The State of U.S.-Iraqi Ties and Areas for Improvement

The United States and Iraq are tied together by shared history. Since 2003, the relationship between these two countries has been forged in war and occupation, but also in liberation, victory, and rebuilding. As laid out in the Strategic Framework Agreement of 2007 (SFA), Iraq and the U.S. are committed to a “long-term relationship of cooperation and friendship.”¹

The United States maintains ties to Iraq in three critical areas: military-to-military ties, diplomatic and cultural ties, and economic ties. In each of these areas there is great opportunity and potential in a post-ISIS Iraq, but also areas for improvement.

Military-to-military ties make up a key aspect of the U.S.-Iraqi relationship. Ensuring a secure and prosperous post-ISIS Iraq will require further development of these ties.

The military relationship is comprised of two basic elements: equipping and training, and advising. In each of these areas there is a need for improvement.

In the short term, priority should be given to the regeneration of the Iraqi National Army, and in particular its Counter-Terrorism Service (CTS). The “Golden Division,” as the CTS is popularly known, was the go-to force for most of the anti-ISIS fight, suffering 40 percent casualties in the Mosul battle alone, according to the U.S. Department of Defense.² The U.S. built the CTS in the decade after 2003 and must now re-rebuild it. The Baathist, criminal, and jihadi elements at the heart of ISIS and its predecessors in the Sunni insurgency will not disappear once ISIS gives up its last pockets of territory, and the CTS will have to be strong.

However, the Iraqi and U.S. governments should be making the necessary arrangements for a long-term training mission. While Iraq’s regular army has made great strides, there will continue to be a need for advanced training. Our allies, meanwhile, should be doing the same with the Federal Police. Such a mission would not only be of benefit to the proficiency of the Iraqi security forces, but would also further improve the force’s ability to act without inciting sectarian tension. Such an effort would build upon already favorable ground. The Iraqi Army has emerged as an impressive non-sectarian national institution, with 81 percent favorability nationwide.³

The rest of this section provides more detail on current U.S. efforts to equip and train and advise Iraqi forces, and how they can be improved.

Equipping

The United States has helped the Iraqi military equip itself through at least four programs. First is the Foreign Military Sales (FMS) program. FMS allows the government of Iraq to use its own funds to purchase U.S.-provided goods and services with the Pentagon as an intermediary, encouraging cost-effective pricing and a corruption-free process. Since 2005, over 22 billion dollars worth of sales have been completed through this system.⁴ Iraq’s FMS purchases to date include 146 M1A1 Abrams Main Battle Tanks and 36 F-16 fighter jets.

Since 2014, the United States has also provided, in relatively small amounts (about $2 billion), Foreign Military Financing (FMF) to Iraq. Seen as a tool of U.S. diplomacy, FMF funds are used to pay for American goods and services that Washington sees as desirable but difficult to achieve through the potentially politicized, slow, or corrupt defense ministries of U.S. partners. Via the FMF program, the United States has invested monies in long-term needs in Iraq such as ministerial capacity development and logistical sustainment systems. Provided through the State Department and administered by the Department of Defense, FMF funds have also been used in Iraq for immediate, frontline needs—such as body armor, tank and small-arms ammunition, and Hellfire missiles—in the fight against ISIS.⁵

Two closely related programs, Excess Defense Articles (EDA) and Presidential Drawdown Authority, were used to surge necessary equipment to Iraq in 2014 for the fight against ISIS —various trucks, mine-rollers, anti-tank missiles, body armor, and so on. These came from excess U.S. stocks and were transferred to Iraq free of charge.

Finally, out of the budget for Operation Inherent Resolve (distinct from other Defense or State Department funds), the Pentagon administers the Iraq Train and Equip Funding (ITEF) program, with over $4.6 billion appropriated since 2015. Now re-named the Counter-ISIS Train and Equip Fund (CTEF), the program has been allocated over $1.26 billion for 2018.⁶ Encouragingly, this is more than the amount allocated for 2017.⁷ ITEF has focused on training and basic combat equipment—small arms, mortars, trucks, trailers—for the regenerated Iraqi Army and Kurdish Peshmerga units.

Looking forward, Iraq’s finances will likely stabilize, given reduced war costs and significant expected growth in southern oil production. In this case, it will be possible for the United States to move the bulk of defense items back into FMS channels, meaning that Iraq will pay for them. It would be wise to continue a modest level of FMF, allowing Washington to gift certain U.S. priorities to Iraq on a targeted basis. The aim here would be to strengthen further the bonds between the two militaries and between Iraq and the U.S. defense industrial base.

