What if Nigeria is not an oil economy?
If Nigeria were an oil-dependent economy, how would we know?
One of the best cases made for Nigeria being an oil economy is premised on Nigeria’s dependence on oil for exports.
One traditional view of sector-dependence in economic literature says we should look at the sectoral composition of GDP and see a country as being sector-dependent if one sector had an outsized contribution.
There are theories such as this which would have you believe that unseen sector linkages makes Nigeria an oil economy. In other words, Nigeria has the appearances of a non-oil or diversified economy but in reality, there are unseen but overwhelming forces, that make the country oil dependent.
Michael Ross’s 2012 book proposed a different way of judging if a country was oil dependent which is to look at oil income per capita. On this measure Nigeria does not even feature in the World’s Top 20.
In many ways, the notion of an oil or resource dependent economy is a philosophical rather than an empirical or even theoretical construct.
It is also a rather fuzzy construct. A country that is ‘oil-dependent’ depends on oil for what exactly? This is something that has no clear definition. In general use, the notion of Nigeria’s oil dependence applies to anything from significant contribution to government revenue, to corruption proceeds being a major source of capital formation, to exports being mainly oil, to vulnerability of a vague and general kind to oil prices, to the significance of energy to an economy. It is a fuzzy construct.
If we looked at how the phrase appeared in Economic thinking, and what phenomenon it came to define, what could we learn about oil dependence?
In the late 1970s, an oil glut led to massive imbalances in oil exporting countries. Within a few years, their economic fortunes had declined significantly, marked by high deficits, declining economic output and in some cases hyperinflation brought on by a currency that had rapidly lost value.
Economists then tried to explain so many negative effects that were being seen in oil-rich countries. There has been talk of the Resource Curse and Resource Paradox where oil-rich countries seem locked into poor economic performance by or as a result of their resource wealth.
In most countries with a large extractive industry, it is often found that there are not many ‘linkages’ between that sector and the rest of the economy. This is a phenomenon first explained by Hirschman in the 1950s. Nigeria is not an exception, but perhaps an exemplar, in this regard. The oil sector employs less than 0.5% of the economy in its totality, and the larger part of the financial flows related to oil production do not come into the Nigerian economy. A large part of inputs into oil and gas exploration and production is entirely foreign, and even the labour component is mainly foreign.
If Nigeria were a diversified economy, how would we know?
Of the metrics that are relied on to show that a country is oil-dependent, the only one that substantially applies to Nigeria is percentage of exports accounted for by oil.
Oil exports per capita shows Nigeria as a quite different economy compared to most oil exporting countries. This measure sees Nigeria in the company of countries like the United Kingdom and Ecuador which are not really known as petro-states. Amongst the significant oil exporters, there are two tiers. There is a tier occupied by the likes of Saudi Arabia, Angola, Libya, Venezuela, and there is the tier that includes countries like Nigeria, Indonesia and Malaysia, which were large-ish economies in their own right before the ascendancy of oil, and were significant exporters (albeit of commodities).
Malaysia and Indonesia are countries with large, populous, ethnically diverse oil exporters, with large agricultural sectors like Nigeria. The majority academic view of them is that they avoided oil dependence. It must be said that Nigeria’s economic structure is much more like these states than it is like Saudi Arabia, Kuwait, Libya, Kazakhstan, Gabon and the like.
It is well known that Nigeria was one of the fastest growing economies in the world in the late-Colonial, early-Independence era, and a significant exporter. In many ways, a lot of Nigeria’s industrial base was initiated at that time, especially when you look at geospatial and sectoral dimensions of manufacturing.
Oil, at the time of writing this is about 10% of Nigeria’s GDP. In fact, oil has never had pride of place as the largest economic sector in Nigeria. It was always Agriculture that accounted for most output, most livelihoods, and most income for the vast majority of Nigerian households.
15 years ago, the Nigerian economy was still only Agriculture, Oil and Industry. In the time from then to now, this structure has completely changed. As it changed, it was not at all driven by oil. It was driven by scale effects of a large economy driving the emergence of new sectors like Creative Industries, Hospitality, Telecoms, and others that never existed. The emergence of these sectors was not driven to any significant extent by government policy, and their emergence did not correspond to an era of oil driven growth. In that time, significant manufacturing concerns also reached a large size, as certain industrial sub-sectors like cement came to fore.
