Economic Questions Surrounding Iraqs Draft Constitution

1
Economic Questions Surrounding Iraqs Draft
Constitution

• Robert Looney
• Professor, National Security Affairs
• Naval Postgraduate School
• Briefing on Iraqs Draft Constitution
• Stimson Center, Dirksen Senate Office Building
• Washington, DC, October 4, 2005

2
Economic Evaluation of the Draft Constitution

• In Examining the Draft Constitution from an
  Economic Perspective, Several Questions Appear
  Critical
• Will it Assist in Stabilizing and Reviving the
  Economy?
• Or Will it Undermine the Economy Through Creating
  Internal Conflicts over Resources and Tensions
  Between the Countrys Main Regions?
• Will it Lay the Economic Foundation for a Stable
  Federation?
• Will its Main Economic Provisions Contribute to
  Long-Run Stability and Expansion of the Oil
  Sector? The Private Sector?
• Or, Will it Create More Uncertainty for Both?

3
Current Economic Problems

• Very Mixed Picture Since April 2003 -- Some
  Recovery But
• Unemployment Stabilized at 30-40 -- Possibly
  Higher.
• Unstable/Unreliable Supply Electricity, Fuel,
  Water.
• 95 Government Income Comes from Oil.
• Government Employs 50 Formal Labor Not
  Sustainable.
• Many Households With Lower Incomes than 1980.
• Great Deterioration in Social Capital, Loss of
  Trust Corruption Rate Highest in the Middle
  East.
• High Crime Rate Massive Capital Flight, Brain
  Drain .
• Shadow Economy Increased to 65 GDP, 80 Labor
  Force.

4
Draft Constitution's Implicit Economic Framework

• Based Largely on Ambassador Bremers Reforms of
  Late 2003
• Extreme Version of Neoliberal Reform Package.
• Open Economy, Low Taxes, Economy Open to Foreign
  Private Investment.
• Intent to Wipe Slate Clean and Start New Economy.
• Macroeconomic Stability Independent Central Bank
  But Government Largely Passive in Dealing With
  Economy.
• Strategy Intended to Have High Job Creation
  Through Rapid Private Sector Investment and
  Expanded Output, FDI a Key Ingredient.
• Is this Economic Framework Optimal for Dealing
  With the Countrys Current Economic Difficulties?.

5
Assessment of the Draft Constitutions Implied
Economic Agenda

• While Sound in Many Regards, The Draft
  Constriction's Implied Economic Agenda is Not
  Best Suited for Iraqi Conditions. Earlier Drafts
  Had Included More Stress on Security and Social
  Welfare and Less Stress on Economic Efficiency.
  Problems
• Precludes Large Number of Iraqis from Economic
  Process Lack of Skills, Capital Unemployment
  Likely to Remain High.
• Uncertainty Too Great for Most Private Investors.
• Approach Not Flexible Enough to Adapt to Shocks
  or Adverse Developments Government Not
  Responsive To Obvious Needs.
• Less Extreme Programs in More Favorable Settings
  Have Resulted in Disappointing Results
  Central/Eastern Europe/Latin America.
• Inability to Produce Short-Run Economic Gains
  Likely to Make Economic Approach Easy Target for
  Extremist Groups.

6
Iraqi Opposition To Draft Constitutions
Economic Framework

• 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.
• Entrepreneurs Who Fear Foreign Competition.
  Speculators, Corrupt Officials Profiting From
  Black Market Arbitrage on Administered Priced
  Goods.
• Religious Leaders Who See Reforms as Part of War
  on Islam.
• 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 Some
  Success by the Transition Countries as a Sign of
  Their New Independence are Seen by Iraqis as
  Products of the Countrys Occupation Has Helped
  Extremist Groups Credibility.

