Will Falling Oil Prices Resolve Nigeria’s Dutch Disease?

There has been much speculation in recent months whether the price of oil will continue its downward spiral to spine chilling levels – $20 per barrel springs to mind. One can almost sense a slight quiver in the voices of investors and oilmen when asked how they would cope with such a scenario.

Some argue that falling gas prices act like a tax break for consumers and that every $10-per-barrel drop boosts US GDP by 0.1%. For many, plunging oil prices can only be synonymous with global instability – no producing nation would balance its budget at such a price level, forcing them to burn through their (often shaky or even nonexistent) oil funds to stave off political collapse. Major companies would slash R&D budgets and would halt developing new fields and technologies, thereby hampering the quality of oil production in the long run.

That’s all fine and dandy, but there’s another side to this debate that has not been explored enough. This is that, paradoxically, falling oil prices could lead to an improvement of the overall health of oil-addicted economies over the medium term by providing the necessary impetus for the government to engage in a serious internal debate and come up with innovative policies to diversify its economy.

In times of boom and affluence, few leaders would think about putting breaks on the expansion of the oil sector– a mental map that leads policymakers to what the Economist dubbed “the Dutch disease”, or the resource curse.  Essentially, investment in the oil sector crowds out investment in other sectors (especially in the non tradable sector), and attracts the best talent. The dependence on natural resources makes the economy vulnerable to commodity prices, causes problems of fiscal planning, raises the value of the national currency and renders other exports uncompetitive.

Time and time again, studies have confirmed that resource-poor countries outperform commodity exporters in terms of economic growth by a considerable margin. What’s more, developing countries stricken with the Dutch disease tend to perform worse than their non-exporting counterparts in rule of law, income distribution and overall good governance. Populations concentrated around resource-rich areas develop rent-seeking behavior and enjoy much higher standards of living than the rest of the country, thereby increasing intra-state tensions. Oxford University Professor Paul Collier even argues that oil rich countries have higher chances of being engulfed in wars than their resource poor counterparts.

The case for Nigeria

Nigeria, which clocks in at 2 million barrels a day and is Africa’s largest exporter, clearly displays the damaging effects policy myopia can have on a resource rich country.

Beset by terrorism, both in the underdeveloped north where Boko Haram has managed to extend its control over a considerable chunk of territory, and in the oil-rich south, where insurgent militias have blackmailed government after government with attacks on key oil infrastructure, Nigeria has oftentimes seen just the flipside of its natural wealth. Worse, when oil was discovered in the 1950s, the country’s GDP/capita was equal to Indonesia. In 2000, Indonesia’s GDP/capita was actually twice as big as Nigeria’s – $377 versus $789. In spite of oil revenues estimated at some $350 billion over three decades, it seems that the average Nigerian was actually worse off in relative terms.

Nowadays, oil and natural gas account for 35% of Nigeria’s GDP, 80% of total government revenue and 90% of exports. The country’s 2015 budget balances out at $65 per barrel, a benchmark that looks unrealistic at this point, which has prompted the country’s finance minister to announce painful austerity measures. Even if the currency (the naira) lost 13% of its value last year and is expected to lose even more this year, slightly offsetting the fall in oil prices, the budgetary math simply does not add up. Nigeria ‘s finances are also in a vulnerable state. Unlike other resource-rich countries, its oil fund shrunk to just $4 billion in 2014 – a paltry figure for a $550 billion economy.

The spell of oil has transfixed the leaders and the rebels of this country alike. For the past two decades, presidential elections have been held in a general atmosphere of horse-trading, with the central government paying off the southern rebels in exchange for promises they will not sabotage its pipelines and refineries. A Presidential Amnesty Program, which pays monthly stipends to ex-militants, has been in place since 2010, after a series of debilitating attacks on Nigeria’s oil infrastructure.

But Nigeria still has much untapped economic potential. All 36 states in the country can boast at least three mineral resources, ranging from iron-ore to gold to rock salt. Under the current administration, the GDP expanded and overtook South Africa as the continent’s largest economy, powered in part by a sprawling services sector, which captured a share of 51% of the economy (up from 26%). The government has also put in place an ambitious agricultural policy that seeks to transform Nigeria into one of the world’s biggest rice producers. Taken together, these policies show that the country has enough assets to replace declining oil revenues.

Unfortunately, the country is bound to experience new episodes of political and social instability this year, against the backdrop of the February presidential elections. The two contenders, incumbent Goodluck Jonathan and opposition figure Muhammadu Buhari, a former military strongman from the 1980s, will square off on February 14. The latter is a contested figure in Nigeria’s history – from his commitment to Sharia law to his questionable ties with Boko Haram insurgents, who once named him as trusted mediator, to his flabbergasting electoral promise that he will stabilize world oil prices. The outcome of the election will be a litmus test for Nigeria’s democratic future.

The case for Nigeria to move away from its reliance on oil is quite compelling, as the country is almost a textbook case of the Dutch disease, coupled with oil-fueled political instability. It just needs the political will to see through structural reforms. Falling oil prices can do just that.

One Response to "Will Falling Oil Prices Resolve Nigeria’s Dutch Disease?"

  1. Durendal   January 24, 2015 at 7:46 am

    "Dutch disease" in economic theory was coined in the 1960's to describe the sharp rise in the value of a currency following the discovery of large energy reserves and its subsequent negative effect on exports.It is also known as the downside to discovering large energy reserves.It has nothing to do with economic dependence on energy exports or the lack of economic diversity.