Economic Policy Options for a Prosperous This page intentionally left blank Options for a Prosperous Nigeria

Edited by

Paul Collier Chukwuma C. Soludo and Catherine Pattillo © Paul Collier, Chukwuma C. Soludo and the International Monetary Fund 2008 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2008 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, and other countries. Palgrave is a registered trademark in the and other countries. ISBN 978-0-230-54273-0 ISBN 978-0-230-58319-1 (eBook) DOI 10.1057/9780230583191

This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10987654321 17 16 15 14 13 12 11 10 09 08 Contents

List of Tables vii List of Figures xi Preface xiii Acknowledgements xx

Introduction: Towards Evidence-based Policy 1 Paul Collier, Catherine Pattillo and Chukwuma C. Soludo

Section I: Oil and the Macroeconomy 11

1 Binding Constraints to Growth in Nigeria 13 Victoria Kwakwa, Adeola Adenikinju, Peter Mousley and Mavis Owusu-Gyamfi 2 Oil, Growth and Governance in Nigeria 45 Paul Collier 3 Addressing the Natural Resource Curse: An Illustration from Nigeria 61 Xavier Sala-i-Martin and Arvind Subramanian 4 Modelling Policy Options for Nigeria: Fiscal Responsibility, Monetary Credibility, and Regional Integration 93 Xavier Debrun, Paul Masson and Catherine Pattillo 5 and Oil Price Surges in Nigeria 121 Christopher Adam and Benedikt Goderis 6 Trade Policy: Prospects and Challenges 147 Olumuyiwa Alaba, Adeola Adenikinju and Paul Collier 7 Economic Growth and Policy Choice in Nigeria: Lessons from the Asia Pacific 167 Obadiah Mailafia Managing Extreme Volatility for Long-run Growth Doug Addison www.csae.ox.ac.uk/books

Section II: Government: Fiscal Management within a Federal System 185 8 Issues in Fiscal Policy Management under the Economic Reforms (2003–7) 187 Bright Okogu and Philip Osafo-Kwaako

v vi Contents

9 Towards Securing Fiscal Policy Coordination in Nigeria 205 Olu Ajakaiye 10 Fiscal Federalism in Nigeria: Issues, Challenges and Agenda for Reform 221 Akpan H. Ekpo and Abwaku Englama Stocktaking the Reforms in Public Financial Management Michael L.O. Stevens and Lev M. Freinkman www.csae.ox.ac.uk/books Fiscal Federalism: Fiscal Discipline and Service Delivery in Nigeria Festus O. Odoko and Okwu J. Nnanna www.csae.ox.ac.uk/books

Section III: Firms and Farms: The Policy Climate for Private Activity 245 11 Towards a More Competitive Manufacturing Sector 247 Adeel Malik and Francis Teal

12 How Competitive and Efficient are Nigerian Ports? 275 Okechukwu George Oji and Chukwuma Agu

13 Nigeria’s Power Sector: Opportunities and Challenges 301 Prasad V.S.N. Tallapragada and B.S. Adebusuyi

Agricultural Export Potential in Nigeria Adebiyi Daramola, Simeon Ehui, Emmanuel Ukeje and John McIntire www.csae.ox.ac.uk/books

