4.EC 7:1R 1/3/CORR. S. Hrg. 108-220 TRANSFORMING IRAQ'S ECONOMY HEARING before the JOINT ECONOMIC COMMITTEE CONGRESS OF THE UNITED STATES ONE HUNDRED EIGHTH CONGRESS FIRST SESSION June 11, 2003 Printed for the use of the Joint Economic Committee Pennsylvania State University Libraries APR - 2.2004 Documents Collection U.S. Depository Copy U.S. GOVERNMENT PRINTING OFFICE WASHINGTON: 2003 * 90-904 PDF For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001 JOINT ECONOMIC COMMITTEE [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress] SENATE ROBERT F. BENNETT, Utah, Chairman SAM BROWNBACK, Kansas JEFF SESSIONS, Alabama JOHN SUNUNU, New Hampshire LAMAR ALEXANDER, Tennessee SUSAN COLLINS, Maine JACK REED, Rhode Island EDWARD M. KENNEDY, Massachusetts PAUL S. SARBANES, Maryland JEFF BINGAMAN, New Mexico EE HOUSE OF REPRESENTATIVES JIM SAXTON, New Jersey, Vice Chairman PAUL RYAN, Wisconsin JENNIFER DUNN, Washington PHIL ENGLISH, Pennsylvania ADAM H. PUTNAM, Florida RON PAUL, Texas PETE STARK, California CAROLYN B. MALONEY, New York MELVIN L. WATT, North Carolina BARON P. HILL, Indiana DONALD B. MARRON, Executive Director and Chief Economist WENDELL PRIMUS, Minority Staff Director CONTENTS OPENING STATEMENT OF MEMBERS Senator Robert F. Bennett, Chairman Representative Pete Stark, Ranking Member ........... Representative Carolyn B. Maloney ........... Representative Jim Saxton, Vice Chairman auw an ........ ................... WITNESSES Statement of Mr. Basil Al-Rahim, Founder and Board Member of the Iraq Foundation, Managing Director of MerchantBridge ............... 9 Statement of Mr. Hernando de Soto, President, Institute for Liberty and Democracy .. 13 Statement of David P. Ellerman, Ph.D., Author and Former Economist at the World Bank ....... ........ 16 Statement of Rachel Bronson, Ph.D., Olin Senior Fellow and Director, Middle East Programs, Council on Foreign Relations ............... 19 SUBMISSIONS FOR THE RECORD .. 45 Prepared Statement of Senator Robert F. Bennett, Chairman .............. 43 Prepared Statement of Representative Pete Stark, Ranking Minority Member New Yorker article entitled Building Nation, Hendrik Hertzberg, submitted by Representative Pete Stark, Ranking Minority Member ............... 46 Prepared Statement of Representative Carolyn B. Maloney .............. 49 Prepared Statement, including H.R. 2338, of Representative Jim Saxton, Vice Chairman ........ ..................... 51 Prepared Statement of Mr. Basil Al-Rahim, Founder and Board Member of the Iraq Foundation, Managing Director of MerchantBridge ............... ......................... 54 Prepared Statement of Hernando de Soto, President, Institute for Liberty and Democracy ... ...... 67 Prepared Statement of David P. Ellerman, Ph.D., Author and Former Economist at the World Bank Prepared Statement of Rachel Bronson, Ph.D., Olin Senior Fellow and Director, Middle East Programs, Council on Foreign Relations ... 78 ......... 73 (iii) Transforming Iraq's Economy Wednesday, June 11, 2003 CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, WASHINGTON, D.C. The Committee met, pursuant to notice, at 9:30 p.m., in Room 628, Dirksen Senate Office Building, the Honorable Robert F. Bennett, Chairman of the Committee, presiding. Present: Senators Bennett, Sununu; Representatives Stark, Saxton, Maloney, English, Paul, Hill. Staff Present: Donald Marron, Ike Brannon, Jeff Wrase, Chris Frenze, Robert Keleher, Brian Higginbotham, Kurt Schuler, Colleen Healy, Melissa Barnson, Gary Blank, Wendell Primus, Chad Stone, Rachel Klastorin, Nan Gibson. OPENING STATEMENT OF SENATOR ROBERT F. BENNETT, CHAIRMAN Senator Bennett. The Committee will come to order. I have a prepared opening statement which has been distributed, and I don't back away from it. But I am going to deviate from it a little in the actual remarks that I make to kick off the hearing, because I think the best demonstration of the atmosphere in which this hearing is being held comes from this morning's papers. Here is The Washington Post and its cover picture. And it says: “In Holy City, Things Are Going Right. U.S. Forces and Iraqis Work Together In Shiite Stronghold of Karbala.” The New York Times, however, says: “G.I.s In Iraqi City Are Stalked By Faceless Enemies At Night.” And the lead says: “Since the American command quadrupled in military presence here last week, not a day has gone by without troops weathering an ambush, a rocket-propelled grenade attack, an assault with automatic weapons, or a mine blast.”. Reminiscent of the war, when we won it on Fox, but lost it on CNN. (Laughter.) There is a constant sense of instant conclusion that goes on in the media. We must know, pre-season, who is going to win the World Series. We must know, pre-season, which two teams are going to go to the Super Bowl and which one is going to win. We have national rankings of college basketball teams before the first dribble is ever bounced on a hardwood floor. And we carry that same sense of determination to announce outcomes immediately over into politics. So everything is going well in one newspaper, everything is a disaster in another newspaper. We're going to triumph. There is no hope. Pick your paper. Pick your conclusion. The purpose of this hearing today is to get above that kind of babble of voices one way or the other and recognize that we will not know whether we have succeeded in establishing a democratic, stable regime in Iraq for a year, two, or even longer. The implications of that quest, the desire to replace a brutal tyranny and harsh dictatorship with a functioning, stable government ready to join the world and participate as a true partner in the world economic structure, has enormous implications for the United States. It has enormous implications for our economy. But it has even bigger implications for the world at large. The establishment of a peaceful, stable, and economically-viable Iraq will transform the Middle East if it is successful. If it is not, we will pay a price that is almost incalculable at this point. So I want to say to everyone who is listening -- I don't think I need to say it to our witnesses who are testifying -- that if you have come here to try to get the latest answer for are we making progress in getting the water turned on? Will the electricity be available by next Friday? Where are we in finding the latest artistic treasure? This is not the hearing for you. This is a hearing to be discussing very long-term prospects and very long-term strategies, to help the Congress and we hope through the Congress, the American people. And yes, if I may be so bold, to help the Administration to understand some of the strategies that might work, some of the strategies that should be avoided, and overall, the opportunity and challenge that we are presented with. There's never been a time in history where more is riding on a successful post-war engagement. Now I say that looking back, that's probably not true if you look at the accomplishments that followed the Second World War. But the Second World War kicked off an entirely different international situation. As we followed the Second World War, we went into the Cold War, where there was a polarization of forces, with the United States and the other countries of the West on one side, the Soviet Union and its satellites on the other. And the successes that were achieved in Japan Representative Stark. -- that describes Iraq. Why it's a supply- sider's dream. There are no taxes. There are no environmental regulations to get in the way of you free-enterprises. Why, religion is the government. There's no separation of church and state. I have never seen a place where a free-market economy is running amuck. Charlton Heston would love to go there. Everybody's got a gun. He could organize the NRA and be there. Why, the Club for Growth ought to build their national headquarters there. (Laughter.) I just think, Mr. Chairman, that this is the nirvana for the supply- siders and the right-wing Republicans. Now I'm afraid that's not what we're going to hear from our witnesses today. The facts are that Iraq's economy and their civilian society is a mess, and I suspect we have a long and expensive reconstruction ahead of us. I don't think we should be surprised if the Administration put as much time into preparing for the inevitable problems with the reconstruction process, instead of preparing their public relations campaign to get us to invade and preparing the prime-time movie about Private Jessica Lynch. Why, maybe we'd have had some ideas. But that's not what happened and we have to pick up the pieces. So we'll hear some creative ideas from our panel. But I hope they won't lull us into thinking that this is going to be easy. I think it's going to be expensive and long-term, and I hope you'll be very honest with us so that we can be honest with the American public for a change, and tell them what the consequences are, because I'm afraid if we don't change our domestic policy soon, that our next hearing will be on restructuring the American economy. Thank you, Mr. Chairman, and I look forward to the testimony of our witnesses. [The prepared statement of Representative Stark appears in the Submissions for the Record on page 45. New Yorker article entitled Building Nations, Hendrik Hertzberg submitted by Representative Stark appears in Submissions for the Record on page 46.] Representative Maloney. Thank you, Mr. Chairman, so very, very much. Senator Bennett. I was going to Mr. Saxton. Representative Saxton. She can go if she wants. That's okay. Senator Bennett. All right. Mr. Saxton yields to you. So go ahead. OPENING STATEMENT OF REPRESENTATIVE CAROLYN B. MALONEY Representative Maloney. Thank you so much, Mr. Chairman, and Mr. Saxton. At this point, I'm supposed to be at Financial Services Committee hearing in which I'm Ranking Member, but I feel that this is a tremendously important hearing and I ask permission to revise and extend my remarks and just briefly say that in this hearing, we will hear several approaches for setting the groundwork for reconstruction. One issue that I believe should be a significant part of the discussion is debt relief. As we have seen in post-war Germany, debt relief can be an essential tool in rebuilding a nation destroyed by war and humiliated by its leadership. We have also seen in recent years that debt relief is an effective development tool that releases funds within a nation that can be used to address poverty and meet essential human needs. The case for some debt cancellation is even more compelling in Iraq, given that much of the debt can be characterized as odious. Odious debt is internationally recognized as debt that is taken on by a country for the personal benefit of corrupt leaders or for the oppression of a people. Clearly, much of the Iraqi debt falls in this category. To address the issue, this week I will introduce legislation in the House calling for debt relief from Iraq's international debts, including funds it owes the World Bank and IMF. Who should pay debt that Sadaam owes? How can we ask the people of Iraq who lived in fear of Hussein's secret police to pay back the loans that supported these armed assassins? You don't have to travel far outside of Baghdad to see a sprawling