Iraq faces significant economic challenges, in particular stemming from its dependence on oil revenue and the country’s bloated public sector. Private sector growth is particularly constrained
by the dominance of state-owned enterprises (SOEs), restrictive regulations, lack of access to finance, shortage of skilled labour and inadequate infrastructure.
This review drew largely on reports by international development partners (most notably the World Bank) as well as policy papers; it found a dearth of relevant academic literature. While there was a significant mention of women in the literature, it made negligible reference to persons with disabilities. Key findings of the review are as follows:
- Recent growth has not translated into poverty reduction: Economic growth has fluctuated substantially in recent years, growing up to 2014, but is currently low. Following the defeat of ISIS
and rising oil prices, the macroeconomic outlook for Iraq is better but this has not translated into broad-based growth: poverty and inequality in Iraq are high. There are both geographical disparities in growth and development (poverty is higher in the southern governorates) and certain groups are worst off: internally displaced persons (IDPs), youth and women.
- Iraq’s long history of conflict and instability has undermined growth and development. In particular, the 1991 Gulf War and the stringent sanctions imposed on Iraq up to 2003 saw oil revenues stalled, a decline of non-oil and agriculture sectors, and reduced investment in services, leading in turn to deteriorating development outcomes. Post-2003 insecurity and the 2005-06 sectarian civil war, along with the conflict with ISIS from 2014, all led to the loss of infrastructure as well as making it very difficult for the government to focus on reconstruction and deterring investment.
- Iraq’s economy is heavily dependent on oil, accounting for 58% of GDP in 2015 (World Bank (WB), 2017: 13). However, this does not provide the basis for broad-based economic growth because one, it generates only 1% of total employment and cannot meet the needs of the country’s growing population; and two, oil wealth is not invested effectively (but used to expand an already bloated, inefficient public sector). Oil dependence fuels a rentier state and undermines diversification and private sector growth.
- Iraq is characterised by weak governance and high levels of corruption. Governance shortfalls have turned what should have been advantages – oil wealth, demographic and geographic diversity – into liabilities: oil dependence and ethnic and sectarian divisions. Corruption is endemic and seen in polls as the most important challenge facing the country (WB, 2017: 20). Weak governance stems in part from lack of human capacity, due to a prolonged brain drain from the country as well as the post-2003 policy of ‘De-Ba’athification’ (removing party members from public sector employment).
- The bloated, inefficient public sector dominates the economy, accounting for nearly half of total employment and spending amounting to 61.1% of GDP (Krishnan et al, 2014: 8). Rising oil revenues post-2003 only served to further expand the public sector, as the government saw public sector jobs as one of the few benefits it could deliver to people. The size of the public sector is not reflected in access to or quality of basic services, which are widely seen as extremely deficient.
- The private sector is the key to creating jobs and promoting sustainable growth. There is recognition in the literature that Iraq needs to diversify from oil, and that this has to be led by the private sector. In the long run, this is the only way to prevent further conflict. However, the private sector is constrained by a number of factors:
- The dominance of state-owned enterprises (SOEs): most non-oil private firms have been crowded out by SOEs, which have long served as sources of patronage for Iraqi regimes. Many SOEs are defunct, but still, officially employ and pay large numbers of staff. Obstacles to vital SOE reform include reluctance on the part of governments because of the significant social costs of closure or downsizing (with large lay-offs).
- Laws and regulations act as an impediment to private sector development. Iraq was ranked 168 out of 190 countries in the Doing Business 2018 report, faring particularly badly in access to credit and resolving insolvency (WB, 2018b: 168). Iraq has trade barriers, mainly regulatory and bureaucratic practices, which restrict the level of trade and investment. One consequence of Iraq’s challenging business environment is the country’s very large informal sector – which is a serious constraint on formal firms.
- There is a shortage of skilled labour in Iraq stemming from the country’s long-standing brain drain, poor development indicators, and failure by the education system to provide the skills and training needed in a modern, knowledge economy. The private sector also struggles to attract personnel because of the greater appeal of public sector jobs, with their higher benefits and pensions.
- Difficulties in accessing finance. The financial sector in Iraq is both relatively small compared to GDP and dominated by the state, making it uncompetitive and unable to meet the needs of a growing private economy. State banks account for about 90% of all assets and deposits (Tabaqchali, 2017: 5). The country’s underdeveloped collateral system means that banks over-collateralize loans – typically seeking 140% collateral for a loan to a small firm (WB, 2012: 1-2). The amount of credit provided to the private sector amounts to less than 7% of GDP (compared with 55% on average in other MENA countries) (WB, 2017: 76).
- Lack of infrastructure: Inadequate power supply and weak transport networks have been identified as major constraints to private sector growth. Iraq loses an estimated USD 6-8 billion per year from flaring of gases associated with oil production in-field (WB, 2017: 89) – a gas that could have been used for electricity production instead of expensive and polluting fuel imports. About 40% of the total electricity generated is lost in the distribution network, and cost recovery is extremely low (WB, 2017: 89-90).
- Specific challenges facing the Kurdistan Region of Iraq (KRI): The semi-autonomous KRI was less severely impacted by post-1991 sanctions and remained largely immune to sectarian conflict post-2003, allowing its government to promote private sector growth. However, it faces similar economic challenges to the rest of Iraq: oil dependence, a large and inefficient public sector, dependence on imports, and a weak financial sector. In recent years KRI has been hit by a series of shocks: loss of revenue due to disputes with the federal government, drop in oil prices, and nearby conflict with ISIS leading to the influx of large numbers of IDPs and Syrian refugees into the region. The KRI government has responded to the fiscal crisis by postponing investment projects, letting payments fall into arrears and increasing borrowing – policies which in the medium-term will lead to reduced private sector productivity.
- Areas for intervention to promote inclusive and sustained growth identified in this review are oil diversification, investments in human capital and infrastructure, reform of the public sector and specifically of SOEs, and easing of the regulatory regime for the private sector. The 2017 Report of the Task Force on the Future of Iraq focuses on diversification (including through tax reform) whilst also calling for investment in oil and gas production; promotion of public sector reform by improving the private sector pension system; easing of regulations on private firms and international investment; using technology to tackle corruption; and facilitating private sector access to finance through funding from international partners as well as promotion of Iraq’s capital markets. The World Bank’s 2017 Systematic Country Diagnostic prioritises macroeconomic stability and more effective investment of oil revenues through improved public investment management, as well as a reduction in the size and scope of the public sector and SOEs, and promotion of agriculture and tourism in Iraq.