There is no shortage in economic literature on the importance of economic diversification for healthy, resilient, and sustainable growth, and numerous real case studies support such recommendation. Put simply, a country that puts ‘its eggs in one basket’ is at the mercy of exogenous factors that go beyond any government control, thereby undermining ‘prospects for longer-term economic growth’, as put by the World Bank.
Iraq is a textbook example of the problems of high dependence on a single sector – that is, hydrocarbons. In fact, the Iraqi economy is one of the most oil dependent in the world. In 2020, the oil sector provided more than 90 percent of government revenues, 96 percent of export revenues, and 32 percent of GDP. These figures would have been higher if it wasn’t for the coronavirus pandemic that crashed oil prices last year. In 2019, for example, the oil sector accounted for more than 43 percent of GDP and in 2018 it accounted for nearly 100 percent of export earnings. It is therefore not hard to comprehend the substantial impact of oil prices on the Iraqi economy: when prices are high, the economy obviously benefits and government spending increases. Equally, like passengers on a roller-coaster that they do not control, when prices collapse, the economy suffers, and government spending is significantly curtailed. When oil prices declined by 35 percent in 2020, Iraq’s GDP growth fell by nearly 16 percentage points. A healthy economy, however, requires stable growth instead of this kind of spasmodic growth, while a diversified economy is typically more resilient to price volatility in one sector.
Despite the sheer evidence and advice that span over many decades, economic diversification in oil rich Iraq remains a work in progress. The 2020 launch of the White Paper for Economic Reform brought some hope that the process may be finally gaining momentum. One of the key objectives of the paper is “to put the economy and federal budget on a sustainable path, expand the private sector and revitalize the non-oil sectors”. The cynics, however, would warn of the well-known pattern among oil producers whereby bold reforms are announced under economic hardship following a decline in oil prices, only for those reforms to be put on hold, curtailed or forgotten all together when prices recover.
Today, Iraq can ill afford falling into this old trap. The energy transition and the world’s determination to turn the page on the fossil fuels era are creating new and lasting structural conditions that every oil producer ought to take seriously. Of course, the energy transition is a long-term process that might take decades before fully materializing. However, throughout this process, oil producers will face new challenging dynamics. Experts increasingly contend the world is approaching an inflection point, after which global oil demand will peak before starting to (rapidly) decline. When the oil market starts to plateau — or to shrink — competition among producers will intensify as they will fight to protect their share. In theory, under this scenario, low-cost producers should be the last to leave the market. Blessed with some of the lowest cost proven reserves in the world, Iraq should be in a more privileged position than many of its peers, including within OPEC. However, that advantage is diluted when the harsh macroeconomic reality is factored in.
The fiscal breakeven oil price — the minimum oil price needed to meet the spending commitments of an oil-exporting country while balancing public budgets — illustrates the scale of the challenge. For most Middle Eastern oil exporters, particularly Iraq, fiscal breakeven prices have hovered higher than actual oil prices since at least 2016, according to the IMF. In Iraq, the breakeven price was estimated to be around $64 per barrel (/bbl) in 2020 (and $72 in 2021). Oil prices (Brent) averaged $42/bbl in 2020 – clearly not enough to cover the spending bill. Although the cost of producing one barrel of oil in Iraq is just under $11/bbl, Iraq will need much higher oil prices than the market would provide on its own to balance its books. Under the status quo, the country’s ability to act as the lowest cost producer and to crowd out other producers will therefore be severely hampered. However, by reducing its reliance on the oil sector through economic diversification, Iraq would be able to significantly cut the fiscal breakeven price and therefore truly capitalise on its low-cost reserves.
A well-developed private sector is an important pillar to achieving economic diversification and sustainable growth, as recognised in the White Paper. However, the private sector requires comprehensive regulations and legislation as well as basic services. Here, the road is steep as Iraq’s performance on political and public governance indexes has been disappointing. For instance, the country ranked 160th out of 170 countries on Transparency International’s Corruption Perceptions Index for 2020, just ahead of countries like Afghanistan and North Korea. Iraq also featured among the least free economies (ranking 148 out of 165) in the Fraser’s Institute Economic Freedom of the World 2021.
Interestingly, however, Iraq needs to look no further than its own oil sector to see the benefits of constructively engaging the private sector. Since 2009, Iraq has opened its doors to private capital and international oil companies unlike most of its neighbours, such as Saudi Arabia and Kuwait. Such a move has allowed Iraq to significantly boost its oil production to new records, outpacing production growth among its peers, especially within OPEC. Furthermore, apart from Mauritania and Yemen, Iraq is the only Arab country to join the Extractive Industry Transparency Initiative (EITI), which is the global standard for good governance, open and accountable management of extractive resources, even though its contribution has not been stellar – another area that deserves close attention to improve revenue management in the country.
In this respect, unlike many of its peers, Iraq has failed to save some of the oil revenues in a sovereign wealth fund (SWF). The irony is that, right next door, its neighbour Kuwait has the oldest SWF in the world and the second largest (after Norway’s), while the United Arab Emirates has the third largest SWF. Recent reports indicate that the government is considering establishing such a fund, which is good news. Diverting some (or even most) of the oil revenues into an SWF will help to safeguard the local economy from boom-bust cycles while converting the extracted resources into a portfolio of assets that can provide sustainable income for future generations. However, a SWF is no panacea: sound fiscal management is a satisfactory and primary condition for an effective revenue management, even without a fund. Furthermore, the proper design and management of the fund will shape its success or failure.
For the world’s fifth largest oil producer and proven oil reserves holder in the world, it is time to translate those riches into robust economic growth and sustainable development. For long, Iraq has been resource rich but economically poor. Should it successfully pursue a healthy diversification strategy, however, Iraq has the potential to be both resource rich and economically sound, even when oil gradually falls out of favour in the rest of the world.
 World Bank, 2019. Chapter 5 Economic Diversification, Lessons From Practice. https://www.wto.org/english/res_e/booksp_e/aid4trade19_chap5_e.pdf
 Rystad Energy