slum called Sadaam City that houses 2 million Shiite Muslims. The slum is overrun with garbage and children climb the mountain of refuse to look for scraps of food or things that could be traded for food or clothes. In the face of this poverty, the Iraqi regime spent billions of loaned dollars on palaces and other luxuries. What better way to enhance our efforts at reconstruction and empower the people of Iraq than debt relief? If Iraq is ever truly to be a peaceful and prosperous democracy, its citizens must be allowed to start anew. 50 years ago, 20 nations led by the U.S., England and France agreed to forgive half of Germany's pre- and post-war debt. The so-called London Agreement proved to be the So I look forward to working with you. Representative Maloney. I wish I could stay, but I must go. Representative Saxton. That's okay. Mr. Chairman, during your opening statement, you referenced the development of a long-range strategy to promote Iraq's economy, which has been sinking for years under the rule of Sadaam Hussein. I'd like to talk about at least one important piece of what could become that long-term strategy. The economy in Iraq has for years been doing very poorly. Extensive ownership control and influence of business by the government, its officials, and political cronies undermined economic growth. Iraq's invasion of Kuwait resulted in economic sanctions and the Oil-For-Food Program. And although the recent war has resulted in some economic damage, Iraq's economic situation today is quite similar in my opinion to the Eastern European countries after the collapse of the Soviet Union. New institutions are needed that are compatible with a market economy and improved prospects for economic growth. The prospects for Iraq's economic recovery are clouded by an unsustainable debt burden that Ms. Maloney was just referring to. One of the major challenges to improve the potential of the Iraqi economy is the heavy burden of foreign debt accumulated under the regime of Sadaam Hussein. The hated regime is gone, but the financial legacy should not continue to oppress the Iraqi people, undermining their economic potential. Forgiving much of Iraq's foreign debt is the right thing to do. But foreign creditors may be hesitant if they anticipate an opportunity for a bail-out indirectly through the IMF or the World Bank. A write-down of at least part of Iraq's debt would greatly improve Iraq's economic outlook. Under legislation that I have recently introduced, Iraq's creditors would be encouraged to forgive much of Iraq's outstanding foreign debt rather than to wait for a potential bail-out from the IMF or the World Bank. This legislation, of which this is a copy, would mandate that safeguards be in place to ensure that lending by these institutions could not be used to repay Iraq's creditors, thus encouraging a more timely write-down of some of Iraq's debt and protecting taxpayer money. As I have pointed out many times before, the IMF should not be used as a bail-out agency, as this practice creates a potential for mis-use of IMF funds. 11 recognized because somebody did actually suffer at the end of this adventurism by Sadaam Hussein. The plan proposes trading some of this debt for a point system that can be then used for concessions, licenses, contracts. The point system itself would start having a market value and be traded between people who want to buy those points for use in Iraq on their own. Therefore, you don't eliminate the value of those points, but you shift them to the free market. Attracting foreign direct investment, an aspect of the plan, is critical. And there are very many issues on this. One of the important issues is to avoid economic pillage of the country by foreign investment, which will definitely happen if we are not careful. Restitution of private property has to be a part of that plan. And that has resulted from the 1963 nationalization and just continued through various waves of government. Currency stabilization is critical. A new Iraqi dinar pegged to the dollar and the Euro has to be introduced. The banking sector is very rudimentary. The banking sector is made up of two banks, two government-owned large banks and 18 small private banks. This must be modernized, upgraded. Joint venture banks have to be attracted to help rebuild the banking sector, which is a critical part of any economy. Finally, the component of the plan that we can look at is the capital markets themselves. There is something called the Baghdad Stock Exchange. It's been around for many decades. That has to be expanded, deepened and broadened. And that can be done by linking privatization with ESOPs, with IPOs, and with other forms of participation in the public market. There are three other critical issues and I apologize if I am running over on the time. First and foremost, critical to this plan is the employment and empowerment of the private sector. The private sector has been reduced to poverty subsistence over the past 20 years. The transition to a free market economy and full membership in WTO, which should be the objective of Iraq, cannot happen overnight because we need to protect the population to make sure not to disenfranchise them from the wealth of the nation. Vocational training centers have to be set up so that 400,000 soldiers decommissioned from the army can be brought back in a productive manner into the labor force. A healthy economy in Iraq is a prerequisite for a stable democracy and both are mutually reinforcing. The domino effect can happen and we have to be careful which way it tips. Empowering the private sector is the only solution. Albeit, important, oil is only one part of the equation. The price of losing the peace is not limited to Iraq or even the region, and time is of the essence. Thank you very much. Senator Bennett. Thank you, sir. We appreciate that. Mr. de Soto? [The prepared statement of Mr. Al-Rahim appears in the Submissions for the Record on page 54.] OPENING STATEMENT OF MR. HERNANDO DE SOTO, PRESIDENT, INSTITUTE FOR LIBERTY AND DEMOCRACY Mr. de Soto. Thank you very much, Mr. Chairman, first of all, I would like to tell you how much I appreciate your comments on the fact that so much is at stake in Iraq. All the eyes of the world are on Iraq. And, in effect, if there is not a successful transformation there, that will definitely bolster the arguments of all those people who are already marching on the streets against globalization, against the values of a free market society, and the possibility of creating capital. And if you aren't able to do it in Iraq, the question then will be -- are all countries made for that kind of freedom? If they're not, obviously it can't even work, even if the foremost power of the world is involved. So a lot is at stake. And I think a very important comment was also made by Mr. Saxton, which is that the important thing here is not to repeat mistakes. And that's why it's very useful to look at history and see where mistakes have been made. One of the interesting things about listening to Mr. Al-Rahim, both in a conversation previous to this meeting and here, is that what he says about Iraq is well known and is absolutely true. There is a large technical and professional class in Iraq, and there is an elite, like of course there was in Cuba and there was in my country and there was in Venezuela and there was in Egypt. Now why did we get off the track 40 years ago, and I think that's important to remember? We got off the track because the people who could actually participate in a capitalist society, were, nevertheless, an elite, a minority. And when there are minorities, when it's only 20 percent of the population, 30 percent or 15 or 5 percent of the population that is in an 20 I want to make four points. The transition in Iraq towards a successful economy and successful political situation will take time, it will be dangerous and will require our resolve, it will be expensive, but ultimately, it will be worth it. I want to make sure that we don't leave this hearing thinking that the security situation that, Mr. Chairman, you highlighted by holding up the newspapers, is somehow distinct from the economic transformation of Iraq. They are indeed linked. It is something that we have learned, case after case, particularly in the Balkans. We need to focus on the security situation if we want all of our goals for the economic transformation of Iraq to succeed. We must also remember that this is going to be very time consuming. Secretary of Defense Rumsfeld has pointed out that it took eight years for the United States to move from its period of revolution to a constitution. In Germany, that experience took four years. And in Germany alone, it required $8 billion, in current dollars, between 1948 and 1952. Germany required a significant American and international security presence to help the Germans rebuild law and order in their society. And it took a lot of attention to the international context to help facilitate that outcome. So we know from the experience in the United States, we know from the experience in Germany, we know from the experience of the '90s, this takes a long time. It requires international assistance. It requires serious attention to law and order. I want to focus on law and order because it matters to this Committee, both because it will be very costly to the United States and the lack of attention has already set back Iraq's reconstruction. Much of the looting and the chaos that we've seen in the streets has largely undone all of the good work military planners who carefully considered what to target and what not to target. Areas that were originally kept off the target list, have largely been destroyed anyway by the looters and this will make everything more costly. The lack of law and order also makes it harder for the Iraqis to go back to work. They are afraid to leave their homes because of what might happen to their families and their property. We have to create a situation where they are more comfortable to go back to work. : Focusing on issues of law and order, goes to the heart of the difference between The New York Times and The Washington Post stories that the Chairman referred to. 21 The Washington Post stories are focusing on the slow building back of the basic law and order on the streets, very positive and the Administration can very much take credit for. But the vacuum that was created in the weeks following the war has allowed Sadaam's security forces, loyalists, those in the Baath Party, to begin reconstituting. They are organized. They do not believe this war is over. And the Iraqi people will find it very difficult to work against them if they are not convinced that Sadaam and his sons are dead or that the security forces do not provide an organized opposition to the United States. The average Iraqi is waiting to see who is going to win this, and right now for them, the jury is still out. Law and order will be a very expensive proposition. Before the war, the Council on Foreign Relations, our task force, estimated that, at minimum, 75,000 troops would be needed to secure the peace and cost at least $15 billion a year. We now know that figure is low. The Administration is on record as saying that 150,000 troops in Iraq are costing about $3 billion a month. The longer chaos is allowed to reign, the more costly this will be and the more difficult this will be. That is why I want to be sure that we focus on the connection between law and order and economic reconstruction. But even when we get to reconstruction, even if there had been a seamless transition from our authority back to the Iraqis, this still would have been expensive. Iraq's reconstruction will not be self-financing. The oil industry is in dire straits. Before the war, because of sanctions and poor political leadership in Iraq over the last decade plus, Iraq was losing about 100,000 barrels per day annually. We need to staunch the bleeding of Iraq's oil industry before we can even hope to get back to the levels that they were before 1990, 1991, or the heady predictions that were made before the war. We must remember that before the war, Iraq was bringing in about $10 to $12 billion a year in oil. 70 percent of that was going to the humanitarian needs of the Iraqi people--food and medicine. $3 billion is required to go back into the oil industry just to keep it operating. We estimated that the reconstruction of the oil facilities to get it back to the 3.2 million barrels per day that it was producing before the war could cost up to $5 billion. 