3. Economics

There has been some economic progress in Iraq, and Iraq has tremendous potential for growth. But economic development is hobbled by insecurity, corruption, lack of investment, dilapidated infrastructure, and uncertainty. As one U.S. official observed to us, Iraq’s economy has been badly shocked and is dysfunctional after suffering decades of problems: Iraq had a police state economy in the 1970s, a war economy in the 1980s, and a sanctions economy in the 1990s. Immediate and long-term growth depends predominantly on the oil sector.

Economic Performance

There are some encouraging signs. Currency reserves are stable and growing at $12 billion. Consumer imports of computers, cell phones, and other appliances have increased dramatically. New businesses are opening, and construction is moving forward in secure areas. Because of Iraq’s ample oil reserves, water resources, and fertile lands, significant growth is possible if violence is reduced and the capacity of government improves. For example, wheat yields increased more than 40 percent in Kurdistan during this past year.

The Iraqi government has also made progress in meeting benchmarks set by the International Monetary Fund. Most prominently, subsidies have been reduced—for instance, the price per liter of gas has increased from roughly 1.7 cents to 23 cents (a figure far closer to regional prices). However, energy and food subsidies generally remain a burden, costing Iraq $11 billion per year.

Despite the positive signs, many leading economic indicators are negative. Instead of meeting a target of 10 percent, growth in Iraq is at roughly 4 percent this year. Inflation is above 50 percent. Unemployment estimates range widely from 20 to 60 percent. The investment climate is bleak, with foreign direct investment under 1 percent of GDP. Too many Iraqis do not see tangible improvements in their daily economic situation.

Oil Sector

Oil production and sales account for nearly 70 percent of Iraq’s GDP, and more than 95 percent of government revenues. Iraq produces around 2.2 million barrels per day, and exports about 1.5 million barrels per day. This is below both prewar production levels and the Iraqi government’s target of 2.5 million barrels per day, and far short of the vast potential of the Iraqi oil sector. Fortunately for the government, global energy prices have been higher than projected, making it possible for Iraq to meet its budget revenue targets.

Problems with oil production are caused by lack of security, lack of investment, and lack of technical capacity. Insurgents with a detailed knowledge of Iraq’s infrastructure target pipelines and oil facilities. There is no metering system for the oil. There is poor maintenance at pumping stations, pipelines, and port facilities, as well as inadequate investment in modern technology. Iraq had a cadre of experts in the oil sector, but intimidation and an extended migration of experts to other countries have eroded technical capacity. Foreign companies have been reluctant to invest, and Iraq’s Ministry of Oil has been unable to spend more than 15 percent of its capital budget.

Corruption is also debilitating. Experts estimate that 150,000 to 200,000—and perhaps as many as 500,000—barrels of oil per day are being stolen. Controlled prices for refined products result in shortages within Iraq, which drive consumers to the thriving black market. One senior U.S. official told us that corruption is more responsible than insurgents for breakdowns in the oil sector.

The Politics of Oil

The politics of oil has the potential to further damage the country’s already fragile efforts to create a unified central government. The Iraqi Constitution leaves the door open for regions to take the lead in developing new oil resources. Article 108 states that “oil and gas are the ownership of all the peoples of Iraq in all the regions and governorates,” while Article 109 tasks the federal government with “the management of oil and gas extracted from current fields.” This language has led to contention over what constitutes a “new” or an “existing” resource, a question that has profound ramifications for the ultimate control of future oil revenue.

Senior members of Iraq’s oil industry argue that a national oil company could reduce political tensions by centralizing revenues and reducing regional or local claims to a percentage of the revenue derived from production. However, regional leaders are suspicious and resist this proposal, affirming the rights of local communities to have direct access to the inflow of oil revenue. Kurdish leaders have been particularly aggressive in asserting independent control of their oil assets, signing and implementing investment deals with foreign oil companies in northern Iraq. Shia politicians are also reported to be negotiating oil investment contracts with foreign companies.

There are proposals to redistribute a portion of oil revenues directly to the population on a per capita basis. These proposals have the potential to give all Iraqi citizens a stake in the nation’s chief natural resource, but it would take time to develop a fair distribution system. Oil revenues have been incorporated into state budget projections for the next several years. There is no institution in Iraq at present that could properly implement such a distribution system. It would take substantial time to establish, and would have to be based on a well-developed state census and income tax system, which Iraq currently lacks.

U.S.-Led Reconstruction Efforts

The United States has appropriated a total of about $34 billion to support the reconstruction of Iraq, of which about $21 billion has been appropriated for the “Iraq Relief and Reconstruction Fund.” Nearly $16 billion has been spent, and almost all the funds have been committed. The administration requested $1.6 billion for reconstruction in FY 2006, and received $1.485 billion. The administration requested $750 million for FY 2007. The trend line for economic assistance in FY 2008 also appears downward.

Congress has little appetite for appropriating more funds for reconstruction. There is a substantial need for continued reconstruction in Iraq, but serious questions remain about the capacity of the U.S. and Iraqi governments.

The coordination of assistance programs by the Defense Department, State Department, United States Agency for International Development, and other agencies has been ineffective. There are no clear lines establishing who is in charge of reconstruction.

As resources decline, the U.S. reconstruction effort is changing its focus, shifting from infrastructure, education, and health to smaller-scale ventures that are chosen and to some degree managed by local communities. A major attempt is also being made to improve the capacity of government bureaucracies at the national, regional, and provincial levels to provide services to the population as well as to select and manage infrastructure projects.

The United States has people embedded in several Iraqi ministries, but it confronts problems with access and sustainability. Moqtada al-Sadr objects to the U.S. presence in Iraq, and therefore the ministries he controls—Health, Agriculture, and Transportation—will not work with Americans. It is not clear that Iraqis can or will maintain and operate reconstruction projects launched by the United States.

Several senior military officers commented to us that the Commander’s Emergency Response Program, which funds quick-impact projects such as the clearing of sewage and the restoration of basic services, is vital. The U.S. Agency for International Development, in contrast, is focused on long-term economic development and capacity building, but funds have not been committed to support these efforts into the future. The State Department leads seven Provincial Reconstruction Teams operating around the country. These teams can have a positive effect in secure areas, but not in areas where their work is hampered by significant security constraints.

Substantial reconstruction funds have also been provided to contractors, and the Special Inspector General for Iraq Reconstruction has documented numerous instances of waste and abuse. They have not all been put right. Contracting has gradually improved, as more oversight has been exercised and fewer cost-plus contracts have been granted; in addition, the use of Iraqi contractors has enabled the employment of more Iraqis in reconstruction projects.