There are 48,000 'security contractors' in Iraq, working for private companies growing rich on the back of US policy. But can it be a good thing to have so many mercenaries operating without any democratic control? Jeremy Scahill reports

It was described as a "powder keg" moment. In late May, just across the Tigris river from Baghdad's fortified Green Zone, a heavily armed convoy of American forces was driving down a street near the Iraqi Interior Ministry. They were transporting US officials in what is known widely among the occupation forces as the "red zone" - essentially, any area of Iraq that does not fall inside the US-built "emerald city" in the capital. The American guards were on the look-out for any threat lurking on the roads. Not far from their convoy, an Iraqi driver was pulling out of a petrol station. When the Americans encountered the Iraqi driver, they determined him to be a potential suicide car bomber. In Iraq it has become common for such convoys to fire off rounds from a machine gun at approaching Iraqi vehicles, much to the outrage of Iraqi civilians and officials. The Americans say this particular Iraqi vehicle was getting too close to their convoy and that they tried to warn it to back off. They say they fired a warning shot at the car's radiator before firing directly into the windshield of the car, killing the driver. Some Iraqi witnesses said the shooting was unprovoked.

In the ensuing chaos, the Americans reportedly refused to give their names or details of the incident to Iraqi officials, sparking a tense standoff between the Americans and Iraqi forces, both of which were armed with assault rifles. It could have become even more bloody before a US military convoy arrived on the scene.

A senior US adviser to the Iraqi Interior Ministry's intelligence division told the Washington Post that the incident threatened to "undermine a lot of the cordial relationships that have been built up over the past four years. There's a lot of angry people up here right now."

While there is ongoing outrage between Iraqis and the military over such deadly incidents, this one came with a different, but increasingly common, twist: The Americans involved in the shooting were neither US military nor civilians. They were operatives working for a secretive mercenary firm based in the wilderness of North Carolina. Its name is Blackwater USA.

It was hardly the company's first taste of action in Iraq, where it has operated almost since the first days of the occupation. Its convoys have been ambushed, its helicopters brought down, its men burned and dragged through the streets of Falluja, giving the Bush administration a justification for laying siege to the city. In all, the company has lost about 30 men in Iraq. It has also engaged in firefights with the Shia Mahdi Army, and succeeded by all means necessary in keeping alive every US ambassador to serve in post-invasion Iraq, along with more than 90 visiting US congressional delegations.

Just one day before the May shooting, in almost the exact same neighbourhood, Blackwater operatives found themselves in another gun battle, lasting an hour, that drew in both US military and Iraqi forces, in which at least four Iraqis are said to have died. The shoot-out was reportedly spurred by a well-coordinated ambush of Blackwater's convoy. US sources said the guards "did their job", keeping the officials alive.

In another incident that has caused major tensions between Baghdad and Washington, an off-duty Blackwater operative is alleged to have shot and killed an Iraqi bodyguard of the Shia vice-president Adil Abdul-Mahdi last Christmas Eve inside the Green Zone. Blackwater officials confirm that after the incident they whisked the contractor safely out of Iraq, which they say Washington ordered them to do. Iraqi officials labelled the killing a "murder". The company says it fired the contractor but he has yet to be publicly charged with any crime.

Iraqi officials have consistently complained about the conduct of Blackwater and other contractors - and the legal barriers to their attempts to investigate or prosecute alleged wrongdoing. Four years into the occupation, there is absolutely no effective system of oversight or accountability governing contractors and their operations. They have not been subjected to military justice, and only two cases have ever reached US civilian courts, under the Military Extraterritorial Jurisdiction Act, which covers some contractors working abroad. (One man was charged with stabbing a fellow contractor, in a case that has yet to go to trial, while the other was sentenced to three years for possession of child-pornography images on his computer at Abu Ghraib prison.) No matter what their acts in Iraq, contractors cannot be prosecuted in Iraqi courts, thanks to US-imposed edicts dating back to Paul Bremer's post-invasion Coalition Provisional Authority.

