Download MIT Persian Gulf Initiative Workshop on Iraq`s

Rethinking Iraq’s Neoliberal Reforms
-- Implications for State Formation


Robert Looney
Professor, National Security Affairs
Naval Postgraduate School
Persian Gulf Initiative Workshop on
Iraq
MIT Center for International Studies
April 26-27, 2005
Outline:
Rethinking Iraq’s Neoliberal Reforms

Linkages Between State Formation and The Iraqi Economy.

Neoliberal Reforms in Iraq.

The Likely Effectiveness of Continued Neoliberalism in Iraq.
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Most Important Obstacles to a Viable Market Economy in Iraq.
Large Informal Economy.
Deterioration in Social Capital.
Rentier State Effects.
Insurgency and Corruption the Common Elements.
The Future
Lessons From Other Countries.
Alternative Approaches – Main Considerations.
Conditions for Economic Recovery in Iraq – Intangibles
An Integrated Strategy For Growth and State Formation.
General Propositions: Economic
Component of Iraqi State Formation

The Government Must Reduce Its Role in the Economy and
Expand The Play of Market Forces.

For this, The State Itself Must Be Strengthened so That It Can
Assume an Interventionist Role In:

Assuming Much of the Insurgency-Related Risk.

Liberalizing Economic Activity, Prices and Market Operations.

Establishing Political Accountability for Economic
Performance, as Well as Public Responsiveness to Private
Sector Economic Needs.
General Propositions (contd.)

Developing Indirect, Market-Oriented Instruments for
Macroeconomic Stabilization.

Using these Macroeconomic Instruments to Increase
Market-Based Employment Opportunities for Iraqis.

Achieving Effective Enterprise Management and
Economic Efficiency, Usually Through Privatization.

Establishing Institutional and Legal Framework to
Secure Property Rights, Rule of Law, and Transparent
Market-Entry Regulations.
Key Questions
in Designing Iraqi Policy

Can An Economic Strategy be Developed that is Viable Given the
Likelihood of an On-going Insurgency over the Next Several Years?

Can the Necessary Movement to Free Markets Be Accomplished
Without Creating Another Layer of Angry and Marginalized Iraqis?
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Will a New Market Economy Benefit Some Groups at the Expense of
Others?—Some Regions Over Others? If so are there Satisfactory
Solutions? Or a Equity/Growth Trade-off?
Will There Be Broad-Based Popular Support for Market Liberalization?
Or Will the Movement to Markets Be Perceived as Dictated by Outside
Interests to the Detriment of Iraqis?
The Extent to Which the US/IMF Will Affect the Nature and Speed of
Economic Reforms. Will it be in the Form of Consensus Building? Or
Conditionality for Financial Support?
Economic Impediments
To State Formation in Iraq

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Oil Rents Create a Allocation State as Opposed to a Production
State—Conflicts over the Access to and Control of Rents.
Concentration of Oil Rents Reduces State Need to Extract
Money From Society –Gain Citizen Support In Return For
Valued Services and Effective Economic Management.

Lack of Rigorous Tax System Impedes Emergence of a Strong
State that Legitimately Represents its Citizens.

Oil Creates an Implicit Social Contract – Substitution of
Political Rights for State Provided Welfare.

Oil Revenues Encourage Patrimonial Loyalties as Opposed to
Participatory Democracy.

Associated Corruption Undermines State Formation.
Economic Keys for Successful
State Formation in Iraq

Separate the Government from the Natural Resources.
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Ensure the petroleum benefits the people—Avoid the Curse of
Resources or the Paradox of Plenty Problems.

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Diversify—Follow the Example of Countries Like Mexico,
Successful in Reducing Dependence on oil, by Encouraging
Other Industries as Well as Non-oil Exports.
Design Policies and Institutional Support that are Resilient to
the On-Going Insurgency – Avoid Programs and Policies
Whose Success Depends on Long Time Horizons or Market
Stability.
Attempt to Develop an Environment of Economic
Accountability on the Part of Both the State and the Private
Sector – Each Place Pressure on the Other for Improvements.
Ideal Interaction of Economic
Development and State Formation
Taxes,
Government
Revenues
Economic
Growth
Sophistication
of Company
Operations and
Strategy
Increased
Competition
Market
Liberalization
Two Way
Pressure to
Improve
Productivity
and
Government
Services
Market,
Institutiona l
Reforms
Quality of the
Business
Environment
Responsive ,
Reformist,
Interventionist
State
Critique of the
Neoliberal Reforms in Iraq
Problem: Few of the Economic Policies or Reforms Needed for
Successful State Formation in Iraq Appear to be Occurring:

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Neoliberal Reforms in Iraq Extreme by Most Measures -Oriented Towards Stimulating Private Investment and Creating
a New Economy.
Investors (except oil production and refining) allowed 100%
ownership of Iraqi Assets, Full Repatriation of Profits and Equal
Legal Standing With Local Firms. Foreign Banks May Establish
New Operations or Purchase Equity Shares in Existing Iraqi
Banks.

Income and Corporate Taxes Capped at 15%.

