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[casi-analysis] Op-ed on privatisation in Iraq

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Dear list members,

Lebanon's Daily Star has run an op-ed of mine on privatisation in Iraq.
It first outlines some of the economic theory and practice, and then
attempts to think about its relevance to Iraq.

This last section is the least well developed.  It omits, for example,
the possibility of messy, de facto privatisations, whereby subsidies to
loss making state-owned enterprises are simply not continued.  I would
appreciate the comments of list members on this section.

The piece can be found online at [full text apended]


Colin Rowat

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Mixed messages for a post-war transition
23/12/03, Daily Star, Colin Rowat

Iraq's occupation has made it a test bed for a range of experiments.
With respect to economics, these involve a package of reforms designed
to increase efficiency, including liberalization of trade and investment
and rapid privatization.
An earlier generation of economists was unimpressed by privatization.
More concerned with the abuse of monopoly power, and more optimistic
about the state's role, they feared private monopolies more than
state-owned ones. Ownership, they felt, mattered less than market
structure: Building competitive industries free from monopolies was more
important than privatization.
The debate has moved on. Competition against state-owned enterprises
(SOEs) is hard to foster, since private firms may hesitate to challenge
a government-bankrolled firm. Moreover, sophisticated regulatory
structures can reduce private monopolies' scope for abuse. Finally,
advances in information economics have raised new concerns about
managerial incentives in SOEs.
The owners of private firms have an incentive to ensure their firm's
profitability, since they are, after all, likely to own shares in it.
Governments, as the acting owners of SOEs, have more complicated
motives. They may seek societal well-being, something beyond the mandate
of private firms, and may also be tempted to reward their supporters, or
minimize political embarrassment. Thus, SOE managers are less likely to
be committed to making profits than their private-sector counterparts.
As national income is the sum of its industries' profits, this has
economic costs.
In addition, governments have difficulty shutting down or reorganizing
loss-making SOEs. Doing so diverts political energy from other
priorities, creates a vocal class of opponents (its employees) and is
often embarrassing. Instead, it is tempting to bail out a failing firm,
quietly spreading the costs over the whole tax base. This "soft budget
constraint" also drains society's wealth.
Thus, when sophisticated regulation is possible, theoretical arguments
now favor private ownership and focus on whether private-owned firms are
more efficient than SOEs. That selling SOEs raises quick cash for a
strapped state is not an argument for privatization: Doing so can
transform liquidity problems into solvency ones. This is especially true
in Iraq, whose huge debts leave it in no position to afford handouts to
prospective investors.
International experience with pro-market reforms in recent decades
provides clues as to how privatization might work in Iraq. The former
Soviet bloc countries now in transition are often cited as the closest
parallels to Iraq, having also experienced simultaneous political and
economic change. In 2000, economists Jeffrey Sachs, Clifford Zinnes and
Yair Eilat published an analysis of privatization in these countries.
They distinguished between two types of privatization reforms: First,
"change of title" (COT) reforms - the actual sale of SOEs; and, second,
deeper institutional reforms to reduce incentive problems, harden budget
constraints, increase competition and strengthen state regulation. COT
reforms were vigorously conducted throughout the transition countries.
Institutional reform was patchier, suggesting it is more difficult to
carry out.
The paper's main finding was that COT reforms alone are "not enough to
generate economic performance improvements." Without complementary
institutional reforms, COT privatization "may have a negative
performance impact," since ungoverned robber barons can be worse than
poor state management.
A 2002 survey by economist Jan Svejnar was also ambivalent: "The effect
of privatization on economic performance is surprisingly hard to
determine. At the country level, some of the fastest growing economies
(Poland, Slovenia and also China) have been among the slowest to
privatize ... the results are not conclusive."
Worryingly, privatization is widely felt to increase the gap between
rich and poor, leading to the layoff of workers while capitalists reap
higher returns.
These general results cannot be applied automatically to Iraq. Unlike
Iraq, the former Soviet bloc countries remained sovereign throughout
their turbulent reforms. If sovereignty makes a difference, then even
these countries may be poor guides for Iraq. Worse, the rarity of
foreign occupations leaves Iraq with few close recent parallels.
One way forward may be to regard foreign occupations as "normal"
dictatorships, but with two twists. First, occupying powers have fewer
legal rights than do sovereign governments. As Britain's attorney
general advised Prime Minister Tony Blair, the law of belligerent
occupation "imposes an obligation to respect the laws in force in the
occupied territory 'unless absolutely prevented.' ... wide-ranging
reforms of governmental or administrative structures would not be lawful
... the imposition of major structural economic reforms would not be
authorized by international law."
A June report to the US Congress also took this view, claiming that "the
establishment of a legitimate government" is the "second requirement"
for Iraqi economic development.
The occupying powers in Iraq have decided to chance it. While they are
largely above the law, the law often codifies the practical. Thus, their
actions create legal uncertainty and raise the possibility of unforeseen
legal costs for future Iraqi businesses. This may have a deterrent
effect on investment. Less investment means less domestic competition -
one of the deep reforms found to complement COT privatization.
Liberalized trade could, however, compensate for this by forcing Iraqi
firms into international competition.
A second twist is the occupation itself, which works in both directions.
Currently, US guns underwrite Iraqi governance. Indeed, with Iraq's
formal institutions crippled, the US occupation may be all that prevents
their complete collapse.
In the longer run, the occupation will end. Yet, how and when will it
end, and what will replace it? The intrinsic uncertainties of political
transition have been exacerbated by the Bush administration's behavior
in Iraq: It has displayed little sensitivity to Iraqi concerns, has
thwarted its own attempts to plan for the occupation, has fought to
remain unaccountable, often appears confused and will drop Iraq if it
becomes politically costly.
Ironically, given that the theoretical case for privatization is that it
can reduces firms' incentive problems, the Bush administration has
little incentive to govern Iraq on behalf of Iraqis - something apparent
in America's Iraq policy for three decades. Iraqis, after all, do not
vote in US elections. Thus, some of the most vocal critics of
privatization plans have been Iraqi economists.
These twists complicate implementation of the complementary
institutional reforms that seem important for COT privatization to yield
economic benefits. Confidence in Iraqi regulatory reform, its legality,
permanence and ability to regulate in the Iraqi interest could be low.
This can form a destructive spiral: A perception that Iraq is
floundering may encourage local actors to strip it of its assets,
fulfilling the perception.
Foreign businesses, for their part, may not view an uncertain, legally
complicated environment as worth the risk. Even Iraq's oil is
resistible: With more countries competing for their attention, the oil
majors will wait for Iraq to stabilize before building vulnerable
Privatization offers real gains if done well. Even in the former Soviet
bloc economies, however, the record is mixed. Iraq may present an even
more difficult case: Its occupation may hinder the development of strong
institutions and competitive markets, without which COT privatization
could backfire. Perhaps recognizing this, the occupying powers have
placed privatization on the backburner. If more attention is now devoted
to rebuilding strong, legitimate governance in Iraq, this is good news.

Colin Rowat is an economist at the University of Birmingham and a member
of the advisory board of Iraq Revenue Watch, an initiative of the Open
Society Institute. He wrote this commentary for THE DAILY STAR

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