Asymmetry in Oil Resource Allocation in Nigeria between Interventionist Policy and the Market:

An Empirical Framework
Mudasiru Olawale Ibrahim
Department of Cooperative Economics and Management
Federal Polytechnic, Ile – Oluji
waleibrahim20@gmail.com, mudibrahim@fedpolel.edu.ng
Abstract
Economists from Adam Smith had asserted that efficient allocation of resources is by the forces of demand and
supply in the market. In fact, information in the market was assumed to be free and available to the consumer.
However, recent market conditions had shown that information is not ‘free’ and ‘available’; especially when
one agent to a transaction gains from a hidden information.
This condition had been termed as information asymmetry. Which can either lead to adverse selection or moral
hazard in the market.
As the main concern in Nigeria is the allocation of oil wealth; and its management in order to attain efficiency
in allocation. This article examined the empirical framework for allocation in oil sector in Nigeria between the
interventionist policy of the Government and the market.
With heavy presence of Nigerian National Petroleum Corporation in the upstream and downstream oil sector
in Nigeria, coupled with intervention in price control; the question that comes to mind are quite enormous
regarding motive of the Nigerian Government’s policies on these interventions.
Keywords: Asymmetry, adverse selection, moral hazard, signalling, hidden characteristics, interventionist
policy

INTRODUCTION
Debates about the gains and management of the Nigerian oil wealth have been the basis of argument about
resource curse effect in the economy. The abundance of these resources had often created more problems than
benefits. But the fact is that the stagnation in economic condition is not pertinent to Nigeria alone, in fact it
seemingly categorizes oil producing countries as nations with economic problems. Resource dependent
economics tend to grow more slowly than non – resource dependent economics at comparable levels of
development (Davis, Osssowski, Fedelino, 2003). Of course as it may be, one may attribute these problems to
the clustering effect of oil prices in the world market, but since the effect in short term on the economic
condition, policy formation to correct expenditure pattern had since helped Nigeria’s economy. The oil price
clustering effect is indeed a phenomenon that is part of oil market in the world. Even recent expenditure
smoothing pattern in Nigeria since 2003 as against the spending spree in 1980’s had curbed the negative effect
of oil price clustering effect on the economy.

But in Nigeria as in any other developing economies, the main problem had been inefficiency in the allocation
of resources. Since resources themselves are scarce and subject to diversity in uses, then there is the need to
efficiently allocate these resources to kindle the development in the economic. This is borne out of the fact that
the resources available are limited in supply so that the direction of uses of the resources reflects the cost and
benefits decision. The allocation of resources is subjected between the market as an agent in the economy and
government as an agent. Hence the decision on the allocation between the government as an agent and the
market is vested on the benefit scale from the agents. Therefore, the determination of the allocation principle is
expressed in the volume of benefit scale that can efficiently allocate the resources between the market outcome
and government intervention. The benefit scale determination is rather ambiguous in Nigeria due to the
conflicting interest of the government as an economic agent against the market. This is because the information
that hinges on oil as a resource is sometimes ambiguous and subject to hidden characteristics.

There are so many causes to the informational “hidden characteristics” in the oil sector, but the quicker
assessment is seen in the question: Do government gain from information asymmetry in the oil sector? The
extent to which this question is answered goes a long way in the determination of resources allocation in
relation to the information disclosure in the oil sector. Also, there is the need to overview the political economy
of oil sector control and ownership, the production and the oil gain allocation; and of course this goes hand in
hand with the colliding interests of different strata of the government in the oil political economy and the urge
to reveal the information in the entire facet of the oil sector. After these factors are overviewed, then the
question of who owns oil as a resource, who produces it, and how are the gain allocated, how willing is the
government to disclose information in the oil sector can be asked in relation to the allocation decisions.

