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Private Sector Economic Development in the KRG

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Private Sector Economic Development in the KRG

On May 2nd, 2016, Dr. Frank R. Gunther, Professor of Economics at Lehigh University in Pennsylvania, visited AUIS and gave a guest lecture titled: “Private Sector Economic Development in the KRG.” Professor Gunter is the author of The Political Economy of Iraq: Restoring Balance in a Post-Conflict Society (2013), which was selected by Choice magazine as an “outstanding academic title” of the year.

The Arabic version, translated by Mohaned al Hamdi Ph.D., was published in Iraq in 2015 and quickly became the best selling business or economics book in the country. He kindly donated his book –one English version and one Arabic version –to the University library at the occasion of his lecture.

Dr. Gunter is familiar with Iraq and the Kurdistan Region of Iraq (KRI), having worked here as the Senior Civilian Economics Advisor for Multi-National Corps – Iraq at Camp Victory, Iraq (July 2008 – July 2009). He was responsible for briefing the Commanding Generals of Multi-National Corps/Force on Iraqi economic development issues including impact of corruption, oil prices, state owned enterprises, and budget decisions.

Previously, he was assigned as military Chief of Economics Section for Multi-National Force – Iraq (MNF-I) in Baghdad, Iraq with similar responsibilities (November 2005 – May 2006).

During his lecture, he addressed the main issues prohibiting private sector economic development in Iraq in general, and in the KRI in particular. He raised concerns and highlighted policy recommendations, given the current circumstances. His central argument calls for a reduction of the regulatory burden imposed on small and medium enterprises (SMEs), which have proven to be the greatest vector of job creation in other countries, such as the United States, in recent years.

The Next Decade: Economic Assumptions for Policymaking

Dr. Gunter started his talk with what he considers to be the four main assumptions on which economic policymaking should be based in the medium run.

First, he believes that while ISIS will not be defeated altogether, it will devolve from a “state” to a “vicious insurgency,” thereby remaining a destabilizing factor in the region.

Second, with the increase in supplies coming from Iran and the United States and a reduction in demand from large economies such as India and China, oil prices are likely to remain within the $20 to $60 per barrel range for the next ten years.

Third, refugees and internally displaced persons (IDPs) currently living in the KRI will only gradually withdraw, as different cities and provinces are liberated. This process, he estimates, will take more than three years.

Finally, Baghdad and Iraq’s central government will continue to operate under what he calls “crisis mode” –a state of narrow-minded policymaking, where short-term decisions are made with the hopes of “getting through the week, the month.”

Unemployment in the KRG

The most serious challenge to economic development, Dr. Gunter argues, is unemployment.

While the Kurdistan Regional Government (KRG) has not published data in a few years, he estimates that, for 2016 about 20% (280,000) of the permanent population and 70% (350,000) of the refugee population are unemployed. This makes for a total of 630,000 people out of work in the KRI at the moment.

This high level of unemployment is accompanied by important social and political consequences. The annual unemployment growth rate means that the KRG will have to create 70,000 new jobs annually in order to prevent from the pool of unemployment from growing larger.

Options for Job Creation

1. Increase the amount of available public sector jobs. While this option has been used by both Baghdad and Erbil over the past decade, it is no longer on the table.

Important budgetary constraints will prevent the government from spending more on human resources.

2. Government-directed private sector job creation. This option has consistently failed in the past due to the large amount of regulation attached to policies and the arbitrary way in which they are applied.

3. The creation of space for private sector entrepreneurship (SMEs, mainly) to flourish, with limited involvement of the government in the form of regulatory reform at the beginnin

With this in mind, Dr. Gunter asks the following questions: What type of entrepreneurship needs support the most, in the KRI? How can barriers to private sector jobs creation be eliminated?

His answer is that there is no shortage of what he calls “creative,” or Schumpetarian, entrepreneurs in the KRI. Such entrepreneurs capitalize on the creation of knowledge –ideas, inventions, and innovations –to expand the barrier of societal productivity.

This usually requires considerable amounts of start-up capital and governmental support, which the KRG is in no financial position to provide at the moment.

In this sense, he suggests focusing on helping “arbitrage-speculation,” or Kirznerian entrepreneurs, who make opportunities out of shock-induced disequilibria in the economy, thereby ensuring that societal productivity is optimized within existing limits.

In other words, he argues, the full potential of private sector economy is not currently achieved within the KRI because of technical constraints. Several jobs could in fact be created, he claimed, by using existing products, processes, and markets to restore lost equilibria.