While these structural changes were underway, we saw a stagnation in the oil sector. In terms of real output, the sector stood still or mildly contracted depending on how one looks at it. For the earlier 5–8 years of this 15 year period in which the Nigerian economy restructured itself, oil prices were not even very high, and were in the $40–60 range. Real oil prices were higher than the preceding 15 years, that much is true.
As it is, oil is one of 5 or 6 significant economic sectors in Nigeria. Each of Nigeria’s other significant economic sectors employs more people than the oil sector. This is important because, GDP, the one measure that gives us a composite picture of any economy is calculated based on value-added. Most of what creates value and earns people income in Nigeria is not oil.
Oil constitutes 90% of what Nigeria exports in dollar terms. This means that a huge chunk of the country’s foreign exchange is what comes to the Central Bank as proceeds from the sale of crude oil.
Not only are Nigeria’s exports not diversified, its value creating sectors often rely on imports for inputs and intermediate goods. This means that the vagaries of oil as a globally-traded commodity will dictate the fortunes of Nigeria’s manufacturing sector. But the sector is not completely coupled to oil. Most readers will be surprised to learn that if you take out fuel imports from our merchandise imports, our manufacturing sector is about the same size as our total imports! Nigeria’s imports were $63.7b in 2014 according to the World Bank, and 20% of that figure was fuel imports. Non-fuel imports are thus ~$53b, while Manufacturing output in the same year was $54.7b.
This lends credence to the view that Nigeria’s dependence on oil for export earnings is not the same thing as Nigeria’s lack of manufacturing competitiveness. Nigeria’s lack of manufacturing competitiveness is quite likely a different function that’s driven by factors like skills, availability of long term capital, degraded infrastructure, a bad economic environment, and so on. The key variable is not oil or oil-dependence, it is something internal to the Nigerian system.
The value of explaining the Nigerian economy in terms of oil-dependence is unclear if the biggest explanatory factors to outcomes are endogenous, and separate. Even in pure narrative terms, it is more useful to explain the plight of Nigerian manufacturing in terms that are actionable for actors in and around Nigerian manufacturing. Explaining it in terms of oil dependence, beyond not being actionable, is likely to obscure thinking.
Nigeria is not a developed economy by any means. Nigeria does not have an economy diversified to the level of OECD countries, or even to the extent of other large developing countries with similar socio-economic structure like Indonesia and Malaysia. Nigeria has a long way to go in economic diversification, and in export diversification.
It is necessary to separate export diversification from economic diversification. The policy implication of each is quite different from the other. If you want to diversify exports, then you’re looking at measures to reduce the cost of producing what Nigeria already produces across sectors. You would be looking to improve sophistication of products, moving up value chains, and so on. If you’re looking to diversify the economy, you’re looking to create whole new sectors and scale them.
What nobody needs at this stage is 100,000 Nigerians pontificating about ‘the need to diversify the economy’, which everyone mouths but nobody can go to town with. What is needed is 170 million Nigerians with a clear sense of action: “We have to export more”, “we need to move up the value chain of our products and produce”, “we need to revolutionise power and transport infrastructure”, “we need to build a mighty pool of savings”, “we need to deepen the capital markets”, etc etc.
Oil sneezed, Nigeria caught a cold. How can you say Nigeria is not dependent on oil!?
Nigeria is very vulnerable to oil price shocks. Since the Nigerian elite being completely beholden to the belief that Nigeria is oil-dependent, the Nigerian government relies on oil for the bulk of its revenues.
In fairness, this state of affairs is also explained by the nature of the colonial economy which was extractive and export-oriented. Government finances were based on levies on exports. This state of affairs continued into the pre-oil Independence era and then into the oil-era.
Nigeria does not have to depend on oil for government revenue. With the country collecting less than 5% of GDP in taxes, it is not hard to see that improving tax collection to say 10% of GDP will see the governments at all level collect more than oil generates for the government.
What Nigeria should do with oil rent is to treat it as financial flows that go into an investment fund for the economy. The actual budget of government should be financed and can easily be financed by taxation.
Decoupling the government budget from oil will remove half of the way oil impacts the economy. The other half is foreign exchange supply.
Up to 90% of forex available to Nigerian importers comes from the sale of oil. A major contraction in oil receipts without significant forex reserve and other buffers would lead to a currency crisis. The phenomenon that manifests as a currency crisis can accurately be seen as a country struggling to afford its imports. The only way to afford imports is exports. Once your exports suddenly reduce significantly, imports become very hard to afford. If imports could adjust easily and instantaneously to such a shock, the currency would remain stable. Imports do not, partly because as is the current case with Nigeria, most people don’t see why they should suddenly not be able to afford that foreign trip.