In the main, Iraq will be able to carry its own weight, determine its own priorities, and pay its own bills. If U.S. allies continue to emerge victorious from Iraqi elections, there is every reason to expect the country to be a U.S. arms customer on a Saudi-type scale.

Training and Advising

Training provided by the United States has been decisive in the fight against ISIS. The CTS, the unit that carried the bulk of the fight against ISIS, was created by the United States in 2003 and has been sustained by the Pentagon for the past 15 years. The years of training by U.S. Special Forces paid dividends in the battles to take Fallujah, Ramadi, and Mosul back from ISIS. In the 2014 siege of the vital Baiji Refinery, a hundred-odd Golden Division commandos successfully held out against ISIS for 18 weeks, until successfully relieved.⁸

The impact of U.S. training is also visible in the regular forces of the Iraqi Army and the Iraqi Air Force. During the battle for Ramadi in late 2015 and early 2016, Iraqi Army engineering units were able to build and maintain a floating bridge over the Euphrates—a complex military task, especially under battle conditions, that reflects a high level of training.⁹ These are skills that did not exist prior to U.S. training.

In coming years, it is important that the United States continues to train Iraqi forces. Iraq is in a neighborhood with many threats, ISIS not the least among them. Iraqi forces will have to be trained to deal with both the “high-end” threat from other countries (despite the low probability, defending against invasion is still the raison d’etre of an army), and the lower intensity threat from Baathists and jihadis that may last for a generation. Interoperability, meanwhile, is a major benefit of bilateral military training: the more forces from two countries train together, the better they fight together when the time comes.

Despite the lessons of the ISIS crisis, extending the U.S. training mission in Iraq may encounter political difficulties in both Washington and Baghdad. These are surmountable on both sides. So long as the U.S. trainers can stick to low-profile locations out of general public view, both sides should be able to work out an agreement for a long-term presence.

The silver lining to the precipitous U.S. military and diplomatic withdrawal in 2011 is that the aura of occupation was broken. The return of U.S. forces at the explicit request of the government of Iraq, genuinely to save the day against ISIS, means that the political environment for this discussion has changed. A long-term, peacetime U.S. presence in the range of at least 5,000 uniformed personnel should be sustainable on both sides. Larger presences have been successful in post-conflict Germany, South Korea, Japan, and elsewhere. As long as U.S. troops continue to be welcome in Iraq, there is no reason not to have a presence there that brings the capabilities Iraq requires.

The Pentagon’s International Military Education Training (IMET) program, which sends foreign officers to U.S. command and general staff colleges, currently includes ten Iraqis at an annual cost of approximately $1 million.¹⁰ Expanding this for a frontline, proven ally like Iraq could prove economical down the road. The United States should also continue to offer advisors, both military and civilian, to the Iraqi military, interior forces, and intelligence services, as well as other parts of the Iraqi government if requested. Building leadership capacity in our long-term partner is primarily a matter of a few well-targeted initiatives and can be achieved discreetly and at relatively low cost.

The United States must continue to find ways to develop non-military ties with Iraq, as laid out in the SFA. Expanding diplomatic and cultural ties is an essential part of this effort. The unprecedented prestige and goodwill that the United States currently enjoys in Iraq make the timing for this work propitious. The two countries have something in common that is meaningful and rare: Both are democracies for which their peoples fought hard and sacrificed much in bloody wars. Very few U.S. allies and partners around the world—and none in the Arab world—share bonds like those that link the United States and Iraq.

Further contact between Iraqis and Americans in civilian settings will help build on the deep connections that already exist in the security sector. Iraq already sends thousands of students to the United States for advanced academic degrees via a number of programs. The most notable of these has been Iraq’s Higher Commission for Educational Development, which has sent 2,800 graduate students (Masters and Doctoral) to the United States and elsewhere to develop both capacity and Western ties, and 1,200 Iraqis have now returned to Iraq with degrees.¹¹

Thanks to Baghdad’s budgetary constraints during the recent financial “perfect storm” of dropping oil prices at the same time as the ISIS crisis, no new students have been sent since 2015. Ways to fill this gap should be explored. Cultural exchanges could be expanded, and an international effort focused on Iraq’s rich historical sites—places of global stature, including Babylon, Ur, Nineveh, and elsewhere—would benefit all involved.

