EFFECT OF RECESSION ON NIGERIA ECONOMIC GROWTH AND DEVELOPMENT
CHAPTER TWO
LITERATURE REVIEW
Conceptual Framework
Generally in economics, a recession is a negative economic growth for two consecutive quarters. It is also a business cycle contraction which results in a general slowdown in economic activity (Merriam-Webster Online Dictionary, 2008). Macroeconomic indicators such as GDP (gross domestic product), investment spending, capacity utilization, household income, business profits, and inflation fall, while bankruptcies and the unemployment rate rise.
According to the National Bureau of Economic Research (NBER) recession is “a significant decline in economic activity spread across the macro economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale – retail sales”.
Kamar (2012) states that recession may be triggered by financial crisis and or credit crunch, as well as demand and supply side shocks. Recession, if not controlled, can have a devastating effect on the economy as most macroeconomic indicators remain negative for a long time, usually more than two years.
2.1 CONCEPT OF RECESSION
Recession is an economic situation in which a country experiences negative growth in gross domestic product (GDP) in two consecutive quarters of the year. www.Study.com defines economic recession “as a decline in GDP for two or more consecutive quarters. As it is known that GDP is the sum total of all goods and services produced within a country in a year.” The Economic Times defines recession as a “slowdown or a massive contraction in economic activities, caused by a significant fall in spending.”
In Economics, recession has been identified as one of the phases of business cycle. Jhingan defines business cycle as “recurrent fluctuations in aggregate employment, income, output, and price level. The other phases of business cycle are: prosperity, recovery and depression.
The principal cause of economic recession as described by J. M. Keynes is the fall in aggregate demand. To him, a fall in consumption and aggregate demand for goods and services translates to a fall in output occasioned by a fall in revenue of manufacturing firms. A fall in output leads to decrease in production activities which invariably leads to laying-off of workers, because these firms wouldn’t be able to cover their cost of production; and this results in an increase in the rate of unemployment in the country.
Economists have explained that recession is the period characterized by a decline in income, aggregate demand, prices of goods and services, investment and employment in the country. These characteristics and many others are present in Nigeria except one, decline in prices of goods and services. What makes the current recession in Nigeria peculiar is that, it is a combination of balance of payment deficit, high exchange rate, a rise in prices of goods and services (inflation), low aggregate demand, low output, rising unemployment, and low income. However, the current recession didn’t just happen, it occurred as a result of actions and some decisions taken in the past by administrators and policy makers.
RECESSION IN NIGERIA
Prior to the current economic recession, National Bureau of Statistics (NBS) reported that Nigeria experienced a growth rate of 4.45 percent in real gross domestic product (GDP) in the first quarter of 2013, and then went on to have 5.40 percent and 5.17 percent increase in the second and third quarters respectively. The highest growth rate was experienced in the fourth quarter of 2013 with 6.77 percent increase in real GDP.
The first quarter of 2014 saw a fall in growth rate to 6.21 percent and subsequently to 6.54 and 6.23 percent in the second and third quarters respectively. Growth rate further declined to 5.94 percent in the fourth quarter of that same year. This was the year Nigeria was declared as the country with the largest economy in Africa.
The decline in growth rate continued as it fell to 3.96 percent and 2.35 percent in the first and second quarters of 2015. The third and fourth quarters of 2015 witnessed a 2.84 percent and 2.11 percent growth rate. However, the Nigerian economy started showing symptoms of recession when NBS reported a negative growth of -0.36 percent in the first quarter of 2016. The country then went into a full-blown recession as a result of another negative growth of -2.06 percent in GDP in the second quarter of the same year.