Section IV: The Well-being of Households: Income and Education 329

14 Poverty in Nigeria 331 Simon Appleton, Andrew McKay and Babatunde Adewumi Alayande

15 The Impact of Universal Primary Education on Socio-economic Outcomes: A Nigerian Experiment 373 Una Okonkwo Osili

16 Female Schooling and Women’s Labour Market Participation in Nigeria 397 Adebayo B. Aromolaran

Index 429 List of Tables

1.1 Comparative indicators of competitiveness 16 1.2 Nigeria: main crops, area harvested, production and yield, 1999, 2003 and 2004 16 1.3 Manufacturing value added, 1980–2005 (% of GDP) 16 1.4 Return on assets (%) in selected Nigeria formal manufacturing sectors 19 1.5 Productivity of investment – returns 19 1.6A Banking sector liquidity 22 1.6B Banking sector liquidity: cross-country comparison 22 1.7 Indicators of financial intermediation across countries (data for 2004–5) 23 1.8 Indicators of size and quality of human capital 24 1.9 Comparative structure of manufacturing in Nigeria and SSA 1992 and 2002 26 1.10 Returns to education 27 1.11 Common tax administrative complaints 34 1.12 Import clearance sequence for non-EPZ firms 35 1.13 Contract enforcement indicators 37 3.1 Comparative indicators 63 3.2 Growth, institutions and natural resources in aggregate 67 3.3 Growth, institutions and individual natural resources 69 3.4 Growth, institutions and natural resources: robustness to covariates 70 3.5 Growth, institutions and natural resources: robustness to alternative measures of institutions 71 3.6 Growth, institutions and natural resources: robustness to influential observations, regional dummies, sample and instrument for institutions 72 3.7 Growth, institutions and natural resources: maximizing sample size 73 3.8 Growth, institutions and natural resources: is Nigeria unusual? 77 4.1 The DMP model in a nutshell (benchmark case of dependent central banks) 100 4.2 Inflation rates under alternative monetary regimes 106 4.3 Public spending on health and institutional quality 110 4.4 Expenditure on health: estimates of resource diversion and UFN 111

vii viii List of Tables

4.5 WAMZ monetary union: net benefits for participants 113 4.6 ECOWAS monetary union: net benefits for participants 114 4.7 ECOWAS monetary union: net benefits for participants 116 4.8 Nigeria: alternative calibrations of UFN 116 5.1 Impulse responses to a 12.5 per cent positive shock to oil prices 133 5.2 Standard deviations under alternative fiscal and monetary rules: responses to a 12.5 per cent shock to oil prices 140 5.3 Standard deviations and impulse responses with bond sterilization: responses to a 12.5 per cent shock to oil prices 142 5.A1 Model calibration values 145 6.1 The Common External Tariff Structure 157 6.2 MFN applied tariffs for West (2158–2004) 158 6.3 Final MFN bound tariffs (%), West African countries 159 6.4 Official checkpoints on selected West African highways, December 2000 160 6.5 Structure of ECOWAS economies in 2005 (as percentages of GDP) 161 6.6 Direction of change in import tariffs due to the adoption of ECOWAS CET 163 6.7 Impact of CET adoption 163 6.8 Changes in output after the adoption of ECOWAS tariffs (%) 164 7.1 Gross capital formation and gross savings as a ratio to GDP 168 7.2 Sectoral contribution to GDP 169 7.3 Percentage of children performing at or above level of mathematical scales by age 13 years 175 7.4 Nigeria: selected macroeconomic indicators, 2000–2005 177 8.1 Consolidated government operations 193 8.2 Selected economic indicators 195 8.3 Total public debt (1999–2006) 196 9.1 Structure of Federation Account Revenue, 1999–2004 212 9.2 Summary of federal government finances, 1999–2004 213 9.3 Summary of state government expenditure, 1999–2004 214 9.4 Summary of local government finances, 1999–2004 214 10.1 Assignment of expenditure responsibilities in Nigeria 230 10.2 Disposition of major tax powers among the three tiers of government 233 10.3 Nigeria: State Governments’ Finances, 2001–2005 236 10.4 Nigeria: Local Governments’ Finances, 2001–2005 237 11.1 Reliance on privately provided electricity 251 11.2 Supply and reliability of utilities 252 11.3 The procedural barriers to investment 260 List of Tables ix

