Rethinking Nigeria’s industrial policy

thinkingHere is my confession – I believe that free markets are the best way to organize an economy but that government regulation and intervention is necessary to keep markets functioning properly. In most countries in the world, this makes me a left leaning centrist. In Nigeria this makes me a free market fundamentalist.

Nigeria’s antipathy to free markets is nothing new. We are inherently distrustful of a mechanism that cannot be controlled and one whose outcomes are unpredictable. Nowhere is this clearer than in the design of Nigeria’s industrial policy.

There is joke amongst people who make such jokes that one can predict the imminent formation of a new industrial policy directive once newspaper articles lamenting the amount foreign exchange we are wasting importing a product begin to appear.

As a left leaning centrist, I’m in support of industrial policy in general, but I’m violently opposed to the way industrial policy is done in Nigeria. One of the fundamental truths of life is that incentives matter – people do what they are encouraged to do. Unfortunately most of our industrial policy is set up with horrible incentives, which is why most of them do more harm than good.

Our industrial policy generally consists of either banning the finished product or raising the tariffs on the good to obscene levels. The rationale is that if consumers have no options, they will consume the made in Nigeria versions of these products.

Due to nationalistic reasons, a lot of Nigerians welcome this flavor of industrial policy. They applaud the creation of Dangote Cement, the rise of the Chi Group’s Chivita, and the dominance of Dufil Prima’s indomie noodles. All three were created by the import bans on cement, fruit juice and noodles respectively.

Now these are all successful companies worth at hundreds of millions of dollars at a minimum. Whilst the various owners should be lauded for their execution capability, I’m not sure the government should be celebrating their success. Was the goal of the cement policy to pay two times the global average for cement? Was the goal of the fruit juice policy to create a “local” industry with 80% to 90% foreign content? Was the goal of the noodles policy to have indomie own 75% of the market?

These are only three examples, but pretty much every time the Nigerian government supports a local industry, the consumers in the industry suffer higher prices or loss of quality and the industry participants that successfully execute under the policy become successful.

I find it very amusing that Dangote Cement apparently sells the cement it exports from Nigeria at lower prices than it charges in Nigeria. How ironic is it that the citizens of other countries are benefitting from our industrial policy at our expense?

This is not an issue with the companies who are benefiting from the policy. The companies have responsibilities to their shareholders and their employees to maximize their profits. However the government should not be in the business of creating industries for people to get rich.

So what is the solution? What is the best way to create an industrial policy that aligns the incentives of the companies with the incentives of the government?

I believe that the focus of industrial policy should be to build a supply chain rather than to domesticate manufacturing. My focus is more on backward integration and increased local value add rather than simply to claim that things are made in Nigeria. In my book, a successful industrial policy is one that develops a value chain.

For example let us take tomato paste. Let us say 100% of tomato paste is currently imported and I wanted to build a local industry on tomato paste. The first thing I’d do is encourage the establishment of a tomato paste plant. This is a plant that uses tomato to produce the paste. To encourage that plant, I’d put an exceptional sliding tariff of 70% on imported paste. The tariff starts at 70% but every two years it drops by 10% until it hits 20%.

However you can’t just stop there. Otherwise you’ll end up with the situation in the fruit juice sector where all you had was manufacturing assembly and everything else is imported.

So the primary input for the tomato plant is raw tomatoes which is used to make tomato concentrate. So the maker of tomato paste can use raw tomatoes locally or import tomato concentrate. In order to develop the tomato market, you will slap a 20% tariff on the imported tomato concentrate and raise it by 10% a year until the tariff on imported tomato concentrate hits 70% in year five. You will then keep it at 70% for 5 years before reducing it to 20% in year 10.

If you’ve done it right you’d have provided the incentives to both develop the tomato paste manufacturing business and also give them the incentive to backward integrate.

Will people try to game the policy? Absolutely, but this way you will ensure that your aims are clear upfront and that industrial policy isn’t a way to exclude foreign competition but to improve the linkages in the economy.

While I believe that some infant industries need to be protected from foreign competition, it is not always true. Take a look at the music business – 10 years ago 90% of the music played in Nigeria was foreign. Currently probably 60% is local. No industrial policy created that. Most industries fare better when they have foreign competition.

The job of the industrial policy maker is to judge with industries truly need protection and which newspaper articles about forex loss to ignore. The industrial policy maker needs to remember that incentives matter and to stop creating bad incentives for Nigerian businesses. Do this and we will all be better for it.

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