Iraq's economy: Past, present, future

Report
from Government of the United States of America
Published on 03 Jun 2003
Jonathan E. Sanford
Coordinator
Foreign Affairs, Defense, and Trade Division

Summary

For most of its history, the government of Iraq has played an active role stimulating and directing the Iraqi economy. This pattern was most pronounced during the recent regime of Saddam Hussein, which was at root a centrally-directed command economy with some trappings of market economics and crony capitalism. Iraq's industrial sector was created, in large part, as a result of government efforts to diversify the economy through economic development projects using the proceeds from Iraq's oil wealth and borrowed funds. Many of these initiatives were not viable without government subsidies. Much of the industrial base has now been destroyed, either by direct attack in the Iran-Iraq or the two Gulf wars or through atrophy caused by neglect. Iraq has suffered absolute declines in gross domestic product (GDP), chronic inflation, wholesale depreciation of its currency, virtually non-existent foreign investment and the accumulation of a crushing debt burden.

This report, which will be updated periodically, identifies issues to be addressed before Iraq can participate normally in the world economy. It will need civil peace and a new legitimate government - Hague and Geneva conventions place limits on the capacity of an occupying power to restructure or develop the economy of an occupied state by its own decisions alone. It will need a sound monetary system and a market-oriented banking and finance system. It will need to recast its industrial sector on sounder principles with attention to productivity and relative prices. It will also need to ensure that the government cannot use the massive oil revenues passing through its hands to establish once again a new authoritarian regime.

Should Iraq's oil fields be restored to their pre-war conditions, Iraq could reenter the world oil market as one of the largest suppliers, generating up to $24 billion in annual revenues. It has large undeveloped potential. Long term, it may be the world's largest oil producer, generating even larger export revenues - perhaps doubling or more its income within a decade. How Iraq uses this prospective oil wealth - and its effect on the rest of the economy - will be a concern. At present, its oil revenue will go into the internationally-audited Development Fund for Iraq. Iraq's agricultural sector is small. Output during the 1980s was stimulated by incentives and subsidies, but production lagged and imports supplied most of the country's agricultural needs. During the 1990s, through poor practices, Iraq's farmland was heavily damaged by salinization. Years will be required to rebuild Iraq's agricultural productivity. In the meantime, Iraq will rely on imports to meet its agricultural needs. As a result, among other things, urbanization will increase.

Iraq has large foreign debts, with estimates ranging from $42 billion (plus unpaid interest since 1991) to $64 billion and $78 billion. This does not include 1980s war-loans from Gulf or other Arab states or war damage claims. Most of the debt stems from the Iran-Iraq war or from loans incurred before 1990 to fund consumer needs and industrial or infrastructure projects. The earlier U.N. sanctions regime and the Security Council resolution of May 22, 2003 shield Iraq against action by its creditors and claimants to settle claims. The issue will need to be resolved before normalization of Iraq's international trade and financial relations can occur.

Contents

Introduction
Government and the Economy

- The Constitutional Monarchy

  • Government
  • Economic Policies
- The Military Regimes
  • Governments
  • Economic Policies
- The Baathist Regime
  • Government
  • Economic Policies
Demographic and Social Conditions

- Overview
- Role of Women in the Government and Economy of Iraq

Iraq's Economy in Recent Years

- Macroeconomic Policy and Conditions

  • Economic Policy
  • Gross Domestic Product (GDP)
  • Currency and the Balance of Payments
  • Inflation
  • Foreign Investment
  • Foreign Debt
  • Compensation Claims
  • Pending Contracts
- The Oil for Food Program
- Petroleum
  • Oil Resources - Overview
  • Oil Production - History
  • Current Situation
  • Iraq's Oil Industry - Current Status
  • Iraq and OPEC
  • Potential Iraqi Oil Revenues
- Agriculture
  • Overview
  • Agro-climatic setting
  • Pre-U.N. Sanctions (1980-89)
  • U.N. Sanctions period (1990 to 2003)
  • Prospects
- Banking and Financial Institutions
- Transportation and Infrastructure
  • Shipping
  • Railways
  • Air Transportation
  • Roadways
  • Communications
  • Power Generation
- Industry
  • Industrial Development
  • War and Sanctions
  • Prospects
- International Trade
  • Exports
  • Imports
  • Illicit Trade
  • Prospects
  • Fiscal Levies on Foreign Trade
The Post-War Situation

- Assessing the Damage

  • Critical Infrastructure
  • Transportation Infrastructure
- Humanitarian Assistance and Post-War Relief
  • Provision of Relief
  • Medical Services
  • Food Supplies
  • U.S. Activity
Major Issues Affecting Iraq's Economic Future

- Preconditions for Economic Development
- Avoiding Rentier State Authoritarianism

