Report No. 36483-NG Nigeria Competitiveness and Growth Country Economic Memorandum (In Three Volumes) Volume I: Executive Summary May 30, 2007 Poverty Reduction and Economic Management 3 Country Department 12 Africa Region UK DFID Document of the World Bank EXECUTIVESUMMARY 1. Nigeria's economic potential is well recognized. The country's considerable resource endowment and coastal location should allow the emergence o f a strong growth pole for Sub- SaharanAfrica. Yet Nigeria has realized very little of this potential. Instead, its history has been marked by economic stagnation and associated with declining welfare and social instability. Over the last few years Nigeria has been experiencing a growth turnaround and conditions seem right for launchingonto a path o f sustainedand rapid growth. The Government i s anxious to seize this opportunity to begin to build a diversified economy able to provide jobs and improved welfare for Nigerians. The theme of this report is Nigeria's competitiveness and growth. Chapter 1 sets the context by reviewing recent economic developments and providing a snapshot of the non-oil economy. Chapter 2 analyses the constraints to the competitiveness and growth o f the Nigerian economy and prioritizes the areas for government action. The next three chapters discuss the ways in which further progress can be made in tackling these constraints. Chapter 6 discusses how Nigeria could use domestic, international and regional trade more effectively to sustain growth. Key policy conclusions and recommendations are presented inthe final chapter. Nigeria's GrowthandCompetitivenessChallenge 2. Nigeria faces two fundamental development challenges that are common to natural resource dependent economies: (i)managing the macroeconomy to build and maintain strong competitiveness of the non-oil sector in the face of considerable external inflows from oil; (ii) addressing the culture o f rent seeking and corruption created by access to "easy" oil rents which reduces incentives to create wealth that can be taxed. Dependence on oil rents as opposed to taxation reduces government accountability and therefore undermines the effectiveness of political and economic institutions. Nigeria has historically been less successful than other resource dependenteconomies inaddressingthese challenges. 3. In the last few years Nigeria has begun to tackle these challenges more boldly and has made gains in growth. However, at the current pace (an average ofjust under 6 percent over the last five years) and pattern o f growth, the country is not likely to achieve the MDG of reducing the poverty level to about 28 percent. With low rates of formal job creation, the majority of the work force is employed in low productivity, poorly remunerated activities (in agriculture and the informal economy) that limit their contribution to growth and prevent an escape from poverty. 4. While there are pockets of competitiveness, the non-oil economy i s still largely uncompetitive. Rankings on both composite and individual sector competitiveness indicators are still low. To achieve sustained and more rapid growth and the creation o f productive jobs, this competitiveness gap needs to be closed. Moreover, the economy has a dualistic nature with a large informal economy that has little to do with the formal economy. This hinders efficient resource allocation and reducesthe competitive pressureto drive up productivity inthe economy. 5. Raising productivity and efficiency at the firm level and also across the economy, including through shifting the structure of production towards higher valued added activities, should be at the heart of Nigeria's non-oil growth strategy. This cannot be achieved without a 1 stronger human capital base and improved use o f technology. Long-term strategies are urgently needed in both areas to guide action. The Government has begun preparation o f a long term plan for education. 6. The analysis o f the report suggests that the most immediate constraints that need to be addressed include infrastructure -notably power and roads-and the business environment, in that order. Enhancing access to finance will also allow the economy's considerable resources to be intermediated more effectively for private sector growth. Policy action in each area will have to pay special attention to the challenge o f helping firms make the transition from informality to the formal sector. 7. While the domestic market is relatively large, it i s small compared with even small European economies like that o f Belgium. Nigeria cannot rely on the domestic market alone to sustain rapid growth over the long term and will need to access regional and global markets as well. Nevertheless, domestic trade needs to and indeed can be used more effectively than in the past to promote firm efficiency and productivity and provide a platform for the emergence o f firms able to compete in global markets. In the short and medium term, domestic and regional trade can be important drivers o f growth and can help to build international competitiveness. Actions to improve the functioning o f domestic markets will therefore also be an important part o f the competitiveness and growth agenda. 8. The numerous special programs to support specific areas o f activity need to be consistent with the long term objective o f strengthening the productivity and competitiveness o f the economy. They need to be based on the analysis o f the costs and benefits o f different options and built on transparency and accountability for results. 9. The Government is already carrying out reforms to tackle the economy's competitiveness constraints. Going forward, what is needed is a more strategic approach that pays attention to prioritization and to targeting areas for early wins. Appreciable economy-wide improvements are likely to take some time to achieve. The Government could therefore strategically focus its attention on first relieving the constraints to specific high potential growth areas (specific value chains and growth poles). Inaddition, in some areas, policies need to be fine-tuned to ensure that they enhance productivity. In other areas, new measures are needed for greater impact. Several o f the areas o f action are under the purview o f the federal government but considerable action is also needed at the level o f the states. Greater coordination and collaboration is therefore required between the federal and state governments in the context o f a framework through which reforms can achieve competitiveness and growth. 10. The analysis in this report suggests the following key elements for a growth strategy for Nigeria: Strengthening actions to tackle the most immediate constraints to the competitiveness o f the economy presented by infrastructure and the business environment. Improving access to long term finance, will also be important to ensuring that Nigeria's considerable oil resources are intermediated more effectively in support o f non-oil growth. The focus in these areas would need to be first on early wins through successful pilots for competitiveness improvements in selected high potential value chains and highgrowth areas. 0 Using domestic trade more effectively to enhance productivity and competitiveness by strengthening their functioning, and buildingstronger linkages betweenthe oil and 2 non-oil sectors, and over time strengthening Nigeria's integration into global markets; 0 Ensuring that the poor can participate more fully in growth by placing urgent emphasis on (i)finding ways to give back some of the proceeds of oil windfall directly to Nigerians; (ii)raising agricultural productivity-including through enhanced technology; and (iii)encouraging the transition from informality to the formal sector; and Buildingthe human capital and technological base of the economy over the longer term. 11. This strategy must be underpinned by efforts to address the corruption and rent seeking around oil revenues and raise the efficiency with which oil revenues are used. Recent Economic Developments 12. A number of recent developments present Nigeria with a historic opportunity for growth and economic progress. First, oil prices are at unprecedented levels, thus significantly increasing Nigeria's development financing envelope. Second, with the appointment of a strongly technocratic and reform-minded economic team in 2003, radical shifts have been made in macroeconomic management, allowing better use of these growing resources to leverage growth in other parts of the economy. Third, the implementation of a broad agenda of reforms is changing the policy framework and creating an environment more supportive o f growth. As part of these reforms, Nigeria's debt overhang has been addressed through the Paris Club debt deal completed in 2006. Finally, democratic governance in Nigeria i s providing the conditions for addressing some of the political economy challenges that have contributed to poor growth outcomes. 