CASI internet version of November 1999.

This paper was published, in a slightly modified form, in The International Spectator (Journal of Istituto Affari Internazionali, Rome), Volume XXXIII, July-September 1998, pp. 41-6

Reproduced with permission.

Introduction

Economic, Political and Institutional Background

Invasion of Kuwait, Sanctions and War

Other information suggests that the case of the SBAR is not atypical.Universities, the health service and public services generally are reported to have lost staff on a dramatic scale.Indeed, agricultural research is an area which has received some Government support and where there have been some notable achievements in adverse circumstances, including plant breeding and animal feed preparations.²⁰

Free public services and the administration have therefore deteriorated, and there is now a widespread practice of unregulated payments to public servants.Education, health and municipal services are increasingly affected, and it is said that even justice, taxation and the administration of private property are affected.

Government policy appears to have been task driven with little attention paid to prudent economic management.The specific tasks undertaken were: first the supply and organisation of a limited food ration provision; second, reconstruction of war damage; third, the implementation of a number of prestige and politically-motivated projects, including presidential palaces, marsh drainage schemes and symbolic civil engineering projects.In addition military expenditure has remained high.

These limited tasks were carried out with technical efficiency but at a high and unsustainable economic cost.Depreciation of capital, haemorrhage of skilled labour, impoverishment of the middle class, depletion of stocks, environmental damage and other consequences, and runaway inflation, have all forced restraint on government expenditure.

Policies for rehabilitation will require a combination of that determination to accomplish tasks, prudent restraint and a sophisticated policy package.Such a package must include a restoration of rationality in economic management, credibility of the currency, confidence of economic agents and stability of institutional arrangements.

In turn this requires depoliticising and strengthening economic administration, rebuilding the capability for policy coordination and tackling monetary, fiscal, price and other distortions in the economy.²¹Failure to do so will have drastic consequences.

The Budget Deficit and its Finance
Prior to the Invasion of Kuwait the Iraqi economy was straining under serious macro and oil market constraints.The performance of its main commodity sectors of manufacturing and agriculture was poor and it did not promise an early return to growth and revenue potential.²²A welfare programme including food and other subsidies, education, health and social services, pension provisions and other support were all to be provided on a very narrow public revenue base.The privatisation programme may have been part of an attempt to shed subsidy and social commitments which the state was no longer able to sustain.Indeed, the proceeds of privatisation itself were low.²³

Figures for the government's budget have not been made available for many years, but published budget outlines showed a substantial deficit back in the early 1980's.²⁴It is likely that reconstruction, development and military expenditure had continued to demand deficit financing on the eve of the Kuwait crisis.Oil revenues had reached an expected peak, and began declining as prices fell in 1990.Policy decisions taken during the 1970's oil boom had already narrowed the tax base.Furthermore, as durable consumer goods imports declined after the early 1980's and as the parallel market exchange rate began to predominate in external transactions, the scope for increasing revenues from import duties was also curtailed.The burden of a decade of war had been postponed by earlier accumulated surpluses and a buildup of debt.The war with Iran ended with the economy in difficulty and debts maturing.The Government's ability to raise indirect taxes was limited by the stagnant trade and material commodity sectors and by already declining levels of living.

The annual average of indirect taxes during 1984-1986 was ID 766.3 million, rising to ID 798.0 during 1987-1989.Between the same two periods, Government subsidies increased, also in current price terms, from an average of ID 344.8 million to ID 384.7 million per year.²⁵Both indirect taxes and subsidies declined in real terms as the consumer Price Index rose from 100 in 1985 to 140 in 1988.

In 1989, Government Consumption was ID 5,990.1 million, and Public Sector Gross Fixed Capital Formation was ID 3,744 million²⁶ most of the latter would have had to be funded directly from the state budget rather than from the surpluses of public corporations.The combined total of the Operating Surpluses of public corporations, Direct Taxes and other internal revenue sources is unlikely to have met the cost of Public Sector Capital Formation, while oil revenues fall well short of the requirements of financing Government Consumption.As a very rough estimate, the budget deficit may be said to have been somewhere in the region of 10% of GDP excluding interest and repayments on foreign debt, and with oil revenues measured at the official exchange rate.²⁷

In depriving the economy of oil revenues, sanctions have had an impact on the budget which has probably been even greater than the approximate figure of 18% of GDP which these revenues represented in 1989.²⁸Furthermore, the devastating impact of the 1991 war and the continuation of sanctions on industry and trade would certainly have reduced other government revenues including public enterprise income and indirect taxes.The sharp decline in GDP in itself would raise the relative size of the deficit.The collapse in the value of the Iraqi Dinar and the onset of hyperinflation has forced the government to compensate by increasing the nominal value of its expenditure just as revenue sources were declining.Deficit financing continued to fuel inflation until strict fiscal measures were implemented late in 1995, followed by the Food-for-Oil deal.

The magnitude of the shock of sanctions has been so great that the deficit was going to be inevitably very large.Again using rough national accounts estimates, we may conclude that the deficit was in the region of 30% or more of GDP in 1993.²⁹This has been the case despite a sharp fall in the share of the Government in GDP from 55.3% in 1989 to 13.6% in 1992,³⁰ and despite the destitution of the vast majority of civil servants, pensioners and military personnel whose combined total number is nearly 2 million, representing with their dependants, 1 in 3 of the population.

It can therefore be seen that the priority given to food and military security, and initially also to reconstruction of war damage, has had very heavy welfare costs, not all of which could be justified.In addition to the squeeze on civilian public sector pay, education, health, pensions, social services, public administration and regulatory activities, and even civilian policing, all have been neglected.The collapse in services has been well documented elsewhere.³¹Nonetheless, the budget deficit has grown and continued to perpetuate itself, as agriculture, the main productive sector benefiting from the deficit was not generating revenue, but has itself been a direct recipient of subsidies.

