Stability, Security and Development

1. Stability, Security and Development GP3200 May 21, 2012 Economic Development Dr Robert E. Looney relooney@nps.edu

2. Outline • Considerations in Economic Development • Iraq Case Study • CERP Programs • Overview of Expeditionary Economics

3. Economics of Stabilization and Reconstruction: Overview • Want to provide an overview of what is needed in the economic area for stabilization and reconstruction • What are some of the practical problems encountered in implementing economic strategies in post-conflict settings. • What are the differences between post-conflict and other development settings? • These differences have major implications for economic objectives, goals, and metrics • What to an economist would normally be “optimal” in traditional development settings often becomes counterproductive in post-conflict settings • One way to conceptualize the economy is to depict the pillars on which a healthy economy depends. • Economic health also depends on adequate security, governance and social considerations

4. Factors Contributing to Economic Health

5. General Economic Issues I • Factor tree could apply either to post-conflict or normal developing settings, but with differences • relating to the relative intensity of effort on different factors, • the sequencing of those efforts • the type of aid employed and • the type of market system used • For a given country in a given situation, some of the branches will be much more problematic than others • In this context there are a number of controversies in this area with disagreements as to what developed countries can and should do for the poor of the world • No question much is being spent by the developed countries – US $90 billion in foreign assistance going from the developed to the poorer countries in 2008

6. General Economic Issues II • Still major questions over the effectiveness of aid • Some like Paul Collier and Jeffrey Sachs often argue that aid money, spent wisely can help bring development to the poor of the world. • Others like William Easterly easterly and Dombisa Moyo, contend that the aid system is broken and that donor countries may actually be preventing growth in the countries they are trying to help • He debate is heated and shows no sign of being resolved. • Part of the problem is that measuring the effects of aid is difficult – impact will also vary considerably by setting, level of governance, and the strength of domestic institutions.

7. Economic Issues in Post-Conflict Settings I • Many issues faced by developing countries are the same as in normal and post-conflict circumstances, but exacerbated in the latter • There are also important differences. • By most accounts, countries in post-conflict transition have roughly a 50% chance of reverting to war or chaos. • A basic goal of S&R then, is to avoid relapse into conflict • Beyond that, post-conflict states are defined by inadequate human resources, weak institutions, lack of technology and industrialization and low administrative and managerial capacity to use aid effectively • Ideally S&R projects pave the way for economic development, but in these circumstances the challenge is enormous. • Some of the more dramatic differences between development in normal and post-conflict situations:

8. Economic Planning in Normal vs. Post-Conflict Settings

9. Economic Issues in Post-Conflict Settings II • Economists seeking to advise in post-conflict circumstances must adjust their thinking substantially: he usual paradigms of “good economics don’t necessarily apply • These differences are at the heart of bitter disagreements between some development economists and the World Bank and International Monetary Fund (IMF). • The IMF’s central policies include the desire to establish sustainable fiscal and monetary conditions and external balances which often leads to the adoption of austerity measures. • Makes sense for the long term but can be the wrong prescription if the economy has completely collapsed as in a post-conflict situation • In the long term such austerity measures as not printing money, cuts in public spending, high interest rates, and credit constraints are necessary to keep down inflation and decrease debt • But in the short term interveners in post-conflict settings must do the opposite so that people can start getting paid and money can start flowing through the system.

10. Economic Issues in Post-Conflict Settings III • Insecurity strongly affects economic aspects of S&R • Generalized insecurity (murders, kidnappings, presence of landmines) make it difficult to develop the economy beyond substance levels • Other security related post-conflict problems include lack of economic opportunity • Businesses that were closed during the war may not yet be hiring (and may be damaged), • New-job creation is limited because investors and entrepreneurs are deterred • It follows that the intervening powers, international financial institutions and nongovernmental organizations seeking to get people back to work first need to restore the confidence of citizens, investors, and would-be builders.

