Illicit International Transactions

Linked with Bradford Dillman – USA, with undergraduate study of International Political Economy, and with Lessons for US Policy in the Arab World.

Implications for Reconstruction in Iraq, Palestine, and Algeria – DRAFT, NOT FOR CITATION, by Bradford Dillman, Assistant Professor of International Political Economy, The University of Puget Sound, 1500 N. Warner St., #1057, Tacoma, WA 98416, Mail, 253-879-3594.

This text is from a workshop on “Rebuilding Devastated Economies in the Middle East”, G.E. von Grunebaum Center for Near Eastern Studies, UCLA, Session II, February 3-5, 2005.

For more than a decade, violence has devastated the economies of Iraq, the Palestinian Territories, and Algeria. All three nations are beset with high unemployment, degraded infrastructure, and low or negative per capita economic growth.

Reconstruction is hampered by continuing civil conflict, although Algeria’s Islamist insurgency has tapered off in recent years. National elites face the daunting challenge of re-establishing security, strengthening state institutions, enforcing a rule of law, expanding social services, and providing productive employment for large numbers of youth entering the workforce. At the same time, leaders face mounting internal and external pressure for political liberalization.

It is easy enough to catalogue a panoply of actions that domestic and international actors should undertake to rebuild these economies, but it is much more difficult to assess whether the policies will be politically viable or effective if implemented. This paper examines the impact that illicit international transactions have on economic recovery efforts. It places shadow actors and illicit transactions front-and-center in a political economy analysis of Iraq, the Palestinian Territories, and Algeria. Its central thesis is that cross-border “shadow” networks imperil reconstruction in conflict-ridden countries. Understanding the importance of actors in illicit transnational networks allows us to better assess policy options and anticipate the roadblocks those options may encounter. Illicit international transactions are defined as activities that result in a transfer of goods, services, and money across borders by actors that contravene domestic laws or violate international norms of good governance. These transactions typically involve the misuse of public resources, evasion of economic regulations, and undermining of competition. Some of the most important examples of transnational shadow activities are: smuggling; money laundering; illegal capital flight; commission-taking on international contracts; monopolization of importing through coercion; sanctions-busting; and misappropriation of external rents such as aid and oil revenues.

Scholarship on the Middle East has for years underestimated the centrality of illicit transactions in structuring political systems and channeling resource distribution. This is not to say that analysts of the Middle East have ignored illicit activities such as corruption, criminality, and trading in the informal economy, but that they tend to portray them as domestic, episodic, and secondary phenomena. The rentier state literature is a partial exception. Comparative and statistical analysis of rentier states suggests, among other things, that rents tend to facilitate corruption, impede economic reform, and limit democratization (see Karl 1997; Vandewalle 1998; and Ross 2001). Iraq, the Palestinian Territories, and Algeria – all rentier states – show evidence of these effects. If reconstruction efforts center on expansion of the oil sector and increases in international aid, they may actually reinforce some of these negative structural characteristics.

There are two other bodies of literature that prominently factor illicit transactions into development processes, but neither has been systematically applied to a wide range of Middle East cases. Literature on the politics of economic reform – much of it drawing on post-communist cases – has traced a number of unintended illicit effects of market-oriented transitions: personalization of public property; privatization scams; stripping of industrial assets; capital flight; and money laundering; and the rise of a mafia-oligarch-state nexus. Joel Hellman (1998), for example, argues that economic liberalization in former command economies creates a set of early “winners” who seek to monopolize ill-gotten gains by preventing complete liberalization from occurring. Béatrice Hibou (2004), looking at sub-Saharan Africa, contends that adoption of Washington-Consensus policies has led to a thoroughly corrupt “privatization” of the state. My own analyses suggests that North African elites tap international resource inflows during partial economic reform to bolster extra-budgetary funds, consolidate patronage, and re-regulate the economy (see Dillman 2002; 2001; and 2000). This body of literature – which also includes “infitah” studies – cautions that economic reform is not a panacea; it often creates shadow networks with damaging consequences.

The third body of literature of relevance to the Arab cases looks at economies of violence. The International Peace Academy’s Economic Agendas in Civil Wars (EACW) program has published a number of cases studies of societies engulfed in war or extreme violence (unfortunately there are no Arab cases). The studies suggest that illicit trade in commodities like blood diamonds, small arms, and timber lengthens the duration of conflict and creates potential “peace spoilers” (see Ballantine 2004). Rebel financing tends to come from external third parties, while government elites in times of war often loot private and public assets. A separate ethnography by Carolyn Nordstrom (2004) uncovers entrenched illicit networks in African conflict zones where foreign military actors, foreign donors, and foreign commercial actors join in the profiteering. Iraq, the Palestinian Territories, and Algeria have suffered prolonged violence (short of civil war) with similar processes of smuggling, profiteering, conflict financing, and (shadowy) “differential accumulation.”

A brief look at several recent “funny money” activities in the three Arab cases illustrates some of their broad implications for rebuilding. In the case of Iraq, newspapers reported on a shadowy arms deal carried out by the interim government. Four Iraqi cabinet members – including Defense Minister Hazim al-Shalaan – apparently approved the physical transfer of $300 million from the Iraqi Central Bank to Lebanon for the purchase of weapons from international arms dealers (Filkins 2005). The actors who either participated in or “green-lighted” the unorthodox transaction allegedly included Iraqi cabinet officials, American financial overseers, a private Iraqi bank, intermediaries in Lebanon, and manufacturers of weapons in Poland, the Czech Republic, Turkey, the Ukraine, and the United States. In the case of Palestine, there was much ballyhoo at the time of Yasser Arafat’s death about the fate of billions of dollars of “hidden cash” he had allegedly skimmed from public coffers and stashed in international assets. An International Monetary Fund audit of Palestinian Authority finances in 2003 estimated that since 1995 Arafat had diverted $900 million to a variety of commercial investments outside the West Bank and Gaza (Erlanger 2004). In Algeria, the country’s largest private bank – Khalifa Bank – collapsed in 2003 and entered into government receivership following a financial scandal. It has been alleged that the managers of the bank duped depositors – many of whom were state entities – and embezzled funds estimated at some $1.5 billion that were transferred out of the country (see Crumley 2003).