13. In contrast to the last two decades, the Nigerian economy has expanded at a rapid pace since 2000. Non-oil GDP has grown at an annual average rate of 5.8 percent. In the past two years non-oil growth accelerated, reaching 7.4 percent in 2004, 8.2 percent in 2005. GDP per capita in current US dollars has more than doubled over the same period. Provisional estimates for 2006, indicate that non-oil growth was about 8.9 percent for the year although overall growth fell to about 5.9 percent and oil sector growth to -0.8 percent because of disruption in oil production inthe Niger Delta. 14. Key macroeconomic balances have also improved. The overall fiscal balance strengthened from a surplus of 6 percent o f GDP in 2000 to 9.3 percent of GDP in 2005. However the non-oil deficit expanded as a share of non-oil GDP from 30 percent in2002 to 34.2 percent in 2004 and 38.9 percent in 2005. The increases reflect in part the Government's efforts to settle outstanding claims from several years back, including pension and domestic contractor arrears, as well as the costs of some the ongoing reforms including the monetization o f public service benefits. Provisional estimates for 2006 are an overall fiscal surplus of 12.0 percent of GDP, and a non-oil fiscal deficit of 42 percent of non-oil GDP. 15. The external current account balance has improved dramatically from a deficit of 8.4 percent in 1999 to a surplus of 12.1 percent of GDP in 2005, and an estimated 12.5 percent of GDP in 2006. FDI has picked up -- net FDI doubled during a three-year period (from US$3 billion in 2003 to more than US$6 billion in 2005). Non-oil FDI increased from US$0.6 to US$1.7 billion. The overall balance of payments was in surplus in 2004 and 2005, allowing the accumulation of sizable foreign exchange reserves; these reached US$28.3billion at the end of 2005 and an estimated US$46.5 billion in December 2006, after the setting aside of U S $19 billion for clearing arrears and the buy-back operation with the Paris Club. The recent growth pattern is nevertheless inadequate to achieve the MDG on poverty. Growth will have to be stronger (at least 7 percentannually)andwill needto create morejobs. Trends in GDP Growthand Sectoral Contributionto Growth, 1999-2005. 150 1 I 6 0 800 7 ,60 140 50 130 40 30 120 20 110 10 100 0 0 4 I O 1999 2000 2001 2002 2003 2004 2005 1999 2000 2001 2002 2003 2004 2005 -eRealGDP(at90f.c.) +Oil GDP +GDP capita (in US. dollars) +Non-oilGDP -Oil price, (righi +-Non-qilperGDPpercapita(inU.S.dollars) -Oil price, (right scale) 16. Improvementin fiscal management, inparticularthe implementationof anoil-pricebased fiscal rule (OPFR) since the 2004 budget, has been the centrepiece of macroeconomic policy improvements over the period. This rule is designedto link government spendingto a notionof a long-runoil price, thereby de-linkinggovernment spending from current oil revenues.The budget reference price per barrel for oil was US$25, US$20 and US$35 in the 2004, 2005 and 2006 budgets, respectively,compared with the realizedprices of US$38.5 and US$55.3 in 2004 and 2005, respectively, and the estimated price of US$68 for 2006. Several new measures have helped to improve the conduct of monetary policy, and exchange rate management has become more flexible. Since the move to the Wholesale Dutch Auction System in February 2006, the functioningof the foreign exchange markets has improved and, for the first time, the rates have converged. 17. Higher oil income, a more cautious fiscal policy and the recently concluded debt relief agreementwith the Paris Club resulted in a substantialdecline inNigeria's externaldebt position to aroundUS$5 billion in2006. 18. Ifthe fiscal rule is continued, it is likely that Nigeriawouldbe able to survive a sizeable negativeoil shock of at least five years' durationwithoutrequiringdramatic fiscal adjustment and with only modest debt accumulation. In contrast, if Nigeria abandons the rule and oil prices return to their historical "base level" (US$25 per bbl in real terms), the non-oil deficit would increase rapidly. Nigeriawould exhaust its oil savings very quickly, afterwhich sizable financing gaps would emerge. This would likely leadto a repeat ofthe past and ultimatelyto unsustainable levels ofpublic debt within five years ofthe ParisClub debt agreement. 19. Recent economic progress underscores two important lessons. First, planning on long run expenditure commitments that are low enough to be financed from much lower oil revenues than the current levels is the only way to ensure sustainability and avoid another round of debt overhang induced economic decline. This would meannon-oildeficits that are geared towards a sustainable balance based on oil prices in a range of between US$25-30. The new fiscal policy 4 rules and the conservative reference price chosen to underpin it are both necessary to ensure that Nigeria's macroeconomic policies are sufficiently robust given the high volatility o f the price o f oil. The passage o f the proposed Fiscal Responsibility Bill which seeks to enshrine this rule in law is critical. Inaddition, it would be useful to put in place a more formal arrangement for the management o fthe savings, including clear and transparent governance rules for its operation. 20. Related to this i s the need for greater efticiency in the use o f Nigeria's considerable public resources. Oil resources can be turned into a blessing instead o f the curse that they have been inthe past. This will depend critically on how the Government chooses to use its revenues from oil and on how efficiently these resources are used. Public expenditures choices need to target productivity improvements. Mechanisms are also needed to strengthen the quality o f public investment projects-especially in the infrastructure sectors where projects tend to be the largest and therefore more prone to waste--and to monitor their implementation and impact. The Government's ongoing budget, financial management and procurement reforms need to be sustained and deepened to achieve this.' 21. The second lesson is that a cautious move towards greater exchange rate flexibility, coupled with expenditure restraint to reduce pressure towards real appreciation, i s essential if Nigeria is to avoid the boom-bust cycles o f the past. The extent to which exchange rates rise with rising oil prices is directly related to the degree to which the Government succeeds in smoothing out expenditure levels through the use o f oil savings. If such a savings mechanism is instituted, only structural up-shiftsin oil income would require real exchange rate adjustment. Nigeria'sNon-OilEconomy 22. Nigeria's non-oil economy i s essentially a domestic economy, producing to supply domestic demand. Activity in the sector is narrowly focused on and driven by markets for food and beverages. The productivity and competitiveness o f the sector has been declining over the years, as is evidenced in consistently declining total factor productivity. The World Economic Forum (WEF) 2006 report ranks Nigeria number 88 out o f 117 countries on its Global Competitiveness Indicators (GCI). Despite the large domestic market, only a small proportion of producers have been unable to develop into sizeable businesses able to compete internationally. Non-oil exports are negligible, about 1percent o f GDP in 2005. Nigeria has lost market share in several o f its traditional non-oil export markets (namely, cocoa, rubber and oil palm) and has not managed to replace these with significant new higher value products. Table 1: ComparativeIndicatorsof Competitiveness Country lGCl2005 Rank lGCl2005 Score lGCl2004 Rank South Africa I 42I 4.31I 41 llndia I 4.041 These issuesare discussedindetailinthe PublicExpenditureManagementandFinancialAccountability Report(PEMFAR). WorldBank ReportNo. NG-36496 5 23. The duality between the formal and informal sectors is also an important factor in the lack of competitiveness ofthe non-oilsector. Ineach ofthe majorsectors ofthe non-oileconomy there is a sharp divide betweena smallnumber of highly productive, internationallycompetitive producers and a very large number of small producersherviceproviders with low productivity. The duality of the economy results in a lack of dynamism and competition. A very high proportion of firms are long-established businesses. As in the rest of the world, the longer established a Nigerian firm is the less dynamic it becomes in terms of growing output and employment. Addressing the duality of the economy is therefore vital for strengthening and sustainingnon-oilgrowth. 24. Consistent with the high level of informality and low productivity, job creation is insufficient:only an estimated 5-10 percentofthe estimated6 millionnew entrants into the labor marketfindjobs andwages are low. Youthunemployment(15-29 years) is estimated at about 60 percent. Further research is needed to ascertain whether labor laws strike the right balance betweenthe incentiveprovidedto employers to increase employmentby increasingthe flexibility to hire and fire and reducingpersonalbenefits on the one hand, and the rights of workers on the other. 