Can occupation fuel U.S. recovery?

The American economy's new-found buoyancy is in large measure the result of the defence spending fuelled by the occupation of Iraq. But its sustainability is doubtful in view of the fact that the Iraq misadventure is proving to be much more prolonged than expected, more unilateral than multilateral and costly in terms of the number of American lives lost.

THE last day of July brought news of unexpected vigour in United States economic growth. Commerce Department figures show that in the second quarter of 2003, the U.S. economy grew by 2.4 per cent, which was well above the 1.5 per cent predicted by many analysts. Interestingly, there is consensus on the cause of this buoyancy, which has been hastily interpreted as the first sign of a long-awaited recovery. Analysts point their finger at the substantial rise in government spending fuelled by the occupation of Iraq, which has been assessed by the Financial Times, London, as being the "largest run-up in government spending since the Vietnam War".

Pentagon estimates of the cost of the war in Iraq thus far are quoted at $48 billion. Currently, with the U.S. finding little support in terms of men, materials and money from countries other than Britain, it is estimated to be spending a further $3.9 billion a month to finance its occupation. As a result, defence spending in the recent past has been rising at a 44 per cent annualised rate. Not surprisingly, overall government spending rose by an annualised 22 per cent in the second quarter of 2003, contributing, according to some estimates, as much as 1.5 percentage points to the 2.4 per cent second-quarter growth rate.

The second-quarter growth figure must be giving cause for celebration to a government that is fast loosing domestic support for its Iraq misadventure that is proving much more prolonged than expected, more unilateral than multilateral and more costly in terms of U.S. lives that are being lost virtually every day. But these very factors make the task of sustaining the spending that yields that growth rate difficult. The view that the direct financial cost of the occupation is proving too heavy for the U.S. government, even if it is proving to be good for American business and the American economy, is gaining ground. If growth is to be sustained, therefore, the U.S. must ensure that other international governments contribute to the reconstruction effort and that the "external" benefits of that effort must flow to the U.S.

However, while a solely U.S. occupation and reconstruction effort is increasingly proving infeasible, support from the international community has been virtually absent, not just in terms of sending troops but also in terms of finance for reconstruction. With the occupation unlikely to be short-lived, estimates suggest that the cost of the occupation alone for the U.S. could amount to around $3 billion a month for the next four years, or a total of around $150 billion.

To this must be added the cost of the ongoing, even if limited, process of reconstruction. That process is to be financed partly with U.S. funds approved by Congress and substantially with revenues from Iraqi oil, production and export of which is still to reach its full potential. Lael Brainard and Michael O'Hanlon of the Brookings Institution quote estimates, based on the presumption that Iraqi oil production is unlikely to be restored to potential in the near future, which place spending for reconstruction at anywhere between $5 billion and $120 billion a year over the next several years.

In April this year, Congress approved $3.6 billion towards the reconstruction effort. According to White House Budget Director Joshua Bolten, funds from various sources such as frozen Iraqi assets, revenues from oil and $800 million in cash found inside Iraq, had helped add to the congressional appropriation and secure $7.7 billion for rebuilding efforts during 2003. But the Iraqi administration is likely to run through this money relatively fast. Paul Bremer, U.S. administrator in Iraq, recently informed the Bush administration that he expected to spend $7.3 billion by the end of the year. Speaking to CNBC's Capital Report regarding the cost of rehabilitating and reconstructing Iraq, Bremer said: "It's probably well above $50 billion, $60 billion, maybe $100 billion. It's a lot of money." He clearly intends to return to Washington with a large request for funds.

Thus, even if the actual spending on reconstruction is a small fraction of the Brookings estimate, deficit-financed spending by the U.S. is bound to increase substantially if outside help is not forthcoming. Though current trends indicate that this could convert the recent buoyancy of the U.S. economy into a robust recovery, there are ideological and congressional limits to that process. However, if the U.S. manages to restore Iraqi oil production to potential in the near future, the gains it gets from financing the costs of occupation would be strengthened by the benefits derived by U.S. business from the reconstruction spending financed with oil revenues. Even if the occupation alone can be sustained, the purely economic gain for the U.S. from the occupation could be substantial. But if governments outside the war coalition could be persuaded to contribute to the reconstruction effort, then a U.S. recovery is a real prospect.

IRAQ, the victim, is meanwhile less fortunate. It remains devastated by the war, with little benefit as yet from reconstruction. Electricity and water facilities are still to be restored to pre-war levels and hospitals are short of supplies. This shows that the level of spending and its allocation were inadequate from the point of view of quick-impact reconstruction. In late July, White House officials provided the U.S. Senate Foreign Relations Committee members with a report on the extent and pattern of spending, as of June 30, out of the $7.7 billion funds that was available for reconstruction. Till that date, allocations totalled slightly more than $2.7 billion. Of this, $2 billion came from the funds approved by Congress and $750 million from seized and vested Iraqi state assets. Of the $5 billion that remained $2.2 billion was from funds appropriated by Congress, $1.8 billion from seized and vested Iraqi state assets and approximately $1 billion from the Iraq Development Fund.

