How can we best understand developments in Iraq? The pictureemerging from journalistic and official reports suggests thatsenior-level civilians in the White House and Pentagon were guidedby a mix of ideology and the desire to have their decision to go towar validated. This repeatedly led them to underestimate the risksand challenges posed by the occupation. They hoped Iraq mightrapidly become a clean slate on which to construct a new MiddleEastern society. By most accounts, the prospect of an ongoinginsurgency scarcely appeared in their scenarios.

And so one misstep followed another: failure to preventimmediate postwar looting of buildings, infrastructure and armsdepots; too few coalition forces; disbanding the Iraqi army;excessive de-Ba'athification, creating a sizeable class of angryand idle middle- and higher-level managers and bureaucrats; failureto seal the borders with Iran and Syria, in part because, havingdisbanded the army, resources for doing so were lacking; inadequateoutreach to Iraqi civil society; not understanding the depth ofIraqi disaffection with the occupation; failure to enforce criminallaw and coalition anti-militia measures against radical Shi'acleric Moqtada Sadr and his Mahdi Army; and carelessly beginningthe high-risk military operation in Fallujah in April that couldnot be completed.

Missteps in economic policy followed the same pattern. Thecoalition's overall objectives for Iraqi economic development weresensible enough--replacing a one-industry oil-pump economy, repletewith war- and dictatorship-related corruption, with a diversifiedmarket economy. This would require the introduction of contract lawand property rights, reduction of subsidies so that the economymight respond to price signals, encouraging enterprise and foreigninvestment, revitalizing the monetary system and banking sector,and encouraging private sector development. The coalition alsointended that oil sector recovery and U.S. and internationalreconstruction funds would generate an economic boom.

With the exception of the last, these were long-term goals. Andthe goals were important, insofar as regime change in Iraq wasintended to introduce national or regional economic liberalization.But the game plan offered little mechanism for moving from thechaos of a collapsed, state-dominated economy to the liberalizedend-state the planners would prefer. To the extent that anyone hada plan for recovery itself, it was a combination of pouring oninfrastructure contracts and cold-turkey privatization ofstate-owned enterprises.

By fall 2003, it was clear that large-scale unemploymentpersisted, with estimates that as much as 70 percent of adult maleswere affected. It was equally evident to many, including seniorcoalition military officials, that economic distress was animportant contributor to support for insurgency--high unemploymentwas a critical political and military problem.

And so, even before the Abu Ghraib abuses became public, it wasclear that support for the occupation among Iraqis was rapidlyeroding. One year after the invasion, physical security wasdeteriorating, and, despite indicators of modest economicimprovement, large numbers of Iraqis could not find regularwork.

The answers should have been almost as clear as the diagnosis.Where an economy generates insufficient demand to put people towork, the government should step in to boost demand. This isespecially the case where investment outlays are constrained by theuncertainties of war, and where market imbalances are unlikely tobe self-correcting. Much of the Iraqi budget nevertheless has notbeen apportioned in a way that would boost employment or demand fordomestic production. Much government spending is used to importgoods, often in large bulk purchases of food and refined fuelproducts, or is distributed to citizens who then use it forconsumption imports. Growing amounts are now also spent formilitary and security purposes, which do indeed createemployment--but often without boosting the supply of domesticcivilian goods and services. The usual economic result of suchspending is to increase imports.

A more effective way to raise both employment and domesticproduction would have been to allocate large sums--perhaps $2-3billion from the $87 billion 2003 Supplemental Budget, or from theportion of $18.6 billion earmarked for Iraqi reconstruction--toprojects that would bring rapid deployment of local Iraqi labor andsupplies. An obvious use for such outlays would involve buildinghouses and apartments. Lead times and advance planning would beshort, and demand for living space was and is quite high, followingyears of deprivation and rapid population growth. A second usemight have been improvement in municipal services. Conversationwith a few Iraqis in almost any ministry reveals a sore point to bethe poor quality of such services, for example, garbage collection.It would have been straightforward to develop and implement aseries of demand-boosting projects, if it had dawned on anyone atthe right juncture that it was critical from a strategicperspective to do so. And security considerations are different forIraqi workers and contractors: Unlike expatriates, most Iraqis willnot stop working or leave their country for fear of physicalsafety.

