Iraq's Next Shock Will be Shock Therapy

With one exception - the actual military "victory," which looks increasingly Pyrrhic - President Bush's Iraqi adventure has been marked by repeated failures. Scant signs of weapons of mass destruction have been found, and, according to David Kay, America's chief arms inspector, the stockpiles either never existed or were destroyed years ago. So Bush simply ignored the data, gathered by Hans Blix's UN inspectors, and the evidence on which he based his case for war seems to have been largely fabricated.

Worse still, it is now clear that Bush never had a plan for when the war ended. Instead of moving towards peace and democracy, the situation in Iraq remains so dangerous that Paul Bremer, the American occupation leader, is using instability as his rationale for avoiding democratic elections this year.

Of course, America tried to keep real order in some places, revealing a lot about what it truly valued in Iraq. When Baghdad fell, the oil ministry was quickly protected, while museums and hospitals were allowed to be looted. 

If there was not outright corruption in the $7 billion in contracts awarded to Halliburton, whose former chairman was Vice President Dick Cheney, there was undoubtedly a strong whiff of crony capitalism. Halliburton and its subsidiaries have been ensnared in charges of war profiteering ever since, and have had to pay back millions of dollars to the US government.

Now, everyone agrees, the most important task - beyond creating a democratic state and restoring security - is reconstructing the economy. Blinded by ideology, however, the Bush administration seems determined to continue its record of dismal failures by ignoring past experience.

When the Berlin Wall fell, the countries of Eastern Europe and the former Soviet Union began transitions to a market economy, with heated debates over how this should be accomplished. One choice was shock therapy - quick privatization of state-owned assets and abrupt liberalization of trade, prices, and capital flows - while the other was gradual market liberalization to allow for the rule of law to be established at the same time.

Today, there is a broad consensus that shock therapy, at least at the level of microeconomic reforms, failed, and that countries (Hungary, Poland, and Slovenia) that took the gradualist approach to privatization and the reconstruction of institutional infrastructure managed their transitions far better than those that tried to leapfrog into a laissez-faire economy. Shock-therapy countries saw incomes plunge and poverty soar. Social indicators, such as life expectancy, mirrored the dismal GDP numbers. 

More than a decade after the beginning of the transition, many postcommunist countries have not even returned to pre-transition income levels. Worse, the prognosis for establishing a stable democracy and the rule of law in most shock-therapy countries looks bleak.

This record suggests that one should think twice before trying shock therapy again. But the Bush administration, backed by a few handpicked Iraqis, is pushing Iraq towards an even more radical form of shock therapy than was pursued in the former Soviet world. Indeed, shock therapy's advocates argue that its failures were due not to excessive speed - too much shock and not enough therapy - but to insufficient shock. So Iraqis better prepare for an even more brutal dose.

There are, of course, similarities and differences between the former communist countries and Iraq. In both cases, economies were pervasively weakened before they collapsed. But the Gulf War and sanctions weakened Iraq's economy much more than communism weakened the USSR's.

Moreover, while both Russia and Iraq are heavily dependent on natural resources, Russia at least possessed demonstrated abilities in some other areas. Russia had a highly educated labor force, with advanced technological capabilities; Iraq is a developing country.

To be sure, Russians went decades without opportunities to exercise entrepreneurship, while Ba'athist rule did not suppress Iraq's merchant class and entrepreneurial spirit in any comparable way. But Iraq's location puts it at a distinct disadvantage compared to Russia and many postcommunist states: none of Iraq's neighbors is doing particularly well economically, while many postcommunist countries sat next door to the European Union during the 1990's boom. Most importantly, ongoing instability in the Middle East will deter foreign investment (other than in the oil sector).

These factors, together with the ongoing occupation, make quick privatization particularly problematic. The low prices that the privatized assets are likely to fetch will create the sense of an illegitimate sell-off foisted on the country by the occupiers and their collaborators.

Without legitimacy, any purchaser will worry about the security of his property rights, which will contribute to even lower prices. Furthermore, those buying privatized assets may then be reluctant to invest in them; instead, as happened elsewhere, their efforts may be directed more at asset stripping than at wealth creation.

If Iraq's prospects are as dismal as my analysis suggests, any international contribution to the US-driven reconstruction effort is likely to be little more than money flushed down the drain. This does not mean that the world should abandon Iraq. But the international community should direct its money to humanitarian causes, such as hospitals and schools, rather than backing American designs.

The World Bank and other institutions considering assistance through loans face even greater difficulties. Piling more debt onto Iraq's already huge obligations will only make matters worse. If Iraq's economy falters as a result of a misguided economic reconstruction program based on shock therapy, the country will be further indebted with little to show for it.

The dream of Iraq's American invaders was to create a stable, prosperous, and democratic Middle East. But America's economic program for reconstructing Iraq is laying the foundations for poverty and chaos.

Joseph E. Stiglitz, a Nobel laureate in economics, is Professor of Economics at Columbia University and was Chairman of the Council of Economic Advisers to President Clinton and Chief Economist and Senior Vice President at the World Bank. His most recent book is The Roaring Nineties: A New History of the World's Most Prosperous Decade.