A self-described conservative with an unshakable faith in the power of the free market, McPherson believed that the best way to promote economic development was through a vibrant private sector. He had never worked in the Middle East or in a post-conflict environment, but when a senior Treasury Department official called and offered him the job of CPA economic policy director, he didn’t hesitate in accepting. Bremer was bringing democracy to Iraq. McPherson’s mission, he was told, would be to bring capitalism.
The neoconservative architects of the war—Wolfowitz, Feith, Rumsfeld, and Cheney—regarded wholesale economic change in Iraq as an integral part of the American mission to remake the country. To them, a free economy and a free society went hand in hand. If the United States were serious about having democracy flourish in Iraq, it would have to teach Iraqis a whole new way of doing business—the American way.
In the months leading up to the war, while the State Department and Pentagon were feuding over how political authority should be devolved to Iraqis, USAID and the Treasury Department agreed to collaborate in promoting aggressive free-market reforms sought by the neoconservatives. After months of secretive discussions, USAID and Treasury officials came up with an ambitious plan for economic transformation. The plan was detailed in a confidential, 101-page document titled “Moving the Iraqi Economy from Recovery to Sustainable Growth,” which specified the work that USAID wanted a private contractor to perform. The goal, according to the document, was to lay “the groundwork for a market-oriented private sector economic recovery.” The plan envisioned the sale of state-owned enterprises through a “broad-based mass privatization program,” the establishment of a “world-class exchange” for trading stocks, and “a comprehensive income tax system consistent with current international practice.”
Iraqis, like many of their Arab neighbors, were wary of full foreign ownership of domestic businesses and the privatization of the oil industry. But USAID and Treasury required the contractor to promote investment laws that would be “blind as to whether the investor is from that country or elsewhere.” The contractor also was to promote “private sector involvement… especially in the oil and supporting sectors.” Notably absent from the thick plan was much reference to consultation with Iraqi leaders or even an interim Iraqi government. USAID and Treasury knew what Iraq needed.
In the days after Saddam’s government was toppled, if you asked any Iraqi—from a man on the street to one of the formerly exiled political leaders—what the country’s biggest economic problem was, the response was always the same: unemployment. Nobody could be sure how many people were out of a job, but it seemed that more than half of working-age men were unemployed; estimates pegged unemployment at about 40 percent. But the USAID-Treasury document outlined no program to create jobs. The words tax and privatize were mentioned dozens more times than the word employment.
USAID was helped in developing the plan by BearingPoint Incorporated, a Virginia-based consulting firm. When it came time to award the contract, valued at $79 million for the first year, USAID chose BearingPoint. USAID’s inspector general subsequently scolded the agency for its handling of the contract, writing in a scathing report that “BearingPoint’s extensive involvement in the development of the Iraq economic reform program creates the appearance of unfair competitive advantage.” But the controversy didn’t weaken the relationship between USAID and BearingPoint. In September 2004, the agency awarded the company a follow-on contract worth as much as $225 million.
McPherson wasn’t involved in drafting the 101-page plan. But he didn’t find anything in it to quibble about. His vision for economic reform in Iraq hewed to the same philosophy. Instead of using government money to create new jobs in an Iraqi version of the New Deal, he favored a supply-side strategy: reduce the role of government industry through privatization, eliminate subsidies for electricity and fuel, cut tariffs, lower taxes, promote foreign investment, and enact pro-business laws. Those changes, he reasoned, would draw multinational firms, and even wealthy Iraqis, to set up businesses in Iraq that would create jobs for the unemployed. The key to economic growth, he believed, was “the development of a robust private sector.”
“We need to shrink government employment,” he said to me in that first interview, “not increase it.”
McPherson landed in Baghdad a month after the city’s liberation. He was eager to have BearingPoint get to work as soon as possible, but the company’s consultants were not scheduled to land for several weeks. To McPherson, time was of the essence. He wanted to move forward right away with privatization and the elimination of subsidies. The faster you addressed those problems, he reasoned, the faster you would achieve economic growth. He also had a personal desire for alacrity. He had asked Michigan State’s board of trustees for only 130 days of leave.
