Challenge of Policy Making in Developing Countries: The Nigerian Case

Aloy Nwosu

Synopsis of Policy – Making Process

Governments usually intervene to address major economic concerns by first articulating economic policies which set out the mode of intervention or the course of action to be undertaken by government to address the economic issue or to achieve an objective.

The government has at its disposal a vast array of policy instruments from which it can choose to deal with the issue of concern or achieve the objective. A critical aspect of the policy formulation process is choosing the policy instrument or combination of instruments that would most effectively achieve the desired goal. The pressing question is: Which policy option, among alternatives, offers the “best” prospect for resolving the issue of concern or achieving the specific economic objective?

Selecting the policy option is usually done in stages. The first step is to generate a shortlist of policy options that are considered to offer prospects to resolve or address the issue of concern. The second step is to actually attempt to assess or quantify or “forecast” the prospect of resolving the issue offered by each of the shortlisted policy options. This is the policy “impact analysis” stage. It is an ex ante analysis which has to be undertaken for purposeful policy making.

The relevance of impact analysis is perhaps, made clearer by the following economic management questions which it ought to address: (i)What are the benefits and costs of the policy option? (ii) How are the costs and benefits distributed among social classes and demographic groups? (iii) How acceptable to the general public or the affected groups is the policy option? (iv) How relatively easy is operationalizing the policy option? Or, how practicable is the policy option? (v) Is the policy option compatible with existing policy and legal frameworks or is a new legislation required? 

The above questions are encapsulated in a set of criteria which form the basis for selecting policy options, in the policy formulation process. They are the criteria of “effectiveness”, “time lags”, “predictability”, “consistency” and “unintended effects”.

The meaning and implications of the selection criteria will become clearer as we attempt to apply them to the recent policies implemented in Nigeria: (i) Abrogation of Premium Motor Spirit (PMS) Subsidy (ii) Decontrol of Exchange Rate System (iii) Re-instatement of 43 items removed from the import list.

To achieve the objectives of the policies, the government adopted the Direct Control policy option which entails issuing directives or “fiat” to specify the level or the mode of conduct in the procurement of an economic activity. The advantage of the policy option is that it takes immediate effect unless otherwise stated. The directives issued by the President at his inauguration was all that was required for the policies to take effect.

PMS Subsidy Abrogation Policy

The “effectiveness” of a policy instrument is usually analyzed in the context of government objective for making the policy. As indicated by the government, the primary objective for implementing the subsidy removal policy is to harness the huge amount of financial resources hitherto, channeled into a subsidy programme that was corruption ridden and was said to have become a drain pipe for illicitly siphoning public funds into private pockets. There were secondary objectives, as indicated in the news media, such as: (i) Raising the price of petrol in Nigeria to prevent the smuggling of the commodity to neighbouring countries where the price is relatively higher and (ii) Bringing about a more efficient utilization of the commodity in Nigeria.      

From all indications the primary objective has been achieved. The government has stated that it has amassed huge savings during the brief period of implementation of the policy. And, available statistics show that the quantity of petrol dispensed locally has reduced drastically. Apparently, Nigerians are making more efficient use of the commodity and the cross border trade appears to have reduced. There is of course, no reckoning of the opportunity cost of the economic activities forgone as a result of the inaccessibility of the commodity, occasioned by the price escalation that came with subsidy removal.

Apparently, “time lags” did not pose any problem as there was absolutely no bureaucratic red tape. The pronouncement was more like a “fiat” issued on national television. The marketers adjusted their pump prices on the same day, as if they were waiting in anticipation of the directive.

