the need to gain Iraqi political buy-in on important reform measures. To foster stipport of reforms, Ambassador Bremer held a series of remarkable Monday night forums with Iraqi business and government leaders in the summer of 2008. Topics discussed included potential reforms to Iraq's agricultural system, whetlier Iraq should have a tax system (or simply rely on oil revenues to fund the government), how to limit the economic power of former Baathists, how state-owned enterprises should he reformed and the benefits of foreign investment. These seminars were two-way exchanges of information, with Coalition officials learning crucial institu- tional details and Iraqis learning about hest practices from elsewhere in the world. A formal political constraint on policymaking came when the Iraqi Governing Council was formed on Jtily 13, 2008. The Council's founding agreement called for the CPA to consult with it on all major policy changes; in practical terms, this meant that Council approval was a prerequisite for all important reforms. The Council also appointed new ministers to exercise day-to-day control of ministries starting in September, although senior advisors who worked for the Coalition still held final decision-making authority.
The third logistical constraint facing economic policymakers stemmed from the security situation, which hindered their attempts to learn about Iraq's economy. Almost every workday, advisers donned tbeir helmets and flak jackeLs for trips to the Central Bank or the Ministry of Finance, riding through Baghdad's crowded streets in SUVs escorted by army Humvees. But advisers could not take unescorted trips outside the heavily protected Green Zone to talk with shopkeepers about regulation, witb workers of state-owned enterprises about potential privatization schemes, or with consumers about potential reforms to the food distribution system. Combined with a lack of official data from Iraq's statistical agencies, advisers often felt that they were navigating the Iraqi economy virtually blind.
Influences on Economic Poliey The biggest influence on Coalition economic policy was the experience of the
transition economies of eastern Europe and central Asia during the 1990s. Though all of the economies experienced "transition recessions" in the early years of reform, proper policies helped release resources that were absorbed by the private sector. "With time, if the busine.ss environment favors production and innovation rather than rent seeking, restructured and new enterprises gain the critical mass to
60 Journal ojEconomic Perspectives
overcome the negative effects of old enterprises, leading to recovery and econo- mywide growth" (World Bank, 2002, p. xiv).
Iraq, of course, is not Poland. For one thing, direct employment by the government in state-owned enterprises was much smaller in Iraq than in most of the formerly socialist countries. Even more importantly, most of Iraq's GDP comes from oil. Perhaps the central economic question in Iraq is how oil revenues will he distributed—through payments directly to individuals, for example, or by the government through its spending decisions.
At the present time, Iraq needs every oil dollar it can get to rebuild its infrastructure. According to World Bank and CPA assessments, Iraq infrastructure investment requirements totaled $55 billion immediately after the war. This amount is far in excess of the $12 to $15 billion Iraq will receive in yearly oil reventies in the near future. As a result, Iraq not only had to ask the international community for help in rebuilding (which it did in an October 2003 donor's conference held in Madrid), the cotmtry must also allocate most of oil revenues either to rimning the government or to rebuilding the country, not for redistribu- tion from an oil revenue trtist ftmd.
With explicit redistribution schemes on the back burner, economic policy in 2003 focused on installing pro-market reforms that would be maintained by future Iraqi governments. Additionally, Coalition policymakers worked to impose disci- pline on state-owned enterprises and devise short-term stabilization measures tbat would be consistent with long-term growth. The two goals of pro-market reform and economic stabilization were central to tbe first major issue that Coahtion economists confronted: What should be done with the Iraqi dinar?
Currency Reform Early in the reconstruction, economists worried that the dinar would collapse.
Because each dinar featured the image of a smiling Saddam Hussein, fears that the dinar would become worthless once the Coalition took over caused it to weaken to more than 4,000 to the dollar in the spring of 2003. Coalition officials, of course, had no desire to erase the country's dinar-denominated assets. To send a signal that both the dollar and the dinar would be valued in the new Iraq, officials made an explicit decision to pay the April 2003 salaries of Iraqi government workers in dinars. These payments were complemented with "emergency payments" made in U.S. dollars. The signal of support for the dinar and the supply of new dollars arri\ing in the country caused the dinar to strengthen to below 1,500 to the dollar by the end of May 2003. Yet even as a collapse in the dinar was avoided, Iraq's currency situation was disintegrating nonetheless.
