Reform is hard

And Nigeria's attempt at bluffing through it will not fool anyone

Happy New Year, and I hope everyone had a fun holiday season. Observing the festive atmosphere in Lagos this year, it seemed somewhat subdued. I believe this is primarily due to the ongoing cost-of-living crisis affecting the country, a trend that has become more noticeable since the start of the previous Buhari administration. Unsurprisingly, the nation's economic situation became a focal point of discussions at various social gatherings, from weddings to dinner parties and beach outings. One key observation from these conversations stood out: the Nigerian government's handling of its reform agenda is still not receiving the attention it deserves, even though there's a growing awareness of the economy's critical condition. This oversight significantly affects how citizens, analysts, the media, and civil society organizations engage with and hold the government accountable.

Reforms need credibility

The major policy changes announced immediately after the new government was sworn in, such as reducing the petrol subsidy and devaluing the currency, haven't been the instant solutions many hoped for. Some argue for patience, believing these measures will eventually yield positive results. Others view the lack of immediate economic improvement as evidence of Nigeria's unique economic challenges and the limitations of such reforms.

I have objections to both perspectives. Inflation is still on the rise, recently reaching a 27-year high. Devaluation did not bring any sanity and transparency to the foreign exchange market, and the expected capital inflow from that move has not materialised. Multinational firms are announcing their exit from the country, and despite celebrated trips to India, U.A.E, and Saudi Arabia, foreign direct investment has all but dried up completely. It is a bit strange to presume some of these cosmetic measures are all there is to reforms - and then conclude that the problem must be that Nigeria's situation is unrecognisably complex. Reforms need legitimacy, credibility, coordination, and clear communication. And the government has had a false start on all fronts.

In line with a recurring topic discussed on this blog, implementing economic reform is a challenging task, one that demands full commitment and cannot be approached half-heartedly. Renowned economist Moises Naim, who also served as Venezuela's Minister of Trade and Industry, adeptly examined this subject in a Wall Street Journal article, drawing on Argentina and its newly elected president as a case study. He aptly described many of the choices facing a government trying to do reform as 'wicked problems', and identified what policymakers and scholars have learned in the last few decades;

Thankfully, there’s no need for the new president to reinvent the wheel. In the 35 years since the Berlin Wall fell, the world has learned much about what it takes to breathe life into limp, inflationary, state-controlled economies. Not just in Eastern Europe but in East Asia and Latin America, decades of experience now shine a light on the most common pitfalls to be avoided and on the tricky trade-offs involved in pursuing a successful program of economic reforms.

I only wish I’d had access to these insights back in 1989, when I served as an economics minister in Venezuela and the country faced challenges similar to the ones Argentina faces today: state coffers bare, soaring inflation, macroeconomic indicators all flashing red, and voters fed up with declining living standards. It’s a daunting challenge.

Among the trickiest questions is how to sequence reforms. What should go first, eliminating subsidies for gasoline or for milk? Privatization or reforming the social safety net? And the big, overarching question: What should take precedence, reforming the economy or the political system?

Argentina seems to be in a far worse situation than Nigeria. Still, the lessons are applicable because we have pursued similar policies that now have a perennially familiar outcome as David Lubin of Chatham House explained;

Just as there are different ways of getting out of economic trouble, there are different ways of getting into it. In Türkiye’s case, the original sin is, mostly, rotten monetary policy. Argentina’s is more a case of persistent fiscal incontinence.

Türkiye’s monetary policy problem famously lies in Erdoğan’s claim that high interest rates cause inflation rather than prevent it. More than 10 years of insistence on this frankly absurd view helped drain the central bank of its credibility, a problem reinforced by a revolving door in the governor’s office: Türkiye has had six governors in the past 10 years.

Since the Turkish central bank’s policy interest rate has mostly been lower than the inflation rate during this period, trust in the currency has progressively collapsed. The result is that the lira’s value against other currencies is around half what it was 10 years ago in real terms and Türkiye’s foreign reserves are negative: the central bank owes more dollars than it owns.

