IRAQ: Huge economic challenges after Saddam

Analysis

The prospect of President Saddam Hussein's removal opens up not only huge new potential for development of the Iraqi economy, but also greatly increased uncertainty compared, for instance, with the situation in 2000, when Iraq seemed to be gradually slipping free of sanctions on its own terms. Not only the course of the war, but also the success or otherwise of post-war efforts to stabilise and rehabilitate the country, presently offer uncertain prospects.

New regime.The form that regime change takes will be a key determinant of immediate economic prospects (see IRAQ: Dictator, democracy or chaos? - life after Saddam - September 18, 2002). The least economically damaging political transition in Iraq is likely to follow a military coup or a 'perfect war' in which Iraqi units surrender without fighting. Rapid international recognition of a new government would reduce the prospects of a civil war. At the other extreme are outcomes in which non-conventional weapons are used in urban fighting, and in which civil war erupts (see PROSPECTS 2003: Year of destiny for Saddam's regime - December 16, 2002).

Expectations.The most important economic tasks of a new government will be to show quickly that it is making a difference, to maintain control over Iraq and to restore relations with the United States. A change of regime, which is likely in most circumstances to be accompanied by the lifting of sanctions, will release 30 years of unfulfilled hopes in Iraq. A government that is not seen as able to meet these hopes risks losing public confidence, and may itself be succeeded quickly.

The management of expectations proved difficult after the 1988 ceasefire in the Iran-Iraq war, as Baghdad tried to reintegrate demobbed soldiers into a stagnant, indebted economy. Its limited ability to do so was a chief factor in the invasion of Kuwait. Iraqis today may not have such high expectations, most of them never having experienced the optimism of the 1970s. Against this, many Iraqis may have a deeper sense of grievance and victimisation, having survived twelve years of sanctions and another war; this may spur a sense of entitlement. A successor government may be expected to deliver rapid improvements in public services, but have more limited means to do so than in 1988-90, with budget constraints tighter and institutional capacity weakened.

An influx of repatriated money will spur inflation, as may the presence of relatively wealthy occupation forces. Furthermore, if the black market gains legal recognition, prices may rise in this sector, reflecting the increased value resulting from, for example, the ability to borrow against assets at commercial rates. The eventual end of the subsidised prices of the 'oil-for-food' programme will also be inflationary.

Controlling Iraq.Iraqi government control is necessary for economic growth for at least two reasons:

• Control reduces uncertainty, which is costly. Post-war uncertainties will be considerable, with the risk of armed conflict reaching down even to villages.
• Iraq's legal system and economic institutions, such as the Central Bank of Iraq, are in need of significant restructuring and capacity building. As the collapse of the Soviet Union showed, major institutional change in the absence of political stability can be disastrous.

A coup led by current members of the Iraqi regime seems to stand the best chance of effecting a smooth transition of power, as they would retain intact existing security networks. In the longer run, Iraqis' hopes for a more representative government would be frustrated by a new dictatorship, generating problems for the new government unless plans are rapidly unveiled for a democratic transition. To this end, Washington envisages the installation in any event of a US military administration, which could be augmented by UN staff continuing a version of 'oil-for-food' (see IRAQ: US occupation plans invite 'colonial' stigma - February 25, 2003). With a substantial US military presence, this configuration offers promise for short-term stability. However, while political structures intended to facilitate control may speed Iraq's economic and political re-integration, they are also likely over time to generate civil unrest and to inspire attempts from outside Iraq to undermine them (see MIDDLE EAST: Will Saddam's demise spur Arab democracy? - March 7, 2003).

US relations.The suspension or lifting of sanctions will require US support in the Security Council. More help still will be needed: the removal of sanctions may require Iraq again to service its international debt, an immediate cost that will not be matched by immediate income (see IRAQ: Oil revenues insufficient to finance reconstruction - January 31, 2003). The UN currently estimates Iraq's debt at 100-150 billion dollars. Some de facto debt servicing has occurred under sanctions. Nevertheless, by any of the usual ratios, Iraq is highly indebted. Debt restructuring or forgiveness will be difficult without US support.

A second major category of international obligations is compensation for damages arising from its invasion of Kuwait. Outstanding claims worth 197 billion dollars await assessment. If they are resolved with the same success rate as past claims, 87 billion more will be awarded. Kuwait has announced it will pursue outstanding claims (25 billion) even in the event of a change of government. US government pressure may be exerted to drop these. Corporate claims (4 billion) may be dropped for different reasons: future Iraqi governments are likely to continue the present practice of conditioning contracts to foreign companies on the waiving of compensation claims. The war reparations can only be altered by the Security Council, and are thus subject to a US veto.

However, good relations between a new government and the United States could be problematic. US policy is perceived by many Iraqis as a principal cause of their suffering for over 20 years. This legacy of distrust will not be overcome easily, especially with US forces occupying a proud nation. Furthermore, with Iraqi nationalists likely to stress their commitment to an independent and viable Palestine, a democratic Iraq may clash with administration US officials currently shaping Iraq policy.

No aid boom.In spite of discussion of a 'Marshall Plan' for Iraq, significant untied aid seems implausible. The perception that Iraq is a wealthy country, only temporarily impoverished, has complicated fund-raising for it since 1991 given competition from 'truly' poor countries. The United States has only offered small sums for humanitarian relief to date. Indeed, with the federal budget running record deficits even without the costs of war, and some elements of the administration envisaging recouping US costs from Iraqi oil, significant new promises are unlikely.

The more likely forms of aid are tied aid -- designed to give foreign firms preferential access to Iraq -- and debt restructuring or forgiveness. Energy, construction and other infrastructure firms may lobby their governments heavily for support in their attempts to win contracts in Iraq. The US government has reportedly invited five US companies to bid for reconstruction projects worth up to 900 million dollars. A future Iraqi government may find itself expected to accept lower quality international offers in return for political support. Hiring foreign contractors would be very expensive, particularly given the low wages of skilled Iraqis. Debt negotiations are rarely easy, and are likely to be difficult for Iraq as well. Some creditors, such as Russia, are now poor themselves and loathe to renounce their claims. More generally, negotiations can still be expected to take place in a highly politicised environment.