Only two denominations of the "Saddam" dinar circulated widely by the end of the war: the 250-dinar note (worth about 17 cents) and a 10,000-dinar note that had been introduced in late 2002 (worth about $6.50). Immediately after the war, presses, plates, and paper for printing the 10,000-dinar note were stolen from the Central Bank's Dar Al-Nahrain printing works in Baghdad, leading to fears that the 10,000 would be widely counterfeited. Additionally, the relatively high value of the
Christopher Foote, William Block, Keith Crane and Simon Cray 61
10,000 made it difficult to use in everyday transactions. For both of these reasons, the larger note traded at a 10 to 30 percent discount relative to the smaller one when the reconstruction began. The discount made the 10,000 unattractive for salary payments and forced Iraqis to carry large wads of 250s when they went shopping. In June, the Coalition decided to print new 250s to try to meet the demand (complete with Saddam Hussein's picture), but that did little to narrow the discount on the larger bill.
The monetary situation was further complicated by an essentially separate currency in northern Iraq. The Kurdisb area continued to use the banknotes that Iraq bad used before the Gulf War, wbicb were nicknamed "Swiss dinars."" Because the Kurdisb governorates did not have access to the printing plates for the Swiss dinars—and because they refused to follow Saddam's example and print low-quality notes of their own—the supply of Swiss dinars In the north had remained essentially fixed for 13 years. The separate northern currency allowed the region to escape Iraq's ruinous inflation rates of the early 1990s. Yet by 2003, many of tbe Swiss dinars were falling apart from overuse, held togetber with tape and staples.
Given tbis situation, why didn't the Coalition just dollarize the economy, as some observers had suggested (for example. Svejnar, 2003)? Dollarization would have forced Iraq, a major oil exporter, to share tbe monetary policy of tbe United States, a major oil importer. It would bave also required a massive and expensive airlift of coins to the country', as the Iraqi economy requires several denominations with a lower value than the U.S. Si bill. Perhaps most importantly, the political symbolism of dollarization would bave been disastrous.
Once tbe decision to create a new, unified currency had been made, econo- mists needed to come up witb an acceptable conversion rate between the Swiss dinar in the nortb and the Saddam dinar in the center and south. The price of a Swiss dinar in terms of the Saddam dinar hovered at about 100:1 from July 1998 to January 2002. Btit the Swiss dinar appreciated steadily throughotit 2002, and the Saddam dinar depreciated in the rim-up to the war. By January 2003, the exchange rate was about 300:1, falling to about 250:1 by mid-2003. A comparison of prices in tbe two regions of the country indicated that a 250:1 rate would be far out of line with ptirchasing power parity. The PPP rate appeared mtich closer to the 100:1 exchange rate that had prevailed from 1998 to 2002. After extensive discussions that included Iraqi leaders in both parts of the countiy, the Coalition Provisional Authority decided to set the conversion rate at one Swiss dinar to 150 Saddam dinars—essentially a compromise between tbe PPP rate and the market rate.
One way to bring about a "new" currency would have been to print up new Swiss dinars and distribute them arotuid the cotintr\\ This plan wotild have
^The origin n! the "Swivs diiiai" term is murky. Kvcn the acting Minister of Finance did nut know where the name came from. One possibility is that the name derives froni the fact that the plates for this currency were made in Switzerland (thoiigii most bills wert- acttially primed in ETiglkiiicl). Another rumored possibility is that because Iraq did not havt- a hisiuiy of inflation bef()rc ihi- (lulf War. people thought the Iraqi dinar was "as solid as a Swiss iranc."