When oil shocks happen to an economy that almost solely exports oil, it forces currency and price level adjustments. This is the biggest, clearest effect that oil has on the Nigerian economy. Since Nigeria does not export manufactured products or any other product at any significant level, the price adjustments and currency level adjustments attract all the downsides and none of the upsides of eroded currency value.
The shock effect of such a disruption is the main problem in the Nigerian case. When oil sold at well above $100 the Naira was still under pressure because of factors like capital flight. This implies that a positive oil price does not determine the Naira’s value. It is hard to imagine that the oil price would go up so high as to for example force Naira exchange parity with the dollar. Oil prices don’t determine the Naira’s value. Fundamentals within the Nigerian economy do.
This again suggests a vulnerability to oil shocks, and much less suggests that Nigerian economic fundamentals are determined by the fortunes of oil in global commodity markets.
On the other hand, diversifying Nigeria’s exports could take a generation. Perhaps this is where one can start to see a case for dependence. The fact that a vulnerability can not be reformed or restructured away, makes it a structural problem.
Nevertheless, a country like Mexico has shown that even remittances can lessen a lack of true export diversification. And in any case, not being able to afford imports still leaves the option of replacing imports with locally made substitutes as a means to restore equilibrium. Structural vulnerability or even dependence on oil for forex does not need to damage the fundamentals of the Nigerian economy.
Oil is a significant sector of the Nigerian economy on which so much depends. A contraction in any key economic sector will affect the Nigerian economy. The headwinds generated by an oil shock will affect every single open economy id est any economy in the world that imports and exports a lot. As we have often seen, oil shocks tend to be accompanied by commodity price shocks.
Dutch Disease theory as explained by Sweder van Wijnbergen tells us how oil booms cause a rise in non-traded sectors. Non-traded sectors are those which can only be provided locally (like shoe shine and massage, although Nigerians would bring in masseurs for the weekend). This is saying that when there is an oil boom, people can buy a lot of local services. This is another way through which oil can have a big impact on the economy. We have seen this happen in Nigeria especially in the urban economies of Lagos, Abuja, Port Harcourt but not in most of Nigeria.
There is a lot of solid evidence that Nigeria’s growth of the last decade was not driven by oil. The oil sector was contracting or stagnant, while many other sectors soared, driven by increased Foreign Direct Investment and improved capital formation and mobilisation as well as the scale effects of a large economy. Nigeria’s creative industry sector has reached critical mass because of the large economy it feeds. This is also true for Nigeria’s telecoms sector which is the biggest and most vibrant in Africa and receives some of the highest level of investments in the world. There is also the financial sector which has plateaued after a period of consolidation and is now much larger than it ever was. Oil had nothing to do with these examples.
Conversely the uptick in global oil prices from around 1988 to around 1991 led to growth in many oil exporting countries but not Nigeria.
Why does this topic even matter?
The question of whether Nigeria is an ‘oil-dependent’ economy or not is quite weighty. It is not about semantics. It underpins every possible conception of the country’s economy and economic policy.
If Nigeria is an oil-dependent economy which fortune is fully tied to oil, then it makes sense for the country to continue to invest scarce cash in the oil joint ventures and production sharing contracts. If Nigeria is not an oil-dependent economy, this particular policy is moronic, since the country would be better off investing resources in its other sectors which have more employment impact and linkages to other sectors.
If Nigeria is an oil-dependent country, every single Nigerian livelihood is about to be threatened significantly by the prospect of long term oversupply of oil which implies a low oil price environment for a long time to come. In this case it means that investors should stay off. The only fundamentals of the economy are those created by oil, and the future is to be determined by what happens to oil.
In the end, the notion of oil-dependence could be viewed as some form of economic model. Any economic model explains and predicts what would happen to economic phenomena when variables (like oil price and exchange rate) change.
The explanatory power of oil-dependence is significant if it gives us a robust set of answers about the Nigerian economy. Is the emergence of critical new sectors accommodated in the model of oil dependence? Does oil-dependence explain how investments in the oil palm value chain would improve the country’s export base?
If there’s any takeaway for a reader reading this it is that if Nigeria had an economy that was say 70% oil, the Nigerian economy and its structure would be very different from now when it is 10%. The resilience to deal with oil shocks, it goes without saying, is significantly higher for Nigeria than for an oil economy.