Iraq: Mixed Opportunities, Messy Outlook? (Part I: The Road To Entrapment)

February 8, 2012Iraqby Isam al Khafaji

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Iraq: Mixed Opportunities, Messy Outlook? (Part I: The Road To Entrapment)

The Iraqi economy has gone through a roller coaster of changes for the last sixty years. In the first part of our analysis, we explore how Iraq fundamentally changed from an agricultural-based economy to one that relied solely on oil. We also question how this reliance on oil shaped the aftermath of Iraq’s economy and society after the Iran-Iraq war as well as the first Gulf war.

Read: Iraq: Mixed Opportunities, Messy Outlook? (Part II: Not Quite A Dreamland Yet)

During the 1970s, Iraq was widely seen as a model of a third world modernizing state; electricity grids reached 95 percent of households, schools were built in the remotest places in the country and the people had access to medical care with nominal or free prices.

Yet despite the widespread perceptions, Iraq’s progress at that time was far from impressive or exemplary even when compared to other countries in the region, including the non-oil producing ones. The improvements, as it turned out, were only belying deep structural imbalances that would surface during the Iran-Iraq war between 1980 and 1988, the longest war in the post WWII era, and eventually leave an imprint on the country’s society and politics.

The Road To Entrapment

For the last sixty years, Iraq had been transforming into a textbook case of a rentier economy. In 1952, the country had a “normally” functioning underdeveloped economy that relied mainly on agriculture (23 percent of GDP) and manufacturing (8 percent) – in addition to the construction, transport, banking, trade and real estate sectors. Taxes and customs were also the state’s main sources for finance and foreign currency.

But a radical shift in the economy began with the signing of so-called “profit sharing agreements” with oil producing companies that year. Thanks to these agreements, the value of oil exports jumped from 120 million Iraqi dinars (ID) in 1953 to 348 million in 1969, with oil now comprising 93 percent of Iraq’s total exports. Another jump occurred with the nationalization of the oil industry in 1972 and the oil price hikes in 1973.

Related: Iraq Oil and Gas Industry

Related: What it Means for Iraq To Become The World's Largest Oil Producer

All this happened as the Ba’th Party began to come into power in 1968, with Saddam Hussein assuming its leadership and presidency of Iraq from 1979 until 2003. Under that regime, a strategy of co-opting the populace was adopted. Their pillars included providing widespread public services, rewarding supporters and followers, forcing acquiescence and subjecting opposition to brutal measures.

As a result, corruption and waste of significant resources began to surface. However, this was centralised so to speak; only Saddam Hussein and his close family were allowed to siphon resources for their own enrichment, while part of the tremendous wealth had been used to buy off high ranking officials and followers while the rest ended up in foreign banks, building luxurious palaces and so on.

The Iraqi government also adopted five-year plans aimed at increasing the role of manufacturing industries in the economy. The end results though were disappointing. In actual practice, the government was still throwing its weight behind raising the oil export capacity, which reached its peak of 3.7 million barrels per day in 1979 on the eve of the Iran-Iraq war. Saddam Hussein, who was presiding over the all powerful Committee of Oil before his presidency, was also behind a politically motivated strategy to maximize oil exports by extending Iraq’s oil pipelines, passing through Syria, Turkey and the Persian Gulf terminal, to and from the Turkish outlet of Ceyhan.

In addition, the industrialization effort in Iraq failed because the country had been afflicted by the Dutch Disease – a heavy dependence on oil exports to finance its budget. As the Iraqi currency continued to appreciate in value, previously productive sectors turned uncompetitive. The share of the manufacturing industry in Iraq’s GDP also plummeted to 8 percent while agriculture fell to 6 percent during the 1970s. In fact, the only industries, apart from oil, that managed to benefit from Iraq’s so-called economic boom were those engaged in non-tradable goods such as construction and transport, which were hugely reliant on the state being their single largest purchaser and employer. Ultimately, this came to a point where the number of employees in civil service, health, education and state-owned enterprises had jumped from 20,000 in 1958 to 580,000 in 1977 and 821,000 by 1993. These figures did not include armed, intelligence and Para-military forces or party members on public payroll.