22 To get its energy sector back up to where it was could cost as much as $20 billion. Iraq was a sophisticated society with a sophisticated infrastructure. It is not like repairing Afghanistan. There are a number of other things that will be required and some of my fellow panelists, the witnesses here today, have made reference to them, and I will quickly go through them and then leave you. First, there is a requirement to diversify Iraq's economy. Over 95 percent of its resources come from oil. This was not the case just a few decades ago. But relying on this sole commodity is bad for the Iraqi people and bad for the economy. It also makes it very difficult to get to any sort of democratic future. When the leadership owns the major resource, it doesn't depend on the people to participate. And so, we need to think about the transformation of its oil sector and its larger economy if we're trying to reach any different political outcome. Restructuring Iraq's debt is going to be a massive undertaking and we need to show our own commitment to the process before those around the world are likely to forgive the debt. And also, we have to support a stable, transparent political order. If we want investment to flow into Iraq or if we want to keep the Iraqi money at home, there has to be something to invest in. This kind of political order will take time. If we move too quickly, the Balkans show us you get black markets, drug lords, and money-laundering. The Administration was right to step away from the interim authority and trying to create one too early. But by bringing up the topic of an interim authority so soon after the fall of the Sadaam regime created unnecessary expectations. The way forward is going to be very difficult in Iraq, but it is well worth doing. Iraq can be a model for the region. I receive calls from those around the region on a regular basis, from our dwindling number of supporters begging us to get this right. Our supporters out there need a win that they can point to. And right now, their hopes are on Iraq. And I think we should make sure that their hopes are realized. Thank you very much. [The prepared statement of Dr. Rachel Bronson appears in the Submissions for the Record on page 78.] Senator Bennett. Thank you. Thanks to all of you. I think you've given us the provocative insight that we had hoped for. 24 And that's why what I insisted upon before was how important it is to get an inventory of what has actually happened on the ground in Iraq over the last 30 years to find out where there are claims, where there are conflicting claims, to make sure whatever property system is redesigned and put into place, actually serves the majority of people's interests. Otherwise, you won't get the constituency to have a stable economy. Very different than in the situation, for example, of Germany, because the property rights system or the legal system that defined property rights had already been defined in the 19th century. So the occupation really didn't involve getting into the thick of that because there was a consensus on property. In most developing countries, that consensus does not exist. What you will probably find are widespread markets and anarchy regarding the law and therefore, the need to re-adapt whatever law exists to reality. Representative Hill. Well, I'll go back to something that Dr. Bronson had said, that the people are waiting to see who is going to emerge in leadership positions. It seems to me that none of that can happen until there is some certainty in Iraq. Is that true or not true? And how long will that take? What has to be done? What should we be doing? Mr. de Soto. Well, the first thing that you did in Japan, which was very interesting, or rather, that the Japanese did under Gen. MacArthur's sponsorship, is have an inventory done of what the situation was all about. It took about two years to put the inventory together. In other words, underneath the feudal class of Japan there were people who held property, but they were not within the law, or their stakes were not recognized by the law. It took two years to actually find out who owned what. It's the whole experience you had in all of the west of the United States. There were people that went around and tried to calculate how many trees were felled in Wyoming to create a cabin and then find out those that would be calculated improvements and create a property law that was adequate to it. Your own Congress passed 32 pre-emption acts, the purpose of which was to violate an existing common law that no longer responded to the situation on the ground. The first thing you did was an inventory, state by state, and then you put the law together. 27 The more committed and more present you are up front, the faster we can pull our men and women home. And the reason for that is Iraqis are looking to go back to work. They're looking to go on the streets. They need an authority there and a heavy American presence. As long as chaos reigns, everything takes longer. Everything is more expensive. The Administration's recognition that more military police, and more soldiers, were needed is actually a good sign. It bodes well that we may actually be able to pull out earlier because if you allow the sort of chaos because we don't have enough people and commitment there, it makes everything much harder. Will Iraq break down into three distinct territories? If we don't stay committed, there is the possibility of it. But I think if you look back to original meetings that the opposition was having in the early 1990s, there was a preference, for instance, in the Kurdish community, their first preference was to have their own independent state. They also recognized that that was unlikely to happen. The second best alternative is participation in a full and free Iraq. We need to keep them focused on that, that their first preference is unattainable, but their second preference is truly attainable. And that gets back to some of these economic and political issues we're talking about. We need to think through how the oil from the north and the south goes back to the central government and then resources go back to the provinces. As long as you can get that kind of system going where the money goes in and goes back out, you will keep Iraq whole. But if there is no organization committed to that reality, people will start fighting over keeping that oil in the north and the south and that will be a problem for Iraq. Representative Paul. You assume that it is crucial that it be kept whole. Is that correct? Dr. Bronson. That's right, I do. If it is not kept whole, all of the fears of the critics of this war will come to pass. And that is because if it starts fracturing, you will certainly see Turkey moving in because they will be worried about an independent Kurdistan on its border. You will see the Iranians much more active than we are seeing now if there is going to be some sort of independent Shia state in the south. 28 It is crucial to the neighborhood and the United States that Iraq remains whole, but that's good news. There is a shared interest. And it's a second preference of the Iraqis themselves which gives us a good basis for moving forward. We have to have a centralized authority with some independent autonomy in the provinces that allows them to benefit from that kind of vision. Representative Paul. Thank you. Other comments? Mr. de Soto. Yes. The only comment or reference to the issue of property claims, what has happened in many developing countries, practically in all developing countries, and many former Soviet Union countries, over the last 34 years, is that, in some cases, because of natural migrations, in other cases, because dictatorships, also need some kind of legitimacy and they go around redistributing land and redistributing property. And they've done that and probably, Sadaam Hussein has had to do the whole thing to create legitimacy for his own regime. It is very surprising what you see once the dictator is out. The first thing that you will have seen is that one person may have owned just one estate. Today, there are 15,000 people living on that estate. And so, what do you do? Do you just restitute to where you were before? Do you give California back to 15 Mexican families or do you keep the 3 million people with big guns on them? What do you do? So what I'm saying that I think is important, and it gives you an idea of the time, is you have to make an inventory of what has happened. I don't think that even Sadaam Hussein actually knows what was happening underneath his nose. It's a whole social process that's been going into place. Take Egypt: The logical thing of course would seem restitution. There were rent controls. Property was redistributed at the time of the revolution. The Egyptians want to welcome investment again. But they find out that it's impossible because the families that will be benefitted are a small minority and those that would be dislodged are the large majority that you need for the rule of law to come into place. The plan for how you go about this cannot be designed until you have an inventory of who is where, who owns what, and what are the different claims within the land: Then you can start creating the kind of law that peacefully settles those conflicts and allows you to bring in stability. 