Defunding Inkblot

With the announcement that reconstruction funding for Iraq is coming to an end this signifies the end of any significant effort of a hearts and minds approach to counter-insurgency in Iraq. The Washington Post article states “U.S. officials in Baghdad have made clear, other foreign donors and the fledgling Iraqi government will have to take up what authorities say is tens of billions of dollars of work yet to be done merely to bring reliable electricity, water and other services to Iraq’s 26 million people.” However this is an unrealistic assumption.

For this statement to be true, one of two things need to be occuring. The first is for a stable and predictable environment for foriegn funds to enter. The second is for the Iraqi government to be able to collect significant revenue and maintain clear lines of communication between its import entry points and the end points. Both of these actions presuppose security is sufficient to have a chance in hell of making money.

Investors will rarely send their money to locations where they expect to be routinely shot up. Iraq is one such place. The few instances of private investment in the Iraqi oil industry have occurred in the very quiet and secured Kurdish controlled regions. However this region is not the problem that the rest of the country is. However the Kurdish regions are still affected by the insurgency and the general lack of security as pointed out by John Robb that while the Kurds may control Kirkuk’s oil fields as well as other newly found fields, they might never be able to profit from it”.

There are no good means for foreigners to invest significant capital sums into the current Iraqi economy and expect to see stable long term returns. Consumer goods and retail distribution may be a source of profits that have been financed by Iraqi hard currency savings, but capital projects are not paying off at this time due to security concerns.

The Iraqi government’s primary source of income is the export of petroleum for hard currencies. 2005 oil production is less than 2004 oil production by about 10%. November 2005 production was only 60% of the average 2004 daily production and the December 2005 production level was 55% of the 2004 average daily production. 2005 saw a boost in overall revenue compared to 2004 despite the lower levels of production and exports due to the increase in price, but this is a one time windfall profit and not a sustainable trend in government revenue. Right now the a href=””>NYMEX futures market for light crude does not predict a massive price spike. Instead, the market predicts a fall in oil prices of about 1.7%/year over the next five years in nominal terms, and with a 4.5% discount rate, a decline in real price of roughly 25% for the Dec. 2012 contract.

So if we are to assume constant production, and no growth in Iraqi internal consumption, then the Iraqi government will face an even more significant revenue squeeze in the future. We know that already the Iraqi government has had problems paying its soldiers and conducting normal day to operations due to cash constraints. If we are to assume that the combination of the insurgencies and general lack of maitenance over time continues to degrade the extraction, refinement and distribution systems of the oil industry, then the cash flow problems become even worse for the Iraqi government. Already, due to the two problems of an effective sabotage campaign and long deferred maitenance, the Iraqi government imports $200 million dollars worth of refined fuel per month, eating up 10% of total hard currency earnings. This is a weak spot which will only get weaker as maitenance continues to be deferred or as repaired pipelines get blown up again.

The Iraqi Army has seen multiple company sized units overrun in the past month. Checkpoints and roadblocks are again being overrun as the current concern of the Iraqi military is not actually fighting but preparing for the sectarian civil war with all the militias that have reflagged themselves and re-equipped with US funding.

The trend in the effectiveness of the insurgency has been stable or improving in their lethality. Glaivester makes a strong argument that the insurgency has become on average more capable, consistent and deadly this year than in 2004. The insurgency may not be able to control territory in the face of brigade and division sized assaults of US heavy armor backed up by air power, but they have disrupted Iraq’s ability to function as a modern state. And this military disruption veto is very unlikely to subside, especially if the US attempts to stop reconstruction funding.

Why do I say this?

Simple, for the current fad of clear and hold to implement the inkblot (PDF) is both a military and a socio-political-economic strategy. The military part is dependent on both an effective American heavy clearing force, and then competent and motivated Iraqi forces as the follow-on holding force. The socio-political-economic side is dependent on money.

The military campaign is for the US heavy forces to go in, punch out any dug in insurgents and clear the local town or city. Afterwards Iraqi Army and police units show up and provide a bubble of security with US assistance. Within this bubble basic governmental goods such as security, predictability and then public goods are introduced to create a positive alternative to the insurgency. These public goods include energy, clean water, good schools, jobs, and economic activity. From here, the theory is that you will get a positive feedback mechanism where the marginal person as the inform/non-inform or cooperate/fight decision decides to cooperate with government forces, and that tomorrow, the person who is the new marginal decider decides to help the government forces because they provide a much better environment than the insurgency.

Hopefully after three to six months the counter-insurgent force sees a cascade of these positive decisions which allows them to quickly, cheaply and effectively roll-up any hold-outs in the area as well as the supportting guerilla infrastructure. Therefore the town is now secured. After this area is secured, the surge forces can evacuate and leave behind maitenance forces (primarily police) to maintain order on their own while the surge forces go on and repeat the process in the next village/town/city on the list.

One of the primary sources of potential public goodies has been the US reconstruction funding. A good chunk of that has been diverted to security related funding, but it is still the largest chunk of change in the entire country that could be dumped into an area to create a bubble of positive public and governmental goods that people want to consume. This money has not been that successful in fulfilling the role of giving out major public goodies, but it is by far larger than the spare change that the Iraqi government has available, it is far larger than probable USAID cash, it is a far larger slush fund than the civil affairs budgets that US battalion, brigade and division commanders have available to them. There is some money available for “clear and hold” to transition into “inkblot” but with the removal of reconstruction funding from the budget, it is a fraction of what it has been over the past two years.

So I should expect to see a continued increase in the pace of US airstrikes to increase, electricity and petroleum production to remain stable at a negative equilibrium and for the Iraqi police and military to still be ineffective. I also am expecting to see the Iraqi government get real creative in saying that the check is in the mail, especially to foreign lendors as the last round of policy and price changes resulted in significant protests. I expect to see a mess this year going forward.

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