Doing Business In Iraq

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When I set out to write a story on Iraq's economic situation, I didn't just want to trace the GDP statistics.  For one thing, as I wrote years ago, the statistics in Iraq are terrible.  They've gotten a little better since then, but we still don't know basic things like how many people there are in Iraq. The last full census was taken in 1987 (the 1997 census excluded Kurdistan), and while the Iraqis need to take a full census in order to settle the final status of Kurdistan, they're afraid to do so, because it will make official what has long been evident: the long-dominant Sunnis who fueled the insurgency are a minority of the population.  It is also likely to inflame tensions in disputed mixed-ethnicity areas like Kirkuk, which is claimed by both Kurdistan, and the rest of Iraq.  So they've delayed it again and again; at this point, I've lost count of how many times.  As you can imagine, this makes it hard to calculate things like per-capita GDP.  So does the sizeable grey economy.


The other reason not to simply say "how's the economy doing?" is that the economy is so dependent on oil.  When oil prices are high, Iraq does well; if they don't, the country is in trouble.  This may be a fine thing for the Iraqis (though it has its drawbacks, in terms of kleptocracy), but it is not the sign of a healthy, productive, economy.  For Iraq's people to be really prosperous, they don't just need to extract rents from the black stuff in the ground; they need to build productive capacity in other sectors.

Since the invasion, I think it's pretty clear that living standards have risen (quality of life, which would include the heightened risk of violence, and also the lesser risk of being tortured by your awful authoritarian regime, is a little harder to assess).  Access to electricity has improved pretty dramatically, as their government and ours have started to repair Iraq's crumbling infrastructure (though this has been uneven--Baghdad, which used to get 24 hours a day of electricity, now has to share with the rest of the country, so their service level has dropped, making the residents very angry).  The sorts of consumer goods that require electricity have also risen substantially, as the lifting of sanctions has made it easier to bring these things into the country.  Other basic needs such as potable water, adequate fuel, trash collection, fire service, and so on are also being better filled.  Meanwhile, of course, higher oil prices are making the country richer--and since the government employs about half the country's workers, and many more Iraqis receive basic income support from the state, this has translated into a better standard of living for Iraqis.

And yet the economy is most definitely not healthy.  The oil sector is in the best shape, and it's not good.  Production has basically not improved from prewar levels.  This may change now that FDI has poured in from foreign oil companies (interestingly, not American ones, who have gotten little foothold in the country).  But like everyone else, they're hampered by the still-unreliable electricity grid, the terrible infrastructure for storing and transporting oil, and the rampant corruption.  Right now, the government's oil revenues are being propped up by higher oil prices, not enhanced capacity.

The other sectors of the economy are much, much worse.  The agricultural sector, which has a fair amount of water available, is hampered by primitive irrigation techniques, which exacerbate soil salinization, and government controls.  As a result, according to one government minister, Iraq imports about 80% of its food.  One of the experts I talked to said that a frozen chicken from Brazil costs less in the Baghdad markets than a fresh chicken raised a few miles away in the city suburbs.

The industrial sector, meanwhile, barely exists.  Most Iraqi factories are still closed, and the government's attempts to auction off its state-owned firms have mostly gone nowhere, resulting in only a handful of privatizations.  As I chronicle in my article, this is in large part because the government itself is unwilling to really liberalize--not at the risk of unemployment.  Looking at the demonstrations in other Arab countries right now, some of which are at least partially fueled by liberalizing measures, this is not surprising.  But it is crippling.  No one is going to buy a factory if the government demands--as it apparently has in some cases--that you keep it overstaffed by a factor of ten.  Even a very basic good like cement, which is relatively simple to produce, and critical to rebuilding Iraq's infrastructure, is mostly being imported from abroad.

The banking sector is also dominated by the state, also moribund and inefficient, and not really in the business of providing either loans or services to most Iraqis--one person I talked to recounted having to carry tens of thousands of dollars worth of cash around when they put on a conference in Iraq, because the hotel was not set up to take checks or credit cards.  Naturally, this hampers entrepreneurship, as does the fact that a bunch of capital fled Iraq during the invasion and the insurgency, and hasn't come back.  Meanwhile, the niches, like retail, that are customarily filled by small business are hampered by excess regulation, corruption, and poor infrastructure. 75% of Iraqi business owners surveyed by CIPE in 2007 reported that corruption added at least 10% to their cost of doing business, and 20% said the added cost was 40% or more.  This is not necessarily the most immediate concern of business owners, who often worry more about things like adequate electricity.  But it is probably the biggest long term problem.  The World Bank now ranks Iraq 166 out of 183 countries on its "Doing Business" survey (Afghanistan is right below it); with the exception of a few places like Venezuela and East Timor, most of the countries below them are in sub-Saharan Africa.

