Transcript Colloquium on Iraq`s Constitutional Process

The Economic Consequences
of Iraq’s Draft Constitution
Robert Looney
Professor, National Security Affairs
Naval Postgraduate School
Colloquium on Iraq’s Constitutional Process
Woodrow Wilson International Center for Scholars
Washington, DC, October 3, 2005
Evaluating the Draft Constitution
Iraq’s Draft constitution should be evaluated on two standards:
Its substance in the areas of democracy, human rights and
proposed political structure; and its potential to be a national
compact that brings Iraqis together and undermines the
insurgency. It meets the first test. With respect to the second,
the jury will decide in the October 15 referendum. – U.S.
Ambassador Zalmay Khalilzad
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Also Important to Evaluate the Draft Constitution from An
Economic Prospective:
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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
Country’s Main Regions? Lay the Economic Foundation for
a Stable Federation?
Will it’s 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?
Outline
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Current State of The Economy – Main Problems.
Economic Focus of the Draft Constitution.
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Ability to Deal with Current Economic Crisis.
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Potential Conflicts Between Regions Over Preferred
Economic System.
Treatment of Oil – Methods of Assigning Revenues.
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Draft Constitution Formulas.
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Potential Problems.
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Lessons From Other Countries.
General Assessment.
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Probable Linkages to Economy-Economic Performance.
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Possible Alternative Constructs.
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Summary – Main Conclusions- Critical Unknowns.
Current Economic Problems
Very Mixed Picture Since April 2003 -- Some Recovery But:
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Unemployment Stabilized at 30-40% -- Possibly Higher.
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Unstable/Unreliable Supply Electricity, Fuel, Water.
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95% Government Income Comes from Oil.
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Government Employs 50% Formal Labor – Not Sustainable.
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Many Households With Lower Incomes than 1980.
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Great Deterioration in Social Capital, Loss of Trust –
Corruption Rate Highest in the Middle East.
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High Crime Rate – Massive Capital Flight, Brain Drain .
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Shadow Economy Increased to 65% GDP, 80% Labor Force.
Economic Orientation
of the Draft Constitution
Article 25 “The State Shall Guarantee the Reforming of the Iraqi
Economy According to Modern Economic Bases, in a Way that
Ensures Complement of Its Resources, Diversifying its Sources
and Encouraging the Development of the Private Sector.”
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Appears to Move Away From A Form of Welfare State Proposed
in Earlier Drafts Where “Social Justice is the Basis of Building
Society.”
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All of Iraq’s Natural Resources Would be Owned
Collectively by the Iraqi People.
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The State Would be Legally Bound to Provide Employment
Opportunities for Everyone.
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The State Would Be the Iraqi People’s Collective
Instrument for Achieving Development.
Legitimizes the Controversial Neo-Liberal Washington
Consensus Reform Program Initiated by the Coalition
Provisional Government (CPA) in 2003.
Draft Constitution's
Implicit Economic Framework
Based Largely on Transition Economy (Shock Therapy).
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Extreme Version of Neoliberal Reform Package.
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Open Economy, Low Taxes, Economy Open to Foreign Private
Investment.
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Intent to Wipe Slate Clean and Start New Economy.
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Macroeconomic Stability– Independent Central Bank But
Government Largely Passive in Dealing With Economy.
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Strategy Intended to Have High Job Creation Through Rapid
Private Sector Investment and Expanded Output, FDI a Key
Ingredient.
Assumes Numerous Profitable Opportunities Created by
Imbalances Associated With Massive Reconstruction Projects.
Assessment of the Draft
Constitution’s Implied Economic Agenda
While Sound in Many Regards, The Draft Constriction's Implied
Economic Agenda is Not Best Suited for Iraqi Conditions:
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Precludes Large Number of Iraqis from Economic Process –
Lack of Skills, Capital.
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Uncertainty Too Great for Private Investors.
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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 –
Imperialism. Little Popular Support Among Iraqis.
Iraqi Opposition To
Draft Constitution’s Economic Framework
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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 Country’s
Occupation – Has Helped Extremist Group’s Credibility.
Economic Reforms and Federalism
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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:
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Elements of Islamic System in the Shiite Areas.
State 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 Systems at a
Distinct Disadvantage?
Issues Surrounding Iraq’s Oil
and the Maintenance of Rentier State
Oil is an Additional Complicating Factor. How Will The Draft
Constitution Affect These Common Rentier State Problems?:
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Oil Rents Usually Result in the Development of an Distributive
State as Opposed to a Production State—Conflicts 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.
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Lack of Rigorous Tax System Impedes Emergence of a Strong
State that Legitimately Represents its Citizens.
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Oil Revenues Encourage Patrimonial Loyalties as Opposed to
Participatory Democracy.
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Associated Corruption Undermines Economic Efficiency and
State Formation.
