Business March 2011

When Freedom Is Bad for Business

How the U.S. invasion made Iraq’s economy worse, not better
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Karim Kadim/Associated Press

If you are planning to open a business in Iraq, I would advise you to bring a book. Something substantial, perhaps Tolstoy or Proust, or the unabridged Oxford English Dictionary. You’ll want a sizable knapsack, too, so you can comfortably carry not just all 20 volumes, but the enormous stacks of cash that the process will require.

Here is what the World Bank estimates you must do to open a new firm in Iraq. First, you will need to spend a couple of days deciding on a company name, determining whether it is already registered, and obtaining a “name reservation letter” from the Baghdad Chamber of Commerce at a cost of 350,000 Iraqi dinars ($300). Then, for about 900,000 dinars ($770), you must hire a lawyer to spend a day drafting articles of association for your company. You will need a couple more days to deposit 5,000 dinars ($4.30) in a commercial bank and obtain a confirming receipt, and up to two weeks and another 350,000 dinars ($300) to file for registration at the Commercial Registry. Advertising your incorporation notice in the local paper will set you back 80,000 dinars ($70), and you will lose another three days. Following that, you will expend two days and 20,000 dinars ($17) to make a company seal, but take heart—only one more day is needed to obtain your registration certificate from the Commercial Registry, which includes it absolutely free in the price of your registration filing.

Don’t get too giddy, however, because you’re not done yet. Registering with the tax authority and legalizing your accounting books will suck up four more days and 625,500 dinars ($535), followed by three days to register your employees for social security. Then you find a chair, open up Volume III of the OED, and settle in for the long wait: the 30-to-60-day process of applying for a trade license. All in all, the World Bank says, the process takes an average of 77 days and more than 2 million dinars, or nearly $2,000—more than 100 percent of Iraq’s annual per capita income. That’s why the World Bank ranks Iraq 174th out of 183 countries for starting a business; by contrast, in America (ranked ninth) the process takes six days and about $675. In America, in exchange, you’ll get a safe environment, ready electricity, clean water, and adequate roads. In Iraq, you’ll get a certificate from the Commercial Registry.

Eight years have passed since the invasion of coalition forces into Iraq. There seems to have been no one reason the war was launched, but certainly one of the things we often heard was that Operation Iraqi Freedom would liberate markets as well as people from the predations of Saddam Hussein’s odious regime. It’s hard not to cringe while reading George W. Bush’s October 2002 speech in Cincinnati, where he promised,

Freed from the weight of oppression, Iraq’s people will be able to share in the progress and prosperity of our time … rebuild their economy, and create the institutions of liberty in a unified Iraq, at peace with its neighbors.

Or The Washington Post opining that removing Saddam “would free millions of Iraqis from deprivation and oppression” and relieve the “political and economic backwardness” that fostered terrorism. Or, for that matter, your humble correspondent suggesting,

Most of the larger costs … aren’t going to be borne by Americans either directly or indirectly, but by Iraqi oil. That’s the oil that will be able to flow freely for the first time in ten years because of this war—and the revenue from which will flow to the Iraqi people for the first time in a decade.

Things haven’t turned out quite as we expected, which is why I have reluctantly come to believe that my country and I made a disastrous mistake. To be sure, the situation is not all bad. The violence has abated, Iraq now has an elected government, and the standard of living for most of the country is higher than it was under Saddam. We have not, as both I and some of the war’s fiercest critics suggested we would, helped ourselves to Iraqi oil.

But if American imperialism isn’t all that imperialistic, neither is Iraq’s free market very free. It remains hard to open a legal business, difficult to keep one running, and virtually impossible to shut one down. Frank Gunter is an associate professor of economics at Lehigh University and a Marine reservist who served as both deputy chief of coalition operations and the senior economic adviser to the U.S. military in Iraq. He points me to a grim recent study of Iraqi business: “They cannot find evidence that any business has been legally closed in the last 10 years. What they do if they want to close a business is wait until the day before payday, loot everything, and then disappear.”