Revenue raising capacities and resources have to be found in order to help deal with the budget deficit.The obvious source when the embargo is lifted is oil.In the meantime, some important, but politically difficult measures could be taken.These would have to challenge vested interests which have thrived under war and sanctions.However, it can be argued that in building palaces and prestige projects, the regime is not only contributing to the budget deficit, but also signalling retrenchment of its oligarchic character.

The Food-for-Oil deal is designed not to interact with the budget deficit.Indeed, it can be said that the deal relieves immediate suffering and the humanitarian pressure for lifting sanctions, without permitting the regeneration of the economy.

The main direct way in which the Government budget can benefit is through reduced procurement and/or buying prices of subsidised staple food grain in the domestic market.This would foster dependency upon the continuation of the arrangement and add to the political vulnerability to outside pressure.

The Government has not so far taken this option.Quite the contrary, the rise in the value of the Iraqi Dinar has raised the compulsory purchase price relative to other prices.In other words, the ratio of the deficit to GDP would not have increased much if at all as a result of the implementation of the deal.

As the value of oil sales increase, and as the arrangement is extended, the agreed import procurement plan will be crucial.Plans which continue to emphasise food imports will be competitive with domestic production, and they would not increase the production capacity of the economy.The Government will be able to shift expenditure away from food, but without complimentary imports and the ability to regenerate production, a high level of Government expenditure will continue to be inflationary.


The State of Manufacturing and Agriculture
Manufacturing Industry
Despite the emphasis on industry during the years following the 1970's oil boom, civilian industrial output increased only very modestly between 1978 and 1989.Some major industrial plant sustained heavy damage or were completely destroyed during the early phase of the Iraq-Iran war.³²Moreover, effort, skills and finance were directed towards developing military industries during the 1980's.The present UN effort is concentrating on destroying "capability" rather returning on redirecting the potential towards civilian production.

The development of private sector industries has been hindered since the nationalisations and strict capitalisation limits of 1964.A consequence of that policy has been the accentuation of the trade and real estate speculative orientation of the private sector.The policy has inhibited industrial investment, skills and managerial development, and it may have retarded the progress of the state's monitoring and regulatory functions.The private industrial sector was also deprived of investment finance, as the Industrial Bank offered very limited facilities amounting to 1-2 % of the total value of industrial investment.Short periods of peacetime boom as in the mid 1970's showed that small scale private industry was capable of very rapid growth under the conducive conditions of a booming economy, ample finance and an adequate infrastructure.

Such conditions were not sustained, and industry remained dependent on heavy direct public sector investment.Thus, industrial growth was not only slow during the 1980's, but its pattern was unsuitable for the post-war economic conditions where employment generation is now a major objective, and where finance has become extremely tight and market competition in relevant activities increasingly fierce.Employment in civilian manufacturing had in fact declined during the 1980's, and the wage bill in large industrial establishments (defined as those employing 30 or more persons) amounted to no more than 10% of the value of output.³³Much of Iraq's industry is capital intensive, technologically dependent and heavily reliant on imported inputs, making this sector especially vulnerable to trade sanctions.Without substantial investment, it would be difficult for this sector to advance from rehabilitation and recovery to growth.

Despite the privatisation and administrative reforms of the late 1980's, the industrial sector remained divided into a small number of large mainly public sector and capital intensive firms and a large number of small workshops concentrating mainly on repair and maintenance, and on limited processing and packaging of consumer goods.This dichotomy subjected the manufacturing sector to constraints at both ends leading to a poor performance overall.

Between 1978 and 1989, output of Food Industries had increased by an annual average of 1% while the annual growth rate of Textiles and Shoes industries was 3%, and the general index number of industrial output increased by less than 4% per annum.Only Oil and Chemicals industries grew rapidly, having benefited from the high capital investments in this sector through the 1970's and the 1980's.³⁴These figures, which probably exclude military industries, reveal stagnation in consumer goods production and relatively rapid growth in a capital-intensive industrial sector that had benefited from the high public sector investment of earlier years.

The 1991 war resulted in further heavy damage to industrial plant, this time largely to chemical industries and oil refining.The continuing embargo however, led to a paralysis of the industrial sector.According to Al-Khudayri, Iraq's manufacturing industry relies on imports for almost 80% of its inputs of intermediates, spare parts and components.³⁵The effect of the embargo has been devastating, reducing Manufacturing Value Added in 1994 to 23.5% of the 1985 level measured in constant 1990 prices.³⁶Paralysis is leading to loss of skilled labour and lack of maintenance, especially in many of the larger industries.

The dependence of the industrial sector on imported inputs is damaging not only because of the physical shortage of these inputs, but also because of the cost.Small private industries are able to obtain required inputs in contravention of the sanctions, but the cost at the parallel exchange rate frequently means that there is no market for the product.³⁷Part of the collapse of manufacturing stems from the general malaise of the economy and the collapse of incomes under sanctions.Regenerating demand in the economy would stimulate the small industrial sector.However, rehabilitating the industrial sector in general, requires a broader strategy because of the high investment requirements and the skills shortages that have developed over the past years.³⁸This strategy must address the dichotomy of the industrial sector, rehabilitating capacities in both large and small scale industries, and in both the public and private sectors.Ultimately, the strategy must encourage growth across the board by changing the general business environment and stimulating investment and resource mobilisation.

The industrial sector more than other sectors needs to have a stable and secure environment in order to be fully rehabilitated.The structure of its ownership and management, and its access to skills and capital must be allowed to change.Manufacturing industry also needs to develop export markets and strategic partnerships.Industry's requirements for capital and technology are unlikely to be satisfied from domestic sources alone, while these will only flow into the country after political and financial issues are settled.