12.1 Global competitiveness ranking, 2005 and 2006, shifts in position among African countries 277 12.2 TEU of shipment to Africa by regions 281 12.3 TEU of shipment handled by countries 282 12.4 Documents, time and cost of imports and exports in Nigeria and selected regions 283 12.5 Regression estimates (Nigerian responses) 288 12.6 Port reforms toolkit and progress in reforms in Nigeria, 2003 to date 291 13.1 Power sector performance of some developing countries 305 13.2 Unit selling price of electricity (kobo) 306 13.3 System losses (%) 306 13.4 Status of existing power generating stations on national grid 308 13.5 PHCN power generation projections under implementation 309 13.6 NIPP power generation projects under implementation 310 13.7 Status of planned major power projects 311 13.8 Independent power projects by indigenous and foreign companies under implementation 312 14.1 Evidence on poverty and inequality trends 336 14.2 Poverty indicators 340 14.3 Inequality indicators 343 14.4 Modelling welfare and poverty 346 14.5 Simultaneous quantile regression for log welfare 348 14.6 Effect of employment sector on welfare and poverty 354 14.7 Summary characteristics of earnings, disaggregated by employment status 356 14.8 Estimates of the public-private sector wage premium allowing for different worker characteristics, in percentage points 358 14.9 Summary earnings from public and private sector wage employment, by sector of employment and skill level 361 14.10a Quantile regression results for correlates of log earnings: public sector workers 362 14.10b Quantile regression results for correlates of log earnings: private sector workers 364 15.1 Landmark events and universal primary education in Nigeria 376 15.2 Federal capital funds allocated for primary school construction in 1976 379 15.3 Changes in schooling inputs (state means with standard deviations in parentheses) 382 15.4 Summary statistics of the 1999 NDHS data 383 x List of Tables

15.5 Impact of the UPE programme on socio-economic outcomes: programme intensity measured by 1976 per capita federal funds disbursed for primary school construction. Treatment group: born 1970–75 (age 1–6 in 1976); control group: born 1956–61 (age 15–20 in 1976) 388 15.6 The impact of primary schooling on socio-economic outcomes – an instrumental variables approach: treatment group born 1970–75 (age 1–6 in 1976); control group born 1956–61 (age 15–20 in 1976) 390 15.7 Federal government recurrent grants and capital funds released to the states for the UPE scheme (in naira): 1974–79 392 16.1 Nigeria: economically active population as a proportion of total population by sex and age 398 16.2 Gross school enrolment rates in Nigeria (1970–94) 399 16.3 Schooling attainment of women in Nigeria by age and grade 400 16.4 Percentage distribution of women by marital status and employment type 407 16.5 Occupational distribution for women living with spouse only (percentage) 408 16.6 Relationship between level of education and married women’s labour market participation rates by age group 410 16.7 Proportion of women who are married or single by age group and level of education 417 16.8 Probability model regression results for total market employment 420 16.9 Probability model regression results for wage employment 421 16.10 Probability model regression results for self-employment (women living with spouse and aged between 30 and 54 years) 422 List of Figures

1.1 Cumulative TFP for alternative initial capital-output ratios 15 1.2 Gross fixed capital formation (% of GDP) 17 1.3 Gross national savings, including NCTR (% of GDP) 18 1.4 EMBI Global stripped spreads (bps) of Nigeria’s external debt 20 1.5 Revenues and expenditures, 1971–2005 28 1.6 Deposit and credit structure of deposit banks in Nigeria (%), 2005 30 1.7 Entry procedures 36 3.1 Poverty rates, 1970–2000 62 3.2 Poverty count, 1970–2000 62 3.3 Cumulative revenues from oil, 1965–2000 (at 1995 prices) 63 3.4 GDP, capital and TFP, 1965–2000 75 3.5A Nigeria: REER – official and parallel, 1965–2000 78 3.5B Nigeria: ratio of tradable to non-tradable prices, 1970–2000 78 3.6 Nigeria: shares of sectors in real GDP 80 5.1 Inflation 1999–2006 124 5.2 Log spot price for Nigerian Forcados crude oil (constant US$ per barrel) 1980–2005 130 6.1 Government revenue from oil with no import restrictions 149 6.2 Government revenue from oil with a uniform import tariff 150 6.3 Government revenue from oil with multiple import tariffs 151 6.4 Sources of imports (%), 1994–2000 152 6.5 Ranking of countries within ECOWAS on integration efforts since 1994 158 7.1 Years to complete transition from high to low birth and death rates 174 8.1 Pro-cyclical public expenditure pattern, 1992–2005 192 11.1 Perceived main problems 250 11.2 The state of roads directly outside the enterprise 253 11.3 Proportion of firms with access to bank loans in 2003 255 11.4 Proportion of banks facing liquidity problems in 2003 255 11.5 How do firms respond to liquidity problems? 256 11.6 Reliance on bank loans remains limited 257 11.7 Reasons for not applying for a bank loan 258 11.8 Unofficial payments in the provision of public services 261 11.9 Customs delays 262

