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The Case Against Privatization-Iraq

Middle East Economic Survey - 10/11/2003


The following article was written for MEES by Abbas Alnasrawi, Professor
Emeritus of Economics at the Uni-versity of Vermont and past president
of the Middle East Economic Association. Dr Alnasrawi graduated from
Baghdad University and earned his PhD in Economics from Harvard
University in 1965. He has authored six books and has consulted for
major international economic organizations, including OPEC and the World
Bank.

The recent announcement by Iraq's administrator Paul Bremer that Iraq's
state owned enterprises (SOEs) will be privatized may be looked at as a
prelude to the privatization of the oil industry. In this space it will
be argued that such privatization will be fraught with legal, political,
social and economic difficulties that will set back the pace of Iraq's
reconstruction and development.

It is a well known fact that a movement toward privatizing SOEs received
a major shot in the arm when the Conservative party under the leadership
of Margaret Thatcher came to power in the UK in 1979. This change in
Britain's economic direction was re-enforced in 1981 when the Ronald
Reagan administration, which advocated the narrowing of the role of the
state in the economy and embraced the main tenets of supply side
economics, came to power in the US.

The central point in the campaign for privatization is that, left to its
devices, a privately owned enterprise is by definition more efficient
than its publicly owned counterpart. By more efficient is meant that
more output may be obtained from a given amount of input or the same
output may be obtained by using smaller input. To attain these goals,
market forces should be allowed to operate free from state intervention
including the international side of the economy. However, there are many
problems with this assertion.

In the first place it assumes that efficiency is a function of whether
the enterprise is in the hands of the public sector or in the hands of
individuals or private companies. Economic efficiency, however, is
independent of the ownership of the factors of production. A simple look
at recent corporate scandals and corruption is proof enough that
inefficient allocation of resources could be found to be rife in the
private sector.

What is particularly troubling about the privatization measures is that
they were taken to facilitate the entry of foreign investment into the
economy of Iraq. Yet foreign investment of the type being encouraged by
the Coali-tion Provisional Authority (CPA) is precisely the type of
foreign investment which Iraq does not need at this critical juncture in
its economic history.

It goes without saying that Iraq needs massive amounts of foreign
investment; but it is real investment that it needs - investment that
adds to its productive capacity of goods and services and not the
sterile investment en-visaged by the CPA. This is so because the foreign
investment that will buy existing enterprise will result only in
replacing local ownership with foreign ownership without changing the
level of Iraq's gross domestic product. The same reservation can be
applied to local capital in that to the extent that Iraqi-owned capital
will be invested in already established enterprises it will deprive the
economy from the investment of this capital in new enter-prises capable
of increasing Iraq's GDP.

As a matter of fact it can be argued that the contemplated privatization
has other drawbacks. One is that foreign capital is in a position to
outbid local capital for the ownership of SOEs. This in turn will induce
the flight of Iraqi capital abroad to the detriment of the Iraqi
economy.

In addition to these economic problems there are other issues which the
privatization order gives rise to. In the first place there is the
question of the legality of the order itself. This is so because the
CPA's privatization decree runs counter to the provisions of
international law. Such a conclusion was articulated by the UK's
Attorney Gen-eral when he informed British Prime Minister Tony Blair
that international law obligates an occupying power to respect the laws
in force in the occupied country, that wide-ranging reforms of
governmental and administrative structures would not be lawful and that
the imposition of major structural economic reforms would not be
authorized by international law (MEES 6 October). It is very clear that
the order to privatize 192 SOEs allows foreign investment to enter Iraq
without restrictions, conditions or reservations, and to drastically
lower taxes and tariff rates cannot be considered anything but major
structural economic reform - the type which interna-tional law
prohibits.

As to the political problem associated with this kind of economic reform
one needs only refer to the difficult po-sition that the manner in which
the CPA's decree was presented to the world and how it placed Iraq's
Govern-ing Council (GC) in an embarrassing situation. To an outsider the
hesitancy and the tentativeness with which the GC found itself dealing
with the issue indicate that both CPA and GC had failed to thoroughly
examine the ramifications of the privatization measure, again to the
detriment of the Iraqi economy and the people.

Furthermore, a giant step such as privatization should have waited until
a representative government had been installed and given time to weigh
the costs and the benefits of such measure among a number of
alternatives.

As to the social implications of privatization, the obvious one is that
it introduces an element of uncertainty to all those associated with
these SOEs such as managers, workers, suppliers, customers, etc. This
uncertainty is the last thing that the country needs where stability and
security are scarce commodities. In other words the country can ill
afford any decline in output and employment which result from such
economic upheavals.

It is important to conclude this section by saying that privatization of
SOEs should not be implemented at this juncture. This does not mean
privatization could not be considered in the future. Policy makers could
consider such an option when its implementation is judged to cause the
least disruption to the economy. In fact the World Bank, which The Wall
Street Journal referred to it as the apostle of privatization, warned
against immediate action on Iraq's 192 SOEs and saying they should be
kept in the public sector "to preserve employment and social sta-bility"
before being prepared for possible privatization in four or five years
time. In short, the economy of Iraq is not in a position to be one of
the most open economies to foreign investment and imports at this time.

