"I paid $800 to get my job," says Ahmed Abdul, a technician working for Karada municipality in Baghdad. "People know this is wrong, but there is no way round it." In Iraq corruption is pervasive at every level.

"Corruption exists all over the world but is at its worst here," laments Ateej Saleh Midhat, a 26-year-old employee of the state-owned Rafidain Bank. "In 2008 and 2009 it was difficult for any graduate to have a job without paying $500 [£300] to $1,500 according to what kind of job it was. But what about the people who cannot afford to pay?"

Iraq is the world's premier kleptomaniac state. According to Transparency International, the only countries deemed more crooked than Iraq are Somalia and Burma, while Haiti and Afghanistan rank just behind. In contrast to Iraq, which enjoys significant oil revenues, none of these countries has much money to steal.

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Iraqis resent paying a bribe for almost everything, but do not see what they can do about it. Nor will they believe that the government is serious in its claim to be clamping down on corruption until senior officials are punished. The first sign that this might be beginning to happen came last month when the former minister of trade, Abdul Falah al-Sudani, was arrested after the plane on which he was travelling to Dubai was dramatically turned round in mid-air and ordered to return to Baghdad. The trade ministry is known to Iraqis as "the ministry of corruption" because it runs the $6bn food rationing system, which gives endless opportunities for profiting by taking bribes from suppliers or sending tainted goods to the shops. The trade ministry scandal had already become very public when Mr Sudani's guards shot it out at the ministry headquarters with police come to arrest 10 officials, who were able to escape through a back entrance during the gun battle. A video circulated from phone to phone in Baghdad shows trade ministry officials cavorting with prostitutes at a party.

The corruption most Iraqis run into is at a humbler level and usually means that the smallest bureaucratic hurdle can be overcome only with a bribe. Several years ago the government starting issuing special passports, which were supposedly more secure than before. But since the easiest way to obtain one is through a bribe, in which case few questions are asked, the new passports are even more insecure than their predecessors. The same is true of other identity documents. If a bribe is not paid to facilitate such transactions, officials subject their victim to bureaucratic harassment until he or she pays up.

It is not just that Iraqis object to paying off officials; they are not sure they will get what they pay for. Laila Fadel Amr is a young housewife who graduated from a teacher training institute in 2005, but has never held a job since. "I didn't want to join any of the Islamic parties," she says. "And I didn't want to pay my money for a job and then find that promises were not kept." If a job is obtained, the bribe-giver has to start taking backhanders to pay back money borrowed for the original bribe.

Iraq has offered extraordinary opportunities for fraud since the fall of Saddam Hussein. War diverted attention from theft and made it difficult to monitor what was really going on. In one notorious case in 2004-05, the government allocated $1.3bn for weapons purchases. These were carried out by the then head of military procurement, Ziyad Cattan, a Polish-Iraqi who had once run a pizza parlour outside Bonn. The minister of defence was Hazem al-Shalaan, who had been involved in property in a small way in London in the 1990s. Little equipment was ever received by the Iraqi military aside from some Soviet helicopters too antique to fly and second-hand vehicles deemed obsolete by the Pakistani army.

The height of the violence in Iraq in 2004-07 made it highly dangerous to check if goods paid for by the government had ever been delivered or even existed. One instance now being investigated concerns $600m in food rations supposedly sent to Anbar and other Sunni provinces when they were part-controlled by the insurgents. They may never have reached shops to be distributed to needy customers.

Iraq was not always uniquely corrupt. Its 1970s administration was probably more efficient and honest than that in most oil-producing countries: the aftermath of the invasion of Kuwait in 1990 criminalised Iraqi society.

UN sanctions imposed a tight economic siege and were designed to keep oil revenue out of the hands of the ruling elite. Extended over 13 years they destroyed society and the economy. The government had no money to pay its employees. The currency collapsed. A university professor suddenly found he was paid the equivalent of $5 a month and was not allowed to resign from government service. One I knew called Jawad succeeded in retiring only by faking a heart attack and paying off doctors to produce charts showing he was about to expire. Since they were not paid by the government, state employees simply charged the public for any services they provided. Though officials are now quite well paid, this system still goes on.

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Saddam Hussein and his lieutenants quickly found ways of evading sanctions by controlling the black market. Uday, Saddam's eldest son, was paid millions of dollars by cigarette importers. Russian oil brokers kicked back on contracts they were awarded, so money went to the government in Baghdad and not to the UN as it was meant to under the oil-for-food programme. The men who had orchestrated these black market deals quickly established the same sort of corrupt relationship with post-Saddam governments.

As Iraq was impoverished by sanctions street robberies and burglaries became common. In a country which had had little civil crime, taxi drivers began carrying pistols. To stem criminal violence the government started amputating the ears and hands of thieves and televising the gory results.

By 2003 millions of impoverished Iraqis would do anything for a living. With the fall of Baghdad they had their opportunity. The beneficiaries of the looting of Iraq were nicknamed al-hawasim – "the finalists" – a joking reference to Saddam's boast that the US invasion would see "the final battle". They stole and, since they viewed the US-installed Iraqi government as illegitimate and an American puppet, they thought they were right to steal. This attitude has not died away.

As violence ebbed from its 2006-07 high point, Iraqis have become more resentful at corruption and theft. They know that many officials and politicians own luxury villas in Jordan and Egypt. Reconstruction is painfully slow as money allocated to it vanishes. Many families react to a relative being imprisoned by immediately finding out how much they have to pay to get him freed. Political parties use ministries they control as a source of plunder and patronage.

Even the best connected have to pay. The relative of one man, a life-long opponent of Saddam Hussein, was shot and badly wounded this year. The man knew everybody in the top ranks of government and was promised a prompt investigation. He had a strong suspicion about who might have carried out the attempted assassination, but found the police and judges involved were moving very slowly. He suspected some conspiracy by his political enemies and consulted his lawyer, who laughed at his suspicions. "No, there is a simpler reason why the police and the judge aren't doing anything to find the gunmen," the lawyer said. "They are waiting for you to bribe them before they start their investigation."

Peace plan: Milestones on the road ahead

2009

29 June Energy giants, including BP, ExxonMobil and Total, expected to bid for contracts to develop oil and gas fields

30 June Deadline by which US troops must withdraw from cities and towns in Iraq

25 July Elections to be held in the Kurdish provinces of Iraq, delayed from Oct 2008

31 July Deadline for remaining British troops to leave Iraq, although some military advisers likely to remain

1 August Date on which the Iraq war inquiry may begin

7 August United Nations Assistance Mission in Iraq (Unami) expires, unless extended

3 October Public holiday to celebrate National Iraqi Day, held for the first time in 2008 after the Iraqi government replaced all holidays that had connotations with Saddam Hussein's rule

2010

30 January Elections due to be held for Iraq's 275-seat Council of Representatives

1 April 16,000 US Marines expected to leave Iraq in spring 2010

2011

31 December Deadline by which all US forces should leave Iraq, under the terms of the US-Iraqi security agreement

Jonathan Owen