Poverty, Conflict and Political–Economic Crisis in a Fragile Iraq

Zeinab F. Shuker | 21 Jan 2021

Iraq’s economic outlook has rapidly deteriorated since the onset of the COVID-19 pandemic. For many years, economic progress and state legitimacy in the country have been undermined by an undiversified economy, as well as Iraq’s dependence on oil revenues, bloated public sector, rigid budget, rampant corruption and weak state capacity. This economic and political deterioration has inspired conflict and instability, contributing in 2019 to the rise of one of the country’s biggest social and political uprisings. It has also left the country with limited capacity to mitigate and manage the COVID-19 crisis and its socio-economic impacts.

However, unlike previous crises, the current economic breakdown and its resultant political consequences are far from temporary. The 2021 year does not promise any significant improvement in this regard, with a budget deficit estimated at 63 trillion dinars (US $43 billion) – the biggest in Iraq’s history and the highest among the OPEC countries.[1] The measures implemented now by Iraq’s ruling elites will be instrumental in determining the future of the country and the overall stability of the region. Therefore, how will the country's worsening economic situation and rising poverty affect its already unstable political structure?

Precursors to the Current Iraqi Crisis

Over the past two decades, corruption and weak state capacities have left Iraq vulnerable to a multitude of economic, political and humanitarian crises. Weak state capacity has led to the formation of multiple ‘states within the state’ – political parties and interests that control the various different ministries and state institutions. Unchecked corruption, a vast system of patronage and an accompanying network of “ghost employees” have allowed these political parties to redirect oil revenues towards their own interests and constituencies, providing jobs and protection to their supporters.

The impacts of this situation have stripped the state of its ability to govern, destroyed any vestiges of a private sector and left young people – of which Iraq has the largest proportion in the region – with little to no alternatives other than to seek employment in an already bloated public sector, join one of the many militias, or emigrate. And even then, political groups monopolize the system of jobs-through-patronage, which are sold to the highest bidder, leaving many people unemployed and impoverished.

There are three main consequences to these dysfunctional circumstances. First, oil revenues – the main driver of the Iraqi economy since the 1950s – have continued to dominate the economy and undermine the private sector, a status quo there is little incentive for political parties to change.

Second, poverty and economic hardship have increased steadily; a 2018 report by The Iraqi Central Bureau of Statistics showed that unemployment had reached 13.8 percent and poverty 20 percent for individuals aged 15 years and over. More than a fifth of young people in the country were neither employed nor in school in the same year, and women represented only 12 percent of the labor force.[2]

Third, the fallout from the COVID-19 crisis and the decline in oil prices have aggravated the already vulnerable economic and political situation. A spokesman for the Ministry of Planning stated that a study prepared with the World Bank and UNICEF found that the number of people in poverty increased by 2.7 million in 2020, on top of the 6.9 million who were previously known to the Ministry. He added that the poverty rate in Iraq had reached 31 percent, with at least 2.8 million children living below the poverty line. In certain parts of the country, such as the Muthanna province, the poverty rate was as high as 52 percent, with some individual villages within the province reaching 70 percent. Furthermore, 3.4 million people – or 12 percent of the population of Iraq – live in slums.[3]

These numbers are not surprising. The Iraqi government requires around $5 billion each month for salaries and pensions and $2 billion to cover essential services and operating costs. Yet, with the decline in oil prices, Iraq’s monthly income in 2020 fell to between $2.5 and $3.5 billion, leaving the country with a $3.5–4.5 billion monthly deficit and $80 billion of debt.[4]

The Problematic Nature of the 2021 Budget

In an effort to address the ongoing crisis, a team from the International Monetary Fund (IMF), led by Tokhir Mirzoev, held a virtual liaison with the Iraqi authorities from November 11 to December 10, 2020 to conduct discussions on the situation. The conclusions drawn from these discussions was clear – real GDP growth had contracted by 11 percent in 2020, and without structural changes, Iraq’s net foreign assets would continue to drop into 2024, leaving the country with one of the highest debt-to-GDP ratios among the OPEC+ countries.[5] According to Finance Minister, Ali Allawi, Iraq will run out of hard currency 6–7 months into 2021 if oil prices remain below $70 per barrel (although in the 2021 budget, oil prices are estimated at $42 per barrel).[6] Most projections suggest the continuation of low energy demand and further price volatility in 2021.[7] The IMF recommendations included reversing the expansion of wage and pension bills, raising non-oil revenues, rationalizing the electricity sector, introducing and enforcing tax and customs policies, and reforming state-owned banks.[8] This is not particularly surprising, argues Naomi Klein, who explains that "shock treatment" approaches such as these capitalize on disruptions such as the COVID-19 crisis and the oil price collapse to pass economic and social policies that the population would ordinarily reject. The next steps of the Iraqi government will likely reflect the suggestions of the IMF.