In the longer term, a proper regulator framework, clear fiscal rules, a flexible labour market, investment in infrastructure, skills and training, and a healthy macro-environment need to replace many rigid bureaucratic allocation and managerial decisions.In the short term, and while sanctions remain in place, a strategy for rehabilitation must be developed in order to establish priority industries.Al-Khudayri suggests five criteria for selecting industries for regeneration.These are: 1) importance of the product for the population's urgent needs; 2) technological level and cost of the production facility; 3) availability of skilled labour; 4) degree of reliance on imported inputs; 5) export potential or linkages with other industries.³⁹Evidently, these are not issues to be left to market decisions, and an industrial rehabilitation strategy will have to be developed without losing sight of the need for a long-term policy framework.

Agriculture
The performance of the agricultural sector was also weak.By 1990, output was stagnant for two decades in most areas of agricultural production except vegetables, fruit and poultry, all of which tended to be capital intensive activities that are concentrated near urban centres and heavily dependent upon a range of industrial inputs and expatriate labour.Production of field crops, dates, red meats and dairy, all traditional Iraqi farm products had been stagnant despite increased use of modern inputs such as improved seeds, fertilisers, pesticides, vaccines and feed concentrates.Farm incomes were maintained by two factors:a sharp decline in labour inputs and improved terms of trade for agricultural commodities.⁴⁰The Iraqi rural small and medium farm holding sector which had been boosted by the agrarian reforms, went into decline prior to the legal changes favouring capitalist farming and permitting the consolidation of private landholding after 1983.A new capitalist farming sector grew unmatched by the development of the indigenous research and extension infrastructure that is necessary for realising the modern farming potential of Iraq's resources.The agricultural sector's weak contribution to employment, output, equitable income distribution and food security, and the sector's heavy dependence upon industrial inputs have all placed Iraq in a relatively disadvantageous position under sanctions conditions.⁴¹Iraq's dependence upon imported food prior to 1990 was especially high in basic staples, where investment in water storage, irrigation and land reclamation had not resulted in increased output or substantially rising land productivity.

The Iraqi economy was thus especially vulnerable to sanctions, because of its reliance upon both imported inputs and essential consumer goods, and also because the export ban did almost nothing to divert supplies destined to international markets towards the domestic economy.The vulnerability of the economy had not been lessened by the structural reform and the consolidation of holdings in agriculture during the first half of the 1980's, and privatisation of manufacturing during the second half.There were also administrative, price and foreign exchange reform measures, adding altogether to a major market oriented package which was rapidly implemented with drastic socio-economic consequences, including accelerated inflation and declining industrial output.⁴²

Regarding agricultural output, the main areas that had been stimulated by the reforms were high capital and import-intensive activities such as poultry and fish farming.However, there was no evidence of sustained growth or of increased productivity in the main cereal crops sector until sanctions were introduced.The Government respondedto sanctions with a package of measures which included higher procurement prices and stepped up administrative measures, including directives regarding land use.Although procurement prices remained below those obtained in the open market, the differences according to Boone et al, did not represent an onerous level of taxation.⁴³However, the 1996 FAO Report and Ahmad considered these procurement prices to be a disincentive to cereal production.⁴⁴In all cases, official procurement for the ration system is responsible for generating significant additional demand.Without the ration, the farm price itself may not be as high.The question is whether the Government should operate a guaranteed procurement price or a compulsory one, and at what level.

The Government must be able to procure the ration with as small a subsidy as possible and without discouraging production.The procurement system as implemented has been successful in raising production.Whether a different procurement policy could have achieved a similar rise in output at lower financial and environmental cost and with a more equitable result, is another matter.Another question relates to what might be an appropriate level for compulsory procurement prices and to whether the levels actually applied have been economically and socially optimal.These prices have tended to yield relatively high agricultural earnings even though they remained below free market levels.

A switch to a policy offree markets and targeted subsidies has its formal attractions, but its implementation requires a more stable economic situation and a greater and more flexible institutional capability in order to ensure effective targeting.In our view the mass destitution of Iraq's population makes it highly risky to attempt to restructure the ration and procurement policy, and it limits the possible benefits of any such change.One of the major problems is that until a stable political and economic environment is established targetting would be very difficult.The vulnerable would not be an identified group, but many people can rapidly descend into that position.A public commitment to procurement is also necessary given the continued market instability.

Despite the structural problems which the agricultural sector had developed during the oil period, and notwithstanding serious environmental problems, agricultural remains the mainstay of Iraq's non-oil economy.Iraq has land and water resources which can be harnessed to provide a substantial measure of food security.Whereas agricultural land productivity and incomes are low, the present depressed conditions have stimulated a considerable return to the land and increases in the cultivated area, employment, and output of staple foods.This has happened despite a considerable decline in the availability of inputs such as treated and improved seeds fertilisers, pesticides and farm machinery.

Table 2: Wheat and Barley Areas, Production and Yields Before and After Sanctions

Wheat

Barley

	Area ('000 Ha)	Yield (Kg/Ha)	Production ('000 tons)	Area ('000 Ha)	Yield (Kg/Ha)	Production ('000 tons)
Annual Average, 1984-88	1,035	887	913	1,125	895	1,008
Annual Average, 1990-95	1,791	721	1,241	1,943	658	1,259

Source: Boone, et al, Table 6.Calculated by authors from FAO Production Yearbooks, various.

These increases in output must be weighed against the general decline in the stock and output of livestock.Overall, agricultural output may have been sustained and value added increased due to the substitution of labour for manufactured inputs.Agricultural output per capita of the agricultural population may be found to have declined once the return migration to rural areas and the increased employment on the land are taken into account.