Draft Constitution and Oil
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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 (Region’s)
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 Iraq’s 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.
Draft Constitution and Oil (contd).
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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
Country’s 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 Country’s Fiscal
Expenditures?
Major Issues
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Draft Constitution Article 111-- Regions Have Right to Exercise
Legislative, Executive and Legal Power.
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If a Dispute Arises with Federal Government, The Laws of the
Region Take Precedence:
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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.
Lessons From Nigeria
Central Government Weakness in Federal Nigeria, Remnant of
Colonial Era Has Led to Economic Instability:
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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 – Problem When Federation Forced Rather Than
Developed.
Assessment: Potential Problems
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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 Constitution’s Sections On Oil Appear to
Satisfy Kurdish and Shiite 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.
The Likely Regional Assignment of Oil Revenues Will Make
Make Macroeconomic Stabilization Extremely Difficult – The
Resulting Instability – Inflation, Erratic Movement in
Exchange Rates May Undermine the Ability of the Neoliberal
Economic System to Bring Prosperity to the Country.
How this Will Be Resolved is Unclear With Completion Possibly
Favoring One Region’s Economic System at the Expense of the
Other Region’s Economies Thus Creating Additional Frictions.
Assessment: Viability of Federation
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Federalism Predicated on Meeting Two, Seemingly
Irreconcilable Goals:
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Seeks to Unify Diverse, Often Hostile Localities Under a Single
National Banner.
Allow Considerable Authority to Remain at the Local Level.
Unless It is Structured skillfully, Any Federal System Will Find
it Difficult to Maintain An Appropriate Balance Between Local
and Central Power.
Tentatively, Must Conclude That as Written The Economic
Sections of The Draft Constitution Will Create An Environment
In Which It Will Be Very Difficult If Not Impossible to Maintain
This Balance.
With Oil Revenue Assignment Shifting More Toward The
Producing Regions, Their Ability and Perhaps Willingness To
Pursue Independent Policies Will Increase With Time.
Possible Solutions
Possible Solutions to Minimize Risk And Achieve Broader Based
Political Support If Draft Constitution Approved:
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Privatize Oil So It Is Owned by Separate Entity – Not People
Who Live Over It.
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New Ownership Better Able to Finance Needed Modernization
and Infrastructure in Oil Sector.
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To Be Politically Attractive, Might Consider Setting Up Alaska
Type Fund So Citizens Can Begin to Receive Immediate
Benefits.
Centralize Oil Revenues to Better Stabilize Economy, While
Dealing With Regional Inequalities.
Whatever Done it is Critical That Citizens Have a Direct Stake
in Success of The Economy and That Government Official are
Accountable and Constrained Through Transparency
Requirements From Corruption or Wasteful Use of Oil Rents.
Critical Variable:
Avoidance of Rentier State
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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.
Alternative – Direct Distribution Fund—Immediate 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 Programs—Many 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.
Summary -- Iraq: Key
Constitutional – Economic Linkages
Policy
Preferences
Short vs Long
Term
Policy
Orientation
Security vs.
Efficiency
Insurgency
Kurdish/
Shiite
Political
Strength-Oil
Geography
Oil Revenue
Assignment
Shiite
Religious
Concerns
Islamic Content
DynamicsVicious Circles
and Collapse of
Federal System
vs. Virtuous
Circles and the
Strengthening
of the
Federation
Economic
Outcomes
Rentier
State
Effects
Markets
Corruption
National vs
Regional
Emphasis on
Economic
Stabilization,
Development
Strategy
Efficiency vs.
Diversionary
Policy
Decisions
Constitutional
Rules
Political
Outcomes
Neo-Liberal
Economic
System
United
States- IMF
Financial
Assistance/
Debt Relief
Critical Unknowns
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Likely: The Kurdish Regions will Likely Thrive Under A
Wide Range of Possible Environments.
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Will This Success Assist or Undermine Development in the
other Regions?
The Federation?
Critical Unknowns:
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How Will the Draft Constitution Affect the Manner In Which
The Rentier State Evolves? Many Have Become
Authoritarian.
Does The Draft Constitution Make Corruption Less Likely?
Provide Motivation for Continuing the Insurgency? Will it
Provide Incentive for Resource Wars as in Much of Africa?
Will These Forces Culminate in a Virtuous Circle of
Democracy and Success? Or Will They Set in Motion a
Vicious Circle of Conflict and Failure?
Likely Outcomes
In Assessing the Draft Constitution, One is Immediately Struck By
the Realization that We Know Very Little About the Set of
Forces that Will be Unleashed if it is Passed. Many of These
are Identified in the Previous Diagram.
While The Constitution Leaves Much To Be Decided By Future
National Assemblies, In Terms of the Questions Posed
Earlier, Some Tentative Conclusions. Will the Draft
Constitution:
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2.
3.
4.
5.
6.
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.