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Appendix 2. Oil and Economic Development in Nigeria15

Niko Hobdari, Eric Le Borgne, Chonira Aturupane, Koba Gvenetadze, John Wakeman-Linn, and Stephan Danninger
Published Date:
April 2004
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Nigeria has an abundance of hydrocarbon resources. It is the thirteenth largest oil producer in the world, the third largest oil producer in Africa, and the most prolific oil producer in sub-Saharan Africa. Prior to 1960, agriculture was the dominant sector in the Nigerian economy and the country was a major producer of cocoa and palm products. Oil production in Nigeria started in 1958 and increased over time to reach the export of 2 million barrels of oil per day by 1972.

With the first oil boom of 1972–78, Nigeria’s terms of trade increased three times; international reserves increased almost tenfold between 1973 and 1974. Oil revenues accounted for almost 85 percent of the country’s total exports and around 60 percent of federal government revenues in 1973. At this stage, the government faced the question of how to use such vast unplanned revenues. The fiscal authorities ignored the risk of future reversal of the current favorable conditions and chose to spend these revenues by undertaking massive domestic investment projects. Public capital spending accelerated rapidly, absorbing more than the total increase in 1970–76 oil revenues, resulting in a large budget deficit, which was financed with the use of reserves accumulated in 1973–74 and monetary expansion. These policies resulted in inflation—prices increased by 22 percent and, with a mainly fixed exchange rate, the real exchange rate appreciated strongly.

The government was not successful in diversifying the economy, particularly as specific policies further negatively affected the once strong agriculture sector. Production of major agricultural export crops shrunk by half from 1964 to 1978, partly because the government created commodity boards to stabilize crop prices and taxed farmers by paying them substantially less than world prices. Nigeria became a net importer of agricultural products in 1975. The government responded to the difficult economic situation by expenditure cuts in 1978, but did not address the issue of the overvalued real exchange rate.

The second oil boom saved the government from undertaking further painful adjustments. Nigeria’s terms of trade increased by 25 percent and 40 percent in 1979 and 1980, respectively, and the international reserves position strengthened significantly. However, the Nigerian government did not take into account the lessons of the past. In light of the increasing oil revenues, fiscal constraints were relaxed and expenditures rose by 65 percent in 1980, to resume the suspended construction projects and to undertake new ones. However, the second oil boom did not last long; oil export receipts halved between 1980 and 1982, and this expansionary fiscal policy resulted once again in large fiscal deficits by 1982. Foreign exchange reserves fell sharply and the real effective exchange rate appreciated by 125 percent compared to its 1976 level. Inflation reached 60 percent during 1980–83. The government introduced restrictive quantitative controls and import quotas on goods and services that hurt the manufacturing sector. In addition, payments arrears on foreign debt were accumulated, adversely affecting Nigeria’s credibility in international capital markets. At this point, the government approached creditors to prolong existing loans and to get new financing. By the end of 1983, the Nigerian economy was in trouble again.

Nigeria failed to use its oil wealth for the benefit of its people during the boom years. Experience in Nigeria shows that the high level of expenditures during oil boom periods was difficult to reverse after price falls, thus resulting in widened fiscal deficits. Fiscal volatility adversely affected the economy through appreciating real exchange rates. The authorities spent the oil income mainly for domestic investment and consumption. Any savings of oil revenues was short-lived; revenues were saved only immediately following the surge in windfall income and were then subsequently spent quickly. The large public investment projects did not succeed because of constraints in the implementation process. Investments in the industry sector failed to generate the much-needed non-oil exports and the authorities did not manage to diversify the economy during the windfall decade. The decision to adjust to shrinking oil revenues through trade restrictions rather than through devaluation had a ruinous impact on the economy. In addition, heavy and long dependence on oil revenues resulted in a narrowing of the non-oil tax base and inefficient tax administration, which played a negative role in the country’s macroeconomic performance throughout the 1980s and 1990s, as oil prices fluctuated.

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