CORRECTED COPY - IRAQ: STAYING CLEAR OF THE MESS

C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 002744

SIPDIS

SIPDIS

E.O. 12958: DECL: 07/31/2016
TAGS: PREL EAID ECON EINV KPRV IZ
SUBJECT: CORRECTED COPY - IRAQ: STAYING CLEAR OF THE MESS
AT STATE-OWNED ENTERPRISES

REF: A. BAGHDAD 2716 (NOTAL)

B. BAGHDAD 2375 (NOTAL)


1. (C) Summary: Econoff on July 17 accompanied a U.S.
military team on visits to two Iraqi state-owned enterprises
(SOEs) to assess the condition of the companies and determine
how best to assist them to improve overall security
conditions. The visits illustrated difficulties in dealing
with state bureaucracy and the risks inherent in assisting
the GOI to revitalize its SOEs. The visit also delineated
the difficult challenges we face in Iraq trying to ensure
that a security objective -- providing gainful employment --
does not undercut a primary economic objective -- assisting
the transition of this state economy to market-based
principles. End summary.

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Subsidy Addictions, Bloated Payrolls, Outdated Facilities
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2. (SBU) The State Company for Electrical Industries (SCEI),
which our team visited, tells a typical story of Iraq's
entrenched state-controlled economy and the risks inherent in
assisting the GOI to revitalize its SOEs. SCEI, owned
entirely by the Ministry of Industry and Minerals (MIM),
produces a range of electrical products, including
generators, air conditioners, and light fixtures. According
to company management, SCEI sells 75% of its output to the
Iraqi government, and the remainder on the open market at
lower prices. Besides government support on the output side,
SCEI benefits from subsidized power and raw materials.
Management told us SCEI employs 4,500 workers, 30% of whom
actually work. The remainder of SCEI's workforce stays home,
and they are compensated at 65% of their normal salary to do
so. Salaries of full-time employees are paid out of company
earnings; those of stay-at-home employees are covered by the
Ministry of Finance (MoF). SCEI's facilities and processes,
though well-maintained, are outdated and noncompetitive. As
one engineer said after requesting help modernizing SCEI's
technology: "We're stuck in the 80's!"


3. (SBU) SCEI management told us SCEI is operating at no more
than 20% of its capacity, running one seven-hour shift five
days per week, mainly because government-provided power
supplies are inadequate. Indeed, management believes the
government's failure to adequately support SCEI is the main
cause of all the SOE's problems, particularly its inability
to provide a secure environment for SCEI's workforce as it
goes to and from work. (A firefight between unidentified
combatants broke out directly across the street from SCEI
during our visit and lasted approximately 40 minutes.)


4. (SBU) A close second to security failures, says
management, is the GOI's failure to finance adequate salaries
for SCEI's employees. Management said the average SCEI
worker makes approximately $300 per month (when working),
which they argued is inadequate to support a typical Iraqi
family. (Note: According to USAID's Economic Governance II
Project, the average Iraqi family needs approximately $180
per month, or $1 per day per individual, to survive at a
"poverty" level. About 20% of Iraqi households fall under
this category and are currently eligible to receive benefits
under the Social Safety Net administered by the Ministry of
Labor & Social Affairs. End note.)


5. (SBU) SCEI management also told our team that the GOI
should erect protective barriers against unfair Chinese
competition, including tariffs and "buy-Iraq" laws. "Our
quality is better," said one manager, "but their prices are
lower."

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Not Getting It
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6. (SBU) SCEI management also laid out what they hoped the
USG could do for them: "What kind of technology can you
provide?" "What kind of access to money do you have?" "Can
you link us up with foreign investors?" SCEI management
believes that if only they could revitalize their operations,
upgrading equipment and hiring back non-working employees,
then they could operate at full capacity. They made no
mention of the need to understand changing market conditions
and adopt flexible, innovative business practices to compete.
Despite our efforts to the contrary, free-market principles
have yet to take root in Iraq's SOEs.


7. (C) Deputy Minister Sami of the Ministry of Industry &
Minerals (MIM),which owns the largest share of Iraq's SOEs
at 31%, told Embassy officials July 24 that the public sector
is currently the best source for employing Iraqis because the
private sector is "too weak" (ref A). This tracks with the

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2006 year-to-date increase in SOE employment from
approximately 500,000 to 600,000 employees (most of whom
appear to be not working). DM Sami said he strongly favors
private sector development, but that the GOI needs to
"rehabilitate" its SOEs. His long-term vision (five years
out),he told us, includes retained government ownership in
"privatized" SOEs. His vision also seems to include a larger
MIM profiting from "rehabilitated" SOEs. The main problem,
as DM Sami pointed out to us, is that the GOI does not have
the money necessary to perform successful "rehabilitation."