The internet is alive with videos of contractors seemingly using Iraqi vehicles for target practice, much to the embarrassment of the firms involved. Yet, despite these incidents, and although 64 US soldiers have been court-martialled on murder-related charges, not a single armed contractor has been prosecuted for any crime, let alone a crime against an Iraqi. US contractors in Iraq reportedly have a motto: "What happens here today, stays here today."

At home in America, Blackwater is facing at least two wrongful-death lawsuits, one stemming from the mob killings of four of its men in Falluja in March 2004, the other for a Blackwater plane crash in Afghanistan in November 2004, in which a number of US soldiers were killed. In both cases, families of the deceased charge that Blackwater's negligence led to the deaths. (Blackwater has argued that it cannot be sued and should enjoy the same immunity as the US military.) The company is also facing a mounting Congressional investigation into its activities. Despite all of this, US State Department officials heap nothing but words of praise on Blackwater for doing the job and doing it well.

There are now 630 companies working in Iraq on contract for the US government, with personnel from more than 100 countries offering services ranging from cooking and driving to the protection of high-ranking army officers. Their 180,000 employees now outnumber America's 160,000 official troops. The precise number of mercenaries is unclear, but last year, a US government report identified 48,000 employees of private military/security firms.

Blackwater is far from being the biggest mercenary firm operating in Iraq, nor is it the most profitable. But it has the closest proximity to the throne in Washington and to radical rightwing causes, leading some critics to label it a "Republican guard". Blackwater offers the services of some of the most elite forces in the world and is tasked with some of the occupation's most "mission-critical" activities, namely keeping alive the most hated men in Baghdad - a fact it has deftly used as a marketing tool. Since the Iraq invasion began four years ago, Blackwater has emerged out of its compound near the Great Dismal Swamp of North Carolina as the trendsetter of the mercenary industry, leading the way toward a legitimisation of one of the world's dirtiest professions. And it owes its meteoric rise to the policies of the Bush administration.

Since the launch of the "war on terror", the administration has funnelled billions of dollars in public funds to US war corporations such as Blackwater USA, DynCorp and Triple Canopy. These companies have used the money to build up private armies that rival or outgun many of the world's national militaries.

A decade ago, Blackwater barely existed; and yet its "diplomatic security" contracts since mid-2004, with the State Department alone, total more than $750m (£370m). It protects the US ambassador and other senior officials in Iraq as well as visiting Congressional delegations; it trains Afghan security forces, and was deployed in the oil-rich Caspian Sea region, setting up a "command and control" centre just miles from the Iranian border. The company was also hired to protect emergency operations and facilities in New Orleans after Hurricane Katrina, where it raked in $240,000 (£120,000) a day from the American taxpayer, billing $950 (£470) a day per Blackwater contractor.

Yet this is still just a fraction of the company's business. It also runs an impressive domestic law-enforcement and military training system inside the US. While some of its competitors may have more forces deployed in more countries around the globe, none have organised their troops and facilities more like an actual military.

At present, Blackwater has forces deployed in nine countries and boasts a database of 21,000 additional troops at the ready, a fleet of more than 20 aircraft, including helicopter gun-ships, and the world's largest private military facility - a 7,000-acre compound in North Carolina. It recently opened a new facility in Illinois (Blackwater North) and is fighting local opposition to a third planned domestic facility near San Diego (Blackwater West) by the Mexican border. It is also manufacturing an armoured vehicle (nicknamed the Grizzly) and surveillance blimps.

The man behind this empire is 38-year-old Erik Prince, a secretive, conservative Christian who once served with the US Navy's special forces and has made major campaign contributions to President Bush and his allies. Among Blackwater's senior executives are J Cofer Black, former head of counterterrorism at the CIA; Robert Richer, former deputy director of operations at the CIA; Joseph Schmitz, former Pentagon inspector general; and an impressive array of other retired military and intelligence officials. Company executives recently announced the creation of a new private intelligence company, Total Intelligence, to be headed by Black and Richer. Blackwater executives boast that some of their work for the government is so sensitive that the company cannot tell one federal agency what it is doing for another.

