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The Impact Of Oil Price Changes On The Economic Growth Of Nigeria

ABSTRACT

This study examines the impact of oil price changes on the economics growth of Nigeria; this explains that the changes have a negative impact on the GDP (Gross Domestic Product). This change is also known as price volatility. An economic analysis was employed using the method of ordinary least square and from the result of the analysis, it was clear that oil price change has effect/impact on the Gross Domestic Product where some of the variables has negative and others positive. The Exchange rate has a positive significance on the Gross Domestic Product at the rate of 83%, interest rate and oil export increase leads to a decrease in the Gross Domestic Product (GDP) hence it has a negative impact on the economics growth in Nigeria

CHAPTER ONE

1.1 BACKGROUND OF THE STUDY

Prior to the discovery and exploration of crude oil in Nigeria, the Nigeria economy was highly dependent on the agricultural sector in terms of revenue and foreign exchange earnings needed for development, this include, cocoa from the Western and groundnut from the Northern part of the country. Cocoa was contributing about 45% and groundnut 25% to the gross domestic product of the economy. It is remarkable that at this time, Nigeria ranked second only to Ghana then known as the Gold coast in terms of production of cocoa.

Agriculture’s contribution to the gross domestic product (GDP) of Nigeria was about 63% in 1988, not because the industrial sector increased its share but due to the neglect of the agricultural sector, and this led Nigeria to be importers of basic food items instead of being producers by 1975.

The then political leader in person of Yakubu Gowon brought about the “oil boom” in Nigeria, making money as it was made to believe was not the matter but how to spend it because the country had so much money. The oil boom led to the neglect of other sectors of the economy even as Nigeria is blessed with both mineral and material resources. Even the crude oil the economy rely on does not receive proper attention as none of Nigeria’s refineries is working properly, refined oil are imported.

The position of crude oil as the bed rock of the world financial system can only be ignored today at the world’s fall which makes it a vital sector of the economy leading to economic growth of the economy. Oil contribution to economic growth is in its returns in excess of production costs in the Nigeria economy from 1970 to 1999, oil generated almost $231 billion in rents and since 1974, these rents have constituted between 21% and 48% of the gross domestic product (Darby1998).

The impact of oil in the economy was felt with the slide in oil price which also reflected in the nation’s service, with potentially serious consequences for the country’s political stability. This was illustrated in 1998, when the government raised the salary of public employees by about 30% basic salary but defaulted on its promise three (3) months later as the amount was slashed by almost half because of declining oil earnings. This led to a strike action that stagnated the economy since most state government failed to implement the new wage for lack of funds. The discovery of oil has both positive and negative effect on the Nigeria economy.

Its positive effect financially includes the earning of about #166.6 million out of the #632.0 million in 1970 which represent 26.3% in 1973, it also account for about 89.1% in 1985 and 96.7% in 2003. The value of Nigeria’s total exports stood at #15,262,093.1 million in 1973 out of this total oil exports accounted for #141,852,435.5 million representing 97.3%. In the period 1960-1970 the gross domestic product recorded 3.1% growth annually, during the oil boom era, roughly 1970-1978 positive growth to 6.2% as the boom lured labor away from the rural sectors in the economy (Ferderer, 1996).

The discovery of oil in Nigeria came with corruption, corruption with mismanagement, mismanagement with marginalization and this to agitation. All of these, led to the abandonment of the agricultural sector as every single state in Nigeria were concerned with how to benefit from oil generated revenue. The negative effect also includes social and political unrest, particularly in the Niger Delta, the unrest among the Ogoni and Ijaw people in the Niger Delta. Agitated, abduction of white and even Nigeria oil workers set in, thus oil which ordinarily ought to be a blessing to the citizens of Nigeria in the form of increased economic growth, transformed to crisis, hunger, fear of the unknown, refugees in one’s own country and other vices alike.

