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The Impact Of Oil Price Changes On Government Expenditure In Nigeria

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The Impact Of Oil Price Changes On Government Expenditure In Nigeria

 

ABSTRACT

 

Change in oil prices has been occurring since the end of the Second World War. Nowadays, the rate of changes (up and down) in oil price is more pronounced. This has made serious impact on Nigeria as a country practicing a mono cultural economy. This work thus examines the impact of oil price changes on government expenditure in Nigeria (1979–2008), a period of 30 years. Using the Classical Linear Regression Model (CLRM) through an OLS estimator, the impact of oil price changes on government expenditure and investment in Nigeria was examined. In the two models, all variables were in log form. The result shows that changes in oil price has no significant impact on the two macroeconomic indicators (government expenditure and investment) used in this study. From the regression result, oil prices have negative relationship with government expenditure and positive relationship with investment. In order to explain the three key variables (oil price, government expenditure and investment) employed in this study, the researcher discovered that a unit change in oil prices reduces government expenditure by 0.12948 units and increases investment by 0.11368 units. Thus, the need to diversify the economy is the paramount issue, so as to awaken the two macroeconomic indicators (government expenditure and investment) used in this study. Nigerian policy makers are being advised to save more when oil price increases so as to assist developmental expenditures and also to encourage investment when oil price falls.

 

CHAPTER ONE

 

INTRODUCTION

 

1.1   BACKGROUND OF THE STUDY

 

It has been proved by various countries (especially developing countries) that government expenditure in one way or the other has contributed a large quota on economic growth and development. Thus, government expenditure is the sole duty or responsibility of any country practicing mixed or socialist economic system.

 

Crude oil is a publicly traded commodity, its price is determined in the commodity market through the interaction of demand and supply worldwide and it constantly fluctuates. Changes in the price of crude oil force government to adjust its expenditures in line with such changes. This creates a dilemma especially for development or capital expenditures because they are entirely financed by oil revenues.

 

Oil was first discovered in commercial quantities in Nigeria in 1956 at Oloibiri in Niger-Delta, while actual production started in 1958. Since the discovery of oil in commercial quantities in Nigeria, oil has dominated the economy of the country. In Nigeria, oil accounts for more than 90% of its export, 25% of its Gross Domestic Product (GDP), and 80% of its government total revenue (Gunu U. and Kilishi A. A., 2010). Thus, a small oil price change can have a large impact on the economy. For instance a US$1 increase in the oil price in the early 1990s  increased Nigerians foreign exchange earnings by about US$650 million (2 percent of GDP) and its government revenue by US$320 million a year (Gunu U. and Kilishi A. A. 2010).

 

Oil is an important commodity in the economy of any country in the world because it is a major source of energy for domestic and industrial uses. Oil therefore serves as an intermediate product and as well as consumers commodity. There are different end products of oil: these include kerosene, diesel, gasoline and other changes in the prices of either the crude oil or any of the end products are expected to have impact on users and at large.

 

Oil prices traditionally have been more volatile than many other commodity or asset prices since World War II. The trend of demand and supply in the global economy coupled with activities of OPEC consistently affects the price of oil. The recent changes in oil price in the global economy are so rapid and unprecedented. This is partly due to increased demand of oil by China and India. However, the recent global economic meltdown of 2008 suddenly counteracted the skyrocketing oil price. At the beginning of the crisis, oil price crashed below US$40 per barrel in the world market which had serious consequences on Nigerian fiscal budget which led to the downward review of the budget oil benchmark price. Today oil price is oscillating between US$60 per barrel and US$75 per barrel.

 

The massive increase in oil revenue as an aftermath of the Middle-East war of 1973 created unprecedented, unexpected and unplanned wealth for Nigeria. This began the dramatic shift of policies from a holistic approach to benchmarking them against the state of the oil sector.

 

Now, in order to make the business environment conducive for new investment, the government began investing (government expenditure) on the newfound wealth in socio-economic infrastructure across the country especially in the urban areas. As well, the services sector grew. The relative attractiveness of the urban centres made many able-bodied Nigerians to migrate from the hinterland, abandoning their farmlands for the cities and hoping to partake in the growing and prosperous (oil driven) urban economy. This created social problems of congestion, pollution, unemployment and crimes (Adeibe, B. 2004).

 

1.2   STATEMENT OF THE PROBLEM

 

The strength of the Naira to US Dollar in 1985 made Nigeria an import- oriented consumption habit that soon turned her into a perennial net importer, this turned out a major problem when oil revenue decreased alongside with international oil prices. External reserves collapsed, fiscal deficit mounted and external borrowing increased in order to finance the deficit. This led to the unstableness of the macroeconomic indicators in Nigeria.

 

Researchers like; Olomola (2006) reveals that oil price changes has an impact on real imports and government expenditure in Nigeria. Eltony and Al-Awadi (2001), in a study on Kuwait (one of the oil producing nations), also reveals the importance of oil price changes on government expenditure. While a study undertaken by Anashasy, (2005) in Venezuela (the highest oil producing country under OPEC) reveals a long-run relationship between oil price volatility rate and government expenditure.

 

Researchers like Olusegun O.A, (2008); Christopher A. and Benedict, G (2008) did not discover any significant impact on government expenditure in Nigeria, while Mammad B. (2010) did not discover any significant impact of oil price changes on real government expenditure in Azerbaijan.