The main advantage of promoting this type of entrepreneurship is that it requires very limited initial financing, and is thus accessible to most members of society.

“If you are trying to discourage the private sector, then give it something that’s complex, uncertain, and arbitrary.”

According to Dr. Gunter’s research, several factors come in the way of private sector economic development.

He names corruption, a hostile regulatory environment, and the lack of financing available for SMEs as particularly harmful ones.

He illustrated his argument as follows: “If you are small enough to fly under the radar, you are good. If you are large enough to entertain the necessary political connexions, you are also good. The problem is if you are located in the middle. And that is where a reform of the regulatory environment would be most impactful.”

His approach to overcoming those obstacles in the short run is thus twofold.

First, the current regulatory hostility towards the private sector must be addressed.

Citing the 2014 World Bank rankings, he points to the fact that both Baghdad (72nd worst) and Erbil (57th worst) are scoring quite poorly in terms of business environment.

Some striking examples of that relate to the length and cost of processes to start a new business. Dr. Gunter states that, “to legally start a small business in the KRI, one must pay about 50% of what the average resident earns in a year in governmental bureaucratic procedures.”

Other examples are the facts that obtaining a construction permits legally can take up to 249 days, or that it will cost $2,808 and take 90 days to get permission to export one container through the Basra port. Most striking, however, was the bankruptcy recovery rate: no successful bankruptcies have ever been reported within Iraq. Those figures speak of very harsh entrepreneurial conditions.

In that context, Dr. Gunter discussed with a student the issue of public-private partnerships (PPPs). He argued that, in the case of both Iraq and the KRI, those effectively embody one more form of regulatory hostility. In practice, the public input in PPPs is limited to name legitimization, and often comes at a high cost for entrepreneurs.

To effectively and efficiently address those issues, Dr. Gunter suggests adopting the commercial code of the United Arab Emirates –because it is in Arabic and Sharia law compliant –, which rank reasonably high in terms of business environment in the region.

“A radical proposal for radical times,” he remarked. Indeed, he made the case that rewriting the KRI’s commercial code would require extensive resources and time, both of which are luxuries the KRG cannot afford at the moment.

Furthermore, he underlines the fact that such a reform of the commercial code comes at a relatively low political cost, which makes it realistic for implementation; the experiences of Egypt and Jordan prove this point.

Finally, regulatory reform would contribute to changing the economic incentives associated with corruption: more reasonable processes would decrease the need to find alternative ways to operate for entrepreneurs.

Second, Dr. Gunter also hints at the problem of financing, a major issue in a society where private banking is practically nonexistent.

As one of the most “under banked” countries in the world, he claimed, the Iraqi government, and the KRG, must increase access to microfinance through both ministerial grants and non-governmental organization (NGO) assistance.

The war with ISIS has indeed exacerbated the micro financing crisis throughout the country, making investment much riskier than it used to be.

In this sense, he recommends strengthening financial laws by eliminating the several contradictions that currently exist between laws applying to micro finance and investment. He argues that this small regulatory alignment would in fact have sizable positive impacts.

Finally, Dr. Gunter calls for the creation of a registry for movable assets, in order to allow individuals to use them as loan collateral.

Responding to a question about privatization as a means of creating jobs, Dr. Gunter pointed to the considerable loss in political capital associated with the privatization of state-owned companies.

Employees are a strong political force, especially in a context where most of the population is on government payroll. According to him, the best option, if any, would be the “Chinese way,” which consists of stopping public sector growth and phasing it out over time.

Will Iraq Ever Be Oil Rich?

Dr. Gunter firmly makes the case that oil prices will not rise again over the course of next decade.

Even if they were to, population increases will not allow for a return to the golden age of the 1970s.

Iraq is in fact one of the few countries in the Middle East where there has not been a sharp decline in fertility rate. A large, and growing, young population, further fuelled by regional migration, cannot prosper merely through oil exports.

Policy Development Needs

Dr. Gunter concluded by calling upon universities and academic institutions within the KRG to play a role towards private sector economic development. He highlighted the lack of up-to-date economic data and analyses –on topics such as the characteristics of private sector MSME and financials demand –as a major impediment to attracting foreign direct investment (FDI) and foreign businesses.

Answering a student’s question about the role of the younger educated generation in the process, he replied that new graduates should push for those reforms to be implemented, but that it is ultimately the role of politicians in place to act.

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