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Constructing a New Liberal Economy in Iraq


Create An Example for the Region of a Successful, Liberal, Democratic Country. ... Market Economy Leading to Stronger Democratic Institutions Chile With Oil. ... – PowerPoint PPT presentation

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Title: Constructing a New Liberal Economy in Iraq

Constructing a NewLiberal Economy in Iraq
  • Robert Looney
  • Professor, National Security Affairs
  • Naval Postgraduate School
  • Politics of Reconstructing Iraq Seminar
  • MIT Center for International Studies
  • April 4, 2005

Outline Economic Transition in Iraq
  • Approach Taken to Market Transition in Iraq.
  • Lessons from the Transition Countries.
  • Current Obstacles to a Liberal Market Economy in
  • Possible Economic/Political Outcomes.
  • Factors Affecting Alternative Scenarios.
  • Critical Intangibles For the Future.
  • While Political Developments Will be Critical In
    Effecting the Likelihood of a Liberal Market
    Economy in Iraq, the Focus Here Will be Mainly on
    the Economic Reform Processes Likely Under
    Different Circumstances .

Difficulties in Evaluating Iraqi Economic Policy
and Performance
  • Lack of Economic Data. Even before 2003 War, Very
    Little Basic Data on Economy.
  • Lack of Objective Reporting Many Accounts
    Derived from Perception Rather than Fact.
  • Lack of Reliable Surveys Insurgency Has Limited
    Field Work.

Transition to Liberal Market Economy Implies
  • Liberalizing Economic Activity, Prices and Market
  • Allocating Resources to their Most Efficient Use.
  • Developing Indirect, Market-Oriented Instruments
    for Macroeconomic Stabilization.
  • Achieving Effective Enterprise Management and
    Economic Efficiency, Usually Through
  • Establishing Institutional and Legal Framework to
    Secure Property Rights, Rule of Law, and
    Transparent Market-Entry Regulations.

American Economic Objectives - Iraq
  • Controversial With Numerous Interpretations.
  • Conventional U.S. View Create a Modern
    Democratic State With a Liberal Market Economy
    Assist in War on Terrorism.
  • Create An Example for the Region of a Successful,
    Liberal, Democratic Country .
  • Prevent the Economy and Country from Reverting
    Back to an Unstable, State-Dominated Nation.
  • Provide the Environment for a Stable, Secure
    Source of Oil.
  • Alternative Views Various Just After the Oil,
    Captive Markets for U.S. Multinationals Modern
  • Actions Taken Suggest A Naïve Version of the
    Conventional View An Attempt to Replicate the
    Chilean Experience in the mid-1970s and Several
    of the Successful Transition Countries.
  • Goal is Improved Economic Freedom Along with

Lessons From The Transition Countries
  • Sustained Macroeconomic Stabilization is
  • Delayed Reforms Risk Negative Growth.
  • No One Component To Reform Stands Out Need To
    Implement All Components.
  • Unfavorable Initial Conditions Can Be Offset
    Through Correct Reforms.
  • Most Jobs Created by Small-Medium Scale New

Transition Lessons (contd.)
  • Improving Investment Climate Critical for
    Creation of New Firms.
  • Development of a Legal Framework Critical.
  • If Country Puts off Implementing Rule of Law,
    Enforcing Discipline, Securing Property Rights,
    then other Reforms Are Unlikely to Produce
    Significant Benefits.
  • Successful Transition Countries Create Groups
    That Have a High Stake in Pressing for Further
    and Deeper Reforms Over Time.
  • U.S. Policymakers Apparently Thought that
    Transition Success Stemmed Mainly From an
    Application of Washington Consensus Reforms.

Washington Consensus in Iraq
  • Fiscal Discipline Limit Budget Deficits.
  • Public Expenditure Priorities Redirect
    Expenditure Toward Human Capital and
  • Tax Reform Broaden Tax Base and Cut Marginal
    Tax Rates.
  • Financial Liberalization Abolish Interest Rate
  • Exchange Rates Introduce Unified and
    Competitive Exchange Rate.
  • Trade Liberalization Replace Quantitative
    Restrictions by Tariffs then Reduce Tariffs Over

Washington Consensus (contd.)
  • Foreign Direct Investment Encourage Increased
    International Capital Flows.
  • Privatization Privatize State Enterprises.
  • Deregulation Regulate only Safety, Environment,
    and Financial Sectors.
  • Property Rights Introduce Secure Enforcement at
    Low Cost.
  • To Date Only Limited Progress Has Been Made
    Mainly in the Neoliberal Core of Reforms.

