Economic diversification and the wealth of nations: Lessons and the path forward for Nigeria

“Diversify the economy” is a standing mantra in Nigeria’s national discourse. It is at once the promised goal of every government in office and the request of citizens who understand a simple fact they don’t need to be economists to grasp: that Nigeria is a mono-product economy that relies on crude oil revenues for 70% of its overall government revenues and 90% of its foreign exchange earnings.

As with many petrostates, crude oil has come to define Nigeria over the past 50 years. It is the small god Nigeria’s governments worship, as its price determines the fiscal health of the country and the “black gold” is seen as the glue that binds together the county’s political elite and its disparate interest groups. Oil has created a crony capitalist economy of rent-seekers, stupendously wealthy individuals in Nigeria’s rising sea of poverty in which 100 million Nigerians now live in extreme poverty — the highest numbers in the world — and giving the country the dubious distinction of the “poverty capital” of the world.

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Without achieving economic diversification in reality — instead of endless rhetoric about it — Nigeria has very little realistic hope of lifting its teeming millions of the poor out of poverty. Our country would have, in effect, very little hope of escaping a poverty trap in which, with a population of 200 million and counting, and the future moving toward renewable energy, unstable oil rents simply cannot “carry” Nigeria’s economy. Already, the country is borrowing externally at frightening levels as a result of the inability of our government to diversify the economy. Economic diversification is therefore not an option, but a matter of existential importance.

What economic diversification means….

Economic diversification is the process of shifting economies away from a reliance on one or a few products such as natural resources or agricultural products toward the production and export of a wider range of value-added products manufactured and traded competitively. Diversification is achieved through a combination of expanding the production value chain in already existing sectors (e.g. agribusiness manufacturing or refining and exporting petroleum products) and expanding into new sectors based on market opportunities or state-driven industrial policy.

Economic diversification is a fundamental requirement for real development, in the form of a trajectory that includes (a) human development (basic quality of life indices such as a potable water, healthcare, nutrition, life expectancy), (b) economic growth, by which we mean an increase in the market value of the goods and services an economy produces over given periods, and ©️ structural transformation — achieved when the productive structure of an economy has become more sophisticated, diversified, and resilient. Agriculture in this scenario plays a vastly reduced role in the overall economy. The structural transformation of a national economy cannot be achieved without a true diversification of its value-added production.

There are three main types of economic diversification. The first is GDP diversification, in which the sectors that contribute to the GDP become diversified. This has happened to a significant extent in Nigeria, with the oil and gas sector having shrunk as a percentage of the GDP from about 35% to 10% over the past three decades, and agriculture, industry and services rising in their contributions to 22%, 23% and 54% of the GDP respectively.

The second type, far more important than the first, is trade export diversification — the diversity of the products a country exports, and how much of that export base is value-added manufacturing. One way to refer to this is as the level of “economic complexity” an economy has achieved. (This means that, in an economic sense, a shift by Nigeria toward exporting cashew nuts or yam tubers is not a “diversification” of the economy in a structural sense).

Economic complexity is the ability of an economic system to produce and export complex products with unique knowledge and insight, and competitively, into international markets. This ability is determined largely by knowhow, or “productive knowledge” (PK). Countries that diversify their knowhow such as India, Turkey and the Philippines, are able to develop productive capacity that enables them enter new sectors and achieve sustained growth in the years ahead.

An Economic Complexity Index that ranks countries on this score was developed by Cesar Hidalgo of the Massachusetts Institute of Technology (MIT) Media Lab and Riacrdo Hausmann of Harvard University’s Kennedy School of Government. Nigeria ranked 133 out of the 133 countries assessed on their economic complexity as of 2018, with a declining direction of complexity over 10 years from 2008-2018.

The third aspect of economic diversification is fiscal diversification. It involves the expansion of government fiscal revenue sources and how targeted government spending can help stimulate broad economic transformation through investments in specific industries.

And why it matters

As we can see from Nigeria’s experience, an undiversified economic structure has not only prevented our economy from achieving sustained growth, it also has frequently left the economy exposed to external shocks. This results in boom and bust cycles in the economy. The absence of diversification — and the inability to create it while relying on oil rents — has taken away any incentive to create a real social contract between the state and the citizens, one in which the state is able to extract and utilize taxes for development and social security. It distorts Nigeria’s national and sub-national politics, weakens the quality of our democracy and the capacity of the Nigerian state to govern its territory and citizens effectively.