These cases are emblematic of a wider set of illicit transactions about which several observations can be made. First, grand corruption is rarely confined to the domestic sphere; proceeds from “swindling” are often parked outside the territorial unit from which they were derived. Second, carrying out shadow activities typically requires a network of domestic and international actors. Economists often portray the key actors as “private rent-seekers” who illegally extract gains from public officials. Policy makers in the post-9/11 world tend to identify key culprits as organized criminal mafias and terrorists. Yet public officials are often key actors, which is one of the reasons for the widely-held public perception in the MENA that governments are like kleptocracies. Third, analysts often assume that economic and political elites want more transparency and rule of law to dampen opportunities for transnational corruption. However, the record in Iraq, the Palestinian Territories, and Algeria suggests that powerholders rarely police themselves or their private allies, especially during periods of civil violence. Fourth, reconstruction policies sometimes make the illicit problem worse, and illicit actors often hamper policy reform. Policy prescriptions focused on economic liberalization, international aid inflows, foreign investment enhancement, state-institution strengthening, and democratization may unintentionally complicate matters. Finally, illicit transactions affect development prospects and governance, but it is often difficult to know precisely how. Tracking clandestine networks and large transfers of resources is an inherently imprecise, but necessary, daunting task.

Placing Illicit Transactions in an International Context:

Many studies suggest that illicit activities tend to lower growth, reduce social trust, and discourage foreign investment. Petty illicit activities in some instances can be a survival mechanism for the poor and can grease the wheels of government with positive macro-economic effects. Shadow economies grow substantially in societies beset by civil conflict. The breakdown in government institutions encourages both political elites and rival non-state actors to pursue ill-gotten gains. The risk of punishment in conflict societies like Iraq, Palestine, and Algeria tends to decrease at the same time that scarcity of good and services creates windfall profits for those willing to deal in the shadows.

There are two proxy indicators of the scale of transnational illicit activities in the Middle East: capital flight and contract-intensive money. It seems reasonable to assume that actors in devastated economies or countries with civil conflict want to hold a significant proportion of their money (legal or ill-gotten gains) outside the country. Capital flight is a means of transferring or laundering illicit proceeds to banks and other depositories outside one’s borders. By many estimates, wealth flight as a percentage of Middle East GDP is higher than for almost any other region in the world. In the 1990s, a commonly accepted figure for the amount of Arab capital invested abroad was $500 billion (Henry and Springborg 2001: 97). A proportion of this flight capital was generated through shadow activities. Volatile exchange rates and significant variations between official and black market foreign currency rates could also reflect capital flight. Similarly, Henry and Springborg (2001) assess levels of institutional credibility and accountability in the Middle East by measuring the ratio of contract-intensive money (CIM) in banks to the total money supply. The ratio is lowest in “bunker” regimes like Iraq and Algeria – where weak property rights, corruption, and violence dissuade people from parking funds in domestic commercial banks. This proxy indicator also seems to correlate with corruption perception surveys and other measures of rule of law. If illicit accumulators of funds are not parking assets in banks, under their beds, or in local real estate, we would expect a significant proportion will be parked outside the country.

In recognition of the development implications of illegality, international institutions have ratcheted up funding for programs to combat corruption and to create transparency in state finances. The International Monetary Fund and the World Bank have many good-governance and anti-corruption programs. The World Bank now compiles Investment Climate Surveys and a “Doing Business” database to measure perceptions of corruption, lack of contract enforcement, and regulatory unpredictability. The United States and the European Union have also joined in anti-corruption funding through USAID and the Euro-Mediterranean Partnership’s MEDA program. These actors, joined by international NGOs like Transparency International, tend to focus on reforming Middle East administrative apparatuses, legal systems, and law enforcement capacities. Their policy targets are domestic Middle East actors and institutions. The problem, however, is that policy prescriptions that focus solely on the domestic level are unlikely to have a significant dampening effect on shadow economies. Grand corruption that impacts the prospects for reconstruction usually has an important transnational dimension. International organizations increasingly advocate policy interventions that can be targeted at different points in the illegal transnational chain.

The security policies of the occupying powers in the Palestinian Territories and Iraq indicate that Israel and the United States are increasingly cognizant of the regional and international dimensions of illicit transactions. Israel’s separation wall may, among other things, prevent arms smuggling into the West Bank and constrict the points through which Palestinians can access Israeli goods that end up in the hands of Palestinian Authority monopolies and illicit trade networks. And the Israeli government’s secret decision in July 2004 to authorize seizure without compensation of Palestinian-owned property inside the security wall (Myre 2005) is the extension of a decades-long practice of illegal expropriation [aka primitive accumulation] hampering Palestinian state-building.

US pressure on Syria and Iran to prevent smuggling of weapons to Iraqi insurgents is part of a more general effort to police importing into Iraq. Policing of illicit exports, however, seems to have met with mixed success, even though these exports are a direct drain on public resources. A number of newspaper reports in 2004 indicated that since the US invasion criminal networks have been dismantling Iraqi infrastructure and factories, smuggling the stripped machinery, parts, and scrap metal into Jordan and other neighboring countries. Similarly, criminal rackets apparently continue to illegally tap crude oil pipelines and ship the diverted oil out of the country. A 2004 audit of the Coalition Provisional Authority by the International Advisory and Monitoring Board concluded that the CPA could not estimate the amount of illegal oil smuggling when sovereignty was handed over to the Iraqi interim government, partly because the there was a lack of metering equipment in the oil industry (Revenue Watch 2004).

