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Cablegate: Jurassic Park On the Tigris: Saving Baghdad's

VZCZCXRO6373
PP RUEHBC RUEHDA RUEHDE RUEHIHL RUEHKUK
DE RUEHGB #3924/01 3501248
ZNR UUUUU ZZH
P 151248Z DEC 08
FM AMEMBASSY BAGHDAD
TO RUEHC/SECSTATE WASHDC PRIORITY 0868
INFO RUCNRAQ/IRAQ COLLECTIVE PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHC/DEPT OF LABOR WASHDC PRIORITY
RUEKJCS/DIA WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 BAGHDAD 003924

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EIND EINV ECON IZ
SUBJECT: JURASSIC PARK ON THE TIGRIS: SAVING BAGHDAD'S
ECONOMY FROM INDUSTRIAL DINOSAURS

This is a Baghdad EPRT-2 reporting cable.

1. Summary: The Baghdad economy depends heavily on
state-owned enterprises (SOEs), but these dinosaurs have
uncertain prospects in Iraq,s nascent free-market economy.
Poor leadership and daunting capital needs are their biggest
challenges. We need to have realistic expectations for the
restructuring and privatization of SOEs in Baghdad. While
there is no hope for some, we must remain engaged with others
to capitalize on opportunities for both short-term
counterinsurgency gains and longer term economic development.
End summary.

SOEs Still Dominate the Economy
-------------------------------

2. (SBU) Outside of the public service, SOEs are the largest
employers in the eastern Baghdad districts of Rusafa, Karada,
and 9 Nissan -- EPRT-2,s area of operations (AO). Over 77
SOEs employ an estimated 40,000 people making a wide range of
products -- paints, foods, plastic items, electrical
appliances, bottled drinks, construction materials, cooking
oil, agricultural supplies, leather goods and apparel.
Almost all medium and heavy industry in the AO is
state-owned. Over the past 18 months, EPRT-2 has visited
many of these SOEs and implemented projects with several of
them, trying to stimulate productivity and increase
employment. The results have been mixed. SOEs in Baghdad
face two main challenges: people and capital. Because these
SOEs employ so many people, their progress will have an
important effect on both the local economy in Baghdad and on
its security.

Dinosaurs in a Tarpit
---------------------

3. (SBU) Iraq's changing economy worries SOE managers in
Baghdad. Many hope the future will be like the past; they
are content to wait for the GOI to ride to the rescue and
revive the pre-2003 command economy. The director general
(DG) of National Chemical and Plastics Industries (NCPI)
recently admitted, "The employees and I are looking at the
Saddam days as the glory days. The old regime used to
support domestic production." Other DGs are quick to suggest
that Coalition Forces should support their SOEs. Failing
that, they hope the GOI will "take care of us." Many
managers are demoralized and even emotionally overwhelmed by
the jolting economic changes of the past few years. They
frequently look for scapegoats, with Iranian and Chinese
imports at the top of the list. The technical director at
NCPI, for example, reasoned that because imports were being
sold cheaper than his inputs, there was "a conspiracy to
destroy Iraqi industry."

4. (SBU) Some SOE managers in the EPRT-2 AO are open to
change and motivated to adapt to the new rules of competitive
business and management practices. Frequently, however, they
do not have the skills or mindset the free market demands.
We visited two SOEs to inquire about their participation in a
Ministry of Industry and Minerals (MIM) program to fund
turn-around plans for SOEs. We were handed two "business
plans" that were essentially bills of quantity and pricing
for production equipment with no strategic, financial or
sales plans attached. The managers were simply looking to
restart production, unaware of the need for training or
strategic management.

5. (SBU) Managers skilled in sales and marketing are
especially rare. NCPI,s DG, for example, responded to a
question about the role of his sales force by saying, "We
Qquestion about the role of his sales force by saying, "We
have a sales force, but no one calls them anymore." The DG
of Modern Paints Industries (MPI), which is partially
state-owned, told us his new "marketing strategy" was to try
to get city building codes changed to require the use of his
company,s paint.

6. (SBU) Even when a manager has the will and the skills to
succeed, GOI interference can keep SOE dinosaurs trapped in
the tarpit. The DG of the State Company for Vegetable Oils
(SCVO), an SOE in Baghdad's Karada neighborhood, told us in
August that MIM had ordered SOEs to increase workers'
salaries by 80 percent and return idle workers to full-time
status. (Note: Most SOEs have many "employees" who get paid
but do not regularly come to work. End note.) The directive

BAGHDAD 00003924 002 OF 003


forced SCVO to bring over 2,000 workers back, even though the
company,s production lines were stalled because of an
overstock of product. These constricting mandates do not
allow managers to make crucial decisions to cut overhead and
make the companies profitable. Furthermore, the Ministry
also limits the ability of managers to perform crucial
functions such as issue debt, raise capital, purchase or sell
property, and negotiate the terms of joint ventures.

