Friday, April 29, 2016

Government must let the markets work.

By Olu Akanmu
If there is any lesson the federal government must learn from the lingering petrol crises, in the unabated long queues at our petrol stations, it is that that a government cannot substitute itself for the market no matter the depth of its patriotic intentions.  From the management of the foreign exchange to petrol markets, we see an economic management paradigm that markets do not matter, that a government can take over the fundamental functions of markets from the supply of goods, to the determination of demand and the ultimate fixing of prices. Nothing illustrates the fallacy of this economic paradigm more than the current petrol crisis. When economic goods are mechanically and artificially priced below their true economic value, the effective and efficient functioning of markets are distorted, supply dries up and demand becomes over-bloated. This leads to secondary and parallel markets where economic goods will ultimately find prices closer to its true value. The few privileged elites who control supply benefit from unjustifiable rent, the market becomes inefficient and productivity and economic output ultimately decline. It will be useful to estimate the productivity loss and output decline occasioned by the current petrol crisis in all sectors of the economy including small business and the impact on the quality of life of Nigerian households.
If the economic and output implications issues of a fixed pricing of foreign exchange are not as clear, it should be clearer with the petrol product crisis.  Essentially, the fixed price of petrol below its economic value created little incentive for the private sector to participate in the petrol market leaving virtually the NNPC as the sole supplier. Despite all patriotic intentions and the best of logistic management, the NNPC alone has been unable to cope and meet national demand. If any government must be open to market logic, it should be the one operating in a time of heavy fiscal constrains like the current administration. In the period of fiscal abundance, a government might have the resources to call the bluff of markets, even controversially so but certainly not in the period of fiscal constrains where private sector resources need to be deliberately courted and mobilized to complement constrained fiscal supplies. From Venezuela to Nigeria, we see the same challenge of the anti-market economic policy and its negative effect on output and employment. A genuinely patriotic Hugo Chavez could call the bluff of markets when oil prices were high in his days in Venezuela but not the current Maduro government operating in period of low oil prices and heavily constrained fiscal state resources. Outputs have shrunk; inflation and unemployment have skyrocketed in Maduro’s Venezuela.  Shops are empty and there are typical long queues for basic essential groceries. Like Zimbabwe with the same unorthodox economic policies, we in Nigeria are now beginning to queue perpetually for fuel, queue for forex and queue for electricity.   
As it affects petrol and forex markets, the same issues affect the infrastructure and power markets. The Works and Power Minister has lamented  that while his ministry needs two trillion naira to complete just the road projects inherited from the previous administration, his ministry will at best have just about N400billion from the budget, which is expected to finance road construction, including investments required to radically upgrade our power infrastructure. It should be obvious that if we do not get our power markets to work with the right pricing of economic goods that provide sufficient incentives for private investments from home and abroad, we should say good-bye to serious improvement in our electricity situation. Babatunde Fashola despite his good track record may be potentially demystified by the current government economic policy.  
 It is not that markets are always perfect and cannot fail. There are in fact critical instances where markets fail and their dysfunction necessitates the intervention of the state to protect the poor and the socially vulnerable. In the case of public goods like education and health, where the social benefits of investments are far bigger than private returns to capital, when private capital will not sufficiently invest in public goods, the state must intervene to correct market failure to ensure the protection of the socially vulnerable, the poor and the larger society.  The state will achieve this by driving public investments in social services including the provision of subsidies targeting the socially vulnerable.  Such public investments and social subsidies especially in a fiscally constrained state must be appropriately targeted to ensure that they are going to only those who deserve such subsidies, those who cannot afford to pay commercial prices.  Designing such social subsidy program can be very challenging as we see in the petrol subsidy program as well as in the current forex allocation program, which is effectively a social subsidy program to buy the dollar at prices below its true economic value. The true economic value or price of the dollar is the equilibrium price that balances demand and supply in the forex market. This price given parallel market rate today is clearly above the official fixed exchange rate.
The distortion in the current forex subsidy program is obvious. The subsidy program is benefiting the rich and narrow elites more than the poor. The poor do not buy dollars. They do not process letter of credit nor buy dollars for capital investments in their companies and their subsidiaries abroad. They do not pay overseas school fees neither do they pay mortgages abroad using our dollar commonwealth. They do not travel overseas and certainly do not buy Personal Travel Allowances at official rates. And, there is certainly very little trickle-down effect of this heavy subsidizing of the dollar consumption of narrow elites as production inputs are priced at near parallel market rates, in the determination of market prices, even among businesses that are privileged to get the dollar at official rate.  The evidence of rising inflation confirms that the current non- market, fixed forex pricing policy, despite its good intentions has not delivered low prices of goods for the poor.
The same distortion also happens in the petrol subsidy program. The wealthy consumes more petrol with several fuel guzzling cars per household compared to the low income that uses mass-shared public transportation. The wealthy benefit from petroleum product subsidy more than the poor.  The petrol product market will be more efficient if prices reflect their true economic value at equilibrium prices that balance demand and supply. At true economic prices, demand will reduce to match available supply. This will solve the lamentation of the State Petroleum minister that thirty percent of our fuel imports are ferried across the border to Cameroun and Chad where petroleum product prices are closer to their economic value.  In a market driven pricing regime, the arbitrage margin between local price and cross-border price of petroleum product shrinks eliminating incentives to smuggle petrol across the border. Fuel imports and demand for dollar for fuel import will crash; the naira will appreciate with positive spiral effect on social welfare. Private sector supply of petroleum products will also increase at market prices, reducing the pressure on NNPC to supply and fulfil virtually most of national demand. We can then save resources from NNPC and plough them to fund social investments in infrastructure, public transportation, health and education.
Our argument in essence is that a fiscally constrained government such as we have, cannot afford to distort markets in area where they are potentially efficient and create inefficiencies by its commission or omission. The social cost of such market distortions is high on society, the economy and general public welfare. While the anti-corruption stance of the Buhari government is commendable, it must embrace real economic pragmatism and allow markets to function if it will make a difference in reversing the economic downturn. There is very little evidence, even if nascent, that the anti-market economic policy orientation of the government is working. Growth rate is at its lowest in decades, unemployment and inflation are rising. It is now time for change. It is time for the government to let the markets work.
Olu Akanmu publishes a blog on Strategy and Public Policy on