Indeed, the highlighted facts above are the impacts of the government as an agent in the economy, therefore the
decisional impact of the market as agent and the outcome needs to be overviewed. The fact remains that there
had never been the role given to the market as an agent in the oil sector from the downstream to the upstream
and the midstream sector. While ownership in the upstream sector is by the government, the activities in the oil
downstream sector is majorly decided by the government including pricing and distribution, hence the market
as an agent is given no role in the allocation decision. Therefore, the interest of the government in hiding the
information that hinges on the oil sector raises the question whether there is information asymmetry in the
resource allocation or not. And this reflects in the market criterion as a decisional variable in the allocation in
the oil sector, both in production and pricing.

STATEMENT OF THE PROBLEM

The convergence of oil and the allocation principle in Nigeria did not hedge out a development strategy as
envisaged. Unfortunately, the returns from the oil sector of the economy do not reflect an upward shift in
allocation and distribution. And given the stance of development, a functional allocation principle that forms
the basis of the economy as a system, the abundance of resources in Nigeria suffices the developmental strategy
that if adopted can make the economy grow at a faster rate. The mirage in Chinese economic development
within a span period of three decades made different economic theorist eager to quickly attribute China to their
development theory. The Chinese economy is now the “son” of all economic theory. Hence as it had been
asserted, the different economic agents have a role to play in the economic development. Therefore, the
government role in the oil sector in relation to the other sectors has been an issue of continued concern to the
basis of economic condition.

If the government stand to gain from its dominance in the oil sector, then is it because the market system is
inefficient for the allocation principle or is it that there exists other conflicting interest of the government? Or
worst of all, is it that there exists information asymmetry in the oil industry that benefits the government as an
agent in the economy? And more importantly, does this information asymmetry lead to negative selection in the
allocation of resources in Nigeria?

THEORETICAL FRAMEWORK
The allocation principle in an economy is built on the fact that there are two agents of production in the
economy, the government and the market. Therefore, the level of resource allocation in the economy is directed
by the division of resources between the government and the market, the higher the government’s production,
the higher the resources used by the government and vice versa. Therefore allocation principle is jostled
between the central allocation and the market outcome. The notion that either the allocation of resource where
there exists entire government production or market production in the economy, that the allocation would be
efficient had since been proven to be wrong. This is borne out of the fact that the empirical evidences had
shown the negative effect of an entire market system in an economy so also the central allocation. Hence the
proposal of an interventionist policy where there exists juxtaposition between the market and the government
had since taken over the world economies. But the proposal for a moderate degree of interventionist policy was
based on the diagnosis that the failure of the central allocation principle was due to the lack of interaction
between the market and the government (Wlodzimierz 1992). Although as the government fail in allocation, so
also the market may fail, especially in the less developed countries like Nigeria. This is because if there are too
many non-monetised sectors in an economy, the price system would exist in rudimentary form thereby leading
to market failure (Jhingan 2002). The argument for the use of the market as the basis of the allocation of
resources in an economy is built on the assertion that there exists perfect availability of information from the
market outcome. Key to this assertion is that a definitive competitive equilibrium in a full information condition
fazes out efficiency loss. But the equilibrium concept hinges on the buyers’ beliefs about the quality of product
at a particular given price in relation to the sellers’ incentive to sell at the given price.

Price in itself reveals information about a product. A high priced good signals higher quality than a low priced
product. The expectation of a buyer of high priced product rests on the higher utility derivable from the product
as against the low priced product. Therefore, the market schemes out a prospect in pricing that seeks to reveal
the quality of product from the price. More precisely, the limit of continuous transaction show that buyers of
high priced products seem to arrive at a slower position rate because if takes time to sell at high price (Nicholas
2012). This is because high priced product although signals quality, but are rather more expensive and the
buyers are willing to buy low priced goods to compensate for a substitute even if not a close substitute to the
high priced goods. One of such problem from the informational lag in the market is negative selection.
Sometimes one side of the market may have more information than the other side, and this phenomenon rather
referred to as asymmetric information leads to efficiency loss in the market allocation principle. Information
asymmetry may either show the tendency of “hidden characteristics” or “hidden action”. A hidden
characteristic occurs when one side of a transaction knows more about a product while hidden action is an
action of a does not observe. The “hidden characteristics” leads to adverse selection while “hidden action” is
synonymous with moral hazard. The presence of adverse selection in the allocation principle is as a result of
information asymmetry while the resultant effect is efficiency loss in the allocation principle. If there exist
adverse selection in the allocation principle, then why had there been no outcry from the other economic
agents? Despite the straight forward understanding from conventional theory of demand and the fact that
asymmetric information often lead to efficiency loss, it is quite invisible (Finkelsteinand 2004). The other fact
is that given that there exists adverse selection in the allocation principle in the market, to what extent should
the buyers be concerned? So often time, buyers in the market are unaware of the presence of adverse selection.
Therefore, the task of evaluating adverse selection and formulating against it is much more rigorous. Hence,
different strategies to curb adverse selection in allocation are vested on the interest of standby agent that would
normalize information disclosure in the market. This agent is often a third party in the market. But the
credibility of the third party as an observant of the information in the market may be erring; this is shown with
the financial crisis in the world market recently arising from the global economic meltdown which stemmed
from the 2007 – 2008 financial crisis in the United States.

