Iraq economy in shambles, but the oil awaits

Mike Meyers, Star Tribune National Economics Correspondent Published April 27, 2003 ECON27

Clifford Anderson is eager to invade Iraq.

But he's worried about the cost of the campaign, how many people he would have to muster and whether they could be assured of coming back alive. Anderson wants to be certain he can prevail -- and reap the rewards of triumph.

As chief executive officer of Roseville-based Crown Iron Works Co., Anderson is accustomed to deploying workers to far-away places -- to fight for commerce.

Crown, started 125 years ago as a maker of decorative iron ornaments, today designs and installs equipment to transform soybeans into oil and animal feed. The company, with 70 employees in Minnesota, has worked at more than 500 locations, on all seven continents, practically every place soybeans are used. In the Middle East, it has customers in Egypt, Dubai and Israel.

What happens next in Iraq matters more than a hill of beans, both to the people of that country and to international companies such as Crown. Now that the battle of Baghdad is over, the struggle has begun to transform Iraq's economy, plagued by war, trade sanctions and a quarter century of mismanagement.

"If it were not for the fact that we had problems for the last many years in Iraq, we'd have been doing some business there now," Anderson said. "There's a market there and we've been locked out."

What Anderson needs to fulfill his ambitions for entering Iraq reads like a checklist of what economists say is required for that nation to rebuild its economy, one step at a time.

• Iraq will have to rid its streets of marauders. Few foreign companies will want to send workers to a country that's known to be hazardous.

• It must restore and modernize water, electricity and other public works. Nobody can run a soybean processing plant -- or just about any enterprise -- without water and power.

• It must replace its worthless currency and revive its faltering banks. A 100-dinar note of Iraqi currency is worth pennies. The inflation rate in Iraq was estimated to be in triple digits before the chaos of war, according to the World Bank. A home-grown banking system provides the cash to finance new business ventures.

• It must see an end to United Nations trade sanctions. Companies are less likely to trade with and invest in Iraq until they can be sure that it's legal.

• It must establish laws -- and law enforcement -- to protect private property and ensure that foreign investors can take home profits.

A big job

In the 1970s, Iraq nationalized foreign oil companies, discouraging foreign investment over the decades that followed.

"Who knows what's going to happen there next?" Anderson said. "It's going to have to smooth out there before we go there."

Some of the tasks needed to fashion a healthy Iraqi economy may take weeks or months, while many others could take years.

"It's a big, big job," said Harvard University economist Richard Cooper.

To be sure, Iraq has more going for it than Afghanistan, Bosnia and East Timor, all countries with economies ravaged by recent wars.

Said Anderson: "They've got water. They've got oil. Until Saddam Hussein messed it up, Iraq was one of the most viable economies in the Middle East."

The Tigris and Euphrates rivers run through Iraq, promising a bounty in agriculture since ancient times when the region was called the "fertile crescent." Although three-quarters of Iraq's 24 million people live in cities, food production was a thriving industry until a few years ago, when the nation's economy began to unravel. From 1990 to 2000, the output of Iraq's food chain fell by nearly 50 percent, by the estimate of the World Bank.

Yet Iraq has something that most countries do not. It has oil and lots of it -- the world's second-largest reserve, after Saudi Arabia.

"It's very rich in resources and presumably will want to use those resources for reconstruction," Cooper said.

But oil riches are a mixed blessing.

"They've got a huge asset if they can be persuaded to look on it as being simply money," said Morris Adelman, an economist at the Massachusetts Institute of Technology.

"Unfortunately, oil is not usually seen that way," he said. Oil often is viewed as "the blood of the people, the symbol of a nation's vitality."

Oil politics

Iraq, by the count of the World Bank, has 112 billion barrels in oil reserves. But no oil company would pay the current world rate of $25 for a barrel of crude for rights to drill in Iraq, Adelman said.

Typically, oil rights go for about a third of the world price of oil -- or about $8 for a barrel of oil in the ground, at present values.

"Actually, [in Iraq] it's worth a lot less because there's a lot of risk involved,' Adelman said.

"If they said they were going to get the highest price offered, and if foreign companies really trust Iraqi determination to enforce ownership and property rights, they'll get perhaps half of that $8 and it will go up" over time, he said.

Much of that potential revenue already is claimed, however.

Iraq owes huge amounts of money to other countries, including France, Germany, Russia and the United States, for exports made to that country as long ago as the 1970s. In addition, Iraq owes war reparations to Iran and Kuwait for past wars.

Exactly how much money is owed is in dispute. Estimates range from $60 billion to as much as $400 billion. Much of that debt, almost certainly, will be repaid far more slowly than originally anticipated, but economists say Iraq will be forced to repay much of the debt. The reason: It must convince foreigners that their future investments in Iraq will be safe.

"One strategy is to get foreign capital, to bring in money and managerial know-how," Cooper said. "But, of course, it's politically sensitive."

With Iraq's colonial history -- the country was in the hands of the British for much of the first half of the 20th century -- many in Iraq will see foreigners as potential threats, as well as potential saviors, Cooper said.

But any country with major oil reserves has another problem -- the threat of the "Dutch disease." It's a story of the few prospering at the expense of the many.

After valuable natural gas deposits were discovered in the Netherlands a half century ago, energy became the dominant industry in that country. No other enterprise, from agriculture to manufacturing, could keep pace. The outcome was a period of inflation, job stagnation and economic setbacks for anyone without links to the energy industry.

Unhappy history

In 2000, revenues from oil exports represented 83 percent of the value of all goods and services produced in Iraq, by the estimate of the World Bank.

"Most countries that have oil revenues do not have a happy history of using those assets for the benefits of all of the people," said Steve Davis, a University of Chicago economist. "Over the longer term, the political and economic success of the Iraqi people will depend on how those oil sources are treated."

International economists have written many a treatise on the same phenomenon in energy-rich countries such as Mexico, Venezuela, Nigeria and Indonesia.

"To avoid such a situation to occur in the middle of a resource boom, the country must make some tough decisions on consumption, savings and investment," economist Moazzem Hossain wrote in one such study at Griffith University in Brisbane, Australia.

"If the country has not been preparing itself properly before the boom takes place, this will at the end bring unprecedented political chaos and even disintegration and civil unrest," he said.

Economists agree that Iraq will have to rely on advice from institutions such as the World Bank and International Monetary Fund to keep its economy from reeling.

"Saddam expropriated much of the wealth for himself, his family and his cronies,' said Davis, at the University of Chicago. "You could end up with another regime doing the same or a regime where the oil revenues are squandered in an inappropriate way.

"There's no panacea to ensure this won't happen. But transparency and international oversight would be a useful institution to put in place for several years," he said.

Davis said he's concerned the U.S. government may not be willing to stay to see the job done, however.

"I'm a bit concerned that many Americans, including many who supported the invasion, have the view that we should get out of there as soon as they've established some semblance of a democracy," Davis said.

As for Crown, Anderson said he's not likely to look for business in Iraq soon. But he can't speak for his British affiliate, where globe-trotting dealmakers seem to have a different assessment of risk.

"The English office is pretty aggressive," Anderson said. "I may get a call tomorrow saying, 'I just got back from Baghdad and everything is cool.' "

Mike Meyers is at meyers@startribune.com.