11. Economic Issues in Post-Conflict Settings IV • Weak Rule of Law, or Bad Law • Economic development depends heavily on the rule of law. • In the case of economic S&R rule of law is used primarily as it reflects on the ability to do business. • This involves not just physical security and freedom from crime but also laws and regulations that allow for transparent and safe investment. Specifically: • A clear and well-publicized legal code to which everyone is to adhere • Property rights (ideally both physical and intellectual property rights) and licensing, witch must also prevent government appropriation • Building and enforceable legal agreements, which also requires a functioning and independent judiciary and clear rules on taxation of commercial activities and earned income. • Other elements include the assurance that laws will be enforced by the administrative and judicial systems, and sufficient checks and balances so that the systems will operate fairly

12. Economic Issues in Post-Conflict Settings V • Corruption, Poor Governance, and Weak Institutions • Institutions are fundamental to economic change and maintenance of economic equilibrium • Administrative weakness can lead to a dysfunctional government. • Governments must raise money by taxing citizenry. If they are unable to do so because of unchecked activities in the informal sectors or because they lack the infrastructure to enforce taxation, they they will be unable to be self sufficient. • This will lead either to state failure on ongoing dependence on foreign aid. • Depending on the quality of pre-conflict institutions and human capital, corruption may be high, expertise may be low or both

13. Economic Issues in Post-Conflict Settings V • Corruption, and Weak Institutions (contd.) • Post-conflict countries may be missing a large part of their population, either due to economic migration or conflict. • If large numbers of educated workers were killed or driven away, the country may not have enough sufficiently educated people left to administer programs • This lack of human capital may make the society more dependent on foreign aid and technical assistance. • However if institutional structures of an underdeveloped country are not functioning, they may be unable to use donations effectively cutting the potential benefits of aid • Institutions ability to use aid effectively may also reflect their ability to use tax revenue effectively • There can be considerable resistance to paying taxes if it appears money is being spent poorly or that corrupt officials are embezzling the money • The poor capacity of the administrative infrastructure to exact revenue from the populace can lead to a cycle of aid

14. Economic Issues in Post-Conflict Settings VI • Corruption, and Weak Institutions (contd.) • Weak institutions can foster corruption in the system, potentially exacerbating inequality • the rich are generally better able to pay bribes and find their way in a corrupt system • Even if the institutions are not in fact corrupt or especially corrupt, if they are not trusted by the citizenry, they they will be incapable of carrying out their mission • Anticorruption efforts must begin immediately in conjunction with other stability efforts • Evidence that the longer people live with corruption the longer it takes to purge it from the system • Spending time and resources to get institutions right to begin with can save a lot of problems in the long run.

15. General Pattern of Economic Recovery I • Security is a necessary precondition for economic recovery • When levels of violence fall, economies tend to go through similar (although not identical) stages as economic growth resumes (Figure) • Some policies like short-term job creation projects are more effective during the initial stages of recovery • Refugees are returning or local businesses have not yet been reestablished • In contrast larger scale infrastructure projects are usually better suited for later stages • After supply chains have been reestablished • Local and national governments are in better shape to plan, contract and manage major projects. • The first stage is rapid growth • Since World War II, every country in which the U.S. has conducted stability operations has experienced an initial period of rapid economic growth once violence declined

16. Timing of Post-Conflict Economic Growth Program Emphasis

17. General Pattern of Economic Recovery II • During the first period of recovery: • Trade expands and refugees return as security improves • Usually a huge increase in imports of consumer goods from aboard • People reconstruct their homes and towns, return to farming and start new businesses • Often an influx of foreign assistance contributes to a rebound in economic activity especially in the service sector as demand soars for restaurant meals and translators • At this time U.S. Army units may support • short-term public works projects like road repair, cleaning out irrigation systems, and restarting electricity supply • Army engineering units may play a role at this stage in overseeing public-works projects or repairing roads and bridges • However the activities of the local inhabitants, not foreign donors are the key drivers of growth.