There was certainly lack of concern for the “predictability” of the policy option. This manifested in the absolute lack of preparation for the attendant socio-economic challenges. Firstly, anyone who is fairly conversant with the behavior of petrol marketers and indeed, the behavior of a “typical” Nigerian “businessman” would have predicted the instantaneous reaction of the marketers. Secondly, “subsidy removal” is a “decontrol” policy measure. There were some socio-economic challenges which, in the first place, necessitated the “control” measure (i.e. subsidy payment). Unless those challenges are perceived to have disappeared, subsidy removal could lead to their re-emergence or exercabation. Furthermore, there is hardly any area of activity (economic or non-economic) in which energy is not required in one form or another. In an economy in which electric energy is grossly inadequate and epileptic in supply and, in which solar, gas and other sources of energy have remained underdeveloped, fossil fuels (precisely petrol and diesel) become the primary sources of energy. If the required ex ante analysis was conducted, it would have been clear that fuel subsidy removal would have horrific, economy – wide effects. And, at least some thought would have been given to how to implement the policy and how the adverse effects would be ameliorated in the short-run and completely resolved in the medium to long-term.

The issue of the “consistency” of a new policy instrument is difficult to determine in an economy – wide setting because a gamut of policy instruments are employed to manage the economy at any point in time. Nevertheless, it should be apparent that while the subsidy removal policy may be in consonance with other policies aimed at expanding government revenue, it certainly will be expected to be at variance with policies aimed at enhancing socio-economic welfare and increasing government spending. Purposeful policy making requires that the ways and means of ameliorating the effects of such unavoidable policy conflicts be determined a priori.

There was certainly no concern shown for the “unintended effects” of the policy option. There appeared to be a consensus among Nigerian elites that the corruption ridden subsidy programme should be scrapped. What deterred taking action in this direction was not “lack of political will”, as some analysts have averred, but the concern for the negative unintended side effects. Choosing policy options that would reduce to the barest minimum the unintended effects and would allay the fears of the labour unions was the major challenge.

It should now be apparent that ignoring the concerns for the consistency, predictability and unintended effects of a policy option is froth with serious challenges. The ramifications of the impact of fuel subsidy removal go beyond raising fuel prices and increasing government revenue. Fuel subsidy removal has contributed significantly to the unprecedented, economy – wide price escalation. The associated economic and welfare losses are reflective of the loss of incomes, increasing poverty and starvation arising from its crushing effects on households, micro, small and medium – scale enterprises. The economic impact on large – scale manufacturing in further manifested in capacity under – utilization, closure or relocation out of the country and the attendant shedding of the workforce. The ensuing pains and groans of the people have tended to undermine the usefulness of a policy measure which hitherto, appeared to enjoy considerable support from the elite.

Exchange Rate Decontrol Policy

The principle reason for floating a currency is to achieve “improvement of balance of payments” which is predicated on boosting the export trade and the inflow of foreign capital resources. Free floating of a currency invariably results in a massive devaluation of the currency which in effect makes the country’s exports cheaper and the imports dearer. In the specific case of Nigeria, the primary objective of floating the naira is to boost the inflow of foreign resources in the forms of increased export earnings and foreign direct investments (FDI). FDI may take the forms of the purchase of securities, acquisition of plants and financing of projects.

The prospects of boosting export earnings via the massive devaluation of the naira is very slim for at least two reasons. Firstly, Nigeria is now a net importer of all the primary commodities (except perhaps, cocoa) which in the past, had earned foreign exchange. Secondly, crude oil is about the only export commodity worthy of note, currently contributing about 95 percent of the foreign exchange earnings of Nigeria. However, because the price of crude oil is determined not in the local market, but in the international market, the massive devaluation of the local currency (i.e. naira) does not affect the quantity of crude oil sold (i.e. exported). Hence, massive currency devaluation, per se, would not result in increase foreign exchange earnings from crude oil exports.

However, Nigeria has immense prospects of achieving increased foreign exchange earnings from oil exports by expanding domestic production to take advantage of crude oil price increases in the international market. Nigeria is current producing far below the quota allocated by OPEC and the level of export of the commodity has declined. Thus, the current strident effort made by the Nigerian government to revamp domestic production and eliminate the leakages and fraudulent activities that plague the crude oil industry and have caused the rapid decline in production and exports, is certainly the way to expand foreign exchange earnings.