The crisis in the Niger Delta being the negative effect in the discovery of oil arose in the early 1990s over tensions between the foreign oil corporations and a number of the Niger Delta’s minority ethnic groups who felt they were being exploited (particularly the Ogoni and the Ijaw), this persisted through 2007.This crisis was further fueled by competition for oil wealth created by oil the benefit have been slow to trickle down to the majority of the population who since the 1960s have increasingly been forced to forced to abandon their traditional agricultural practices.

The Delta region has a steadily growing population estimated to be over 30 million people as at 2005, accounting for more than 23% of Nigeria’s total population, this led to poverty and urbanization in this area but this urbanization is not accompanied by economic growth to provide jobs and also has led to destruction of the eco system.

The president of Nigeria Good Luck Jonathan may have resolved to tackle the amnesty program me introduced by his predecessor squarely by directing that all issue concerning the laudable program be domiciled in the office of the president adviser on Niger Delta and formal Managing Director of Niger Delta Development Commission (NDDC) Chief Timi Alaibe. The Nigeria Liquidity Natural Gas Company (LNG) lost about $300 billion at the peak of the crisis in 2009; this hampered the nation’s export.

According to the presidential adviser, he said that kidnapping which had stopped for a while has found a new abode in the Eastern part of the country and that this has stalled development projects in the area too.

Amnesty was used as a prerequisite to promote economic development, to stabilize the area and promote peace through retrieval of weapons. This was as a result of the program me of the DDI (Disarmament, Demobilization and Integration). This has paid off as peace now reigns in this region. This crisis reduced production of oil but now production has increased from 700,000 barrel per day to 2.3 million as confidence is been restored.

The oil price changes has great impact on the economic growth of Nigeria that some policies were formulated, one of such policies is the Structural Adjustment Program (SAP) as it relates to the development of the economy and also the welfare of the citizens.

The Structural Adjustment Program (SAP) was formed by the Babangida Administration in August 1985 at a time of depressed oil price. The program lasted between 1986 and 1988.In September 1986, the government introduced a second-tier foreign exchange market (SFEM), sold on auction for a near equilibrium price and used for export earnings and import trade requirement. Under SFEM, the Naira depreciated 66% to #1=us &0.64(#1.56=us$1) and declined further in value through July 1987.The first and second tiers were merged; Nigeria abolished the ex-factory price control set by the price. This led to the reduction of oil price which affects the economic standard of Nigeria as the excess money seen disappeared and borrowing became the last resort.

The empirical evidence from a growing body of academic literature clearly suggests that oil price change, whether an increase or decrease affects the economic growth of Nigeria. This price changes in oil has complicated the task of policy makers and business leaders over the past three (3) decades. The so-called oil macroeconomic relationship has been statically measurable since the later 1940’s (Jones, Leiby and Paik 2004) and although the empirical evidence has grown and become more significant in the last 29 years, policy makers have shown little interest in this literature or in the powerful implications of the oil-macro economic variables relationship.

Even the International Energy Agency (IEA) which long ignored the issue of price change, recently estimated that a $10 price increase would lead to 0.5% of global Gross Domestic Product creating $255 billion in losses over several years (IEA, 2004). The IEA however makes no mention of the significant implications its estimate carries or renewable energy (RE) and other non-fossil technologies. In absolute terms, the magnitude of these figures is staggering yet economist and the press widely conclude that the economy will “shake off” such oil spike effect. Awerbuch and saiter (2004) quoting (NN,2004).

Monetary and fiscal policies play a role in the effect that oil price changes. Although monetary policy response is often immediate in an effort to prevent inflation, the responses is not always the same after oil price decreases. FerdererS (1996), however, found a significant relationship between oil prices increases and counter inflationary responses, the observed that price increases predict output, monetary policy notwithstanding. In general, policies that do not change expectations quickly or that cannot be expected to persist cannot offset the consequences of oil shocks in the short run (Tatom 1993). Generally, the influence of oil shocks on employment was twice as important as the monetary policy responses (David and Haltiwanger, 2001). Merrill (2002) observes that the combined effects of oil price increase and monetary policy produce a trifecta of trouble that cubs GDP by an average of 2.5%.

Although the issue of price changes increases uncertainty about future oil prices that lead companies to postpone irreversible investments. Changes in the economic growth rate affect the changes of income and therefore also represent a measure of the uncertainty that economic agents face about the future.

