Brad Setser

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The IMF staff report on Iraq is a goldmine

by Brad Setser
October 20, 2004

I don’t expect many journalists will delve into it, but the IMF staff report on Iraq is a fountain of information. My favorite number: in 2004, the amount Iraq will spend importing (yes, importing) refined petroleum ($2.1 billion) will exceed the amount Iraq received in grant aid from the world (tranfers are projected at $2.05 billion). The refined gasoline that Iraq imports is then basically given away inside Iraq (the going price apparently is 1.7 cents a litre, which I think works out to less than 10 cents a gallon, though my metric conversion skills are a bit rusty) along with some gasoline Iraq refines itself, at a fiscal cost of $7 billion (or 30% of GDP, that is the IMF’s estimate of the cost of Iraq’s subsidy for domestic oil). Iraqis then take some of this cheap gasoline, put it on trucks, and ship it back across the border where it is sold at a profit, providing income and jobs for Iraqis (Iraq consumes an amazing amount of petroleum domestically for a $21 billion economy … ). The free market in action!

You may think I am making this up, but all apart from the oil smuggling story (which is pretty widely known, Iraqis smuggled oil out before the war, and from domestic consumption numbers, still do now) comes straight from the IMF, though you have to piece together the various parts to produce this tale …The estimated grant aid of $2.05 billion for 2004 is particularly disappointing. That is a tiny yield from the $18 billion plus in aid the US congress approved in 2003(see my earlier post on this) and the additional funds pledged by other countries at the Madrid donors conference. The net transfer of funds to Iraq is even less, only $1.2 billion, since Iraq is transferring $0.8 billion out of the country. This is almost certainly going to Kuwait, which is getting 5% of Iraq’s 16 billion in 04 oil export revenues to pay off the reparations the UN awarded for the first gulf war.

But net flows of grant aid (i.e. grants minus reparations) of only $1.2 billion is still way too small. The low number is partially the product of the deteriorating security environment, but it also reflects the fact that the Bush administration low-balled the cost of reconstruction going in (remember, oil, not the US taxpayer, was going to pay for everything, and fast). Consequently, the administration did not have a supply of appropriated funds ready to deploy immediately after “catastrophic success.” Rather, the US initially relied on unfreezing frozen Iraqi assets and the cash the US found in Baghdad. This, plus $2 billion in appropriated aid, was going to tide Iraq over until Iraq’s oil made Iraq self-financing … the dreams of early 2003.

The IMF staff report also delves into the free market wonder that is Iraq. Iraq is a country where government spending is more than a 100% of gross domestic product (2004 budget is $22.6 billion, 04 GDP seems to more like $21.2 billion, a rather amazing statistic). The state still intermediates most economic activity, and buys most of Iraq’s imports. Iraq’s economy is simple: the state basically uses Iraq’s oil revenue to finance Iraqi consumption, both directly by providing a range of goods and services to Iraqi, and indirectly.

— The government supplies gasoline for next to nothing, at enormous budget cost. Reselling that gasoline to neighbors where gasoline is less subsidized provides jobs and supports economic activity (tho Iraq has promised to reduce this subsidy going forward … let’s see if that is politically possible)

— The government also does not, it would seem, charge for electricity. When the electricity is on, it takes a loss there, paid for by oil exports.

— The government supplies Iraqis with basic food, for free, using its oil revenues; this is the oil for food program, which has been retained. Iraq has promised to shift toward a more market based mechanism of cash subsidies, just not yet. In 2004, imports of food and consumer goods by the government ($7.9 billion) are expected to exceeded private imports ($6.8 billion). The government also imported $4.8 billion in capital goods, in part to rehabilitate the oil industry.

— Government controlled exports (oil) accounted for 98% of all of Iraq’s export revenue.

I note this not to criticize it: the whole idea of applying harsh shock therapy to the economic system that emerged out of saddam and sanctions was silly, and the decision to back off was the right one. The initial effect of shock therapy would have been a sharp fall in output, as old economic structures disappear before new ones are put in place. But the large role of Iraq’s state in Iraq’s current economy does illustrate how far the US remains from the Bush Administration’s initial dream of turning Iraq into a free market nirvana. Of course, an unrealistic plan for economic transformation was not the biggest mistake the US made after taking over Baghdad.

But it is illustrative, I think, of a broader failure to understand Iraq, and to understand what could and should be changed quickly, and what needed a bit more time. By aiming too high, the US ended up achieving far less — notably in the economic realm — than anyone would have expected. Most people in Iraq depended on the state’s oil revenue in one way or another for the economic welfare before the war, and they still do now. Lots of oil revenue was used to pay for the army and police before the war, lots of oil revenue will be used to pay for the army (as one is created) and police in the new Iraq.

To be fair, the staff report documents two US successes in Iraq. Projected oil revenues of $16 billion exceed earlier forecasts. This, though, in part reflects good luck — oil prices exceeded expectations. The old dinar for new dinar currency swap also went well. That reflects a wise decision not to try to impose a new currency on Iraq, or to dollarize Iraq as part of some plan to transform Iraq into a WSJ oped page approved paradise. Rather the US improved the look of Iraq’s currency (getting Saddam’s face off the dinar is an improvement, by any standard), added security features, and expanded the range of notes in circulation. Before the swap, Iraq had the equivalent of a $1 and $50 bill, but no 5s, 10s or 20s. The US fixed that. There is a nice box on the currency swap in the staff report. Treasury Under Secretary John Taylor also touches on the currency swap in a recent, quite introspective, speech .

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