29 And that's what you in the U.S. Congress did in your own country 32 times before you created the Homestead Act. There's always people who believe that the Homestead Act started the process whereby a large majority of Americans who had squatted now had a right to property. It was actually the last of your acts. You had 32 going before, including when President Washington had a third of his farms invaded by what he called the Banditti. But, first of all, you had to take stock of what had gone on. And in many cases in Iraq, I don't think that anybody really knows what's going on. And the process is going to take time. Senator Bennett. Mr. English? Representative English. Thank you very much, Mr. Chairman. Starting with Mr. De Soto, given the natural potential of Iraq's mineral wealth, what options would you suggest to maximize the potential of the petroleum industry since we've brought it up, in order to spur investment and growth in the overall economy in Iraq? And at the same time, how do you utilize that asset without leading to an imbalanced economy, such as you have in Venezuela, where petroleum had become pretty much the only driver in the economy. Recognizing Mr. Al-Rahim's point that there has been an industrial base in Iraq, how do you use petroleum and at the same time, encourage a movement towards a strong mixed economy? Mr. de Soto. Thank you for your question, but I'm afraid I know very little about the use of petroleum. I know about successful experiments, your own in the United States in Alaska bringing a wide amount of people to participate in the wealth. I know what, for example, the Bolivians have done in terms of their gas industry and how they've made all citizens stake holders. But I know very little about the headlines, sir. Representative English. Mr. Al-Rahim, would you like to take a whack at that? Mr. Al-Rahim. Mr. English, thank you. Obviously, the oil sector is very important. But I see it as important only as a catalyst for the economy. Just to put it in context, Iraq has 113 billion of proven reserves. The last count or assessment of those reserves is 20 years old. Assume that if a new assessment is made, the reserves may be as high as three times that. Putting reserves in the ground, proven reserves, 1-1/2 times those of Saudi Arabia and, in fact, the largest in the world. 31 Representative English. And which country in central and eastern Europe do you feel has most successfully undertaken that approach? Dr. Ellerman. Well, all the countries use very mixed programs. You've got to almost go program by program. But in Poland, for example, what they call privatization by liquidation program was a type of lease buy-out. And ESOP is like a lease buy-out, where the ownership goes to the management and the workers in it, but they have to pay it off over time. So it's like a lease purchase arrangement where the company itself pays it off. Something like that also happened in Hungary which was very successful. The country that I used to live in and worked in was Slovenia, and it was certainly very successful in Slovenia. So something like that is a way of empowering people, a way of giving them a stake fairly quickly. And for your question and for the previous question, this idea of us getting into nation-building, what I keep trying to say is we have to get the reconstruction effort conceptualized as their building their own nation, not as us doing nation-building to them. And something like the ESOP, something like these programs where people can formalize their property rights and feel that they can then know what they can do, they're empowered to do it, and they can go further, that's the key thing to make it their effort and not ours. Representative English. Thank you. And I need to head to the House floor, so I thank you, Mr. Chairman Senator Bennett. Thank you, sir. Senator Sununu? Senator Sununu. Thank you, Mr. Chairman. Mr. Al-Rahim, you mentioned an organization established in the '50s or '60s you mentioned as a good model, a good structure for coordinating and maybe identifying prospective investment. What is it about that model or that structure that works from an economic perspective or a cultural perspective? Mr. Al-Rahim. Mr. Sununu, that was a development board set up in the '50s, independent of the government, staffed by technocrats, where, at the time, this was prior to the revolution, the government decided to allocate 70 percent of oil revenues to this board. And the board also had the benefit of a number of prominent international economists invited to it. 34 Have you seen the phenomenon where sort of political forces desire to have a system where ownership rights are vague or not easily enforced? Mr. de Soto. I was coming to that, sir. The thing is that when you are aware, if you're a politician, that in fact you are not governing 88 percent of the people who work in the private sector because they work outside your system, that you really don't know who is living where in 90 percent of your land, you have every political interest for that to change. I have not found resistance for change coming from somebody saying, well, it's all right. 90 percent can live outside the law. I don't really care if they have property rights or not, because the consequences of not having property rights are not only the fact that you don't get development because credit, investment, is all based on property rights. But it's also that you can't even police these places. You don't know where Osama bin Laden is hiding because you don't have a system of addresses. You cannot participate in the global economy. Where the danger comes from, sir, is the following one. It has a lot to do with ideology and with cultural myths. So let me tell you a little bit just how we work there in two minutes and why we're optimistic about the fact that these changes will be adopted. For example, Egypt has been trying to pass a mortgage law for many years now and has been unable to because the forces of resistance say, how are you going to have a system whereby people are able to use their homes or their chattel, their goods, their animals, their equipment, to guarantee to secure a credit? Because credit only functions where people have something to lose. That's what basically creates the trusts and that's what allows you also to enforce noncompliance. And therefore, the idea is you can't impose this on poor people. Therefore, you will not be able to pass a mortgage system. That has been stopping them for years and years now, if not decades. What we do is try and look at the dark side of the economy because it actually provides the answers in an unideological form. So we start asking, for example, how do people in this large extra-legal sector of Egypt, but we could also be talking about Mexico, survive on a day-to-day basis within their small enterprises? Do they get credit? 35 And the reply is they do. And the question then is, how is it guaranteed? And it's guaranteed by an instrument which, as a matter of fact, the Arabic culture created 700 years ago, which is the check system. I think it even comes from an Arabic word. There were Arab checks circulating all the way up to Shanghai 700 years ago. So the way it would work, sir, is that if you asked me for $12,000, I will say that the guarantee will constitute a check written against your account for that amount. Excuse me -- not for that amount, but it will be drawn blank. If you do not pay, I can get you in a month or two in jail because in all these countries, there is debtors jail. And a great amount of the prisoners are people who haven't paid their debts. So what we do are the statistics, which are the following one: How many people today of Egyptians actually -- there's no mortgage law, mind you -- but how many people to pay off the debt and not to go to jail, have had to sell their houses? One point five percent. How many people have gone to jail and anyhow had to sell their houses? Another 4.5 percent. How many people have had to flee the region which they live because they've not been able to pay their debts? 20 percent, and therefore, have had to sell their houses as well. And then we put it next to, for example, U.S. statistics, that say - - the Fannie Mae statistics that I've got, at least -- only 0.3 percent of Americans lose their homes as a result of the mortgage system. So then the argument becomes the following one: Not having a mortgage system violates human rights and property rights much more than having a mortgage system. But the examples that you bring are not the examples from how good this works in the United States because then you get a Samuel Huntington telling you that there's something in the Anglo-Saxon gene that makes it work in the states. What you do is you compare it to the credit system that already exists for most Egyptians, and in this case, for most Iraqis, show how badly it works, how many more little old ladies actually lose their homes under the lack of the rule of law, and that's how you get your rule of law passed. 37 small farmer in America sells his land to Archer-Daniels-Midland or whoever, and takes that money and goes off to the city and becomes an entrepreneur in some other kind of circumstance. So it seems to me that there's a connection between that opportunity. And we should focus on that because we have become so pre-occupied with oil, we should recognize that there are many other opportunities. I want to come back to you, Dr. Bronson, and a point which was your fourth one which I think has been lost in some of the specifics that we've gotten tied up with here. When you say this is timely, dangerous, expensive and worth it. And I think we should focus on the worth it. This is, after all, the Joint Economic Committee. We want to talk about the impact economically on the United States. And let me just philosophize for a minute and then get your reactions, any of you. Dr. Ellerman, you're in this field as well. Looking back at the examples that have been talked about here, Japan and Germany at the end of the Second World War, those were enormously expensive operations on the part of the United States of America. Japan at least dealt with a very, very different culture. The Germans were used to a western style of entrepreneurial activity, the kind that would be compatible with their neighbors. The Japanese were a feudal empire. Dr. Ellerman, MacArthur kept a bridge on the other side of the chasm. He did not eliminate the emperor. Indeed, when Japan was being bombed, they did not bomb the Imperial palace. I remember as a businessman driving through the streets of Tokyo with my manager when I owned a business in Japan and looking at all of the buildings, some of which were modern skyscrapers and some of which looked much more traditional. And I asked, how many of these buildings were built since the Second World War? And the answer was all of them, because every building in Tokyo, with the exception of the Imperial Palace and the Diechi Insurance Company was destroyed by the American bombs. So MacArthur very wisely kept at least one toe on the old bridge by keeping the emperor in place, but eliminated the system of slavery. We don't realize that the Japanese had slaves in the 20th century, in the feudal system that they had. The woman who managed my business in Japan was part of the team -- she was a translator for the American occupation forces and was part of the team that went into those areas and told these people, you're now going to have property rights. Told these people, you are no longer slaves. 