Devaluation nevertheless, offers the prospect of vastly expanding government revenue, in the local currency (i.e. naira), through exchange rate differentials. For instance if Nigeria sells a barrel of crude oil for $80, this would translate to N360,000, assuming an exchange rate of N450/dollar. If however, the naira depreciates further and the exchange rate rises to about N800/dollar (as is currently the case), the same amount ($80) would translate to N60,000. Thus, the policy of naira float, and the attendant massive devaluation would massively expand government revenue (i.e. in naira). It is important to note that in this regard, the policy of currency float is “consistent” with the fuel subsidy removal policy. The indication is that government has garnered huge revenues in naira, in the few months of implementation of both policies. The vastly expanded revenue would enable government met its domestic commitments and fulfill its promises to the people, including the provision of the so called “palliatives”, wage awards, minimum wage review, etc, etc.

The primary expectation of government nevertheless is that massive devaluation of the naira would facilitate huge influx of foreign direct investment (FDI). It is perhaps, reasonable to again argue that the expected huge inflow of FDI may not materialize. The free float of the naira with intent to achieve massive devaluation was a key instrument in the structural adjustment programme (SAP), incepted in June 1986. SAP policies and the depreciation of the naira continued until mid 1990s when the CBN, in an effort to stabilize the value of the naira and the economy embarked on different shades of “managed float” which allowed for period intervention in the foreign exchange market. It was the failure of the intervention measures to stabilize the naira and the economy that necessitated the “fixing” of the exchange rate and the formalization of other exchange rate windows, in recent years. The skepticism expressed here is predicated on the fact that, as available statistics indicate, the expected huge influx of FDI did not materialize, despite numerous overseas investment drives undertaken by top government officials and the billions of dollars of investment pledges made by foreign investors and project financiers. The thinking is that there must be other factors that affect the inflow of FDI into the Nigerian economy.

The first of such factors would appear to be the pervading climate of insecurity that has for decades, engulfed Nigeria. The situation has worsened over time and has been so bad that some foreign governments had occasionally issued to their nationals travel bans to Nigeria or to some parts of Nigeria. The climate of insecurity heightens the risk of investment failure; foreign investors are highly sensitive to it.

The dearth of production and distribution infrastructure, that leads to cost escalation and whittles down profit level, has grave disincentive effect on business decisions of foreign investors. In the case of Nigeria the cost of providing own power, own water supply and the cost of haulage of raw materials and wares by trucks, on bad roads, become prohibitive and mar the profitability of business ventures. It is said that some major companies have relocated to neighbouring countries on account of “poor operating environment”.              

It is also said that foreign investors in expectation of the large profits and dividends, which they would repatriate in the nearest future are highly cautious about investing in economies where the exchange rate is in continuous depreciation or is prone to violent fluctuations. The massive and continuing devaluation of the naira since the mid 1980s would have devastating effects on repatriable profits and dividends and consequently, on decisions to invest in Nigeria. The current float of the naira would only worsen the situation.

Furthermore, there is the reputation of corruption, fraud, lack of transparency and impunity that appears to pervade all socio-economic and business activities and indeed, life in Nigeria, that is known to foreigners. Stories abound of foreign private investors, contractors and visitors who have been defrauded in Nigeria. Nigeria appears to be a country of high investment risks without commensurate returns.

The above reasons may not be only the basis for the air of pessimism expressed here, they may in fact explain why the billions of dollars in pledges made by foreign investors during investments hunt by Nigerian leaders, may never materialize. The fact is that private foreign investors borrow funds largely from commercial financial institutions in their home countries or international financial institutions, and their financiers are very sensitive to investment failures and would withhold financing, especially in a developing country, when the risk of failure is considered very high.

There is also the other side of the devaluation “coin” that is hardly talked about; that is, that devaluation, by lowering the value of the local currency, raises the price of imports. The implication is that with the massive devaluation of the naira, Nigeria’s import bill will rise sharply. For a country that is highly import dependent, the situation portends acute shortage of all sorts of supplies and hyper inflation, such as currently being experienced.