A significant share of the $2.7 billion spending till June 30 had gone towards emergency payments and salaries for Iraqi civil servants and pensioners ($400 million) and to support the operations of the Coalition Provisional Authority (CPA) in Baghdad ($200 million). The U.S. administration in Iraq had spent about $730 million on humanitarian initiatives like restoring food distribution and augmenting medical supplies leaving $1.37 billion for reconstruction including restoring basic services and oil production. This compares with the U.S. civil administration's own estimates that it would cost $13 billion to rebuild the electricity infrastructure and the United Nations' forecast that it would take $16 billion over four years to restore water supplies.

With the reconstruction effort proving inadequate, three months after the end of the war, Bremer announced at the end of July a "detailed timetable and clear benchmarks" to restore crucial services to pre-war levels in 60 days. Experts are sceptical. In the case of electricity supply, for example, this would require increasing generation from 3,000 MW at present to 4,000 MW. But security problems, ageing equipment, lack of spare parts and the effects of the looting of high voltage power lines imply that such an increase, even if achieved, would not be sustainable.

Even though reconstruction has been slow, policies to ensure that the gains from occupation would accrue to corporate America and the U.S. economy are being rapidly put in place. In particular, the CPA has initiated moves that would open up the Iraqi economy for foreign operators. In July, the CPA while announcing a competition for mobile phone licences in Iraq, promised to waive Iraqi legislation requiring foreign investors to allocate a 51 per cent equity share in projects in Iraq to Iraqi entities.

Another example is the call for proposals from international banks and consulting firms to help restructure Iraq's two biggest state-owned banks - the Rafidain Bank, with deposits of over $1 billion, and the smaller Rasheed bank - with 150 branches each. This restructuring process is seen as a prelude to allowing the contractor who undertakes the process to buy into the banks' equity.

The "privatisation" in favour of foreign investors is problematic because of evidence that it is primarily U.S. firms that are benefiting and are likely to benefit from the still limited reconstruction effort. On July 31, Halliburton, the second biggest oilfield service company in the world and one of the largest private contractors in Iraq, reported that work in Iraq had boosted its revenue and helped it swing from a loss to record second-quarter net income of $26 million. Dick Cheney was the chief executive of Halliburton from 1995 to 2000 before he became U.S. Vice-President and its activities have been controversial because its German subsidiary Halliburton Company Germany GmBH has contracts with Libya even though the Iran-Libya Sanctions Act passed in 1996 by the U.S. Congress seeks to keep U.S. companies out of Libya. On May 30, Halliburton had announced that it had finalised a $6 million agreement to settle 20 lawsuits alleging that the company used deceptive accounting practices when Dick Cheney ran the company. Halliburton's role in Iraq has been controversial since the U.S. Army's Corps of Engineers awarded it a contract worth $7 billion to extinguish oil-well fires and undertake emergency repairs without calling for bids from competitors. The lead the company got appears to be favouring it subsequently as well. Recently, its rival Bechtel announced that it would not participate in two calls for bids totalling $1 billion for repairs in Iraq's oil sector.

These trends explain in part the unwillingness of other countries of the Organisation for Economic Co-operation and Development (OECD) to contribute substantially to the reconstruction effort. As pressure builds on the U.S. to seek financial support from other countries to accelerate the reconstruction effort, and Bush has put out an appeal for such support, France and Germany have called for the creation of an independent fund as an alternative to the U.S.-controlled Iraq Development Fund to which contributions likely to be pledged at a proposed donor conference in October can be made.

Gunter Pleuger, Germany's Ambassador to the United Nations, has announced that "Germany stands ready to contribute its share", but that "international support to the necessary extent will only be forthcoming if full transparency and international participation in the decision- making process will be assured." In Germany's view, "the creation of a separate international fund could dispel some concerns, expressed by some members of the United Nations, with regard to the Development Fund for Iraq."

France's Ambassador to the U.N., Jean-Marc de La Sablire, supported the suggestion when he said: "We favour creating a special multilateral fund, managed collectively by the United Nations Development Programme and the international financial institutions." Others have suggested that even the Iraq Development Fund, through which oil revenues are to be channelled into reconstruction, should be subject to scrutiny by an international board created for the purpose.

If the U.S. is forced to accept these conditions to legitimise its occupation with accelerated reconstruction and a return to normalcy and if the growing domestic opposition forces it to cut back on its defence spending and, therefore, its own military presence in Iraq, then the hope of recovery spurred by the second quarter growth figure would definitely remain unrealised.