7
Economic Reforms and Federalism

• Economics of Draft Constitution Assumes a Limited
  Involvement of the Central Government Markets
  Left To Play Key Role in Reviving Economy.
• Theoretically Federalism Should Encourage Market
  Development, Efficiency and Allow Individual
  Preferences Political and Economic to Prevail
  at the Local Level.
• Little Popular Support and Make-up of Iraq May
  Thwart These Forces. Weak Central Government May
  Not Be Able to Combat Development of Competing
  Economic Systems
• Elements of Islamic System in the Shiite Areas.
• Government Intervention in the Sunni Areas
• Relatively Free Markets, Foreign Investment
  Friendly Kurdish Areas.
• Can These Three Competing Systems Coexist or Will
  the Situation be Unstable With One or Two of the
  Regions at a Distinct Disadvantage?

8
Issues Surrounding Iraqs Oil and the of
Rentier State

• Oil is an Additional Complicating Factor. How
  Will The Draft Constitution Affect These Common
  Rentier State Problems?
• Oil Rents Usually Result in the Development of an
  Distributive State as Opposed to a Production
  StateConflicts over the Access to and Control of
  Oil Rents.
• Concentration of Oil Rents Reduces State Need to
  Extract Money From Society Gain Citizen Support
  In Return for Redistributing Oil Rents
  Substitution of Political Rights by State
  Provided Welfare.
• Lack of Rigorous Tax System Impedes Emergence of
  a Strong State that Legitimately Represents its
  Citizens.
• Oil Revenues Encourage Patrimonial Loyalties as
  Opposed to Participatory Democracy.
• Associated Corruption Undermines Economic
  Efficiency and State Formation.

9
Draft Constitution and Oil Revenue Sharing

• While Article 109 States that Oil and Gas
  Reserves Belong to the Entire Iraqi People,
  Article 110 Greatly Limits the Role of the
  Federal Government in Managing these Resources.
• Article 110 Clarifies that Revenue Sharing Will
  Be Based on Needs as well as Demography
  Reflecting the Region's Duties and Obligations,
  and Taking Into Consideration the (Regions)
  Resources and Needs
• Also a Compensation Factor For Regions that Lost
  Under Saddam. Suggests Sunni Areas Could be
  Disadvantaged for Some Time. Exact Formula for
  Revenue Sharing Will be Shaped by Iraqs National
  Parliament.
• Kurds Had Originally Proposed Formula With
  Revenues Shared Between Center and Region 30
  To Federal Government, 5 to Producing
  Governorate and 65 to Region Where Oil Is
  located.

10
Draft Constitution and Oil Management Issues

• Oil and Gas Wealth are to Be Developed in a Way
  That Ensures the Best Benefit to the People
  Using the Latest Market Principles and Promotes
  Investments.
• However by Dropping Phrase Collectively Owned
  Opens Way for Privatization of Iraqi National Oil
  Company and to Open Countrys Reserves to Foreign
  Investors.
• Federal Government along With Regional
  Governments and Producing Governorates to Jointly
  Manage Oil and Gas in Current Producing Fields.
• Creates Great Uncertainty Areas of Authority
  Not Defined Open to Interpretation. Role of
  Federal Government in Oil Matters May Be
  Marginalized.
• Other Issue Is Stabilization Policy How Will
  The Central Government be Able to Pursue
  Macroeconomic Stabilization if The Regions
  Control Most of the Countrys Fiscal
  Expenditures?

11
Draft Constitution and Oil Future Issues

• Draft Constitution Article 111-- Regions Have
  Right to Exercise Legislative, Executive and
  Legal Power.
• If a Dispute Arises with Federal Government, The
  Laws of the Region Take Precedence
• By Limiting Joint Management of Federal
  Government and Regions to Currently Producing
  Fields, Draft Constitution Excludes Fields not in
  Production and Fields to Be Discovered. However,
  Does Not Say who will Manage Them.
• Same Problems for Revenue Assignment From
  Non-Producing Fields and New Fields Producing at
  a Later Date. Draft Can be Interpreted as License
  for Producing Regions to Benefit Exclusively.
  Most of the Discovered But Not Developed Fields
  Lie in the Shiite Regions of Southern Iraq.
• In Sum, Although There Were Other Options
  Available, The Draft Constitution Creates
  Potentially Serious Problems for Economic
  Stabilization and Regional Income Distribution.