Although there are positive trends in both output and value added, and although agriculture has provided a basic safety net of income and food production, trends in the agricultural sector do not offer dynamic growth prospects for the longer term.The agricultural sector has not merely reduced its previously excessive capital intensity, but it may also have loosened its relations with other sectors of the economy, and reduced its own diversity and the balance between its range of farm activities.The opportunities and benefits of crop rotation and of crop-livestock interaction are reduced at the same time as the advantages of modern inputs and research are being denied to farmers.

Some Issues of Risk and Time Preference
While agriculture has thrived, it has done so as a result of the shortage of food and the high prices enjoyed by the sector's products.Agricultural costs have also risen and have tended to make farmers more cautious in investment and input decisions.Delays in repairs to machinery arising from disruption of the market for spare parts has affected economic behaviour.Farm machinery owners are now disinclined to hire out their equipment in case breakdowns leave them unable to tend to their own farms.Similarly, uncertainty about water supplies and the maintenance of irrigation and drainage systems has at times hampered co-operation.Farmers with resources that enable them to overcome the difficulties may be less inclined to co-operate in joint solutions.

There is much less emphasis upon longer term management of resources in agriculture than before the sanctions.Marginal agricultural land that is suitable for pasture is now ploughed for a cereal crop, and a crop-fallow rotation is all but discontinued in the rainfed areas.The effects on the soil are neglected under current circumstances where the Government is encouraging maximum production.Similarly, short-term considerations have led to a considerable expansion in rice cultivation with negative consequences for soil salinity and downstream
water resource availability.

In the northern Kurdish areas the cutting of wood for fuel has done considerable environmental damage while the Government withheld supplies of oil products.Similarly, safety and environmental considerations are also neglected in industry and in other areas of activity.The report of a UN group of experts concerning the status of Iraq's oil production capacity, found that the Government was too optimistic about Iraq's ability to sustain a high level of oil exports.⁴⁵In effect, the Government is prepared to take risks that run against accepted principles of "good oil field husbandry".The Group also found significant pollution and environmental damage in relation to refining activities.Short-term imperatives and uncertainty about Iraq's future make it impossible to calculate risk and environmental consequences and to take proper account of them.In all other areas of economic activity, such as trade, transport and financial transactions, uncertainty has become commonplace.People take much higher risks in their daily economic activities out of necessity.However, it is long-term investment decisions that are particularly adversely affected.At present, the Government, individuals, firms, the UN's economic monitors are all engaged in short-term fixing activities.Shortages throughout the economy have also reinforced rent-seeking behaviour, particularly in urban trade.It will be a major task of any rehabilitation strategy to create the conditions for altering these behaviour patterns, and to attempt to reinforce other attributes such as greater self-reliance, prudence and a more positive attitude towards manual work.

External Debt
Iraq became heavily indebted as a direct consequence of the war with Iran and of poor financial management against the background of the war.Estimates of Iraqi arms purchases during the 1980's vary between $52 billion and $102 billion.⁴⁶Nevertheless, with Arab and international backing, Iraq was treated as being solvent, and there was no incentive for either side to seek a multi-lateral debt rescheduling arrangement.Indeed, as Jiyad suggests, some creditors seemed to prefer the bilateral arrangements, a policy which in time led to a deterioration in the terms upon which Iraq acquired new loans in order to meet existing commitments.⁴⁷In particular, the Iraqi Government was not ready to open its books to international, or for that matter, domestic scrutiny. The Iraqi Government had, in effect, adopted standard IMF conditions with the possible exception of fiscal reform, without having gone to the organisation and without negotiating with the Paris Club for multi-lateral debt arrangements.Consequently, the debt continued rising and its maturity terms were shortening.

According to a Government memorandum presented to the United Nations, Iraq's total foreign debt (except any obligations to the Gulf Co-operation Council countries, which Iraq considered as grants) stood at $42.1 billions at the end of 1990.⁴⁸This debt was said to carry an 8% rate of interest and 97% of it was to mature within 5 years.Jiyad suggests that this figure is likely to be global and to include both military and civilian, and both official and market debt, an interpretation which is supported by OECD figures.⁴⁹Further evidence is provided to the United Nations by the Paris Club, showing that debt claimed to be owing to 16 countries including all major OECD members except the United States, was $13.4 billion on 1 April 1991.⁵⁰

The extent and the status of the GCC loans is uncertain.The total stock of this debt has been subject to speculative comment, but Saudi Arabia has stated a figure of for its own lending of $26 billion.On this basis, the total for all GCC countries is likely to have exceeded $40 billion.However, Iraq is likely to argue that these payments should be treated as contributions to the common defence by Iraq of the Arab states of the Gulf during the Iraq-Iran war.No term structure or interest rates are known with regard to this debt.Moreover, in the case of both Saudi Arabia and Kuwait, a significant part of their contribution was made in the form of oil sold from the shared Neutral Zone fields between the two Peninsula countries, in favour of Iraq.Thus, even if payment is due (e.g. if it were forced on Iraq through inclusion in any Paris Club arrangements, or if Iraq's obligations are deemed to fall under Paragraph 17 of Security Council Resolution 687 declaring any Iraqi repudiation of this debt to be null and void), Iraq might still argue that payment could be made in kind.In all likelihood however, the status of this outstanding matter will be settled under regional political arrangements rather than as a part of international financial settlements.

Under the terms of all Security Council resolutions permitting supervised export of oil prior to the lifting of sanctions, the issue of external debt is postponed, while compensation payments are given precedence.When sanctions are lifted, debt servicing will begin to compete for a share of export earnings with both compensation payments and import requirements.Negotiations on debt reduction and repayment scheduling would have to take account of Iraq's requirements and global commitments.The negotiations are likely to be protracted and to cover a range of issues, including Iraq's future economic management and political stability, as well as the military procurement purpose of much of the debt, prudential management decisions of the creditors, and the issue of interest during the prolonged period of sanctions.

