Iraq’s Oil Mess

“We’re dealing with a country that can really finance its own reconstruction, and relatively soon,” Deputy Defense Secretary Paul Wolfowitz assured Congress shortly after the war to oust Saddam Hussein was launched. That was then, this is now. Wolfowitz seems to have been off by a few hundred billion dollars.

The opponents of the war—with what National Interest editor John O’Sullivan calls their “sleeping radical instincts and . . . inverted patriotism” aroused—predicted a long and bloody battle; they were wrong. The advocates of regime change foresaw garland-bearing welcoming committees and an Iraq so awash in oil and so ripe for Western-style democracy that the cost to the United States of Iraq’s reconstruction would be minimal; they, too, were wrong. The former are, predictably, unapologetic. The latter are faced with the costly proposition that he who would call the tune must pay the piper—or share tune-calling authority with other potential paymasters.

The expense of reconstruction will be exacerbated by ongoing acts of sabotage and efforts to stop them. A recent survey by the U.S. Army Corps of Engineers of 700 miles of wire in Iraq found 623 destroyed transmission towers, compared with just 20 after the war (Wall Street Journal, September 5, 2003). Even under the most optimistic assumptions about our ability to secure the nation’s oil field equipment, pipelines, ports, and transmission grid—and optimistic assumptions are the spécialité du maison of the Pentagon—Iraq cannot possibly export enough oil in the foreseeable future to cover the costs of reconstructing its clapped-out physical and government infrastructures, never mind paying off whatever portion of its massive debt falls outside the category known as “odious debts” (those taken on by despots merely to strengthen the regime and repress the population).

There is worse, much worse. Solving current security problems is only one essential if the Bush administration is to achieve its long-term goal of creating a democratic, market-oriented government that will be a model for other Middle Eastern countries. Equally and arguably even more important is the question of just what sort of oil industry we plan to bequeath to the new Iraqi government; for if we know one thing about countries that rely on oil revenues for the great bulk of their incomes and wealth, it is that government control of a preponderant portion of a nation’s gross domestic product (GDP) distorts economic activity, creates incentives for the entrepreneurial classes to seek their fortunes by catering to government bureaucrats rather than to consumers, provides governments with the ability to purchase the tools necessary to repress their peoples and to buy off terrorists by funding their activities in other countries, and results in the sort of society and government we now see in Saudi Arabia—unless, of course, we are among those blinded by the administration’s penchant for shielding the Saudi royal family from criticism.

Unsafe for Democracy

As things now seem to be shaping up, any hope for major changes in the structure of Iraq’s oil industry has become the most important victim. Pentagon sources say that all energy, physical and intellectual, is being absorbed by the current attempt to gain control of the country, at the expense of all other policy chores. When all is said and done, Iraq will have a state-owned-and-operated monopoly oil industry that is a dutiful member of the OPEC cartel, providing a flow of funds to a central government that we will find uncongenial. Indeed, even if we do find the energy to attempt to plant the seeds of a free-market economy of the sort that our designated administrator, Paul Bremer, originally had in mind, it is unlikely that those seeds will flower in Iraq’s desert soil and hostile climate—witness the rallying of Iraq’s business class around the protectionist banner. (One leading Iraqi businessman says that in the absence of protection from foreign competition, “local companies will be completely smashed” [Wall Street Journal, June 25, 2003], a not-unreasonable assumption given the lack of investment in these companies for several decades, and their forced operation in a non-market economy.)

