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Economic Questions Surrounding Iraq’s Draft Constitution Robert Looney Professor, National Security Affairs Naval Postgraduate School Briefing on Iraq’s Draft Constitution Stimson Center, Dirksen Senate Office Building Washington, DC, October 4, 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.