xi xii List of Figures

11.10 Real output by average firm size, 1998–2003 263 11.11 Real output per employee, 1998–2003 264 11.12 Output per employee and capital intensity by firm size 264 11.13 Firm probability 265 11.14 Reported reasons for idle capacity (%) 268 11.15 Propensity to export: Nigeria compared to Africa 269 11.16 Where do jobs get created? 270 11.17 Where do better jobs get created? 271 12.1 Number of documents required for exports and imports 284 12.2 Time required for exports and imports (days) 284 13.1 Electricity generation and consumption in Nigeria 1970–2000 303 13.2 Proportion of electricity loss 1970–2005 304 13.3 Federal government expenditure on the power sector 315 13.4 NEPA staff strength 320 13.5 NEPA’s cost and price of electricity 322 14.1 Real private consumption per capita 336 14.2 Poverty incidence curves 342 14.3 Kernel estimate of the density of log consumption per adult equivalent 342 14.4 Kernel density plots of the logarithm values of public and private sector earnings 357 15.1A The states of Nigeria in 1976 and their experience with universal primary education 377 15.1B Universal primary education in Nigeria: actual versus projected enrolment ratios in the first year of the programme (for Grade 1) 377 16.1 Average years of schooling – age profile (for women aged 25-54 years) 401 16.2 Labour market participation rate and years of schooling of married women (ages 30–54 years) 412 16.3 Labour market participation rate and years of schooling of married women (ages 30–34 years) 412 Preface

In 2002, I mooted the idea for this book in a conversation with Professor Paul Collier. I envisioned a collaborative project that would bring together colleagues from Nigeria, Oxford and Washington to produce a work that would provide viable policy options for Nigerian decision-makers. We assigned topics of policy relevance to different authors from Nigeria, Oxford and Washington to research upon. This was before I came into government in 2003, first as the Economic Advisor to the President of the Federal Republic of Nigeria, and latterly as Governor of the Central Bank. More recently, we were able to revive the idea by inviting the authors of the assigned topics from Oxford and Washington to a two-day workshop that took place on 23–24 October 2006 at the in Abuja. Papers were presented on issues ranging from oil and the macroeconomic framework to monetary policy, trade and macroeconomic volatility, private investment, poverty and income distribution, fiscal federalism and public services delivery. Each chapter has been subjected to a process of criticism and peer review. Authors were held to a high standard of analytical rigour, aware of the fact that African governments have grown weary of outsiders preaching at them and prescribing solutions with scant regard to evidence and analysis. We are persuaded that policy has to be informed by knowledge and evidence if it is to be favourably received by leaders and articulate publics alike. In our opinion, the best way to convince leaders and citizens in Africa, as elsewhere, is to present the evidence of scientific analysis and to let ‘the facts speak for themselves’. This is what this book has sought to do. A major finding that comes out is the fact that Nigeria’s performance since independence has been rather disappointing despite considerable inflows of rev- enues from oil. The Nigerian experience provides telling confirmation of the role of waste and corruption in undermining growth rather than the classical ‘Dutch disease’ syndrome that is often associated with natural resource endowment. Perhaps nowhere have the structural weaknesses of the Nigerian economy been more glaring than in agriculture and manufacturing. Ever since the dis- covery of oil, agricultural exports have dwindled over the decades, appearing to recover only in recent times. The challenge for policy in the years ahead is to deploy agrarian strategies that would boost peasant production while giv- ing increasing attention to large-scale agricultural holdings. The lessons of the Green Revolution in Asia need to be taken on board. With the rise of India and China and the US Africa Growth and Opportunities Act (AGOA), there is an

