By Roger Guiu
If Kurdistan is to develop as a state, it must first resolve its finances. Exploiting its natural resources – seemingly one of its best assets – seems an obvious move.
However as the experience of many resource rich developing countries has shown, reliance on non-renewable resources can backfire if it is not carefully managed.
Since January, Baghdad has frozen budget payments to Erbil in an ongoing dispute between the federal government and the Kurdish Regional Government (KRG) over rights to exploit oil in the region. Underlying this dispute is the KRG’s goal of wider autonomy within Iraq, if not full independence.
Baghdad’s current control of the purse strings undermines the ability of Erbil to maintain public institutions. Adding to the burden is the expense of the conflict with ISIS and the humanitarian emergency in the north of Iraq.
The priority for Erbil is obviously to establish a revenue base, ahead of any push for independence.
Kurdish authorities argue that further self-government would provide the KRG with the powers and tools to freely develop their natural resources and, ultimately, move towards statehood.
Kurdistan has vast and untapped oil reserves that could generate enough revenue to offset annual transfers of $12 billion from Baghdad. On the surface, funding public finances from oil revenues is an attractive option for any government in the process of state-building. Already the KRG has made steps in this direction by signing contracts with international oil companies and transporting the oil produced to the Ceyhan seaport in Turkey for sale, both without Baghdad’s consent.
However if the aim is to become not just politically autonomous but economically independent too, the challenge is bigger.
In the short term the KRG has struggled to offset the loss of budgetary transfers from Baghdad. Kurdistan lacks the infrastructure capacity to produce or transport sufficient oil and the legal uncertainty of the KRG’s right to sell what it does produce has deterred potential buyers.
Moreover, a development strategy limited to banking oil resources runs the risk of falling into the same trap as many oil-rich countries in the Middle East: becoming a rentier state, vulnerable to external shocks and paying lip service to democratisation.
Avoiding the resource curse – the paradox by which many countries with an abundance of natural resources tend to have less economic growth, slower development and poorer governance than countries with fewer natural resources – will depend on the KRG’s ability to create institutions to sensibly invest this capital for the future.
Chile and Venezuela, two South American countries of a similar development level to Kurdistan, offer case studies in differing approaches to investing revenues from non-renewable resources. In Chile, the world’s large copper producer, revenue from mining was put in a national fund to invest in infrastructure and education. Venezuela on the other hand used oil revenue to lower taxes, which arguably led to growing debt, a sliding productive capacity, a high fiscal deficit, and inflation.
Currently the KRG is attempting to build a state without implementing the reforms needed to avoid the resource curse. Spending revenue from non-renewable sources such as oil on recurrent expenses such as government salaries – as the KRG is currently doing – is not a sustainable financial model. Instead, oil revenues should be invested in other forms of capital such as infrastructure (physical capital) and education (human capital). Such investments are the basis for economic growth, attracting private capital, generating income and encouraging consumption.
Developing mechanisms to tax these elements to fund recurrent expenses should be a priority for the KRG if it is to avoid dependence on limited natural resources. Without this, government spending will remain unsustainable.
Creating an effective taxation system is also dependent on a sophisticated banking system, something currently lacking in Iraq. Without capable and trusted banks, the task of implementing taxation effectively becomes significantly more difficult.
Finally, citizens will only accept taxation if there are channels for civic participation which allow the public to genuinely influence how taxes are levied and how they are spent.
The oil dispute with Baghdad and current fiscal crisis in Kurdistan offer a unique opportunity for Kurds to start on a new development path. Certainly structural reform will be tough and costly to implement. However, distrust of Baghdad and the current sense of unity between Kurdistan’s different political factions have created a social context in which reforms are more likely to be accepted if the outcome is a state with better governance.
Roger Guiu is researcher in the Economics, Energy, Environment programme at the Erbil-based Middle East Research Institute (MERI).
If Kurdistan is to develop as a state, it must first resolve its finances. Exploiting its natural resources – seemingly one of its best assets – seems an obvious move.
However as the experience of many resource rich developing countries has shown, reliance on non-renewable resources can backfire if it is not carefully managed.
Since January, Baghdad has frozen budget payments to Erbil in an ongoing dispute between the federal government and the Kurdish Regional Government (KRG) over rights to exploit oil in the region. Underlying this dispute is the KRG’s goal of wider autonomy within Iraq, if not full independence.
Baghdad’s current control of the purse strings undermines the ability of Erbil to maintain public institutions. Adding to the burden is the expense of the conflict with ISIS and the humanitarian emergency in the north of Iraq.
The priority for Erbil is obviously to establish a revenue base, ahead of any push for independence.
Kurdish authorities argue that further self-government would provide the KRG with the powers and tools to freely develop their natural resources and, ultimately, move towards statehood.
Kurdistan has vast and untapped oil reserves that could generate enough revenue to offset annual transfers of $12 billion from Baghdad. On the surface, funding public finances from oil revenues is an attractive option for any government in the process of state-building. Already the KRG has made steps in this direction by signing contracts with international oil companies and transporting the oil produced to the Ceyhan seaport in Turkey for sale, both without Baghdad’s consent.
However if the aim is to become not just politically autonomous but economically independent too, the challenge is bigger.
In the short term the KRG has struggled to offset the loss of budgetary transfers from Baghdad. Kurdistan lacks the infrastructure capacity to produce or transport sufficient oil and the legal uncertainty of the KRG’s right to sell what it does produce has deterred potential buyers.
Moreover, a development strategy limited to banking oil resources runs the risk of falling into the same trap as many oil-rich countries in the Middle East: becoming a rentier state, vulnerable to external shocks and paying lip service to democratisation.
Avoiding the resource curse – the paradox by which many countries with an abundance of natural resources tend to have less economic growth, slower development and poorer governance than countries with fewer natural resources – will depend on the KRG’s ability to create institutions to sensibly invest this capital for the future.
Chile and Venezuela, two South American countries of a similar development level to Kurdistan, offer case studies in differing approaches to investing revenues from non-renewable resources. In Chile, the world’s large copper producer, revenue from mining was put in a national fund to invest in infrastructure and education. Venezuela on the other hand used oil revenue to lower taxes, which arguably led to growing debt, a sliding productive capacity, a high fiscal deficit, and inflation.
Currently the KRG is attempting to build a state without implementing the reforms needed to avoid the resource curse. Spending revenue from non-renewable sources such as oil on recurrent expenses such as government salaries – as the KRG is currently doing – is not a sustainable financial model. Instead, oil revenues should be invested in other forms of capital such as infrastructure (physical capital) and education (human capital). Such investments are the basis for economic growth, attracting private capital, generating income and encouraging consumption.
Developing mechanisms to tax these elements to fund recurrent expenses should be a priority for the KRG if it is to avoid dependence on limited natural resources. Without this, government spending will remain unsustainable.
Creating an effective taxation system is also dependent on a sophisticated banking system, something currently lacking in Iraq. Without capable and trusted banks, the task of implementing taxation effectively becomes significantly more difficult.
Finally, citizens will only accept taxation if there are channels for civic participation which allow the public to genuinely influence how taxes are levied and how they are spent.
The oil dispute with Baghdad and current fiscal crisis in Kurdistan offer a unique opportunity for Kurds to start on a new development path. Certainly structural reform will be tough and costly to implement. However, distrust of Baghdad and the current sense of unity between Kurdistan’s different political factions have created a social context in which reforms are more likely to be accepted if the outcome is a state with better governance.
Roger Guiu is researcher in the Economics, Energy, Environment programme at the Erbil-based Middle East Research Institute (MERI).
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