Why was it not done? One reason is that the Washington budgetprocess did not serve us well. It is cumbersome and demandsapprovals--and often brings delays--at every step. Also, in thenature of things, budgeting tends to favor contracts for U.S.companies, so large portions of outlays are spent in the UnitedStates rather than in host countries. Perhaps the usual procedurescould have been circumvented had a demand-boosting amount beendesignated as a military imperative. Indeed, in what most of usthought were effective operations, some money was spent in Iraqitowns and cities by Army and Marine Corps civil affairs units. Butthe aggregate amounts ran no higher than a few hundred milliondollars.

A second reason was a belief that money would soon pour in fromother sources--U.S. reconstruction money, internationalcontributions and foreign investment. A parallel claim was thateconomic activity would move soon to such a fever pitch that Iraqwould face a labor shortage and have to import workers from poorerthird world countries by as early as summer 2004. We know of coursethat by September 2004, no more than $1 billion of the $18.6billion reconstruction amount had been spent, and very littleprivate sector foreign investment has appeared--although someexpatriate Iraqi money has come home. In fact, in the midst of theinsurgency, security concerns increased, investment stalled andprojects were delayed. Thus we had no economic strategy forcountering insurgency. We implicitly assumed that the insurgencywould go away.

A third reason may be that the whole matter of linkingdemand-boosting policy to dampening support for insurgents nevergot the attention of the right people. But ideological hostilityalso played a role. It is one thing to spend money on contracts forU.S. firms, but something quite different to provide aKeynesian-style demand boost to a foreign country, and an oil-richcountry at that. Indeed, some of the people in the coalition knownto be personally close to the Bush Administration occasionally saidthings like: "There is no connection between unemployment andsupport for the rebels, and anyway, the insurgency will shrink asthe private sector recovers." The underlying preference was that weshould rely on the private sector to generate jobs--apparently,even in the midst of a U.S. foreign policy emergency, and facing acontested presidential election, the outcome of which might dependin part on whether the Iraqi insurgency could be contained.

Now, after a year and a half of growing insurgency and continuedhigh unemployment, and as the reconstruction budget isreconfigured, the U.S. embassy is asking for $286 million to"accelerate employment." This is only a small fraction of thenecessary amount, and it is hard to imagine that it is enough tomake much difference, even assuming it is spent fairly soon.Economic distress has continued to feed the insurgency, which bynow indicates serious policy failure.

Another area where economic policy became disconnected from themilitary and political situation involves privatization andstate-owned enterprises (SOEs). For at least some of the Bushappointees, Iraq became an economics drawing board, a prospectiveshowcase for the benefits of free markets. One driving notion wasto sell SOEs and henceforth let the market sort matters. If someonepointed to corruption that might result from the privatizationprocess--as often observed a few years earlier in the former SovietUnion--the ideologues would simple-mindedly counter that the curefor corruption was a smaller government. In any event, how couldthe market reallocate corporate resources in an economy lackingorganized financial markets, and with no better than muffled pricesignals and dubious judicial mechanisms? Most advisors affiliatedwith the coalition doubted that rapid privatization would achievethe hoped-for results--especially not in the context of extrememarket distortions caused by the growing insurgency and by pricecontrols long in place for most commodities. Also, apparently onlyafter the Coalition Provisional Authority had been in place formonths did anyone notice that the Hague conventions of 1908 and theGeneva conventions of 1949 are usually understood to make it aviolation of international law for an occupier to sell a hostcountry's state-owned property.

A related issue concerns contract procedures. Many Iraqisexpressed anger that bidding for U.S. and coalition contracts andsubcontracts was not more open to Iraqi firms. In fact, the chargewas somewhat unfair, as the U.S. Agency for InternationalDevelopment and others made efforts to encourage subcontracting toIraqis. Furthermore, by May 2004, coalition lawyers concluded thatthere were no legal restraints on the full participation of Iraqifirms, including SOEs, in bidding on reconstruction contracts andsubcontracts originating in any of the coalition countries. Thecoalition contracting office largely adopted that legal view aspolicy and invited bidding across the board. Nevertheless, somegroups inside the coalition objected to soe eligibility, basicallyon the grounds that SOEs should first be privatized. While thecontracting office keeps bidding open to all comers, the coalitionhas never reinforced this practice with a formal policyannouncement so as to ensure that it would continue for futurecontracts and under future administrations. A formal policymemorandum would have created predictability in an area wheredecisions are essentially ad hoc. This is essential, becausecontract officers and evaluation committees tend to be risk-averse.Furthermore, cultural tendencies often lead Iraqis to assume thatwhat is not specifically authorized is prohibited. Similarly, anumber of proposals for financing lending funds did not get off theground because they sought to deal only with private sector firms,or in other ways demanded that links with the Iraqi government besevered as a precondition for eligibility.

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