Neoliberal Reforms in Iraq
  • Neoliberal Reforms in Iraq Oriented Towards
    Stimulating Investment and Creating a New
  • Investors (except oil production and refining)
    allowed 100 ownership of Iraqi Assets, Full
    Repatriation of Profits and Equal Legal Standing
    With Local Firms. Foreign Banks May Establish
    New Operations or Purchase Equity Shares in
    Existing Iraqi Banks.
  • Income and Corporate Taxes Capped at 15.
  • Tariffs Reduced to Universal 5 With None on
    Food, Drugs, and Other Humanitarian Imports.
  • Independent Central Bank Created.

Neoliberal Reforms (contd.)
  • State Owned Enterprises to be Privatized, No
    Timeframe or Method Specified.
  • Text-Book Application of Reforms Belief in
    Advantages of Shock Therapy -- Little or No
    Consultation With or Input From Iraqis on Design
    or implementation of Reforms.
  • Main Problem Status of Reforms in Future
    Governments Not Clear Imposed by Occupying
    Power, but May Be Overturned or Significantly
    Modified by an Elected Iraqi Government Effect
    Has been to Create More Investor Uncertainty on
    top of the Insurgency.

Neoliberal Reforms (contd.)
  • Adequate Foundation Not Laid To Take Advantage of
    Reforms Strengths.
  • Reforms Stalled, Incomplete Limited Benefits
    and Numerous Dislocations.
  • Because of Initial Failure, Now Have to Face Many
    More Severe Obstacles than in Initial Pre-War

Impediments to Liberal Market Development
  • Corruption.
  • Insurgency.
  • Deterioration of Social Capital.
  • Rentier StateResource Curse Effects.
  • Large and Growing Informal Economy.
  • Macroeconomic Instability.
  • Opposition to Further Reforms.
  • All are Interrelated to Some Extent With
    Corruption the Common Element.

(1) Corruption in Iraq
  • Long History in Iraq Diversionary State Under
    Saddam When Corruption Became Institutionalized.
  • In Transparency Internationals Corruption Index
    For 2004 Iraq Was the Most Corrupt Country in the
    Middle East, Ranking 129th down from 113th in
  • Economic Impacts of Corruption in Iraq
  • Undermines Market System Limits Government
  • Distorts Incentives Encourages Rent Seeking.
  • Creates Inefficient Industries Protection From
  • Creates Arbitrary and Uncertain Tax Wasted
  • Weakens Financial System Cash Economy.
  • Creates Perverse Public Sector Priorities Big
    Project Bias.

(2) Insurgency Economy
(3) Social Capital in Iraq
  • Social Capital Represents Networks of
    Relationships that Bind People TogetherDeteriorat
    ed Significantly Under Saddam.
  • Trust a Key Element of Social Capital. In Iraq
  • Ascribed Trust Kinship Groups and Family
  • Process Based Trust Individuals That Have Known
    Each Other for Some Time Key Element in
    Business Networks
  • Extended Trust Transactions Between Individuals
    With Only Limited Information About Counterparts

(3) Social Capital in Iraq (contd.)
  • In Iraq Today, Most Networks Ascribed Trust, With
    Some Process Based and Fewer Extended Extended
    Critical for Liberal Market Development.
  • May Explain Some of the Problems Encountered by
    the Neoliberal Reforms
  • Lack of Response to Price Movements
  • Limited Growth of Markets and Exchange
  • Regional, Local Market Development Rather than

(4) Rentier State Effects
  • Expectation that Favorable Natural Endowments
    Would Lead to Growth has been Disappointed.
  • Many Economies Have Become Progressively More
    Reliant on Natural Resources.
  • Several Countries Have been Able to Avoid the
    Resource Curse Indonesia 1970s
  • Resource Curse Stems from Combination of 4
  • Dutch Disease.
  • High Volatility of Commodity Prices.
  • Inefficient Specialization.
  • Rent-Seeking.

(5) Informal Economy
  • At End of Saddam Husseins Regime Accounted for
    About 35 of GDP and 68 of the Labor Force.
  • Currently Accounts for About 65 of GDP and 80
    of the Labor Force.
  • Statistically Corruption and Protection From
    Trade Main Determinants of Informal Economies in
    the MENA Region.
  • Demographic Bulge Also a Prime Determinant.
  • Black Markets/Illegal Activities Impede Liberal
    Market Economy No Tax Base, Weakens Fiscal
    Policy, Macroeconomic Stabilization.
  • Will Require Specific Policies/Reforms if Sector
    to be Incorporated into Formal Market Economy
    Free Markets and Growth Alone Unlikely to
    Integrate the Economy .

(6) Macroeconomic Stabilization
  • Main Difficulties
  • Cash Economy Difficult to Control Money Supply.
  • Beginning to Develop a Government Bond Market.
  • Interest Rates Have Been Allowed to Fluctuate.
  • Exchange Rate Floats, But Has Been Relatively
    Stable Perhaps Overvalued.
  • Concerns Inflation Rising, Possible Bubble in
    Real Estate, Existing Monetary Tools May Be
    Ineffective at Stopping Inflation.
  • Flexible Exchange Rate Makes Sense With Large
    External SectorHowever Means Monetary Policy
    Assigned to Domestic Stabilization May not be
    up to the Task.

