Kuwait's Economic Quandary

Karen Pfeifer

(Karen Pfeifer teaches economics at Smith College and serves on the editorial committee of Middle East Report.)

Aiming to restore Kuwait's historic role as a hub of trade in the Persian Gulf, a member of the ruling family is spearheading a team to consider the deepening of economic ties with Iran and, eventually, with Iraq. Sheikh Nasser Sabah al-Ahmad Al Sabah's effort to revive an old model of regional integration is a new twist in Kuwait's post-1991 economic strategy, a strategy that entails the literal and figurative readjustment of its borders. It also represents a reluctant and long overdue admission that the pumping of ever more oil is not going to provide the basis for sustained economic development. But pumping more oil is exactly what Kuwait is now obliged to do, thanks to the penetration by the United States of all dimensions of the Kuwaiti economy. How can Kuwait remain in the US embrace and simultaneously integrate its economy with former enemy states belonging to the US-designated "axis of evil"?

Boundary Adjustments

The power balance between Kuwait and Iraq was deliberately shifted by changes to their common border after 1991.[1] A close examination of a 1988 resource map shows the southernmost tip of Iraq's Rumaila oilfield barely grazing the Kuwait border. Kuwait's alleged extraction of oil from the Rumaila oilfield was one grievance among several justifying Iraq's decision to invade in 1990, and, indeed, the 1988 resource map shows no part of this oilfield on Kuwait's side of the border. This friction was officially resolved in 1992, when, without consulting Iraq, the UN Boundary Commission consented to Kuwait's request to move its border more than 1,800 feet to the north, giving Kuwait easy access to the Rumaila oilfield. Newer maps of Kuwait's oil deposits now include an area called "Ratqa," one of the intended targets of Kuwait's oil expansion program, which is clearly the southernmost extension of the Rumaila field (see map).

This boundary-drawing procedure echoes a historic precedent in the region.[2] Britain and the ruler of Kuwait set up a secret protectorate arrangement in 1898 that remained in force until Kuwait's independence in 1961. In 1922, Britain was also awarded the League of Nations mandate over the former Ottoman territory of Iraq. With no compunction to consult either territory under its "protection," the British political agent simply called a meeting with the emerging rulers of what was to become "Saudi" Arabia to determine the common borders of the three new nation-states. The agent drew the boundaries to achieve three ends. First, they maximized Britain's ability to manage Gulf and peninsular affairs by excluding other colonial powers. Second, they stabilized Britain's relationship with the Saudis by giving them a part of what the Kuwaitis believed to be their territory. Third, they minimized Iraq's ambitions to become a Gulf regional power by confining the southeastern end of the country to a narrow strip of marshland on the Fao peninsula. These boundaries would also turn out to be advantageous for British and other energy corporations when they later negotiated to extract oil from the massive reserves of three separate countries with three separate and non-coordinating governments.

While the city-state of Kuwait had had an independent history and its own political dynamic from the early eighteenth century, the map drawn by the British yields the impression that Kuwait had been deliberately scooped out of the southeastern end of Iraq. Iraqi governments formally recognized these borders during regime changes in 1934 and 1963, but periodically reiterated the claim that Kuwait should have been an integral part -- the "nineteenth province" -- of the nation-state of Iraq. British troops remained at the ready, however, to enforce Kuwait's territorial sovereignty whenever Iraq made political or military feints to stake its claim -- and remain so today. In May 2002, Britain's defense minister, Geoffrey Hoon, assured the emir and his close associates that, "Britain remains fully committed to the security of Kuwait and to containing the threat still posed by [Iraqi president] Saddam Hussein to regional and indeed international stability."[3]

Controlling Access to the Gulf

The pre-1992 boundaries had left the Shatt al-Arab waterway along the Fao Peninsula as Iraq's sole water route to the Gulf. To optimize its use, the economy of Iraq had long depended on the interior port city of Basra at the northern end of the waterway. After the 1958 revolution, the Iraqi government also developed a north-south corridor from Basra to Umm Qasr, where it established a naval base. Located on the western side of the Fao Peninsula is Umm Qasr, on a small inlet just north of the islands of Bubiyan and Warba in the northwest corner of the Gulf.

