The last day of July brought news of unexpected vigour in US economic growth. Figures in the US Commerce Department show that in the second quarter of 2003, the economy grew by 2.4 per cent, which was well above the 1.5 per cent predicted by many analysts. Interestingly, there is consensus on the cause of this buoyancy, which has been hastily interpreted as the first sign of a long-awaited recovery. Analysts point to the substantial rise in government spending fuelled by the occupation of Iraq, which has been assessed by the Financial Times, London as being the 'largest run-up in government spending since the Vietnam War'.

Pentagon estimates of the costs of war in Iraq thus far are quoted at $48 billion. Currently, with the US finding little support in terms of men, materials and money from countries other than Britain, it is estimated to be spending a further $3.9 billion a month to finance its occupation. As a result, defence spending in the recent past has risen at an annual rate of 44 per cent. Not surprisingly, overall government spending rose by an annual rate of 22 per cent in the second quarter of 2003, contributing, according to some estimates, as much as 1.5 percentage points to the 2.4 per cent second-quarter growth rate.

The second-quarter growth figure may be cause for celebration for a government that is fast losing domestic support for its misadventure in Iraq-'one that has been more prolonged than expected, more unilateral and more costly in terms of US lives that are being lost virtually every day. But these very factors make the task of sustaining the spending, which yields that growth rate, difficult. The view that direct financial cost of the occupation is proving too heavy for the US government, even though it is proving to be good for American business and the American economy, is gaining ground. Therefore, if growth is to be sustained, the US must ensure that other international governments contribute to the reconstruction effort and that 'external' benefits of that effort must flow to the US.

While an occupation and reconstruction effort undertaken solely by the US is increasingly proving infeasible, support from the international community has been virtually absent, not just in terms of sending troops but also in terms of organizing the finance for reconstruction. With the occupation unlikely to be short-lived, estimates suggest that the cost of the occupation, for the US alone, could amount to around $3 billion a month for the next four years, or a total of around $150 billion.

To this must be added the cost of the ongoing, though limited, process of reconstruction. This process is to be financed partly with US funds approved by Congress and substantially with revenues from Iraqi oil, production and export of which is still to reach its full potential. Lael Brainard and Michael O'Hanlon of the Brookings Institution quote estimates, based on the presumption that Iraqi oil production is unlikely to be restored to potential in the near future, which suggest that spending for reconstruction may be anywhere between $5 billion and $120 billion a year over the next several years.

In April this year, the Congress approved $3.6 billion towards the reconstruction effort. According to White House Budget Director Joshua Bolten, funds from various sources such as frozen Iraqi assets, revenues from oil and $800 million in cash found inside Iraq, helped add to the congressional appropriation and secure $7.7 billion for rebuilding efforts during 2003. But the Iraqi administration is likely to run through this money relatively fast. Paul Bremer, the US administrator in Iraq, recently informed the Bush administration that he expected to spend $7.3 billion by the end of the year. Speaking to CNBC's Capital Report regarding the cost of rehabilitating and reconstructing Iraq, Bremer said, 'It's probably well above $50bn, $60bn, maybe $100bn. It's a lot of money.' He clearly intends to return to Washington with a request for more funds.

Thus, even if the actual spending on reconstruction is a small fraction of the Brookings estimate, deficit-financed spending by the US is bound to increase substantially if external help is not forthcoming. Though current trends indicate that this could convert the recent buoyancy of the US economy into a robust recovery, there are ideological and congressional limits to that process. However, if the US manages to restore Iraqi oil production to its full potential in the near future, the gains it will receive from financing the costs of occupation would be strengthened by the benefits derived by US business from the reconstruction spending financed with oil revenues. Even if the occupation alone can be sustained, the purely economic gain for the US from it could be substantial. But, if governments outside the war coalition could be persuaded to contribute to the reconstruction effort, then a US recovery is a real prospect.

Iraq, the victim, meanwhile is less fortunate. It is still devastated by the war, with little benefit as yet from reconstruction. Electricity and water facilities are yet to be restored to pre-war levels and hospitals are short of supplies. This shows that the level of spending and its allocation are inadequate from the point of view of quick-impact reconstruction. In late July, White House officials provided the US Senate foreign relations committee with a report on the extent and pattern of spending as of 30 June. Out of the $7.7 billion that was available for reconstruction, allocations totalled slightly more than $2.7 billion. Of the latter, $2 billion came from the funds approved by Congress and $750m from seized and vested Iraqi state assets. Of the $5 billion that remained, $2.2 billion was from funds appropriated by Congress, $1.8 billion from seized and vested Iraqi state assets and approximately $1 billion from the Development Fund for Iraq.