Compensation Payments
United Nations Security Council Resolution 687 reaffirmed in Section E that without prejudice to Iraq's debts and obligations arising prior to 1990, Iraqis liable for any direct loss, damage or injury to foreign Governments, nationals and corporations as a result of the invasion and occupation of Kuwait.The United Nations Compensation Fund together with the Compensation Commission administering it were set up according to Security Council Resolution 692, and the mechanisms and level of Iraqi payments were subsequently determined.

The figure of 30% of oil revenues to be allocated to compensation was adopted as a maximum according to Security Council Resolution 705 of 15 August 1991.This figure was based on the following assumptions:

(a) Iraq's oil export revenues would reach $21 billion by 1993.
(b) The country's imports would amount to 48% of export earnings including about $8 billion which is based on historic civilian requirements of the Iraqi economy.
(c) Debt servicing would claim 22% of the projected export earnings or $4.6 billion annually.⁵¹

It is clear that in deciding upon compensation and in determining the proportion of oil revenues to be deducted, both the needs of the Iraqi economy and the external debt obligations took precedence over compensation.Furthermore, the needs of the economy were defined at a level exceeding historic import requirements, thereby acknowledging the needs of reconstruction and emergency requirements.Subsequent resolutions (especially Resolution 712 and its successors) setting up the oil-for-food arrangements gave precedence to compensation and the payments of UN costs, and the percentage deduction for compensation was set at the maximum figure of 30% of Iraq's oil revenues, permitted under Resolution 705 of 1991.Further deductions for the payment of UN costs amounted to over 5% of the revenues raised under the initial Food-for Oil arrangement.However, that should decline in time and exports increase.

Given that oil export revenues are unlikely to reach original estimates due to export restrictions, production capacities and depressed prices, Iraq will be unable to meet all its obligations in the manner noted above.The total of compensation claims is very high.Apart from the personal claims, the largest number of which are for forced departure, more than 6,000 corporate claims have been made, totalling over $280 billion.Some of these claims have been rejected and others scaled down, as was the case with the Kuwait Oil Company's claim for the cost of putting out the well fires.⁵² However, the majority of corporate claims are yet to be dealt with, including most of the $210 billion of category "F" claims filed by governments, especially that of Kuwait.The astronomical figures involved would imply a perpetual bondage for Iraq and are politically untenable.The claims resolved so far, have resulted in awards amounting to 20% of the total value claimed by corporate bodies.However, the test will be in the way the Kuwaiti Government claims are handled.

In any final settlement of claims, Iran would also want to be included, but there is no mechanism for assessing damage, apportioning blame or ensuring payment to Iran.The Iranian case for compensation for the 1980-88 war was enhanced after the Kuwait War with a retrospective assessment from the UN Secretary General of Iraq as having initiated the war with Iran in 1980.⁵³

The issue of reparations for Iran illustrates the imponderables of the Iraqi economic situation.Unknown levels of reparations and of debt service payments are to be paid out of uncertain and fluctuating oil revenues, while Iraq is in urgent need of funds for the basic requirements for the population, for reconstruction and for development.

Since the implementation of Security Council Resolution 986 in December 1996, Iraq has been paying 30% of its gross oil sales revenues into the UN Compensation Fund.So far, individual claimants are being compensated, but the major claims are corporate ones which are due to be dispensed next.Payment of corporate claims however, raises the issues of other claimants, particularly Iraq's creditors before 1990.Iraq's international debt excluding debt owing to the Gulf states, would reach $77.9 billion by the end of 1998, on the assumption of an interest rate of 8%.The combination of debt and reparations will result in an unsustainable burden under any realistic assumptions regarding oil revenues and import requirements.Using what may be optimistic assumptions about oil production and prices, Al-Shabibi simulated the behaviour of Iraq's macroeconomy and concluded that 'if relief is not obtainable and if debt is paid according to a strict amortisation schedule, the conditions of the Iraqi economy will continue to deteriorate even if sanctions are lifted'.⁵⁴According to these figures, a 'no-reduction' situation points to continued collapse of the Iraqi economy, with continually declining consumption levels and rising external debt.⁵⁵Clearly, a rehabilitation process will be interrupted without substantial relief from external obligations.

The Oil Sector
The crude oil production sector has been operating below capacity for most of the past 18 years.Upstream investment has therefore been neglected except for oil transport pipelines during the 1980's.The transport system suffered heavy damage in both Gulf wars, but it is possible within a short period of time to rehabilitate enough transport capacity to enable Iraq to export all it can safely produce.According to Chalabi, the partial shutdown of much of Iraq's production capacity during the 1980's has resulted in a loss of 400,000 b/d of production capacity to 3.4 mbd.⁵⁶It appears that further deterioration, war damage and the near complete shutdown and lack of maintenance under sanctions have accelerated the loss of capacity, reducing it to 2.16 mbd under current conditions.⁵⁷

Estimates for the cost of rehabilitation of Iraq's oil industry vary from the UN Expert Group's estimate of $1.2 billion to achieve a sustained output of 3 mbd, to Chalabi's $5 billion required to completely restore the war damage to all the facilities including transport, storage and refining capacities.⁵⁸These estimates are not necessarily inconsistent with each other.

If we took the Expert Group's estimate, we can consider any additional export capacity beyond 3mbd at its full development cost.Clearly, for political and economic reasons, Iraq is at present not in a position to raise the capital for major investment in oil production arrangements.It may thus be safe to assume that production would not exceed 3 mbd before the removal of the sanctions and settlement of outstanding issues.

