From 1990 to 2003, Iraq languished under comprehensive UN sanctions that prohibited foreign trade. When sanctions were finally lifted, many economists and pundits, as well as Iraqis themselves, hoped for a rapidly expanding economy, brisk reconstruction and a return to prosperity. They have been sorely disappointed.
Iraqis and outside observers have been frustrated by what they see as the “under-performance” of the Iraqi economy since the old regime’s violent ouster from power. Critics note the endemic corruption, elevated poverty rates, continuing insecurity, bureaucratic wrangling and poor public services that still characterize economic life today, ten years after the removal of sanctions. This criticism, however, ignores the discrepancy between Iraq’s colossal oil wealth and the country’s meager development record. Indeed, such analyses typically compare Iraq today to the potential suggested by a (sometimes idealized but definitely expanding) developmental past — a sort of romanticized snapshot of some point in time, usually in the 1970s, when the country was frenetically engaged in human and physical capital formation. The problem with this view is that it leads to a negatively skewed assessment of today’s economic outcomes and prevailing realities.
Lackluster Growth
Iraq’s recovery from war and sanctions has been tepid at best. Real GDP measures the quantities of goods and services produced in the domestic economy. It is widely used as an indicator of social wellbeing, in contrast to nominal GDP, which simply reports the money value of the goods and services. (If the prices of all goods and services rise by 5 percent and the amounts that are produced remain unchanged, nominal GDP would rise accordingly by 5 percent. But real GDP would remain constant.) As the adjacent table shows, real GDP declined precipitously in 2003, the year in which the US invaded and occupied Iraq. Not surprisingly, it recovered swiftly in 2004 after the end of “major combat.” 
But since then, the rates of growth have been subdued: The growth rate of real GDP averaged between 6 and 7 percent from 2005 to 2011, fluctuating from a low of almost zero in 2007 to a high of 12 percent in 2011. When the rate of growth of population, roughly 2-3 percent per annum, is deducted from these figures to calculate per capita growth rates of real GDP, the results appear even less impressive. These estimates are actually broadly similar to the growth rates experienced by other Middle Eastern oil exporters, such as Algeria, Iran and Saudi Arabia, [1] none of which were emerging from more than a decade of economic isolation and penury brought about by war and sanctions, as Iraq was.
As real GDP has puttered along, oil revenues have expanded markedly, despite stagnant oil production and exports. As shown in the table, the output of crude oil (most of which is exported) actually declined after 2003 and reached its pre-war level only in 2009 to 2010. Rising oil prices offset this decline. With the exception of a brief period in late 2008 and 2009, when prices collapsed at the depth of the global financial crisis, international oil prices have been climbing steadily since the early 2000s. The price of a barrel of Basra Light, a class of crude oil that Iraq exports, increased from $23 in 2002 to $58 in 2006 to $106 in 2011. [2] Oil revenues have more than doubled — from $40 billion in 2007 to $86 billion in 2011 — because higher oil prices have more than compensated for lackluster output (and hence exports). [3] It is sometimes fashionable to view revenues derived from oil or other natural resources — known to economists as “rents” — in an unambiguously negative light. Rents are said to make the state less accountable to the citizenry, for example, because they take the place of taxes in government coffers. They also have the potential to stifle the growth of goods-producing sectors, such as agriculture and manufacturing. Indeed, the negative corollaries of the “resource curse” have been in evidence in Iraq over the last half-century. Yet the upsurge in oil prices and hence revenues over the last ten years must be counted as a blessing rather than a curse for Iraq. The influx of exogenous rents occurred despite Iraq’s inability to increase petroleum output.
Spending these resources has proven more difficult than generating them. Unlike funds generated through labor-intensive agriculture or manufacturing, oil revenues do not automatically flow into the rest of the economy. The oil sector is highly capital-intensive: It employs very few workers and requires specialized inputs. In Iraq, even though oil accounts for most of GDP and almost all exports and government revenues, the sector employs only 1 percent of the labor force. [4] And few domestic suppliers are able to meet the technological and skilled manpower demands of the petroleum sector. Most parts and equipment for the sector are imported, for example. This gap leaves oil mostly independent of the other sectors of the economy. The budget of the central government, which receives the oil revenues, is one mechanism that can overcome the asymmetry, by directing revenues to social infrastructure, such as schools, hospitals and roads, and various productive activities, as well as by augmenting incomes.