25. In all sectors of the non-oil economy there is the potential for further growth. In agriculture, which represents 23 percent of GDP, declining yields is a major policy challenge. Productivity has declinedfor both commercialand food crops in Nigeria over the last 20 years. For commercial crops, production levels have fallen as well. In contrast, productionlevels of foodcrops have increasedsubstantiallyandNigeriahas overcome the extreme import dependence for basic foodstuffs which occurred inthe 1980s. However, growth has been drivenby a steady and substantial increase inthe area cultivatedand harvestedwhile yield levelshave dropped. In the case of roots and tubers, for example, a fourfold increase in the area plantedsince the mid- 1980s has been accompanied by a decline in yields in excess of 40 percent. Similar but less dramatic outcomes are observed for cereals, beans and groundnuts. In contrast, at the internationallevelyields have beenincreasing. Figure2: Index of CropYields (per hectare) 1.4 I 1.3 - 3 h 0 1.2 II - Q\ 9 -.;;.-x v 1.1 - Cereals Q) a 1 - i P 90 0.9 - L E 0.8 - P I 0.7 - Roots & tubers 0 . 6 ' ' ' ' ' ' ' ' ' ' ' ' ' 1990 1992 1994 1996 1998 2000 2002 2004 6 26. It will take time to bridge the internationalcompetitiveness gap in agriculture. Thus, the strategic focus for the short term should be on improving the competitiveness of Nigerian agriculture in domestic and regional markets. Growth i s likely to continue to be led by smallholder farmers looking to improve their incomes, and therefore measures to enhance their productivity are important. For the longer term the strategic focus should be on restoring the competitiveness o f traditional exports and promotingnewer, highvalue exports. Competitiveness in these products would benefit from larger scale investments than smallholders are able to undertake. Therefore, improving the investment climate so that large-scale investment may eventually resume inNigerian agriculture will be crucial. 27. Nigeria's manufacturing sector has shrunk from 8.4 percent in 1980, to 5.5 percent in 1999 and 4.6 percent in 2005. It is ranked number 83 out of 117 countries on the UNIDO Competitive Performance Index (CPI). Manufacturing value added per capita has stagnated at around US$17 between 1990 and 2002, compared with increases from US$133 to US$273 for Indonesia and US$600 to US$1066 for Mexico over the same period. Manufacturing firms tend to be small, tend not to invest at all or to invest very little, and have to have low technology intensity. They typically do not engage in exports and also have a lot o f unused capacity, averaging 55 percent2. Additional manufacturing and industry growth could come from agro- industry, oil and gas based industrial activity and the development o f the solid minerals sector. Tourism is also a potential area for growth that could take off over time as the country's external image improves. Nigeria and Emerging Economies Manufacturing Value Added, 1984-2004 (percent of GDP) -loo 35 01 30 0 25 0 20 0 15 0 10 0 5 0 0 0 28. The service sector represents close to 20 percent of GDP compared with 60-65 percent for major regional services hubs in Africa. The ongoing liberalization o f core infrastructure services, including telecommunications, should allow services trade to play a significant role in the diversification and growth of the economy. Services exports have outpaced other non-oil exports and in 2004 were almost four times as important as non-oil merchandise exports. Key areas for further growth include banking and finance and transportation-particularly air This couldbe due inpart to obsolescence ofplant and equipment 7 transportation. Inboth areas Nigeria could become a regional hub. Nigerian airlines and banks are already beginningto extend servicesto several neighboring countries. 29. Inthe domestic market, there is also strong room for growth in the supply of services to the oil and gas sector by Nigerian firms. Nigeria's aspiration is to increase its crude oil reserves from the current level of about 35 billion barrels to 40 billion barrels by 2010 and to almost double production to 4 million barrels per day. The country's gas resources are estimated at about 150 - 160 trillion standard cubic feet (SCF). New large multi-billion dollar projects are under way. Investment is projectedto grow to around US$10 to US$12 billionannually, making Nigeria one of the largest oil and gas markets inthe world. Investment is expectedto total around US$67 billion between 2005 and 2008 as compared to about US$80 billion between 1990 and 2004. This expansion can generate considerable services needs that can be tapped to strengthen the linkages betweenthe oil and the non-oil sectors and to promote higher standards of efficiency inthe non-oil sector. 30. The Government has set ambitious targets to raise the Nigerian content inthe oil and gas industry from 5-25 percent to 70 per cent by 2010. However, few oil-producing countries have been able to sustain local a content of 70 percent. It will therefore be important to focus on growing the Nigerian content rather than on the targets themselves. In addition, the focus of the local content guidelines needs to shift from the deep water potential, where projects require significant technological competence, to onshore and shallow water projects, where Nigerian firms should have more o f a competitive advantage. Contracts for maintenance, modification and operation is also potentially more promising, since local companies are close to the management of the facilities and can train and develop their staff and organizations to handle this work. The market is also more stable. Developing a strategy to promote the local supply industry through R&D programs where the oil majors contribute with funding, expertise or both can help narrow the technology gap between domestic and foreign companies. Disclosing the benefits and costs of local content policies can help to reduce the risk of corruption. 31. These different potential sources of growth could be supported initially by increased domestic and regional demand and eventually strong demand from global markets. Exports of goods and services represented 55 percent of GDP in2005, a relatively high level for a country of Nigeria's size. This i s explained by the considerable oil resources and the dominance of oil in total exports. Non-oil exports have been declining over time, and even during the recent rapid growth of the non-oil economy, they have been falling by about 9 percent annually between 2000 and 2005. Nigeria should be able to increase supply in most o f her nontraditional export markets, without potentially puttingdownward pressure on her earnings. Inseveral other areas in which Nigeria could break into exports, global demand is not constrained. Moreover, Nigerian f i r m s are not significantly unproductive compared to firms in countries such as Ghana or Kenya and should be able to raise export performance to at least similar levels to these comparator countries. Improving competitiveness in regional markets in which several Nigerian goods are already competitive should not be too difficult. However achieving competitiveness in global markets will be more difficult and will take time. Nigeria's large population could inprinciple be a source of a strong consumption demand that could fuel rapid growth in the short and medium term. Since 2000, real private consumption has grown rapidly. In the short to medium term, domestic demand for human consumption and for the feed industrywithin the agriculture sector are likely to be more important than the demand for raw materials for deeper processing by the manufacturing sector, which i s currently small in relation to sector output and i s not growing rapidly. 