If recent indicators are anything to go by, Nigeria’s economy is in shambles. The Naira is trading at over N500/$ at the open market, inflation in double-digits, unemployment at a record high, uninspiring debt levels, and deteriorating welfare indicators. The past few years have been such a downhill ride. But you should expect little from an economy coordinated by policymakers who live in ivory towers? Nigeria may very well just be a victim of inappropriate policies and malinvestments i.e., misallocation of resources, not just in the present but also in its past.
De facto, Nigeria’s economy is bifurcated into oil & non-oil sectors. While there is sufficient evidence to back up the macroeconomic volatility precipitated by natural resource wealth, resource windfalls-if properly managed- can also serve as buffers for the economy, especially in downturns. Unfortunately, the country’s pro-cyclical fiscal structure amidst expensive costly energy subsidies has dried up previous savings. Nigeria’s economy is clearly in dire straits, but how can the country build back better?
There have been recent talks about reining in subsidies to create fiscal space so the government can accommodate more productive spending. But there is no doubt that mispricing of energy in the country eased cost pressures on a population whose income has been crimped for years and weaning the people of their only government-sponsored benefit is unpopular in the political sphere. But by just how much will subsidy removal bolster economic health?
A personal study I embarked on to assess the multi-scenario impact of different plausible policy actions suggests that subsidies are unhealthy for economic wellbeing (-0.12), and interventions amid subsidies come at a higher economic cost (-0.47). While it is established that the removal of subsidies bodes well for the economy, the removal of power subsidies seemed to be of a more beneficial effect to the economy (+1.32) than the removal of fuel subsidies (+0.77) if investment in the manufacturing sector is scaled up further by 50%.
However, complete removal of both subsidies is likely to yield a less optimal economic outcome (+0.94) when compared with eliminating only power subsidies (+1.32) but higher than the outcome obtained when only fuel subsidies were removed (+0.77). This suggests that while the removal of power subsidies is beneficial, the economy could still need some form of support via fuel subsidies to produce the best outcome. Power subsidies are not necessarily pro-poor as poor people are less likely to afford access to electricity. This suggests that subsidy payments on electricity tend to benefit the non-poor more than they do the poor. Unlike power subsidies, fuel subsidies tend to support the poor to some degree especially since they rely on road transport to access markets and earn a living. Hence, complete removal of power subsidies could be beneficial, but it is economically prudent to roll back only some (50%), not all the fuel subsidies.
A plausible scenario for utilizing the freed funds is investing the 50% fuel subsidy roll back in power infrastructure to scale up the country’s power generation capacity, improve electrification infrastructure, and/or renewable energy access. This culminates in a near-optimal outcome (+1.58) while simultaneously increasing investment in the agriculture sector by 50%, just like the manufacturing sector gives the best outcome (+1.62). While the analysis postulates that investment in power infrastructure – rather than electricity consumption subsidies and isolated interventions to farmers and manufacturers – could bolster the economy to a healthy state, the excessive investment could also result in inefficiencies as the outcome (+1.59) of plowing back all the subsidy roll back into power sector investment suggests.
The current economic crisis that is bedeviling the Nigerian economy is clearly a consequence of misguided government interventions in preference sectors that, in isolation, do not have the capacity to catalyze economic transformation. These misallocations of resources have culminated in unintended consequences, including stubbornly high inflation, more frequent recession episodes, and rising income inequality that threatens both social and political stability.
Nigeria needs to improve its production function to gain economies of scale so the industrial sector can be more competitive and, in turn, improve the volume of exports. This will have multiple positive knock-on effects on the economy. Electricity is a major input for any industrial unit and re-directing consumption subsidies to investing in the power sector can help Nigeria’s industry achieve cost-efficiency, with trickle-down effects to the agriculture sector and service providers.