62 Journal of Economic Perspectives
absolved the Coalition from making the tricky political decision of what—or who—should appear on the faces of the new banknotes. Btit spreading the Swiss dinar would have meant that the center and south— home of more than 80 percent of the population—would have had to change their prices and wages. The solution came when a visiting currency expert pointed out that technology existed to change the denominations on the Swiss dinar plates without affecting the designs on their faces. Existing Swiss plates could thus bt̂ modified to create higher-denomination dinars that would be in lint- with the price level in most of the country. The new dinars could then be exchanged at a one-to-one rate with the Saddam dinar. To prevent confusion with existing Swiss dinars, the new dinars would also be printed in different colors. Anticotmteifeiting measures would also be included.
Figure 4 shows the exchange rates for the Saddam dinar in mid-2003. On May 5, 2003 (the earliest date for which official daily data are available), the exchange rate for the 250 stood at about 2,000 to the dollar while the rate for tlie 10,000 stood at more than 2,500. The 250/10,000 gap fluctuated between 15 and 35 percent following the July 7 announcement of the impending banknote exchange. The gap finally closed in the first week of September 2003, a few weeks before the start of the currency exchange, when both denominations traded near 2,100 to the dollar. By mid-2004, the dinar has since strengthened to about 1,450 to the dollar.
On October 15, 2003, the currency exchange for new dinars began. The massive movements of currency arotmd the country went off well, although two currency convoys were unsticccssfully attacked in an intense firefight near Samarra in late November 2003. By the time the currency exchange ended three months later, a potind of old currency had been turned in for every man, woman and child in the country.
Reopening Banks and Encouraging Lending Though some private banks exist, Iraq's banking system is dominated by the
two state-owned banks, Riifidain and Rasheed. Taken together, in 2003 these two banks held about 90 percent of total banking sector assets {about $2 billion) and operated 340 branches around the country. Each of these branches was a tempting target to postwar looters. Some bank managers displayed great braveiy in the days following the war, saving the assets and records of their banks from being stolen or destroyed. Most vatilts were not breached by looters, though doors were damaged and building interiors were trashed.^ Reopening bank branches presented financial and logistical challenges, such a.s organizing a military escort for currency move- ments to a re-opened bank. Despite these challenges, most bank branches had been reopened by the end of the summer.
The Coalition Provisional Authority took two major steps in 2003 intended to
•* One example is the Central Bank of traq itsplf, where looters atiempu-d to blow open ihe vaults. Perhaps iinbcknown.st lo them, Ihe vaults liad held a prkeless collection of ancient jeweliy, the Trca-suresoCNimriKi. Fortunately, the dooi^s held, thoiij^h tfic central bank building it.self was gulted and burned in the immediate postwar chaos.
Economic Policy and Prospects in Iraq 63
Figure 4
Exchange Rates for the Iraqi Dinar
3000 n
250() -
= 2000 •a
I 1000 -
500-
Values on Mav f>
Banknote Exchange Announced (July 7)
(Missing data for lOK)
lO.OOO-dinar note
Banknote Exchange Begins (Octotier 15)
New Dinar
CN i i ' ' Ĥ TV , V ^ X * > C \ ^ cW^ ji*J^ LVO rV*,i ^ jJO j,\> |-\* i-JO -JO - M i W _-i*J ,.-A.i c «
strengthen Iraq's banking indtistry over the long run. In November, the Trade Bank of Iraq was begun to facilitate large international transactions. In late Sep- tember, the Coalition and the Governing Council isstied a 66-page commercial bank law that followed international best practices, covering virtually all aspecLs of banking operations. The order requires that the country's private banks have paid-in capital of at least 10 billion dinars (around $5 million at that point), though the country's 17 existing private banks were given 18 months to reach that amount. The bank law also allows six foreign banks to have majority-tjwned subsidiaries or to establish branches in Iraq during the next five years, and allows an unlimited number of foreign banks to buy up to 50 percent of an existing Iraqi bank. Other financial reforms included the "micro-lending" credit facilities established around the country and the liberalization of interest rates, which took place on March 1, 2004.
