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
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 Country’s Main Regions?
Will it Lay the Economic Foundation for a Stable
Federation?
Will it’s Main Economic Provisions Contribute to LongRun Stability and Expansion of the Oil Sector? The
Private Sector?
Or, Will it Create More Uncertainty for Both?
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.
Draft Constitution's
Implicit Economic Framework
Based Largely on Ambassador Bremer’s 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
Country’s Current Economic Difficulties?.
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.
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.
Iraqi Opposition To
Draft Constitution’s 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 Country’s
Occupation – Has Helped Extremist Group’s Credibility.
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?
Issues Surrounding Iraq’s
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 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.

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.
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 (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 – 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
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?
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.
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.
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 Constitution’s 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.
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 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
Constitutional
Rules
Political
Outcomes
Neo-Liberal
Economic
System
Corruption
National vs
Regional
Emphasis on
Economic
Stabilization,
Development
Strategy
Efficiency vs.
Diversionary
Policy
Decisions
Note:
Predominance
of Vicious vs
Virtuous Circle
Depends
Critically on
The Manner
The Rentier
State Develops
United
States- IMF
Financial
Assistance/
Debt Relief
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:
1.
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.