18. General Pattern of Economic Recovery III • After a year or so of rebound the local economy is likely to enter a second stage • More successful local businesses begin to make larger investments in expanding their services • Trucking companies invest in new trucks • Warehouses and storage facilities are constructed • Small scale hosing and retail developments are built • Construction takes off as both demand and prices for cement, grave, timber and other building supplies rise • Farmers make longer term investments – orchards destroyed in Afghanistan • Local entrepreneurs and some foreign investors, usually of local descent, offer new services, like cell phones or satellite dishes • In this stage some of the most effective assistance strategies focus on improving the investment climate and creating an environment where private enterprise can thrive.

19. General Pattern of Economic Recovery IV • At this second stage: • U.S. Army personnel may be engaged with local communities in identifying priority local projects • Best projects are those that can be contracted and managed locally and that reinforce stability and enhance the legitimacy of the local government • In some cases this engagement with local communities can take place while conflict is still raging as has been the experience in Afghanistan and Iraq. • In successful stability operations the economy transitions to a third stage • in which the expanding private sector increasingly demands better services • foreign investors may finally become an appreciable force in the economy as they invest in telecommunications networks, banking distribution centers, mines and even manufacturing plants

20. General Pattern of Economic Recovery V • Third stage of recovery (contd.) • Local and national governments begin to develop the capacity to improve and expand the educational and public health care systems • Donors focus on working with local and national governments to improve government operations, the provision of public services and the regulation and operation of the financial sector • Demand for electricity and transport are likely to be rising sharply • Fore the first time large-scale infrastructure projects like new power plants, dams, ports, or railroads become truly feasible • Lending from international financial institutions may begin to replace grant aid • At this stage U.S. Army units should focus on transferring remaining responsibilities for economic and infrastructure development to civilian agencies. • Not all areas of the country will be at the same stage at the same time. As violence ebbs and flows, economic activity will ebb and flow with it.

21. Goals and Measurements for Economic Reconstruction I • Given the many variables and challenges faced in a post conflict reconstruction setting, a realistic set of aims should be to rehabilitate basic services and infrastructure and lay a framework for recovery growth. This includes: • Creating a macroeconomic agenda for the for the reactivation of licit investment and sustainable and equitable growth • To consolidate and maintain the peace. • How can these broad goals be measured? • Helpful to break the goals down into smaller, more concrete goals with associated metrics. • Many of these relate to creating and administrative system that is strong and transparent and able to manage the program of economic reforms

22. Goals and Measurements for Economic Reconstruction II • Measures should be realistically gatherable, which is a challenge • Example: getting accurate estimates of an informal economy can be very difficult • Often necessary to find reasonable proxies for values of interest – proxies that can be measured fairly often so that they can be used to inform potential mid-course corrections • Ultimately interveners wish to know whether their efforts had a positive impact • For that they need to collect a lot of information, preferably reliable before and after data and preferably data from similar places only some of which benefited from S&R programs • Unfortunately it is not always possible to collect such extensive data

23. Economic Recovery: Measuring Effectiveness I • Measurement Effectiveness at the Local Level • Because local economic conditions vary and are likely to fluctuate it is important that units understand how the economy is faring • Economic assistance is provided to support the broader goals of stability • Assistance is only effective if it produces an outcome that improves people’s lives on a sustainable basis • To evaluate the effectiveness of a projective or initiative the key is to focus on outcomes (more children learning to read) rather than output (number of schools rebuilt) and especially inputs (money spent rebuilding schools) • The need to measure outcomes means that measurements may be more qualitative than quantitative • Outcomes often much more difficult to quantify and outputs, especially inputs • The unit should focus its efforts on evaluating effects

