Are Animal Spirits Driving the Nigerian Economy?

Photo by JOhaza from Pixabay Copyright-free

By

Chimere Iheonu

Date Published

May 19, 2022

Category

Insight

Introduction

The Nigerian economy has experienced two recessions recently, one in 2016 and the other in 2020. Within this period, annual economic growth averaged 1.4 percent even though annual population growth exceeded 2 percent, putting increased strain on available resources.

External shocks such as the coronavirus pandemic and crude oil price shocks have wreaked havoc on the economy. According to National Bureau of Statistics (NBS) data, the unemployment rate in Nigeria is 33.3 percent, with youth unemployment at 42.5 percent. The current inflation rate is 16.82 percent, with food inflation at 18.37 percent. The Nigerian exchange rate to the United States dollar currently hovers around 600 naira to a dollar in the parallel market. 

These crucial economic indicators reveal a country's economic health and, more importantly, how weak Nigeria's economy has been. The naira's constant depreciation and double-digit inflation rate are signs of the Nigerian economy's low productivity. Manufacturing value-added growth has been disappointingly slow, with a rate of -2.8 percent in 2020.

The Nigerian economy has been hampered by a lack of new investment and a high rate of investment outflow. In 2019, the net inflow of foreign direct investment (FDI) as a percentage of GDP was 0.5 percent, well below the sub-Saharan African average of 1.8 percent.

What are Animal Spirits?

The animal spirit explains some of the reasons why key indicators of the Nigerian economy have deteriorated over time. Formed by the British Economist, John Meynard Keynes in his 1936 book—The General Theory of Employment, Interest and Money, animal spirit is described as the instincts and emotions that influence and guide human behavior and is measured in terms of consumer confidence. These emotions influence how individuals make financial decisions in times of economic uncertainty. In the world today, animal spirits are emotions of optimism and pessimism that can influence financial decision-making, which can either propel or constrain economic growth. The waves of optimism and pessimism determine economic growth (among other growth determinants) and the dynamics of job creation and job losses.

The Keynesian doctrine emanated from the failures of classical economics to fully explain market disequilibrium. Classical economics had explained that individuals were rational and that market forces propel the economy to equilibrium. However, the disposition failed to hold due to the failure of the classicists to take into consideration human psychology. When individuals are optimistic about the economy, there are tendencies for the growth of new investment. However, when individuals are pessimistic about the economy, individuals and businesses would not be willing to invest. This in turn stagnates economic growth and job creation.

What factors create Pessimism in the Nigerian Economy?

While rising inflation and currency depreciation are consequences of pessimism, they also are factors that drive pessimism –revealing the two-way nature of the relationship.

Rising inflation levels and exchange rate volatility are key factors that create pessimism. Both indices are signs of pessimistic spirits. Basically, decisions on whether to invest are a function of numerous parameters including business confidence and the ease and cost of doing business. High inflation rates propel responses of tightening measures from the monetary authority which increases interest rates in the banking system. Higher interest rates in turn create pessimism and discourage investment. Inflation can also erode the value of a currency and further discourage new investment.

Further, the volatility of the Naira is creating uncertainties which increase pessimistic behavior of both domestic and foreign investors. For the domestic producer who imports inputs, uncertainties in the future exchange rate discourage new investment. For the foreign investor, it becomes difficult to project future revenue values and profit. 

Also, Political instability and terrorism that have overwhelmed the country for over a decade has also driven pessimism. There have been cases of conflict with non-state actors in almost every geopolitical zone of the country. In fact, Nigeria ranks 6th in the global terrorism index and is the 8th least peaceful country in Africa. These indices alone can deter any investor from investing in the country. These issues are key drivers of animal spirits and are essential elements in new investments, both domestic and foreign.

This pessimism leads to a deeper economic slump, lower aggregate supply levels, higher inflation rates, greater unemployment rates, and output that drifts further away from its potential. The trend in these indices in Nigeria is a clear example of the elements that contribute to stagflation, a type of recession that is resistant to traditional monetary policy.

What is the way forward?

Single Digit Inflation: Nigeria’s inflation rate is driven majorly by supply-side constraints, limiting the effectiveness of monetary policy. As such, cost-push measures are necessary. Firstly, I argue that the rising taxes within the Nigerian economy pushed up the cost of production and contributed to rising prices. While the government intends to increase its fiscal space, increasing taxes would also place pressure on price level through the increase in the cost of production.

Countering cost-push inflation requires supply-side policies aimed at increasing aggregate supply and easing the pressure on long-term costs.  Reducing taxes within the value chain in agriculture, manufacturing and the service industry is one measure, albeit the Nigerian government may not be willing to implement such a measure due to the short-term fall in government revenue. Furthermore, the continuous depreciation of the naira has also fed into prices. Nigeria is heavily dependent on imported producer and consumer goods, and as the naira depreciates, prices also increase. This calls for policies to be aimed at both export promotion and import substitution, and also calls for the government to improve on its forex revenue diversification agenda.

Exchange Rate Stability: The volatility of the exchange rate calls for deliberate policies from the government in halting the depreciation of the naira. Conscious efforts aimed at diversifying the economy are essential for the stabilization of the exchange rate and a further appreciation of the naira. Crude oil accounting for the bulk of Nigeria’s export means that fluctuations in crude oil prices directly transmit to changes in the value of the naira. To check this, it is important that measures are put in place to improve the export base and reduce the overdependence on crude oil. Achieving exchange rate stability will improve investors’ confidence in the Nigerian economy.

Improving Security: The need to improve security in Nigeria cannot be overstated in a bid to prop up confidence in the Nigerian economy. Investors shy away from countries with political instability. This calls for adequately tackling key security issues in the country. It is necessary to complement existing military measures with non-military measures in finding solutions to Nigeria’s security challenges. Improving internal security can unlock hitherto inaccessible agricultural land for production, which contributes to the rising food inflation.

Achieving a single-digit inflation rate, stabilizing the naira, and improving security will reduce investors’ pessimism and boost confidence to invest in the Nigerian economy.

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Disclaimer: This information in this article is NOT investment advice. It is intended for information and entertainment purposes only.

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