Collapsing Foreign Exchange Windows into One

This policy was meant to serve two closely related purposes. The first is to facilitate the foreign exchange deregulation policy. The second is to checkmate the activities of foreign exchange hoarders and speculators. It is said that the scarcity of foreign exchange in Nigeria is, to some extent, artificially, created by the political class and all those who are in the corridors of power, that have access to the national “pie”. They are corruptly awash with naira with which they buy up the more stable and highly valued dollar from the foreign exchange market. The highly privileged group also has a tight grip on the banks and registered financial institutions through which exchange rate policies are implemented. They are further said to be patrons of the thriving parallel market (i.e. black market). It is said that a substantial proportion of the foreign exchange made avail at the forex market is diverted by this privileged group to other uses such as importing gold and silver and acquiring assets abroad. The thinking here is that unless stringent measure are taken to checkmate the activities of the privileged political class and their associates regulate the interests in the financial institutions and extirpate the thriving parallel market the policy may not achieve its objective. Simply collapsing exchange rate windows into a single official window by “fiat”, may not resolve the challenges of the foreign exchange market.

Reinstatement of Items Proscribed From Foreign Exchange List

The basis for the reinstatement of all 43 items, hitherto proscribed from the foreign exchange allocation list, is not clear. There is no doubt that by the imposition of forex restriction on 43 items, the CBN, at the time, was interfering with the free working of the foreign exchange market, contrary to the principle of “free” markets espoused by the IMF and other proponents of the free market economy. Yet, the decision of the CBN would appear justified on several grounds. First, given the state of the Nigerian economy, prudent economic management demands that the allocation of scarce resources be carefully rationalized to ensure that economic activities, enterprises and industries (e.g. agriculture) considered critical do not lose out to some frivolous and strictly unessential demands in the tussle for scarce resources (including foreign exchange). Market forces that allocate resources on the basis of profitability would ignore such handicapped but critical economic activities. Secondly, in a situation of dire shortage of supply of foreign exchange, efforts should be made to expand domestic production and to protect it against stifling foreign competition by restricting foreign exchange allocation to the imports of the commodities. Furthermore, faced with massive and rapidly growing unemployment, it does not make economic and socio-political sense to allocate the little available foreign exchange to the imports of commodities for which Nigeria has a natural endowment and proven capacity to produce, even if Nigeria is a relatively high cost producer. The emphasis should be to conserve foreign exchange and allocate the little available resources to enhance domestic production to create more employment. Finally, it is farfetched to argue that the removal of the 43 items from the forex list had hindered foreign investment. The question is: How much foreign investment had come in during the long period of severe socio-economic crisis while the items were on the import list?

Summary and Conclusion

The challenge of policy making in many developing countries is the tendency to announce economic policies without first evaluating the policy options by subjecting them to the established selection criteria. The criteria that would give indication of how each policy option would work: the order, the sequence and the prospective effects and also reveal the severity and range of the unintended effects. While the “off-hand” or “impromptu” approach to policy pronouncements may yield dividends in the political realm, it may portend danger when applied to resolve nation-wide socio-economic challenges. The unsavoury socio-economic conditions that have followed the PMS subsidy removal and the exchange rate decontrol policies which were applied simultaneously without prior analysis of the impact of the policy options, are illustrative of the dangers posed by the “impromptu” approach to policy making. Another point that should be made here is that the practice of announcing major economic policy options without the necessary ex ante policy analysis is rare in the advanced industrial countries where the political leadership is held accountable and where drastic socio-economic consequences arising from policies (as now experienced in Nigeria) have severe political repercussions.

With respect to fuel subsidy removal, a few points need to be highlighted. Firstly, fuel subsidy payment in Nigeria is not unique nor is it a “bad” policy as some commentators have averred. The payment of subsidies aimed at reducing the prices of specified commodities and services is common practice across the world. The advanced industrial countries provide subsidies for specified commodities or services either for the entire population or segments of the population or sectors of the economy. Some industrialized countries even provide subsidies on exports of some manufactured goods to encourage their sale abroad. Agricultural subsidies are commonly applied in most developed countries to encourage expansion of output of farm products and to keep farmers in business. The problem with the fuel subsidy programme was that it became a drain pipe for corruptly siphoning off public funds by a cabal of political power-brokers.