38 How long did it take MacArthur to make that transition? Seven years? Five years? Something along that line. How much did it cost us? I don't know. But it was huge. Dr. Bronson, it was obviously worth it. Japan, even with its deflation and problems now, is still the second largest national economy in the world, a major trading partner. Most Americans love Japanese cars, if nothing else. We have created an island of stability and prosperity in a part of the world that desperately needed it. And we have the opportunity to do the same thing here -- create an island of stability and prosperity, property rights, proper kinds of capitalism -- I remember the Russian ambassador saying to me when we were talking about some of their problems, we've had plenty of shock, but damn little therapy. And you're right. We did not do the Russian thing right, and we need to learn from that and do the Iraqi thing properly. Am I just a rosy-glasses idealist here who's looking at the best thing? Or is this in fact an enormously valuable opportunity, how difficult and dangerous and expensive and timely it may be? Is Dr. Bronson really right, everybody, that this is overwhelmingly worth all of the challenge that we need to put into it, and the advantages -- being very selfish -- the advantages to America, to our children, in terms of what could happen out of this, could be as great as the advantages that came to us because our parents did what they did in Japan and Germany at the end of the Second World War? That's a philosophical question, but I think that's what we really want to deal with in this hearing as a whole. Responses? Mr. de Soto? Mr. de Soto. Well, one reply to your question is, regardless of whether that's the way it should have taken place or not taken place, your occupation of Iraq, the fact is that it's done and you're there. (Laughter.) And now that you're there, it is an opportunity, not only because, Senator Bennett, it's an island of stability, but it's because these islands of stability are very contagious. Senator Bennett. Yes. Mr. de Soto. In the case of China, you didn't get it at the first throw with Chung Kai Chek. But by leaving behind the Brits two ports, with market economies and freedom, at least economic freedom, Singapore and Hong Kong, by allowing widespread property in all of these places, including Japan, what is today South Korea and what is today Taiwan, after 40 years, now the larger continent is also following. 40 Mr. Al-Rahim, you had a comment. Mr. Al-Rahim. Mr. Chairman, I have to tell you that I agree, not just fully with Dr. Bronson, but even more than she imagines because Iraq is so geo-politically important. And I'm not talking just about the benefits to the Iraqis. This country made such a fuss about going into Iraq. The trumpet of changing the face of the region. There's a serious commitment to the world, not just Iraq, that was made about America's intentions, American abilities, and their visions of the future of this whole planet. I think to get Iraq wrong, if nothing else, is egg on the face of this nation for the next 20, 30 years. It's not like eastern Europe. When the wall fell down, everybody looked around and said, we won, turned their back and walked away. The western Europeans had to come in because they had to worry about primarily migration problems. So they stepped in very quickly. Today, if America does not get Iraq right and Iraq will start the domino effect. The domino effect will start from Iraq under all circumstances. The real question is which way is that domino going to tip? And if it tips in the wrong way, don't forget Iraq's neighbors are Iran, Turkey, Saudi Arabia, Syria -- Israel is not very far down the road. It's a volatile region. And if it tips the wrong way, everybody's going to feel it. We're not just talking about the Middle East any more. And so, I think that's an added incentive of what you just very clearly and eloquently mentioned, that in Japan, you created an island of stability, of growth, of prosperity, as an example, because the tiger nations that eventually emerged in Southeast Asia really followed the example of Japan. That was closer to them. And you can see that same thing happening again. I can tell you, it's no secret -- much of the Middle East is still living in the 14th and 15th century, whether it's politically, whether it's systems of ownership, whether it's a feudal mentality, et cetera, et cetera. And that has to change. The only question is, will that change happen violently and in the wrong direction, or can it happen peacefully by seeing the right example. And that's one thing that we should all be concerned about. Senator Bennett. I don't think there's any question but that we are in it for the long haul. We have to stay in it for the long haul. We have to do everything that we possibly can to get it right. 45 PREPARED STATEMENT OF REPRESENTATIVE PETE STARK, RANKING MINORITY MEMBER Thank you, Chairman Bennett. I would like to commend you for holding this hearing on “Transforming Iraq's Economy.” It's an important topic, and an important responsibility that President Bush has put on the shoulders of American taxpayers—or maybe I should say debt-holders, since this Administration doesn't believe in taxes. It is clear, instead, that the Bush Administration prefers the easy route of arguing that taxes are an unnecessary burden rather than accepting that taxes are a necessary means to meeting important responsibilities. As I was thinking about this hearing, I was reminded of an interesting piece in the latest New Yorker. The author, Hendrik Hertzberg, observed that in many ways Iraq right now is a conservative's paradise, with limited government, limited regulation, limited gun control, and so forth. I would say, in addition, that if the theories underlying President Bush's economic policies are correct, Iraq should be poised for a robust economic recovery, since there is no meaningful government and no tax burden. I suspect that this is not the testimony we will hear from our witnesses today. In fact, Iraq's economy and civil society are a mess. And we have a long and expensive reconstruction ahead of us. Should this outcome have been a surprise? Of course not. Should the Administration have put as much time and effort into preparing for the inevitable problems we would face in postwar Iraq as they did into developing an elaborate P.R. campaign to justify the war? Of course. But that is not what happened, and now we have to pick up the pieces. I am sure we will hear some creative ideas from the economists at this hearing, but I hope they won't try to lull us into thinking that the transformation of Iraq's economy will be a cakewalk, and that all we need to do is set up the right conditions for the free market to flourish. The American public deserves honest answers about the task that lies before us so that we can make wise choices. The Bush Administration does not have a very good record of looking down the road and telling the public about the future consequences of its policies. If that doesn't change soon, we will be having a hearing on “Reconstructing the American Economy.” Thank you Mr. Chairman and I look forward to the testimony of our witnesses. The New Yorker June 9, 2003 SECTION: THE TALK OF THE TOWN; Comment; Pg. 39 LENGTH: 1180 words HEADLINE: BUILDING NATIONS BYLINE: Hendrik Hertzberg BODY: The other day, the Times quoted one of that ever-helpful breed, a "senior administration official," as expressing surprise at the horrendous condition of Iraq's "infrastructure," even before the destruction brought about by the war and its aftermath. "From the outside it looked like Baghdad was a city that works," the senior official said. "It isn't." The quintessential city that works (or, at least, has a cleverly cultivated reputation for being the city that works) is, of course, Chicago. The ward heelers and aldermen of that city understand (or, at least, are celebrated in song and story for understanding) that political power flows not from the barrel of a gun, and not even, necessarily, from the ballot box (whose contents can change in the counting), but from the ability to fix potholes. Garbage that gets collected, buses and trains that take people places, cops that whack bad guys upside the head, taps that yield water when you turn them, lights that go on when you flip the switch, all lubricated by taxes and a bit of honest graft-these are what keep streets calm, voters pacified, and righteous "reformers" out of City Hall. By Chicago standards, Baghdad, along with almost all the rest of Iraq, is a catastrophe. For that matter, conditions are disastrous even by the looser standards of places like Beirut, Bogota, and Bombay. Reports from the scene are in general agreement on the essentials. Iraq is well rid of the murderous regime of Saddam Hussein. But the blithe assumptions of the Iraq war's Pentagon architects-that a grateful Iraqi nation, with a little help from American know-how and Iraqi oil cash, would quickly pick itself up, dust itself off, and start all over again-are as shattered as the buildings that used to house Saddam's favorite 48 and safety inspectors and environmental busybodies are nowhere to be seen. The Ministry of Finance, Iraq's equivalent of the Internal Revenue Service, is a scorched ruin. Museums and other cultural institutions, having been largely emptied of their contents, no longer have much use for public subsidies. Gun control is being kept within reasonable limits. (Although the occupying authorities are trying to discourage possession of heavy munitions, AK-47s and other assault weapons-guns of the type whose manufacture Tom DeLay and most of the House Republicans plan to re-legalize back home-have been given a pass.) And, in the absence of welfare programs and other free-lunch giveaways, faith-based initiatives are flourishing. The faith in question may be Iranian-style militant Shiism, but at least it's fundamentalist. The Bush Administration no longer flaunts its contempt for nation- building abroad, but it remains resolutely hostile to nation-building at home. Its domestic policy consists almost solely of a never-ending campaign to reduce the taxes of the very rich. Not all of this largesse will be paid for by loading debt onto future generations. Some of it is being paid for right now, by cuts in public services-cuts that outweigh the spare-change breaks for less affluent families which the Administration, in selling its successive tax elixirs, has had to include in order to suppress the electorate's gag reflex. The pain is especially acute at the state level, where net federal help is in decline. States are cancelling school construction, truncating the academic year, increasing class sizes, and eliminating preschool and after-school programs. Health benefits are being slashed, and a million people will likely lose coverage altogether. In many states, even cops are getting laid off. As it happens,these are the very kinds of public services that America's proconsuls are promising to bring to Iraq. Of course, being nice to Iraq does not necessarily require the United States to be nice to itself. Nor does denying medicine to kids in Texas require denying it to kids in Baghdad. The connection is more karmic than causal. But it's also political. Whatever one may think of the global democratic-imperial ambitions of the present Administration, they cannot long coexist with the combination of narrow greed and public neglect it thinks sufficient for what it is pleased to call the homeland. At some point-the sooner the better-a critical mass of Americans will