Nigeria: Accepting the new reality

The collapse in the world price of oil is unlikely to be a blip. The global slowdown, combined with large new sources of energy supply, suggest that prices are likely to stay fairly low for several years. Nobody knows, – the oil price has been all  over the place – but it would be foolish to gamble on a rapid upturn.

Nigeria will need to accept the new reality rather than remain in denial. Given the immense damage that oil has done to Nigerian politics, this may be no bad thing: the non-oil Nigerian economy has been a slumbering colossus which could now awaken. But what does the oil shock imply?

What Nigeria receives as income from oil is determined by the difference between the world price and the costs of extracting it: what economists term the ‘rents on oil’. While the oil price has approximately halved, the costs of extracting oil have not changed much, and so the rents on oil have declined by more than half. To put some numbers on it, if the costs of extraction are around $20 per barrel, then at a world price of $110, the rents are $90. At a world price of $50 the rents are only $30. So, when the oil price halves, income from oil drops by two-thirds. This is roughly the size of shock that Nigeria has suffered.

It impacts two sectors: government and international trade. Until the price collapse, oil provided 70 percent of government revenues. So, perhaps two-thirds of those oil revenues have now gone. Either new revenues must be found, or expenditure will need to be cut by the same proportion.

Fortunately, it should be easy for the government to raise revenues from new taxes on the non-oil economy. Currently, non-oil taxation amounts to only 3 percent of national income. This is quite astonishingly low by world standards. In most modern economies the figure would be around 35 percent, and even in poor parts of Africa it is around 12 percent. It should also be easy to reduce nonsense government spending such as the fuel subsidy – a gigantic scam for patronage politics. However, both new taxation and the elimination of scams require a degree of political courage. The easy option is to pretend that nothing much has happened and run a large fiscal deficit financed by borrowing, domestically and from abroad. But kicking the can down the road leads to trouble: Nigeria has been there before.

Oil provides over 90 percent of Nigeria’s export income. Exports are what pay for imports and so there will inevitably be a major reduction in imports. Yes, in the short term the blow can be softened by borrowing abroad and by running down foreign exchange reserves, but these are again not really economic strategies, but political expedients to postpone facing the new reality. There are two ways to reduce imports: one is bans on particular imports and rationing of foreign exchange; the other is changing the price of foreign exchange. Bans and rationing rapidly become wildly inefficient, and even more wildly corrupt. The well-connected bribe their way into access of under-priced foreign exchange and enrich themselves by selling their privileged access to imports on at inflated prices to ordinary people.

This is what happened last time Nigeria ran short of export revenues in 1984; during the 1980s it was a familiar story around the continent. Nigeria has been run by a political class that wants to be able to buy imports cheaply. Cumulatively, this has been disastrous for Nigerian industry. That class may now allow the exchange rate to depreciate, or it may continue to insist on maintaining it at an artificial level. This is now the acid test of whether the next few years are a continuation of the old patronage politics, or the beginning of a new and more productive Nigeria. Will the next fortunes be made by patronage dispensed in Abuja, or by innovative businesses in Lagos and Kano?