2.1.1 FACTORS THAT LED TO THE ECONOMIC RECESSION
i. Fall in Demand for Nigeria’s Crude Oil
Following the boom in shale oil production in 2014, the United States of America (USA) announced that it had reached the level of self-sufficiency and does not see the need to import crude oil anymore. This led to a fall in the total demand for Nigeria’s crude oil from 2.29 million barrels per day in the first quarter of 2013 to 2.05 million barrels per day in the second quarter of 2015; and a fall in the percentage contribution of crude oil and gas to real GDP from 14.75 percent in the first quarter of 2013 to 9.80 percent in the second quarter of 2015; thereby leading to a fall in foreign exchange earnings. The fall in foreign exchange earnings then worsened the country’s balance of payment. This is the genesis of the problem.
ii. Crude Oil Supply Glut
The fall in international demand for crude oil and the lifting of ban on export of Iran’s crude oil led to a supply glut in the international market, thereby leading to the fall in global oil price from an all-time high of $114.49 per barrel in December 2012 to $53.77 per barrel on July 30 2015, and subsequently, to an all-time low of $27.82 per barrel on January 20 2016.
iii. Activities of Insurgents
The Niger Delta militants resumed insurgency in the South-South region of the country, which is the main location of crude oil production in Nigeria, by bombing oil installations and vandalizing pipelines. On 25th of March 2016, the militants attacked and vandalized a crude oil pipeline. BudgIT reported that the attack led to the complete shutdown of Shell Forcados terminal which caused a shortfall of 380,000 barrels per day of crude oil export, thereby leading to a loss of about $2 billion in potential revenue. The bombings of pipelines by the insurgents continued and this led to a huge decline in Nigeria’s crude oil export from about 2.16 million barrels per day in the fourth quarter of 2015 to an all-time low of 1.69 million barrels per day in the second quarter of 2016.
The fall in supply of crude oil from Nigeria eased the supply glut in the international market, consequently leading to a reduction in the gap between global demand and supply of crude oil. This led to a rebound in its price to an average of $53.20 per barrel on October 10 2016. However, it is quite unfortunate that Nigeria has not been able to benefit from this rise in price because of the continued attacks on the country’s crude oil installations. This has resulted in a further fall in the country’s foreign exchange earnings, thereby further widening the gap between receipts and payments.
iv. Over-dependence on Importation
The country depends heavily on importation of goods and services. As a result of this, a fall in foreign exchange earnings led to an increase in the gap between the demand and supply of foreign exchange, thereby leading to a fall in the value of Naira. Nigeria, that was practicing a fixed exchange rate regime, had to devalue her currency, which led to the adoption of a floating exchange rate regime in June 2016. This action was taken in order to forestall the complete depletion of the country’s foreign exchange reserves.
v. Removal of Fuel Subsidy
The federal government also designed a new framework for petroleum products supply, distribution and pricing in May 2016 which sought to reduce the Federal Government’s foreign exchange support (subsidy) for marketers and distributors of premium motor spirit (PMS) to import the product. This led to an increase of 59.06 percent in the pump price of PMS in the country from N87 per litre to an average price of N147.3 per litre.
vi. Irregular Power Supply
In Nigeria, households and businesses generate their daily requirements of electricity using PMS and diesel-powered generators. This is done in order to augment the little electricity from the national grid. The increase in the price of PMS led to an increase in the cost of transportation and cost of production.
vii. Shortage of Gas Supply to Manufacturing Companies and Gas Based Industries
Vandalism of gas pipelines by the Niger Delta militants also affected manufacturing companies that utilize natural gas either as feedstock or as a source of energy. This led to an increase in the cost of production, because some of these companies resorted to alternative means of transporting gas (virtual pipeline); while others turned to diesel as their alternative source of energy. In addition to this, the rise in exchange rate led to an increase in the cost of importing raw materials. These alternative sources to pipeline gas, coupled with high cost of importing raw materials, led to an increase in the cost of production thereby contributing to the hike in prices of finished goods.
viii. Delay in Signing the 2016 Budget
Another factor that contributed to this recession is the delay in signing the 2016 budget into law. This caused a delay in the commencement of the development of capital projects in the country.