8 32. Findingways to returnsome of Nigeria's oil windfall back to Nigerianswould also help to stimulate domestic privateconsumption. This couldalso allow a largernumber ofNigeriansto benefitfrom the oil boom and see improvementsintheir living conditions in a shorter periodand reduce the sense of economic and social marginalizationwhich has fueled rising violence and instability-particularly inareas such as the Niger Delta. This wouldreducepublic sector control of oil resources and in turn limit opportunitiesfor rent-seeking around oil. Nigeriacould draw lessonsfrom the experiences of other countries that have institutedsuccessful programs to return some oftheir resourcewindfallsto their citizens. The BindingConstraintsto Growth 33. Both savings and investment in Nigeria have historically been low relative to more rapidly growing economies. Investment has averaged 19.5 percent of GDP while savings averagedabout 18 percent of GDP between 1980and 2005. Poor investment efficiency suggests that "effective" investment is even lower. Although savings in Nigeriahas been lower than in more rapidly growing economies, this is not the main factor in the economy's low growth: the low levelof external debt (5 percentofGDP) andexternal current account surpluses averaging --- over the last three years show that Nigeriais not makingextensive useof foreign savings. This is contrary to what could be expected if savings was scarce and the binding constraint on investment. Moreover, Nigerian banks have historically held excessive liquidity. The bank liquidity index is 10 comparedto 6 in Sub-SaharanAfrica and 5 in low income countries. Low savingstherefore does not appear to bethe issue. Nevertheless, low access to finance and interest rate volatility appear to be more serious constraints to economic operators. Inparticular,term financing is scarce. Less than 16 percent of respondentsto a 2002 firm survey sample reported havingloans longer than one year in duration.Existingloan maturitiesdo not meetthe long-term financing needs of enterprises and infrastructureprojects.Ina financial market characterized by volatile interest rates and short-term funding, banks have historically been willing to take maturityrisk only on borrowers with outstandingcredit quality.For blue chip clients, some banks are preparedto take a refinancingrisk and providemedium-termloans by rolling over short-term funds up to a maturity of 7-9 years. With the exception of the telecommunications sector, loan maturitiesfall short ofthe long-termfinancinghorizonof 10-20years requiredfor investments in infrastructureandproject finance. BankingSector Liquidity Nigeria 1998 1999 2000 2001 2002 2003 2004 Liquid Assets / Total Deposits and Short-Term Borrowing (YO) 82 91 86 86 94 87 88 Liquid Assets / Total Assets (YO) 52 61 62 59 62 59 59 Banking Liquidity Index 10 10 10 9 10 10 10 Source:World BankFinancialSector DevelopmentIndicators 34. Low returnon investment appears to be at the root of low investment and low growth in Nigeria. Ina few sectors(oil, bankingand some segmentsofthe food andbeverage industry), ere is evidence of high returns. The oil sector operates at a high level of efficiency, matchingglobal standards, and it is not surprisingthat it achieves high returns. Returns to equity for top notch banks before the bank consolidation reform are estimated at 35-40 percent, but this appears to have been a function of distortions in the sector. Large banks made their profits primarily from foreign exchange transactions and investment in government securities and not from lending. 9 Moreover, some banks were more privilegedthan others intheir access to foreign exchange.The highreturnwas therefore not a reflectionof a well-functioningsystem. Instead, the system was fragmented and delivered little credit to viable potentialborrowers. A privilegedtier of banks had superior access to foreign exchange which allowed them to make high returns. In some segments of the food and beverage industry returns are high, and several of the multinational operators (Cadbury, Nestle) are expanding their operations and undertaking new investments. The marketaveragepriceto earningratiofor firms quoted on the Nigerianstock exchange is high at 22.34 percent, but again this covers less than half of the economy. For the large share of the economy returns are low given the weak productivity of the economy and, in particular, the decliningyields inagriculture. 35. Low returns to investment in Nigeria are a function of both low underlyingreturns and low ability of the private sector to appropriate/access returns.Underlyingreturns are low in large part because of severe infrastructure bottlenecks. Poor infrastructurereduces productivity and competitiveness on two fronts: it adds to firm costs and it reduces competitive pressure in the economy. Infrastructureaccess and quality are significantly below the levels in comparators, including countries in Africa. Power and road transport are the most severe infrastructure constraints. Poor access to power forces firms to invest in self-generation, divertingsubstantial resources from reinvestment in their productive businesses. In some areas of activity, self- provisionof infrastructure by firms adds as much as 20 percent to firm costs. High transport costs due to poor roads port and rail conditions, significantlyincrease the cost of doingbusiness in Nigeria and increases time to market. Given their sunk investments, in proprietary infrastructure,older firms, particularlythose that may have fully or substantiallyamortized their infrastructure service investments are at a significant cost advantage relative to new entrants. Thus, competition for existing businesses from new entrants in any given sector is reduced. Lowhumancapitalis also a factor. Nigeria's largepopulationof over 130million is an important asset. However, its development lags behind that of several comparators, including even comparators inAfrica. 36. Educationalquality has fallen over the last 20 years and new recruits typically need a considerable amount of training for their jobs. But data on returns to education in Nigeria are low: private return to primary and secondary education in Nigeria is estimated at between 2-4 percent per year; and return on post-secondary education is estimated at 10-15 percent. These estimatesare low comparedto the resultsfor Africa, LatinAmericaandAsia as estimatedover 20 years ago. The low estimated returns suggest that low human capital might not be the binding constraint to raisingunderlyingproductivity. Nevertheless,the fact that the structure ofNigerian industry is skewed towards low technology activities suggests that low human capital is still an important constraint to enhancing firm efficiencyandproductivity. Table 3 Indicators of Size and Quality of Human Capital 1970and 2003 Literacy rate LifeExpectancy at birth Mortality Rate 1970 2003 1970 2003 1970 2003 Nigeria 20.1 66.8 43.5 44.9 140 98 Indonesia 56.1 87.8 49.2 66.9 104 31 Korea 61.4 74.2 43.0 5.0 Mexico 73.5 90.0 62.6 73.6 79.0 23.O South Africa 69.5 86.0 53.9 45.7 N a 53.0 Source: World Development Indicators and CBN Statistical Bulletin 37. Nigeria's highly volatile economic environment makes it a risky environment for business and consequently increases the "transactions" costs of doingbusiness. This reducesthe 10 ability of firms to appropriate returns. At the micro economic level risks arise from the corruptionand relatedweaknesses of institutionthat should facilitate privatesector access to key business services (tax, .trade facilitation, registrationand contract enforcement to name a few). Corruption and weak institutions have increased the cost of doing business for Nigerian firms through "unofficial payments" for access to basic business services, including public service connections, licensingand permit processing, government contracts and customs. The quality, integrity and efficiency of most public institutions is also ranked poorly by the private sector. Several of these indicators are improving but nevertheless this still remains a major area of challenge. 38. At the macroeconomic level, the significant volatility of key economic variables, stemming principally from the poor management of the oil revenue cycle, is the underlying driver. Poor management of windfalls ledto debt build-up, appreciatingreal exchange rates and extreme volatility in key macroeconomic variables that inhibitedinvestment and growth. Using 1970 as a benchmark, Nigeria gained an extra US$390 billion in oil-relatedfiscal revenue over the period 1971-2005, or close to five times the 2005 GDP, expressed in constant US dollars. Much of this was used to finance the rapid expansion of wasteful capital expenditures by both federal and state governments. While fiscal expansion contributed substantially to debt expansioninthe years after the price collapse, the volatility of public expenditures was the more important factor. Public expenditure remained highly correlated with oil fiscal revenue and fluctuatedwidely as a result of weak fiscal discipline and high oil price volatility. Fiscalpolicy pushedvolatility beyondthat stemming from variable oil prices. In effect the Government itself became a source of macroeconomic volatility. Nigeriahas been ranked among the most volatile in severalmacroeconomic indicators, includinginterest rates, exchange rates, inflationandGDP. 39. The highlevelofvolatility and risk makesit hard for economic agentsto planandacts as a tax on investment. Moreover, it reduces incentives to engage in longer-term productive investments and focuses activity in lower risk areas such as retail trade. At the macroeconomic level, as noted above, the implementationof the OPFR is beginning to address the underlying factor inexcessivemacroeconomic volatility. 