xiii xiv Preface expanding global market for agricultural export. Diversification of exports, in addition to increasing value-added in terms of processing and semi-processing of such products, would change the revenue base positively while creating an avenue for increased employment opportunities in the country. The manufacturing sector has not fared any better. Once thriving industries – notably textiles – have virtually disappeared; massive capacity under-utilization has also severely afflicted others. The challenges facing this sector have to do with the country’s poor investment climate, skilled labour shortages, limited access to finance and absence of adequate physical infrastructure. These con- straints have continued to erode the job-creating potentials of the nation’s manufacturing sector, negatively affecting its international competitiveness and export performance. The key to reversing this downward secular trend lies in the provision of an incentive package for the manufacturing sector to make it more export oriented, creating firm-level efficiency, reducing transaction costs and minimizing risks and uncertainties in the business environment. When we cast a glance at the infrastructure sector, the same dismal pic- ture stares us in the face. Nigeria’s railways, for example, have been virtually dormant for decades; its roads and highways remain in a state of massive disre- pair. Water and electricity are way below the minimum needs of the country’s expanding population and of the demands of mega-cities such as Lagos, Port Harcourt, Ibadan, Kano, Onitsha and Aba. Although succeeding governments have committed significant resources (in terms of budgetary allocation) to the needs of the infrastructure sector, many such schemes have fallen victim to cor- ruption and rent-seeking behaviour. Several of the recent initiatives to address the infrastructure deficit are welcome. These include the US$8 billion Lagos– Kano–Abuja railway project and the private–public partnership in infrastructure development. With regard to the power sector, one would note that current economic reforms promise encouraging results. The Energy Reform Act, which permits privatization of the national company and private sector participation in the sector as well as the establishment of the Energy Regulatory Commission, is commendable. What is needed is careful planning on a national scale, innova- tive financing approaches and an effective monitoring and regulatory regime for the sector to thrive in the years ahead. Coming to grips with this one sector alone and providing a steady power supply would considerably boost national GDP and would radically improve economic performance across the nation. In considering the case of infrastructure, we must not forget the role and importance of ports development and the customs practices. The examples of Singapore and Hong Kong point to the fact that the development of port facil- ities could play a significant role in a nation’s economic growth. Nigeria has a considerable stretch of coastline with enormous potential for the development of ports and harbours. Sea transportation is of particular significance because it Preface xv offers an important avenue for linking the country with the rest of the world, thereby contributing to its international competitiveness. The country’s ports have consistently failed to support effectively the external trade needs of the country, while a substantial component of the country’s import business has consistently been diverted to neighbouring ports with significant losses in terms of revenues to the government. Nigeria has all it takes to provide world-class ports facilities and practices that would out-compete any other port in West Africa. With appropriate reforms, there is no reason why importers should not clear customs in less than 24 hours. However, the benefits from ports and tariff reforms may prove of limited benefit unless attention is also paid to the factors determining the internal costs of production. Equally problematic has been the incidence of poverty. Although the inci- dence of poverty has fallen from 65.7 per cent in 1996 to 54 per cent in 2004, it is still considered relatively high. Empirical evidence suggests that, although the high level of poverty is incontestable, the issue of absolute poverty in the country has tended to be overemphasized. Using three measures of poverty – the head count, poverty gap and an index of poverty severity – Nigeria remains on a rather high poverty scale compared with some less resourceful African coun- tries such as Uganda, Tanzania and Rwanda. National distribution of poverty is, however, concentrated more in the rural areas, and the severity is higher in the northern states. For the areas under consideration, economic distance is a factor in the incidence of poverty, explaining why a large proportion of poor people are concentrated in the rural areas. Major causes of household poverty are the size of household and the educational attainment of the head of household. Although schemes such as the National Poverty Eradication Programme, sponsored by the Federal Government, may have some impact, micro-level interventions for poverty reduction should be the domain of the state and local governments. In the long run, what would be most critical is a policy mix that boosts employ- ment generation, enhances rapid industrialization, develops export-oriented trade and promotes accelerated growth. Promoting universal access and quali- tative education is critical to the long-term solution to poverty, and programmes to enhance the productivity of peasant agriculture in the short to medium term would also help. There is also the issue of human capital, skills and basic education. Over the last decades, Nigeria has witnessed a troubling decrease in child school enrolment, scoring lower than countries with far fewer economic resources. Evidence shows that rapid growth of basic primary education is positively cor- related with labour and non-labour market outcomes. It is also an established fact that women with the highest rates of universal primary education (UPE) exposure are also more likely to delay their first marriage and have fewer chil- dren than otherwise. Given these potentials, there is a strong case for increased investment in a universal primary education programme. xvi Preface