As a result of this, the government couldn’t release money into the economy for the construction of infrastructures; and as such, there was no way to provide capital goods on time. This limited government spending; thus, labour could not be hired and there was a reduction in the circulation of money in the economy, thereby contributing to the fall in aggregate demand. ix. War Against Corruption
The current administration’s war against corruption led to the mop up of black money from circulation. The government was able to do this by enforcing the policies of “Treasury Single Account (TSA)” and “Biometric Verification Number (BVN)” that commenced in 2012 and February 2014. This led to a reduction in the liquidity of banks thereby leading to downsizing in the financial sector; and then, to massive unemployment and a fall in people’s income. This liquidity problem hindered banks from lending out money to intending investors; hence, a fall in the level of investment in the country.
2.2 EFFECTS OF RECESSION IN NIGERIA
A slowdown in economic activities affects all aspect of national life. Many jobs are usually lost, families usually adjust budget during recession and in the process, social activities are also affected. The effect of recession on politic, business, employment and social life are discussed below.
2.2.1 Business: When household incomes are cut as a result of economic recession, they reduce their demand for goods and services. As a result of low demand from households, firms reduce their production of such goods and services in order to cut cost and profit will decline. As a consequence of production fall, workers will be laid off, there will be no buying of new equipment, no funding for research and development, no new product rollouts and general business activities would also fall. Recession affect both small and large businesses. Specifically, in business recession result in one or more of the following:
2.2.2 Falling Stocks and Dwindling Dividends: Stocks prices mirror the performance of business because they move proportionately to the returns earned. As revenues decline on the statutory reports of business, lower dividends are declared. This will depress the prices of stocks in the market. So many businesses lost their viabilities because of the risks they are carrying at the moment. When dividends fall or vanish, it creates other problems such as the sacking of the board of directors and senior management of the company. They advertising/marketing unit will be affected, creating unemployment problems for their economy. When the manufacturer’s stock falls and dividends decline or stop, institutional investors holding the stocks may sell and reinvest the proceeds into better-performing stocks. This will further depress the company’s stock price and affect the entire equities market and the cycle continues.
2.2.3 Credit Default and Bankruptcy: Recession also have effects on their ability of customers to pay their debts to the creditors, leading to growing Non-Performing Loans (NPL). As a result so many banks went bankrupt. Also, when debtors are not able to repay their debts, company’s ability to repay their creditors is hampered as a result of falling revenues. This leads to default in paying interest and the principal. The resulting consequence is debt downgrade and rescheduling. In the process, investors will lose confidence in the company and the company may not able to raise money from the capital market. When the source of funding ceases, the business will fold up resulting in employee lay-off, and increasing the unemployment in the economy.
2.2.4Product Quality Compromise: Recession affects the revenue of firms, and by extension, profitability. In an effort to cut costs and improve its bottom line, the company compromise product quality, and in the process lost its market share a baker could offer the same loaf of bread at the same price but reduce major ingredient such as milk, butter, etc. so as to cut cost and improve bottom line during recession. Recession could force airline to lower their maintenance standard in order to cut cost and break even. They may cut flight to routes that are not profitable and frequently cancel flight when there are insufficient passengers, leading to economic loss.
2.2.5 FINANCIAL MARKET: The other sector that usually takes the heat during recession is the financial markets. Recession has lead to general fall in interest rates, crash of stock prices and rise in prices of some commodities. Regulators lower interest rate in order to stimulate borrowing for investment that would lead to economic activities and growth. Equities prices mirror the performance of listed companies on the exchange. Any time investors noticed a dwindling fortune with such listed companies, the usually offloaded their shares. In times of confidence investors turned to assets which they perceived as tangible or sustainable.
2.2.6 UNEMPLOYMENT: One of the consequences of recession is unemployment which tends to increase, especially among the low-skilled workers, due to companies and even government agencies laying off staff as a way of curtailing expanses. Unfortunately, this results in further restriction in overall spending which is required to help people pull the economy out of recession. Where family or individual income is drastically reduced due to loss of employment or underemployment, discretionary spending or disposable income, is severely restricted. This reduction in income, in turn, lead to non-payment or delayed payment if debt obligations especially credit cards. This further reduces the funds available for financial institutions to lend out to businesses for expansion/investment to increase productivity; a process that could have resulting in increased employment, income and spending that could help pull the nation out of recession.