notice. LOAD-DATE: June 9, 2003 49 PREPARED STATEMENT OF REPRESENTATIVE CAROLYN B. MALONEY I thank the Chairman and Ranking Member for calling this hearing on the post-war rebuilding of Iraq and its economy. In the aftermath of war, the immediate problems of restoring order and basic infrastructure for the people of Iraq have proven daunting. It seems that every morning the newspapers carry demoralizing stories of the latest attacks on American troops and of growing resentment of U.S. forces by the people. Given this atmosphere in the country it is particularly important for Congress to focus on ways that we can boost the Iraqi economy so the people can see that the U.S. action will have a substantial long-lasting positive impact on their daily lives. In this hearing, we will hear several approaches for setting the groundwork for reconstruction of the country. One issue that I believe should be a significant part of the discussion is debt relief. As we saw in post-war Germany, debt relief can be an essential tool in rebuilding a nation destroyed by war and humiliated by its leadership. We have also seen in recent years that debt relief is an effective development tool that releases funds within a nation that can be used to address poverty and meet essential human needs. The case for some debt cancellation is even more compelling in Iraq given that much of the debt can be characterized as odious. Odious debt is internationally recognized as debt that is taken on by a country for the personal benefit of corrupt leaders or for the oppression of a people. Clearly much of the Iraqi debt falls in this category. To address this issue, this week I will introduce legislation in the House calling for debt relief from Iraq's odious debt and relief from the debt Iraq owes the World Bank and IMF. Who should pay debt that Saddam owes? The dictator who incurred the debts or those he oppressed and brutalized? How can we ask the people of Iraq who lived in fear of Hussein's secret police to pay back the loans that supported these armed assassins? You don't have to travel far outside of Baghdad to see a sprawling slum called Saddam City that houses two million Shiite Muslims. The slum is over-run with garbage and children climb the mountains of refuse to look for scraps or things that can be traded for food or clothes. In the face of this poverty, the Iraqi regime spent billions of loaned dollars on palaces and other luxuries. What better way to enhance our efforts at reconstruction and empower the people of Iraq than debt relief? If Iraq is ever truly to be a peaceful and prosperous democracy, its citizens must be allowed to start anew. 52 108TH CONGRESS IsT SESSION CONGRESS H. R. 2338 To preront loans for Iraq from the International Monetary Fund or the to pay of Increditors. ROSPORT IN THE HOUSE OF REPRESENTATIVES JUNE 4, 2003 Mr. SAXTON introduced the following bill: which was referred to the ("ommitter om Fim neinl Services A BILL To prevent loans for Iraq from the International Monetary Hund or the International Bank for Reconstruction and Development from being used to pay off Iraq's creditors. I Be it enacted by the Senate and House of Representa- 2 tires of the United States of America in Congress assembled, 3 SECTION 1. PREVENTION OF LOANS FROM IRAQ FROM THE INTERNATIONAL MONETARY FUND OR THE INTERNATIONAL BANK FOR RECONSTRUC. TION AND DEVELOPMENT FROM BEING USED TO PAY OFF IRAQ'S CREDITORS. The Bretton Woods Agreements Act (22 C.SC. 286 9 28600) is amended by adding at the end the following: 1 "SEC. 64. PREVENTION OF INTERNATIONAL MONETARY FUND LOANS FOR IRAQ FROM BEING USED TO PAY OFF IRAQ'S CREDITORS. 4 "The Secretary of the Treasury shall instruct the 5 United States Executive Director at the Fund and at the 6 Bank to use the voice, vote, and influence of the United 7 States to oppose the making of a loan by the Fund or 8 the Bank, respectively, to the government of Iraq unless 9 the Secretary of the Treasury determines that there are 10 sufficient safeguards in place to prevent the loan proceeds 11 from being used to reimburse persons or governments 12 holding debt arising from credit extended to the govern- 13 ment of Iraq, and outstanding as of the date of the enact- 14 ment of this section, for any losses with respect to the 15 debt.". 59 countries in the world all vying to attract privatisation money making it very much of a buyers market – witness the failure of both the Egyptian effort over the past six years and the more recent failure of the Saudi gas initiative. Given the above factors fair valuation means that today “auctions' will not do the job! Better to develop a programme that values assets progressively over the next few years using a set of pre-agreed benchmarks; e.g. EBITDA, Gross Sales or market share etc. This would give the buyer the assurance of the acquisition through an executed purchase and Sale Agreement, while giving the seller (the government) part of the cash price today and part at a later date when the full value of the asset is more properly measurable. Such Agreements can also incorporate Put and Call options between the parties that further ensure a “fairness” to both sides. Second, as regards the broad distribution of the assets it is important to learn the lessons of Eastern Europe to avoid the economic disenfranchisement of the lower economic classes (essentially the overwhelming majority of the population in Iraq today) and prevent the emergence of a handful of oligarchs. This can be accomplished both through an extensive system of ESOPs and Trusts. For example, at every privatisation full vesting of any ESOP shares would be gradual, for example start paying dividend but delay conveying ownership (and thus the ability to sell) until full value was better reflected by actual performance and understood by the stakeholder. Alternatively, shares to be distributed to the population may be held by a specially created fund e.g. in the case of capital-intensive industries with small employee numbers. The Fund can then administer the assets until such time as value is realisable and it can find an equitable or attractive distribution strategy not only to the direct employees but also perhaps to a wider base of beneficiaries (e.g. regional or geographic within certain proscribed guidelines). A. Debt Forgiveness & Re-Scheduling An important feature of the economic plan is clear and final resolution of the debt issue as it impacts almost all aspects of the program. New lenders need to know what other creditors are owed before extending new facilities. Investors need to understand the solvency status of the country, the local government must properly budget to meet its obligations and individuals must achieve a level of confidence before they start investing or saving. 61 An independent Property Restitution Authority must be set up to look into all legitimate claims and provide proper compensation or restitution. In this regard the experience of Eastern Europe is valuable and needs to be carefully assessed to provide guidance. In addition to being ethically correct such action will have two added benefits; first, it will go some way towards redistributing assets away from the state and its cronies and second, it will inject a measure of wealth back into the middle class which having been totally dispossessed and decimated, will be able to revive and participate in the economy again. While the work of such an Authority may not be straightforward, nevertheless a concerted and consistent effort has to be made. F. Currency Stabilization A stable local currency must be created as an ongoing tool of monetary policy and the creation of credit in the banking sector. The new currency should be pegged to a basket of the US dollar and the Euro reflecting the country's primary import and export position. Such currency stability will not only help the average Iraqi feel secure but also help to allay the concerns of foreign investors. At a later point in time and subject to the building up of adequate reserves the Central Bank may decide on changing the basket mix or free market floatation. G. The Banking Sector At present there is no proper banking sector to speak of. There are two large government owned and about twenty minuscule commercial and investment banks. The sector is utterly rudimentary by almost every standard. It is imperative to develop a strong and modern banking infrastructure to support economic growth both at the retail and the corporate level. A vibrant banking sector will accelerate the circulation of money, promote investment and capital expenditure to boost every sector of the economy, encourage consumer spending and saving, and contribute to an active deeper stock market. Specialized lending such as consumer credit, leasing, mortgage lending, trade finance, agricultural finance and micro lending must be introduced and vigorously promoted. Foreign expertise will also be required in this sector and international banks should be encouraged to participate in a dynamic manner. Here again the participation of the Iraqi private sector must be safeguarded at the initial stage, which can be done by requiring foreign investors to have local partners with a minimum ownership during a pre-agreed initial period. As with other sectors involving large international players, ESOP and/or public listing requirements can be built into the license agreements as a partial means of providing such safeguards. 63 Real and effective protections need to be put in place during the first five years of the plan to achieve a proper distribution of wealth to the population at large, limit the emergence of oligarchs and avoid economic pillage by cronies of the old regime and foreign vulture investors. Furthermore, specific provisions and benefits programs need to be introduced that start the process of reversing the “brain drain” and attracting competent professional Iraqi exiles back to the country. One example is that followed in the GCC whereby regulation requires that 51% of any business activity is locally owned. Furthermore it is not enough to limit control to Iraqi ownership, but in certain cases the identity of the owners must also be vetted. Already dubious characters and vulture investors are beginning to circle. The first category is more dangerous as it comprises many local cronies of the old regime who quietly accumulated large amounts of clandestine wealth in shady deals on their on behalf and on behalf of senior members of the Baath regime. Large and unaccounted for amounts of money held by persons with no discernable business backgrounds or worse still from unsavoury business backgrounds are waiting to transform their liquid assets into legitimate businesses in Iraq. Some of these characters are teaming up with gullible international investors, to gain legitimacy, by selling their supposed access and knowledge of the country. This also must not be allowed to happen. As the international community has cracked down on money laundering activities in other parts of the world, it must remain vigilant that another equally virulent strain of this activity does not happen in Iraq. The Iraq Development Fund There has been talk in the press of plans to set up an Iraq Development Fund that would receive all the oil