International Openness After more than a decade of international sanctions and limited trade, Iraqis
were starved for imports. Soon after entering Baghdad, American officials an- nounced that Iraq's borders were open, and on June 8, 2003, the Coalition formalized a "tariff holiday" that eliminated virtually all barriers to trade until December 31, 2003. Imports poured into Iraq's stores, street markets and roadside stands. Demand was especially strong for goods that had been prohibited by the previous regime, such as satellite dishes.
The tariff holiday was never intended to be permanent. On September 19,
64 Journal of Economic Perspectives
2003, the Coalition isstied an order calling for a uniform 5 percent "reconstruction surcharge" to be levied on imports into the country, excluding food, medicine, clothing and books. Some advisors would have preferred a zero surcharge, while other advisors argued that the distortionary effects of a small, uniform tariff were jiistified given the desire for government revenues. After some rescheduling (to allow a collection system to be set up), the le\y was ultimately scheduled to go into effect on April I, 2004. The levy is set to end on January 1, 2006.
Encouraging Iraqis to embrace an open foreign-investment regime was also a Coalition priority. Iraq's previous government had barred investment from non- Arab countries. After the war, many Iraqis feared that allowing better funded and more productive foreign firms into fraq would destroy domestic businesses. Econ- omists from the Coalition and from international financial institutions responded to these concerns with three arguments. First, tbt'y noted that Iraq was starved for capital. If foreigners could supply some of the capital that Iraq needed, so much the better. Second, they argued that foreign investment would dilute the power of rich domestic investors who had amassed their fortunes through corrupt connections with the previous regime. Third, they cited studies and presented data showing that in other countries, foreign investment has been a prime source of technology transfer and downstream demand for domestically produced goods.
After some debate, the Governing Council endorsed this view. In September 2003, Iraqi Finance Minister Kamel al-Gailani announced a new foreign investment law designed to treat all foreign investors the same as domestic ones. The new law allows foreign investors to own 100 percent of businesses outside of the natural resource industries like the oil sector. All after-tax profits can be repatriated. In addition to the bar against foreign oil investment, the law requires that foreign retailers post a $100,000 bond and prohibits foreigners from purchasing land, which can nevertheless be leased for up to 40 years, in February 2004, Iraq was granted obsei^er status at the World Trade Organization.
Fiscal and Monetary Policy Iraq's oil wealth means that it does not have to levy domestic taxes. Arguments
for the exclusive use of oil revenues to fund the government include the distortions that arise from any proportional tax and the costs ot administering a tax system. In Iraq's case, the stimulus to business of a no-tax regime might be especially valuable, because Iraq's exports of natural resources may put upward pressure on its real exchange rate and thereby limit nonenergy exports (the so-called "Dutch disease"). Yet a tax system would allow Iraqis to experience directly the opportunity cost of government spending. It would also send a message to international donors that Iraqis are bearing part of the cost of their own reconstruction.
In September, the Coalition announced that all taxes for 2003 were sus- pended, but that taxes would be imposed for future years. The final tax strategy calls for indi\idual taxes to be assessed on a progressive basis beginning April 1, 2004, witb the top individtml rate of 15 percent kicking in at incomes of about per year. Business income is to be taxed at a flat rate of 15 percent.
Christopher Foote, William Block, Keith Crane and Simon Gray 65
Oil exports also influence Iraq's monetary policy, because two-thirds of Iraq's economic output is received by selling oil to international markets for a price denominated in U.S. dollars. Hence, monetary policy is closely intertwined with the exchange rate and how these U.S. dollars are converted to dinars. Early on, Coalition advisers considered an exchange rate regime involving a hard peg to the U.S. dollar (or other foreign currency) to provide the economy with a transparent nominal anchor.' Ultimately, Iraq has adopted a de facto managed float instead. A floating exchange rate allows Iraq's economy some cushion for oil-price shocks, since a drop in the oil price is likely to cause the dinar to fall. This would encourage Iraq's as-yet-limited nonoil exports to rise and increase demand for its import- competing industries.