40. The immediate bindingconstraint to investment and growth inNigeriaappearsto be low underlyingreturns driven in large part by the weak access to and poor quality of infrastructure. The high risk environment also limits the ability of firms to appropriate returns that may exist. The immediate focus of the Government's growth strategy should therefore be on reforms and investmentsthat will improveinvestmentreturns, particularlyenhancingthe access to and quality of physicalinfrastructure. The nextpriority for policymakers'attentionis institutingreformsthat will raise the ability of economic agents to appropriate returns. This refers to actions that will address macroeconomic instability, particularly from oil revenue volatility, and microeconomic risks from the corruption and related weaknesses of institutions and regulations to guide investmentbehavior. Actions that would strengthenthe business environment wouldbe generally easier to implement and could help deliver some quick wins. While savings was not the key factor in the past low growth, enhancing access to capital, especially term finance, will be importantto ensuringthat Nigeria'sconsiderable oil resourcesare intermediatedmore effectively in support of non-oil growth. The recent bank consolidation and the introduction of a contributory pensions scheme provide an opportunity for strengthening financial sector intermediationwhichmust be seized. 41. Without improvement inthe quality of humancapital, Nigeriacannot successfully change the composition of economic activities toward higher productivity areas. Neither can the 11 economy eventually integrate more fully into the global market. Successful action in this area will be critical for sustaining rapid growth over the longer term. Closingthe InfrastructureGap 42. An efficient and competitively priced economic infrastructure is central to raising productivity and increasing growth. Much o fNigeria's public sector infrastructure dates from the 1970s and 1980s. Since then, under-investment in the rehabilitation and maintenance o f the existing infrastructure, significant underspending on infrastructure, and the poor quality o f this limited spending have resulted inthe poor access and low quality o f the available infrastructure. 43. Nigeria ranks poorly on several indicators o f infrastructure access, cost and quality. In power, the installed generation capacity i s 6,000MW compared to available energy output o f only about 3,000 MW. Actual demand i s estimated to be 10,000 MW. The transmission network i s poorly configured for reliability and lines extend over distances that are too long for efficient and reliable load flows. The transmission and distribution networks are in poor condition, causing highenergy and financial losses. 44. Nigeria's port services are among the most inefficient and expensive in the world as evidenced by high waiting times, low handling speeds, and high container "dwell" times. As a resulto fthese inefficiencies, the costs o f shippinghave spiraled upwards. The costs o f moving a container through the port are also very high. Port entry charges at Lagos are the highest in the region. Customs clearance and freight forwarding costs vary widely but are extremely high, with average delays o f 21 days being considered normal. Nigeria's railways hardly function. The infrastructure i s dilapidated and there is a lack of serviceable locomotives and rolling stock. Only about 5 percent o f freight is handled by the railways. The Nigerian Railways Corporation (NRC) i s virtually bankrupt. In 2003 and 2004, the federal Government provided subsidies o f N3.9b and N1.6 billion, respectively. 45. The aggregate network o f classified roads has seen a much smaller increase than in comparable countries. About 50 percent o f Nigeria's federal roads are in poor condition. N o effective action has yet been possible to control excessive axle loads, which has resulted in serious damage to road surfaces and increased expenditure requirements for maintenanceheconstruction. 46. This infrastructure deficit imposes significant additional costs on businesses and reduces their competitiveness. High transport costs due to poor road and rail conditions significantly increase the cost o f doing business in Nigeria and increase the time to market. Taking a 30 ton truck trailer from Maiduguri (at the northern tip) to Lagos (on the coast) costs about N320, 000, more than the equivalent sea freight from Europe. The 2001 WED survey found that a representative business enterprise in Nigeria spent an annual average o f N50,703 for electricity, o f which 31percent was payment for public-sector electricity and 69 percent was the runningcost o fthe business-owned generator. 47. Under the reform program, the Government i s redefining its role from that o f an exclusive provider o f infrastructure to a dual role o f infrastructure provider and facilitator o f infrastructure provision. Additional measures to tackle cross-cutting, as well as specific infrastructure sector issues, could allow further progress. These measures include the following: 0 Strengthening medium-term investment strategies for all infrastructure sectors to bring about closer links between strategies and the achievement o f realistic 12 infrastructuretargets to ensure proper costingand the inclusionof clear performance indicators. In addition, project preparation should be strengthened and clear criteria for selecting between different infrastructure projects should be adopted. Significant capacity buildingwill beneededto achievethis. Adopting a standardized and transparent approach to government support in public- private partnerships (PPPs) with a view to (i)attracting a maximum number of bidders to foster competitionand reduce prices, and (ii)limiting fiscal costs to the Government. Conducting a detailed electricity demand study to help,the Government conclude power purchaseagreements(PPAs) on independentpower projects(IPPs) Strengthening the capacity of the energy regulator, (NERC), securing a long-term funding base to ensure its independence, and developingan operational framework for the unbundlingofthe former NEPAcompanies. Effectively implementingthe National Policy on Rural Travel and Transport should ensure seamless infrastructural linkage between rural Nigeria and the rest of the country. Assessing and rationally apportioningrural road network responsibilitieswithin the three tiers of Government; and enhancing road infrastructure planning and implementationcapacity in the States and Local Governments will be important for strengtheningruralinfrastructureprovision. Establishinga RoadFundfor periodicandroutinemaintenanceofroads, to be funded througha surcharge on fuel. The Fundwould be managedby a private/publicboard and its resourceswould beprovidedonthe basisof performance. Carryingout an economic analysis of the merits of government funding of the large majority of track rehabilitations and future improvements in the context of ongoing railway concessioning. This review should informthe discussion of alternative ways ofproceedingwith the concessioning. Establishing and consolidating an economic and safety regulation function for the transport sector inthe TransportRegulatory Commissionandbuildingandpublishing a database of key performance indicators for each transport concession to stimulate performanceimprovements. Reviewingand adjustingthe mandates of the different ministriesand agencies inthe transport sector to minimize the duplicationof effort, and eventually consolidating the three transport ministriesinto one MinistryofTransport. Improvingthe BusinessConditionsfor Growth 48. Micro level risks and macroeconomic instability are key factors in explaining low investment and growth inNigeria. Micro levelrisks arise from the policies,regulationsand laws that guide private sector development and their implementation. These represent core areas in which the Government plays a crucial role in creating an environment conducive to business confidence and investment. The Doing Business Surveys have demonstrated that an 13 improvement in the institutions that guide businesses can result in an increased growth performance o f up to 2.3 percent. There i s also considerable conclusive evidence inthe empirical analysis o f the negative impact o f macroeconomic instability on growth. As explained above, a fundamental cause o f macroeconomic instability inNigeria has been poor management o f the oil revenue cycle. Micro Level Risks 49. Several aspects o fNigeria's business and regulatory environment are ranked poorly inthe Doing Business Surveys. These weaknesses impose significant costs on economic activity and productivity. Four areas - taxation, trade facilitation, business registration and licensing, and contract enforcement-are repeatedly identified by businesses as among the weakest elements o f the business climate. Furthermore, they represent areas where relatively quick progress can be made that would have a positive impact on enterprise performance and would enhance productivity. 