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[ This message has been sent to you via the CASI-analysis mailing list ] 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 http://www.dailystar.com.lb/opinion/23_12_03_b.asp [full text apended] Best, Colin Rowat work | Room 406, Department of Economics | The University of Birmingham | Birmingham, B15 2TT, UK | web.bham.ac.uk/c.rowat | ( 44/0) 121 414 3754 | (+44/0) 121 414 7377 (fax) | c.rowat@bham.ac.uk personal | (+44/0) 7768 056 984 (mobile) | (+44/0) 7092 378 517 (fax) | (707) 221 3672 (US fax) | c.rowat@espero.org.uk 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 facilities. 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 _______________________________________________ Sent via the CASI-analysis mailing list To unsubscribe, visit http://lists.casi.org.uk/mailman/listinfo/casi-analysis All postings are archived on CASI's website at http://www.casi.org.uk