  • Oil and Authoritarianism
  • Possible Alternatives
- Reviving the Non-Oil Economy
- Settling Debt and Overhanging Claims
- Establishing a Currency and Monetary System
  • The Dinar Lacks Sufficient Credibility
  • Interim Dollarization by Default
  • A New Currency Requires Key Decisions
  • Importance of Monetary Control
  • Choosing an Exchange Rate Regime
  • Short-run Credibility vs. Long-run Flexibility
  • Oil and Monetary Policy
- Rebuilding the Financial System
  • Change to a Market-Based System
  • Administration Plans
- Export and Border Control Capabilities
- Access to Foreign Resources
  • Iraq and the International Financial Institutions
  • The United Nations Development Programme
List of Figures

Figure 1. Iraq's Gross Domestic Product
Figure 2. Sectoral Composition of GDP, 1989
Figure 3. Iraq's Oil Production and Consumption, 1980-2002 (Est.)

List of Tables

Table 1. Iraqi Oil Production, Current and Potential
Table 2. Iraq's Top Exports, 1989
Table 3. Iraq's Top 10 Imports, 1989
Table 4. Iraq's Imports under OFFP, 1997-2003

Iraq's Economy: Past, Present, Future

Introduction1

This report provides information on the economy of Iraq in the recent past and on current post-war conditions. It also discusses issues and factors which will likely influence Iraq's future economic prospects. In the 1980s, Iraq had one of the Arab world's most advanced economies. Though buffeted by the strains of the Iran-Iraq war, it had - besides petroleum -- a considerable industrial sector, a relatively well-developed transport system, and comparatively good infrastructure. Iraq had a relatively large middle class, per capita income levels comparable to Venezuela, Trinidad or Korea, one of the best educational systems in the Arab world, a well educated population and generally good standards of medical care. Nevertheless, Iraq was a centrally directed command economy that was heavily dependant on oil revenue to fund its key institutions and its development program. Iraq experimented in the late 1980s with privatization, functional autonomy for some elements of the economy, and limited use of market forces. This initiative ended, however, with the advent of the first Gulf war.

In the dozen years since 1991, Iraq's industrial and agricultural capacity has decayed, its transportation and infrastructure systems have deteriorated, and the education levels and standard of living for its population have declined. Oil exports resumed under the U.N. Oil for Food Program (OFFP) after 1995, albeit at a lower rate. However, its production capacity deteriorated from lack of inputs. Some economic facilities were damaged in the recent war and its chaotic aftermath. In effect, Iraq must start over as it rebuilds its economy. Its massive oil resources can serve as an engine of future growth and development. It does not start, though, with a blank slate. The experience, expectations, and aspirations of the past will have important - if unknown - effects on Iraq's future economy. What Iraq learns from its past and how it adapts itself for the future will be important considerations.

An important feature of centrally planned economies, such as Iraq under Saddam Hussein, is the absence of the legal, political, economic, and regulatory institutions that are the necessary underpinning of successful market economies. According to Dani Rodrik, a prominent development economist, "in the long run, the main thing that ensures convergence with the living standards of advanced countries is the acquisition of high-quality institutions."2 Institutions are the "rules of the game," the sets of rules and norms that organize society and allow a market economy to function. Thus, the focus of the Iraqi reconstruction efforts must be the creation of institutions that not only stabilize the economy, but can serve as an engine for sustained long-term growth. Iraq will need to learn how to build and maintain good institutions and how to use them effectively to rebuild its economy.

This report provides background on the different sectors and institutions of the Iraqi economy. It also identifies some questions and issues which may have significant bearing on Iraq's future prospects and may need to be addressed as Iraq, the United States, and the international community seek to put the economy of Iraq on a sounder long-term foundation.

Government and the Economy3

The history of Iraq during the 20th century falls into three fairly distinct periods:

  • 1921-1958: A constitutional monarchy under direct British control at first and later under significant British influence.

  • 1958-1968: A series of nominally republican regimes headed by military officers who assumed power in most cases through a military coup d'etat.

  • 1968-2003: A government controlled by the socialist, pan-Arab Baath Party, which quickly developed into a vehicle for one-man rule by leading party official Saddam Hussein.
The Constitutional Monarchy

Government. During the first period, Britain established a monarchy in Iraq under King Faysal I, a leading member of the prestigious Hashemite family (of which a collateral branch continues to govern Jordan). In 1932, Iraq became an independent country, but the bilateral treaties replacing the British mandate provided for a continued British role in Iraq, particularly in defense and foreign affairs. Rising opposition to Iraq's western ties and mounting nationalist sentiment among younger Iraqis including the armed forces created growing disaffection from the regime. In July 1958, a group of army officers led a coup in which the King and leading officials were killed, many other officials imprisoned, and a republic was proclaimed.

