Unlocking the potential of the power sector for industrialization and poverty alleviation in Nigeria
Nigeria is the biggest economy in Africa, and now, has the potential to play a more active role in the global economy than in the past. Actualizing this potential will depend largely on the degree to which it can achieve industrial development and create the conditions for long term sustained growth and poverty reduction.
So far, Nigeria has made very modest progress in terms of manufacturing development due to domestic policy failures, structural and infrastructural constraints and a challenging global economic environment.
This paper examines the role of poor power supply services in the challenge of industrialization in Nigeria. It also reviews recent reforms implemented by the Nigerian government to address the power problem and makes policy recommendations on what needs to happen for the power sector to play a more supportive role in the industrial development process.
The Nigerian industrial sector: structure and performance
In the medium to long term, developments in the industrial sector will, to a large extent, determine whether Nigeria achieves its development vision, and play a more active role in the global economy relative to its past. Economic theory and evidence suggest that achieving sustained growth and development requires structural change and that industry is the key driver of structural change. Nigeria has a rapidly growing labor force, most of which is currently employed in the agricultural sector. Given the constraint on expansion of agricultural employment imposed by the use of a fixed factor (land) and the need to improve agricultural productivity, labor has to move from agriculture into other sectors of the economy. This resource shift should lead to growth enhancing structural change – assuming that these resources move to more productive activities in manufacturing, agro-industry and tradable services.
Over the past few decades, some structural changes have taken place in the Nigerian economy. For example, the share of agriculture in total value added fell from 36 percent in 1980-89 to 26 percent in 2008-14, but the share of industry also fell from 34 percent to 30 percent over the same period. By contrast, the share of services rose from 30 percent to 45 percent; indicating that the services sector is now the most dominant sector of the economy. These facts suggest that Nigeria is deindustrializing at an early stage in the development process when the industrial sector should be expanding to generate additional employment, and absorb the growing labor force. The decline in the industrial sector’s contribution to output over the past few decades has gone hand in hand with a change in the composition of industrial output. The share of crude petroleum and natural gas in industrial output declined over the past three decades, while that of manufacturing increased significantly. For example, over the 1981-89 period, crude petroleum and natural gas accounted for 76 percent of industrial output while manufacturing accounted for 23 percent and solid minerals for about 1 percent. However, in the 2010-15 period, the contribution of crude petroleum and natural gas fell to 59 percent while that of manufacturing rose to 41 percent.
Within the manufacturing sub-sector, the category “Food, Beverages and Tobacco” is the most dominant component of manufacturing followed by “Textiles, Apparel and Footwear”. In terms of changes taking place in the manufacturing sub-sector, there are both positive and negative developments. For example, manufacturing has experienced significant growth over the past few decades. The average annual growth in manufacturing value-added increased from 1.6 percent in the 1980-89 period to 13.2 percent in the 2008- 14 period. Another positive development is that the share of manufactures exports in total merchandise exports increased from 0.1 percent in 1980-89 to 4.4 percent in 2008-14. Notwithstanding these positive developments, the contribution of manufacturing to total value added remains very low and this should be of concern because Nigeria depends heavily on manufactures imports, which indicate that there is a huge domestic demand for manufactures that is not being met through domestic production. Over the past three decades, the share of manufactures imports in total merchandise imports has been above 70 percent. The high dependence on manufactures imports has serious negative consequences for foreign exchange, the development of local industries, and employment creation. In this context, there is the need for the Nigerian government to make the reduction of dependence on manufactures imports a key item on its priority list in the medium term. There is also the need for the government to recognize that addressing this issue will require novel policy measures to effectively tackle the perennial challenges facing manufacturing and the private sector in general.