Elevated Consumption and Incomes
Indeed, expanded government expenditures paid for by the higher oil revenues have increased consumption, both public and private. The Iraqi state is a very large employer. In 2012, an astounding 60 percent of all full-time workers worked in the public sector [5]; the comparable figure for the autonomous (de facto independent) Kurdistan Regional Government is even higher. Moreover, many of those employed in the private sector depend indirectly on government spending via outsourcing. Thus, it has proven relatively easy to use oil revenues to buttress personal incomes. Both average pay and total public employment have grown substantially. Public-sector employment (both part-time and full-time) increased from 32 percent of total employment in 2003 to 43 percent of Iraq’s (rapidly expanding) labor force in 2008, doubling in absolute terms. [6]
These expenditures have raised the incomes of Iraqis, which were depressed after 13 years of sanctions. Unemployment (broadly defined to include underemployment) has declined from 38 percent in 2004 to 20 percent in 2013. [7] Better benefits, working conditions and pay make employment in the public sector more attractive than private-sector work for job seekers, many of whom queue to work in government. But the demobilization of the Iraqi army and debaathification stripped thousands of workers of their government jobs (though many have been reinstated). Moreover, conflict-induced migration and dislocation within Iraq, as well as abroad, has deprived possibly hundreds of thousands of others of their jobs, in both the public and private sectors. These disruptions help to explain why, as of 2009, the incomes of 23 percent of households in Iraq fell below the national poverty line, [8] despite rising personal incomes. Households with no one in public employment, as well as those headed by women (most of whom are widows), are more likely to be poor. [9]
Rising consumption and incomes have done little to stimulate agriculture and manufacturing, key goods-producing sectors. Ordinarily, one might expect a strong multiplier effect from increased domestic spending, but in this case, rising incomes have not lifted many boats. The ability of agriculture and manufacturing to respond to rising demand is very limited. According to an Iraqi Ministry of Finance study, increased competition from agricultural imports following the removal of import controls and reduction of tariffs by the Coalition Provisional Authority (CPA) in 2003, along with chronic under-investment in the sector, further weakened an already strained Iraqi agriculture. [10] And energy-intensive manufacturing, devastated by wars and sanctions, could hardly be expected to expand rapidly when, according to World Bank data, per capita electricity consumption was lower in 2010 than in 2002. What rising personal incomes have done is to generate a boom in imports, services and real estate, with Baghdad property prices rising twenty-fold or more in some instances.
Yet it is exceedingly unlikely that the oil-funded rise in public employment and consumption has displaced private-sector workers. More likely, the opposite is true. Government spending has buoyed private-sector employment, as the state usually outsources some of its work. And private employment depends greatly on investment (including foreign direct investment), which has only recently, since 2010, begun to rise with the relative improvement in security. Reducing the size of the state bureaucracy or the extent of public-sector spending would not magically increase private-sector employment.
Sluggish Investment and Reconstruction
And, interestingly, elevated levels of consumption spending have not come at the cost of reduced investments, because the Iraqi economy’s ability to carry through investments has been severely degraded over the last three decades. The 1990-1991 Gulf war, in the words of a UN report, “relegated [Iraq] to the pre-industrial age, but with all the disabilities of post-industrial dependency on an intensive use of energy and technology.” [11] The devastatingly tight economic sanctions regime that followed kept the country from rebuilding. Infant mortality and malnutrition soared, inflation wiped out middle-class savings and incomes collapsed. Many Iraqis, notably those with technical and managerial skills that are essential for rebuilding, emigrated. The UN High Commissioner for Refugees estimates that 4 million Iraqis were living outside the country by 2002, and migration has continued and perhaps accelerated since. Implementing capital investments on a large scale after 2003 was never going to be easy.
