FAO Quotables

"But being right, even morally right, isn't everything. It is also important to be competent, to be consistent, and to be knowledgeable. It's important for your soldiers and diplomats to speak the language of the people you want to influence. It's important to understand the ethnic and tribal divisions of the place you hope to assist."
-Anne Applebaum

Thursday, November 22, 2012

Notes on "Nigeria's Shot at Redemption"

BONUS LINK:  My entire (so far) grad school notes collection can be found here. 

This is a great article I read for my international economics class.  It stands as sage advice for newly resource rich countries or potentially resource rich countries like Madagascar.

Mistakes made:
- The mistakes left Nigeria saddled with enormous debt
- 1973-4 and 79-80 gave Nigeria $300 billion windfall entre 1970-2001
- They didn’t account for the two givens of oil windfalls: non-renewability and price volatility
- They focused on the wrong things (or didn’t focus broadly enough) and assumed that oil prices would always rise—didn’t account for price volatility. 
-  In an effort to avoid Dutch Disease (deterioration of non-resource traded good sectors due to abundance and development of natural resource sector at its expense) they ignored the dangers of debt overhang.  This means: credibility gap and inability to attract foreign financing despite potential for high RoR investments. 
- corruption and bad governance degraded public institutions
- Failure to correct for inflation each year

Lessons Learned:
- even brief mismanagement can yield decades of hangover effects.  Management of an oil windfall is paramount
- need for oil-price-based fiscal rule: disconnects oil revenue from government expenditure—this dampens the effect that pricing changes can have on the overall economy by limiting appreciation and volatility of real exchange rate (RER).  This was signed into law.
- OPBFR is not enough since even accruing oil revenues still means asset depletion, therefore gov spending requires a robust rate of return which requires a:
- due process mechanism:  competitive bidding for gov contracts.  Also NEEDS still a systematic cost-benefit analysis system for public investments—they did a good job of this when they bought back their Paris Club debt in 2005. 
- governments must anticipate that oil prices won’t always rise and accordingly must adopt conservative fiscal policies.
- corrective measures can’t be limited to economic policy but must extend to embrace good governance and transparency—the EITI++ rating is essential in this as well as its publication of government revenues. 

3 actions: responsible gov. investments with high RoR, future generations benefit assurance and management of oil price volatility. 
3 outcomes: avoid debt overhang, lower volatility of RER, diversified economy to include non-oil industry. 

What's a new (better) approach to oil revenue management?
- oil price boom of the early 21st century gives Nigeria a shot at redemption that may be a worthwhile model for other countries to emulate. 
- management must have it’s eye on future generations so that they can benefit from a resource that will eventually disappear—this is done with a healthy and diversified economy and low indebtedness. 
- Nigeria did this in two steps:  first it tackled corruption and political stability (99-2003), then it expanded its focus (2003-2007) to economic and anti-corruption reform (emphasizing, fiscal, structural and institutional and governance reforms measures).
- EITI- Extractive Industries Transparency Initiative—voluntary measures to promote transparency and accountability.  Country must publish what it pay and make public revenues from oil, gas, mining.  Nigeria one of first adopters in May 2007—they have also exceeded this minimum and set a basis for other countries. 
- reforms carry momentum which must be capitalized.  It also requires political leadership to break the cycle of corruption and put things like OPBFR into law

- Holland 1950’s discovered natural gas in north sea.  Brings a lot of dollars into country.  Real exchange rate productivity of economy

 - Distributional fund is the right way to do it.  Alaska has done this to a certain extent with a certain amount of revenues getting earmarked and the citizens getting a check.  Subisidies are inefficient because they don’t target specific disadvantaged groups—everyone (including the rich) get benefit of subsidy. 

      Nigeria experienced an oil boom from 1973-4 and then another from 1979-80.  In all they experienced a $300 billion windfall from 1979-2001.  They squandered this windfall in four ways.  First, they failed to account for the two givens of the oil industry: it is non-renewable and it is subject to price volatility.  Second, they focused too much on the wrong thing.  The government was so worried about combatting Dutch disease (i.e., an overdevelopment of an extractive industry at the expense of the non-traded good sector) that they completed ignored the significance of the threat of debt overhang.  Third, they failed to correct for ensuing rising inflation each year (as the Real Exchange Rate skyrocketed in appreciation 56%).  Finally, rampant corruption and poor governance only served to amplify all of these problems. 
            All of these mistakes combined to illustrate that even a short period of mismanagement can produce decades of hangover effects.  Significantly the Nigerian governments actions at the end of the 90’s offer valuable lessons with regard to oil revenue management.  The biggest step the government took was signing into law the Oil Price Based Fiscal Rule (OPBFR).  The law effectively disconnected the oil revenue from government spending.  This served to dampen the volatility of RER appreciation.  They were also one of the first nations to voluntarily join the Extractive Industries Transparency Initiative (EITI) in 2007.  This initiative made revenues from oil, gas and mining all available to the public.  This transparency encouraged fiduciary responsibility throughout all sectors.   Furthermore they were proactive in combatting their debt overhang.  A major stride came in 2006 when they bought back their Paris Club debt. 
            All in all, Nigeria handled their new oil windfall in measured steps.  The first step took place from 1999-2003 as they tackled corruption and built political stability.  Once progress had been made there they enacted major reforms in the anti-corruption and economic arena.  These efforts served to diversify the economy, promote RER stability and eliminate debt overhang.  The final step was (and continues to be) to harness the momentum of change.  This requires political leadership as the government must be kept on task in diversifying their investments from oil revenue to insure a high rate of return.  This return is necessary to give their future generations the assurance that the benefits from the oil will last after the resource itself is long gone.  One significant shortfall of the Nigerian government not mentioned in the article is their embrace of gasoline subsidies for the general public.  This measure robs their government coffers of billions of dollars and benefits myriad individuals in Nigeria that have no need for a subsidy.  They would be far better served to target those they benefit with a yearly distribution of revenue from the oil industry as is done in Alaska. 

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