Capital Infrastructure Outdated, Investment Needs Large
--------------------------------------------- ----------

7. (SBU) Lack of modern equipment is the second huge obstacle
standing between SOEs and increased production capacity.
Because of Iraq,s wars and the UN embargo, almost all
capital infrastructure is at least 20 years old. Even if
equipment has not been looted or stolen, it is generally in
poor repair and woefully out of date. Much equipment was
manufactured in East Germany or the Soviet Union and often
the manufacturer no longer exists, making it impossible to
find parts to resurrect production lines. Ingenious
engineers must improvise replacement parts to keep such
equipment operating despite rampant cannibalization.

8. (SBU) Working capital is non-existent in many companies in
Baghdad. This is especially hard on SOEs that have to manage
long, dysfunctional supply chains. SCVO, for example, must
import its feedstock of vegetable oils from as far away as
Malaysia and Brazil. Transactions to procure the oil require
navigation through a labyrinth of personnel at various
ministries. After the bureaucrats approve a purchase, an SOE
bank must coordinate the transfer. This system exacerbates
the shortage of working capital.

9. (SBU) Investment needs among SOEs in EPRT-2's AO are
large, ranging up to $100 million. For now, SOEs cannot move
forward unless the state or large investors provide capital
for equipment and operations. While MIM has begun
implementing a limited program to supply capital to SOEs, the
effort is limited by the enterprises, management capability
and the funds available to each company. The DG of MPI told
us in October that MIM had recently set aside $85 million for
the mixed sector. Loans would be interest-free for two years
and cost four percent after that. The DG of NCPI reported in
October that loans would be at six percent for five years.
MPI and NCPI have been allocated $4 million and $7 million
for their investment projects. It was not clear to either DG
how these decisions were made.

10. (SBU) Poor security strictly limits prospects for
international investment in Iraq's SOEs. Further obstacles
to investment are inadequate banking and investment laws, and
the complicated management structure imposed by GOI
ownership. DGs report that while MIM has encouraged them to
court foreign joint ventures, the Ministry has provided no
support or guidance. Meanwhile, the private Iraqi investors
in mixed enterprises are waiting for the GOI to show
leadership. One DG told us that his private shareholders
were interested in investing more in the company, but were
holding off to see what resources the GOI would give to the
companies and what the GOI planned to do with its shares.

Comment
-------

11. (SBU) While there is a strong free-market argument to
letting SOE dinosaurs in Baghdad fail, this could undermine
Qletting SOE dinosaurs in Baghdad fail, this could undermine
our counter-insurgency strategy. Keeping SOE employees on
the payroll reduces incentives to join an insurgency or turn
to criminal groups for sustenance. To the extent that
insurgent activity is economically driven, letting SOEs fail
poses the risk of turning up to 40,000 bread-winners into the
streets of East Baghdad, and potentially reversing the
hard-won security gains of the past year.

12. (SBU) Thus, despite the dismal long-term economic outlook
for most SOEs, security concerns argue for continued
engagement with them to avoid a large economic disruption at
this critical time. Neither EPRT-2 nor the U.S. military has
the resources or capacity to facilitate wholesale turnarounds
for these companies. Thus our primary focus will remain on
propping them up over the short term. Helping NCPI, for
example, make sub-contracting arrangements with USG
contractors keeps workers and equipment active and buys time
for the managers and the GOI to develop a transition plan.

BAGHDAD 00003924 003 OF 003

13. (SBU) A few companies have the potential to make the
transition. With MPI, the EPRT piloted a management-training
program earlier in the fall designed to transform the sales
and marketing team from an order-taking organization to a
streamlined sales force. Initial results have been hopeful
though the real effect will only be visible later.
14. Finally, working with SOEs provides opportunities to
educate on a broader scale and to teach modern management
skills to Iraqis who may be in the workforce for decades to
come. Although a USAID-funded Small Business Development
Center offers courses in basic management skills in the
EPRT-2 AO, little is available for the middle or upper
manager of a larger enterprise. The effort may not
ultimately reverse any particular company, but it can improve
the management skills of a large group of mid-level managers.
These skills will be important no matter where they are
applied to rebuild Iraq,s economy.
CROCKER

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