In many ways, Blackwater's rapid ascent to prominence within the US war machine symbolises what could be called Bush's mercenary revolution. Much has been made of the administration's "failure" to build international consensus for the invasion of Iraq, but perhaps that was never the intention. Almost from the beginning, the White House substituted international diplomacy with lucrative war contracts. When US tanks rolled into Iraq in March 2003, they brought with them the largest army of "private contractors" ever deployed in a war.

While precise data on the extent of American spending on mercenary services is nearly impossible to obtain, Congressional sources say that the US has spent at least $6bn (£3bn) in Iraq, while Britain has spent some £200m. Like America, Britain has used private security from firms like ArmorGroup to guard Foreign Office and International Development officials in Iraq. Other British firms are used to protect private companies and media, but UK firms do their biggest business with Washington. The single largest US contract for private security in Iraq has for years been held by the British firm Aegis, headed by Tim Spicer, the retired British lieutenant-colonel who was implicated in the Arms to Africa scandal of the late 1990s, when weapons were shipped to a Sierra Leone militia leader during a weapons embargo. Aegis's Iraq contract - essentially coordinating the private military firms in Iraq - was valued at approximately $300m (£1147m) and drew protests from US competitors and lawmakers.

At present, a US or British special forces veteran working for a private security company in Iraq can make $650 (£320) a day, after the company takes its cut. At times the rate has reached $1,000 (£490) a day - pay that dwarfs that of active-duty troops. "We got [tens of thousands of] contractors over there, some of them making more than the secretary of defense," John Murtha, chairman of the House defense appropriations subcommittee, recently said. "How in the hell do you justify that?"

In part, these contractors do mundane jobs that traditionally have been performed by soldiers, from driving trucks to doing laundry. These services are provided through companies such as Halliburton, KBR and Fluor and through their vast labyrinth of subcontractors. But increasingly, private personnel are engaged in armed combat and "security" operations. They interrogate prisoners, gather intelligence, operate rendition flights, protect senior occupation officials - including some commanding US generals - and in some cases have taken command of US and international troops in battle. In an admission that speaks volumes about the extent of the privatisation, General David Petraeus, who is implementing Bush's troop surge, said earlier this year that he has, at times, not been guarded in Iraq by the US military but "secured by contract security". At least three US commanding generals are currently being guarded in Iraq by hired guns.

"To have half of your army be contractors, I don't know that there's a precedent for that," says Congressman Dennis Kucinich, a member of the House oversight and government reform committee, which has been investigating war contractors. "There's no democratic control and there's no intention to have democratic control here."

The implications, still unacknowledged by many US lawmakers and world leaders four years into this revolution, are devastating. "One of the key tenets of managing international crises in the aftermath of the cold war was established in the first Gulf war," says a veteran US diplomat, Joe Wilson, who served as the last US ambassador to Iraq before the 1991 Gulf war. "It was that management of these crises would be a coalition of like-minded nation states under the auspices of a United Nations Security Council resolution which gave the exercise the benefit of international law." This time, "there is no underlying international legitimacy that sustains us throughout this action that we've taken."

Moreover, this revolution means the US no longer needs to rely on its own citizens and those of its nation-state allies to staff its wars, nor does it need to implement a draft, which would have made the Iraq war politically untenable. Just as importantly, perhaps, it reduces the figure of "official" casualties. In Iraq alone, more than 900 US contractors have been killed, with another 13,000 wounded. The majority of these are not American citizens and these numbers are not counted in the official death toll at a time when Americans are increasingly disturbed by their losses.

In Iraq, many contractors are run by Americans or Britons and have elite forces staffed by well-trained veterans of powerful militaries for use in sensitive actions or operations. But lower down, the ranks are filled by Iraqis and third-country nationals. Hundreds of Chilean mercenaries, for example, have been deployed by US companies such as Blackwater and Triple Canopy, despite the fact that Chile opposed the invasion and continues to oppose the occupation of Iraq. Some of the Chileans are alleged to be seasoned veterans of the Pinochet era.

