The economic transition in Iraq

By Christopher Coyle
web posted June 14, 2004

As the transfer of sovereignty to an interim Iraqi government
takes place later this month while an insurgency continues to bog
down American efforts to stabilize the country, the Bush
administration has made a point of emphasizing the importance of
establishing a competent democracy in Iraq. Yet, in the
administration's continued reiteration on the political reforms
needed to establish democracy, they have been disappointedly
quiet in spotlighting another fundamental issue crucial to a future,
prosperous Iraq: a free market economy.

This was not always the case. Leading up to the war and
especially after the swift military defeat of Saddam Hussein's
regime, optimism was running high along with the hopes of
American planners to remake Iraq into a free nation with a
liberalized economy. A 15 per cent flat income tax for individuals
and businesses was instituted, creating an organized tax structure
lacking under Saddam that would nurture the foundations of a
low-tax state, conducive to economic growth. A low, broad-
based 5 per cent tariff on imports encourages the establishment
of free-trade policies, while reformation of the Iraqi commercial
code, such as allowing foreign enterprises to own 100 per cent
of most types of businesses in Iraq, may encourage much needed
foreign investment.

And for now, at least, these policies are still in effect. Yet, these
positive developments are in a precarious position as sovereignty
is transferred on June 30. An Iraqi government in control of its
own economy could easily reverse such policies in the future in
favor of returning to the more nationalist, protectionist, and
socialist policies under the former regime. Indeed, the tariff
policy has only been instituted for a two year time span, begging
the question of what a democratically-elected government
endowed with full sovereignty will do when that time runs out.

Despite general agreement that Iraq's extremely inefficient state-
owned enterprises need to be privatized, the United States
backtracked earlier this year on the issue with concern to the oil
industry, which accounts for the largest portion of the state-
owned sector. Given the importance that the oil industry will
inevitably hold in any future Iraq (they currently have the second
largest known reserves of oil in the world, behind Saudi Arabia),
private enterprises will be desperately needed in this sector to
rebuild and maintain the deteriorating infrastructure with new
capital investment, as well as instituting a profit-and-loss
mechanism into the industry in order to rationally allocate funds
to various projects.

The Coalition Provisional Authority has also maintained much of
the extensive subsidy system in place during the former regime.
Iraqi automobile drivers benefit from 5 cent gasoline prices,
maintained by the $500 million in gasoline expenditures the U.S.
makes every three months to support the subsidies. The majority
of Iraqi citizens still rely on a heavily-subsidized monthly "food
basket" in order to meet their basic needs. A precursor to any
market system becoming established in Iraq will need to be the
elimination of these massive market-distorting subsidies on these
basic commodities.

Of course, given the continued insurgency that U.S. forces have
faced in Iraq and our desire to win over the Iraqi population, the
coalition has found the implementing these other reforms would
be difficult, since drastically driving up the prices for their gas and
food purchases will only further fan the flames of animosity. And
obviously, shifting Iraq away from the planned economy that
existed under Saddam Hussein will take time.

What is most disheartening, however, is the lack of promotion or
devotion to free markets by the Bush administration as a key to
success in Iraq. Though many in the administration may be in
favor of such changes, none have been adamant, unlike in their
case for democracy, about it. Though progress has been made,
the economic changes that have occurred so far have been
relatively easy, politically speaking. Implementing a low income
tax is easier in a country with no history of an organized tax
system under its former regime, for instance. Plans for more
politically sensitive issues, such as the "food baskets," are not
nearly as bold; current plans will simply replace the commodities'
basket with money payments. It is important for the
administration to continually stress support for the goal of free
markets both to state why these changes must take place and
thereby win support for such reforms (which currently do not
seem to be very popular) as well as to prepare for the short-term
hardships that will admittedly take place.

The biggest danger hindering long-term economic stability would
be for the United States or the Iraqis to inhibit further reforms or
to backtrack on the reforms that have already been implemented
in order to appease current popular opinion in the country.
Though this may make the situation easier to manage in the
short-run, it will only retard the economy and prevent any chance
of Iraqis to prosper in a new Iraq. A country mired in poverty
will much more difficult to govern.

Indeed, this fear has already been partially realized, most notably
in the coalition's decision to keep the Iraqi oil industry in state-
owned hands. There's no reason to believe that, if the U.S.
continues to have a difficult time quelling the insurgency, the same
will not be done with respect to other market-oriented reforms.

There is no question that rebuilding the Iraqi economy will be an
arduous task. Despite expected GDP growth of approximately
20 per cent this year (thanks to the $20 billion in American
reconstruction money), inflation will be increasing just as quickly
while unemployment continues to hover around 50 per cent.
Meanwhile, government finances are in a state of disrepair;
America is still trying to persuade foreign creditors to forgive or
restructure the vast $120 billion in debt piled up by Saddam, not
to mention the approximately $200 billion in war reparation
claims which Iraq is seeking to reduce. Attempting to reform the
remnants of Saddam's planned economy, where an annual
national budget was never written while he was in power, will be
daunting.

And yet, such a task much be done, if we wish to see Iraq rise
above the shadows of Saddam's regime and become a
successful and prosperous state. Last year, the Financial Times
stated that, "Iraq is in no state to endure some free market
laboratory experiment." However, the truth of the matter is that
Iraq is in no state to endure for any longer the failed policies of
Saddam's socialist economy. Because for all the talk the
administration has made on the importance of democracy in the
region, without a stable, market economy in Iraq, democracy
may not mean all that much.

Christopher Coyle is the president of The Liberty Coalition at the
University of Virginia.