Supporting Iraq’s cultural heritage, and antiquities in particular, is a uniquely powerful way to aid economic development and strengthen non-sectarian national sentiment while signaling our profound respect for the country and its people. Cultural sites in the area around Mosul suffered severely under ISIS, and as this diverse region is the country’s main flashpoint, Mosul and the Nineveh Plain would make sense as a priority for job-creating, politically unifying cultural heritage support.¹²

Finally, there is one quick, easy, and inexpensive method by which the United States can strengthen its influence in Iraq: Washington should send a political ambassador. The role is so important to Iraqis that the U.S. ambassador is often a household name in the country. Iraqis, like most people in real-world “hot spots,” are far more impressed by power, and perceived closeness to power, than they are by even the most distinguished bureaucratic résumé. The ideal individual would be as conversant in markets-led economic growth as he or she would be in Iraq’s culture and politics.

A political ambassador brings a different level of relationship between a foreign government and the White House. For a foreign capital to know that the ambassador can reach, if not the president, at least someone in his inner circle, can be very reassuring. This prestige in turn allows the United States to get more done. In Iraq’s case in particular, the State Department’s traditional posture is not always consistent with the president’s more vigorous approach, which was so successful against ISIS in 2017. Iraqis know which has been the more successful for them.

As Washington formulates policy for a post-ISIS Iraq, it should be axiomatic that the more the United States succeeds at helping Iraq on the economic front, the less it will need to do on the security front. President Trump’s senior Iraq team should be as replete with experienced capitalists as it is with elite national security talent.

With ISIS defeated as a territorial force, and a fully independent Iraq enjoying under al-Abadi its first legitimate and non-sectarian leadership since the fall of the monarchy in 1958, security and identitarianism are giving way to more normal daily concerns as priorities for Iraqis. The 2017 NDI poll put corruption and jobs as the top concerns, at 43 percent and 41 percent respectively.¹³ Security and sectarianism were at 34 percent and 15 percent.

Four areas are particularly important to U.S.-Iraqi economic ties and the future of Iraq’s economy: the maintenance of sufficient international lending, the promotion of the Iraqi private sector, oil economy reform, and the modernization of Iraq’s economy more broadly.

International Lending

Iraq’s handling of the international lending universe has been a major success story. This has not only contributed to Iraq’s deft navigation of its recent financial crisis, but also shown two of Iraq’s greatest assets: the technical capacity of the country’s high-level human resources, and the fundamental maturity and pragmatism of Iraq’s political system.

After intense negotiations among the political parties in Baghdad, an important breakthrough came last July when the Iraqi Parliament passed a supplementary budget seen favorably by international lenders. Trimming spending and making provisions for debt payments and arrears, the budget was particularly welcomed by the IMF.¹⁴ The IMF gave Iraq a positive review at its subsequent monitoring exercise and in late July of 2017 disbursed the second tranche ($825 million) of the $5.3 billion facility agreed in 2016.¹⁵

The IMF program has provided much-needed liquidity, imposed various necessary reforms on the Iraqi economy—including a freeze on federal hiring and bonuses in the 2018 budget—and catalyzed support from other international funders, including the World Bank, the G7, the Islamic Development Bank, and numerous others. Washington should continue to support these activities with diplomatic and technical assistance.

Global capital markets have responded favorably to al-Abadi-era Iraq’s financing initiatives. In January 2017, Iraq successfully floated a $1 billion U.S. Treasury-backed Eurobond, arranged by J.P. Morgan, Citigroup, and Deutsche Bank.¹⁶ In August, a second $1 billion Eurobond issue, arranged by the same banks but without the U.S. guarantee, was almost seven times over-subscribed by international investors.¹⁷

As of February 23rd, the bond with the U.S. guarantee was yielding about 3.95 percent and the unguaranteed bond was trading at a yield of approximately 6.15 percent. The blended borrowing rate of just over 5 percent represents a solid achievement on Baghdad’s part and demonstrates the utility of well-directed U.S. support.

Iraq’s Private Sector

In terms of Iraq’s private sector economy, there are numerous areas where the United States is well-positioned to help spur growth. Widespread inefficiency, dependency, and corruption are among the worst ongoing legacies of Iraq’s Saddam-era bureaucratic superstate. Fighting corruption is a nice mantra, but the way to reduce it in practical terms is to reduce the footprint of government involvement in daily economic life. Having run his own engineering business and consultancy in the United Kingdom during his years in exile before Saddam’s fall, Prime Minister al-Abadi is one of the very few important national leaders on the global stage with a personal background in the entrepreneurial private sector. It bodes well for the ongoing U.S.-Iraq relationship that he shares this status with President Trump.