But transitions are hard, many of my commenters have already noted--isn't the important question what the future holds?  I'm afraid that, much as I would like to, I didn't find a lot of reasons to be all that optimistic.  Since 2003, growth has been driven by a few trends:

1)  Rising oil prices
2)  The lifting of sanctions
3)  Increasing supply of things like electricity and cell phones thanks to regime change
4)  The decline of violence

Infrastructure is, of course, a big boon to manufacturing--but it is not, by itself, a sign of an economy on the mend.  The US had a healthy economy in 1885 with almost no electric capacity, because it had a lot of entrepreneurs and seasoned capitalists, and an environment that let them thrive.  Iraq is not generating really substantial new domestic production of anything; it can't even revive much of the capacity it had.  If all Iraq does is remove the worst of the Saddam-era limitations, it will still be a very hard place to live.

One of the great mistakes that free market economists made was the way they handled Russia's transition to a non-communist regime.  With little experience with the abrupt fall of an entire economic system, we tried "shock therapy", which one might describe as "privatize them all, and let the market sort them out." 

It turns out that free markets are not just an absence of government intervention, or even a simple and clear set of rules.  Liberal market economies require a huge amount of what you might call "software" to run:  not just a good legal system, but respect for the law; not just a central bank, but consensus about the central banker's role; not just unrestrained trade, but a shared set of assumptions about what sorts of trades are fair; not just penalties but trust; not just anti-corruption laws, but a society that demands corruption cease, rather than attempting to use it to get around inconvenient but necessary rules.

After 70 years of communism, Russia had adapted its culture and institutions to living in a command economy.  When we ripped out the old system, they didn't simply adopt our values; they adapted what they already had to the new system.  The result was widespread corruption and violence against which Russia still struggles.  

Despite that lesson, we sort of did the same thing to Iraq.  We didn't prepare for the insurgency that surged into the power vacuum left by Saddam's fall, and we also didn't prepare for what institutions that had grown up under Saddam's rule would turn into in a post-Saddam economy.  According to Frank Gunter, one of the experts to whom I spoke, corruption is now getting worse.  The Saddam regime was bad, but it had reached a basically stable equilibrium.  Once we got rid of that, the corruption became was he calls "entrepreneurial", with ministries competing with each other to extract bribes.

And how do you best extract bribes?  You enact regulations for people to violate.  Iraq's regulatory regime is actually getting worse, not better, according to Gunter, pushing businesses into the grey economy.  Though some conservatives and libertarians have sort of a soft spot for people who protest excessive taxes and regulations by disappearing into the cash economy, this is terrible for the economy as a whole.  Grey market firms have little access to capital, difficulty enforcing contracts, and are constantly vulnerable to the whims of officials who extort favors or money.

This doesn't necessarily mean that invading was a net economic loss for the Iraqis.  (I think it was a bad idea, but the point of this article is not to fight another proxy battle over the correctness of the decision to invade.)  Sanctions were obviously crippling, Saddam was diverting a hell of a lot of money to his kleptocratic coterie, and the regime was not exactly good at generating economic growth, either.

But for Iraq to generate a healthy economy--rather than just another semi-failed oil state, with most of its population limping along on the income from dwindling oil reserves--it needs much more than the absence of Saddam.  When I started writing this piece, most of the war supporters I spoke to assumed that the major obstacle to economic growth in Iraq was Saddam's legacy--insufficient education, crumbling infrastructure.  Most of the war opponents assumed it was the violence.

But neither is the major problem now.  We're fixing the infrastructure, and the violence is declining.  Instead, the major problem is creating political and social institutions that support a vibrant, entrepreneurial business culture.  And that's not just absent now; it actively seems to be going in the wrong direction.  And the reason Iraq is going in the wrong direction is not that our violence begot violence, but that the freedom and democracy, which work so well in America, may actually be promoting more corruption and rent-seeking than a horrible dictatorship.  

Of course, I am not defending horrible dictatorship in any way, or saying that Iraqis would be better off under one.  But Americans tend to think that the good things about our system are something of a package deal.  And this is far from the truth.  Political and economic freedom here are bound tightly together because we have the political institutions, and bourgeois values, that keep them tightly linked.  Where that underlying software is absent, there may actually be a tradeoff.

This is not the final word, obviously.  But there are a lot of malfunctioning oil states in the world; history doesn't exactly give us a lot of reason for optimism.  And unfortunately, neither did any of the experts I talked to.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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