Two huge economic consequences ensued from the above developments. Agricultural activities were becoming less attractive and non-profitable, causing waves of rural citizens to migrate to major cities looking for employment activities in the government, construction and transport sectors. Iraq’s rural population, which comprised 66 percent of the total population in 1947, saw a complete reversal in its size, and by 1977, the urban population now represented 64 percent of the nation.

Secondly, almost all private economic (and social) activities were now dependent on the state. This allowed the government to reward its cronies without recourse – enriching a handful of nouveaux rich and wasting a lot of resources.

Eventually, Iraq’s human development record soon began to lag behind its neighbours. Life expectancy was at 59.8 years compared with 63.3 for Syria, 64.2 for Jordan, 61.7 for Saudi Arabia, 71.6 for Kuwait and 72.7 for the United Arab Emirates; Infant mortality during the same period was 73.8 per thousand live births compared with 54.6, 50, 61.2, 21.8 and 35.6 for the above mentioned countries respectively; Per capita food production also fell to 70.9, while that of Syria, Jordan and Saudi Arabia were 111.7, 115.8 and 118.7 respectively; Per capita protein intake lagged behind all the countries in the region with the exception of Jordan; the population per doctor was only second worst after Syria; the percentage of literate adults was the lowest among the six countries; and according to the World Bank and the UNDP, Iraq lagged in most indicators behind the group of lower middle income countries to which it belonged.

It is on this background that Iraq entered its war with Iran in 1980. By then, Iraq had reportedly already accumulated US$30-35 billion in foreign reserve. But in two years time, the war would expose the country’s economic vulnerability.

Saddam’s regime had counted on his foreign reserves to adopt a policy of guns and butter – guns to fight the war and butter to keep a semblance of normality among the people. But this policy was one that even the great powers could not afford during World War II. Furthermore, one of the first things that Iran would target during the war were the oil terminals that lay on the narrow strip linking Iraq to the Persian Gulf. The destruction of these terminals crippled Iraq’s export capabilities throughout the war (and beyond).

By 1983, Iraq’s Achilles Heel would be dealt another blow when Syria, the main ally of Iran in the war, halted Iraq’s exports through its territory. This left Iraq with only its Turkish oil outlet – with an export capacity of around 1.6 million barrels per day – as well as trucks that were used to export oil to Jordan. It would also take the country several years to extend two pipelines through Saudi territory.

But by then the harsh realities of the war were beginning to show. The United Arab Emirates and Saudi Arabia began to pump 310 thousand barrels per day from their own oil on behalf of Iraq; and for various reasons the latter started to enjoy wide international support, which helped the economy afloat through credits and soft loans including supplying the country with high tech military equipment. For the first time ever, Saddam Hussein, who forced acquiescence on its people through rewards, was now turning to Iraqis for donations to the war effort.

On the Verge of Collapse

By the end of the Iran-Iraq war in 1988, Iraq’s GDP per capita was $1765, compared to its peak of $4200 in 1979. The toll of the war also put additional strains on the Iraqi economy as more and more of its workforce were drawn to the frontlines of battle. In 1981, the ratio of armed forces to the total workforce was only 12 percent, but by 1988, this figure jumped to 21.3 percent.

To compensate for that drainage, Iraq imported large numbers of Egyptian workers to perform jobs in the agricultural and construction sectors. But, what the government failed to predict was that the imported workforce would place more pressure on Iraq’s foreign exchange reserves in the form of remittance.

According to Abbas Al-Nasrawi, who wrote Iraq’s Burden: Oil, Sanctions and Underdevelopment, “Iraq was becoming like an Athenian society of citizen-warriors and slave-workers”. Due to these developments the Iraqi dinar lost some 65 percent of its value against the US dollar, plummeting from 3.12 in 1979 to 2.8 in 1987 and to 0.33 in October 1989, thus causing a serious deterioration in Iraqi finances as the value of imports appreciated significantly.