US efforts to secure the return of Saddam-era funds deposited in foreign banks has apparently had a modicum of success, but Syria and other Arab states have dragged their heels. Lebanon, Syria, Jordan, and the Gulf countries remain banking havens for criminal elites throughout the region. These countries remain largely resistant to international banking standards, although the Gulf states appear to be increasing banking oversight and regulation of money transfer agents. As long as these banking and trade entrepots remain accessible, regional actors will use them for money laundering and financing of a wide range of illicit current transactions. Moreover, as James Henry (2003) argues, there are plenty of Northern “blood bankers” who accommodate kleptocrats and criminals seeking to launder absconded public funds.

The Centrality of State Actors in Shadow Economies:

Who are the primary illicit transactors, facilitators, and beneficiaries in the Middle East? “Rent-seeking” theorists tend to define the main instigators of informal transactions as private actors who offer public officials bribes to gain government-granted privileges. Since the start of the second intifada and the 9/11 attacks, security-oriented policymakers have focused on insurgents and terrorists who engage in money laundering and arms trafficking. But terrorists, criminals, and businesspeople are only a subset of the actors involved in Middle East shadow economies, and not necessarily the most important ones. Participants often hold formal positions in the government or the state apparatus. Paul Salem (2003) argues that in state-socialist holdovers such as Iraq and Algeria, massive corruption and profiteering reached into the highest levels of government, security, military, and party elites, turning the regimes into what the public regarded (or regards) as kleptocracies. Transnational illicit activities blur the distinction between public/private and state/business. Actors frequently “straddle” formal juridical categories and associate through some degree of separation with actors in various juridical and institutional categories.

Steven Heydemann (2004) and Reinoud Leenders and John Sfakianakis (2003) argue that we should focus on cross-juridical and cross-institutional domestic networks. A network or transactional approach concentrates on chains of connection between a range of individuals and entities who structure the interests of political and coercive institutions. Within these networks, there are varying degrees of separation between actors who cooperate for mutual gain. The networks are not simply government patronage systems in which the “state” is the distributor and “social actors” are the recipients, nor are they simply bribery rackets in which businesspeople “pay” for officials’ favoritism. Political elites may be part of the networks but exercise little control over them. In a similar fashion, Ballantine (2004) advocates a focus on “stakeholders” in conflict economies. The aim is not to distinguish between actors merely on the basis of where they “sit,” but rather to distinguish between actors in terms of their motivation: whether they enter illicit economies for survival, exploit war to amass resources, or steal resources in order to conduct war. From this perspective, the relevant network actors include military elites, bureaucrats, private businessmen, smugglers, transporters, criminals, foreign contractors, foreign suppliers, foreign investors, and foreign bankers.

When looking at cross-border networks, distinguishing between the motives of actors becomes an important issue with ramifications for reconstruction. Non-national actors and institutions are not necessarily willing accomplices; their presence in illicit networks may simply be functional to the achievement of the ends of some of the network’s members. In other words, the “complicity” of international actors is not necessarily one of intent; it may occur by default. International financial institutions and aid donors who facilitate financial flows to Iraq, Algeria, and the Palestinian Authority create opportunities for funds-diversion, but they can be unwilling or unwitting participants. Even if they know that funds are misused and placed in secret accounts, the alternative of cutting off flows may be worse (politically). Whether out of strategic self-interest or some notion of respect for the principle of sovereignty, the United States, the European Union, and international organizations generally do not “take to task” friendly kleptocrats—they tend to target pariahs and rogue states. When domestic actors know this – or when they know that foreign actors are not willing to unseat them or push the reform agenda too far – they are in a better position to instrumentalize foreign actors to support their extra-legal activities.

In the cases under consideration in this paper, I argue that, on balance, the key shadow actors are public officials, military and security elites, and their allies in the private sector. This is not to deny the significance of insurgent/ terrorist/ rebel actors and networks. Hamas, Ansar al-Islam, Saddam loyalists, al-Qa’ida, the GSPC, and the GIA also operate in the shadow economy and affect prospects for reconstruction. Yet the state-military-business troika – what Algerians often refer to as the “politico-administrative mafia” – has its hands in the public coffers and probably has a much more significant impact on resource redistribution. This troika often has privileged access to international rents and controls large interstate trade. In conflict zones, it is often the predominant holder of the means of coercion, and it can put those means of coercion to use for extortion and racketeering as well as security operations. Military, security, and intelligence services are particularly important members of this troika. Ironically, security policies in Iraq, Palestine, and Algeria designed to bolster the size and scope of military forces may in the very process expand the size and scope of these same forces’ extralegal “moonlighting.” If rebuilding a devastated economy means reestablishing the government’s monopoly on the legitimate use of force, and assuming that the use or threat of force is an important tool in many illicit activities, the rebuilt state apparatus – especially if unaccountable to the electorat – may increase corruption.

The centrality of state officials in illicit transactions can be seen in the Palestinian Territories, Algeria, and Iraq. After the Oslo Accords, Arafat constructed a neo-patrimonial regime, much of whose revenue ultimately came from outside the territories. According to Hans-Joachim Rabe (2004), a core economic elite emerged involving Arafat loyalists, security officials, Palestinian Authority professionals, and private businessmen. Similarly, Markus Bouillon (2004) argues that the political economy of peace initially rewarded the “Tunisians” and diaspora entrepreneurs who wove a fabric of corruption based on indirect collaboration with Israelis and foreign aid providers. PA authorities and security services became the key intermediaries between foreign actors and local actors. PA officials established their own private businesses and channeled government purchasing to foreign firms in which they had financial interests. Importing, public procurement, and taxation became important mechanisms to accumulate private capital. The dividing line between legitimate government extraction and illegal personal rent-taking was blurred, just as it has been blurred in Iraq and Algeria.