Central banks in small open economies typically intervene in currency markets to limit extreme volatility. Currently, the tool used by the Central Bank of Iraq to influence the exchange rate and control the growth of the domestic monetary base is a foreign exchange auction, which has occurred on a daily basis since October 2003. The Ministry of Finance sells dollars from its oil receipts to the Central Bank of Iraq, purchasing dinars to pay for government operations. The Central Bank of Iraq then sells some of those dollars in the daily foreign exchange auctions. Transactions at this auction were typically $10-$15 million a day by the end of March 2004.
As of mid-2004, Iraq is effectively a dual-currency economy, in which major consumer purchases are priced and paid for in dollars. Although dinars are preferred for small-scale transactions, dollars are readily accepted. Consequently, fluctuations in the exchange rate have an immediate impact on the money supply, real and nominal, as denominated in a combination of dollars or dinars. In the future, the Central Bank of Iraq will be able to undertake open market operations, trading existing Ministry of Finance securities. For the immediate future, however, the foreign exchange auction is likely to remain the central bank's primary mon- etary policy tool.
In the long run, the credibility and independence of the Central Bank of Iraq will be vital no matter what its specific monetary instruments. In March 2004, the Coalition and Governing Council adopted a central bank law that incorporates global best practices. Central to the law is the statement that "[t]be primary objectives of the CBI [Central Bank ol Iraq] shall be to achieve and maintain
"̂ In particular, a currency board arrangemenl would have required that the Centra! Bank of Iraq only issue new currency when the hills were fully backed with foreign exchange reserves. But this approach had practical difficulties. It was dilhcult !o know the correct parity between the dinar and the dollar. Additionally, central banks can circumvent a ctirrency board through official borrowing of foreign currency from abroad. Finally, had Iraq been required to back iLs currency fully with dollar-denominated assets, it would have been forced to purchase from $2-$4 billion of financial securities that would have been better invested in Iraq's infrastructure. Once a currency board was ruled out, a hard exchange rate peg without full backing was i-uied out as well, since it seemed likely to encourage speculators to test the peg by selling dinars for dollars until (he central bank had drained its foreign exchange reserves and was forced to break the peg.
66 Journal of Economic Perspectives
domestic price stability and to foster and maintain a stable and competitive market- based financial system. Subject to these objectives, the CBI sball also promote sustainable growth, employment, and prosperity in Iraq."
Legal Reform Over time, Iraq's commercial laws were corrupted by the inclusion of socialist
objectives or imperfect enforcement of the laws by the former regime. On April 1, 2004, the Coalition and Governing Council issued an amended version of the Companies Law of 1997, streamlining registration procedures for private firms (so they can be completed in a month or less) and removing tbe ability of government planners to control private business decisions. Work was also underway on reform- ing Iraq's bankruptcy, labor and secured transactions laws. By Marcb 2004, the Coalition had also vetted 80 percent of Iraq's judges, removing 25 percent and hiring an additional 130. A Commission on Public Integrity had been formed, and Inspector Generals were planned for each government Ministry.
Reforms Left for Future Iraqi Governments
As of early April 2004, most economic reforms that had been enacted did not entail much short-term sacrifice on tbe part of Iraqis. Iraqis were generally glad to get a new currency. They were not immediately affected by new banking or commercial laws, nor bad the infrastructure for tax collection yet been put in place. But achieving maximal rates of per capita income growth in tbe long run will require some short-term sacrifices. This section discusses two reforms that were left undone by the Coalition for fear of worsening unrest in the country. It concludes with a third tbat was omitted for fear that there was no margin for error in case it went wrong.
