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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.

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