One of the main challenges facing manufacturing and the private sector in Nigeria is lack of access to stable and affordable power supply. Power supply is difficult to access, unstable and expensive. The power problem is a challenge and is an important factor militating against the ability of producers and consumers to effectively participate in the growth and development process. Relative to other developing countries, access to electricity in Nigeria is very low. For example, in 2013, the electrification rate in Nigeria was 45 percent compared with the developing countries average of 78 percent, and the North African average of 99 percent. The Manufacturers Association of Nigeria estimates that in 2014 an average manufacturer experienced power outages 5 times per day, and was supplied electricity for just 6 hours per day. A study by the World Bank found that power outage is a more serious problem in Nigeria compared to countries such as: Brazil, China, Cote d’Ivoire, Ethiopia, Ghana, Kenya, Russia and South Africa. An average manufacturing firm in Nigeria losses about 17 percent of its sales due to power outages compared with less than 1 percent for firms in China and Russia, 1 percent for those in South Africa and 5 percent for those in Ethiopia.
Poor access to affordable finance is also an important factor that militates against manufacturing development in Nigeria. In a 2014-15 enterprise survey, 33 percent of firms reported access to finance as the main obstacle for the private sector, while 48 and 45 percent reported electricity and corruption, respectively, as major obstacles. The survey also indicates that small firms are more affected by poor access to finance relative to large firms. One indicator of the degree of access to finance by domestic enterprises is domestic credit to the private sector as a percentage of GDP. In the 2008-14 period, domestic credit to the Nigerian private sector as a percentage of GDP was about 20 percent. This is very low compared with the average for Sub-Saharan Africa (51 percent), Latin America and the Caribbean (43 percent) and East Asia and the Pacific (136 percent). In addition to the low level of credit provided to the private sector in Nigeria, there is also the issue of the high cost of finance. In the period 2008-14 the average domestic lending rate was about 17 percent and the risk premium on lending was about 8 percent. The high domestic interest rates faced by domestic enterprises deter investment and is not conducive to the promotion of private sector development.
Another factor that has had a negative impact on manufacturing development is exchange rate volatility. Over the past decade, there has been a significant depreciation of the Nigerian Naira against most major currencies. For example, on the 13th of April 2010, the Naira was being exchanged for the US dollar at I47 Naira to the dollar and by the 13th of April 2017 it had depreciated to 305 Naira to the dollar. Big exchange rate changes of this magnitude present problems for domestic enterprises because they depend heavily on imported intermediate inputs. In 2014, about 54 percent of the raw materials used by manufacturing firms in Nigeria were imported. When imported intermediate inputs represent a large percentage of the inputs used by domestic firms, big depreciations of the exchange rate result in a significant increase in production costs and have a negative impact on investment decisions.
The other challenges of manufacturing in Nigeria include industrial disputes and the dumping of fake, counterfeit and smuggled goods in the domestic market. The manufacturers in the country have to grapple with the challenge of dealing with frequent industrial disputes. In 2014, Nigeria had 234 industrial disputes out of which 175 resulted in strikes. About 1,610 workers in the manufacturing sector were involved in these disputes and the sector lost about 355,128 man-days. Nigerian manufacturers have also raised serious concerns about the issue of fake, counterfeit and smuggled products dumped on the domestic market thereby displacing locally produced goods. In 2015, the Manufacturers Association of Nigeria called upon the government to address this issue because it negatively impacts local initiative and makes it challenging for domestic firms to compete and thrive.
Power and industrial development in Nigeria: linkages and impact
The history of industrial development in both advanced and emerging economies indicates that power plays a vital role in the industrialization process. Energy was a major driver of the English Industrial Revolution, and no country has been able to initiate and sustain an industrialization program without access to good, stable and affordable power supply. Against this backdrop, success in promoting industrialization in Nigeria depends largely on the extent that the government can effectively deal with the energy challenge, which has and continues to constrain the development of domestic enterprises. There are at least three principal channels through which the poor access, unstable supply, and the high cost of electricity in Nigeria has had a deleterious impact on industrialization. This includes: low manufacturing capacity utilization rates, low competitiveness of manufacturing firms, and lack of firm growth, particularly for small and medium enterprises (SMEs). One of the main effects of lack of access to stable and affordable power supply in Nigeria is its impact on the ability for firms to operate at full capacity. It also results in underinvestment in the sector, thereby, limiting the ability of domestic firms to expand capacity when need arises in the future.
