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
Others:
- 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.
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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.
