With this framework in mind, where is the Kurdistan region’s economy heading in the foreseeable future?

Public Sector

On one hand, balancing revenues and expenses for the Kurdistan Regional Government (KRG) is dependent on oil prices and the rate of export. On the other, it is determined by public spending and the rate of borrowing. Though the KRG’s capacity to export oil will gradually increase, it has no control over the global price of crude, while the boost in oil production will not necessarily translate into significantly better economic conditions over the next few years. The KRG’s public borrowings of more than $15 billion are higher than its annual income and these have not been spent on productive investments. Most of the KRG’s budget is allocated to paying $700 million worth of monthly salaries. The number of public employees is estimated to be an extraordinary 1,350,000.

If approached wisely, the current challenges faced by the Kurdistan Region will become opportunities in the future.

It is true that these salaries stimulate demand for goods and services, encouraging everyday business in the region. However, wasteful public expenditures simply inject more cash into the economy, increasing inflationary pressures on imported consumer goods. Local production is hardly helped by this trend. Goods and services produced in the Kurdistan region can hardly compete with better, cheaper imported foreign products and services.

Highly unproductive public spending is not sustainable, especially given that the KRG is facing a financial crisis. Such a spending pattern will keep the government’s budget under pressure and divert scarce funds away from productive investments.

Private Sector

Unsustainable price rises have shaped unreasonable expectations for a high rate of return on investments and business activities. These expectations were formed in a context of political stability, superior investment opportunities, robust security and generous government policies between 2004 and 2014. These factors were blunted by the fall of oil prices, the rise of ISIS and Baghdad’s salary cuts in 2014.

Better infrastructure and a skilled, efficient labor force are essential for boosting productivity. In the case of the KRG, improving the quality of education will open the way to replacing the foreign workforce with a local one.

We should not underestimate the impact of the business cycle, which has been overshadowed by security challenges and budgetary issues. For example, the real estate sector is witnessing a correction after a recent, steep rise in prices. It will take a considerable amount of time for this sector to recover.

Expectations in the private sector of high profits have slowed its adjustment to the changes in prices that have been dictated by market circumstances. This slow adaptation to new economic realities – a key shortcoming of the private sector in the Kurdistan region – will also slow down the KRG’s broader economic recovery.

An important principle of economics suggests that rational people think at the margin: a dose of such marginal thinking is needed in Kurdistan’s newly developing economy. Until the region has fully weathered the current economic downturn, businesses need to be content with a marginal rate of return and adjust their expectations to new economic conditions. To do so, they need to increase productivity, efficiency and competitiveness.

From a consumer perspective, the macroeconomic pressures on Kurdistan’s private sector could be beneficial in the long run. Among others, the real estate, retail and restaurant sectors are facing increased competition. Many of the businesses that were price makers are gradually becoming price takers. They will be forced to improve the quality of their products and services while offering lower prices. The high, pre-ISIS rates of return are no longer feasible.

The key to the Kurdistan Region’s long-term macroeconomic stability lies in policies that increase public and private productivity. Real gains in local productivity, rather than simple wage increases, will enhance economic growth and keep a lid on inflation. Well-researched policies that account for the region’s comparative economic advantages are necessary and would be strengthened by the establishment of protective measures for local industry.

Privatization of unproductive public sectors, especially electricity, could be another solution. Privatizing boosts efficiency and shifts some of the price burden away from the government.

In sectors where uncertainty and challenging economic circumstances make the private sector less likely to invest, the key to economic recovery is public spending on productive, long-term investments in infrastructure, including education and vocational training. Better infrastructure and a skilled, efficient labor force are essential for boosting productivity. In the case of the KRG, improving the quality of education will open the way to replacing the foreign workforce with a local one.

Merit-based employment in both the public and private sector is equally important. Addressing corruption in employment processes, avoiding further political appointments in technocratic positions and better economic management at all levels in the government and private sectors are needed in order to improve the efficiency of the economy.

Given the political nature of state appointments in the KRG, trimming down the public sector will be challenging and politically risky. However, responsible political and business leaders need to make firm decisions and prioritize long term development over destructive, populist policies.

To enhance productivity in the public sector, the government can transfer surplus employees from overstaffed to understaffed ministries. A system could be introduced whereby in order to maintain positions employees must demonstrate a commitment to skills development. This will improve the skill level of KRG employees while improving the ability of the state to provide much-needed services.

Considering the burden imposed by low oil prices, large public debt, unstable security conditions and a downward market cycle, Kurdistan’s economy will likely take several years to recover. Even if oil prices rise and energy exports grow, it will take years to pay back public borrowings and boost spending in key sectors.

Economies, like people, learn the most in hard times. But the KRG’s problems can only be solved if its most pressing issues are correctly tackled. If approached wisely, the current challenges faced by the Kurdistan Region will become opportunities in the future.