Nigeria’s fuel subsidy removal was too sudden: why a gradual approach would have been better

 

 

 

By Stephen Onyeiwu, Allegheny College

 

Nigeria removed fuel subsidies entirely in May 2023. This came as a surprise because of the political risks associated with subsidy removal. Previous administrations were reluctant to jettison the subsidies.

The subsidies had been in place since the 1970s, when the government sold petrol to Nigerians at a price below cost – though most consumers weren’t aware of this.

The 1977 Price Control Act made it illegal for some products (including petrol) to be sold above the regulated price. The Olusegun Obasanjo regime introduced this law to cushion the effects of inflation, caused by a worldwide increase in energy prices.

Fuel subsidies have been controversial in Nigeria, and some analysts see them as inequitable. Very few Nigerians own vehicles. Nigeria is among the countries with the least number of vehicles per capita, with 0.06 vehicles per person or 50 vehicles per 1,000 Nigerians.

So critics have argued that the subsidies benefited mainly the elites even though they could afford to buy fuel at market prices.

The subsidies were also considered to be a drain on public finances, costing the government US$10 billion in 2022. About 40% of Nigeria’s revenue in 2022 was spent on fuel subsidies.

Fuel subsidies in Nigeria were notorious for their opacity and graft. Billions of dollars were said to have been lost through corrupt practices in the payment of the subsidies.

These are some of the reasons they were removed.

But now questions are being asked about the way it was done. In a public opinion poll conducted last year, 73% of Nigerians said they were dissatisfied with the manner in which the fuel subsidy was removed.

As an economist who has studied the Nigerian economy for over four decades, I can see why the fuel subsidy had to go.

As I argued in a previous article, fuel subsidies were bad for the Nigerian economy. They worsened budget deficits and the country’s debt profile, encouraged corruption, and diverted resources away from critical sectors of the economy. They were also inequitable, transferring the national wealth to elites.

But, as has become clear from the unprecedented inflation in the country partly caused by the removal of fuel subsidies, the abrupt removal of the subsidy was not the best strategy to use.

I believe this action should have been staggered over several months. This would have provided a soft landing, and gradually exposed Nigerians to the full market price of fuel. Doing so in one fell swoop amounts to shock therapy that is very traumatic for an already beleaguered and impoverished citizenry.

Why removing the subsidy should have been gradual

The Bola Tinubu administration could have chosen from various mechanisms to minimise the negative impact of subsidy removal.

As proposed by the World Bank, a temporary price cap would have ensured that fuel price increases did not inflict too much pain on consumers. This approach would also have enabled the government to significantly reduce, but not eliminate, the fiscal burden of the subsidy.

Another approach is periodic price adjustments: setting the price based on a moving average of previous months’ import costs. These adjustments could have been made together with a price cap. The Philippines is one country that successfully removed fuel subsidies in the 1990s, using the price adjustment mechanism.

Gradually phasing out subsidies would have been a better approach for a number of reasons.

Firstly, Nigerians had become suspicious of government’s intentions, given their economic experiences with the previous administration of Muhammadu Buhari. Those experiences include high inflation and unemployment rates, rising poverty and insecurity.

Tinubu should have re-established government credibility and good intentions first. He could have offered economic succour such as cash transfers and food subsidies for poor Nigerians, wage increases for workers and retirees, scholarships or tuition waivers for indigent students in tertiary institutions, free lunches for primary and secondary students in public schools, and subsidised public transport.

After demonstrating he meant well, he should have gradually rolled out the subsidy removal. Nigerians would have been psychologically prepared for what was coming, including inflation.

The inflationary impact of subsidy removal would have been less severe. Nigerians would have been more tolerant of difficult economic policies. People will accept difficult economic policies if they know their government is humane and pro-people.

Secondly, an incremental approach would have enabled the government to come up with programmes targeted at those most likely to be hurt by subsidy removal. This would have ensured buy-in. The “palliatives” introduced by the Tinubu administration and state governments are temporary and have a limited reach.

Gradual subsidy removal would have enabled the government to engage with groups that would be affected by the policy. Groups representing labour, manufacturers, students, women and others could have provided insights into what would be needed to help their members adjust.

This interactive approach would have promoted transparency and credibility in the conduct of government policies.

Many vulnerable Nigerians were already under severe economic pressure. Apart from high unemployment and poverty rates, inflation was biting very hard.

The abrupt removal of fuel subsidies, without first putting in place shock-absorbing measures, will make it more difficult for the government to achieve the policy’s long-term aims: fiscal sustainability; higher levels of investment in productive sectors of the economy; economic growth; and investment in renewable energy.

Minimising the negative impact of subsidy removal

Tinubu should minimise the negative impact of subsidy removal and liberalisation of the foreign exchange market. These two phenomena interact to cause the inflation that the country is facing.

First, savings from ending the subsidy should be used to develop productive capacities in agriculture, labour-intensive manufacturing and services.

Manufacturing activities like agro-processing, textiles, footwear, leather products, arts and crafts should be targeted for development. This would generate high-paying jobs that might help Nigerians to cushion the effects of inflation.

In an economy that’s functioning well, wages always adjust to reflect price increases. In Nigeria, however, too many people are either unemployed or in the informal sector, with limited opportunities to adjust their earnings to reflect inflation.

Funds saved from subsidy removal should be invested in public infrastructure (mass transportation, road construction, electricity generation, water supply).

Funds should also be used to develop people’s capabilities through massive investment in health and education. Part of the savings should be used to support and sustain the student loan programme announced by the Tinubu administration.

Successful radical economic reforms, such as the ones implemented in Rwanda, usually give people an incentive to be more productive, creative and innovative. But policies that are punitive, with marginal or no benefits, are unlikely to succeed.

It remains to be seen whether Tinubu’s economic policies will spur sustained and inclusive economic growth, as well as alleviate poverty.

Stephen Onyeiwu, Professor of Economics & Business, Allegheny College

This article is republished from The Conversation under a Creative Commons license. Read the original article.