Americans cannot avoid asking themselves the obvious question: did we do this? The troubling answer is that we may have—and more troubling still is how we may have done it. The biggest problem with Iraq’s business climate is no longer the lingering violence, according to Maura O’Brien-Ali, Iraq program officer at the Center for International Private Enterprise. “Security has changed dramatically over the last couple of years. You can see it in the perceptions of the local business community … That’s not the number-one issue anymore.” Nor is the biggest problem even the punishing legacy of Saddam’s totalitarian rule. No, it’s worse than that. Apparently, freedom and democracy themselves may actually be creating many of the most severe problems in the economy—our virtues, and not our sins, may be what’s hurting Iraqis.

Iraq is the birthplace of some of the world’s first great commercial centers. Nineveh, Babylon, Ur of the Chaldees … these were the New York, the Tokyo, the London of their day. That’s why we still know their names; they were the cities important enough to leave their mark on the authors of the Bible. Under the Abbasid caliphate, Baghdad was the hub of a trade network that stretched from the Indian Ocean to the Mediterranean. This land has a history rich with what Adam Smith called the “propensity to truck, barter and exchange … common to all men, and to be found in no other race of animals.” It also has 115 billion barrels of proven oil reserves, the fourth-largest supply in the world.

Nearly 30 years of utter misrule under Saddam squandered both these legacies. International sanctions throttled the economy down to practically a subsistence level, even as Saddam diverted massive sums to disastrous military adventures and dozens of palaces. Much of the infrastructure necessary to extract Iraq’s oil is primitive, or in awful disrepair. Exports fall off during the stormy season because Basra, the major port, lacks the facilities to move large oil tankers through large waves, while its elderly pipelines can no longer handle more than a fraction of their original capacity. The country is flaring huge amounts of valuable natural gas off its oil wells because it lacks the infrastructure to collect and transport it.

Until these facilities are improved, says Michael O’Hanlon of the Brookings Institution, “all those dreams of 6 million barrels a day of oil production will continue to be so many sugarplums dancing in someone’s head.” Iraq’s production remains stuck at about 2.5 million barrels a day, roughly where it was before the invasion; GDP growth is driven almost entirely by changes in the price of oil.

But at least the oil is still flowing, and high prices help the government make up for shortcomings elsewhere. According to Frank Gunter, the economy needs to create about 250,000 net new jobs every year in order to absorb the young people coming of age. “A good year,” he says, “is a year when oil prices are high, which allows the government to create those 250,000 jobs.” And a bad year? That was 2006, when maintenance and capital investment were slashed. “You had Iraqi ministry employees going to work and sitting in the dark because there was no money for lightbulbs … but no one was fired, and no pensions were cut.”

Half of the labor force works for the national government, either directly or indirectly, and another 20 percent or so is unemployed. “Iraqis believe that the only real job is a government job,” Gunter says. It “pays more, has benefits, you can’t be fired, and the work intensity is lower than in the private sector.” Gunter estimates that if the price of oil falls below $40 a barrel, the government is in serious trouble: below that price, it will not have enough revenue to pay salaries and pensions, even if no services are provided at all.

Something is wrong when all the best jobs in a country are in the government. Even strong social democrats like the Swedes need a vibrant private sector, and Iraqis, especially, need something to lessen their dependence on continuing high oil prices. Sadly, most of Iraq’s factories are moribund state-owned enterprises that the government has been fitfully trying to sell. The country has had trouble restoring even the basic capacity to manufacture cement—critical to rebuilding its oil infrastructure.

Tom Box, a consultant who has helped put together tender offers for several state-owned cement firms, says the process is incredibly challenging. Iraqi firms face tough competition from cement manufacturers in neighboring countries, which have more-reliable access to the electricity and fuel that are critical to keeping cement kilns running—and which may be willing to charge ultracheap prices to keep Iraqi competition from emerging. One difficulty in assessing the value of these Iraqi plants is that few of them seem to be running right now. I ask Box if anyone’s actually, um, making cement. “There are a few plants in Iraq producing cement, though at a very low rate,” he cautiously says. “I know there are a few plants in Fallujah making white—you know, decorative—cement …” Too bad the cracks in Iraq’s oil pipelines can’t simply be whitewashed.