During the 1980-1988 war with Iran, the Shatt al-Arab was turned into a major battle zone. It became impossible for freighters to navigate, as it filled with silt due to the lack of dredging and accumulated tons of unexploded ordnance. Iraq attempted to deal with this crippling of its seagoing capacity in two ways. First, Iraq repeatedly appealed to Kuwait to allow it to lease the islands of Bubiyan and Warba to build a deepwater port in the Gulf. Second, Iraq dug a canal from Basra through al-Zubayr to the Umm Qasr region, reconnecting its interior economy and port to the Gulf with an alternative waterway. However, when the new border was drawn in 1992, control of the inlet to the Umm Qasr area passed to Kuwait. Kuwait imposed its sovereign authority by deporting 1,500 Iraqis living in the Umm Qasr region and by digging a 130-mile long trench along the border.

Kuwait's refusal to accede to Iraq's demand to lease the islands was another grievance feeding into the 1990 invasion. Iraq thought it deserved this concession since it had lost the Shatt al-Arab fighting on behalf of all the Arab Gulf countries to contain the Islamic revolution. Kuwait thought it had given Iraq quite enough support for the war effort, for example by lending over $13 billion dollars that Iraq was likely never to repay. By the year 2000, this friction too was resolved in Kuwait's favor (see map). An agreement with Saudi Arabia regarding the northern boundaries of the shared "neutral zone" formalized Kuwait's control over the northwestern corner of the Gulf. The agreement entailed continued sharing of oil and gas extraction between the two countries and the Saudis' cession to Kuwait of sovereignty over two more islands. This northern border now runs along the group of islands around Failaka northeast of the Bay of Kuwait and cuts right across the inlet to Umm Qasr. The Kuwait Oil Company's recent prospecting for oil and natural gas where none was suspected to exist, namely on the island of Bubiyan, was explicitly intended to reaffirm Kuwait's exclusive political claim here as well.

These moves all reinforce the power of Kuwait and its US and British allies to finally and permanently deny Iraq's long-standing ambition to construct a deepwater port on the Gulf. Iraq vigorously protested its exclusion from all of these negotiations, to no avail, and has effectively lost all independent access to the Gulf.

Opening to Foreign Capital

Throughout the 1990s and into 2001, on the advice of the IMF and World Bank, Kuwait began to encourage international investment. In 1995, it opened the government-resuscitated stock market to foreign participants. In 1997, it opened the petrochemicals industry to multinational capital, when Union Carbide, of Bhopal fame and now merged into Dow Chemical, took a 40 percent stake in the Equate corporation. The next steps would be to allow 100 percent foreign ownership of firms based in Kuwait (except for oil extraction), to invite foreign banks to establish branches in Kuwait and to reduce the top rate of corporate-profit taxation from 55 to 25 percent. Finally, the Kuwait Investment Authority was to expand the scope for foreign private capital, as it is already doing for domestic private capital, to buy shares in the firms in its portfolio.

For the decade 1991-2001, Kuwait's main economic growth strategy was simply to pump and sell as much oil as possible. Accordingly, in 2001, the Kuwait Petroleum Company (KPC) announced a massive development program for both the long and medium terms. As of the first quarter of 2002, Kuwait was pumping an average of two million barrels per day -- more than its OPEC quota, but still not enough to sustain economic growth. KPC's long-term project is to create "spare capacity" in its northern oilfields, including Ratqa, of up to five or six million barrels per day. KPC estimates that "Project Kuwait" will cost $7 billion. In the medium term, that is by 2005, KPC aims to improve efficiency in order to raise output from two to three million barrels per day. Arguing that Kuwait's hydrocarbon technology is 20 years behind its competitors, KPC is keen to attract foreign capital and its technical expertise in both stages of this project.