revenues and be responsible in a transparent manner for reconstruction expenditure. While this sounds acceptable in theory there are two major questions that have to be answered. First, what is the mandate of the Fund? If the Fund is just an accounting body, albeit transparent, then that is of very limited use. The Fund if it is to be set up must become a synergistic organ of the overall economic plan. It must work within the parameters and guidelines of the economic blueprint and must have some authority to make decisions not just take instructions to write checks and pay bills. Second, what is the governance and oversight of the Fund? The Fund must have an un-conflicted and qualified Board with local participation. Such governance should have a phased transition to full local authority over a specific period of time. It is intelligent not to 64 repeat the problems and inefficiencies that plagued the Oil For Food Program partially resulting from the governance of that program. Finally thought should be given to The Iraq Development Board that was set up in the country in the 1950's, whereby 70% of oil revenues were allocated exclusively, outside of government budgets, to the fund to be expended towards economic development. Such a model or a variation thereof may be very relevant in the present circumstances. B. Infrastructure De-Regulation There are certain infrastructure sectors that would benefit from phased de-regulation and expedite the economic revival of the country. These include; power, water, transportation and telecommunications initially, to be followed by other sectors such as education and healthcare. The objective is to either get the state completely out of these sectors, fast (e.g. telecom & transportation), or over the medium term (e.g. power & water), or at least to run in parallel with the private sector (e.g. education & healthcare). There are a number of well-documented examples one can learn from such as the successful British experience with extensive infrastructure privatisation under Margaret Thatcher; the minimal role of the state from the healthcare system in the USA which is one of the best in the world; and the recent mixed experience with de-regulating the power sector again in the USA. In the context of de-regulation a separate note must be made of the role of the Media, which in the past was dominated by the Baath state and used solely to serve their purposes. A number of different media outlets have already started springing up, however all controlled by the different political parties. It is important to encourage independent and non-political outlets in radio, television, newspapers and the Internet not just for education and information but also for entertainment and especially for the young. IX. Role of the USA & other International Players The US must continue in its leadership role in the reconstruction of Iraq; it is critical not to abdicate it to any other single or multinational authority. This leadership role is important for Iraq but also for the US. From the US perspective what was started must be successfully completed and should not be left half-baked. As the vision for the new Iraq was explained to Iraqis, the region and indeed the world only the US can bring it about. It is no secret that many 66 have the authority to draft regulations that can be fast-tracked for approval. 2. Any acceptable political system (let alone a vibrant democracy as a beacon to the region) will fail if it is not quickly underpinned by a healthy economy; these two are interlinked and mutually reinforcing in both directions. 3. Oil alone is not enough given the scale of the problem. While it is a big help it is definitely not a 'cure-all’. Empowering the private sector in a comprehensive, transparent and publicly elaborated manner is the only solution. 4. The price of ‘losing the peace’ is not limited to Iraq or even the region. It will stab at the heart of America's leadership in the 21st century and certainly there are a lot of parties, alone and in collusion, waiting to push and twist the dagger. The “Domino Effect” can start in Iraq; better make sure it tips in the right direction. There is not much time. At most the honeymoon in Iraq (if one could call it that) will last three to six months. Already other suitors (some unsavoury) are making 'courting' noises. A population, long oppressed, having recently found freedom will turn desperate without productive occupation and basic means of earning a livelihood. Immediate gainful employment is of the highest priority. The Phoenix Plan is a way to get people off the streets and to work, fill their time, minds, stomachs and pockets in a constructive manner and start the “virtuous cycle” of economic growth. 70 That is why the program we propose for Iraq takes the form of a transformation strategy that is based not only on our experience in the field but on the lessons that the ILD has learned from the successful transitions to market systems in the USA, Europe, and Japan during the 19th and 20th centuries. Before creating a new property system for Iraqi authorities, it is important to get the facts: all extralegal and legal assets must be identified, located, quantified and classified according to the different rules formal and informal—that govern the right to possession and exchange. The rule of law can be established only if the new property law: reflects the extralegal customs and practices of the poor and middle classes; and gives them more easily enforceable rights than they can obtain through bribes and protection provided by extralegal organizations. The program will begin by identifying, locating and classifying extralegal rights over assets, whether they are created by feudal, tribal, refugee, or black market organizations. Such information is an essential prerequisite for writing modern law and shaping recording procedures that will be enforceable and respected in practice. Simultaneously, we will investigate the current laws and regulations that thwart Iraqis who try to gain legal title to assets they are holding, forcing even honest people to operate in the extralegal sector and continue to conduct business in a corrupt environment. The ILD has found that in most developing countries such obstacles to playing by the rules can be truly Sisyphean. Today, in Egypt, for example, which helped set up the Iraqi civil code of 1953, titling a bakery can take up to 540 days of moving from one bureaucracy to another at a cost of 84 times the average wage. In Mexico, even after 15 years of structural adjustment, foreclosing a mortgage takes no less than 43 months. With the information obtained above, we will acquire the material and criteria needed to create an official property law that is more efficient at protecting rights and creating capital than the fragmented extralegal rules and bribes that characterize the shadow economy. In this manner, records and maps can be transformed from quickly outdated snapshots into “living” cadastres. Instead of slipping back into the corrupt practices of the extralegal economy, owners will have the incentive to keep registering their subsequent transactions, thus maintaining current official property records (and the legitimacy of the market economy law). 72 The goal would be to produce a common bedrock law for all citizens. The current extralegal rules that govern most Iraqis should be deconstructed in order to identify the principles that underlie them and see how they can be integrated into a new property law that can be trusted by everyone. One can then proceed to design and help enact a legal property system that consolidates the meaningful aspects of the disparate and dispersed extralegal arrangements (including procedural regulations for refugees and displaced persons) into one modern, codified system that Iraqis will freely choose to abide by and that will meet with a minimum of resistance from official bureaucracies and the formal sector. In this way, the new government can begin to catch the wave of rising expectations instead of being engulfed by it. Lawlessness is terrible, but the whole notion of security is far more complex than what would be achieved by putting a cop on every corner. The rule of law is not the iron fist imposed from above, it is a consensus about people's respect for one another's person and property. It is a social contract that people agree to keep because it protects the sources of their lively hood, their assets, and the customs that they respect and obey. PREPARED STATEMENT OF DAVID P. ELLERMAN, PH.D., AUTHOR AND FORMER ECONOMIST AT THE WORLD BANK Mr. Chairman, members of the Committee, I am David Ellerman, recently retired from the World Bank' where I was an economic advisor to the Chief Economist. Prior to joining the World Bank ten years ago, I started and ran for two years a consulting firm in East Europe to assist in the transition. While in the World Bank, most of my work was on the post-socialist transition with only a small part on the Middle East and North Africa region. The bulk of my remarks today will be based on the many hard lessons learned in trying to help the post-socialist countries make the transition to a private property market economy. While I am not an expert on Iraq, I imagine that many of these lessons would also apply to the post-Baath-socialism transition in that country. 1. The Case for Humility, Caution, and Incrementalism. Western economic advice to the former Soviet Union was partly responsible for the debacle in that region. Professor N. Gregory Mankiw of Harvard, the newly appointed head of the Council of Economic Advisors, noted in a recent book review that the book's author blamed much of the debacle in Russian on the shock therapy advice which came from some of the best and brightest of the economics profession (mostly from Harvard in this case). While Mankiw was more agnostic about the blame, he noted that if the advice "was a mistake..., its enormity makes it one of the greatest blunders in world history."2 After a debacle of such historic proportions, surely we should have some humility about "nation-building" and be skeptical of those academic economists, brimming with self-confidence from building castles in the air, who now think they can socially engineer a new "shock therapy" program for a quick economic transformation in Iraq. 2. Pragmatism about Party Affiliation. The disastrous advice for institutional shock therapy in the FSU arose partly out of very understandable concerns that most of the people in positions of any power were in the Communist Party. Hence much of the western My remarks are solely in personal capacity. 2 Mankiw, N. Gregory 2003. Review of: Reinventing the Bazaar (book by John McMillan). Journal of Economic Literature. XLI(March): p. 257. 