Argentina’s original sin is less monetary and more fiscal. While Türkiye’s public debt stock has remained below 40% of gross domestic product during the past 10 years, Argentina’s doubled from around 40% in 2012 to 85% in 2022.

But what started as a fiscal problem in Argentina has ended as a monetary one. With markets rather unwilling to finance the government’s deficit, the central bank has printed money to fund it. The result: inflation was 160% in November and, like Türkiye, the central bank’s net foreign reserves have been negative since the middle of last year.

Nigeria is in a sort of mid-way position of what Lubin described above because its policy mistakes involved both excessive government spending and poor monetary decisions. These mistakes created a challenging situation for the next leader after Buhari. The key challenge for the new government is to figure out the right mix of policies to restore confidence, attract investment, and encourage economic growth. At the same time, they need to be careful not to worsen the situation. This is why the idea of organizing reforms in a certain sequence, as mentioned by Moises Naim, is crucial. When implementing reforms, it's always important to decide which steps to take first and in what order. Naim continues;

Wicked problems such as these—where you need to reform A before you can reform B, but you can’t seem to reform B until you’ve reformed A—stalk every reform effort. There is no silver bullet, but experience suggests that fiscal order has to come first. Leaving budget reform for later would undermine market confidence and throw sand in the gears of every other reform.

When President Tinubu boldly announced subsidy to be 'gone' in his inaugural speech, it signalled decisiveness by his government to tackle a problem that everyone agreed was a significant fiscal drain - perhaps hopes that the government will be equally in decisive in dealing with waste, misallocation, and inefficiency of the budget. At least now we know that such hopes were premature, and the government is not at all serious about bringing sanity to the federal budget. It does not help credibility that the government ended petrol subsidy to deal with an impending fiscal crisis, only to outline a record budget spending a few months later without even a plan for improving budget performance. This brings me to the second important point that Naim makes;

A second set of lessons stems from the long-running debate between gradualism and shock therapy. Argentina’s sprawling state sector has grown on the basis of thousands of sweetheart deals, each passing state money to privileged constituencies through a huge number of subsidies, financing agreements and contracts. That money filters down to millions of households who rely on the handouts to make ends meet. Do you try to unwind them all at once or gradually phase them out over time?

The literature shows that gradual reforms are more lasting and give rise to better economic outcomes. But in real life, it’s not that simple. Countries that can afford to reform gradually generally do better precisely because their economic circumstances aren’t so dire to begin with. With a budget deficit running at a crazy 15% of GDP, Argentina may not have the luxury of gradual reform.

But shock therapy will soon teach the new president yet another lesson: The costs of reform are immediate and tangible, while the benefits are just a promise, a hope.

Again, Nigeria's situation is not as dire as Argentina’s which suggests that there might be some room for gradualism. Indeed, many were surprised that the government moved pretty quickly with devaluation and petrol subsidy given the expected inflationary pressures and the weak foreign exchange reserve position. These are policies that could have provided good leverage in securing low-interest multilateral credit facility - rather than the 'scramble for dollars' that is still ongoing. Similarly, the government moved quickly to replace the leadership of the central bank and signalled an end to the monetary financing of the previous regime.

Despite the risk of undermining the independence of the central bank, it was a move that was largely welcomed. One is then left wondering why the government has moved very slowly or barely on some other things. The president appointed a record number of cabinet members and has shown very little appetite for fixing the bloated civil service - despite the budgetary pressures from personnel costs. The government certainly did not follow through on the president's initial 'shock therapy' and has not shown a commitment to a coherent gradualist approach. These mixed signals are undermining any reform intention.

The ''Basic Instincts'' of Leadership

Not every political leader is an economist like Javier Milei, the new president of Argentina. No law guarantees that political leaders who are economists will make better economic policies - although knowledge of economics will be incredibly beneficial to many political leaders. Political leaders simply want to stay in power, and the policies they choose often reflect this priority. But despite the incentive to hold on to power, politicians, like the rest of us, are imbued with sensibilities for many folk economic theories. My way of looking at this is that powerful political actors like presidents often have some ''basic instincts'' or intuitive preferences for certain policies. These instincts are informed by ideas, for as the great economist John Maynard Keynes once said - ''Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist."