McPherson assembled his own brain trust. He brought over the deputy general counsel from the Treasury Department and two bright government economists, one from the White House’s Council of Economic Advisers and the other from the Federal Reserve Bank of Boston. But McPherson didn’t have the staff to tackle privatization. He had to rely on Corliss and Jackson.
As soon as he arrived, even before asking for the analysis of the state-owned enterprises that Corliss would perform in two weeks, McPherson announced his intention to move forward with privatization. At the Ministry of Industry, Carney, Jackson, and Corliss were still trying to understand how the place worked. On the CPA economics team, everyone was figuring out how to pay salaries to hundreds of thousands of government employees. “Here comes McPherson wanting to talk about privatizing state-owned industries,” one member of the economics team said. “It struck us as so irrelevant.”
There was also a legal roadblock. Article 43 of the second section of the Hague Convention of 1899—the first set of international treaties that attempted to create laws of warfare—requires an occupying power to respect all the laws of the occupied country except when it is necessary to promote public order and safety. Although the United States had the blessing of the United Nations Security Council, in Resolution 1483, to promote “economic reconstruction and the conditions for sustainable development” in Iraq, CPA lawyers were generally opposed to the sale of Iraq’s industries, on the grounds that such sales violated the Hague Convention. What if a sovereign Iraqi government objected to privatization? You couldn’t reverse the sale of a factory. Better to leave it to a future Iraqi administration, the CPA lawyers said.
Even more significant at the time was a practical challenge. There was no way Corliss, Jackson, and Carney could do it by themselves. Financial records would have to be scoured, offers posted and evaluated, financing arranged. When the trio met with a team of Germans to discuss how factories in the former East Germany had been privatized, the CPA team was told that the Germans had eight thousand people working on the project. “How many do you guys have?” one of the Germans asked.
“You’re looking at all of them,” Corliss responded.
The German laughed and asked again. “No, how many people work for you?”
“No, this is it. Three people,” Corliss said.
“Don’t bother starting,” the German said.
Corliss quickly came to regard rapid privatization as a fool’s errand. “So let’s say that everyone within the CPA, every single bureaucrat in there, from Peter McPherson all the way down to little guys like me, all say privatization is the way to go. You then step out to the Iraqi ministry and you say, ‘Guess what, guys? We’re privatizing your factories. Starting today and starting with the vegetable oil factory. We’re going to privatize it from our own funding.’ The Iraqis would look at you and say, ‘Really? Okay. Thanks. We’ll get to work on that. We’ll talk to you tomorrow.’ And they’d walk off and say, ‘Stupid, freaking Americans.’ And they just wouldn’t do it.
“We never were really in control. Now, again, why not? Well, there’s 150,000 people within that ministry, all of which have their own little vested interests, and they
’ve been there for years, if not decades. There were three of us responsible for the ministry. They sort of looked at us like clowns that kind of came in there and had ideas and concepts but never had any assets to back it up. We barked out orders at them and they just looked at us and said, ‘Yeah. Sure. Sounds good. Great. You’ll be back tomorrow, right? Super, we’ll have some chai and we’ll talk about it some more.’
“The point of all of this is we could choose to privatize or not to privatize. It didn’t matter. We didn’t have the power to privatize. We didn’t have the power to do anything, ’cause we didn’t have control of these assets. It’s like one man walking into a country—a hugely militarized country—with a piece of paper and saying, ‘This piece of paper now says I run the country,’ and that country has twenty-four million people with weapons. They’re just going to look at him and go, ‘Oh, why don’t you sit down over there in the corner, crazy guy?’ That’s what the Iraqis were like to us. They were like, ‘What are you talking about? There’s three of you. There’s 150,000 of us. You haven’t seen most of the factories. Why do you think that you’re going to make any of the decisions?’ So they just kept doing their thing, and we sort of played in our little, imaginary world over at the CPA.”