With the interventionist policy as tool to curb the exegesis of the market, it may also lead to adverse selection.
This thrives on the potential role of policy intervention on pricing and welfare. One of such instance is the
subsidy in consumption of some products, especially in the tradable sector of the economy. The policy often
has a distributional effect in general equilibrium across all sectors, raising the value of a sector’s product and
lowering the value of other sector’s product (Nicholas 2012). But this does not elude the fact that market
naturally creates solution to adverse selection (Nicholas 2012). The competitiveness among different forces in
the market makes each producer disclose information about the products; the higher the competitive market, the
more the information available in the market. Although the price to trade heterogeneous durable goods for a
homogeneous consumption goods tend to depend on the individual choices, but these choices are affected by
the product’s quality and type and the trading expectations from the agents in the market. Therefore, adverse
selection thrives more where there exists an allocation system and the market outcome is minimal or non –
existing. Hence the degree of the government interest as an economic agent in relation to the market as another
standing opposite agent would hedge out the allocation principle whether it contains adverse selection or not.
LITERATURE REVIEW
The studies aimed at asymmetric information in its relation to adverse selection had been quite tolling. Vickrey
(1961) in proposing the revenue equivalence theorem asserted that any member of a large class of auction gives
the seller of the same revenue that is attainable and that for a seller to achieve higher revenue, he must take a
chance on giving the item to an agent with a lower valuation, hence this means that the seller might risk not
selling at all. And of course this formed the basis for other research work, hence the quest for an efficiency in
public goods even in a condition where agents have private valuations prompted the improvement on the
equivalence theorem where public choice problems are treated and a public project’s cost in borne by all agents
(Clarke 1971, Groves 1973). Hence the choice of socially efficient allocation of public goods in a situation of
private information is possible. In other words, the problem of “tragedy of commons” under certain conditions,
in particular quasilinear utility condition is not needed for allocation.
The disclosure of information about ‘good products” or “bad products” are explained in term of the “Lemon
Problem” (Akerlof 1971) in which the information asymmetry is witnessed in the difference in the quality of
goods in the market, hence the goods are either pooled together or separated where the good products and the
bad products depend on the information disclosed by the sellers. Although an agent in the market may have a
quasilinear utility where the principal has prior information over the agent's utility, the transfer function may
yet be easy and efficient. Mirrlees (1971) introduced the efficient transfer function where the principal and the
agent can transfer products. Given that the quasilinear utility and the principal produces at a convex marginal
cost and expect profit. The transfer function can be efficient by enveloping the principal and the agent’s
transfer. But sometimes in the allocation function there exist higher social choice problem where the choice
may be dictatorial (Gibbard 1973, Satterthwaite 1975). The social choice function is dictatorial if one agent
always receives his most favoured goods allocation. Then there is the need to hedge out the dictatorial function.
The view about the effect of adverse selection that it favours the sellers alone may be misleading especially in
certain conditions. The claims of losses by the policy holders in selected insurance companies may be high
above the average rate of loss of the population used by the insurers to set their premiums (Rothschild, Stiglitz
1973). While Siegelman (2004) informational asymmetry study showed that asymmetries are in favour of
insurers and not the insured, because the insurers utilize various strategies of underwriting risks and its
classification that compensate or even overcome informational advantage of policy holders.
In trading, the parties involved cannot trade efficiently in they both have secret and probabilistically varying
valuation for the good traded without the risk of forcing one party to trade at loss (Myerson and Satterthwaite
1983). Hence for an efficient market, the information that hinges on the traded product determines the level of
loss by the agents in the market. Hence in the sense of pricing and the information, the price in itself is a form
of signaling prospect; therefore, adverse selection and allocation are negatively related to underpricing in the
capital market (Rock 1986). An uninformed investor in the market earns a negative allocation – weighted initial
return on their investment. But in practice high positive return proposed in investment portfolios cannot be
earned. This is due to adverse selection. Also there may be information cascades in investment portfolios where
the behaviors of other investors may serve as a signal to a particular investor (Welch 1992), hence an insurer
would create a cascade situation where their stock is underpriced in order to herd the buyers. In signaling about
the quality of a security, a security design by an issuer with private information would make the issuer retain
the ownership of some security in order to signal that it is of high quality ( De Marzo and Duffie 1999).
And of course a prisoner dilemma may be created in the herding process (Carrille and Dempster 2001). The
rationality of the investors may make him meander past the herding in the market by behaving irrationally and
selling the product to an irrational buyer before the bust in the market. But of course a random matching may
occur between the uninformed buyers and the inform sellers where the indigenous composition of sellers may
mitigate against adverse selection in the matching process (Carmago and Lester 2011). The buyers are given the
chance to make a “take it or leave it" offer to the sellers at a price. The financial crisis of 2007 – 2008 indeed
highlighted the effect of adverse selection. The observation was that buyers of assets would like to re- invest in
some other assets; hence the decline in the demand of asset – backed securities would boost the demand of
other assets that do not suffer from adverse selection (Gorton 2008). And of course the business cycle in any
economy determines the economy, hence, the critiquing of the Mises – Hayek business cycle theorem that
homogeneous entrepreneurs should exhibit rational expectation seems to show that adverse selection could not
be systematic (Nicholas 2010).

