The institutional role in oil revenue‐economic growth nexus in Nigeria

• Published date: 01 March 2021
• Author: Isiaka Akande Raifu
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/opec.12197

The Institutional role in oil revenue-

economic growth nexus in Nigeria

Isiaka Akande Raifu

Honorary Research Fellow, ILMA University, Karachi, Pakistan. Email: heritagetiamiyu@gmail.com

Abstract

The mixed empirical f‌indings from the previous studies that examined the impact of oil revenue on

economic growth in oil-rich countries have raised a lot of questions as to why oil revenue has not

produced the expected growth effect in some of those countries. One of the factors responsible for

such a phenomenon is the poor institutional quality that characterises some of these countries.

Given this, this study investigates the role of institutional quality in oil revenue-economic growth

nexus in Nigeria over the period of 1984–2018. Using ARDL as an estimation method, our results

show that, irrespective of the choice of oil revenue and economic growth variables, oil revenue is

still indispensable to economic growth in the short run and the long run. However, interacting each

of the institutional quality variables with real oil revenue and oil rents yields mixed empirical

f‌indings. Although some of the interacting variables produce positive effects on economic growth

in both runs, the positive effect of some become insignif‌icant and even turn negative in the

robustness analysis. With the interaction of overall institutional quality index with oil revenue, oil

revenue worsens economic growth in both runs. Given these results, it is suggested that

government should improve institutional apparatuses in the country.

1. Introduction

Most of the oil-exporting countries including Nigeria depend heavily on the revenue

realised from the sales of crude oil to power their economies. This makes their

economies subject to the f‌luctuations of the prices of crude oil. There are pieces of

empirical evidence which show that a decline in the prices of crude oil usually precedes

economic downturn in oil-exporting countries just like the increase in the prices of crude

oil often precedes economic recession in oil-importing countries (Raifu and Raheem,

2018, Aminu and Raifu, 2019). The economic recession does happen because such a

decline in the prices of crude oil often results in a reduction in oil revenue accrued to the

governments of the oil-exporting countries. Consequently, dwindling oil revenue, most

of the time, leads to a contraction of government expenditure meant to f‌inance the

provision of infrastructural facilities. Since there is a close connection between the

availability of infrastructural facilities and economic growth, inadequacy of

©2021 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

52

infrastructural facilities such as good road networks, modern railway lines, generating

and supplying of electricity, pipe water, affordable education and health care could lead

to the economic crisis.

Apart from this, an increase in the prices of crude oil that is expected to be a blessing

to many oil-exporting countries has become a source of concern to many due to

syndrome called Dutch disease. Dutch diseases hypothesis is propounded by Corden and

Neary (1982). In its original form, the doctrine of Dutch disease stipulates that wealth

realised from the exporting of products of a booming sector leads to shrinkage of other

tradable sectors’activities. This occurs as a result of the real appreciation of the domestic

currency (Kojo, 2015).

1

Moreover, the quality of institutions in oil-exporting countries

has also been ascribed to how the oil wealth is judiciously used. Since the series of the

works of Douglas North and other researchers on institutions, the role of institutional

quality in facilitating business investment, economic growth and development has been

well spelt out (North, 1991; Hodgson, 2006). Institutions allow all the players in the

economy to play according to the rule of the game and this ensures smooth facilitation of

business transactions among the parties (Aminu et al., 2019). In other words, good

institutions constraint the excessive behaviour of the players that would have truncated

the smooth running of the economic system. Thus, institutions are indispensable to

economic growth and development. However, when institutions are weak, they havea

potential to crowd out the gains from the oil wealth (Oechslin, 2010; Mehrara et al.,

2010; Hassan, et al., 2019). A country characterised by a high level of corruption would

also directly or indirectly be characterised by a high wastage of oil wealth owing to

misappropriation or wrong investment of oil revenue. Also, in a country bedevilled with

political instability and absence of the rule of law, diversion of public funds meant for

the provision of basic infrastructure facilities for personal gain is inevitable.