KPC's plans just happen to conform to the strategy put forth in the energy policy report from the commission headed by Vice President Dick Cheney in 2001. Such plans may also help to secure foreign governments' commitment to defending Kuwait and its new borders against any future incursions by Iraq. The report reads:

By 2020, Gulf oil producers are projected to supply between 54 and 67 percent of the world's oil. Thus, the global economy will almost certainly continue to depend on the supply of oil from OPEC members, particularly in the Gulf. This region will remain vital to US interests. �[The group] recommends that the President support initiatives by Saudi Arabia, Kuwait�and other suppliers to open up areas of their energy sectors to foreign investment.[4]

US and European multinational energy corporations are anxious to participate in "Project Kuwait" but they refuse to conform to the constrictions of the service contracts previously imposed on them by the KPC. They insist on investing directly and sharing profits per barrel in proportion to their stake. As of March 2002, however, after years of debate, Kuwait's National Assembly had still not ratified the legal changes needed to denationalize the oil industry.

Confluence of Ambitions

Kuwait's financial ties to the US were tightened after 1991 and its direction of trade shifted to favor the US. The Kuwaiti dinar was formally tied to a "basket of currencies," predominantly the US dollar, and interest rates in Kuwait now fluctuate in tandem with US interest rates, thus keying Kuwaiti monetary policy directly into US monetary policy. While the Kuwaiti government intended to diversify its trading partners in the direction of the Asian economies, especially in oil refining and petrochemicals, the US became the second-ranked purchaser of Kuwaiti exports, a shift from a share of less than ten percent in the 1980s to up to 20 percent in the 1990s.

The US also replaced Japan as the top supplier of imports into Kuwait, due partly to continuous arms sales. Kuwait spent $3.3 billion on the military in 1999 alone -- a billion more than had been budgeted -- and planned another $2.6 billion worth of military spending in 2000. At the end of the decade, Kuwait's annual per capita spending, $1,440, was in the same league with Israel's, $1,465. In 2001, Kuwait and the US signed another defense agreement, which will keep 4,500 US troops and US and UK air bases in Kuwait for another ten years, mostly at Kuwait's expense.

Perhaps most remarkable is Kuwait's blossoming economic friendship with the Islamic Republic of Iran. Kuwait gave Iran access to the free zone at Shuweikh port in the heart of Kuwait City, and Iranian exports to Kuwait increased by a factor of about ten in five years. As of March 2002, Kuwait and Iran were negotiating to settle the eastern border of the "neutral zone" and divvy up offshore oil and gas rights. They were talking of Iran supplying natural gas and fresh water to Kuwait via pipelines running under the Gulf, pointedly bypassing Iraq, and of a cross-Gulf rail link.

Kuwait's proposed shift to regional -- as opposed to global -- integration and a more diversified economy would be healthy. Ultimately such regional development would have to involve Iraq, but Kuwait is on deck only to play the role of senior partner. Given Iraq's lack of independent access to the Gulf, Sheikh Nasser declared, Kuwait could serve as Iraq's lifeline to the outside via shipping, re-exporting, financial intermediation and tanker loading of oil shipped from Iraq to Kuwait by pipeline. As long as Kuwait remains the military and economic prot�g� of the US, its ambition to become a regional hub for Iran and an intravenous drip for Iraq can be reconciled with US aims of toppling Saddam, containing both Iraq and Iran, and maximizing the flow of oil from the region.

Endnotes

1 Information on these and other changes after 1991 comes from Anthony Cordesman, Kuwait: Recovery and Security after the Gulf War (Boulder, CO: Westview Press, 1997, especially ch. 2), and the Economist Intelligence Unit, Country Report: Kuwait (quarterly) 2002-2001. [back to text]

2 Information on the history of Kuwait comes from Jill Crystal, Kuwait: The Transformation of an Oil State (Boulder, CO: Westview Press, 1992); Jill Crystal, Oil and Politics in the Gulf: Rulers and Merchants in Kuwait and Qatar (Cambridge: Cambridge University Press, 1995); and Jacqueline S. Ismael, Kuwait: Dependency and Class in a Rentier State (Gainesville, FL: University Press of Florida, 1993).[back to text]

3 Jordan Times, May 15, 2002.[back to text]

4 National Energy Policy Development Report, May 2001, ch. 8, pp. 4-5.[back to text]