MACRO ALLOCATION AND EFFICIENCY LOSSES

The macro allocation objective of any economy is to efficiently allocate the available resources for
developmental purposes. Many economies in pursuance of a better allocation principle had been opening up
their economies to the market system. But the allocation principle in the oil producing countries had followed
same trend. The government had been the dominant force in the upstream sector, while the downstream sector
is controlled with supply decision and pricing by the government parastatals. While the argument for its total
dominance in the upstream sector was based on the decision to fast tract the available resources for
development and derive as much more as possible development from the resources. The decision on domestic
control in the downstream sector was built on the fact that every nation wants to prevent itself from the
recurrence of the 1970’s oil price shock, therefore the proliferation of National Oil Companies (NOCs) in the
oil producing countries (OPCs) was in rage; this was to militate against oil supply insecurity in the domestic
economy and price fixing to combat domestic volatility effect of the price of oil (McPherson 2003).

While OPECs objective to guard against over supply or under supply in the world market has helped reshape
the supply pattern, the National Oil Companies (NOCs) serves the same objectives in the oil producing
counties. Therefore, the allocation principle is seen in the light of the internal effect of supply and pricing of oil
in reaction to world supply and the volatility effect of the world oil price. Also on the other hand is the
government interest concerning the internal and external effect, the other side is the role of the market
allocation function. As it had been pointed out, allocation of resources between the government as a decisional
agent in the economy and the market as other agent is based on the extent of the benefit scale in Nigeria. While
factors like resource control and ownership, the production model and oil gain allocation determines the
government decision on allocation, the information available in the oil sector can be seen in the light of these
factors. The foundation to the resource control and ownership and the likelihood of withholding information in
the oil sector is seen in the conflicting stipulations of the Land Use Act and the Petroleum Act in Nigeria. While
the Land Use Act although vies land ownership in the hand of the central government, it sees the states as the
supervisors. The Petroleum Industrial Act on the other hand vested the power to allocate the oil blocs on the
central government, therefore the tendency to hide information on the resources lies in between the loop holes
in the stipulations of the Land Use Act and the Petroleum Industrial Act. Also more confusing is the veto power
of the President to allocate oil block at will as stipulated in the Petroleum Industrial Act.