The actions of the CPA, the US-British body that governed Iraq from May 2003 to June 2004, made capital formation even harder. The CPA tried to implement radical shock therapy. Its policies increased unemployment, aggravated insecurity and restricted capital formation. [12] The US spent tens of billions of dollars on reconstruction, during the CPA’s tenure and subsequently, but the actual value of what was constructed represents only a fraction of that expenditure, because of mismanagement, corruption and high security costs. [13] According to Stuart Bowen, head of the Special Inspector General for Iraq Reconstruction office, a “conservative” estimate is that $8 billion of the $60 billion was simply wasted. [14]
One problem with the mass firing of Baathists under the CPA is that many had acquired technical or managerial skills that the state required to carry out reconstruction. And providing security to capital projects has proven to be expensive, at one point taking up one third to one half of total project costs. [15] More generally, a cumbersome state bureaucracy that dates back several decades has added to the difficulties. As a result of these factors, investment and reconstruction have moved slowly. The Iraqi government, a major domestic investor, was able to spend only 28 percent of its investment budget in 2007. In contrast, it spent 80 percent of its operating budget, most of which went to pay the salaries of public workers. [16] Former Deputy Defense Secretary Paul Wolfowitz’s pre-war assessment that Iraq would be able to “finance its own reconstruction” has proven to be perversely accurate. The country has been able to spend only a fraction of its allocated funds, in part because the US was never wholly able to provide security.
The Iraqi government’s inability to spend all the allocated expenditures has generated large fiscal surpluses. The glut has not blunted the drive to expand oil production. More lucrative petrochemical industries require large and lengthy investment streams and highly skilled human capital, well outside Iraq’s present capabilities. Instead, the Iraqi government has announced ambitious plans to double oil output by 2020. The promise of more oil rents offers peace of mind in case of some unforeseen decline in the price of oil, as occurred in 2008 and 2009, which might hamper the state’s ability to pay its workers.
Corruption and Political Dysfunction
Improved security, rather than higher oil revenues, has helped to ease the investment bottleneck since 2009 and 2010. The rate of growth of real GDP has accordingly been higher in the last few years. But rebuilding is being held back by corruption and political fragmentation, sustained to a great extent by petroleum rents.
Iraq ranks number 169 on the list of 174 countries in Transparency International’s 2012 Corruption Perception Index. Job applicants pay bribes to secure appointments in the state sector and money greases the wheels of routine bureaucratic procedures. [17] Funds often find their way to political parties or militias that control the various government ministries. In a country without a culture of political donations, political parties use this mechanism to fund their operations. Unlike petty corruption, this type of activity has the potential to promote violence and instability, with rival political factions engaging in armed clashes over turf within the state. It can also retard investment and growth. Cooperation of ministries controlled by competing parties or organizations is often required to execute investment projects, and such coordination often has been absent.