Moreover, economic diversification is correlated with income levels. This is because it creates more inclusive kinds of growth — increased labor productivity as well as broad-based growth across sectors. More diversified economies tend to have more GDP per capita. It should be no surprise, therefore, that Nigeria’s average GDP per capita between independence in 1960 and 2019 was a paltry USD 1747. Nigeria’s GDP per capita in 1960 was USD 93 and USD 2,431 in 2021. South Korea’s GDP per capita in 1960 was $158 and USD 34,865 in 2021. For Thailand it was USD 100 in 1960 and USD 6,600 in 2021. For Malaysia it was USD234 in 1960 and USD11, 604 in 2021. All these economies have steadily become more complex and diversified in the past 60 years, while Nigeria has not.

Lessons from other countries

We must understand that true economic diversification is a very difficult goal to achieve for resource dependent countries such as Nigeria. There are only a few countries that have done it successfully. These include Chile, Indonesia, Malaysia, and Thailand. And yet, it remains an imperative for our country to become part of this elite club.

Diversification takes time and policy consistency, and domestic political support for it is essential. Lessons from the countries mentioned above show that successful diversification requires strong government policy engagement with the economy because there must be deliberate intent. This in turn calls for both political will and competent economic management, which is not the same thing as statism or populism.

Malaysia

In Malaysia, for example, the country began with a shift from agricultural commodity dependence (mostly rubber and then timber exports) to exports of value-added goods derived from agriculture, but in more recent years to knowledge-based economic activities. In particular, Malaysia learnt the lesson that it should not rely, even in its diversification efforts, on a narrow base of manufacturing. A broad based approach is essential, but this requires a diversified base of productive knowledge. While manufacturing was 10% of total exports in 1970, it had increased to 80% by the late 1990s. While agriculture was 60% of the country’s exports in 1970 and minerals (tin) were 25%, exports from agriculture were only 10% by 2005. The driving forces of Malaysia’s transformation were trade policy, industrialization and industrial policy.

Thailand

In Thailand, foreign investment, attracted by the low cost of labour, played a key role in diversification into sectors such as electronics, automotive and chemicals, plastic, textiles and apparel. Today, manufacturing is 35% of GDP and is well diversified. Thailand is the second largest economy in Southeast Asia after Indonesia. According to the International Monetary Fund, the Thai economy, which relied previously mainly on exports of hardwood, is now “diversified and, especially in recent years, has taken on more characteristics of resilience…” The country, with a population of 70 million, has an unemployment rate of 0.07%, one of the lowest in the world.

Chile

Chile, with 38% of the world’s copper reserves and the world’s largest producer of the valuable resource, diversified from mining to salmon, wine, pork and berry industries, based first on import substitution policies, and then a shift to more market friendly policies. A return to democracy and a focus on social and economic development, and finally legal and institutional reforms that included the establishment of a Sovereign Wealth Fund and a resource savings rule, as well as a national strategy of innovation and competitiveness, have helped transform the Chilean economy from resource dependency to one that has achieved economic diversification.

How Nigeria can achieve economic diversification

Achieving economic diversification in Nigeria will require a comprehensive and joined up approach to economic policy, rather than the silo approach we have seen for many years in which specific aspects of economic policy appear to be in conflict with stated policy objectives of diversification. For such an approach to succeed, the two most important requirements, which are lacking in the Nigerian context, are, first, a clear philosophical foundation for our country’s economic policy that is based on a clearly defined vision and sets out the balance between the role of the government and the role of the market.

Second, competent political leadership that understands and prioritizes economic development over the crony capitalism of vested interests, backed up by competent economic management and a capable state bureaucracy, is essential. Our leaders in the First Republic, and even in the military regimes of Yakubu Gowon and Murtala Muhammad/Olusegun Obasanjo regimes, demonstrated a better understanding of the imperatives of long-term structural economic transformation with an emphasis on periodic development plans and industrialization.

In more recent years, Nigeria suffered from a decline in structural economic thinking led in the past by economists such as Pius Okigbo, Adebajo Adedeji and Sam Aluko, and a somewhat premature shift, under pressure from the Bretton Woods institutions the IMF and the World Bank, to extreme liberalization of trade without an appropriate foundation of industrialization that would have made us more competitive in the global economy with diversified exports. In this context, the failure of the Ajaokuta Steel industry represents a tragic failure of political leadership for economic transformation in Nigeria, as iron and steel are an important basis for an industrialized economy.