50. The four areas also provide considerable scope for government misuse o f its monopoly and discretionary powers, thereby inflicting some o f the most severe constraints to business growth in Nigeria. Corruption and the predatory behaviour o f public servants in these areas has significantly raised "transactions" costs for Nigerian businesses. Nevertheless, they represent areas where relatively quick progress can be made. Three o f these indicators -taxation, licensing and registration and trade facilitation - also entail some o f the most direct exchange that the different levels o f government have with businesses. Thus, progress in these areas provides an opportunity to build confidence in the facilitative role o f government for private sector led growth. This could have a major positive impact on enterprise investment and formalization decisions. Lowering the transaction cost o f transitioning firms from informality can contribute significantly to Nigeria's growth goals. 51. As regards reform approach, in order to obtain measurable results within a reasonable timeframe and, taking into account the different constraints across the states and across industries, a strategic option for reform to strengthen the business conditions for growth is to target initially specific states and industries where impact could be greatest. States should opt-in to pursue reforms at their level and benchmarking needs to be implemented in parallel with efforts at the Federal level. In the case o f industrytargeting, those sectors that offer the strongest potential for non-oil sector employment based growth should be the first to benefit from a reform program. This would suggest strongly that the first generation candidates should include key agricultural crops, particularly those with the greatest value-adding and export potential such as cassava, palm oil, leather and rice. A further sector for particular attention would be tourism covering both service and product (e.g. artisanal products) sub-industries. The solid mineral and construction sectors, which could also play important roles in Nigeria's non-oil sector, could also be considered. 52. Tuxution. The tax burden on Nigerian business is internationally competitive with a marginal effective tax rate (METR) o f 27.1 percent. But the burden o f administration is one o f the worst in the world. Multiple taxes levied by the three tiers o f government (federal, state and local) have also resulted in a proliferation o f taxes, some o f which are illegal. Predatory behavior on the part o f tax officials-including private tax consultants-has put the integrity of the tax system in question and contributes to high levels o f informality. Important actions to reduce this burden include: 14 Passingand implementingof the federal Government's tax policy and administration proposals is a criticalfirst step. Resolvingthe issue of multiple taxation among tiers and abolishing illegal taxes at the state and local government levels. This will need strong coordination among federal, state and localgovernments. The JointTax Boardcouldleadthis effort. Reviewing(state and localgovernments) the impact of outsourcingof tax collection to privatesector andaddressingadverseside effects on businessactivity. Strengthening tax administration efficiency at federal and state levels through computerizationand staffskill strengthening Raisingpublic awareness of what taxes are payable and to whom, and institutinga mechanism(includingclear performance targets) for private sector monitoringof tax agency performance, would empower the private sector to demand better performancefiom tax agencies and officials. 53. TradeFacilitation. The DoingBusiness Survey of 2006 ratedNigeriaamongthe bottom 20 countries assessed globally on trade facilitation. Delays and high costs at the port, discussed above are further compoundedby onerous administrativeand customs procedures. The potential for delays is further augmented by an import-exportprocessing system that is almost entirely paper-based, with informationtechnology only partially implemented through the ASYCUDA system. It is characterized by excessive documentation, and repeated checking of the same information. Actions that couldstrengthentrade facilitationinclude: 0 Simplifyingtrade documentation requirements and providing public informationon procedures. 0 Introducingpre-shippinginspectionswith randomor risk-basedsite inspection 0 Enforcingthe reductionof agencieswith permanentportpresence 0 Implementingcustoms reforms, including streamlining customs procedures in line with Kyoto ConventionGuidelines. Given the difficult political economy issues in this area, one option might be to begin by exploring possibilities for contracting customs services intargeted business-intenselocations suchas Tinapa. 54. Business Registration and Licenses. Over the past five years significant reforms have been taking place in Nigeria's business registration process, including the establishment of a "one-stop" shop. Despitethis, the process is still slow and cumbersome. To start a business it is estimatedthat an entrepreneur has to go through nine procedures over a 43 day period. Given that entry and licensing procedures are some of the biggest constraints to doing business in Nigeriatoday, continuedreform is desirable. It is importantthat the Government continues its ongoingeffortsto improveregistrationaccess andto streamline licensing. Specific actions could include: 0 Further streamlining federal agency involvement in registrationto harmonize FIRS andCAC requirements. 15 Reviewing and streamlining licensingrequirements for key sectors across the three tiers of government. Setting benchmarks for official license processing with some private sector monitoringofperformanceto bringabout pressurefor improvedperformance. 55. Contract Enforcement Nigeria is one of the worst countries in the world regarding the settlingof commercialdispute. It takes 730 days to settle a basic contractualdispute through the court system. With a huge backlog of cases in the formaljudicial system, only large firms can afford to use the system. The costs including the time needed to settle, vastly outweigh the potentialbenefits for the majority of plaintiffs. This is compoundedby outdated legislationthat inhibits modernbusiness activity and practices. Legaland court reformas well as improvements to ADR are at a relativelyearly stage. Goingforward, the following actions coulddeliver further improvements: Extendingthe fast track courtsmodelbeingimplementedinLagosto other states. Scalingup successfulADR pilot programs Reformingcourtjurisdictions(e.g. thresholds), civil procedures, practices(e.g. abuse of adjournments). Reviewingand revisingor repealing key business legislationincludingthe Company and Allied MattersAct, the Investment Decree sundry access to finance legislation relatedto hire purchase and related issues, and the Tax Act in respect of accounting proceduresaffectingtaxable amounts between1essorAesseeon leasingarrangements. Introducingnew legislationincluding the CompetitionAct (currently pending at the NationalAssembly), and a SecuredLendingAct Building the capacity ofjudges, registrars and court clerks to lead the reform effort and building a paralegal profession to support contract enforcement objectives over time. Macro Level Risks 56. The Governmenthas already beguntacklingthe key source of macroeconomic instability throughthe implementationofthe OPFR. To date, the fiscal rule has beenappliedon the basis of a "political" agreement betweenthe federal Government and the State governments. To sustain this importantreform, it will be importantto e Securingthe passageofthe FiscalResponsibilityBillwhichwill legallybindallthree tiers of government to implementingthe oil pricebasedrule. Designing a more formal framework for the management o f the oil savings. Currentlythis is held inan account at the CBN. Globalexperience demonstratesthat it is importantto formalize savings as a fund under the professionalmanagementof an autonomous body as an independent fund. Proper governance of such a fund, including clear rules governing investment and withdrawal from its resources, is needed. 16 Access to Long T e r m Finance 57. The limitedintermediationcapacity ofNigeria's financial systemmeansthat a large share of savings is not channeled into productive investments.Banks are burdenedwith excess liquidity but are simultaneously very cautious in providing credit to the private sector. Excess liquidity exists because financial intermediaries lack investment opportunities with sufficient returns or perceive the risks in intermediating funds to be too great. Weak financial sector intermediation capacity has limited the access to finance for investments. Firms have been forced to rely to a highdegree on self-financing. 58. As the largest financial market inAfrica other than South Africa, Nigeriahas inherently a better term finance capacity than most African countries. Up until 2004, Nigeria's banking sector was characterized by a large number of small banks that taxed supervisory capabilities. In July 2004 the CBN increasedthe minimumcapital requirementsfor banks from N 2 billionto N25 billion. The increase is intended to help bring about a diversified, stable financial sector that would ensure the safety of deposits while at the same time contributing to economic development via intermediation. These larger banks are also intended to compete more effectively in the regional and global financial system. A relatively successful outcome has been achieved from the consolidation. While the system continues to be shallow, the consolidation process has increased the capital and deposit base which can be leveraged for term finance and outreach.. Ongoing pension reform and the planned consolidation of the insurance industry provide an impetus for increased long-term savings which are a natural source of long-term investment and facilitate capital market development. 