76 rapidly multiply successes in the retail businesses, and business education can give hope to a new generation. Instead of setting up cargo-cult stock markets, what is required is quiet and patient work with the banking system so that it can serve small businesses. Where businesses are informal and property rights are de facto, they should be formalized and protected as urged by Hernando de Soto so that people can use these "erector sets" to build more. In the small business and family farm, ownership is closely tied to control. There is no long hard-to-police and ripoff-prone chain of authority from shareholders to boards of directors to managers to middle managers and finally to workers. People feel they are empowered and responsible. For larger firms or organizations to be restarted and privatized, the same principle applies. Try to find pragmatic arrangements so that the formal structures of ownership and responsibility are "shrink-wrapped" around the set of stakeholders who have to co-operate in order for the firms to function again. On that basis, they can build a better economy. 7. Don't give aid to the Iraqi people; give them the tools to help themselves. Lincoln said he would like to be neither a slave nor a master. In like manner, just as Americans would not like to receive charity from others, so we should not aspire to bestow charity upon others. Instead we should aspire to get the tools into the hands of the Iraqi people so they can sow and reap on their own—so they can help themselves. Aid recipients in the former Soviet Union sometimes complained that they were being treated like a conquered people. Since the Iraqi people are in that unfortunate position, we must be doubly careful to show respect rather than benevolence. Charity corrupts, and long-term charity corrupts long term. For instance, there is the short-term rush to supply aid in commodity form (e.g., food and supplies) but that will tend in the longer term to undercut the markets that might provide those goods. Phasing in something like a food stamp program would help to restart the Iraqi supply chain of businesses that used to supply those goods. Or, for another example, there will be the temptation to demonstrate American goodwill and know-how by paying U.S. firms to do the reconstruction work. But the Iraqis will see this as adding the insult of presumed helplessness to their injuries. Instead the contracts should go to the Iraqi organizations and firms that can reconstruct local infrastructure perhaps with some additional learning as the work goes along. 8. A Regional Bank for Reconstruction and Development. One of the strokes of genius in the Marshall Plan was that the resources for European reconstruction were channeled through the Organization for 78 PREPARED STATEMENT OF RACHEL BRONSON, PH.D., OLIN SENIOR FELLOW AND DIRECTOR, MIDDLE EAST PROGRAMS, COUNCIL ON FOREIGN RELATIONS Mr. Chairman, thank you for the invitation to speak before the Joint Economic Committee about the challenges confronting Iraq's economic transformation. As you may know, I co-directed “Guiding Principles for U.S. Post-Conflict Policy in Iraq,” a December 2002 report co-sponsored by the Council on Foreign Relations and the James A. Baker III Institute for Public Policy. Ambassadors Edward P. Djerejian and Frank G. Wisner co-chaired the report. In addition, during “Operation Iraqi Freedom,” and the weeks prior to it, I traveled twice to the Persian Gulf to discuss the war and its aftermath with those in the region. Although the Council on Foreign Relations makes my research possible, it bears no responsibility for these remarks. MAGNITUDE OF THE CHALLENGE The task we confront in Iraq is enormous. Iraq sits in the strategic heartland of the Middle East. Historically, Baghdad has been a major player in Middle Eastern affairs and has been at the center of inter-Arab politics since its independence in 1932. Economically, Iraq has the second largest proven oil reserves in the world, estimated at 112 billion barrels, with as many as 220 billion barrels of oil resources deemed probable. Culturally, Iraq's universities and religious seminaries have shaped the thinking of large sectors of the region's, citizenship. In short, what happens in Iraq matters immensely to millions of people in the region and beyond, as it does, of course, to the Iraqis themselves. We have set high expectations for ourselves and the Iraqis. But even establishing a basic level of stability, security and economic recovery will be time-consuming and expensive. As Secretary of Defense Donald Rumsfeld has pointed out, after the American Revolution “it took eight years of contentious debate before [the United States] finally adopted a Constitution and inaugurated our first president.” In Germany, it took four years to move from the end of the war to a constitution. The German experience, of course, also benefitted from approximately $8 billion of Marshall Aid money (in current dollars), a robust American and international security presence, and an international political context that America organized around Europe's recovery. Time, money and security were required in Germany. In Iraq, there is no reason to expect it will take anything 80 of low-level casualties. The use of guerilla tactics that is beginning to emerge in western Iraq is an ominous warning of things to come. Unless America and its partners deal firmly with such opposition, and make clear their commitment to provide for a better future for all Iraqis, all other goals for Iraq will be illusory. A heavy security presence will be necessary to fill the power vacuum left in Iraq. Prior to the war, a Council on Foreign Relations task force estimated that a stability force of 75,000 American troops would cost no less than $15 billion per year. This estimate did not include reconstruction and humanitarian costs. U.S. administration officials now estimate that the current force levels of about 150,000 (and expected to remain steady for the near future) are costing in excess of $3 billion per month. The original hope of reducing American presence to 30,000 by this fall is no longer viable given the chaotic reality on the ground. The Administration deserves credit for the growing evidence that law and order is slowly being restored. Maintaining large number of soldiers in the country, supplemented by military police and Special Forces, is helping to stabilize the situation. However, the looting and violence that occurred unchecked during the first weeks of the post- conflict phase has set back Iraq's reconstruction. Recovering Iraq's oil potential. Even if law and order had seamlessly transitioned from occupational authority to local control, Iraq would still require considerable outside assistance. Iraq's reconstruction will not be self-financing. Oil is its major source of government revenue. Iraq's oil infrastructure is in decline. After years of sanctions and poor political rule, Iraq's production capacity is decreasing at an annual rate of 100,000 barrels per day. Prior to the war, Iraq generated $10-12 billion in oil revenue per year. Over 70% was spent on basic humanitarian assistance such as food and medicine that still is required today. While official assessments have yet to be concluded, repairing and restoring Iraq's previously used oil facilities may cost $5 billion, in addition to the $3 billion needed for annual operating costs. Up to $20 billion may be required to restore Iraq to its pre-1990 electricity capacity. Before the war, questionable assumptions were made about the cost of the conflict, and the likely speed of reconstruction. Despite heady predictions for Iraq's recovery, there are limited short-term resources available for repairing Iraq's oil industry and decaying infrastructure. Considerable American and international support is required. It is unlikely that the Administration's one time request of $1.7 billion will produce the stable promising Iraq that many advocated before the war. 81 Diversifying the economy. To get Iraq back on its feet economically, greater attention must be given to diversifying Iraq's economy. Over 90% of its export earning comes from oil. In 1980, Iraq relied on oil for only 39% of its gross domestic product. Reliance on a single source of revenue makes Iraq vulnerable to the chronic corruption, monopolistic behavior, under-development, and under-employment that have afflicted other energy-reliant economies in the region, while leaving Iraq hostage to the whims of the market. Throughout the twentieth century, the value of economic output for those working with raw materials, in this case energy has declined by 50%, relative to skilled labor. Re-structuring Iraq's debt. Iraq shoulders a massive debt load. While the exact debt amount is unclear, it is generally agreed to be between $100 and 200 billion. Iraq's debt is largely a result of the Iran-Iraq war of the 1980s, reparations from Desert Storm of 1991, and payments for pending contracts with foreign companies. UN resolution 1483 "welcomes the readiness of creditors, including those of the Paris Club, to seek a solution to Iraq's sovereign debt problems.” When possible, incentives will be required to encourage debt forgiveness. Unfortunately, even if they wanted to forgive Iraq's debt, some of Iraq's creditors are by law unable to do so. In such cases, generous refinancing conditions should be encouraged. Supporting a stable, transparent political order. The Middle East has been woefully unable to attract foreign direct investment. Opaque authoritarian leadership has chased away such funds. To successfully attract capital and keep local capital at home, Iraq will require a transparent, stable, rule-based political system. While a transfer of power from the occupiers to local leaders is necessary, it will not happen quickly. America must plan to remain actively involved until local political experiments in places such as Mosul and Kirkuk can be replicated at the national level. A speedy transition will either return to power the scions of the old system, as happened in many former communist societies, or result in the assumption of power of a regime viewed as an illegitimate puppet of the occupiers. Neither alternative is attractive to foreign capital. For this reason, the Administration's decision to delay the selection of an Iraqi Interim Authority was a correct one. Initially raising the possibility of an early transfer unnecessarily increased expectations and distracted Iraq's potential leadership from the difficult tasks of recovery. 82 MANAGING EXPECTATIONS We must remember that the pre-Saddam Iraq that many hold in their memories is not the Iraq of today, nor will it be the Iraq of tomorrow, even under the best of circumstances. With high unemployment and 42% of its population below the age of 15, Iraq's economic base is considerably worse off than it was before Saddam took office and during the first few years of his rule. At all times, America must make clear to the Iraqi people the reason for our actions and seek to include them in the implementation of policies to the greatest degree possible. Inflated expectations will only lead to discontent and instability. THE WAY FORWARD If done well, the reconstruction of Iraq holds the promise of a better and more enduring security situation for the entire region. Successful reconstruction is a hope that many around the globe share with the United States. To the greatest extent possible, the United States should harness the capabilities of those who are able to contribute to the Herculean task we have set before us. The road to Iraq's reconstruction will be long, difficult, dangerous and costly. We can travel it alone, or we can travel it with others. It is our choice.