PA authorities in collusion with security services and diaspora conglomerates established import monopolies over cement, gasoline, cigarettes, flour, and just about everything else (Bouillon 2004). Importing became a “zero-sum” game, where one actor’s ability to get trucks through the border with Israel denied another actor the opportunity to import (Rabe 2004). Post-Oslo conditions of “privileged movement” helped determine the set of actors who could consistently make connections to the main territorial supplier, Israel. The monopolization of importing damaged Palestinian businesses while providing extra-budgetary resources for powerholders. On the export side, the IMF (2003) notes that despite post-2000 closures, large West Bank and Gazan companies with “good connections (especially with the Israelis)” had little trouble getting their goods through checkpoints and into Israeli and foreign markets. Palestinian security services also diverted money from the Customs Office that was supposed to go to the Treasury. The IMF (2003) describes the process as “diversion of excise revenue…to off-budget activities outside the control of the Ministry of Finance, which contributed to liquidity problems and a buildup of expenditure arrears.”

Sara Roy (2002) and Bouillon (2004) argue that the devastation of the Palestinian economy can be traced to the onset of Oslo, and the second intifada accelerated negative trends. Roy attributes most of the decline to Israeli closure policies, territorial fragmentation, and destruction of infrastructure, but she also cites PA mismanagement and corruption. Beginning in 2000, Israel’s refusal to transfer VAT and customs duties to the PA threatened privileged networks. EU donors and the Arab League ratcheted up funds and diverted project-oriented aid to emergency budgetary support. Corruption has a large part to play in explaining why a “peace process” does not necessarily rebuild a devastated economy. At the same time, closures and curfews since 2000 have undermined some illicit transactions. A revealing example is motor vehicle theft. In the 1990s, auto theft in Israel was estimated to amount to $1 billion.

According to Sergio Herzog (2002), the Oslo process helped spur a thriving, professionalized trade in stolen Israeli vehicles into PA-controlled regions. Palestinian “chop shops” dismantled the vehicles and re-exported car parts to Israel. In this case, peace was good for cross-border criminals and their protectors. Auto theft and smuggling has decreased in the face of Israeli border closures and a 1999 Israeli administrative decision to ban the purchase of used car parts from the Palestinian territories (Herzog 2002).

In Algeria, public officials and military elites have also been implicated in a series of scandals and shadow activities. In 1989, former prime minister Abdelhamid Brahimi accused officials of having appropriated $26 billion in bribes and commissions from foreign companies with contracts in Algeria in the 1980s. [Brahimi later became an Islamist oppositionist in exile. Several dozen members of his extended family were reported to have been killed during one of Algeria’s “mysterious” massacres in the 1990s.] In another scandal in 1990, the National Chamber of Commerce – a public institution – was accused of illegally granting scarce foreign exchange to private sector “insiders.” The outbreak of civil violence following the 1992 coup created an environment in which clandestine transactions flourished. Luis Martinez (2000) traces the creation of new fortunes by both military elites and Islamist networks. Isabelle Werenfels (2004: 178) observes, “The involvement of current and retired military officials in the private and the informal sectors of the economy had been increasing since the 1980s and was indirectly encouraged by an early retirement regulation for civil servants. Not surprisingly, many members of the core elite, for example Belkeir and Mohammed Lamari, placed family members in privileged positions in the private sector and were reputed to have made fortunes.”

Algeria’s military elites and private allies took advantage of trade “liberalization” to stake a claim to the lucrative import trade (Dillman 2000). Djillali Hadjadj (1999) describes a set of state officials, security officers, and private mafias who monopolized importing of foodstuffs and pharmaceuticals. Generals and security officers set up a host of lucrative private security firms offering protective services to public and private enterprises. He also notes that the army, gendarmerie, and military police oversaw imports of arms and security equipment estimated to cost about $3 billion per year during the height of the violence. The amount of this public procurement – much of it conducted without solicitation of competitive bids – is still unknown, and Hadjadj guesses that this type of procurement gave rise to all sorts of misappropriation of public funds. Similarly, opaque public contracts with international firms for the supply of airplanes and engineering services presumably involved a lot of under-the-table money.

It is probably too early to know whether Iraq will witness the emergence of a state/security/private troika under its newly-elected government. The legacy of illicit Baathist networks may influence the behavior of Shia and Kurdish elites.

The insurgency will likely shape new illicit international networks. In conflict zones where military budgets are non-transparent and military actors procure supplies from abroad, opportunities for illicit activities flourish. Security forces and their allies often try to “expropriate” monopolies over cross-border exchange, or at least get into the “game.” During the first year of Iraqi occupation, the Coalition Provisional Authority (CPA) managed the Iraqi budget by drawing on oil revenues and repatriated assets in the Development Fund for Iraq (DFI). The CPA transferred control of this fund in June 2004 to the Iraqi interim government, but the assets are subject to oversight by the International Advisory and Monitoring Board (IAMB). The newly-constituted government in 2005 will have full control over the fund, which is replenished with revenues from oil exports. The IAMB’s most recent audit of the DFI in the first half of 2004 found serious deficiencies in the management of more than $4 billion of Iraqi finances (see Revenue Watch 2004). The CPA usually disbursed funds without seeking competitive bids from contractors. In many cases, the CPA did not monitor the use of funds by Iraqi ministries. The Kurdish Regional Government denied the IAMB access to all of its accounting records.