On a more aggregate scale, oil has transformed the Nigerian economy from an agrarian subsistence-cum-export economy into an oil based mono-cultural economy with all the attendant consequences.

1.2 STATEMENT OF THE PROBLEM

Globally, inconsistent changes in oil price pose great challenge to policy makers. This inconsistent oil price changes do have several fiscal and monetary macro economic implications, both in the oil exporting and importing countries over the four past decades (cashin et al 2000). Some of this study suggests that rising oil price reduced output. This sort of effect is quite familiar from real trade theory. With a temporary oil price shock, the potential GNP contraction also in temporary. If no adjustment costs are incurred, that is, full employment is maintained throughout the period of the shock, the potential GNP effect is the only loss which would occur and it would be incurred for the duration of the higher price regime.

According to LeBlanc and Chinn (2004) economic literature provides no consensus regarding a theoretical frame work for explaining how changing oil price, affect economic growth and activity. Researchers have identified a range of potential mechanisms arguing alternatively that oil price changes primarily effects the economy by increasing input costs, increasing investment uncertainty, as a shock to the aggregate price level, which reduces real money balances and or as a relative shock leading to costly resource reallocation among sectors. Compounding the problems of identifying the actual path way of the oil price effects is that, the effects are difficult to discern and estimate because monetary policy can mask the effect of price movement.

The most obvious indicator of an oil price change is the nominal oil price, more disproportionately is the manner in which oil has become a fundamental preoccupation of Nigeria’s political process. In the early article, Hamilton (1996) shows the increases in the nominal price of oil causes downturns in economic activity. However more recent data have shown this simple measure to have a rather unstable relationship with macroeconomic outcomes, leading subsequent researchers to employ increasing complicated specification of the true relationship between oil and the economy. In particular, Hamilton (1999) argues that the correct measure of oil price changes depends on how the price of oil affects the economy.

On the relationship between oil price and inflation, it is observed that inflationary pressure manifest them when the overall demand for goods and services grows faster than the supply, causing a decrease in the amount of unused productive resources. However, economists have measured economic slack in various ways. Perhaps, the most common measure is the unemployment rate, which measures used resources in the labor market. Another is the output gap, monetary policy is also a vital explanation for any sustained change in the inflation process, but is also believed that this can be made possible if accommodated by monetary policy.

The present study is essential finding that it was not price changes themselves that spur macro economic variables but rather monetary policy’s response to them that caused changes in aggregate economic activity. In a study by Bohi (1999), Bernanke, Gerther and Watson, (1997) explained the possibility that the 1974 economic recession in the united states may have been the consequence of the federal reserve policy response to inflation triggered by an oil price shock. Nigeria is not left alone on this excruciating effect of oil price changes on the economic growth.

In Nigeria, oil accounts for more than 90% of its exports, 25% of its gross domestic product (GDP), and 80% of its public revenues. Thus, a small oil price change can cause a large impact. A US $1 increase in the oil price in the early 1990s did increase her foreign account by about us $320 million a year (Fereder 1999). Nigerian’s reliance on oil production for income generation clearly has serious implications for its economic policy management. In the case of Nigeria, its observed that she is exposed to exchange rate and interest rate uncertainty and this change affect its debt service obligation, and other associated macro economic problems. As some interest rates are not fixed, the economy become sensitive to change in cross-currency exchange and interest rates. Adverse movements in these rates, which have been extremely volatile in the past two decades, explain rapid increase in macro economic problems as a result of international oil price volatility.

Studies conducted have focused on developed economic and few studies exist yet on the effect of oil price shock in key macro economic variables for an oil exporting country as Nigeria. This study tends to fill this gap.

1.3. OBJECTIVES OF THE STUDY

The specific objectives of this study are

1. To analyze the impacts of oil price changes on the economic growth of Nigeria.

2. To measure the magnitude of this impact.

1.4 STATEMENT OF HYPOTHESIS

Oil price changes do not have any effect on the economic growth of Nigeria.

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