24. Economic Recovery: Measuring Effectiveness II • Evaluating stability and security • Because stabilization is the fundamental goal of stability operations, a primary measure of success is whether the area of responsibility is becoming more stable • Useful indicators of a more stable and sescure situaion include: • A decline in the number of deaths, particularly those due to crime or violence • A reduction in the number of people fleeing their homes – displacement is a very accurate indicator of insecurity • A decline in violence – need to be careful. Tallying numbers of reported violent crimes or acts of violence can be misleading. • Unwillingness to report crime • Also successful reconstruction projects are prime targets of insurgence so progress in this area may be accompanied by a short-term uptick in violence

25. Economic Recovery: Measuring Effectiveness III • Evaluating stability and security (contd.) • Hours of operation – good indicator of improved security is when markets, shops, and restaurants stay open longer, especially at night • Increased numbers of people, of different ages and sexes, at markets and shops throughout the day – when people do not fee secure they stop going to restaurants and often only go out during the day • Children, particularly girls attending school regularly – very good indicator parents keep children, especially girls home when they feel risks are too high. • Attacks of lack thereof on coalition forces are not as helpful an indicator of security and stability as violence against the local population • Evaluating economic development and growth. Some general indicators of improvements in the local economy that would be visible to ground forces include: • Increased wage rtes for day laborers • Proliferation of cell phones

26. Economic Recovery: Measuring Effectiveness IV • Indicators of improved economic conditions (contd.) • increased purchases of appliances and electronics • widespread reconstruction and repair of houses • construction and repair of commercial buidings • opening of new businesses and shops • increased motor vehicle traffic • purchases of new or used cars, trucks, or bicycles • planting of orchards and other crops that take more than one year to mature • Increased investment by foreigners or local citizens returning from abroad. • Measuring effectiveness of specific tasks and efforts: • Whether they are being used as intended and • Whether they are improving people’s lives in specific, even small ways

27. Economic Recovery: Measuring Effectiveness V • Developing assessment criteria based on goals and efforts • These should be designed in view of the specific purpose of each projects. Examples • Are local people using newly built facilities (schools, clinics, business centers) regularly? Are there sufficient staff and supplies? • Are people taking advantage of the water from new wells or water purification pants? Do local medical professionals attribute any drop in disease to access to purer water • Are people utilizing humanitarian assistance (food, water) as intended and is the appropriate being provided? If people are reselling aid on the grey economy, throwing it away – may be no longer ne3eded, inappropriate or not reaching those in need • Are roads that you have built or repaired in consistent se for business and personal travel? • Do citizens express gratitude for the facilities, services and goods provided – difficult to gauge in some societies where it is simply polite to give thanks.

28. Case Studies: Economic Stabilization and Reconstruction • Iraq • Afghanistan • Pakistan

29. Introduction • Understanding the Iraqi economy is central to: • Explaining the staying power of the insurgency/militias/gangs • Designing efficient reconstruction strategies • Identifying projects and investments at the local level • Creating the foundation for a viable self-sustaining economy • Incorporating the country’s diverse populations into a modern nation-state • With time, economic factors likely to be more important in determining the eventual outcome in Iraq – need for jobs and a better life key to the country’s future

30. Pre-War Iraqi Economy • In the 1970s, Iraq was set to dominate the Middle East, with oil, industrialization, agriculture, and a large population • However, by 2000, after several wars and sanctions: • The oil sector made up at least 75% of GDP; much of the agricultural sector had been destroyed and the industrial sector was in decline. • There was a distorted pricing system, widespread inefficiency and waste, and a stagnant agricultural sector • 50% of the population was under 24 years of age. • There was widespread unemployment -- up to 50% • 60% of the population depended on food rations • There were macroeconomic imbalances, such as high inflation • The shadow economy made up at least 35% of GDP, with a large criminal economy and rampant corruption

31. Saddam’s Legacy • Saddam bought loyalty using oil money to heavily subsidize necessities • Fuel prices were set at 13 cents a gallon • The Public Distribution System (PDS) provided almost free food baskets • Electricity was provided at a very low cost • Water, medical care and education were free • These programs helped bankrupt Iraq • They were inefficient and a massive drain on the budget • They starved the private sector of funding and resources • They ruined a dynamic agricultural sector • The subsidies and controlled prices facilitated massive corruption/black markets