2.2.7 SOCIAL: Recession affects social life in some aspects, from tourism to certain consumption of household.
According Zagat’s (2009), U.S. Hotels, Resorts and spas survey, business travel has decreased as a result of the recession. Reasons for decline in business travel include company travel policy changes, dwindled personal economic fortune, uncertainties and high airline prices. Hotels are responding to the downturn of dropping rates, ramping of promotion and negotiating deals for both business travelers and tourists.
2.2.8 POLITICS: The recession leads to electoral misfortune though democratic institutions continue to exist. Economic weakness could lead to political instability in many developing nation, even some developed countries experienced political instability.
2.3 CAUSES OF ECONOMIC RECESSION IN NIGERIA
The major causes of economic recession in any economy may include:
1. Poor Economic Planning: Poor economic planning and no concrete implementation of economic recession - budget delay, exchange rate policy the government has proclaimed the usual generalities that every government indulges itself towards
Diversifying the economy
Improving manufacturing/mining sector
Raising agricultural output
Encourage foreign investment among others
Government has taking some steps like the elimination of dollar purchase privileges for importers of 40 items such as rice, cement, toothpicks, private planes, poultry, meats, margarine, wheelbarrows, textiles and soap. Government has on the other hand caused serious poverty in the land by herself. The government through her policy widens the gap between the rich and the poor, creating more economic hardship. For instance, when the Central Bank Nigeria was selling dollar at N315 and people were buying at N480, the highly placed individual in the country were putting call across the banking industry to get dollar at the official rate. This they later resell at the parallel market at N480, thinking of how much they are making! An individual can make as much as N1billion without doing anything according to the former Central Bank of Nigeria governor (Lamido Sanusi). The people that were telling the government that if it didn’t devalue the naira, people will suffer. The poor paid the price of a devalued currency and the schemed off the profits. Remember, Nigeria currency was devalued when crude price in the international market was very low and crude oil export was largely affected by the activities of Niger-Delta militants as such the policies was useless since Nigeria is a mono-product economy. For example should you take dollars, for every $1billion taken from the Federation Accounts and sold by the CBN at N200 to the dollars, the states were losing N100billion that could have gone into salaries, agriculture, healthcare. Yet the states were going to borrow from the same government on a bailout when the government was selling dollars cheaply to a small group of people.
2. High Inflation Rate: Government banning the importation of certain essential agricultural products likes rice without considering gestation period. Removal of fuel subsidy shouldn’t be simultaneously with the banning of these agricultural products. Major causes of inflation, speculation in stock due to budget delay, rise in domestic oil prices due to subsidy removal fall in the global crude oil price deteriorating Nigeria exchange rate, almost the household price skyrocket
Nigeria inflation rate currently stands at 18.63% that is extremely high, the highest for the last decades.
3. High-Interest rate: Interest rate is between 26.77%-27%, its extremely high for investors. This high interest rate is discouraging investors. The poor investment culminate into high rate of unemployment in the country, reduction in aggregate demand especially from the households.
4. High Taxation: it is only in Nigeria that government are charging high tax rate during economic recession. Small businesses are slaughtered with high interest rate. Both high interest and tax rate has lowered Nigeria aggregate demand.
5. Policy conflict: the economic policies appear conflicting. High interest rates, High Tax Rate, are tight monetary policy measures.
2.4 Theoretical Review
The responses to policies on recession are derived mainly from monetary and fiscal measures advocated by the Classical and Keynesian theories.