State-Owned Enterprises Reform of Iraq's state-owned enterprises still has far to go. In 2003, the
Coalition prevented the state-owned enterprises from accessing tbeir bank accounts and limited any subsidies to formal budget items, in contrast with tbe past conven- tion of providing implicit subsidies via below-market exchange rates or other surreptitious accounting conventions. The Coalition also erased all debts between state-owned enterprises as of the end of the war. Tbis was done in order to get the state-owned enterprises to focus on becoming productive in tbe future and to avoid wasting resources on collecting debts inctirred by other state-owned enterprises in the past. Originally, tbe Coalition intended to pay tbe salaries of tbe workers of state-owned enterprises only tbrough tbe end of 2003, but Iraqi opposition to a salary cutoff caused payments to be extended into 2004.
The Coalition has begun taking applications from investors interested in leasing some large state-owned enterprises, which could be a first step to privatizing them under a future Iraqi government. State-owned enterprises have also entered
Economic Policy and Prospects in Iraq 67
into joint ventures with foreign firms, including a deal that a construction state- owned enterprise .signed with a Saudi firm. Yet many state-owned enterprises will have to be closed, including the sugar refinery in Sulamaniyah that was destroyed in the Iran-Iraq war but which never laid off its workforce. An optimal way to close state-owned enterprises would be to give each unemployed worker a large sever- ance payment. Such a pajTncnt would not only cushion the blow of losing a job, but also would give tbe worker some seed money to start his own business should he so desire.
Raising Energy Prices Energy prices in Iraq are far too low. Because of government subsidies, the
price of premium grade gasoline is 50 dinars (or 3.2 cents) per liter, compared with more than $1 per liter in Turkey, $0.42 in Jordan and $0.50 in Syria. Much of the benefit from Iraq's oil subsidies flows to illegal exporters and black-market resell- ers, who profit from the discrepancy in prices. Other forms of energy, such as electricity and liquid propane gas, are also heavily subsidized. The total opportunity cost of the provision of oil products at government-established prices is about $4.9 billion per year—equivalent to more than a third of the 2004 budget. Exac- erbating the costs of the oil product subsidies are their distortionary effects. The U.S. government appropriated $690 million to assist Iraqis in buying for kerosene and other refmed oil products, but Iraqi "demand" for these products at the subsidized prices still could not be satisfied. Moreover, investment funds are being misallocated as Iraqi households purchase diesel generators and air conditioners that will become uneconomical when fuel prices rise to reflect true costs. Finally, the bulk of the subsidies go to the rich, who own more cars, have larger homes and consume more electricity than the poor.
Liberalizing energy prices is bound to be controversial. But tbe experiences of other countries shows that political unrest is minimized by announcing the pro- gram far ahead of time and by ensuring that market demand is met by true liberalization (so that the program is not seen merely as justification for an arbitrary price bike). Unrest is also reduced when it is clear to households that the policy will not be rescinded and when prices are increased in a time of economic upswing, rather than in a downturn.
Replacing Food Rations with a Cash Payment or "Oil Dividend" One ptJtential reform would improve Iraq's microeconomic climate while
establishing a precedent for tbe distribution of oil revenues at the same time. The government's food ration system, now funded by oil sales, could be turned into a monthly allocation of cash. The funds would then provide a source of demand for Iraq's private sector, expand the consumption set of Iraqis and establish the crucial precedent that Iraq's oil wealth belongs to its people and not to the government. To ensure stability, the program could be phased in geographically, neighborhood by neighborhood, after a series of trials.
While most economists were excited about the possibility of monetization,
68 Journal of Economic Perspectives
many Iraqis felt that the cotintry had enotigh on its plate in 2003 and 2004. Undertaking such a massive reform might be destabilizing if people worried that the private sector could not respond quickly enough to meet the cotmtry's food needs. Yet given the benefits of monetization, it is likely that future governments will consider it seriously.