32. Overview of the Economy • Economic Strengths: • Iraq is believed to have second-largest oil and third-largest gas reserve in the world • Technical expertise in oil extraction should result in large increases in production as and when security improves • Economic Weaknesses (in addition to Saddam's Legacy): • Oil rents create an allocation state rather than a production state, leading to conflicts over access to and control of the money • Government employees have little experience with an open economy and technical expertise is limited • Uncertainty surrounds political transition to a unitary state. • The non-oil sector is starved for skilled workers • Infrastructure is in a state of decay • The exchange rate may be too strong to facilitate diversification

33. Defining Iraq's Post-war Economy Iraq's post-war economy was a complicated mix of different models, each of which required a different policy remedy

34. Post-War Economic Strategy I • US post-war economic strategy in Iraq was initially based largely on only the Transition Economy/Shock Therapy model: • This model is an extreme version of shock therapy focus on long-term efficiency • Its goal was to wipe the slate clean and start the economy anew • The strategy aimed to create an open economy with low taxes to promote foreign private investment • Its emphasis was on creating macroeconomic stability and an independent central bank, with government remaining largely passive in dealing with economy • It aimed for high job creation through rapid private sector investment and expanded output, with foreign direct investment (FDI) and profitable imbalances from massive reconstruction projects as its key ingredients--an unbalanced development strategy

35. Post-war Economic Strategy II • The post-war economic strategy assumed that the government must reduce its role in the economy, expand the play of market forces, and undertake key reforms: • Liberalizing economic activity, prices and market operations • Establishing political accountability for economic performance, as well as public responsiveness to private sector economic needs • Developing indirect, market-oriented Instruments for macroeconomic stabilization • Using these instruments to increase market-based employment opportunities for Iraqis • Achieving effective enterprise management and economic efficiency, usually through privatization • Second-stage -- establishing an institutional framework to secure property rights, rule of law, and transparent market-entry regulations.

36. Post-War Strategy Dynamics • Iraq’s post-war strategy was intended to create Porter-type mechanisms of private-sector-induced reforms

37. Flaws in Initial Economic Strategy • With time, it became apparent that initial economic strategy was unsuited to Iraqi reality. It created an environment more favorable to criminals and extremists than to private investors intent on rebuilding the economy • The economic plan shut large numbers of Iraqis with no skills or capital out of the economic process and fueled widespread anger • It was impossible to attract the private investment on which the strategy depended in the face of political and economic uncertainty • The inability to produce sustainable short-run economic gains made economic reforms an easy target for extremist groups • US-led initial reforms did not lead to second stage of Iraqi-led institutional reforms but, instead, created a vacuum that was filled by existing organized religious and criminal groups • The incomplete reforms and inadequate price controls created profitable Black Market opportunities

38. Iraq’s Economic Transition I • Given Iraq’s continued commitment to an open free-market economy, there are a number of key questions surrounding Iraq’s future economic development: • Can the movement to free markets be accomplished without creating another layer of angry, marginalized Iraqis? • Will a new market economy benefit some groups and regions at the expense of others? If so, are there satisfactory solutions, or will there be an equity/growth tradeoff? • Will there be broad-based popular support for market liberalization, or will the movement to markets be perceived as promoting outside interests to the detriment of Iraqis? • To what extent will the US/IMF affect the nature and speed of economic reforms? Will reform be accomplished by consensus- building or through conditionality of financial support? • What factors may limit the economy from fulfilling its potential in contributing to state formation?