• Classical Theory: The Classical theory was the main body of economic theory from the 18th century until the publication of J.M. Keynes’ General Theory of Employment, Interest and Money. The classical theory derived from the Say’s law of market and the Quantity theory of money assumed that market forces operate in the private enterprise system automatically and that supply creates its own demand. When this is the case, competitive economy will automatically bring about full employment of resources and that unemployment is as a result of deficiency in effective demand. To the Classicals, deficiencies in effective demand will result to unemployment, economic downturn and recession. The Classical theory is in line with the Mercantilist doctrine that a country should be great only by having a favourable balance of trade. This could be achieved through aggressive policies to stimulate exports, reduce imports and the accumulation of capital through trade and exchange rate manipulations (Toyo, 2000).
• Keynesian Theory: Keynes disagrees with the Classicals on the concept of self – regulatory equilibrium theory. He focuses his theory on increasing aggregate demand through increased money supply, planned and increased spending by the government, regulation of interest rates and devaluation of the home currency. According to Keynes, unemployment is not just a short – run voluntary issue as claimed by the Classical theory, but a problem caused by ineffective demand and bad economic planning (Brenner, 2006; Bauer, 2009; UNESAP, 2009; Jackson & Victor, 2011; Markard, Raven & Truffer, 2012).
Nigeria is having economic recession alongside inflation. Macroeconomic policies in response to recession are grouped into fiscal and monetary policies. Controlling excess government borrowing, diversification of the economy reduction in imports and boasting of exports, increased domestic production, government investment in key areas of agriculture, manufacturing and infrastructure, promoting small and medium enterprise, reduction in income tax for both household and firms, and regional integration will go a long way in removing the excess pressure on the Naira and reduce the desperate search for foreign exchange. These will generate disposable income, enhance aggregate demand and raise the general economic activities and employment which will serve as a remedy to bring the Nigerian economy out of recession.
2.4 Empirical Review
Studies of various kinds have been embarked upon over the years on the impact of recession on economic growth. However, differences emerged from the results of the various scholars. The need to highlight some of these in this study is germane. For instance, Bauer (2009) linked economic recession and the global financial crisis with poverty incidence in developing countries. Agri, et al., (2017) examined the impact of economic recession on macroeconomic stability and sustainable development in Nigeria from 1980 – 2016. The Ordinary Least Square (OLS) method was adopted for data analysis. The results show negative impact of these variables on economic growth and sustainable development. The recession impacts on socioeconomic and political lives of the Nigerian people, and should be studied to find the root causes and proffer solutions for sustainable economic development. This study perceives economic recession as a symptom of deeper structural problems inherent in the Nigerian economy, and overdependence on external modern capitalist societies.
Oyewole and Olaniyi (2017) examined the business educators' perception of the impact of economic recession on Nigeria’s socio economic lives. The study adopted descriptive survey design. A five point rating scale items structured questionnaire was used for data collection. The research findings showed that the economic recession highly affected Nigeria's socio-economic lives.
Shido-Ikwu (2017) analysed the main reasons for the emergence of the current economic recession in Nigeria. The study gives a theoretical exposition of how government policies can potentially curb the recession and enhance better economic well-being of the Nigerian populace. The research findings indicate that the main causes for the emergence of the economic recession in Nigeria can be grouped under three main factors: legacy factors, policy factors and political/security factors.
Awujola and Ejezie (2015) examined the impact of Global economic recession in the context of the political economy approach. The study used the global economic recession as a variable between Micro and Macro factors in fiscal and monetary policies of the elitist economic managers and state government in the international economic system. It portrayed global economic recession as demise of political and economic capability and ineffectiveness of capitalism up surge of free markets and greed of those who failed to anticipate the consequences of their actions. It affirms that the political and economic implications of Global economic recession can be ameliorated through concerted efforts between states in the international economic system and national governments, under a broad regulatory framework devoid of greed to share and sustain economic growth in the beleaguered financial sector.
In summary, the overall findings of the work reviewed so far indicate that there is somehow a general consensus that there is a direct relationship between recession and economic growth. However, while the robustness of most of the works reviewed could be widely acclaimed, it will be noteworthy that there are some flaws inherent in some others which could somehow hinder the robustness of their results and which this work is intended to correct.