Start with the fact that there is nothing in the history of the region or of the Arab states to suggest that democracy can take root in Iraq. Of twenty-two Arab states, not one has an elected government. As conservative columnist George Will puts it, it is not clear that “national cultures . . . are infinitely malleable under the touch of enlightened reformers.” Even if democracy in some form can be imposed on Iraq, only a truly (wildly?) optimistic analyst can believe that it will result in anything approximating Americans’ notions of a liberal society, replete with institutions erected to shield the citizen from an overweening state. If you doubt the possibility that our plans to shape Iraq’s future—plans based on the premises that we have the knowledge and will have the power to do that—will prove to be nothing more than an imperial conceit, treat yourself to a combination of Bernard Lewis (The Crisis of Islam: Holy War and Unholy Terror, London: Weidenfeld & Nicolson, 2003) and Fareed Zakaria (The Future of Freedom: Illiberal Democracy at Home and Abroad, New York: W. W. Norton & Company, 2003). Or consider whether the outcome of a free election in Saudi Arabia is more likely to confer power on one of the enlightened young Arab democrats whom New York Times columnist Tom Friedman is so fond of interviewing, or on Osama bin Laden or one of his acolytes.

While pondering that question, consider the statement of Hussein Jassem Ijbara, a former general in the Iraqi Republican Guard, now installed by American forces as governor of Salahadin province, and ensconced in what has been described by observers as “a well-appointed office in the government palace in Tikrit” (Financial Times, June 24, 2003). “In my opinion,” says the new governor, “they needed someone strong who could run Salahadin province in the place of Saddam Hussein. . . . We have a system now very much like they have in the United States. Our province is like an American state. I have all the power.” So much for the new Iraqi leaders’ understanding of the American-style democratic government that our policymakers have in mind not only for Iraq but for the entire Middle East.

We are already witnessing the execution of liquor merchants, the censoring of films, and the unwilling use of the hijabe head covering by frightened women who felt no need to cover up when Saddam was in power, perhaps foretelling the emergence of what columnist Nicholas Kristoff calls “Iran Lite.” (See “Cover Your Hair,” New York Times, June 24, 2003. Kristoff also quotes a leader of a Shiite fundamentalist party that is winning support as saying, “Democracy means choosing what people want, not what the West wants.”) And reports from Iraq suggest that after the devastation of the 1991 war, which destroyed power plants and other infrastructure facilities, the country was up and running within forty days, in contrast with the current situation, in which the Coalition Provisional Authority (CPA) was unable until recently to restore services to prewar levels despite inheriting an infrastructure far less war-damaged than the one we left to Saddam after the first Gulf war. (See the report by Charles Clover in the Financial Times, June 25, 2003.)

Sure, there are large parts of the country in which our pacification and reconstruction efforts are bearing fruit. But only those blinded by hatred of the one-sidedly gloomy reports of the antiwar, I-told-you-so faction would argue that we are succeeding at anything approaching the pace we had anticipated when occupying Iraq. Or even that we have figured out how to succeed. Our early plan to assign an adviser to each of the twenty-odd newly appointed Iraqi ministers reflects an arrogance not seen since the last Soviet Gosplanner hung up his computer (more likely, his slide rule).

Our plan is to have each ministry, under the guidance of an American adviser, draw up plans that accurately predict revenues, costs, tax receipts, and the like, while other technocrats set wages, prices, and the right exchange rate for the new currency; decide which debts should be repaid and which repudiated; and perform other chores ordinarily left to the market. Note that we are not content to talk about getting things running at pre-war levels, but are aiming to produce far higher levels of services and prosperity, levels never before seen in Iraq.

Crude Oil Realities

The plans for the oil ministry are a case in point. Ibrahim Mohammed Bahr al-Uloum, the minister appointed by the Governing Council to run the oil industry, is a petroleum engineer, but his main qualification seems to be his choice of father—a leading Shiite cleric who sits on the Council when not temporarily suspending his membership to protest some aspect of U.S. policy or performance. Mr. Bahr al-Uloum favors privatization of downstream facilities such as refineries, but is less certain that the nation’s 112 billion barrels of proven reserves, the world’s largest with the exception of Saudia Arabia’s, should pass from state control. Production-sharing agreements with American and European countries might be countenanced, and Arab neighbors will be asked to help in the rehabilitation of existing fields, but any decision for complete privatization must, the new minister says, await the election of a new government, with the prospects for a “yes” vote on privatization somewhat dimmed by a culture described by the new minister as dominated by the fact that “people lived for the last thirty to forty years with this idea of nationalism” (Financial Times, September 5, 2003), suggesting that a bit of humility about our prospects for reorganizing Iraq’s oil industry along private, competitive lines might be in order.