Low rate of capacity utilization has been a major feature of manufacturing in Nigeria despite the high demand for manufactured goods in the country. Between 1981 and 2010, the annual average rate of capacity utilization in the manufacturing sector fell from a peak of 73 percent in 1981 to a low of 29 percent in 1995. Since 1998 the manufacturing capacity utilization rate has displayed an upward trend, increasing from 32 percent in 1998 to 56 percent in 2010. It is worth noting that the upward trend in the average manufacturing capacity utilization rates masks the fact that there are several sub-sectors of manufacturing that have experienced significant declines in utilization rates relative to the 1980s. For example, in the “Saw Milling” sub-sector, capacity utilization rates fell from 57 percent in 1981-90 to 36 percent in 2001-08. Over the same period, capacity utilization rates in the “Leather Footwear” sub-sector fell from 64 to 46 percent and in the “Beer and Stout” sub-sector it fell from 65 to 51 percent.
Another channel through which the power problem affects industrialization is the reduction in the competitiveness of domestic firms both on the domestic and international markets. Nigerian firms face frequent power cuts and they respond to these outages by buying generators which are expensive not only in terms of cost; but, operation and maintenance as well. Survey data indicate that 71 percent of Nigerian firms use generators. In addition, generator fuel alone accounted for about 23 percent of the total costs of intermediate inputs used in manufacturing in the 2010-12 period. It is also estimated that energy accounts for about 40 percent of the production costs of Nigeria’s manufacturing firms. Incessant power cuts impose additional costs on firms both in terms of wastage of raw materials and deterioration of machinery. They also increase the cost of production and maintenance of factories, making domestic manufactured goods uncompetitive. Enterprise surveys suggest that the total factor productivity (TFP) of Nigeria’s manufacturing sector is below its expected value relative to the country’s per capita income. For example, although Nigeria has a higher per capita income than Ethiopia and Ghana, the median manufacturing firm in Ethiopia has TFP that is two times higher than that of Nigeria, and in Ghana the median firm has TFP that is about three times higher than that of Nigeria. In principle, a country with a low TFP could remain competitive if it has relatively low wages. However, in Nigeria unit labor costs are higher than in some African countries. For the median firm in Nigeria, unit labor costs are about 31 percent of output compared to 10 percent in Ethiopia, 12 percent in Kenya, and 17 percent in Ghana. That said, the median firm in Nigeria has a lower unit labor cost than the median firm in South Africa (45 percent) and Cote d’Ivoire (34 percent).
Lack of firm growth, particularly in relation to small scale enterprises (SSE), is another channel through which the power problem has had a negative impact on industrialization. To build and sustain a dynamic and vibrant manufacturing sector, domestic firms have to grow and make the transition from small to medium and large firms. Good access to finance is vital to the survival and growth of small firms. Unfortunately, small firms in Nigeria have very limited access to finance. Table 4 shows that commercial banks’ loan to SSE in Nigeria is small and has declined significantly over the past few decades both in terms of value and shares. In 1992 commercial banks lent 20.4 billion Naira to SSEs representing 27 percent of total credit. By 2015 lending by commercial banks to SSEs had declined to 11.3 billion Naira; representing 0.1 percent of total credit. One of the reasons for the low access of small firms to bank credit is that commercial banks are often reluctant to lend to them because of the perception that; given the power supply problems, the risks of non-performing loans are likely to be much higher for small firms than for large ones. The power problem also affects small firms’ access to finance through its impact on the cost of funds. Energy cost is an important component of the operating costs of banks, and thus, affects the interest rates they charge for loans. In sum, the problems facing small firms in the power sector in Nigeria works against their effective participation in the domestic credit market, with serious consequences for manufacturing sector development.
This paper was prepared by Patrick N. Osakwe, Division for Africa, Least Developed Countries and Special Programmes at UNCTAD.