(7) Opposition to Further Reforms
  • A Number of Groups are Likely to Oppose Further
    Reforms at this Time
  • Workers in State EnterprisesFear Job Loss.
  • Many Farmers Insecure Over New Market
  • Former Bathists Who See Reforms as New
    Imperialism Forcing Abandonment of Nationalist
  • Influential Intellectuals Who View Neoliberal
    Reforms as Extreme and Detrimental to Economy at
    this Time Point to Failures of Similar Reforms
    in Other Countries Cite Credible Alternatives.

Opposition to Further Reforms (contd.).
  • Entrepreneurs Who Fear Foreign Competition.
  • Speculators, Corrupt Officials Profiting From
    Black Market Arbitrage on Administered Priced
  • Problem Outside of a Few Technocrats and
    Merchants, Little Popular or Influential Support
    for Reforms Neoliberal Reforms Seen as Imposed
    With No Input From Iraqis.
  • The same reforms that were Implemented With Great
    Success by the Transition Countries as a Sign of
    Their New Independence are Seen by Iraqis as
    Products of the Countrys Occupation.
  • Religious Elements Who See Reforms as Part of War
    on Islam.

The Future Alternative Courses
  • Obstacles to Liberal Market Can Be Overcome Under
    Certain Mixes of
  • Economic/Institutional Reforms.
  • Political Environment.
  • Level of Insurgency.
  • Oil Production.
  • Macroeconomic Stability.

Key Empirical Linkages
  • MENA Informal Economies f (Trade Policy,
    Corruption, Rule of Law)
  • Neoliberal Reforms Reduce Political Corruption
    Gerring and Thacker
  • Growth f (macroeconomic Stability) Barro
  • Growth f (financial development) Levine
  • Growth f (trade openness) Barro
  • Growth f (political stability) -- Barro

Rentier State Political Systems
  • Likely Systems
  • Factional Democracy Venezuelan Model
  • Reformist Autocracy Indonesia 1970s
  • Pragmatic Theocracy Iran/Baathist
  • Basic Model Likely to Be Modified to Iraqi
    Conditions and Political Realities.

Rentier State Political Systems (contd.)
  • Unlikely Systems
  • Traditional Theocracy Iran
  • Predatory Autocracy Bathist Model
  • Mature Democracy Norway
  • Paternalistic Autocracy Saudi Arabian Model

Market/Political Variants Possible in Iraq
  • Virtuous Circle Liberal Market Economy Leading
    to Stronger Democratic Institutions Chile With
  • Muddle Through Mixed Economy Nigeria of the
    Middle East
  • Pragmatic Theocracy State Dominated
    Iranian/Baathist Mix Secular Nationalist With
    Strong Islamic Influence.
  • Vicious Circle Diversionary State Eventual
    Collapse -- Yugoslavia With Oil.

Virtuous Circle of Reform, Growth and Liberal
Market Development
  • Infrastructure Led Public Investment Begin
    Rapid Growth to Overcome Development Impediments.
  • Complete Neoliberal Price Reforms Block
    Incentives for Shadow Economy Make Official
    Corruption More Difficult.
  • Insurgency Lessens With Economic Progress.
  • Second Stage Washington Consensus Reforms
    Institutional Development Foundation for
    Private Sector.
  • Dual Track Development Strategy Comparative
    Advantage and Informal Economy Focus on
    Creation of New Small-Medium Scale Enterprises.

Virtuous Circle (contd.)
  • Improved Macroeconomic Stability Market Based
    Financial Instruments Developed CBI Gains
    Better Control of Monetary Policy.
  • Informal Economy Focused Credit New Small-Scale
    Firm Creation.
  • Oil Fund for Public Distribution Helps Develop
    Expanding Domestic Markets.
  • New Firms, Workers and Large Segments of the
    Population Have Stake in Moving the Reform
    Process Ahead.

Virtuous Circle of Growth and Liberal Market
Muddle Through
  • Insurgency Does Not Lessen Significantly.
  • Oil Revenues Pick Up, But Not Significantly.
  • Factional Democracy Largely Stalemated on Key
  • Development Strategy.
  • Moderate Macroeconomic Instability Inflation.
  • Unemployment Gradually Reduced Through Public
    Works Programs, Expanded Bureaucracy Rather Than
    Dynamic Private Sector.
  • Significant Regional Economic Differences
  • Corruption Pervasive.
  • Economy Can Never Build up Enough Momentum to
    Offset Forces Impeding Liberal Market
    Development. Window For Reforms Missed.