The thinking here is that some fiscal rather than the direct control policy option would have been adopted. An approach that would entail critically examining the subsidy payment system with a view to reforming it and extirpating the corruption that has bedeviled it. Then, embark on a graduated upward adjustment of petrol price level such that the consuming public would progressively bear a higher burden of the cost of subsidy while the government rakes in more revenue (i.e. savings engendered by subsidy reduction) and at the same time put in place incentives to entice investors to establish plants to boost local production in the medium – term. This policy option nevertheless, may be much more difficult for government because it entails confronting the cabal of political “heavy – weight” and their business associates, to whom, it is said, the subsidy payment system has been bequitted. It would also take sometime, but it would have saved the populace the pains and groans attendant on the socio-economic crisis that has resulted from removing fuel subsidy by fiat.

Secondly, Nigeria is currently almost entirely import dependent in its supply of petrol. With the removal of subsidy the domestic price of the commodity is largely dependent on both the international market price of petrol and the exchange rate. The point that should be made in this respect in that the domestic price of petrol will keep rising as the exchange rate rises, but may not fall commensurately, if the exchange rate declines, even when the international market price of the commodity is constant. The problem is twofold: the exchange rate like other prices is said to be “sticky” upwards and, a floating exchange rate would usually maintain an upward trend. The implication is that Nigerians can hardly expect an “average” national price less than N600/liter that emerged with the removal of the subsidy. The average price may remain above N600/liter even when local refining of crude substitutes entirely for imports of petrol and especially if the supply of crude oil to local refineries is predicated on the international market price of the commodity.

Thirdly, the indications are that the national average price of N600/liter that emerged with the removal of subsidy has put petrol beyond the reach of most Nigerians, indeed, beyond their income levels. Some common occurrences that are hardly talked about point to this fact: there has been a drastic reduction in the demand for the commodity, most middle-class car owners now keep their vehicles off the road and ride in mass transits to their work places and businesses; mass transits have quadrupled their fares; the work-week has unofficially shrunk from 5 days to about 2 or 3 days in many government offices and parastatals; and low and middle-income neighborhoods now remain in darkness and go silent when the epileptic electricity supply goes off at night because households can no longer afford petrol to power their mini generators. From all indications, it appears the average price of N600/liter and indeed, any price above the N400 -N450/liter range that had prevailed, cannot be accommodated within the current income levels of the people.

To restore people’s access to this “essential” commodity, income levels have to be raised and/or some element of subsidy has to be reintroduced. Incomes have to be raised considerably, for the low and middle – income earners and significant cash transfers made to the overwhelming number of self-employed urban and rural dwellers. This appears to be the approach currently adopted by government to resolve the issues.

The approach of vastly increasing incomes and cash transfers in the short run nevertheless, poses some dilemma for which some analysts have serious reservations. The first is that “pumping” so much money into the Nigerian economic in its present condition is like stoking an incendiary situation. The Nigerian economy is currently plagued by acute shortage of all forms of supplies and run-away inflation, arising from the fact that it is an economy that is highly import – dependent, that is in dire need of foreign exchange to bring in the required imports and whose domestic production capacity has been ravaged by banditry and other socio-economic challenges. Rapidly expanding money supply under these conditions could pose additional challenges.

The other source of concern is that even when domestic production of petrol completely substitutes for imports, the price of the commodity may not fall much below the prevailing N600 – N700/liter range which the current income levels cannot accommodate. The savings in freight and insurance cost of imports may not offset the probable higher domestic production cost and the high cost of distribution in trucks along dilapidated roads across the country. The chances are high that the price of petrol will rise above the N600- N700/liter range even when it is “untied” from the exchange rate, by expanding domestic capacity to refine crude.

To keep the price of petrol below the N600- N700/liter and avoid overheating the economy through huge wage awards and salary increases and massive transfer payments, and make the commodity accessible to all classes of end-users, some element of subsidy, well-targeted at some point in the supply chain, is considered necessary in the short – to medium – term. The pricing of the crude oil supplied to local refineries may implicitly provide the window for reintroducing some element of subsidy.