Iraq is believed to be capable of producing about 1.8 million barrels per day at present, but is probably producing less than that. A few hundred thousand barrels are used for oil field operations, and another 500,000 barrels are needed for domestic consumption—to produce fuel for power plants, and to make gasoline, diesel, and kerosene for domestic use. In addition, the Kurds are siphoning off significant quantities. Repeated sabotage of the main northern pipeline to the Turkish port of Ceyhan makes it impossible to export all of what is produced. Latest figures suggest that exports are running at something like 645,000 barrels per day, far below both prewar levels and the occupying powers’ forecasts. In sum, oil revenues won’t come close to meeting the costs of occupation and reconstruction, even when exports rise substantially.

But let’s assume that, like my fellow economists, I am so accustomed to practicing my “dismal science” that I have difficulty seeing the bright side of things. And let’s assume further that it is indeed within our power to impose a durable new order on Iraq’s oil industry, and that the free-market plans set out by Paul Bremer can indeed be implemented. And just to keep things on the bright side, let’s assume that Iraq can soon again become an important exporter. The principles to follow if we are to have any hope of achieving our goals are straightforward.

First: No return to the prewar structure. We know that the typical system of state ownership is a failure in every particular. In the end, it impoverishes the citizens (if that is the right word) of the producing country; witness the two-thirds decline in per capita income in Saudi Arabia in the past decade. This is a consequence of

·        an inflated currency valuation that makes the producing country unable to compete in world markets as anything but a seller of oil;

·        the belief that wealth springs from the ground, no work needed, which leads a native population, already ill-educated to function in the modern world, to refuse to work and instead to rely on immigrants to do not only the dirty work but all the work;

·        the corruption incident to the huge revenues flowing to a ruling elite, a generally unsavory crowd that uses a small portion of the oil money to bribe the masses into lethargy with free telephone service and a few other amenities, and most of the rest to support a life of luxury unimaginable even in the affluent West, with a little left over to support the terrorist organization du jour so as to fuel the fires of the Israeli-Palestinian war and focus local discontent on Israel rather than on the ruling regime.

That describes Saudi Arabia as it is today, and Iraq as it was before the overthrow of Saddam Hussein and likely will be again if the oil industry is not restructured.

Second: Any reform must have a good chance of surviving the departure of the occupying forces. If we optimistically assume that we have the nous and power to change the way Iraq’s oil wealth is used, the new order we impose must be irreversible. We may be in Iraq longer than we had hoped, and certainly longer than we had planned, but we won’t be there forever. So we must consider the possibility that a post-CPA Iraqi regime will want to turn the clock back to the good old days of palaces for the few and poverty for the many.

In my view, that eliminates as a possibility any scheme that involves setting up some sort of fund to be used in the interests of the Iraqi people. A post-CPA regime could very easily redirect to itself and its Swiss bank accounts, or its military, or its weapons program, the funds flowing into any pot intended to be used for education, health, and other “good” purposes.

In short, Iraq ain’t Alaska, and not only because of differences in climate. In Alaska, oil royalties go into a fund that is distributed directly to the state’s citizens, for them to spend as they see fit, to the consternation of Alaska’s legislators, who repeatedly fail in their attempts to have the money flow into the state’s coffers for redistribution as the politicians and bureaucrats see fit.

The need for a scheme that would survive the departure of American and coalition forces also rules out having the occupying authorities turn ownership of Iraq’s oil reserves over to foreign, and especially American, oil companies. No matter how transparent any bidding procedure, no matter how inflated the price paid to Iraq for rights to its reserves, those contracts will be seen as negotiated between an American administrator and American oil companies. They could not possibly survive the departure of our soldiers.