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A Typical Scenario
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8. (SBU) SCEI is typical of Iraq's approximately 192 SOEs.
Even the GOI's most profitable SOEs are highly dependent on
subsidized inputs and outputs, probably incapable of
operating profitably without them (ref B). From a facilities
perspective, SCEI is probably better off than most of Iraq's
SOEs. The Modern Sewing Company, which we visited the same
day, is even less competitive: its equipment is older and
not as well-maintained; its buildings are in poor condition;
and it has a constant stream of sewage running onto the
grounds, which the management is attempting to dilute by
mixing regular water with the sewage.

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Injecting Ourselves into the Mess
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9. (SBU) The U.S. goal is to help Iraq reform its
dysfunctional economy by moving away from government control
of industry to a competitive free-market economy. The GOI
has been reluctant to pursue privatization for a number of
reasons, chiefly a fear that those presently on the payroll,
including employees who do not work, will be unable to find
other employment.


10. (C) Multi-National Corps - Iraq (MNC) shares the Mission
goal of eventual privatization, but has its own overriding
objective of improving the security environment by improving
economic conditions. MNC's central, but untested, assumption
is that improved economic conditions, measured both by job
creation and psychological effects (i.e. increased confidence
of area residents),will lead to fewer attacks against
Coalition Forces and innocent Iraqis. (Note: Not all
elements of the Mission agree with this assumption, as the
correlation between high unemployment and frequency of
anti-coalition attacks is not robust. Moreover, the
advantages provided to SOEs can be seen as inhibiting to
private-sector activity that might potentially have a greater
economic impact. End note.) As a means to achieving this
greater security, MNC is spending CERP (Commander's Emergency
Response Program) money to assist Iraqi SOEs in strategic
areas.

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Confusing Signals?
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11. (C) MNC's efforts are currently limited to human capital
capacity building (providing training and assistance in
creating business and marketing plans) and assistance in
obtaining contracts. At Hateen Industrial Complex in
Iskandaria, for example, MNC is using CERP money to train
Hateen management on basic business principles. MNC has also
contracted Hateen to paint humvees, and has persuaded the
Ministry of Interior to contract with Hateen on various
projects, such as constructing living containers and buses.
(Prior to the war, Hateen was primarily a bus, truck, and
military vehicle factory.)


12. (C) Considering MNC's limited budget for SOE assistance
and the immense effort expended just to set up business
training for Hateen management, it is unlikely that MNC's
efforts can extend to significant "rehabilitation," such as
procuring new equipment lines or refurbishing obsolescent
facilities. Nonetheless, MNC runs the risk of creating false
expectations through its assistance efforts. During our
meeting with SCEI management, it was apparent they hoped for
a savior to inject much-needed funding into their largely
moribund operations. Civil Affairs teams have visited SCEI
in the past, prior to MNC's new mandate to assess SOEs and
determine best ways to assist in order to improve security
conditions. As a result, SCEI is currently a bit skeptical
about possible outcomes of this newest lookover: "We've been
down this road with you before, and nothing happened."


13. (C) Also, in the absence of an effective privatization
law, MNC is injecting the USG into a SOE rejuvenation process
that may or may not end up in privatization. The danger is

BAGHDAD 00002744 003 OF 003


that in pursuit of important short-term objectives, USG
actions may keep an effectively bankrupt system of
government-controlled enterprises on temporary life support.
Worse yet, we may be unwittingly aiding corrupt GOI officials
who intend to use rehabilitated SOEs as revenue generators
for political or personal purposes.

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Maintain the Middle Ground
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14. (C) Embassy wishes to avoid moving in contradictory
directions on the issue of SOE assistance. Given the
security interests involved, we will continue careful
coordination between Embassy, MNC, and the GOI to maintain
the current middle ground: As MNC provides very limited,
carefully considered assistance, based on realistic
assessments of conditions in Iraq's SOEs, Embassy will
aggressively press the GOI to pass a privatization law. We
believe this law will be necessary to create a transparent
and independent oversight agency, come to grips with the
economic realities of the SOEs, and develop a plan to protect
and assist workers who will eventually be displaced by
privatization.

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Continuing to Work Together
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15. (C) At the same time, Embassy will continue traveling
with MNC as they visit and assess SOEs around Iraq. The
combined trip of July 17 was beneficial in that it enabled
EconOff to observe firsthand SOE operations and develop
relationships with SOE management. It was also an
opportunity for Embassy to explain our policies to the troops
in the field, who more often deal with mid-level Iraqis and
are in a better position to influence them.


16. (C) Post appreciated the cordial welcome extended to
Econoff by the MND-B G9 Public Administration Team, MNC-I C9,
4th Brigade Combat Team/101 Airborne, and A Company/414 Civil
Affairs Battalion, and the excellent spirit of cooperation in
including him in their assessment operations. Their
professionalism throughout the mission was impressive.
SCOBEY