Prime Minister al-Abadi understands the crushing effects of Baath-style statism, and is working effectively to reduce the burden. The task is enormous, and he deserves as much U.S. support in this as possible. The Economic Reform Unit (ERU) that he established in the Office of the Prime Minister is staffed by Iraqis, many of them fairly young, with high-quality international business and legal backgrounds. The United States is currently paying at least some of these salaries, and the ERU is working aggressively to modernize the economy wherever possible. This is the kind of U.S. support that can be extremely efficient.

Iraq’s banking sector is a prime example of the problem Iraq faces. About 90 percent of the sector, as measured by deposits, is state-owned.¹⁸ The country does have numerous private-sector banks, but they are small. These include at least half a dozen owned by respectable foreign institutions and conducting world-class international business. The Bank of Baghdad, for example, (which one of this paper’s authors knows well from a long-term shareholding) is owned by KIPCO of Kuwait, operates internationally through a relationship with Citigroup, and handles payroll in Iraq for major multinational companies.

Business banking in the country is dominated by the state-owned Trade Bank of Iraq, while retail banking almost entirely goes through two Saddam-era public sector giants that in the opinion of these authors would be effectively bankrupt under most modern regulatory regimes. Privatizing the day-to-day banking operations of these institutions would direct huge resources towards the country’s growing and dynamic, but capital-starved, private sector.

Financial-markets reform is desperately needed. Among other restraints, Iraq’s private economy is hampered by a stock market that is almost absurdly small in relation to the size of Iraq’s economy. With a total market value of about $13 billion, the Iraq Stock Exchange (ISX) represents 5 percent of 2017 GDP. ¹⁹ In neighboring Saudi Arabia, with roughly the same number of people and likely similar hydrocarbons reserves, the market capitalization-to-GDP ratio was about 65 percent at the end of 2017.²⁰ The ISX currently comprises a few dozen Saddam-era firms and two modern, foreign-owned telecoms carriers that were required by the terms of their 2004 digital cellular (GSM) licenses to list on the exchange. (There is a third GSM carrier, owned by the Kurdish Barzani family, that prefers simply to rack up the fines, rather than endure the transparency of a local listing.)

Iraq suffers from a lack of local liquidity, the absence of an asset management industry, and the stranglehold of state ownership on much of the old economy. But the economy is dynamic, fundamentally capitalist, and growing. The overwhelming culprit for the anemic stock market is simple: an outmoded, insider-driven regulatory regime that scares off foreign investment and makes initial public offerings (IPOs) close to impossible.

As a result, Iraqis are denied the powerful contribution that a functional equity market makes in providing capital for growing companies. In our extensive work in the Iraqi private sector over the past decade, the authors have come to know many Iraqi entrepreneurs, established family businesses, and enterprises of every stripe. The technology sector is particularly dynamic, with numerous Iraqi Amazons and Ubers benefiting from the local coding camps and startup incubators that are beginning to modernize the economy from below.

These businesses, old and new, would be natural candidates for the kind of job-creating investment that dynamic financial markets have created in so many emerging economies around the world. In Peru, Thailand, or Pakistan, many of these firms would have raised significant money on the public markets. Yet in Iraq not a single such company that we know of has even considered an ISX listing.

Oil Economy Reform

As Iraq gears up for its wealthy future, avoiding the “oil curse” should be a major priority. Easy money, belonging to the state and not the people, leads to the familiar vices of national rentierism: hollowing out of the private, non-resource-based economy, corruption, military adventurism, economic serfdom, handout culture, and unaccountability at the top.

A prime example of the corrupting influence of Iraq’s legacy oil economy is the monthly “food basket” that Iraqis currently receive from their government. Fifteen years after Saddam Hussein’s fall, and despite huge declines in the numbers of Iraqis requiring nutrition assistance, this remains the largest state-sponsored ration system in the world.²¹ The “basket,” picked up from thousands of grocery stores and corner shops around the country, changes month-to-month. The corruption, inefficiencies, and economic demoralization created by this relic of Saddam’s Leviathan need hardly be elaborated here.

In the short term, the food basket should be replaced by a monthly credit to a charge card or mobile-payments account. This will provide Iraqis with a guaranteed minimum capacity to offset basic needs, which can then be supplied on the open market. Cutting out this layer of government will both remove a wasteful and expensive bureaucracy and eliminate huge swathes of corruption.