McPherson soon began to grasp the difficulty of selling off the state-owned firms. Not only was the CPA’s economic team too small, it was hard to imagine any investor braving an eleven-hour drive from Jordan (Baghdad’s airport was closed to commercial traffic) to see a factory that was not operating because it lacked electricity and employees. He eventually concluded that an outright sale would have to wait until Iraq was stabilized.
But there was still something he could do in the interim. The state-run companies sucked up hundreds of millions of dollars a year in subsidies. Cement factories didn’t have to pay for power. Petrochemical factories didn’t have to pay for crude-oil inputs. And nobody had to pay market price for imports. Eliminating the subsidies, he figured, would result in a process of natural selection: viable companies would survive, and unprofitable ones would wither away. McPherson called it “shrinkage.” As inefficient state companies shrank, or simply went out of business, he expected imports to increase and new private firms to flourish. Unemployment wasn’t a concern for him, because the CPA had promised that anyone who worked for the government, even for a shuttered factory, would continue to get a salary. He deemed shrinkage “more practical, for at least a couple of years, than massive privatization.”
To McPherson, looting was a form of much-needed shrinkage. If the theft of government property promoted private enterprise—such as when Baghdad’s municipal bus drivers began driving their own routes and pocketing the fees—it was a positive development in his view. “I thought the privatization that occurs sort of naturally when somebody took over their state vehicle, or began to drive a truck that the state used to own, was just fine,” he said. Fellow CPA officials were aghast. Hundreds of police cars had been stolen and turned into private taxis—good for the private sector but bad for law enforcement. The same problem plagued the Ministry of Trade’s food-distribution system. Many of the trucks that had transported monthly rations were being used to haul private reconstruction supplies. “The Robin Hood philosophy might have sounded good to the economists inside the palace,” one CPA ministry adviser said, “but when you looked at the real-world impact, it was lunacy.”
McPherson also believed that his shrinkage strategy would help to address a vexing issue for his economic team. Nobody could be sure how much money various state-owned enterprises had in the bank—or how big their debts were. Bank records had been destroyed, as well as files at the Ministry of Industry. How much did the state oil company owe the al-Faris Company for products that had been delivered before the war? How much did al-Faris, in turn, owe the State Company for Iron and Steel Products? And what did that firm owe the government mining company? Sorting through everyone’s assets and obligations would require a battalion of accountants. Borrowing a term suggested by Walt Slocombe, the architect of the dissolution of the army, McPherson called that challenge a “hopeless entanglement.”
“There weren’t records to bring to a table and sort out,” he said. “If there had been, it’s clear it would have taken a long period of time to reconcile… . And if you can’t settle debtissues with companies, then they just sit there and you can’t start new. Moreover, what was very clear was that they were all gonna chase each other’s tails. The whole system was pretty clearly bankrupt.”
To make matters worse, McPherson’s team discovered that Iraq’s state-run banks were $1 billion in debt. They had about $2 billion in deposits—about half was from state-owned entities—but only about $1 billion in assets. Whatever happened, McPherson was desperate to avoid a run on the banks, fearing that a slew of withdrawals would undermine what little public confidence existed in the Iraqi currency and in the overall economy.
McPherson’s team met several times in his office to figure out a solution. No Iraqis were invited. Nor were Carney and his staff. McPherson viewed the latter as “special pleaders.”
McPherson advocated a clean-slate approach. All debts and assets would be nullified. State-owned enterprises would start from scratch. Others on the economics team voiced doubts. They cited the precedent of Alexander Hamilton, who, as America’s first treasury secretary, had insisted that the nascent federal government make good on its foreign and domestic debts. Post-Saddam Iraq should follow the same policy, they argued. McPherson refined his argument. The government would make good on private debts. After all, there was $1 billion in the banks to pay private depositors. But intragovernment debts, those among ministries and state companies, would be forgiven. To compensate state firms for their disappearing assets, McPherson promised to allocate $60 million from the 2003 budget to the Ministry of Industry. Carney, Corliss, and Jackson could figure out how to divvy up the money. To McPherson, it seemed more than fair.