The instincts of political leaders shape the behaviours of the policy advisers around them, and they almost always tend towards conforming with the instinct of the leader and not dissenting. Even worse, instincts and policies that are influenced by bad ideas have remarkable longevity. Argentina found itself where it is today because of decades-old bad ideas that have refused to die, as the economic historian Johan Fourie reminds us;

The story actually begins earlier than 1946, but we pick it up in the year when Juan Perón was elected as president. Perón was a Keynesian; he saw himself as the Franklin Roosevelt of Argentina and quoted him extensively in his first state address. In short, he believed that the underperforming Argentine economy could only be corrected through massive state intervention.

As I explain in Chapter 25 of Our Long Walk to Economic Freedom, Perón’s strategy was to replace manufactured imported goods with locally manufactured goods. To do this, he taxed the successful export sector – the farmers – to pay subsidies to industrialists, hoping that subsidies would help make Argentine manufacturers competitive.

But what might have sounded nice in theory was a failure in practice. By the end of the 1940s, agricultural exports had collapsed. This caused a massive balance of payments crisis. Put another way: Argentina’s ability to import was halved between 1948 and 1952. Perón and his government tried to find a solution and in the second five-year plan, agricultural exports were again prioritised. But it was too late. Three years later, Perón’s government was overthrown in a military coup, and the Peronist party was banned. Many African countries would follow the same strategy a decade or two later, with the same disastrous consequences.

This was quite evident during the years of Muhammadu Buhari. Even though Buhari never openly professed any ideology, his instincts were disposed towards subsistence agriculture, import-substitution, and a strong currency as the drivers and markers of prosperity. Despite the presence (perhaps occasionally) of advisers who knew better around him, Buhari was still able to steer policy towards his instincts and set the central bank on a record-breaking path of monetary finance.

The relevant point here is that this should sound a note of caution to those who think some of us who are worried about the false starts of the current government are impatient or overreacting. Nothing about the instincts of the current president suggests that he is worried about the national debt, or improving the bureaucracy to build state capacity - and hence restore the country to good fiscal health. The policies I have cited so far as examples of reforms might simply be the president reordering the national budget to fulfil his spending priorities. The president has also not shown any sign of changing the incentives for bureaucratic functionaries toward better service delivery to drive investment and growth. Rather we seem to be gassing up many agencies to deliver record revenues, even if at the expense of businesses. Well, as anyone who has seen the physical urban dysfunction of Lagos will tell you, improved revenue does not make for better governance and fiscal responsibility.

In fairness to President Tinubu, he has other good instincts. He is a believer in abundance and wealth creation, shunning the scarcity mentality of his predecessor. He needs to channel that outlook to many important policies. Nigeria needs to be an export powerhouse that contributes to global prosperity, not a gigantic and zombified self-sufficient miser. This should be the priority of our trade policy and associated bureaucratic structure. His belief in subnational excellence should also be leaned on to push reform of Nigeria's federal structure for good subnational governance, and away from dependency on allocation from the central government.

Overall, the president must be wary of bad ideas that failed in the past. He must be wary of advisers who only seek to pander to his instincts rather than provide concrete feedback. Reforms need concrete, meaningful, and coordinated actions to be credible. He must resist the pressure to merely sound good as the only necessary action to create confidence. Credible reforms also need to be clearly and honestly communicated - even when you have bad news. The army of image makers who issue false readouts from bilateral meetings and false statistics must be restrained. The legitimacy of the judiciary and the sanctity of the rule of law are important for reforms. A president who meddles with the courts sends the wrong signal to people willing to deploy patient capital.

Finally, the president must move quickly on non-performing bureaucrats and cabinet members. These are the agents of reforms and the success or failure of policies relies on the people responsible for implementing them.