As part of broader plans to trim the bloated public sector and introduce structural changes to the country’s rentier economy, the Iraqi government announced on December 19, 2020 that it was devaluing the dinar – by 23 percent – for the first time since 2003 to secure billions of dollars in foreign aid. As a result, the Finance Ministry will sell its dollars to the Central Bank at an exchange rate of 1,450 dinars per dollar, which will in turn be resold to local banks at 1,460, providing a marginal benefit.[9] The Iraqi government is therefore signaling to the IMF and the world that Iraq is serious about its economic future. However, without accompanying economic reforms – which many political elites refuse to consider – devaluation will only undermine savings, increase prices and raise poverty; and since Iraq imports the majority of its food and goods, devaluation will make these goods scarce, triggering further inflation.

Another step suggested by the IMF, and discussed by the Parliamentary Finance Committee, is the introduction of a value-added tax (VAT) of 12 percent in 2021. Currently, the government collects four types of tax – sales, income, transfer of ownership and company – at rates ranging from 10 percent to 35 percent. However, these taxes, which constitute two percent of GDP, are mostly collected from major concerns such as telecommunications companies and foreign oil firms. Shaker Al-Zubaidi, Director General of the General Authority for Taxes, revealed that the Iraqi government is planning to implement a stipulation in the 2021 budget law that includes imposing a sales tax of 10 percent on commercial centers, markets, hotels, restaurants, cars and leased real estate, as well as creating a law to tax all working Iraqis. Of course, there are many challenges to such a plan. Most purchases and financial exchanges among average Iraqi citizens are in cash; thus, implementing tax law without modernizing the banking system will prove challenging. Furthermore, there are fears that imposing taxes on companies and businesses in the country will only increase the prices of goods and services – which is what happened when the government levied a 20 percent tax on telecommunications companies, leading to a corresponding 20 percent price increase in the services provided.[10] Price increases in goods and services will most severely impact average Iraqi citizens who are already struggling to survive, especially given the absence of a social safety net to protect the poorest and most disadvantaged citizens in society.

Even though the Iraqi government is implementing the steps recommended by the IMF and showing its willingness to introduce meaningful structural changes, the reality in Iraq is unlikely to change. A brief review of the 2021 budget provides some insight in this regard. The expenditures allocated to the Iraqi Popular Mobilization Forces (PMF) – comprising fighters, many of whom belong to militias supported by Iran – amounted to 2.4 trillion dinars. The PMF budget is the equivalent of the combined total budgets of the Ministries of Justice, Foreign Affairs, Culture, Water Resources, Planning and Transportation. It also exceeds the budget of the Ministry of Education and is only slightly less than the budget of the Ministry of Health, despite the ongoing COVID-19 crisis. In spite of the IMF's encouragement for Iraq to develop its non-oil economy, the Ministry of Industry only received 33.22 billion dinars, whilst the Ministry of Agriculture received 43.46 billion dinars and the budget of the Ministry of Water Resources was 143.31 billion dinars.[11]

The superficial changes made by the Iraqi state are unlikely to save the collapsing economic system nor stem the increasing levels of poverty and unemployment in the country. If spending levels continue in their current form without substantial adjustments, within a few years the Iraqi government will be unable to cover its expenditures and will face the risk of bankruptcy. Even if oil prices recover dramatically, reaching $100 per barrel – which is highly unlikely according to most market experts – this increase will not be sufficient to cover rising budget expenditures in the medium term.[12] Thus, even in the best-case scenario, these steps will merely postpone a collapse, rather than sustain a healthy economic system.

The Conflict Trap: The Relationship Between Poverty and Conflict

While research clearly shows that political instability and ethnic diversity can act as precursors to conflict, high poverty levels have also been shown to directly increase the risk of conflict. Collier and Hoeffler (2004) find that countries with a GDP per capita of $250 face a 15 percent risk of war within five years, while countries with a GDP per capita of $600 are at a 7.5% risk of war within five years, and those with a GDP per capita of $5,000 GDP face only a 1% risk of war over the same period.[13] Research by Fearon and Laitin (2003),[14] Sambanis (2003),[15] and Collier, Hoeffler and Rohner (2006),[16] as well as other case studies and cross-national research works, have shown that low income per capita is a good indicator of the likelihood and duration of conflicts. Furthermore, Collier and Hoeffler find that in addition to GDP per capita, a drop in income or change in GDP per capita are also indicators of conflict. They claim that a one percent increase in GDP per capita will increase the risk of conflict by a corresponding one percent.[17] This relationship produces a “conflict trap” wherein conflict tends to undermine the livelihoods of the population and shift public resources away from priorities like education and healthcare, which breeds poverty that leads to further conflict. Hence, there is little doubt that poverty is a good indicator of social, economic and political instability. Therefore, facing increasing levels of poverty and unemployment, and prolonged economic and political crises, the disenfranchised Iraqi population, as well as the competing political factions, are increasingly likely to engage in some form of conflict. 