While capitalism is undoubtedly the basis of wealth creation, it requires certain foundations to create wealth effectively and efficiently. These foundations include full property rights for citizens (which aids financial diversification through property taxes), innovation, and access to capital through efficient private sector financial markets as opposed to a reliance on state funding through, say, a central bank. These policy errors, including a premature embrace of globalization without the structural foundation to become part of the production value chain of globalization — and thus competitive in it — have turned Nigeria into a global market but not a global producer of the hard goods of the globalized economy. It is going to require political leadership with a sophisticated understanding of economic transformation and the capacity and will to execute it, if Nigeria is to be able to change course in the years ahead.

Third, Nigeria must become an economy driven by innovation. We have seen this trend in services such as financial technology (FinTech), but we need to have it both as a policy and as a way of economic life in other aspects of science and technology that can be turned into the local mass manufacturing of value-added products of innovation in our country. This requires a revamp, and the socialization of the idea of intellectual property, which drove innovation to become the main creator of the wealth of economically advanced countries.

Fourth, for Nigerian innovation to drive economic diversification, we must pay very special attention to trade policy. As a result of its inability to achieve structural economic transformation, Sub-Saharan Africa including NIgeria’s share of global merchandise exports has remained virtually stagnant for two decades between 1998, when the continent’s share of global merchandise exports was 1.9%, and 2018, when it was 2.5%. Global trade is based far more on manufactured, complex products (about 50%, than on primary commodities such as agriculture which account for less than 10%.

The fact that most of Nigeria’s trade is with advanced economies makes our trade disadvantage worse. With Nigeria’s ratification of the African Continental Free Trade Act in November 2020, we must now shift our strategic trade focus toward African countries. But this requires that we manufacture competitively and manage the phenomenon of dumping from foreign countries such as China. We need to seek a special dispensation from the World Trade Organization’s Special & Differentiated tariff regime with a strong case for why Nigeria should adopt “smart protectionism” for a limited period to ensure the survival of its infant industry at home.

Fifth, industrial policy must be the basis of our push toward economic diversification, since it is the basis on which we can push for a more favorable international trade environment. Industrial policy requires a certain amount of state intervention even in a market economy, provided that such intervention is targeted and ultimately productive for broad manufacturing sectors, as opposed to special favors for individual industrialists that distorts the market playing field for competitors in the same sector. Industrial policy will typically include identifying areas in which productive knowledge exists to confer competitive advantage, targeted subsidies for export industries, special economic zones, import-substitution industrialization, and temporary protectionist measures for some key sectors such as manufacturing.

Sixth, foreign exchange policy in Nigeria needs to be revamped away from state control, which encourages scarcities, smuggling and arbitrage, if we are to create incentives for a diversified economy. Artificial exchange rates only encourage an import-based economy. Allowing the naira to find its true value in the marketplace will discourage imports of unnecessary items (except, with the appropriate tariffs, for consumers that can afford it) and encourage exports to earn foreign exchange.

Seventh, as explained above, achieving economic diversification depends, at its core, on the existence of knowhow or productive knowledge. This requires Nigeria to focus on creating the skills amongst its young population that will drive competitive manufacturing for exports. This calls for a revamp of the education sector in favour of science and technology, at least for the next two to three decades. This is how China was able to achieve spectacular economic transformation and become the world’s second largest economy.

Eighth, Nigeria’s 1999 Constitution, by placing ownership of natural resources exclusively in the hands of the central government, creates a dis-incentive for economic diversification because it hampers a regional approach to economic diversification and economic management in what is supposedly a federal state. We need a constitutional restructuring that will devolve fiscal autonomy to regions or states, which will engender competitive manufacturing and the diversification that will drive it. This was the case in the First Republic, when Nigeria recorded its best levels of broad based economic growth rather than subsequent boom and bust cycles that were driven by reliance on oil rents.

Finally, Nigeria’s economic policy makers need to begin to measure economic diversification outcomes in an empirical manner. Measuring the sectors of the economy that contribute most effectively or have the promise of diversification, and the exact extent to which this is so, will help the government develop targeted export policies and incentives that will drive diversification. The Theil Index is a well established way to measure economic diversification.

All of this is why the Economic Advisory Council to the President needs to become a full-time body. Managing Nigeria’s economy to transformation will require capable hands that work on it full-time, doing the granular work and analysis that will drive policy. It is important that such a council, and the rest of the country’s economic management apparatus, acquire and establish strong competence in industrial policy if our economy is to become truly diversified.

In conclusion, economic diversification is a 24/7 agenda of decades, not just a slogan. It needs to be made the central thrust of economic policy in Nigeria because we simply cannot achieve development without it.

Text of a keynote address by Professor Moghalu, a former Deputy Governor, Central Bank of Nigeria at the 2021 Annual Conference of the Nigerian Economics Students Association (NESA), University of Port Harcourt