Similarly, in its October 2004 report to Congress, the Coalition Provisional Authority Inspector General found many irregularities in use of DFI funds by the CPA and Iraqi ministries (see Revenue Watch 2004). Among other things, the CPA-IG could find no data on how the Ministry of Finance utilized a $1.4 billion disbursement from the fund just days before the transfer of sovereignty. It noted the lack of transparency in the interim government’s use of Iraqi finances.

In its January 2005 report, the Inspector General found that before the turnover of sovereignty, the CPA gave hundreds of millions of dollars to Iraqi ministries that had not presented plans for how the money would be used, opening the door to corruption and fraud (Eckholm 2005). Iraqi ministries’ lack of skilled workers, equipment, and accounting oversight may open the door for personalization of public resources in the coming years.

Oil Rents and Corruption:

Iraq and Algeria are rentier states that derive a majority of government revenues from oil and gas sales. They will remain rentier states for a long time. In fact, reconstruction will necessarily require investment and expansion in the hydrocarbons sector, making both countries even more dependent on international rents. Efforts to establish financial transparency and reduce corruption will have difficulty counteracting the structural effects of natural resource dependency. The line between use of these hydrocarbons resources for “legal” patronage and misuse for personal accumulation is often blurry. Moreover, according to Karl and Gary (2004), “IFI’s and private commercial banks support lending to deeply indebted oil-exporters, even when it is clear that debt only supports unproductive activities or papers over rent-seeking behaviors.”

A wide body of literature contends that access to natural resource rents and strategic rents tends to make public expenditures non-transparent. Moore (2004: 309) notes that “external banking sanctuary” facilitates nontransparency in natural resource-based regimes that have the “capacity to stash illicit capital in developed countries and enjoy it later.” Transparency International’s 2004 Corruption Perceptions Index ranks Algeria, the Palestinian Territories, and Iraq as having rampant corruption. According to TI chairman Peter Eigen, many of the worst scorers are oil-rich countries where “public contracting in the oil sector is plagued by revenues disappearing into the pockets of western oil executives, middlemen and local officials.” He argues that “without strict anti-bribery measures, the reconstruction of Iraq will be wrecked by a wasteful diversion of resources to corrupt elites” (Transparency International 2004). Saddam Hussein’s end run around the UN Oil-for-Food program is one of the most extraordinary examples of the difficulty of accounting for oil revenue use. Surcharges, kickbacks, and oil-smuggling involving a host of countries, oil companies, and purchasers allowed Saddam to garner $8-$20 billion despite one of the most elaborate sanctions regim

Karl and Gary (2004) argue that “only those who control political power can grant the opportunity to make money from oil, and only those who receive this opportunity can provide the revenues to keep regimes in power.” Control over hydrocarbons generally means control over the budget, foreign exchange, and the ability to import. Prolonged conflict in Algeria and Iraq has decreased industrial production in the public sector and increased already-high reliance on imports of foodstuffs, machinery, and industrial inputs. It is state officials that usually control the terms of access to foreign exchange for the public sector and for many private businesses, and therefore the state often determines who can profit from importing. Dutch disease tends to raise the real exchange rate of the country’s currency. Insiders who get rationed foreign exchange at official exchange rates get a subsidy—low cost credit. The Algerian government also has a history of rationing licenses for trade franchises and importers.

Oil booms fuel public spending, which enhances prospects for economic recovery. The Iraqi government will benefit from recovery of oil export potential. Sustained high oil prices in the last two years have boosted growth of Algerian GDP and left Algeria with $37 billion in foreign exchange reserves by September 2004. President Abdelaziz Bouteflika has launched a massive state spending program. “Black gold,” however, makes possible huge kickbacks and commissions when states issue international contracts for supply of military equipment, turnkey projects, and engineering services. A frenzy of international oil companies seeking oil drilling concessions, joint ventures, and oil services contracts in Algeria (and probably soon in Iraq) has opened the door to extraordinary graft. Leenders and Sfakianakis (2003) provide indirect evidence of the oil-creates-graft thesis by pointing out that corruption in the Middle East and North Africa actually declined in 2001-2002 because an oil-price slump and global recession – which reduced investment in the emerging markets – curtailed opportunities for “commission-taking” by state elites. Paul Stevens (2004) contends that the recent rises in oil and gas prices are dampening the momentum for economic reform. Absent profound political change and legislative oversight of the executive branch, ruling elites will continue to line their own pockets with oil windfalls, reinforcing public perceptions that they are kleptocrats.

Will Elites Promote Transparency and Good Governance?:

Reducing transnational criminality in countries seeking to recover from civil conflict depends on the extent to which political elites are willing to confront the shadows. Extra-legal actors seek to avoid the public spotlight, and states run by “information-shy” elites seek to cover their tracks. There are any number of actors who “talk the good governance talk” in consultation with international institutions and foreign governments. Many may do so based on a conviction that corruption devastates the economy or based on a cost-benefit analysis that better governance will enhance state capacity. The easiest policy in many countries is to create “pockets of efficiency” in the administration, which amounts to targeting particular officials or bodies for cleanup. Targeted campaigns against weak links in the shadows can be successful and not too costly politically. The hope is often that a demonstration effect will occur, persuading illicit actors to be more circumspect, legalize their activities, or withdraw completely from the shadows. In this regard, public scandals can have a catalytic effect, drawing civic groups, legislatures, and authorities into a temporary alliance to root out particular networks. For example, the public outrage over Algeria’s Khalifa Bank scandal has pushed the government to question hundreds of current and former government officials, charge a former governor of the Central Bank, and issue an international arrest warrant for the president of Khalifa Group.