Turning to the issue of public financial management, we are faced with the abiding challenge of evolving a framework of fiscal federalism that actually works. The contending issues have centred on questions of equity, revenue sharing and the neglect of natural resource-producing areas. To ensure a better framework for fiscal federalism, it would be necessary to set up an independent intergovernmental committee to promote a more effective framework for fiscal discipline and fiscal policy coordination and to ensure transparency of the bud- getary process. The system of expenditure controls remains weak, and a situation whereby state and local governments have opportunities to waste public funds on projects that are at best questionable cannot be sustained for long. State gov- ernments should follow a cue from the Federal Government and enact the Fiscal Responsibility Acts for the respective states. There is also a need to decentralize tax administration in the country so as to enhance the fiscal and extractive capacity of the state. Competition and peer pressure based on increased mentor- ing from the federal level, including performance-based grants/transfers, would also prove effective. It would be essential to develop a framework for regular measuring of performance, disseminating good practices and encouraging peer learning. Central to meeting the poverty challenge is the imperative of effective social services delivery, especially to the poor. Evidence from a survey of the revenue and expenditure profile of the Federation and its units shows critical chal- lenges in the area of services delivery. Using five major performance measures – health, education, roads, potable water and sanitation – a rather dismal picture is revealed across all levels of government. In our view, resources may not neces- sarily be the chief binding constraint to public service delivery, as is sometimes claimed. Rather, institutions and leadership matter the most. Through a skil- ful combination of enhanced spending efficiency, increased internal revenue generation and judicious application of incentives/sanctions, leaderships can make a difference. In addition, there is the need to promote healthy compe- tition among the tiers of government through benchmarking/marching grants and improvement in monitoring capacity. During the recent past, Nigeria has been lauded for its significant achieve- ments in economic reform under the administration of President Olusegun Obasanjo. Under the National Economic Empowerment and Development Strategy (NEEDS) framework, a successful programme of economic liberaliza- tion has been put in place; inflation is coming down; significant privatization gains have been recorded; the banking sector has undergone an internationally acclaimed consolidation; growth is looking up; and the country is no longer a debtor nation, having settled its accounts with the Paris Club in a buy-back of its US$30 billion debt and also having exited the London Club. Owing to the reforms, Nigeria has also been de-listed by the Financial Action Task Preface xvii