When Corliss heard about McPherson’s decision, “a hundred red flags” went up. This is bad, he thought. This is really bad.
McPherson’s decision meant that the al-Faris Company, which had $1.5 million in the bank, now had nothing. So much for buying that generator to restart its assembly line. Cement companies were in the same position. They had cash in the bank, or so they thought, that they needed in order to resume production. At the same time, some of the country’s most unprofitable companies would be left with a windfall. Most galling to Corliss was the case of the State Company for Cotton Industries. It had borrowed $75 million from a state-run bank to purchase a three-year supply of cotton. (There was literally a small mountain of raw cotton piled up next to the factory.) All of a sudden, that cotton was free. Instead of using it to produce cloth, factory managers sold it to neighboring countries and pocketed millions of dollars in under-the-table commissions.
“The very companies that matter most to us got hurt the most,” Corliss said. “The very companies that were, in McPherson’s terminology and mine, the dogs that you got to take out back and shoot benefited the most… . Who owes a bunch of money? Weak companies. Who had a bunch of money? Strong companies. So we just reversed that… . It was exactly the opposite of what we were trying to achieve.”
Corliss also maintained that the $60 million that McPherson was allocating to the Ministry of Industry was not nearly enough. Preliminary assessments estimated damages from looting at the forty-eight state-owned companies at more than $400 million. Then there was the cost of buying raw materials and otherwise funding operations. There’s no way we can do this with $60 million, he thought. He asked for a meeting with McPherson.
The two men met for dinner in the palace’s gymnasium-size cafeteria. For over an hour and a half, Corliss explained why he thought McPherson’s decision was wrong. “And his attitude at the end of it was just simply, ‘You’re going to spend forever unwinding these intercompany payables and receivables. They’re going to play games on you, and you already told me the accounting
is a mess. How in the heck do you think you’re going to figure this out?… And by the way, Glenn, all of their deposits in the bank? There’s no money in the bank to back that up. So if I don’t implement this policy, all of your companies that have money in the bank are going to go to the bank to get their money, and guess what? It’s not there. It’s just not there.’
“And what I said to him? ‘That’s fine, sir. I agree with you. You made my life a lot more simple, and believe me, now I’ve got a clean working balance sheet… . But the problem is, sir, you’ve got all these wacky things. You’ve got the cotton company with $75 million worth of cotton. You’ve got the petrochem company that is owed money by all these other companies. And plus you have the problem of every company I now go to talk to, the first words out of their mouth is, “You stole my bank account.” I can tell them the money was never there. They’re not going to believe me. They’re going to say, “You Americans stole my bank account,” and that’s what they’re convinced of.’”
“I agree there’s ramifications,” McPherson said. “But you know, there’s pros and cons to every decision. This is the decision we’re making. We’re moving forward.”
As Corliss walked away, he announced that he wasn’t giving up. “Sir,” he said, “I’m going to try to convince you otherwise.”
The next day, Corliss wrote a one-page e-mail to Carney and Jackson. He didn’t pull any punches. On the cancellation of assets and debts, he wrote, “We will be saddling most of the Companies with negative working capital balances—a major red flag for investors and a drag on future performance of the Company… . This policy also says to the companies, ‘any sales you made before June 1 but haven’t been paid for yet were for naught. Sorry, but you got ripped off. Hope you didn’t work too hard getting that deal done.’” He called the decision to devote just $60 million to the ministry “nothing short of a guaranteed death sentence for all but the strongest” state-owned enterprises. “I recognize that these are controversial opinions and I’ve made little attempt to communicate this diplomatically. Nonetheless, I believe it’s a critical enough issue that one should not mince one’s words. Furthermore, I have little interest in participating in destruction of otherwise viable Companies.”
Imperial Life in the Emerald City Page 13
