Oil subsidy and economic growth: What does economic theory tell us?

In the nearly two and half centuries of economists’ attempts to understand the dynamics of growth the perspective inspired by free market ideology is seminal and up till now represents the most enduring contribution to the field. It first emerged in the 18th century through the works of Adam Smith and later reinforced by other classical and neoclassical writers in the 19th and 20th centuries.

To this tribe of scholars, growth is about maximisation and a faithful commitment to the tenet of free market where price is determined by the twin forces of demand and supply, is celebrated as the best guarantor of high productivity rate and rapid growth. Any departure is considered sub optimal and carries the danger of stifling or hurting the growth process.

The intellectual bedrock of subsidy removal is firmly grounded in this philosophy which has exerted a domineering influence on policy discussions for centuries. Perhaps the best recent expression of this influence is the set of policy prescriptions popularly referred to as the ‘Washington Consensus’ (WC) that was vigorously promoted in the 1980s by the Bretton Woods Institutions as a standard reform package for the worsening economic problems of the developing countries.

However, as implementation progressed, discontent grew and one of the key reasons for this dissatisfaction is the realisation that growth in this neoliberal tradition comes with negative distributional consequence. The tendency for market-oriented policy to benefit a few, usually the strong, and leave behind a large swathe of a country’s population comprising mostly the weak, poor and other vulnerable groups was highlighted by a good number of literature. The policy stood accused of being oblivious to the plight of the poor and contributing to widening the inequality gap in many of the reforming countries. Inequality, as claimed, is toxic to any system as it breeds political and economic instability with potential to immiserise growth or in extreme cases lead to violence, insurgency, civil unrest and ultimately war.

This among other unsettling concerns led to the remarkable failure of WC and consequently ended the hegemony of market philosophy. In its wake, a new set of theories with distribution consciousness was inspired and introduced to this old and unending but exciting debate.

The intellectual thrust of the distributive concern is rooted in heterodox macroeconomic tradition and emerged in the late 1980s first through contributions to the propoor growth literature and later reinforced in the late 2000s by the theory of inclusive growth (IG). Whereas the concern of traditional neoclassical market framework is with pure growth and its maximisation the IG paradigm emphasises the importance of growth with positive distributional consequence. The exclusiveness and ‘winner takes all mentality’ of the market model is rejected and dismissed as unsustainable. To be sustainable growth must carry a large number of people along as participants in its process and beneficiaries of its outcome even if it would come at a cost to the objective of maximisation. In this regard, a growth rate of say 7 per cent which benefits about 90 per cent of the population is preferable in the IG framework to a 10 per cent rate that largely benefits only about 10 per cent of the population.

Beyond enriching our understanding of the growth dynamic, the IG framework also offers a new way of addressing development challenges such as the one presented by the oil subsidy conundrum.

It starts with assumption that for a given economy numerous distortions exist at any given time. In terms of growth obstruction, some of these distortions are more important than others. One option for policymakers desirous of progress is to target all for removal at the same time. But this would practically be infeasible as experience with the failed WC demonstrates. Eliminating some of them may also prove not to be welfare enhancing as the ones left behind may be the more potent hurdle to growth performance. The way out, according to this argument, is for policymakers to figure out the distortion with the biggest multiplier whose elimination would deliver the largest welfare enhancing effect and get rid of it.

The current Nigerian economy is riddled with many types of distortions. If we define distortion to mean a situation where prices are determined by forces other than those of supply and demand we would agree that besides the oil subsidy there are also corruption related distortions associated with welfare subsidy for the parliamentarians and other government officials. Limiting the examples to these two for the purpose of this analysis it would be interesting to ask: which of them constitutes the most binding constraint whose removal would have the greatest positive welfare impact?

A further teaching of the IG perspective is on the virtue of appropriate sequencing of reforms. Some reforms have complimentary relationship suggesting more can be accomplished by implementing them together. Others may exhibit dependent relationship implying that success of one depends on having previously achieved reasonable success with implementation of another. This would seem to be the case with reforms targeting oil subsidy removal and corruption induced welfare subsidies.

Without significantly reducing the level of corruption it is highly unlikely that the anticipated welfare gain from removing subsidy on oil would be achieved. This is because rather than committing resources released from blocking the subsidy leakage to development cause, chances are that the predatory public officials who are still running the show would end up using them to sustain their existing corrupt practises.

Professor Abdelrasaq Na-Allah is the Director of Centre for Innovation & Development, Federal University Dutsin-Ma and Research Associate, Tshwane University of Technology, Pretoria, South Africa. He can be reached at abdelrasaq@yahoo.com