However, Leenders and Sfakianakis (2003) argue that most anti-corruption discourse is rarely translated into sincere policies, and public corruption cases frequently are an effort by governments to “settle political scores.” In countries with pervasive violence or threats to security, taking on powerful networks is politically and personally risky. Those who would enforce transparency may themselves engage in shady transactions or be part of a network that is involved in domestic or cross-border corruption. Werenfels (2004) recounts an interview with an Algerian private sector consultant who is conversant in World Bank-anti corruption lingo and is a participant in fora publicizing governance problems. The same person also has close ties with décideurs and uses those connections to “mediate” between Algerian elites and international organizations. In this case, the actor apparently perceives no contradiction between his public persona and his private economic activities. It should not be surprising that public officials who straddle the public and private realms will not make the fight against illicit activities a crusade but will choose their targets selectively.

Whether authorities decide to earnestly promote transparency depends on calculations of political and economic rationality. In some cases attacking political competitors in illicit networks may enhance one’s political power and also benefit the economy as a whole. Alternatively, it may be politically rational to attack illicit networks in order to “appropriate” their activities, but society will reap no gains. In many cases it is politically suicidal to pressure shadow actors who control government resources or means of coercion. Of course, political and economic self interest may compel some elites to participate fully in shadow economies. In studies of sub-Saharan African cases, William Reno, Béatrice Hibou, and Carolyn Nordstrom argue that leaders who deliberately undermine their national economy and state institutions in pursuit of personal enrichment are often still able to sustain a system of governance.

Establishing budgetary transparency is a necessary but insufficient means to attack public corruption. Extra-budgetary funds are a key source of personal gain and patronage. Military and security actors, for example, often morph into entrepreneurs or godfathers for importers, security services contractors, and factory owners. Their activities – which are often technically illegal and have an international dimension – may depend only tangentially on the state budget. Actors are loathe to give up these activities when violence subsides. Legalization of these activities during reconstruction is one means to create a more vibrant private sector.

Public pressure, legislative activism, and international assistance have helped promote some progress on the transparency issue in the Palestinian Authority, but Iraq and Algeria still appear to be foot-draggers. A Palestinian ministerial reform committee initiated legal changes in 2003 to create a quasi-autonomous financial monitoring office and to require officials to submit financial disclosure statements. A Palestinian Investment Fund is supposed to manage the PA’s commercial assets, many of which are invested in other countries. The Finance Ministry is consolidating budget accounting and expenditures. However, the IMF (2004: 10) is a bit too congratulatory in its claim that “reforms have placed the Palestinian Authority to a level of fiscal responsibility, control, and transparency which rivals the most fiscally advanced countries in the region.” El-Aryan (2004) notes that pensions and insurance funds have not been included in the Palestinian budget, and security agencies have resisted distributing payrolls through the banking system. One is hard-pressed to identify any senior PA official who has been convicted for corruption.

Algeria’s Bouteflika has repeatedly emphasized the importance of establishing a rule of law and rooting out corruption. In 2002 he issued a decree requiring the government to publish provisional awards of contracts so that unsuccessful bidders could appeal the government’s decisions. Parliament is poised to ratify an international money-laundering and anti-terrorist financing treaty. His government is rigorously investigating the Khalifa bank scandal. However, since early 2003 Bouteflika has conducted a campaign of intimidation and imprisonment against journalists and publishers, particularly those who have reported on corruption, embezzlement, and mismanagement by public officials.

Unintended Consequences of Well-Intentioned Reconstruction Policies:

Many of the policy proposals to help devastated economies are based on a neo-liberal worldview. These solutions stress the virtuous, mutually-reinforcing effects of democratization, institution-building, economic liberalization, and North-to-South financial transfers. In a recent article in Foreign Affairs, Stuart Eizenstat, John Porter, and Jeremy Weinstein (2005) argue that the United States should aid, develop, and stabilize weak or failed states. This is to be accomplished in weak states by enhancing their capacity to protect borders, strengthening their security forces, strengthening good governance, and promoting an expansion of world trade. Similarly, the European Union since 1995 has touted a Euro-Mediterranean Partnership in the southern Mediterranean designed to bolster development through free trade and generous aid for structural adjustment and administrative reform. Illicit political economies, however, can weaken or undermine these reconstruction polices. Conversely, we should recognize that these same policies may in some cases unintentionally expand opportunities for illicit transactions.

Market-oriented reforms are commonly proposed for countries seeking to enhance efficiency and transparency. But economic liberalization – absent the establishment of powerful legislative and regulatory institutions – can easily facilitate large-scale personalization of public property. Heydemann (2004: 6) observes that economic reform in the Middle East “reorganizes opportunities for rent-seeking” but does not necessarily eliminate rent-seeking and disproportionate gains by members of pre-existing “networks of privilege.” Economic transition that expands the realm of economic activities to a wider range of actors requires both weakening some regulations and re-regulating some economic activities. Ballantine (2004) finds that donors who promote rapid economic liberalization in post-conflict societies can produce perverse effects that encourage criminality. To the extent that liberalization expands access to international actors – multinational corporations, foreign contractors, international banks, aid agencies, and Northern donors – it also expands opportunities for illicit exchange of resources. In addition, privatization often degenerates into personalization of public property. Hibou (2004) notes that in Sub-Saharan and Northern Africa privatization still allows public officials to indirectly govern through the use of private intermediaries. It allows for new negotiations among public and private actors, blurring public/private and licit/illicit distinctions.