59. The future challenge for financial sector development in Nigeria will be to harness the success of banking consolidation and to develop non-bank finance to (i) improve service delivery and the availability of appropriate products for large and medium enterprises, as well as (ii) improve access to financial services on a small scale to meet the needs of households, micro- enterprises and small businesses. Improving access to finance for the private sector, especially small and medium enterprises, will matter for growth. However, to achieve shared growth it will also be important to increase financial sector outreach and access to finance by low-income households. 60. Although any financial sector strategy will rely substantially on private activity, a major policy role exists for government in providing adequate incentives, building financial sector infrastructure and providing an enabling lending environment. Difficulty in obtaining information about the financial health, credit history and identity o f prospective clients limits the ability of financial institutions to expand their lending business into new market segments. Inefficient land and property registries stifle the ability of banks to offer secured lendingproducts and mortgage finance. Robust creditor rights and insolvency systems will be necessary to foster greater confidence in commercial contracts and facilitate the management and resolution of default risk. 61. Going forward, the following measures could help enhance financial intermediation and strengthenaccessto longterm finance: 0 Augmenting the supervisory capacity o f the CBN and NDIC to take earlier, more guidance-based, intervention inthe behavior of banks. It i s therefore appropriate that the authorities are taking the first steps towards the implementation of risk-based supervision. 17 0 Improving the lending environment through strengthening creditor rights and insolvency frameworks, making investments in credit infrastructure and technology, etc. Without this, financial intermediaries are likely to increase lendingto existing customers rather than expand their services to new market segments. In particular, the Government needs to undertake a substantive review of the creditor rights and insolvency framework with a view to providing legal mechanisms to make enforcement less costly. Initiatives for establishing streamlined commercial court procedures in Lagos and the FCT could provide important policy lessons for other states. 0 Developingoutreach strategies to close the substantial knowledgegap about the size and scope of the demand for financial services outside of the corporate sector and urbanmiddle-incomeretailmarket. 0 Addressing structural factors in the capital market, including: (i)the lack of a long- term pricing benchmark and high interest rate volatility, (ii)the underdeveloped primary bond market for corporate bond issues, and (iii)the absence of a liquid secondary market for sovereign and non-sovereign bonds. This would support the processofincreasingthe availabilityof long-termdomestic investment funding. This wouldhelp improvethe intermediationcapacity of Nigeria's capitalmarkets for term finance. Creatinga public-privatefacility for infrastructureinNigeriathat would help address market failures and maximizelocalcurrency financingfor infrastructure. As various infrastructure PPPs in Nigeriaare faced with similar risks, a cross-sectoralapproach to facilitating private participation in infrastructure would be beneficial. The objective of such a facility would be to providea coherent framework for investment prioritization private sector participation, and government support though various instruments such as a guarantee facility, a liquidity facility, and subordinated debt andequityfunds. 0 Addressing structural issues in the capital markets, including: (i)the lack of a long- term pricing benchmark and the high interest rate volatility, (ii) the underdeveloped primary bond market for corporate bond issues, and (iii)the absence of a liquid secondary market for sovereign and non-sovereign bonds. This would support the processof increasingthe availabilityof long-termdomestic investment funding. HarnessingDomesticandInternationalTrade for Growth 62. Several countries have achieved and sustained rapid growth through an export-led approach. Small economies in particular have very little opportunity to achieve productivityand efficiency gains to support growth without tapping larger markets through external trade. Nigeria's relativelylarge domestic market can support growth but alone cannot deliver sustained growth at the rates needed to make a visible impact on poverty. Nigeria will need to rely on foreign markets as well. Domestic, regional and international trade therefore will need to be harnessedmore effectively in support of growth. In the short to medium term, given Nigeria's considerable competitiveness disadvantages, domestic and regionaltrade in which Nigeria has some naturaland tariff protectionwill needto drive growth. Over the longer term, international trade can and shouldassume more importanceinfuelingNigeria's growth. 18 63. Nigeriais not makingeffectiveuse of the advantage ofa relativelylarge domestic market to help improve firm efficiency and productivity. Domestic markets are segmented and fully integratedregionalor nationalmarkets that will drive competitionand efficiency gains have not emerged. Individual segments are also poorly coordinated and participants suffer from poor facilities and the predatory behavior of public officials. Aside from addressing the transport infrastructure issues that contribute to this, several other factors need the attention of policy makers. Specificactions that couldbeput inplace includethe following: Addressing property rights over commodity markets by encouraging local governments housing the major commodity markets to give long-term leasehold tenure or freehold ownership over the sites to the market associations. These associations shouldinturnsubmit plans for their development includingexpansionof the market, either at the current site or at a more suitable site if congestion is a problem. Removingopportunitiesfor predatory behavior by public officials that stands inthe way of trading across state boundaries. Police check points and state taxes along the mainhighwaysof the country should be removed, and licenses and permits required to trade andmanufacture shouldbe simplified. Changing the tenure of formal wholesale and retail markets from the local government to the market association andgivingthe latter incentivesto managethese marketswell. Improvingthe approval process for formal wholesale and retail market planningand development in localgovernmentalso needsto be improved. 64. Externaltrade is a highshare of GDP inNigeria(84 percent in2004). Butthis is largely becauseNigeriais a specialized commodityexporter. As productionis concentratedon relatively few products, notably petroleum products, trade is a means o f validating domestic surpluses. Indeed, over the past decade, growth in Nigeria's exports of goods and services (20 percent) has lagged behindgrowth in world exports (70 percent) and therefore Nigeriahas been losingworld marketshare. 65. The country has also been unable to achieve diversificationof its export base. Exports continue to be dominated by oil, andthe agriculturalexports that thrived30 years ago have been largely wiped out. Nigeria has the most highly concentrated export structure in the world. In 2003, the country had only 66 product groups with export values exceeding US$lOO,OOO, while five comparator-countries had substantial exports in at least 175 product categories. On a per capita basis, only three countries inthe world have lower non-oil merchandise exports, namely, Burundi, Ethiopia, and Rwanda. The dependence on fuels might even increase further in the medium term, as exports of natural gas, of which Nigeria has very substantial reserves, are projectedto double within the nextfour to fiveyears. 66. Nigeria has had one of the highest levels of domestic market protection in the world. High tariffs and pervasive import prohibitions have burdened consumers with high prices and have shielded producers from international competition. The recent adoption of the ECOWAS common external tariff with its substantially lower duty rates promises to spur productivity growth and to make domestic producers more agile in supplying domestic and international 19 markets. In an effort to promote exports, the Government has put in place several special programs, some of which have sufferedfrom corruptionandabuse. 