12
Lessons From Nigeria

• Central Government Weakness in Federal Nigeria,
  Remnant of Colonial Era Has Led to Economic
  Instability
• Attempt by Groups to Encourage Further
  Centralization or Decentralization to Gain
  Personal of Group Based Benefits Further
  Decentralization Has Predominated. But Attempts
  to Reverse Decentralization Have Led to Increased
  Force.
• Main Difficulty Central Government is The
  Enforcement of Appropriate Distribution of Oil
  Revenues From Oil Regions to Central Govt.
  Regional Governors Often Ignore Court Orders for
  Splitting Oil Revenues.
• By Diffusing Power Across Several Layers of
  Government, Set Up Conflicting Claims of
  Jurisdiction and Legitimacy Often Making it
  Difficult to Achieve Policy Goals-Attract
  Investment.
• Without Strong Central State, Incentives and
  Opportunities for Kurds and Shiites to Act Like
  The Oil States of Nigeria Will Be High.

13
Overall Assessment Potential Problems

• The Draft Constitution Does not Provide A Viable
  Strategy for Avoiding The Rentier State Problems
  Common in Oil Producing Developing Countries
  One Has to Assume The Worst.
• The Economic Sections Are Consistent With U.S.
  Goals and Objectives as Well As IMF Standard
  Guidelines, but Will Find Limited Support in the
  Sunni and Shiite Regions.
• As Written Draft Constitutions Sections On Oil
  Appear to Satisfy Kurdish and Shiite Economic
  Concerns and Needs, but Not Those of The Sunnis.
  Furthermore The Constitution Leaves Open the
  Possibility of Abuse of Economic Power By the
  Kurds and Shiites. Lack of Clarity Also
  Conducive to Corruption and Low Levels of
  Investment.
• The Likely Regional Assignment of Oil Revenues
  Will Make Make Macroeconomic Stabilization
  Extremely Difficult Likely to Experience
  Fiscal Deficits, Inflation, Erratic Movement in
  Exchange Rates. Since Stability in These Areas
  is Critical To The Success of the Neoliberal
  Economic System, One Has to Assume Continued
  Underperformance of the Economy.

14
Possible Solutions Avoidance of a Classic
Rentier State

• Critical Variable in Analysis of Economy is the
  Rentier State Draft Constitution May Create
  Incentives for Bad Aspects to Prevail Regional
  Competition Over Rents, Broadly Perceived
  Inequities in Allocation, Revenue Instability,
  Corruption.
• Alternative Direct Distribution FundImmediate
  Distribution of 25 Oil Revenues to All Citizens
  -- Rapidly Creates A Middle Class With State in
  Success of Federation. Transparency Clauses Help
  Control and Reduce Corruption.
• Gives Sunnis An Alternative to Improve their
  Situation Rather Than Trying to Wrest Control
  Over Resources.
• Allows Central Government to Phase out Corruption
  Plagued Subsidy ProgramsMany of Which Have
  Assisted the Funding of the Insurgents Through
  Smuggling and Shadow Economy.
• Since Dividend a Function of Oil Production,
  Pressure on Insurgents to Cease Attacks on Oil
  Production and Distribution System May Greatly
  Reduce Popular Support for Insurgency.

15
Summary -- Iraq Key Constitutional Economic
Linkages
16
Summary Likely Outcomes

• In Assessing the Draft Constitution, One is
  Immediately Struck By the Realization that We
  Know Very Little About the Forces that Will be
  Unleashed if it is Passed.
• As it Stands, a Vicious Circle of Violence and
  Decline is Likely.
• However, There are Modifications That Conceivably
  Could Produce a Virtuous Circle of Growth and
  Prosperity
• While The Constitution Leaves Much To Be Decided
  By Future National Assemblies, In Terms of the
  Questions Posed Earlier, Will the Draft
  Constitution
• Assist in Stabilizing and Reviving the Economy?
  Unlikely.
• Create Tensions Between Main Regions?
  Probably.
• Contribute to Growth and Stability of Oil Sector?
  Unlikely.
• Encourage Regional Competition over Resources?
  Likely.
• Reduce Uncertainty for Private Investors? No.
• Lay a Foundation for a Stable Federation
  Unlikely.