After that, Iraq's oil policy will be subject to the arrangements under which the country can resume normal international trade, and to the settlement of compensation and debt repayments issues.Currently, compensation and other costs are being deducted as a percentage of oil revenues, resulting in a loss of over 40% of the average and probably almost as much of the marginal value of oil.Compensation alone amounts to approximately 32% of the value of oil at Iraq's frontier.⁵⁹Over 5% ($231 million in total for the first twelve months of oil sales) went to cover a number of UN activities associated with the implementation of Security Council resolutions.A further loss to Iraq arises from the heavy price discounts applied to Iraqi oil due to uncertainty and to the UN monitoring procedures.Expansion in production capacities through new investments are also likely to be associated with debt repayment arrangements.

Since Iraq is now already utilising its established capacities, higher output and exports would have to meet the full cost of development of production and transport capacities.Iraq would need to enter new contractual arrangements with foreign partners or investors, possibly on unfavourable financial conditions given the country's poor bargaining position at present.Any possible benefit to Iraq would also be reduced as a result of the impact of higher oil supplies on prices.Without freeing the country to conduct its oil business and its civilian international trade, and without a sharp reduction in reparations, the marginal cost of additional oil production could be so high as to deter new development.

That said, the present Government's behaviour does not always lend itself to these economic calculations.Increased oil output is viewed as a source of power and prestige as well as of economic opportunity, hence it is possible that the Government would proceed with oil development contracts at the earliest opportunity.In all cases, Iraq may gain from re-establishing its claim to its full share of oil output quotas, given its very high likely reserves of oil.⁶⁰

Iraq has had relatively little exploration and investment in crude oil over the past two decades, and arguably for much longer.Given the country's current economic predicament, oil will be especially important during the rehabilitation process.The structure of the industry is likely to begin to change in order to take account of Iraq's need for capital and technology.Iraq would also be looking to develop strategies for breaking the link between oil production on the one hand, and reparations and debt repayments on the other.This is essentially a political rather than a commercial issue, but if it would have a great bearing on any decisions regarding long term development in the oil sector.


Conclusion: Beyond the Food-for-Oil Arrangement
The Food-for-Oil arrangement took more than five years and prolonged negotiations in order to be brought into effect.The main changes introduced to the arrangement agreed in 1996 were the acceptance by the UN of the "temporary" nature of this arrangement,and the acknowledgement, in principle, of Iraq's sovereignty over its economy.In addition, there was a greater involvement by the Secretary-General of the UN in the implementation of the arrangement, a development viewed with favour by the Iraqi Government.

Nevertheless, all detailed transactions remained subject to the approval of the Committee established by Security Council Resolution 661 and to the veto power of each of its individual members.The Iraqi Government has been forced by the deteriorating conditions to comply with the arrangement.Deterioration was reflected in the decline in the value of the Dinar, continued degradation of the infrastructure and growing difficulty in maintaining the basic ration distribution.

The Government entered the Food-for-Oil arrangement from a politically and economically weak position and it has been attempting to improve its bargaining position and to widen the arrangement, in order to make it more flexible and to reduce the proportion paid out in compensation and costs.The Government's declared aim is that of lifting the sanctions through the implementation of Article 22 of Resolution 687.This can only happen after the Government is deemed by all Permanent Members of the Security Council to have met the demilitarisation requirements, a position which remains unlikely in the near future and liable to be a source of military tension.

Barring a major military conflict, it is now highly unlikely that the Government will back out of the Food-for-Oil arrangement in order to attempt to force an early removal of sanctions.This will be less likely as time goes by and as the resources generated by this arrangement are integrated into the consumption, production and the incentive system.While improvements in living conditions have so far been marginal, it seems that the deterioration of the economy has been arrested.For its part, the United States would also find it difficult to interrupt the arrangement at one of the Security Council's scheduled renewal sessions, in order to put any pressure on the Iraqi Government.

Security Council Resolution 1153 of 20 February 1998 has cleared the way for increasing oil production and for beginning to address the rehabilitation of the oil sector and the infrastructure. However, removal of sanctions in order to permit Iraq to enter economic and financial agreements of a long-term nature and to deal with issues of development and debt repayments must await a political resolution of Iraq's domestic and international relations.

Unless and until Iraq is able to negotiate from a position of acceptance within the international community without the onerous burdens of heavy reparations, the country's future prospects will be severely restricted.Furthermore, Iraq would need to be free from arbitrary decisions exercised through the veto mechanisms of the Security Council.Indeed, a change in economic approach requires that the country is also free from arbitrary rule.

The main economic point which the Government has to come to terms with is that Iraq's fundamental economic situation has been altered irrevocably.The relaxation or removal of sanctions will allow Iraq new options, but none of them take it back to oil-based prosperity.The potential for Iraq is in its combination of resources and in its ability to be engaged peacefully and economically with its neighbours.The process of again mobilising the country's resources will be gradual and it will require all the ingenuity of the people.

The flow of financial resources to the country will generate a momentum for rebuilding the infrastructure, services and state institutions in their wider sense.This process will require wide participation and respect for individual and group initiative, and the initiation of a process of reform and reconciliation.There is an urgent need for economic policy reform, which will consecrate private activities and regulate them.Above all, there is a need to break the organic link between the state and private activities.Ultimately, Iraq cannot advance without the present regime coming to terms with its own reality as a minority political faction within the country.

Life in Iraq remains desperately harsh.A gradual relaxation of sanctions should be ground for optimism and action.Many necessary political, economic and administrative reforms can be initiated during a period of stabilisation and gradual improvement, and it is not necessary to wait until sanctions are lifted or the regime is changed before considering reform.The international community can assist by easing the flow of resources into the country and by engaging in a wide dialogue and relaxing tensions.Iraq is also in need of technical assistance and its problems and experience require ongoing research.

Iraq's government has so far avoided many of the underlying economic issues and concentrated on its political problems.Similarly, the Security Council has been using economic incarceration as a main policy tool to complement US military and political 'containment'.This situation is untenable and damaging.The government will resist attempts to make the food-for-oil arrangement permanent, but its challenges to the status quo will be more effective if it were to develop a credible economic strategy for dealing with Iraq's new economic realities.