67. Additional actions that could strengthen Nigeria's participation in regional and internationaltrade includethe following: 0 Undertakinga systematic reviewofthe existingsubsidy and other incentiveprograms to promote non-oilexports to assess their cost effectiveness in achievingtheir stated aims. Based on the review, these programs should be cancelled or redesigned to reduce their distortionary impact to introduce greater cost-effectiveness, accountabilityandresults orientation. Outlining and implementing a strategy for phasing out special tariffs on sensitive products and for eliminating of import bans by the end of the ECOWAS Common ExternalTariff (CET) transitionalperiodin 2007. This will bring greater credibility and predictability to trade policy, help businesses plan better and ensure that the transitiontimetable is followed. Ensuringthat receipts from the Port DevelopmentLevy are administered to the same standards as generalbudgetreceipts. Inthe longer runthe port levy which constitutes an additional barrier to trade, should be removed and port activities funded from general government budgets. Ensuringthat productspecific leviesand excise duties are applied in a non-discriminatoryway, (i.e. that they apply equally to domestic productsand importedones) will also be important. 0 Taking an active role in shaping the outcome of the Economic Partnership Agreement negotiations with the EU and the WTO Doha Round - when this is resumed--in order to maintainand possibly improvethe terms of goods and services market access inWestern Europe, includingwith respect to rules of originprovisions and trade standards, and to bring down existing barriers to Nigeria's exports in middleincome countries. Embeddingand SustainingReforms 68. As explained above, inthe last few years Nigeriahas made excellentprogress on a broad reformagenda. Suggestions for additionalreforms have also beenprovided. Goingforwardit is important that Government embeds the reform achievements in a manner that enhances their irreversibility. There are four key ways though which reforms could be embedded and consolidated. The first is to build institutions and processes for policy making to support the current reform thrust; the second is to introduce legislationto reinforce the policy changes; the third is to make public informationon government policy and performance routinely available; and the fourth is to facilitate the creation of new and well-informedcoalitionsof interest groups insupportofthe reforms. 69. Reforminginstitutionsto align institutionalincentives with reform objectives and build institutionalcapacity to articulate and implement reforms is critical. Nigeria's reforms have so far tendedto be drivenfrom the top down. There was little alternativein a complex countrywith weak institutionsand strongvested interests against reforms includingin public institutions. This approach has succeeded in kick startingmany reforms, but will not suffice to extend and sustain them. Reformof public service institutionsis proceedingandneedsto be speededup particularly in the key ministries such as the Ministry of Finance and the National Planning Commission 20 leadingthe reforms. This should help create new institutionsthat are intune with the new policy thrust of government and where staff understand and are committed to the new policy shift. Considerable capacity building around policy making, implementationand monitoringwill also be needed. 70. Efforts to strengthen institutionaland organisational capacities at the Federal level must be replicatedat the State and Local Government levels if the reforms are to be embedded. To date, most institutionalreformshavetaken place at the Federallevel, complemented by actions in only a few States, and with little apparent improvement inthe great majority of localgovernment areas. As long as this is the case, distortions to economic activity will not be adequately addressed and competitiveness and growth will be elusive. Extendingthe momentum of reform across Federal, State and Local government levels will reduce probability of reversibility. An appreciable change at all three tiers of governmentwill ensurethat the reforms are meaningfulto the great majority of Nigerians, in the form of either better publicly-provided services or of broader growth. Some ofthe reforms at the federal levelprovide a startingpointwith opportunity to learnlessons, andto reachout increasinglyto those States inwhichconditionsare conducive to improvedeconomic governance and management. Federal government could help by assessing impact of its own reforms and drawing lessons, sharing information with states and local governments and identifyingincentivesfor state and local governmentsto take on similarreforms at their level. A mechanism for performance based grants from the federal level to states that show commitment and action on reforms could be designed and implemented. Nigeria could draw on experiences from other federal countriesinthis regard. 71. Second, the fundamental reforms that have been introducedover the past few years on the basis of "political agreementshnderstanding"needto be institutionalizedthroughthe passage of a number of key bills, currently pending approval. As mentioned above, critical legislation that needsto be passedinclude:the FiscalResponsibilityBill; The Tax Policy andAdministration Bills, The Public ProcurementBill; The NEITI Bill; The Auditor General's Bill; The Statistical Act andother keyregulatorybills. 72. Third, mechanisms of public accountability that create pressure on government and leaders for improved performance need to be strengthened. This should create a dynamic of higher citizenexpectations, so that improvedperformance is widely seen as the norm, generating pressure for further improvement. To achieve durable accountabilitysystems, government must make quality and timely informationroutinely available on a wide range o f government actions, in particular relatingto financial management, but also on the performance and impact of public bodies and on key competitiveness indicators. A good start has been made in a number of areas, however the process needs to be institutionalizedand widened. Improved transparency will create greater scope for `intermediaries,' including the media and non-governmental organizationsto helpcreate a more informedpublic opinion. 73. To optimize its effect on growth, Nigeria's ongoing democratic process needs to be accompanied by a set of measures that reward the political leadership for taking actions that promote economic growth, and holdthem accountable for poor economic performance.This will include demonstrating how political leadership may benefit from broad-based economic growth (e.g. the politicalbenefitsassociatedwith these would includeincreasedemployment and income opportunities, increased revenue and a reduction of poverty related conflict). To achieve this Government needs to address the political economy constraints that have hindered growth over the past four decades.At the heart of the vicious cycle that needsto be broken is the needfor an economy that diversifies beyond oil. Government's efforts to achieve this must be deepened across the three tiers of government to ensure that vested interests that have been created around 21 oil, protected and uncompetitiveindustries, and the inefficientpublic and private sectors can be broken. A more diversifiedeconomy comprisinga more vigorous, competitive and less protected private sector will contribute to more sustainable and equitable growth, and generate a healthier configuration of interest groups, whose incentives would be better aligned with employment basedgrowth. 74. Fourth there is a critical need to widen the range of individuals and organizations that have an interest and commitment in taking the reforms forward. Whilst acknowledging that political leadership will continue to play a pivotal role in driving the reform process, a process must be initiatedwhich moves the policy process from beingdependent on individualleaders to becomingmore firmly rooted in democratic institutions. The internationalcommunitycan assist Government achieve its accountability objectives by helping to empower and strengthen the capacity of the elements of civil society and the private sector whose interests coincide with a growthand competitivenessagenda. This will facilitatethe establishment of coalitionsthat bring together groups and reformist elements of government around common interests. While the support of parts of Nigeria's elites has so far been sufficient to launch some of the reforms, sustaining change will require broader support. Jobs and improved public services are critical. There is a needto work with a range of stakeholders, goingwell beyondthe state to includethe private sector, as well as elements of civil society, especially those with soundly-basedadvocacy programs. 22