The Iraqi constitution is careful to state that the nation’s hydrocarbons wealth is owned not by the state or any group or region, but rather by “all the people of Iraq.”²² Iraq should aspire eventually to have much, if not all, of its oil wealth distributed directly to its citizens. A hallmark of a normal nation is that government expenditures largely come from funds sent up to the government by free individuals, through the taxes agreed by their electorally accountable representatives. In an Iraq where the state relies upon the people for funding, rather than the other way around, Saddamism, Khomeinism, and Putinism will not happen. For Iraq, direct personal oil revenue accounts, comparable to those in Alaska or Norway, would have the added benefit of giving people in non-oil rich parts of the country, for example the Sunni west, a transparent, equal, and accountable stake in the national wealth.

The revenue side of the Iraqi fiscal system is ripe for reform in other ways, too. The current structure of Iraq’s oil contracts (ex-Kurdistan, where the contracts are highly opaque and much smaller) is an especially important candidate for improvement. The existing contract template has been used by Baghdad in all of its deals with international oil companies (IOCs), from Exxon, Lukoil, and BP to state-owned oil majors from around the world. Known as a “technical service contract,” this type of agreement was initially celebrated by Iraqis as a significant victory when the IOCs first started signing up to it, in 2009. It has now become a major liability.

In the hydrocarbons sector, Iraq is in the classic emerging markets position of needing outside investment to get its wealth out of the ground and shipped to market. Most countries in this situation use some kind of “production sharing arrangement” (PSA). In the PSA scenario, the international oil company brings the capital, technology, and expertise—and then shares in the economic risk and reward of the project. The business model of the IOCs is built around taking risk in this way, and the companies enter these projects willingly and with a strong incentive to perform as well as possible. Both sides, the host country and the oil company, ideally win.

In Iraq’s case, the eventual prize is so big that the host country was able to persuade the IOCs to do something that they do almost nowhere else: forego risk-sharing PSAs in favor of service contracts that pay a fixed amount per new barrel extracted.

Thus, BP is paid $2.00 per barrel extracted from the Rumaila field,²³ and Exxon is paid $1.90 per barrel that it extracts from West Kurna.²⁴ It is an economic arrangement that effectively makes the IOCs into service companies, rather than risk-takers, and the IOCs are tiring of it. Shell, for one, announced in September their intention to sell out of its main Iraq oil contract altogether.²⁵ Shell seeks to get out of the contract, but not out of Iraq, demonstrating the importance of the contract structure: Shell announced that it was staying in its $12 billion gas project and $10 billion petro-chemicals project, both near Basra.²⁶

The current oil contracts in Iraq (ex-KRI) deal with increases in production at long-established fields. The country also has potentially vast new fields, currently either unexplored or lightly explored. For these to be developed many new contracts will have to be signed with the IOCs. Denied their traditional profit mechanism, the IOCs’ performance in southern Iraq has been solid but not dynamic. Under the current terms their interest in new, exploration-based contracts is low.

It is a testament to the vast wealth ahead that even under these circumstances—and despite the ISIS crisis, a 40 percent decline in the global oil price (from roughly $110/barrel in early 2014 to about $65/barrel currently),²⁷ and the dramatic disappointment of Iraqi Kurdistan as an oil province to date—Iraq has increased oil production from 2.5mbpm in 2011 (the year of the U.S. withdrawal) to a high of 4.7mbpm in December of 2016 (though production has ebbed since then to about 4.3mbpm,²⁸ due mainly to OPEC quotas and the Kurdish crisis).

Economic Modernization

Much of the rest of the usual list of economic modernization measures also applies in Iraq. Visa access for business visitors must be easier. Land ownership laws must be liberalized to encourage investment. Establishing, registering, and closing companies needs to be much simpler and faster. Prime Minister al-Abadi’s Streamlining Procedures Committee has made some progress on such measures, but work to-date has been the proverbial drop in a bucket.²⁹

The authors are not naïve about the nature of Iraq society, and many of the economic measures discussed here will be difficult to achieve. But political freedom was also considered unsuited to the Iraqi people. Instead, it has been immensely successful. There is no reason to think that Iraq deserves, and will embrace, economic liberty any less than political freedom. The job-creating, liberating reforms we are talking about stand their best chance if enterprising Iraqi politicians perceive their vote-winning potential.