There have been some, albeit few grounds for optimism, such as the successful and relatively efficient rationing system, the post-war reconstruction effort, the policy of raising agricultural purchase prices in response to the sanctions, and the measures to curb inflation in 1995.However, these must be viewed as task-driven and as forms of crisis management, and they do not form a commitment to a rational and coordinated policy that is aimed at achieving explicit objectives over a long time horizon.A shift in that direction is essential, and a new approach would include rebuilding the capacity for policy coordination, restoring the professionalism of monetary and fiscal agencies of the state, and taking action to restore the morale and integrity of public administration.The government alone cannot undertake these tasks successfully, but public participation is a necessary component.As we noted, this requires a greater political openness and relaxation of tension, both domestically and internationally.

The removal of sanctions will still leave Iraqi finances severely restricted by the combination of reparations and international debt.The international community can offer the country a way out of the current impasse, something which has not so far not been offered.Such a strategy would eschew confrontation and it would abandon the policy of exacting punishing reparations.It would attempt to exchange debt reduction for a measure of domestic political openness, a move towards accountable government, and economic and administrative reform.

The restoration of economic and political stability is essential, but Iraq also needs an economic strategy that addresses its current state of affairs.The expanded food-for-oil programme does not fulfil such a requirement.The expansion permits a series of projects and tasks which do not address the policy requirements, nor do they deal with the institutional issues of public sector efficiency and private sector participation.

Increased oil exports will offer immediate relief as if from external sources, and that can never be a substitute for regenerating the economy.Iraq needs an economic strategy which is based on restoration of essential utilities, rebuilding the public education and health services, selectively rehabilitating industrial plant, encouraging investment in raising agricultural productivity, and developing the potential of the oil sector.It is also necessary to restore confidence in the country's economic future.

¹ See A. Jiyad, "Iraq Indebtedness: From Liquidity to Unsustainability".Paper presented to the Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997.

² For details, see A. Alnasrawi, The Economy of Iraq: Oil, Wars, Destruction of Development and Prospects 1950-2010 (Westcott, Conn.: Greenwood Press, 1995), Ch 5.

³ See Organisation of Petroleum Exporting Countries, Annual Statistical Bulletin (Vienna: OPEC, 1991).

⁴ Iraq's oil production capacity is estimated to have been approximately 3.2 mbd.See F. Chalabi, "Post-War Iraq's Oil Capacity:Present Situation and Future Prospects".Paper presented to the Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997.

⁵ For details, see K.A. Chaudhry, "On the Way to Market: Economic Liberalisation and the Iraqi Invasion of Kuwait", Middle East Report, Vol. 21, no. 3, May/June 1991.

⁶ Central Statistical Organisation, Annual Abstract of Statistics, (Baghdad: CSO, various).Henceforth "AAS".

⁷ See S. al-Mukhtar, in Al-Quds Al-Arabi (London Arabic daily), 11 March 1996.

⁸ As early as September 1991, Dreze and Gazdar (1991) reported in a survey that 23% of their respondents had no assets left to sell in order to supplement their low incomes; Table 7, p 47a.See J. Drèze and H. Gazdar, Hunger and Poverty in Iraq (London: Development Economics Research Programme Paper No. 32, London School of Economics, 1991).

⁹ D. Keen, The Kurds in Iraq: How Safe Is Their Haven Now? (London: Save The Children, 1993), p 39.

¹⁰ Iraq's External Trade 1989-1995
(millions of US Dollars)

	1989	1990	1991	1992	1993	1994	1995
Exports	12,246	10,421	487	609	471	382	422
Imports	6,995	4,833	423	602	533	491	611

Source: Arab Monetary Fund, "Foreign Trade of Arab Countries 1985-1995", no. 14 (Abu Dhabi: AMF, 1996), Tables 71 and 72, pp 140-1.(Other sources, e.g. IMF, Direction of Trade Statistics offer different figures.The import figures for 1989 and 1990 in the above table are the ones reported in Iraq's AAS, and they are lower than those given by the IMF.It is likely that the latter include military imports (compare M. A. Zayni, al-Iqtisad al-Iraqi fi Dhil Nidham Saddam Hussain [The Iraqi Economy Under Saddam Hussain's Regime](London: Al-Rafid Publishers, 1995), Table 8.5, p235.Arabic).The Arab Monetary Fund figures for 1991-95 are generally higher than those reported by the IMF, but lower than some other "broad brush" estimates).

¹¹ According to Oil Minister Amer Rasheed, Iraq's sustainable production capacity in March 1998 was 2.65 mbd assuming availability of spares and chemical treatment agents (2.3 mbd without access to the said materials).Capacity can be raised to 3 mbd in under six months providing Iraq is allowed access to equipment and funds to rehabilitate some of its capacity.See Al-Hayat, London Arabic Daily, 22 March 1998.

¹² P. Boone, H. Gazdar and A. Hussain, "The Economy Under Sanctions".Paper presented to the Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997, p 8.

¹³ Dreze and Gazdar, Hunger and Poverty, Table 2a, p 18a.

¹⁴ Ibid, p 19.

¹⁵ Ibid.

¹⁶ Boone, Gazdar and Dreze, "The Economy Under Sanctions", Table 3.

¹⁷ Yet it is possible that the squeeze on incomes is understated by this figure.Wheatflower prices had already been fully adjusted to international levels by the time of the 1991 survey.However, the relative prices of domestically produced non-traded commodities are likely to have risen as these commodities fully adjust to the cost of the imported components.However, the relative prices of these commodities would also have fallen as the relative price of labour to foreign exchange itself declined..

