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At the 1st of October, Financial Times released an article: “Surge in Iraq violence raises fears of return to sectarian civil war” by Borzou Daragahi. This news stated that political violence attacks in Iraq have rise this year between the two major denominations of Islam, Shia and Sunni, especially in the past few months, due to conflicts in Iraq’s neighbour, Syria.

As we know, one of the most important and lucrative businesses in Iraq is the oil industry (Iraq is the second biggest OPEC producer, after Saudi Arabia), which suffers a relatively small impact from this kind of violence, mostly because oil industries are located in isolated and well-protected encampments in the middle of Iraq’s southern desert, far away from conflicting towns.

However, these new attacks and political tensions have begun to affect oil production and the respective exportation, which are vital for Iraq’s economy and are becoming increasingly important to global supply.

Regarding this shock on oil production, one of the most important inputs on Iraq’s economy, it is possible to understand how this may affect this country’s whole economy.

Firstly, analysing the impact of the shock on oil producers, through the General Equilibrium model, their overall annual output forecasted for this year will decline. Producers’ problems are to maximize profits and minimize their cost functions. When occurs a militant attack on oil pipelines, which connect Iraq to its neighbours, it is going to affect both production infrastructures and producer’s profits. Iraqian oil producers’ get their production and distribution facilities damaged, causing an increase in the production costs, declining the possibilities of minimizing their production cost function, with extra expenditures. Their profits are also very affected, in a negative way, because this reduces their volumes of production (less output) and consecutively, their exportations begin to reduce as well (less profit). For example, there was an attack in August, on a pipeline from northern Iraq to southern Turkey that reduced by half the export volumes during that month. Overall annual output for 2013 is forecasted to decline, after two years of constant increasing, mostly because of the insurgence of this kind of violence.

Secondly, we can analyse the impact of the increase in political attacks, on a government’s perspective. Considering the General Equilibrium model, this political context of violence affects government expenditures and international trade. Within this scenario, Iraqian government expenditure is heavily fuelled to health expenditure, making impossible not to increase expenditure. Meanwhile, international trade is very affected by the decrease in production, causing an export cut proved by the stagnation of Iraq’s oil exports compared to last year’s levels (Iraq’s current account surplus has decreased from 26365.4 USD Million to 17581.2 USD Million, due to a decrease in exports from 79680.5 USD Million to 46609.0 USD Million). Government could either subsidize oil production or attract international investment to reach past year’s levels of exports.

Finally, let’s see how Iraqian consumers react to these security problems, taking into account the previous model. Consumers’ problem within this model is to maximize their utility, taking into account price levels, income and technology. Inflation rate in Iraq was reporting a decrease in 2013, since January until June (from 3.61 per cent to 1.1 per cent); but in the last 2 months when these violence attacks reappeared in a larger scale, the inflation rate started increasing again reaching 2.5 per cent in August 2013. These may cause some constraints to consumers if their income did not increased with inflation, letting them worse off, because with higher prices and with some income their optimal consumption point will be in a lower level of consumption.

In conclusion, these security problems with political and militant attacks end up affecting Iraq’s economy, reducing domestic production and stagnate its economy while the violence lasts.

 

 

Francisco Delerue

#635

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Author: studentnovasbe

Master student in Nova Sbe

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