Interestingly, incapacity is sometimes mistaken for corruption. Iraq’s health service provides an example. Once one of the most developed in the Middle East, today the health care system is in tatters. According to data from the World Health Organization, life expectancy at birth has actually declined over the past four decades, from 65 years in 1980 to 58 in 2010. [18] An estimated 18,000 physicians, approximately half the total, have left Iraq since 2003 and few have returned. As a result, as of 2010, a doctor is on staff at only half of the roughly 2,000 primary health care centers in the country. The dearth of medical and managerial expertise, coupled with the gradual erosion of the health care structure, explains in large part why the Health Ministry has been able to spend only a fraction of its allocated spending, a problem which analysts had previously (and erroneously) attributed to corruption. [19]
Iraq’s public sector as a whole appears to be simultaneously bloated and insufficient. The swelling of the ranks of the state bureaucracy and salary hikes over the last few years are unlikely to improve Iraq’s poor record on the completion of capital investment projects, even though the hiring has not directly diminished investment by taking funds away. In fact, part of the purpose of offering higher salaries is to retain skilled personnel. In general, though, Iraq’s state bureaucracy is notoriously inefficient and over-staffed. According to the former planning minister, Ali Baban, 70 percent of those on the public payroll lack a “real job” and are unproductive. [20] Baban’s remarks may exaggerate the extent of the problem, but it is almost certainly true that over-staffing exists side by side with lack of skills. It will take years, if not decades, to rebuild the country’s human capacity, savaged by war, sanctions and migration. [21]
Nonetheless, there are notable encouraging markers for Iraq’s economic future. Paris Club agreements (with mostly Western debtors) have reduced Iraq’s external debt to sustainable levels, and negotiations with remaining debtors are set to cut debt levels further. Oil revenues are expected to rise over the next decade, and foreign direct investment has started to return to the country. Yet, as experience suggests, transforming oil revenues into economic and human development will be challenging, with no ready or obvious resolution to the country’s capacity-building impasse. The possibility of a return to the civil war that engulfed the country from 2005 to 2007 is terrifying, but thankfully distant. Equally unlikely is a swift resolution to the economic and political bottlenecks. But the prospect over the next decade for Iraq to become caught in a low-capacity trap, where the country sustains itself with the sale of oil, and even attracts some oil-connected investor dollars, but nonetheless is unable to offer decent public services or retain its most vital people, is regrettably real.
Endnotes
[1] See, for comparison with other countries in the region, International Monetary Fund, Regional Economic Outlook: Middle East and Central Asia, November 2012, p. 88.
[2] Organization of Petroleum Exporting Countries, Annual Statistical Bulletin 2012, p. 82.
[3] Ibid., p. 16.
[4] UN Development Program, Oil and Gas Factsheet, October 2011, Inter-Agency Information and Analysis Unit, p. 2.
[5] Business Monitor International, Iraq Business Forecast Report, Q1 2013, p. 14.
[6] Calculated from data in the UN Office for the Coordination of Humanitarian Affairs, Iraq Labor Force Analysis, 2003–2008 (January 2009), p. 2.
[7] Al-Zaman, January 23, 2013.
[8] Ibid.
[9] UN Office of Humanitarian Affairs, Iraq Labor Force Analysis, pp. 4-5.
[10] Iraqi Ministry of Finance, The Agricultural Sector in Iraq: Analysis of Problems and Reform Proposals (undated), http://www.mof.gov.iq/uploads/pdf/ektisadia%20researches/17.pdf. [Arabic]
[11] Quoted in Abbas Alnasrawi, Iraq’s Burdens: Oil, Sanctions and Underdevelopment (London: Greenwood Press, 2002), p. 67.
[12] Bassam Yousif, “Economic Restructuring in Iraq: Intended and Unintended Consequences,” Journal of Economic Issues 41/1 (March 2007).
[13] See Special Inspector General for Iraq Reconstruction, various reports, http://www.sigir.mil/.
[14] Spencer Ackerman, “Over $8 Billion of the Money You Spent Rebuilding Iraq Was Wasted Outright,” Wired.com, March 6, 2013.
[15] IMF, “Iraq Staff Report for the Article IV Consultation,” July 8, 2005, p. 7.
[16] Government Accountability Office, Stabilizing and Rebuilding Iraq: Iraqi Revenues, Expenditures and Surplus, September 16, 2008, GAO-08-1144T, p. 3.
[17] Patrick Cockburn, “How Bribery Became a Way of Life in Iraq,” Independent, June 28, 2009.
[18] Paul Webster, “lraq’s Health System Yet to Heal from Ravages of War,” The Lancet, September 3, 2011, p. 864.
[19] Business Monitor International, Iraq Business Forecast Report, Q2 2012, pp. 22-24.
[20] Al-Mada, October 15, 2010.
[21] At a Hollings Center “next-generation dialogue” on Iraq’s economic and foreign policy in Istanbul, I was told by conference organizers that a less developed market economy, civil society and training of personnel made it harder to identify and invite emerging leaders from Iraq than from Afghanistan. For conference proceedings, see http://www.hollingscenter.org/
wp-content/uploads/2010/03/Iraq-NGD-Dialogue-Snapshot-March-2013.pdf.