In light of this, this study investigates the role of institutional quality in the oil

revenue-economic growth nexus in Nigeria. Due to the centrality of oil revenue in

determining the course of the economies of oil-producing countries, several empirical

studies have been conducted in oil-producing countries (see Mehrara, 2008; Mehrara

et al., 2010; Mehrara and Karsalari, 2011; Farzanegan, 2011; Ibeh, 2013; Ijirshar, 2015;

Dreger and Rahmani, 2016; Kabir, 2016; Laourari and Gasmi, 2016; Raifu and Raheem,

2018; Aminu and Raifu, 2019; Al Rasasi, et al., 2019). However, the results from these

series of empirical studies appear at best to be mixed. While some studies report a

positive impact of oil revenue on economic growth (Raifu and Raheem, 2018; Aminu

and Raifu, 2019), others conclude that oil revenue negatively affects economic growth

(Nweze and Edame, 2016; Laourari and Gasmi, 2016).

Some studies have attributed the negative effect of oil revenue on economic growth

to poor quality of institutions characterising some oil-exporting countries (Oechslin,

2010; Mehrara, et al. 2009). Consequently, an attempt has been made to examine the

©2021 Organization of the Petroleum Exporting CountriesOPEC Energy Review March 2021

Institutional quality role in oil revenue-economic growth53

moderating role of institutional quality in the relationship between oil revenue and

economic growth (Hassan, et al., 2019). Precisely, Hassan, et al. (2019) explored the

interactive effect of institutional quality and oil revenue on economic growth in 35 oil-

exporting countries. Although our study is similar to that of Hassan et al (2019), it is

focused on the role of institutional quality in oil revenue-economic growth nexus in

Nigeria. However, it differs in terms of specif‌icity and robustness. In their study, Hassan

et al (2019) used oil rents expressed as a percentage of GDP. Oil rents are def‌ined as the

difference between the value of crude oil production at world prices and total cost of

production. In this study, we compute real oil revenue from nominal oil revenue taking

from the statistical bulletin of the Central Bank of Nigeria after accounting for inf‌lation.

Oil revenue is the revenue the government realised from shipping the crude oil to other

countries or the amount it realises from the sales of ref‌ined petroleum products locally

(Osaghae, 1998; Olayungbo and Adediran, 2017). Thus, this study makes use of real oil

revenue for the main analysis and oil rents for robustness to test the reliability of our

choice of proxy for oil revenue. As regards the specif‌icity of the study, the study by

Hassan et al (2019) pooled together 35 oil-exporting countries and analysed them in the

panel framework. The drawback of this kind of analysis is that it is assumed that all the

oil-exporting countries have the same characteristics. However, the f‌indings from such

studies cannot be generalised, and if it is generalised, it could lead to policy bias. This is

because although these countries are referred to as oil-exporting countries because all of

them export crude oil, they are, however, differed in terms of political and institutional

structures that have the potential to affect how the oil revenue is managed in each

country and its eventual effect on the economy. Thus, to avoid such a pitfall, this study

focuses on Nigeria (one of the major oil-exporting countries) alone. In the case of

robustness, while the study by Hassan et al. (2019) constructed a composite index from

four institutional quality indicators (corruption, bureaucratic quality, democratic

accountability and rule of law), this study makes use of each of these indicators and

examine the moderating role of each of them in oil revenue and economic growth

relation. This follows the assumption that each of them would have a different

moderating role in oil revenue and economic growth nexus. Furthermore, on robustness,

aside from real GDP as a proxy for economic growth, we also use industrial production

index to represent economic growth and then examine the impact of oil rents on it. Also,

the moderating role of each of the institutional quality variables and aggregate

institutional quality index in the oil rents-industrial production index nexus is examined.

Given the brief introduction, the rest of the study is organised as follows. In section

2, the review of existing studies is undertaking. Section 3 presents the methodology, data

sources and description. The empirical f‌indings are presented in section 4, and section 5

concludes with policy recommendations.

OPEC Energy Review March 2021©2021 Organization of the Petroleum Exporting Countries

54 Isiaka Akande Raifu