Regarding the massive devaluation of the naira, there is an adage that says “experience is the best teacher” and another that says “once bitten, twice shy”. The two adages tend to prompt some questions: Must Nigeria go through the route of currency (i.e. naira) float a second time? Should policy making not draw from careful analysis of past experience or learn from hindsight? Floating the naira was the linch pin in the structural adjustment programme (SAP) hoisted on Nigeria in June 1986, as the panacea for resolving the economic crisis that started in late 1970s. The argument was that the naira was overvalued and that had allowed Nigerians to attain a consumption level that was way beyond their productive capacity and that the naira must float to allow market forces determine a “realistic” exchange rate. Right from mid 1980s all through the 2000s to even recent times, exchange rate management has become a primary concern of economic policy.

Experience in Nigeria and elsewhere has shown that with the “float”, the value of the local current will continue to decline unless some stringent intervention measures are taken to halt and stabilize it. Even then, stabilization is not a once-for-all affair but would require intervention at intervals and may be achieved at an exchange rate that makes the local currency of little value in terms of its purchasing power. The intervention measures consist of providing the required foreign exchange at intervals and imposing fiscal measures aimed at restricting imports. The foreign exchange for intervention could derive from export earnings, FDI, drawing down of foreign reserves, sale of foreign assets and foreign loans. One can only talk with some level of certainty in respect of two of the sources – export earnings and foreign loans. The supply of foreign exchange (i.e. dollar) that derives mainly from crude oil exports has been grossly inadequate and unstable, depending on price and quantity conditions in the international market and the production level in Nigeria. If past experience is anything to go by, it would not fill the foreign exchange demand – supply gap for an economy that is heavily import dependent especially, as no restrictive fiscal measures have been taken to accompany the naira “float”.

The government might initially derive loans and investment funds from foreign institutions and governments that would want to support its market oriented policies. The problem is given the continuously depreciating naira occasioned by the float, the foreign exchange deficit would keep growing. The prospects of finding creditors and investors, who would be willing to supply the foreign exchange required for frequent intervention is not bright, especially as Nigeria is currently under an excruciating external debt burden, as reflected in the debt-servicing – total revenue ratio which has commonly been described as detrimental to growth and unacceptable.

It was apparently in an effort to check the unending fall in the value of the naira as reflected in the continuously rising exchange rate, and to prioritize foreign exchange allocation that the CBN, at the time, fixed the exchange rate and introduced the dual wind system. It was also for the same reason that the CBN subsequently imposed foreign exchange restriction on 43 specified items – a restriction that has now being revoked.

The psychological effect of the unending devaluation of the local currency should not be down-played. It could precipitate a massive decline or near complete loss of confidence in the local current. The loss of confidence in the national currency perhaps, explains why some entities and even governments in the developing countries attempt to transact domestic business in convertible currencies. It may also explain why some rich individuals, in the countries, stow away their wealth in foreign banks where money has value and the exchange rate is stable. Or with the local currency, they buy up available convertible currencies and hoard them in their “warehouses”. Suffice it to say that these practices which complicate foreign exchange management are common in Nigeria especially among the political class, their business associates and top government functionaries. The psychological effect and the resultant problems partly, explains why highly industrialized countries which could benefit from the increased export earnings that massive devaluation of currency portends to provide, have shield away from the policy option.

Finally, if the required ex ante impact analysis of the shortlisted policy options were conducted the following conclusions would have been apparent; (i) A graduated approach to fuel subsidy removal would have resulted in a far less socio-economic crisis than we have experienced (ii) Reintroducing a policy of freely floating the naira when the CBN was still battling to check the ending fall of the naira that resulted from the introduction of the same policy in 1986, would not have been contemplated in purposeful policy making; (iii) Both policies would not have been promulgated simultaneously by a fiat. Both reinforce their “effectiveness” in terms of enhancing government revenue (in naira) and at the same time amplifying the gravity of the negative unintended outcomes. Besides, both are inconsistent with the existing socio-economic policy options aimed at reducing inflation, increasing people’s access to consumption goods and raising their standard of living and quality of life. Instead of lifting people out of poverty the joint effects of the policies would rather push more people (including the middle class) below the poverty line. The ultimate benefit of particularly, the currency float is very uncertain, even in the long run.   

Nwosu, a retired professor of agriculture wrote from Umiahia, Abia State