Conclusion: Iraq's Economic Prospects
The year 2004 should sec a sharp economic expansion in Iraq. In addition to private-sector growth, employment driven by public spending is rising, with the Coalition having created about 380,000 jobs directly as of early March 2004. About 220,000 of these jobs were in security or national defense, witb another 68,000 persons working as civilian contractors on (Coalition projects and the remainder in regional jobs programs or military support.
The International Monetary Fund estimates that Iraq's GDP should grow almost 30 percent in dollar terms this year, due in large part to reconstruction expenditures. The United States, for example, plans to allocate $10 billion of the $18.4 billion in reconstruction expenditures it appropriated in late 2003. About 40 percent of these funds should be spent in Iraq. Reconstruction expenditures will also be financed by Iraq's own budget, which remains extraordinarily reliant on oil revenues: More than 95 percent of government revenues in 2005 and 2006 are to come from the oil sector. Thus, Iraq's budget is highly vulnerable both to the risk of sabotage of oil production and also to fluctuations in the world market price of oil. Iraq will not have to pay down its foreign debt until 2005 at the earliest Several large creditors have agreed to "substantial" debt reductions, though details have yet to be worked out
In the long nin, economic growth in Iraq will depend on fostering private- sector growth outside the oil sector. This, in turn, will hinge on whether the future political system maintains the pro-market outlook of Coalition policy. Whether Iraqis are willing to look to the private sector for jobs and prosperity—rather tban to the government that has literally fed them for years—is an open qtiestion. One of the most disheartening pieces of economic information to emerge from Iraq in 2004 was contained in a poll commissioned by the International Republican Institute in December 2003. The poll asked Iraqis what positions they would find most appealing in a political party. Results are graphed in Figure 5. By far the most popular position was "more government jobs," which was endorsed by 49 percent of Iraqis. By contrast, less than 5 percent of Iraqis supported "more private sector jobs." Part of the support for government employment may refiect a desire for stability amid the massive changes going on in the economy. But support may also result from the government's traditional role at the center of Iraq's economic life.
Countering the inertial obstacles to market reform in Iraq will be tbe large group of Iraqis who have embraced market opportunities in the past 18 months— importing goods for sale, opening new firms, seeking out customers for their banks and foreign partners for joint ventures. Iraqi exiles are also returning to the
Christopher Foote, William Block, Keith Crane and Simon Gray 69
Figure 5
Political Attitudes of Iraqis "/ would be more likely to support a party that advocated or p r o m i s e d . . . "
More governnifni jobs Strengthening Iraqi police
Improving electrical service Lowering the price of basic goods
Strengthening Iraqi amiy improving border protection
Promoting religion as a basis for government Departure of Coalition forces
Improving education Improve housing, pensions, and health care
Promote ethnic and religious harmony Higher salaries
Separating religion and governmenl More private sector jobs
Keep Coalition forces until security is good Get telephones working
148.9% I 32.9%
129.1% I 26.8%
12.5.5% 123.1%
country, no doubt driven by the desire to help their country rebuild while making money at the same time. Given these opposing forces, it is impossible to predict the future direction of Iraqi economic policy. The only certainty was voiced by Ambas- sador Bremer in his speech in Amman more than a year ago: "Just as forming a vibrant political climate in Iraq will entail many challenges, so too creating a vibrant economy in Iraq will not be easy."
• The views expressed in this paper are solely those of the authors and do not reflect official
positions of the Coalition Provisional Authority, the U.S. Treasury, the Bank ofFngland, the
U.S. Federal Reserve System or any other national or international agemy. Officials of the
International Monetary Fund and World Bank participated in many of the discussions
outlined in this paper. Though the number of people luho iimrked loith us and thereby
contributed to this paper is far too large to name, we would like to note the particularly useful
contributions two persons: Scott Brown, the IMF's resident representative in Iraq, who was
injured in the bombing of the Canal Hotel on August 19, 2003; and Jacob Nell, a senior
adviser to Iraq's Ministry of Finance on leave from the British government, who was injured
in the attack on the Al-Rmheed hotel on October 26, 2003.
10 Journal of Economic Perspectives
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