The last day of July 2003 brought news of an unexpected vigour in US economic growth. Commerce Department figures showed that in the second quarter of the year, the US economy grew by 2.4 per cent, well above the 1.5 per cent predicted by many analysts. Interestingly, there is consensus on the cause for 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 London Financial Times, as the ‘largest run-up in government spending since the Vietnam War’.

Pentagon estimates of the costs of the 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 been rising at a 44 per cent annualized rate. Not surprisingly, overall government spending rose by an annualized 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 must be cause for celebration to a government that is fast losing domestic support for its Iraq misadventure, which is proving to be  more prolonged than expected, more unilateral than multilateral, and more costly in terms of US lives that are being lost virtually every day. But, these very factors make difficult the task of sustaining the spending that yields that growth rate. A view is gaining ground, that the direct financial costs of the occupation is too much of a burden for the US government, even if it is good for American business and the American economy. If the growth is to be sustained, therefore, the US must ensure that other governments contribute to the reconstruction effort and that the ‘external’ benefits of that effort flow to the US.

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

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

In April 2003, the US Congress approved $3.6 billion towards the reconstruction effort. According to White House Budget Director Joshua Bolten, funds from various other sources such as frozen Iraqi assets, revenues from oil and $800 million in cash found within Iraq, has 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 quite 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’ on the costs 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 larger request for 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 outside 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 potential soon, its gains from financing the costs of occupation would be strengthened by the benefits derived by US business from the reconstruction spending financed through oil revenues. Even if the occupation alone is sustained, the purely economic gain for the US could be substantial. And if governments outside the war coalition can be persuaded to contribute to the reconstruction effort, a US recovery is a real prospect.

Iraq, the victim, is less fortunate. It is still devastated by the war, with little benefit 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 were 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 funds that were available for reconstruction, allocations had totalled to slightly more than $2.7 billion till that date. Of this, $2 billion came from funds approved by the Congress and $750 million from seized and vested Iraqi state assets. The remaining $5 billion comprised, $2.2 billion from funds appropriated by the 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 spent 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 had spent about $730 million on humanitarian initiatives like restoring food distribution and augmenting medical supplies, leaving $1.37 billion for reconstruction, including restoring basic services and oil production. This compares with the US civil administration’s own 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 to be inadequate even 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 sixty days. Experts, however, are sceptical. In the case of electricity supply, for example, this would require increasing generation from the present 3,000 MW to 4,000 MW. Security problems, ageing equipment, lack of spare parts and the effects of looting of high-voltage power lines imply that such an increase, even if achieved, will not be sustainable.

Even though reconstruction has been slow, policies are swiftly being put in place to ensure that the gains from the occupation will accrue to corporate America and the US economy. In particular, the Coalition Provisional Authority has initiated moves that will open up the Iraqi economy for foreign operators. In July, while announcing a competition for mobile phone licences in Iraq, the CPA promised to waive Iraqi legislation that requires foreign investors to allocate a 51 per cent equity share in projects based 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 – the Rafidain Bank, with deposits of over $1 billion, and the smaller Rasheed bank – with 150 branches each. This restructuring process is seen as a prelude to allowing the contractor who undertakes the process to buy into the banks’ equity.

‘Privatisation’ in favour of foreign investors is problematic because of evidence that it is primarily US firms that both are and likely to be beneficiaries of the 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 revenues and helped it swing from a loss to a 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, although the Iran-Libya Sanctions Act passed in 1996 by the US Congress has kept US companies out of Libya. On 30 May, Halliburton announced that it had finalised a $6 million agreement to settle twenty lawsuits alleging that the company had used deceptive accounting practices when Dick Cheney ran it. Halliburton’s role in Iraq has been particularly controversial because 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 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 in Iraq. As pressure builds on the US to seek financial support from other countries to accelerate the reconstruction, 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 can be made at a proposed donor conference in October.

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 will be 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, therefore, its own military presence in Iraq, then the hope of recovery spurred by the second-quarter growth figure will definitely remain unrealized.