39. Iraq’s Economic Transition II • To achieve a successful transition in Iraq, experience to date suggests it is necessary to: • Separate government from natural resources • Ensure that petroleum benefits the people and avoid “curse of resources” or “paradox of plenty” problems • Diversify, following the example of countries like Mexico that succeeded in reducing dependence on oil revenues by encouraging other industries and non-oil exports • Attract back many of the four million highly trained and skilled expatriate Iraqis who have have experience with democracy and the workings of free markets • Attempt to develop an environment of economic accountability on the part of both the state and the private sector, with each placing pressure on the other for improvements. • Main issue: what level of success is possible if some or all of these conditions are not met?

40. Oil as an Economic Obstacle • Oil not only generates income, it creates its own set of forces that undermine the foundations of a strong, self-sustaining economy: • The availability of oil rents reduces the government’s need to extract money from society and, thus, earn citizen support by providing valued services and effective economic management • This lack of a rigorous tax system impedes the emergence of a strong state that legitimately represents its citizens. • Oil creates an implicit social contract in which state-provided welfare is substituted for political rights • Oil revenues encourage patrimonial loyalties, instead of participatory democracy • Exchange rate appreciation hurts rest of export economy (Dutch Disease). • Oil states tend to be authoritarian and many experience on-going conflict

41. Evaluating Economic Performance I • Evaluating Iraq’s economic performance is difficult due to: • Lack of accurate economic data • Little effort was made in pre-war Iraq to compile accurate economic data • Much of the data that existed was destroyed after the war • Limited manpower hindered systematic post-war data collection • Large amounts of Iraq’s economic activity occur in the underground, or shadow, economy • Lack of objective reporting • Many accounts are impressionistic, rather than based on verified facts • Lack of reliable surveys • Insurgency limits fieldwork • Many surveys suffer from systematic biases

42. Evaluating Economic Performance II • Even if macroeconomic data show that revenues and government expenditures are up, it would still be unclear whether the living standards of average Iraqis have improved. • The current data does not reflect: • Income distribution • Regional and local differences • Important sectarian and ethnic differences • Finally, data on government spending is hard to interpret because the productivity of that spending is not measured.

43. National Income • Oil dominates the Iraqi economy • It provides about 75% of GDP and 95% of foreign exchange earnings and government revenues • The non-oil economy consists of: • Agriculture, which makes up 7% and 25% of national employment • Wheat, barley, rice, vegetables, dates, cotton , cattle sheep and poultry – country used to be major agricultural exporter • Industry makes up 67% and 10% of total employment, with only 2 percent employed in petroleum • Services make up 26% and 65% of employment, with government the largest employer. • Shadow economy • May be as high as 40% of GDP and 50% of the labor force

44. Iraq: Relationship Between Oil Revenue and GDP

45. Post-War Economic Performance • Growth in real Gross Domestic Product (GDP) • 2003: -33.1%; 2004: 23.0%; 2005: 3.3%; 2006: 6.2%; 2007: 1.5%; 2008: 7.8%; 2009: 6.1 (proj); 2010: 6.0 (proj). • For non-oil GDP 2005: 12%; 2006: 7.5%; 2007: -2.0; 2008: 3.0% 2009: 5.0% (proj). • Per capita national income • At cost of living (PPP), income per capita was approximately $3,537 in 2007 • This figure affords a standard of living comparable to that of residents of Bolivia, Honduras, and Pakistan

46. Iraq: Trend in Income

47. Productive Sector Trends

48. Service Sector Trends

49. Electricity Constraints • Restoring the electrical infrastructure is critical to reviving the Iraqi economy and ensuring the productivity of the oil sector. • Demand has grown substantially and continues to outstrip supply • In 2008 supply met around 52 percent of demand even with increased generation. • The Iraqi Ministry of Electricity estimated in its 2006-2015 plan that it would need $27 billion over the next 6-10 years to provide reliable electricity across Iraq by 2015. • U.S. Government estimates the true cost may be twice as large • The GAO found: inadequate operating and maintenance practices as well as the lack of skilled technicians, inhibit an effective electrical infrastructure.

50. Iraq: Electricity Supply-Demand Balance