Companies that make offers are required to provide all the capital and know-how, while giving the government a nice share of the profits; they must also keep the plants staffed at current levels. If an employee leaves or dies, the government expects that person to be replaced, because providing jobs is the top political priority, viewed as key not only to ensuring reelection, but to preventing the country from tipping back into chaos.

Iraq’s banking sector is severely underdeveloped and, due to the absence of credit-rating services, makes few loans—except to persons willing to provide portable collateral such as jewelry, to government workers, or to its own employees. O’Brien-Ali says that attracting foreign direct investment is crucial. It doesn’t just build capacity, but also enables skill transfer. But outside firms can be forgiven their extreme reluctance to invest. Factories can be overstaffed by a factor of 10, and worse, poor records make it difficult to determine how many unnecessary workers—or “ghost workers,” who won’t show up at all except to collect their paychecks—they may be taking on. So far, the government has managed to privatize only a handful of the firms that it wants to divest.

Maybe it just takes a little while to leave behind 30 years of misrule. But Gunter squelches this almost happy thought even before it’s formed. “Is this an unloved artifact of Saddam?” he asks rhetorically, and immediately provides the answer. “No. It’s getting worse.”

Gunter argues that the U.S. invasion, by taking out the centralized apparatus of Saddam’s regime, unleashed what he calls “entrepreneurial corruption.” For all the predation of the high-ranking members of the Baath Party, the clear hierarchy offered predictability and stability—as in 1940s Chicago, you always knew exactly who had to be paid off.

In a provocative 1990 article titled “Entrepreneurship: Productive, Unproductive, and Destructive,” the Nobel Prize–winning economist William Baumol suggested that societies have a relatively fixed proportion of entrepreneurs—“if entrepreneurs are to be defined, simply, to be persons who are ingenious and creative in finding ways that add to their own wealth, power, and prestige.” How they exercise that ingenuity depends on the incentives their economy supplies. Where the system rewards productive activity, they create start-ups; where violence or corruption offers the greatest opportunities, they prey on the rest of the citizenry. Since the invasion, Iraq seems to have developed one of the world’s worst incentive structures. Gunter says that government officials now compete with each other to enact rules and extract bribes, strangling private enterprise and building powerful networks that help them block change.

The “propensity to truck, barter and exchange” identified by Adam Smith is not a natural instinct that will simply flourish unless quashed by the heavy hand of the state. It requires support from a wide range of social and political institutions—from mores and social trust, to courts and land titling. If all you do is remove the totalitarian state, without building the institutions that support markets, the result can be corruption even more pervasive, and corrosive, than the regime you replaced.

Iraq has the most highly educated workforce in the region, enough water for large-scale agricultural development, and a lot of oil. Its frail, flawed, fledgling democracy may also turn out to be an asset. No matter how imperfect democracy may be, argues Alejandro Salas of Transparency International, it makes politicians accountable to voters, and if those voters can be given information about government performance—and can learn to believe that they are entitled to something better—then change will follow. Although not exactly parallel, similar processes have worked in countries such as Brazil and Chile, which a couple of decades ago lived under authoritarian regimes. Anecdotal reports suggest that immigrants returning from the United States, who have learned to expect well-functioning civic institutions, may be promoting the demand for greater accountability and transparency from government in Mexico.

Iraqi emigrants are starting businesses in places like Jordan, and they have both the human and the financial capital that Iraqi businesses desperately need, if only they could be persuaded to return. But easing their fears requires functioning institutions that Iraq just doesn’t have. Although everyone I spoke with offered reasons for optimism, no one sounded very convinced. Those of us who supported the invasion might well wish that we’d had a little more of this pessimism in the run-up to the war. Unfortunately, at this point, none of us here in America can do much but emulate the aspiring Iraqi entrepreneur: plunk down more money, muster up a little hope, and wait.

Megan McArdle is the business and economics editor for The Atlantic. She has worked at three start-ups, a consulting firm, an investment bank, a disaster recovery firm at Ground Zero, and the Economist.
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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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