Some 118,000 of the estimated 180,000 contractors in Iraq are Iraqis. The mercenary industry points to this as encouraging: we are giving Iraqis jobs, albeit occupying their own country in the service of a private corporation hired by a hostile invading power. As Doug Brooks, the head of the Orwellian-named mercenary trade group, the International Peace Operations Association, argued early in the occupation, "Museums do not need to be guarded by Abrams tanks when an Iraqi security guard working for a contractor can do the same job for less than one-50th of what it costs to maintain an American soldier. Hiring local guards gives Iraqis a stake in a successful future for their country. They use their pay to support their families and stimulate the economy. Perhaps most significantly, every guard means one less potential guerrilla."

In many ways, however, it is the exact model used by multinational corporations that depend on poorly paid workers in developing countries to staff their highly profitable operations. This keeps prices down in the industrialised world and consumers numb to the reality of how the product ends up in their shopping basket.

"We have now seen the emergence of the hollow army," says Naomi Klein, whose forthcoming book, The Shock Doctrine: The Rise of Disaster Capitalism, explores these themes. "Much as with so-called hollow corporations such as Nike, billions are spent on military technology and design in rich countries while the manual labour and sweat work of invasion and occupation is increasingly outsourced to contractors who compete with each other to fill the work order for the lowest price. Just as this model breeds rampant abuse in the manufacturing sector - with the big-name brands always able to plead ignorance about the actions of their suppliers - so it does in the military, though with stakes that are immeasurably higher."

In the case of Iraq, what is particularly frightening is that the US and UK governments could give the public the false impression that the occupation was being scaled down, while in reality it was simply being privatised. Indeed, shortly after Tony Blair announced that he wanted to withdraw 1,600 soldiers from Basra, reports emerged that the British government was considering sending in private security companies to "fill the gap left behind".

Outsourcing is increasingly extending to extremely sensitive sectors, including intelligence. The investigative blogger RJ Hillhouse, whose site TheSpyWhoBilledMe.com regularly breaks news on the clandestine world of private contractors and US intelligence, recently established that Washington spends $42bn (£21bn) annually on private intelligence contractors, up from $18bn in 2000. Currently, that spending represents 70% of the US intelligence budget.

But the mercenary forces are also diversifying geographically: in Latin America, the massive US firm DynCorp is operating in Colombia, Bolivia and other countries as part of the "war on drugs" - US defence contractors are receiving nearly half the $630m in US military aid for Colombia; in Africa, mercenaries are deploying in Somalia, Congo and Sudan and increasingly have their sights set on tapping into the hefty UN peacekeeping budget; inside the US, private security staff now outnumber official law enforcement. Heavily armed mercenaries were deployed in the aftermath of Hurricane Katrina, while there are proposals to privatise the US border patrol. Brooks, the private military industry lobbyist, says people should not become "overly obsessed with Iraq", saying his association's member companies "have more personnel working in UN and African Union peace operations than all but a handful of countries".

Most worryingly of all, perhaps, powers that were once the exclusive realm of national governments are now in the hands of private companies whose prime loyalty is to their shareholders. CIA-type services, special operations, covert actions and small-scale military and paramilitary forces are now on the world market in a way not seen in modern history.

While the private military/security industry rejects the characterisation of their forces as mercenaries, Blackwater executives have turned the grey area in which they operate into a brand asset. The company has been quietly marketing its services to foreign governments and corporations through an off-shore affiliate, Greystone Ltd, registered in Barbados.

In early 2005, Blackwater held an extravagant, invitation-only Greystone "inauguration" at the swanky Ritz-Carlton hotel in Washington, DC. The guest list for the seven-hour event included weapons manufacturers, oil companies and diplomats from the likes of Uzbekistan, Yemen, the Philippines, Romania, Indonesia, Tunisia, Algeria, Hungary, Poland, Croatia, Kenya, Angola and Jordan. Several of those countries' defence or military attaches attended. "It is more difficult than ever for your country to successfully protect its interests against diverse and complicated threats in today's grey world," Greystone's promotional pamphlet told attendees. "Greystone is an international security services company that offers your country or organisation a complete solution to your most pressing security needs."

Greystone said its forces were prepared for "ready deployment in support of national security objectives as well as private interests". Among the "services" offered were mobile security teams, which could be employed for personal security operations, surveillance and countersurveillance. Applicants for jobs with Greystone were asked to check off their qualifications in weapons: AK-47 rifle, Glock 19, M-16 series rifle, M-4 carbine rifle, machine gun, mortar and shoulder-fired weapons. Among the skills sought were: Sniper, Marksman, Door Gunner, Explosive Ordnance, Counter Assault Team.