The bitter truth is that the fragile Iraqi political structure will not survive the increasingly likely collapse of the country’s economy. This, in turn, may well trigger another round of conflict between competing factions. The collapse of Al-Kadhimi’s government will lead to a political vacuum that tribes, political parties and militias backed by Iran will seek to fill, and will inspire neighboring countries to intervene to protect their interests in Iraq. Economic and political collapse will also trigger widespread public anger and demonstrations – as witnessed in December 2020 in the relatively stable Kurdistan region after the payment of salaries was delayed.

Iraq must commit to meaningful, long-term economic reforms that include the revitalization of the private sector, a shift away from the rentier policies and a reduction in the state’s role in managing the economy. A “white paper” on potential reforms, produced by a specialized government team in 10 October 2020, includes plausible solutions and a road map to this end. However, in the absence of any concerted efforts to include young Iraqis in the political process, and with no central economic philosophy, institutional capacity, or political will to take such difficult steps, disaster will never be far away.

References

[1] Reuters (2020), “Iraq's cabinet approves 2021 draft budget of $103 billion,” https://www.reuters.com/article/iraq-budget-int/iraqs-cabinet-approves-2021-draft-budget-of-103-billion-idUSKBN28V2G8

[2] Iraqi Ministry of Planning (2018), “The Central Bureau of Statistics and the Executive Management implemented the poverty alleviation strategy in the Ministry of Planning,” https://mop.gov.iq/news/view/details?id=76

[3] Nas News (2020), "Detailed figures on the poor in Iraq before and during the 'Corona' pandemic," https://www.nasnews.com/view.php?cat=48918

[4] Alaaldin, Farhad and Kenneth M. Pollack (2020), “ Iraq’s Economic Collapse Could Be Biden’s First Foreign-Policy Headache,” Foreign Policy, https://foreignpolicy.com/2020/12/14/iraqs-economic-collapse-could-be-bidens-first-foreign-policy-headache/

[5] IMF (2020), “IMF Staff Completes 2020 Article IV Mission with Iraq,” https://www.imf.org/en/News/Articles/2020/12/13/pr20372-imf-staff-completes-2020-article-iv-mission-with-iraq

[6] Bloomberg (2020), “Iraq Devalues Dinar to Push Economy Forward Ahead of Deficit,” https://www.bloomberg.com/news/articles/2020-12-19/iraq-devalues-dinar-to-push-economy-forward-ahead-of-deficit

[7] Bradstock, Felicity (2020), “The Real Crisis For Oil Is Yet To Come,” OilPrice.com, https://oilprice.com/Energy/Crude-Oil/The-Real-Crisis-For-Oil-Is-Yet-To-Come.html

[8] IMF (2020), “IMF Staff Completes 2020 Article IV Mission with Iraq,” https://www.imf.org/en/News/Articles/2020/12/13/pr20372-imf-staff-completes-2020-article-iv-mission-with-iraq

[9] AP (2020), “Iraqis panic as leaked budget draft signals devaluation,” https://apnews.com/article/financial-markets-baghdad-iraq-state-budgets-c691936afd77edd12ad776b993e79d9e

[10] Al-Monitor (2020), “Iraqi government considers sales tax to relieve budget crisis,” https://www.al-monitor.com/pulse/originals/2020/12/iraq-economy-tax-finance-parliament.html#ixzz6hI32xtg9

[11] Al-Hurra (2020), "The Iraqi budget ... a huge deficit and ‘illogical’ numbers for mobilization and armaments,” https://arbne.ws/3ixMXDL

[12] Abbas, Aqeel (2020), “The rentier state in Iraq is in its final stage,” SkyNews Arabia, https://bit.ly/3o3DiGc

[13] Collier, Paul, and Anke Hoeffler (2004), “Greed and Grievance in Civil War,” Oxford Economic Papers, 56, pp. 563–595.

[14] Fearon, James D., and David D. Laitin (2003), “Ethnicity, Insurgency and Civil War,” American Political Science Review, 97:1, pp. 75–90.

[15] Sambanis, Nicholas (2003), “Using Case Studies to Expand the Theory of Civil War”, CPR Working Papers.

[16] Collier, Paul, Anke Hoeffler and Dominic Rohner (2006), “Beyond Greed and Grievance: Feasibility and Civil War,” Center for the Study of African Economies, Working Paper.

[17] Collier, Paul and Anke Hoeffler, “Greed and Grievance in Civil War,” Oxford Economic Papers, 56, 2004, pp. 563–595.

 

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