THE IMPACT OF OIL PRICE CHANGES ON GOVERNMENT EXPENDITURE IN NIGERIA

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.