While Blackwater has become one of the most powerful and influential private actors in international conflict since the launch of the war on terror, in many ways it is like a small, high-end boutique surrounded by megastores such as DynCorp, ArmourGroup and Erynis, operating in a $100bn industry. In fact, experts say, there are now more private military companies operating internationally than there are member nations at the UN.

"I think it's extraordinarily dangerous when a nation begins to outsource its monopoly on the use of force ... in support of its foreign policy or national security objectives," says Wilson. The billions of dollars being doled out to these companies, he says, "makes of them a very powerful interest group within the American body politic and an interest group that is, in fact, armed. And the question will arise at some time: to whom do they owe their loyalty?"

Congresswoman Jan Schakowsky, a Democrat and a leading member of the House select committee on intelligence, echoes those fears. "The one thing the people think of as being in the purview of the government is the use of military power. Suddenly you've got a for-profit corporation going around the world that is more powerful than states".

At war with the Pentagon

How Rumsfeld paved the way for Blackwater

The world was a very different place on September 10 2001, when Donald Rumsfeld stepped on to the podium at the Pentagon to deliver one of his first major addresses as defense secretary under President George W Bush. For most Americans, there was no such thing as al-Qaida, and Saddam Hussein was still the president of Iraq. Rumsfeld had served in the post once before - under President Gerald Ford, from 1975 to 1977 - and he returned to the job in 2001 with ambitious visions. That September day, in the first year of the Bush administration, Rumsfeld addressed the Pentagon officials in charge of overseeing the high-stakes business of defence contracting - managing the Halliburtons, DynCorps and Bechtels. The secretary stood before a gaggle of former corporate executives from Enron, Northrop Grumman, General Dynamics and Aerospace Corporation whom he had tapped as his top deputies at the department of defense, and he issued a declaration of war.

"The topic today is an adversary that poses a threat, a serious threat, to the security of the United States of America," Rumsfeld thundered. "This adversary is one of the world's last bastions of central planning. It governs by dictating five-year plans. From a single capital, it attempts to impose its demands across time zones, continents, oceans and beyond. With brutal consistency, it stifles free thought and crushes new ideas. It disrupts the defence of the United States and places the lives of men and women in uniform at risk."

Pausing briefly for dramatic effect, Rumsfeld - himself a veteran cold warrior - told his new staff, "Perhaps this adversary sounds like the former Soviet Union, but that enemy is gone: our foes are more subtle and implacable today. You may think I'm describing one of the last decrepit dictators of the world. But their day, too, is almost past, and they cannot match the strength and size of this adversary. The adversary's much closer to home. It's the Pentagon bureaucracy."

Rumsfeld called for a wholesale shift in the running of the Pentagon, supplanting the old department of defense bureaucracy with a new model, one based on the private sector. The problem, Rumsfeld said, was that unlike businesses, "governments can't die, so we need to find other incentives for bureaucracy to adapt and improve." The stakes, he declared, were dire - "a matter of life and death, ultimately, every American's."

That day, Rumsfeld announced a major initiative to streamline the use of the private sector in the waging of America's wars and predicted his initiative would meet fierce resistance. "Some might ask, 'How in the world could the secretary of defense attack the Pentagon in front of its people?'" Rumsfeld told his audience. "To them I reply, I have no desire to attack the Pentagon; I want to liberate it. We need to save it from itself."

The next morning, the Pentagon would literally be attacked as American Airlines Flight 77 - a Boeing 757 - smashed into its western wall. Rumsfeld would famously assist rescue workers in pulling bodies from the rubble. But it didn't take long for him to seize the almost unthinkable opportunity presented by 9/11 to put his personal war on the fast track.

· An extract from Blackwater: The Rise of the World's Most Powerful Mercenary Army (published by Serpent's Tail, price £12.99). © 2007 Jeremy Scahill. To order a copy for £11.99 with free UK p&p go to theguardian.com/bookshop or call 0870 836 0875.