Pragmatic Theocracy Model
  • Nationalistic Insurgency Co-opted.
  • Goal of Rapid Reduction of Unemployment At
    Possible Expense of Growth.
  • Partial Integration into Global Economy Import
    Substitution Development Strategy.
  • Selective and Limited Foreign Investment.
  • Islamic Financial System.
  • Protection of Islamic/Iraqi Cultural Identity.
  • Reduction in Poverty At Possible Expense of
  • Large State Role in Production and Distribution
    Food Voucher, Gas, Electricity Subsidies

Vicious Circle of Stagnation
  • Unemployment Remains High.
  • Informal Economy Continues Growing.
  • Crime, Shadow Economy Expand.
  • Insurgency Increases.
  • Neoliberal Reforms Repealed/Watered Down.
  • Macroeconomic Instability High Inflation.
  • Vested Interests Compete for Oil Rents.
  • Reforms Blocked by Vested Interests.
  • Surge of New Entrants to Labor Force Expand
  • Insurgency Continues Investment Low Growth
  • Possible Civil/Resource War.

Vicious Circle
Key Assumptions Iraq Market Outcomes
Critical Intangibles
  • What are the Critical Intangibles Likely To
    Influence Iraqs Future Economy?
  • Economic Progress Made Without Significant
    Reduction in Corruption.
  • Extent of U.S./IMF Leverage over Iraqi Policy.
  • Speed and Extent to Which Trust Can be Restored.
  • Ability of the Financial System to Play a
    Significant Role in Private Sector Investment.
  • The Extent to Which Religious Influences Are
    Likely Mold The Countrys Economic Institutions
    Will The Result Make Movement to a Liberal Market
    Economy More Difficult?
  • Effectiveness of USAID/NGO Small-Scale Social
    Capital Projects at Local Level.

Critical Intangibles (contd.)
  • The Extent to Which an Elected Iraqi Government
    is Committed to the CPA Approach to Reforms Is
    Able to Assure Investors of the Governments
    Commitment to Free Markets, Rule of Law and
    Property Rights Before Significant Progress is
    Actually Made in these Areas.
  • Willingness of Iraqis to Adopt a Pragmatic
    Approach Towards Privatization.
  • Ability of the Iraqis to Achieve Political
  • The Manner in Which Oil Revenues are Managed.
  • The Degree and Extent to Which Average Iraqis
    View Free Markets as a Opportunity to Create a
    Better Standard of Living rather than a Threat
    Imposed by Outside Interests.
  • Most Importantly, Has Iraq Missed the Window for
    Initiating Significant Market Liberalizing

Contrasting Views of The Liberal Market
  • If I Am Permitted to Dream, Iraq Will Develop
    into the Japan of the Middle East. Talib
    al-Tabatie, Chairman, Iraq Stock Exchange
  • The Best Thing is to Overhaul the Whole
    Financial System. Its Like When You Have A House
    Infested with Termites. Its Much Easier to Knock
    it Down and Rebuild Than to Keep Spraying for
    Termites and Fixing the Holes. Rubar Sandi, Head
    U.S.-Iraq Business Council.
  • We Want to Go Back to the Old Healthy Management
    of the 1970s. Thamir Ghadhban Oil Minister,
    Iraqi Interim Government

Contrasting Views (contd.)
  • ..the Lack of Law and Order is Bound to Delay
    the Countrys Economic Rebirth. Yet Without that
    Rebirth, the Country Will Remain Sullen,
    Resentful and a Breeding Ground for all Sorts of
    Undesirable Developments. It is a Vicious
    Circle. Al-Jazeerah
  • It Seems that Many Iraqis do not Understandwhy
    a Market Economy Can Make the Poor People Much
    Better off Than They Ever Were When Saddam
    Controlled the Oil Wealth and Doled out Perks to
    the Iraqis Like a Stern Parent Rewards Small
    Children for Being Seen and Not Heard. Ronald
    Rotunda George Mason University Foundation
    Professor of Law.

For Further Reading
  • Presentation Draws on the Following
  • Robert Looney, Iraqs Economic Transition The
    Neoliberal Model and its Role, The Middle East
    Journal, Autumn, 2003.
  • Robert Looney, The Viability of Iraqs Shock
    Therapy, Challenge, September-October 2004.
  • Robert Looney, A Return to Bathist Economics?
    Orient, September 2004.
  • Robert Looney, Iraq as a Transition Economy,
    The Milkin Institute Review, Fourth Quarter 2004
  • Robert Looney, Postwar Iraqs Financial System,
    Middle East Policy, Spring 2005.
  • Robert Looney, Corruptions Reflection Iraqs
    Shadow Economy, Strategic Insights, March 2005.