Economic Policies. Economic institutions developed slowly during the early years of the Iraqi monarchy as the nascent government sought to establish itself and deal with internal tensions and ripple effects of World War II. With the advent of mounting oil revenues in the 1950s, Iraqi were able to concentrate to a greater degree on the nation's economy. At this time, Iraq's economy was largely market-oriented, but based more on feudal and traditional rather than on modern principles. A development board, established in 1950, promulgated multi-year plans that emphasized three priorities: agriculture (including irrigation and flood control), transportation and communications, and construction. Commentators have praised the board for using most of the country's oil income for capital investment and infrastructure development. Some fault it, however, for over-emphasizing agriculture and under-emphasizing industry and human resources, which would have appealed to two increasingly important constituents: the educated elite and the workers.4 By neglecting these groups, the government may have contributed toward the climate of disaffection that helped bring on the revolution in 1958, although political opposition appears to have been a more important factor in the demise of the old regime.

The Military Regimes

Governments. Three military leaders governed Iraq in succession during the decade that followed the overthrow of the Iraqi monarchy by left-wing nationalist army officers. The somewhat eccentric General Abd al-Karim Qasim, who led the coup of 1958, terminated Iraq's ties with the West, withdrew Iraq from the Baghdad Pact, and aligned Iraqi policies to a considerable degree with those of the Soviet Union. Steady erosion of his power base, sapped by growing domestic unrest (including the beginning of a Kurdish insurgency) and regional quarrels, led to a second coup in which Qasim was overthrown and killed in February 1963. Qasim's successors, Generals Abd al-Salam Arif and Abd al-Rahman Arif,5 took somewhat more moderate positions on regional and international affairs, established better relations with other Middle Eastern states (particularly Egypt under then President Gamal Abd al-Nasser), and adopted a more friendly stance toward the West, while retaining ties to the Soviet Union. However, the Arif regimes faced further domestic instability, the Kurdish insurgency continued to simmer, and the government lost much of its credibility-as did other Arab regimes-after Israel quickly defeated Arab armed forces during the "six-day war" in June 1967. A year later, on July 17, 1968, the Arif regime was overthrown by the Baath Party.

Economic Policies. The revolutionary regimes of 1958-1968 reversed many of the economic policies of the old regime, although like the monarchy they continued to devote major resources to transportation and communications, as well as military modernization. General Qasim, the first of the military rulers, and his key advisors were influenced by socialist models and emphasized several themes which bore this stamp: a planned economy, elimination of foreign economic influences (notably in the oil sector), and land reform. The Development Board, associated by Iraq's new leaders with the old regime, was abolished and replaced by a ministry of planning, together with a planning board. In 1961, Qasim moved against one of the principal vehicles for foreign involvement in Iraq's oil sector, the partly British-owned Iraq Petroleum Company (IPC). Law Number 80 expropriated 99.5% of IPC's concessionary area, leaving the company only those areas currently in production. (Iraq subsequently nationalized the company itself, in June 1972.) Land reform, perhaps the most significant of Qasim's economic measures, was an ambitious undertaking designed to break up the old feudal system of land ownership and redistribute land to peasants; however, implementation was slow as the government sought to put in place the necessary machinery to administer the program. One commentator has said the early reform measures "did more to destroy the edifice of the old regime than to construct the foundations of the new."6

Basic economic policies inaugurated by Qasim continued under his two successors, although at a somewhat slower pace. The Arif governments adopted additional measures to increase the role of the public sector in the economy; in July 1964 it nationalized all banks and insurance companies and in the same month it nationalized the 27 largest privately owned industrial firms. The government also reorganized other companies, required profit sharing with workers, and participation by workers in management. These and similar measures contributed toward capital flight and departure of trained management, with an accompanying decline in industrial development during the 1960s.

Footnotes:

1 Prepared by Jonathan E. Sanford, Specialist in International Political Economy, and Martin A. Weiss, Analyst in International Trade and Finance, Foreign Affairs, Defense and Trade Division.

2 Dani Rodrik. "Growth Strategies." April 2003. Available at [http://www.ksg.harvard.edu/rodrick.]

3 Prepared by Alfred Prados, Specialist in Middle East Affairs, Foreign Affairs, Defense and Trade Division.

4 See, for example, Phebe Marr, The Modern History of Iraq, Boulder, Colorado, Westview Press, 1985, pp. 134-135.

5 General Abd al-Salam Arif came to power in conjunction with the Baath Party but ousted his erstwhile Baathist collaborators in a third military coup nine months later. President Arif was killed in a helicopter crash in April 1966 and succeeded by his brother, General Abd al-Rahman Arif, who was serving as chief of staff of the armed forces.

6 Phebe Marr, The Modern History of Iraq, p. 169.

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