What About The Oil Sector?
Prior, during and after the conquest of Iraq voices were raised within
and outside the Bush administration advo-cating privatization or
denationalization of the oil sector in Iraq. Such calls for the
privatization of the oil sector were not grounded in historical facts or
convincing analysis. These calls by the ideologically driven
neoconser-vatives were mere assertions stating that Iraq's oil sector
should be restructured and privatized, that national oil companies have
failed across the board and, Iraq's low production was symptomatic of
centralized national oil companies. Moreover, the denationalization of
the Iraqi oil sector could be used as an instrument to weaken and
ultimately destroy OPEC. The sway of the neoconservatives over policy
was reflected, among other things, in the Pentagon's policy of favoring
those Iraqis expressing public support for privatization for employment
in Iraq's oil sector (MEES 17 February, 14 April and 5 May).

The case against the privatization of Iraq's oil sector is far stronger
than in the case of SOEs for historical, eco-nomic, political and for
the very Iraq-specific conditions of the last 23 years. Before dealing
with these considera-tions it is necessary to debunk the arguments in
favor of privatization. The first and most important argument is that
privatization will encourage foreign investment to flow into the Iraqi
economy. This claim is false since such flow is not constrained by the
form of property whether it is public or private. In its long petroleum
history Iraq experienced both forms of developments. First, it was
foreign capital as represented by Iraq Petroleum Com-pany (IPC) from
1925 to 1972, and then by the state-owned Iraq National Oil Company
(INOC).

It would not be inaccurate to say that most observers of the Iraqi scene
would agree that Iraq's experience dur-ing the era of IPC and its
subsidiaries was not a happy one. The persistent failure of IPC to
develop Iraq's oil resources forced the government in 1961 to issue Law
No 80 which restricted IPC's operations and which also set the stage for
the nationalization measures of 1972. It is also safe to say that the
nationalization measures and the creation of INOC were instrumental in
the emergence in Iraq of a vast number of world-class oil specialists in
all facets of the oil industry.

Another argument for the privatization of the oil sector in Iraq is the
claim that it was the fault of INOC that Iraq's oil output was below
what its optimum level could have been, given Iraq's huge oil reserves.
In other words had Iraq's oil sector been privatized its output would
have been much higher than it actually was. But what this argument
overlooks is that Iraq's output was below what it could have been, not
only in the era of INOC but also in that of IPC. The question is: why
was this the case?

In the era of private sector development, ie IPC, oil output was kept
below what it could have been for at least two reasons. First, the
structure of IPC was such that its corporate owners adopted a production
policy which planned output 10 years in advance, thus depriving IPC the
flexibility to adjust output to changing demand conditions. While the
owners of IPC used their access to oil resources in neighboring
countries to meet unfore-seen conditions, Iraq had no such alternatives.
In other words, Iraq was left to its own devices to absorb the shocks of
changing market conditions.

As to the performance of the national oil sector it is true of course
that output was not up to Iraq's considerable oil resource endowment;
but this had nothing to do with the fact that oil reserves were not in
the hands of the private sector - be it foreign or domestic. The failure
to produce more oil was part and parcel of the destruction of
development in the country as a whole due to the 1980-88 war with Iran,
the invasion of Kuwait and the sub-sequent Gulf war of 1991, the 13-year
economic sanctions regime, the US-led invasion of 2003 and the current
occupation-induced chaotic conditions in the country.

Given these extraordinary conditions affecting the country it is not
surprising that the oil sector has ended up in the lamentable state in
which it finds itself at the present time. Suffice it to say that in a
country where GDP has collapsed in the manner in which Iraq's did in the
1980s and 90s it is a miracle that Iraq still has an oil industry.

It is interesting to note that the calls for the privatization of the
oil sector seem to be confined to Iraq. One is enti-tled to infer from
this that national oil companies in Saudi Arabia, Iran, Kuwait, etc,
seem to be meeting criteria of economic efficiency and that the issue of
privatization does not present itself in these countries.

An argument always presented in defense of privatization is that it
stimulates the flow of needed capital and technology into an industry
which was forced to be on the margins of important technological
advances for dec-ades. While it is true that Iraq's oil industry was
starved of these vital inputs the resumption of their flow need not be
conditional on the act of privatization. It is a well established fact
that Iraq has considerable oil reserves and that its cost of production
is among the lowest in the world. Given these comparative advantages
Iraq should be able to attract these inputs without having to privatize
its oil reserves. It is worth reiterating that in the 1990s and at the
height of the sanctions era many international oil companies signed
contracts to develop Iraq's oil resources without questioning the
country's ownership of its oil resources.

There is also the international legal dimension to any act of
privatization. As was noted earlier, international law does not allow
for the imposition of major structural economic reforms. And no one
should be under any illu-sion that privatizing an oil sector which
contributes more than one half of the country's GDP is not a major
structural economic reform. Indeed, UN Security Council resolution 1483
was very clear in stressing "the right of the Iraqi people… to control
their own natural resources."

Again, and as in the case of the privatization of SOEs, there does not
seem to be any compelling argument for not awaiting the transition to a
constitutional democracy which will confer political legitimacy on major
eco-nomic changes.

Leaving the legal and even the economic arguments there are other
important considerations which argue against privatization. One such
argument is the close association between the oil sector and the
political devel-opment of the country since the inception of Iraq's
political system in 1921. Developments in the oil sector both at the
national and the international levels had deep impacts on the people of
Iraq and their institutions. A sud-den rupture in this long historical
relationship will bring all sorts of destabilization effects which Iraq
can do without.

One of the most serious consequences of a foreign imposed act of
privatization will be in restricting the new government's freedom of
action. A democratically elected government will want to correct some of
the struc-tural social and economic problems which conditions of war,
economic collapse and occupation gave rise to. By privatizing the oil
sector the government will be deprived of access to a massive part of
the national output that would be necessary to correct these problems.
In short the new political system's freedom to act will have been
seriously compromised before its emergence.


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