In post-invasion Iraq there is a new constellation of foreign contractors, foreign buyers of oil, foreign trading partners, and Iraqi “intermediaries.” Paul Bremmer’s precipitous attempt to liberalize the economy may have caused more harm than good. Expansion of the legal market has been concomitant with expansion of the gray market. In post-Oslo Palestine there is a new constellation of Palestinian, Israeli and Jordanian trade partners, foreign contractors, and aid agencies. Public official routinely “moonlight” in private business. Some private investors such as the head of the Palestine International Bank found their businesses targets of public shakedowns, unfair judicial proceedings, and outright seizure (Abu Issa 2004). Post-coup structural adjustment in Algeria has encouraged new oil investments, joint ventures, and import privatization. Under the guise of “financial restructuring,” the government in the 1990s spent billions of dollars to recapitalize state banks and “clean up” ailing state enterprises in preparation for their privatization. Most of the money was misappropriated or wasted. Only a small portion of the largest public enterprises have been privatized in the last decade. Full or partial sales of state-owned enterprises ground to a halt in 2003.

Poorly-managed public banks – whose only purpose seems to be to fund current operations of devastated public enterprises – continue to dominate the financial system, holding 90% of long-term loans and more than 80 percent of banking deposits. Public banks are not audited by reputable foreign companies. In a recent report, the IMF assessed that within Algerian state banks “observance of existing standards is not effectively enforced and a framework of sanctions and penalties is missing” (“Algeria” 2004: 17). The two largest private banks in the country went bankrupt in 2003 following financial scandals, and their remaining assets are under government control. Prime Minister Ahmed Ouyahia’s decision in August 2004 to require all public funds to be held in public banks probably spells the end of Algeria’s experiment with private banking. The experiences of all three economies with civil conflict or on the cusp of recovery suggest that conventional economic reform may not be a viable solution.

Is international aid a panacea, capable of jump-starting economic recovery and decreasing the need for shadow economies? Ballantine (2004) observes that donor countries and international financial institutions that provide “state-focused” development aid during conflict may actually increase opportunities for illicit activities. Similarly, Leenders and Sfakianakis (2003) contend that donor conditionality has had very little effect on corruption in the MENA. World Bank programs to clean up privatization and USAID judiciary-strengthening programs have had limited success. The EU’s MEDA funds are mostly funneled through the hands of authorities who determine which groups in society can join the gravy train. The EU itself recognizes that auditing of funds is inadequate. Part of the problem is that aid money is fungible. It indirectly allows governments to personalize other state resources.

In Palestine it seems clear that massive foreign aid has helped institutionalize a rentier system and provides greater opportunities for top-down patronage. Donors seem to believe that their rigorous monitoring has prevented misuse of funds. In his assessment of aid effectiveness during the Oslo Process, Lasensky (2004: 231) finds, “Donor insistence on transparency and accountability had a positive, but extremely limited effect on PA administrative practices and good governance.” Like the Palestinian Authority, Iraq has become an international mendicant. An International Reconstruction Fund facility run by the World Bank and the United Nations distributes some international assistance. The United States, however, is the primary international donor. Congress has appropriated more than $24 billion to the Iraq Relief and Reconstruction Fund. The CSIS (2004) estimates that some 15% of US funds spent in Iraq thus far have been lost to corruption, fraud, and mismanagement.

Increased foreign investment may not be a savior either. A significant proportion of MENA FDI in non-oil sectors is thought to come from nationals reinvesting in the countries in which they made their fortunes. This recycling will not necessarily enhance transparency or the rule of law. In Iraq and Algeria, the hydrocarbons sector will remain the only big attractor of FDI. We should not expect existing rentier states to become more transparent when investments enhance their source of rent. Foreign investors may be just as likely to pay bribes and commissions to state officials. International NGOs suggest that one way to increase transparency is for international oil companies to adopt the practice of “Publish What You Pay.”


This paper has argued that cross-border illicit activities and the interests of those who operate in the shadows will hinder reconstruction. Corruption is both a cause and consequence of economic devastation. If illicit state-private networks are one of the biggest problems, it is questionable whether international reconstruction policies predicated on cooperation with and strengthening of public officials who are already complicit in national predation will quickly transform economies.

Profound political liberalization – rather than counterinsurgency – may be one of the most important preconditions for national reconstruction. Leenders and Sfakianakis (2003) contend that real structural change to address grand corruption will not occur with dramatic political reform. Salem (2003) states, “Until democratization has reached the highest level of state rule, large-scale corruption will remain a structural fact of public life in the Arab world.” Similarly, Hellman (1998), Ballantine (2004), Dillman (2002), and Heydemann (2004) emphasize that allowing a strong role for the previously disenfranchised can temper “unfair winners” during transition. Successful rebuilding may in some instances require that the state “legalize” past illicit gains of ruling elites and former combatants. Inclusionary politics requires free and fair elections and powerful legislatures. It probably requires a guaranteed political role for large, opposition groups like Sunni Baathists, and for Hamas and the FIS, both of whose notion of the “rule of law” includes implementation of some Sharia law. Iraqi Shia overtures to Sunnis, Abbas’ overtures to Hamas, and Bouteflika’s proposal for a general amnesty may be small steps towards political pluralism. Creating that pluralism could mean, regrettably, that many criminals and illicit predators will never face justice.