Tariffs Reduced to Universal 5% With None on Food, Drugs, and
Other Humanitarian Imports.
Critique: Iraqi
Neoliberal Reforms (contd.)

Independent Central Bank Created.

State Owned Enterprises to be Privatized, No Timeframe or
Method Specified.

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Text-Book Application of Reforms – Belief in Advantages of
Shock Therapy -- Little or No Consultation With or Input From
Iraqis on Design or implementation of Reforms.
Main Problems – Status of Reforms in Future Governments Not
Clear – Imposed by Occupying Power, but May Be Overturned
or Significantly Modified by an Elected Iraqi Government –
Effect Has been to Create More Investor Uncertainty on top of
the Insurgency.
Critique: Iraqi
Neoliberal Reforms (contd.)


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Adequate Foundation Not Laid To Take Advantage of Reforms
Strengths. Extremely Vulnerable to the Insurgency.
By Reducing Interventionist Role of the State, No Way to
Stabilize Economy Once Downward Spiral Began. Now Have to
Face Many More Severe Obstacles than in Initial Pre-War
Period.
Reforms Focused on Long-Term Issues, Structural Changes –
Neglected Short-Term Problems Such as Unemployment –
Reforms Lost Credibility by Not Resolving Pressing Problems.
Reforms Stalled, Incomplete – Limited Benefits and Numerous
Dislocations.
At Issue: Should Iraq -- Abandon Reforms, Continue Along the
Broader Washington Consensus Path or Develop An
Alternative Approach Specific to Iraqi Conditions?
General Criticisms of Neoliberal
Reforms/Washington Consensus
Many Reasons to Question the Wisdom of Continuing to Pursue a
Strict Neoliberal/Washington Consensus Approach to Reforms
in Iraq.

Narrow View of Macroeconomic Stability—Focus on Price
Stability Rather than Demand Management.

Disregard for Role Public Sector Policy Interventions Can Play
in Increasing Investment and Growth.

Hierarchical View With Sound Economic Policies Primacy Over
Social Policies.

One Size Fits All Approach Negates Local Responses to
Unusual Circumstances.

Tendency to Forget that it is the Citizens Who Should Choose
The Economic and Social Institutions they Prefer.
Alternative Approaches: Relevant
Experiences With Reforms
Neoliberal Reforms in Vogue Around 1990 – Since Then Much
Disillusionment With their Effectiveness – No Longer the
Dominant Paradigm.

The Empirical Record Suggests:

Transitions to High Economic Growth Usually Characterized by
Narrow Range of Policy Changes and Institutional Reforms.

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Proper Sequencing of Reforms Extremely Important, but Hard
to Arrive at Generalizations Applicable to a Wide Range of
Environments.
Policy Changes that Initiate Successful Growth Transitions
Typically Combine Elements of Washington Consensus With
Unconventional Institutional Innovations – Need for Creativity
and Local Participation in Inputs.
Alternative Approaches: Relevant
Experiences With Reforms (contd.)

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Institutional Innovations Do Not Migrate Well – Many Are
Specific to Country of Origin.
Sustaining Economic Growth Requires Continual Deepening of
Reforms and Renewing Institutions –Inability to Improve
Regulatory Environment Often Undermines Earlier Successes.
To Initiate Growth, Iraq’s Approach to Reforms and The
Economy Will Have to Successfully Resolve a Number of
Specific Impediments Unique to the Iraqi Context.
A Successful Policy Must Address Each of These Impediments
– Something the Neoliberal Reforms/Washington Consensus
Were Not Designed to Contend With.
Impediments to Economic
Recovery and Growth in Iraq
Major Impediments to Economic Recovery and
State Formation in Iraq Include:
1.
2.
3.
4.
5.
6.
7.
Corruption.
The Insurgency – Criminal Activity.
Deterioration of Social Capital.
Rentier State—Resource Curse Effects.
Large and Growing Informal Economy.
Potential Macroeconomic Instability.
Opposition to Further Economic Reforms.
Iraq: Criminal Activity,
the Insurgency and the Shadow Economy
Black M arket
Arbitrage
Reduced
Gov ernment
Financial
Resources
Low Formal
Sector Job
Cr eation
Relat iv e
Expansion
of the
Shadow,
Informal
Economy
Retarded
M oder n
Agricult ural
Dev elopment
Kidnapping,
Cr ime,
Violence
Lost
Entrepreneurial,
Professional
Class
Limit ed New
Indust ry
Hawala
Financial
Transactions
Retarded
Dev elopment
of a M odern
Financial
System
Iraqi Opposition
To Neoliberal Reforms
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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 Elements 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 Great Success
by the Transition Countries as a Sign of Their New
Independence are Seen by Iraqis as Products of the Country’s
Occupation.
Lessons From
The Transition Countries
Looking at the Transition Country Experience There is Hope for
Iraq in Overcoming These Impediments. The Main Lessons
From This Experience Are:

Sustained Macroeconomic Stabilization is Essential.

Delayed Reforms Risk Negative Growth.

No One Component of Washington Consensus Reforms Stands
Out – Need To Implement All Components.

Unfavorable Initial Conditions Can Be Offset Through Correct
Reforms.