 

The resulting dramatic increase in oil earning made Nigeria to delude itself by confusing wealth with income hence the euphoria and the oil wealth syndrome (Anyanwu 1990). The rapid monetization of her oil earnings led to a spending spree, leading to high import consumption, huge budget deficit (excess of expenditure over revenue), excess money supply and external debt overhang. It is no wonder that like other oil exporting developing nations that experienced oil boom, Nigeria caught the ‘‘Dutch Disease’’ – a situation where high but temporary oil revenue has adversely affected the  non-oil traded  goods sector, thus delaying the learning by doing experience that would improve its comparative advantage (or lessen its comparative disadvantage) in the production of manufactured goods. Thus oil revenue increases (increase in income from oil export), has turned Nigeria into a mono-cultural economy (depending solely on oil proceeds). This has made our economy undiversified, thereby leading to the neglect of investing in other vibrant sectors of the economy, mainly the agricultural sector.

 

Increases and decreases in oil prices, causes changes in government revenue and subsequently government expenditure. The table below shows a ten year time interval from 1979 to 2006 drawn in order to exhibit the inter-relationship between three important variables as regards to the research work such as; the price of oil, oil revenue and government expenditure. This is to provide support for the research question.

 

Table 1: Oil price, oil revenue and government expenditure

 

YEAR

 

OIL PRICE US$ PER BARREL

 

OIL REVENUE (₦ MILLION)

 

GOVERNMENT EXPENDITURE (₦ MILLION)

 

1979

 

33.4

 

8880.8

 

7406.7

 

1982

 

35.6

 

7814.9

 

11923.2

 

1985

 

28.2

 

10923.7

 

13041.1

 

1988

 

15.1

 

19831.7

 

27749.5

 

1991

 

20.5

 

82666.4

 

66584.4

 

1994

 

16.2

 

160192.4

 

160893.2

 

1997

 

19.5

 

416811.1

 

428215.2

 

2000

 

26.1

 

1591675.9

 

701059.4

 

2003

 

29.1

 

2074280

 

1225965.4

 

2006

 

66.5

 

5287546.9

 

1938002.5

 

SOURCE: CBN Statistical Bulletin (2008).

 

Going by the above table (Table 1), we can confidently say that in Nigeria or generally worldwide for oil producing countries, oil contributes a huge sum of revenue to the coffers of the government, which forms a significance portion of its expenditure (government expenditure). But a brief analysis of the table above, shows that the period 1985 – 1997, witnessed a down turn in the price of oil per barrel as US$28.8 and US$19.5 respectively, while the price started rising again from the year 2000 which is US$26.1 per barrel. Evidently, oil revenue and government expenditure is said to have risen proportionately with the rise in oil price in the year 2000 as in ₦1591675.9 million and ₦701059.4 million respectively. In the light of the foregoing analysis the research work was guided by the following questions.

 

  1. What is the impact of oil price changes on government expenditure in Nigeria?

 

  1. What is also the impact of oil price changes on investment in Nigeria?

 

1.3     OBJECTIVE OF THE STUDY

 

Going by the research questions stated at the previous section of this chapter, the specific objectives of this research include the following;

 

  1. To econometrically investigate the impact of oil price changes on government expenditure in Nigeria.

 

  1. To econometrically investigate the impact of oil price changes on investment in Nigeria.

 

1.4    HYPOTHESIS OF THE STUDY

 

The research work involves two models and the hypotheses tested are;

 

  1. The changes in oil price, has no significant impact on government expenditure in Nigeria.

 

  1. The changes in oil price, has no significant impact on investment in Nigeria.

 

1.5   SIGNIFICANCE OF THE STUDY

 

According to Olomola (2006), who used quarterly data from 1970 to 2003 using VAR model, changes in oil price does not affect output significantly in Nigeria. Adding some variables into his model (VAR model) such as; government expenditure and real imports, the encompassed model further revealed that changes in oil price do have implications for imports and government expenditure.

 

The study on the effect of oil price changes on Venezuela’s economic performance undertaken by Anashasy, (2005), using VAR and VECM technique revealed a long run relationship of oil prices and government expenditure

 

On the contrary, Olusegun O.A, (2008), Christopher A. and Benedict, G. (2006) who based their analysis in Nigeria, using VAR model, did not find any significant  impact of oil price changes on government expenditure in Nigeria, while Mammad B, (2010) did not discover any significant impact of oil price changes on government expenditure in Azerbaijan.

 

Going by Olomola whose analysis was based in Nigeria, this research work tried to cover the gap from 2003 to 2008 (5 years gap) which would be achieved through the use of OLS (Ordinary Least Square) methodology as a result of the merits derived by it. Also in the analysis, a yearly time series data from 1979 to 2008 would be used to reduce complexity. The 5 year period in which this study is closing would show if there is any difference in the result obtained.

 

Here is a baseline research on the impact of oil price changes on government expenditure in Nigeria, so as to add to the existing stock of knowledge.

 

1.6      SCOPE AND LIMITATIONS OF THE STUDY

 

The scope of this research study on the impact of oil price changes on government expenditure in Nigeria covers 1979 to 2008 (a period of 30 years). This is to ensure, updated information and to follow trend.

 

A major limitation encountered in the cause of this study is incompleteness of data (oil prices per barrel of 2007 and 2008) from the CBN statistical bulletin 2007. The researcher tried also to assess the CBN statistical bulletin of 2008 and 2009, but was unable to see the data (of oil price per barrel) at all. He therefore resorts to assessing the internet for the missing figures of 2007 and 2008.

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