Grants v. Loans for Iraq

For at least two distinct reasons, this is an interesting development:

Defying weeks of intense White House lobbying, a narrowly divided Senate voted last night to convert half of President Bush’s $20.3 billion Iraq rebuilding plan into a loan that would be forgiven if other donor nations write off the debt incurred by the ousted government of Saddam Hussein.

First of all, this vote shows the depth of Republican uneasiness about Bush’s Iraq policy. Staunch Republicans like Ben Campbell (CO), Lindsey Graham (SC), and Sam Brownback (KS) voted to make part of the $20 bn. a loan instead of a grant – despite some extremely vigorous lobbying on Capitol Hill by Bush and Cheney against doing so.

Second, it raises the economic question of whether it makes sense to give money to Iraq in the form of loans rather than grants. The answer’s not obvious, at least to me. Start with the assumption that we really do want to build a prosperous and stable Iraq, and that it will require a lot of investment in basic infrastructure to achieve that. There are still two valid arguments to be made.

First, one could argue (as the administration did) that loans are bad, because they will reduce the amount of money that Iraq will have to continue developing over the coming decade. There’s a substantial body of research that shows that forgiving loans to developing countries (which is what giving Iraq a grant instead of a loan is equivalent to) really helps those countries tremendously — which is presumably our goal here.

But one could also argue that loans are an economically healthy and normal way to make long-term investments, particularly investments that should clearly improve the ability of Iraq to repay the loans in the future. We would never worry about a company borrowing money to undertake investments that would put it on the path of long-term profit growth, for example.

One final note: there is one provision of the Senate bill that makes absolutely no sense to me, regardless of which argument you find more compelling. The bill switches some of the loans to outright grants in the case that the Bush administration manages to get other countries to forgive most of Iraq’s debt.

But this is exactly backwards. If other countries forgive Iraq’s debt, then Iraq would be in a better position to repay the US’s loans, so we shouldn’t fret about asking to be repaid. And conversely, if other countries don’t forgive Iraq’s debt, that’s precisely when we would think that Iraq needs the grants more than additional debt. Silly Congress.