A significant share of the $2.7 billion spending till 30 June had gone towards emergency payments and salaries for Iraqi civil servants and pensioners ($400 million) and to support the operations of the Coalition Provisional Authority (CPA) in Baghdad ($200 million). The US administration in Iraq spent about $730 million on humanitarian initiatives like restoring food distribution and augmenting medical supplies, leaving $1.37 billion for reconstruction including the restoration of basic services and oil production. This compares with the US civil administration's estimates that it would cost $13 billion to rebuild the electricity infrastructure and the United Nations' forecast that it would take $16 billion over four years to restore water supplies.

With the reconstruction effort proving inadequate three months after the end of the war, Paul Bremer announced at the end of July a 'detailed timetable and clear benchmarks' to restore crucial services to pre-war levels in 60 days. Experts are sceptical about this deadline. In the case of electricity supply, for example, this would require increasing generation from 3,000 MW at present to 4,000 MW. But, security problems, ageing equipment, lack of spare parts and the looting of high voltage power lines imply that such an increase, even if achieved, would not be sustainable.

Even though reconstruction has been slow, policies to ensure that the gains from occupation would accrue to corporate America and the US economy are being rapidly put in place. In particular, the CPA has initiated moves that would open up the Iraqi economy for foreign operators. In July, the CPA while announcing a competition for mobile phone licences in Iraq, promised to waive Iraqi legislation requiring foreign investors to allocate a 51 per cent equity share in projects in Iraq to Iraqi entities.

Another example is the call for proposals from international banks and consulting firms to help restructure Iraq's two biggest state-owned banks with 150 branches each-'the Rafidain Bank, with deposits of over $1 billion, and the smaller Rasheed bank. This restructuring process is seen as a prelude to allowing the contractor who undertakes the process, to buy into the banks' equity.

The 'privatization' in favour of foreign investors is problematic because of evidence that it is primarily US firms that are benefiting and are likely to benefit from the still-limited reconstruction effort. On 31 July, Halliburton, the second biggest oilfield service company in the world and one of the largest private contractors in Iraq, reported that work in Iraq had boosted its revenue and helped it swing from a loss to record second-quarter net income of $26 million. Dick Cheney was the chief executive of Halliburton from 1995 to 2000 before he became US vice-president. The activities of Halliburton have been controversial because its German subsidiary Halliburton Company Germany GmBH has contracts with Libya, even though the Iran–Libya Sanctions Act passed in 1996 by the US Congress has kept US companies out of Libya. On 30 May, Halliburton had announced that it had finalized a $6 million agreement to settle twenty lawsuits alleging that the company used deceptive accounting practices when Dick Cheney ran the company. Halliburton's role in Iraq has been controversial since the US Army's Corps of Engineers awarded it a contract worth $7 billion to extinguish oil-well fires and undertake emergency repairs, without calling for bids from competitors. The lead that the company got appears to be favouring it subsequently as well. Recently, its rival Bechtel announced that it would not participate in two calls for bids totalling $1 billion for repairs in Iraq's oil sector.

These trends explain in part the unwillingness of other OECD countries to contribute substantially to the reconstruction effort. As pressure builds on the US to seek financial support from other countries to accelerate the reconstruction effort, Bush has put out an appeal for such support. However, France and Germany have called for the creation of an independent fund as an alternative to the US-controlled Iraq Development Fund, to which contributions, likely to be pledged at a proposed donor conference in October, can be made.

Gunter Pleuger, Germany's ambassador to the United Nations, has announced that 'Germany stands ready to contribute its share', but that 'international support to the necessary extent will only be forthcoming if full transparency and international participation in the decision-making process are assured.' In Germany's view, 'the creation of a separate international fund could dispel some concerns, expressed by some members of the United Nations, with regard to the Development Fund for Iraq.' France's UN ambassador, Jean-Marc de La Sablière, supported the suggestion when he said, 'We favour creating a special multilateral fund, managed collectively by the United Nations Development Programme and the international financial institutions.' Others have suggested that even the Iraq Development Fund, through which oil revenues are to be channelled into reconstruction, should be subject to scrutiny by an international board created for the purpose.

If the US is forced to accept these conditions to legitimize its occupation with accelerated reconstruction and a return to normalcy, and if the growing domestic opposition forces it to cut back on its defence spending and its own military presence in Iraq, then the hope of recovery spurred by the second-quarter growth figure would definitely remain unrealized.

August 19, 2003.