¹⁸ Ibid, p 15.

¹⁹ See Boone, Gazdar and Hussain, "The Economy Under Sanctions", p13.For a comparison of some public and private pay levels, see Ibid, Table 3.

²⁰ See N. Haddad, "Feed Blocks Prove Hit With Farmers", Caravan, Issue No. 2, Winter 1995/96, (Aleppo: International Center for Agricultural Research in the Dry Areas), pp. 6-7.

²¹ See A. Sayyid-Ali, "Al-Iqtisad Al-Iraqi: Ila Ayn?", Al-Mustaqbal Al-Arabi No. 228, February 1998, Beirut, pp. 78-9.(The paper was presented as "The Iraqi Economy: Where To?"; Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997.

²² For the state of manufacturing, see T. al-Khudayri, "The Manufacturing Industry of Iraq: Status and Future Prospects".Paper presented to the Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997.For agriculture, see K. Mahdi, "The Political Economy of Iraq's Agriculture", in The Middle Eastern Environment ed. E. Watkins (Cambridge, UK: St.Malo, 1995).

²³ Chaudhry, "On the Way to Market".

²⁴ See AAS 1982, Table 6/1, p. 125.

²⁵ Figures from United Nations Economic and Social Commission for Western Asia, National Account Studies of the ESCWA Region.

²⁶ AAS, 1993, Table 5-10, p 193.

²⁷ It is not entirely unreasonable to use this overvalued rate, since much of Government consumption, investment and subsidies would have been composed of imports valued at the official rate.If we were to use a shadow rate of exchange that assumes a Dinar value at half the official rate, the estimated deficit would be 8% of GDP.

²⁸ Our interest here is in the size of the deficit relative to GDP.We have already noted different calculations of the share of oil in GDP.

²⁹ Thisis a rough calculation based on UNESCWA National Accounts statistics.It appears that the deficit was very high during the war year of 1991, declined in 1992, and then rose sharply again in 1993, largely as a result of the increasing cost of the food price subsidy.It has to be said however, that these figures are tentative, and they suffer from the unsettled markets and probably unwarranted relative price movements.It is also likely that some Government activities, including small sanctions busting oil sales, are not included in these figures.

³⁰ Calculated from AAS 1990, Table 5-8, p 189, and AAS 1993, p 183.

³¹ See particularly, G. Simons, The Scourging of Iraq (London: Macmillan Press, 1996).

³² For details, see Al-Khudayri, "The Manufacturing Sector", p 14.

³³ Ibid, Table (4/1), p 148.This figure is low despite the overvaluation of the official currency exchange rate and despite the availability of cheap power, infrastructure, etc.

³⁴ See AAS, 1990, Table 4/15, p 169.

³⁵ Al-Khudayri, "The Manufacturing Sector", p 12.

³⁶ Ibid, Table 1, p 8.

³⁷ Boone et al, "The Economy Under Sanctions",

³⁸ See Al-Khudayri, "The Manufacturing Sector".

³⁹ Ibid, pp. 15-16.

⁴⁰ For a discussion of some of these issues, see Mahdi, "The Political Economy"

⁴¹ For the devastating consequences of sanctions and of the collapse of government agricultural services upon land yields and output, see The Economist, May 2nd 1998.See also Food and Agriculture Organisation, "Report of the November 1996 Mission to Assess the Situation of the Agricultural Sector in Iraq"..

⁴² Chaudhry, "On the Way to Market.

⁴³ See Boone, et al, "The Economy Under Sanctions", pp 35-6 and Appendix 3.

⁴⁴ FAO, "Report", pp.-35;M. Ahmad, "Agricultural Policies Under the Current Embargo Period".Paper presented to the Conference on Frustrated Development: The Iraqi Economy in War and in Peace, Centre for Arab Gulf Studies, Exeter University, 9-11 July 1997.

⁴⁵ UN, Report of The Group of Experts Established Pursuant to Paragraph 12 of Security Council Resolution 1153 (1998).

⁴⁶ U.S. Arms Control and Disarmament Agency, World Military Expenditures and Arms Transfers.Quoted in Zainy, Al-Iqtisad Al-Iraqi, Table 5-8, p 235.See also Pierre Salinger and Eric Laurent, Secret Dossier: The Hidden Agenda Behind the Gulf War (London: Penguin Books, 1991), p 233.

⁴⁷ Jiyad, "Iraq Indebtedness".

⁴⁸ See Zainy (1995), Table (10/1), p 302.

⁴⁹ Jiyad, "Iraq Indebtedness", p 28-9.

⁵⁰ United Nations Department of Public Information, The United Nations and the Iraq-Kuwait Conflict 1990-1996 (New York: The United Nations Blue Book Series Volume IX, 1996), pp. 387-8.

⁵¹ Ibid, pp 258-9, for the Note from the Secretary-General to the President of the Security Council, 31 May 1991, S/22661.

⁵² See N. Ulmer, in Middle East Economic Digest 6 June 1997.According to Ulmer, some claims will be rejected and others would probably be scaled down.The figure of $50,000 is an informed guess based upon information available so far.

⁵³ See United Nations Security Council, Letter for the Secretary-General to the President of the Security Council, 24 December 1991.

⁵⁴ S. Al-Shabibi, Prospects for Iraq's Economy: Facing the New Reality, UNCTAD Reprint Series No. 79,(Geneva: UNCTAD, 1998), p. 64.

⁵⁵ Ibid.

⁵⁶ Chalabi "Post-War Iraq", p 5.

⁵⁷ United Nations, "Report of the Group of Experts"..

⁵⁸ Chalabi, "Post-War Iraq", p 9.

⁵⁹ Compensation payments of 30% are charged on the basis of prices paid at ports, not on a netback basis in the case of sales through Turkey.

⁶⁰ Ibid, p 6.