Third: Durable change can come only if we vest ownership in Iraq’s oil wealth directly in the people. Shares in the nation’s oil companies—and it would be well to have several companies—can be distributed to all Iraqis, perhaps with the proviso that they are not immediately tradable, so as to prevent those who are now very wealthy from extracting unreasonable terms from desperately needy sellers who fared poorly under the old regime. This is not the place to develop all of the details of this plan, even were I competent to do so. That chore is best left to the economist Hernando de Soto and others who specialize in this area. All we need know at this point is that a new Iraqi government, no matter how much it might want to seize control of the nation’s oil income, would have a more difficult time confiscating or nationalizing shares held by Iraqis than it would recapturing ownership rights held by American and other foreign oil companies.

Back to OPEC?

Which leaves the knotty question of OPEC. One of our hopes was that Iraq, eager for current revenue, might remain outside the embrace of the oil cartel, which has invited it back into the fold, an invitation Mr. Bahr al-Uloum has said he will accept. There is still a possibility—increasingly remote—that Iraqis will apply a higher discount rate to future revenue flows than, say, Saudi Arabia, and produce all the oil that Iraq’s fields can pump out without further damaging the nation’s fields. But even if we decide to embrace this rosy scenario, we can’t ignore the fact that, at least for the foreseeable future, the Saudis and their partners are cutting back their own output to make room in the market for such oil as Iraq is capable of producing, leaving the volume of oil reaching world markets unchanged—unless some major new region comes on line more rapidly than it is now reasonable to anticipate. (My Hudson Institute colleague, Max Singer, believes that the production of Canada’s ample reserves of shale oil is increasingly economic and is a viable long-run alternative to Saudi oil. See his “Saudi Arabia’s Overrated Oil Weapon,” The Weekly Standard, August 18, 2003.)

Of course, we do not live only for cheap oil, although competitive prices would have the same effect as an additional tax cut and would entail none of the long-term negative consequences of the current plunge into long-term federal budget deficits. So a restructured Iraqi oil industry that contributed to the dilution of the power of the central government by depriving it of first call on the industry’s oil revenues would be good news not only for Iraqis but also for those of us hoping that a less troublesome Iraq, and a possible model for other countries in the region, will be the long-term payoff for our current pain and that the new Iraqi government will decide not to play ball with the oil cartel.

But regardless of whether it chooses to operate within or outside of OPEC, it is unlikely—not impossible, but unlikely—that Iraq will become an important enough exporter in the next few years to fund its reconstruction. The country’s industry must first be made safe from sabotage, and billions must be invested to upgrade old fields that have suffered from underinvestment and to find new reserves.

Which brings us back to where we started. If America is willing to pay the piper to the tune of, say, 1 percent of its GDP, it can continue to call the tune and hope that my pessimistic view of our chances of converting Iraq and its Middle Eastern neighbors into freedom-loving, tolerant, and largely capitalist nations is simply wrong. If not, we must make the trade-off of further lowering the cost in U.S. blood and treasure by sharing authority with France and “donor” countries that do not share our goals—which will reduce the probability of success below even its low current level.

Whatever else we do, we should remember Kuwait, the country we saved from Saddam and has since refused to allow American companies to participate in its oil industry. Like Kuwait, Iraq’s future behavior is unlikely to be informed by any sense of gratitude.

“What soon grows old? Gratitude.” So said Aristotle. Therein lurks a lesson for American policymakers who are relying on just that virtue as they attempt to reconstruct Iraq, and who continue to rely on the OPEC countries we saved from Saddam in 1991 to provide an uninterrupted flow of competitively priced crude oil. The French, saved by us more than once from becoming German-speakers, and the Germans, saved by us from becoming Russian-Speakers, are living proof of the proposition that expectations of gratitude have no place in the development of foreign policy.