Not surprisingly, Iraq’s foreign reserved would be depleted by the end of Iran-Iraq war; and the country soon found themselves $110 billion in debt. Many experts and observers have linked Iraq’s dismal economic situation in 1988 with the decision to invade Kuwait in 1990 – first to profit from the latter’s oil export facilities and wealth, and second to escape the pressures of finding jobs for a million or so decommissioned soldiers after the end of the Iran-Iraq war at a time when the country had lost the means to provide them with decent living condition.

Still, whether Saddam Hussein could have anticipated the disasters that would befall his country following his reckless adventure remains for the historians to discuss. What we do know is that the invasion would ultimately lead to Iraq being subjugated to the harshest sanctions ever imposed on a country in history.

The UN embargo on Iraq underwent two major stages: one from 1990 when no exports or imports were allowed because of the regime’s intransigent demands that the sanctions must be lifted altogether, and the second from 1996 until the fall of Saddam Hussein when the “Oil for Food Program” was implemented.

The total amounts of oil exports under the second program reached $64 billion, of which 30 percent was withheld from the Iraqis by the UN Compensation Commission for war reparations. Another 15 percent then was spent under UN supervision in the autonomous Kurdistan region, while the remaining 55 percent was in the form of authorized imports by the Iraqi government. A few additional billion flowed into the regime’s coffers through smuggling oil.

Consequently, both oil and non-oil outputs struggled. By the end of the first gulf war, Iraq’s oil output had fall by 95 percent as compared to 1989. Non-oil output fell by 72 percent. Agriculture fell by 18 percent, while public services and trade dropped by 84 percent, with construction declining by 79 percent. Electricity also suffered by 57 percent compared to its 1989 output.

A period of hyperinflation soon ensued from 1990-1995, though the economy managed to return to a more stable course from 1995 onwards. Price increases stabilized at an average annual rate of 10 percent in 1995-2002 compared to 237 percent in 1990-1995. This was closely associated with similar changes in the market rate of exchange. In the period 1999-2002, non-oil output grew by 9 percent annually. Leaders in growth were construction, manufacturing, and electricity. Still by 2002, the non-oil output was only 40 percent of its level in 1989. In addition, GDP per capita was only 43 percent of its 1989 level.

Related: Iraq Economic Statistics and Indicators

Related: Iraq Economic Forecast

A Sequence of Disastrous Events

As one can already tell, the sequence of disastrous events, which the Iraqis suffered from 1980 onwards, were so interrelated that it would be very hard to single out which of these had more effect. The country’s perennial structural problem of almost total dependence on oil eclipsed all productive economic activities, except construction, and it led to the rise of authoritarianism and the tremendous growth in the state tentacles to pervade all aspects of the public space. This in turn was at the heart of militarizing the country, which led to three consecutive wars, the virtual collapse of the economy and the disruption of the social fabric of society.

Were Iraq less dependent on oil proceeds, the impact of the sanctions could have been mitigated thru its domestic food and basic manufacturing activities. However, one might venture to say that the suffocating sanctions were the hardest to hit Iraq.

By Isam al Khafaji

Isam al Khafaji is a special advisor and consultant on the social and economic affairs of the Middle East. After being forced to leave teaching at Iraqi universities in the late 1970s, he proceeded to become a senior expert for the UNDP for launching Syria’s first Human Development report in 2000, and an advisor to the World Bank on issues of political reform in the Middle East in 2001. In 2002, he actively joined the US State Department’s workshops on the “Future of Iraq” and later served as an advisor to the Coalition Provisional Authority in Baghdad until July 2003 when he resigned in protest at the US policies in handling Iraq.

In Part II of Isam al Khafaji’s exclusive feature for EconomyWatch.com, al Khafaji will explore the impact of the US –led invasion on the Iraqi economy, as well as discuss the future for the Iraqi Economy.

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