Most Jobs Created by Small-Medium Scale New Firms.
Transition Country Lessons (contd.)

Improving Investment Climate Critical for Creation of New
Firms.

Development of a Legal Framework Critical.



If Country Puts off Implementing Rule of Law, Enforcing
Discipline, Securing Property Rights, then other Reforms Are
Unlikely to Produce Significant Benefits.
From the Start, Successful Transition Countries Create Groups
That Have a High Stake in Pressing for Further and Deeper
Reforms Over Time.
U.S. Policymakers Apparently Thought that Transition Success
Stemmed Mainly From an Application of Washington
Consensus Reforms. Creativity in Adapting Reforms to Local
Circumstances Appear As or More Important.
Key Empirical Linkages
In Addition to Drawing on the Lessons For Success, A Strategy for
Economic Growth and Recovery Will Have To Take Advantage
of A Number of Key Empirical Linkages. The Most Relevant to
Iraq Appear To Be:

MENA Informal Economies f (Trade Policy, Corruption, Rule of
Law)

Neoliberal Reforms Reduce Political Corruption – Gerring and
Thacker

Growth f (macroeconomic Stability) – Barro
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Growth f (financial development) – Levine
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Growth f (trade openness) – Barro
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Growth f (political stability) -- Barro
The Future: Key Variables
Obstacles to Viable Market Economy And State Formation Can Be
Overcome Under Certain Conditions.
Many Economic/Social/Political Elements in Iraq are
Interrelated: Need to Initiate A Set of Forces So that Each Can
Build on the Other – Growth Through Positive Externalities:
Economic Reforms – Progress, Stage I to II.
 Political Environment – Encompassing.
 Level of Insurgency – Stabilizes/Declines.
 Oil Production – 2.2-2.8 million b/d.
 Creation of Oil Fund for Public Distribution.
 Macroeconomic Stability – Inflation 15-30%.
 Falling Corruption.

Virtuous Circle of Reform, Growth
and Liberal Market Development

Infrastructure Led Public Investment – Increased Use of Iraqi
Firms and Workers -- Begin Rapid Growth to Overcome
Development Impediments.

Complete Neoliberal Price Reforms – Block Incentives for
Shadow Economy – Make Official Corruption More Difficult.

Insurgency Lessens With Economic Progress.

Second Stage Washington Consensus Reforms – Institutional
Development – Foundation for Private Sector Expansion.

Dual Track Development Strategy – Comparative Advantage
and Informal Economy – Focus on Creation of New SmallMedium Scale Enterprises.
Virtuous Circle (contd.)

Improved Macroeconomic Stability – Market Based Financial
Instruments Developed – CBI Gains Better Control of
Monetary Policy.

Informal Economy Focused Credit – State Sponsored SME
Development Banks.

Expanding New SME Firm Creation.

Oil Fund for Public Distribution – Helps Develop Expanding
Domestic Markets –Promote State Formation.

New Firms, Workers and Large Segments of the Population
Have Stake in Moving the Reform Process Ahead.

Expanded Reforms Reduce Corruption, Improve Regulatory
Climate.
Virtuous Circle of Growth
and Liberal Market Development
Development
Strategies/
Policies
Expanded
Number of
SMEs
Increased
Entrepreneurship
Infrastructure
Led
Development
Dual Track
Development
Expanded
Supply -Growth of
the
Economy
Reduced
Corruption
Neoliberal
FDI
ReformsFree Trade
Informal
Economy
Focused
Credit
Oil Fund for
Public
Distribution
Expanded
Public
Expenditures
Education/
Health
Pressures for
Further
NeoliberalInstitutional
Reforms
Development
Extended
Trust
Networks
Expanded
Demand -Domestic
Market
SecondStage
Washington
Consensus
Reforms
Reduced
MarketBased
Corruption
Phase out
Subsidies,
food, oil,
electricity
Critical Intangibles
What are the Critical Intangibles Likely To Influence Iraq’s Future
Economy?

The Extent to Which Economic Progress Made Without
Significant Reduction in Corruption.

Speed and Degree to Which Trust Can be Restored.

The Extent To Which Improved Economic Performance Can
Undermine the Insurgency.


The Level to Which Religious Influences Are Likely Mold The
Country’s Economic Institutions – Will The Result Make
Movement to a Market Economy More Difficult?
Effectiveness of USAID/NGO Small-Scale Social Capital
Projects at Local Level.
Critical Intangibles (contd.)

The Extent to Which an Elected Iraqi Government is Committed to the
CPA Approach to Reforms – Is Able to Assure Investors of the
Government’s Commitment to Free Markets, Rule of Law and Property
Rights Before Significant Progress is Actually Made in these Areas.

Willingness of Iraqis to Adopt a Pragmatic Approach Towards
Privatization.

Ability of the Iraqis to Achieve Political Stability.

The Manner in Which Oil Revenues are Managed – Can Progress Be
Sustained Without an Oil Fund?.


The Degree and Extent to Which Average Iraqis View Free Markets as
a Opportunity to Create a Better Standard of Living rather than a
Threat Imposed by Outside Interests.
Most Importantly, The Extent to Which the Iraqi Government Can
Evolve into a Developmental State.