Force (FATF) from its list of non-compliant countries, and it has been given its first-ever sovereign credit rating of a BB minus. The challenge, going forward, is to build on these achievements and to sustain the reforms way into the future. With the current prospects looking brighter for global oil prices, it is imper- ative that the present opportunity be judiciously utilized in order to avoid the mistakes of the past. Avoiding these errors would require that society must go through the difficult process of changing the incentives and restraints that face individuals. In this case, certain critical decisions would have to be taken with respect to current savings and consumption, asset composition decisions and the type of investments – structures or equipment – that the country can embark upon. One proposal is that Nigeria has got to invest its oil windfall and feed on incomes that are generated from those investments rather than the oil proceeds themselves, which characterizes the current case. There is an alternative pro- posal to carefully target the spending of the oil resources (which is a depletable resource) only on investments that enhance the long-term growth potentials of the country such as education and infrastructure. The point here is that the debate on the best use for revenues from depletable resources should begin. Cur- rently, there is no coherent strategy, and much of the current oil revenues go into current consumption or are simply wasted. Further, the country would need to consolidate on a fiscal process that is consistent with the needs of the domestic economy, in line with the goals of the new macroeconomic directions. In this case, a fiscal rule that imposes a constraint on government’s fiscal behaviour would be an appropriate measure. This would also call for conditions that guarantee a better informed society in terms of fiscal constitution. The role of the Central Bank would, in this regard, be critical because of its dual role as a key component of a fiscal constitution and also the key authority on economic issues that ordinary citizens can trust. Another critical challenge that Nigeria’s economic managers have to face is that of evolving an effective monetary strategy, given a regime of fiscal dominance emanating from excess oil revenue. Although steps have been taken to establish the foundations for effective macroeconomic management – stronger political commitment to economic reform, evident commitment to fis- cal responsibility and financial sector reforms – more needs to be done to put in place a more robust monetary policy regime. Clearly, the independence of the Central Bank would be critical. Equally vital is the need to preserve macroeconomic stability. For several years, the Nigerian economy had the unenviable reputation of being among the most volatile in the world. There are different sources for such volatility: the terms of trade, monetary, revenue, expenditure and real exchange rate volatility. Volatility in major economic indicators reduces the country’s growth potentials and complicates internal macroeconomic balancing problems. Terms-of-trade xviii Preface volatility complicates exchange rate management, reduces investment decisions and productivity; revenue volatility confounds budget planning and execution; expenditure volatility undermines the quality of public investment and services and amplifies monetary and real exchange rate volatility. Clearly, a sustained reduction in volatility will make a big contribution to the country’s long-term growth. Among the remedies to be considered are stability in budgetary spending and real exchange rate stability through establishment of a fiscal rule that has a legal–constitutional backing. This makes the Fiscal Responsibility Act critical. Second, oil revenue hedging or swapping with finan- cial assets would be a preferred choice because it has far-reaching implications: it would broaden the revenue base and also help to control revenue volatility. Similarly, stability of the terms of trade through export diversification would avoid real exchange rate appreciation. In the longer term, it is imperative to take financial sector reforms to a higher level so as to deepen financial sector devel- opment. In this regard, the vigorous implementation of the proposed Financial System Strategy 2020 (FSS 2020) aimed at making Nigeria Africa’s financial hub by the year 2020 is encouraged. Nigeria’s ambition is to be among the developed market economies within the next two decades. To do so, it would have to reform its financial sector, enhance agricultural productivity, accelerate industrialization, modernize the education system, invest massively in human capital and technical skills development, and, above all, deepen its international competitiveness while finding a niche within the integrated global marketplace. Within the West African sub-region, Nigeria largely underwrites the process of integration within the Economic Community of West African States (ECOWAS). One of the pressing policy challenges is the objective of attaining a single cur- rency within the English-speaking West African States, plus Guinea. It goes without saying that much would depend on what happens in Nigeria. A stable macroeconomic environment in Nigeria is a necessary condition for making the monetary union project more acceptable to other countries in the region. Thus, continued reforms to strengthen the effectiveness of monetary policy, institu- tional steps to bolster Central Bank independence and movement towards an inflation-targeting regime are critical measures. Convergence may prove to be a slow and painstaking process, given the economic disparities among the partner countries. Ultimately, the prospects for Africa’s largest nation will hinge largely on the capacity of its government to sustain the path of reform and to build on the foundations that have been laid in the recent past. Careful attention has to be given to the promotion of macroeconomic stability, taking control of the ‘economic fundamentals’, enhancing agricultural productivity, expanding and diversifying exports, accelerating industrialization, investing in human capital, Preface xix getting rid of corruption, strengthening economic and political governance and building enduring institutions. Particular attention must be given to building the physical infrastructure base, boosting incentives to enhance savings and investments and creating a foundation for enduring growth.

CHUKWUMA C. SOLUDO Governor, Central Bank of Nigeria Acknowledgements

Studies done for this book were financed in part by the U.K. Department for International Development in Nigeria through its Policy and Knowledge facility. We would also like to thank the Research Committee of the for funding.

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