Works Cited

  • Abu Issa, Issam. 2004. “Arafat’s Swiss Bank Account.” Middle East Quarterly (Fall).
  • “Algeria: Financial System Stability Assessment, Including Reports on the Observance of Standards and Codes on the Following Topics: Monetary and Financial Policy, Transparency and Banking Supervision.” 2004. Washington, D.C.: International Monetary Fund (May).
  • Ballantine, Karen. 2004. “Program on Economic Agendas in Civil Wars: Principal Research Findings and Policy Recommendations.” New York: International Peace Academy (April).
  • Bouillon, Markus. 2004. “The Failure of Big Business: On the Socio-Economic Reality of the Middle East Peace Process.” Mediterranean Politics 9:1 (Spring): 1-28.
  • Crumley, Bruce. 2003. “Crash and Burn.” Time Europe (22 September).
  • Center for Strategic and International Studies (CSIS). 2004. “Estimated Breakdown of Funding Flows for Iraq’s Reconstruction: How Are the Funds Being Spent?” (December)
  • Dillman, Bradford. 2002. “International Markets and Partial Economic Reforms in North Africa: What Impact on Democratization?” Democratization 9:1 (Spring): 63-86.
  • ———-. 2001. “Facing the Market in North Africa.” The Middle East Journal 55:2 (Spring): 198-215.
  • ———-. 2000. State and Private Sector in Algeria: The Politics of Rent-Seeking and Failed Development. Boulder: Westview Press.
  • Eckholm, Eric. 2005. “Occupation Authority Did Not Properly Monitor Spending of Iraqi Money, U.S. Audit Says.” New York Times (31 January).
  • Eizenstat, Stuart, John Porter, and Jeremy Weinstein. 2005. “Rebuilding Weak States.” Foreign Affairs 84:1 (January-February): 134-136.
  • El-Aryan, Hada. 2004. “Palestinian Authority.” In Global Corruption Report 2004. Transparency International.
  • Erlanger, Steven. 2004. “Arafat Mystery: The Hidden Cash.” New York Times (11 November).
  • Filkins, Dexter. 2004. “Mystery in Iraq as $300 Million is Taken Abroad.” New York Times (22 January).
  • Hadjadj, Djillali. 1999. Corruption et démocratie en Algérie. Paris: La Dispute.
  • Hellman, Joel. 1998. “Winners Take All: The Politics of Partial Reform in Postcommunist Transitions.” World Politics 50:2 (January): 203-234.
  • Henry, Clement and Robert Springborg. 2001. Globalization and the Politics of Development in the Middle East. New York: Cambridge University Press.
  • Henry, James. 2003. Blood Bankers: Tales from the Global Underground Economy. New York: Four Walls Eight Windows.
  • Herzog, Sergio. 2002. “Empirical Analysis of Motor Vehicle Theft in Israel, 1990-97.” The British Journal of Criminology 42:4 (Autumn): 709-728.
  • Heydemann, Steven. 2004. “Networks of Privilege: Rethinking the Politics of Economic Reform in the Middle East.” In Networks of Privilege in the Middle East: The Politics of Economic Reform Revisited, ed. Steven Heydemann. New York: Palgrave Macmillan.
  • Hibou, Béatrice. 2004. “From Privatising the Economy to Privatising the State: An Analysis of the Continual Formation of the State.” In Privatizing the State, ed. Béatrice Hibou. New York: Columbia University Press.
  • Heydemann, Steven, ed. 2004. Networks of Privilege in the Middle East: The Politics of Economic Reform Revisited. New York: Palgrave Macmillan.
  • International Monetary Fund (IMF). 2003. “West Bank and Gaza: Economic Performance and Reform under Conflict Conditions.” Washington, DC (15 September).
  • “Iraq in Transition: Post-Conflict Challenges and Opportunities.” 2004. Open Society Institute and the United Nations Foundation.
  • Karl, Terry Lynn. 1997. The Paradox of Plenty: Oil Booms and Petro-States. Berkeley: University of California Press.
  • Lasensky, Scott. 2004. “Paying for Peace: The Oslo Process and the Limits of American Foreign Aid.” The Middle East Journal 58:2 (Spring): 210-234.
  • Leenders, Reinoud and John Sfakianakis. 2003. “The Middle East and North Africa.” In Global Corruption Report 2003. Transparency International.
  • Martinez, Luis. 2000. The Algerian Civil War, 1990-1998. New York: Columbia University Press.
  • Moore, Mike. 2004. “Revenues, State Formation, and the Quality of Governance in Developing Countries.” International Political Science Review 25:3, 297-319.
  • Myre, Greg. 2005. “Palestinians Fear East Jerusalem Land Grab.” New York Times (25 January).
  • Nordstrom, Carolyn. 2004. Shadows of War: Violence, Power, and Profiteering in the Twenty-First Century. Berkeley: University of California Press.
  • Rabe, Hans-Joachim. 2004. “Palestinian Territories: From State Building to Crisis Management.” In Arab Elites: Negotiating the Politics of Change, ed. Volker Perthes. Boulder: Lynne Rienner. 267-297.
  • Revenue Watch. 2004. “Audit Finds More Irregularities and Mismanagement of Iraq’s Revenues.” Briefing no. 9 (December).
  • Ross, Michael. 2002. “Does Oil Hinder Democracy?” World Politics 53 (April): 325-361.
  • Roy, Sara. 2002. “Ending the Palestinian Economy.” Middle East Policy 9:4 (2002): 122-165.
  • Salem, Paul. 2003. “The Impact of Corruption on Human Development in the Arab World: A Concept Paper.” The Lebanese Transparency Association (April).
  • Stevens, Paul. 2004. “Reform Buried under Oil Cash.” The World Today (November): 7-8.
  • Transparency International. 2004. “Transparency International Corruption Perceptions Index 2004.”
  • Vandewalle, Dirk. 1998. Libya since Independence: Oil and State-Building. Ithaca: Cornell University Press.
  • Werenfels, Isabelle. 2004. “Algeria: System Continuity Through Elite Change.” In Arab Elites: Negotiating the Politics of Change, ed. Volker Perthes. Boulder: Lynne Rienner. 173-205.

Comments are closed.