Although many countries among the oil producing countries have a decentralize production model, many other
OPCs use the federal model of production where equities in the oil companies are proliferated. So the transient
movement of the central government in Nigeria in view of equities owned in the oil companies had increased
rapidly with even the case of a total takeover of an oil company. From about 33.3% in 1971, almost 80% of
some major oil companies’ equity is taken over (Ayodele et al 2003). While the issue of oil gain allocation had
created more problems among the different government set-up, the basis of these misalignments in the oil gain
allocation is seen in the degree of autonomy that exists among the phases of the government. The drastic
reduction in oil revenues allocated to the states where these resources are found had often created problems.
Hence the conflicting interest between the different sectors of the government in Nigeria raises the hope that
there exists information asymmetry. Also, the proliferation of Nigeria National Petroleum Corporation as a
midstream agent that oversees the interest of the government seems to raise the question of the presence of
information asymmetry. The downstream activities such as refining, distribution, marketing and pricing are
done by the NNPC. The market as an agent in the economy is given no basis of the decision of the allocation
principle. The total control of the upstream, midstream and downstream sector seems to debase the possibility
of market outcome in the oil sector in Nigeria. The gap between the market and the government is seen in the
misalignment from the subsidisation policy in the oil sector. The effect of the subsidization policy tends to
shown some asymmetric information effect on product costing as the subsidization led to exponential growth in
oil real cost consumption (Adenikinju 2010). The effect of the policy also is felt in the disincentive to invest in
the oil sector by the private sector and of course compounding the need of review of the subsidization policy is
the supply shortage in the domestic economy that called for the need to import petroleum products at even
higher prices.
With shortage from the local refineries’ supply of oil to the domestic economy, the resort to importation did
indeed change the costing and pricing structure. The pricing structure was changed to an import parity pricing
which is adjusted inclusive of cost of transportation, distribution and marketing. Hence the final price is built on
various components outside the market outcome. The most staggering effect on this pricing had been the
invoicing pattern form the oil importers manifested in over invoicing of oil costs. Therefore, the dominance of
the government in the oil sector in Nigeria points to the presence of adverse selection in resource allocation.
This is seen in the resource control and ownership and the persistent urge to rest on government dominance
rather than ease up with a subsidization policy, hence the market outcome may seemingly be a herding factor in
allocation principle.

CONCLUSION

The allocation of oil wealth in Nigeria had not been efficient over the years giving room for those who
benefitted from information asymmetry ranging from the upstream to the downstream sector of the Oil Sector.
This paper has been able to assert an absolute condition for efficiency and when activities of agents in any
market lead to the presence of information asymmetry.
REFERENCE
Akerlof, George A., (1970): “The Market for “Lemons”: Quality Uncertainty and the Market Mechanism,”
Quarterly Journal of Economics
Antonio C. and Gary C. (2000): Optimal Contracts, Adverse Selection, and Social Preferences: An Experiment,
Universitat Pompeu Fabra, Spain.
Anyawu J.C, Domowo F.A, Oaikhenan H, and Oyefusi A. (1997): The structure of Nigerian Economy (1960-
1997), Joanee, Onitsha.

Ayodele A.S and Falokun G.O. (2003): The Nigerian Economy: structure and Pattern of Development,
Printoteque, Lagos.

Balaam O.N, and Dillman B. (2011): Introduction to International Political Economy (fifth edition), Pearson,
Boston.

Booth P, Chadburn R, Heberman S, James D, Zhorasanee Z, Plumb R. H, Zickayzen B, (Ed) (2004): Modern
Actuarial Theory and Practice (Second Edition), Chapman and Hall / CRC.

Budina. N and Van Wijnbergen S. (2008): Managing oil revenue volatility in Nigeria, International Bank for
Reconstruction and Development (IBRD) / World Bank.

Camargo, B. and Benjamin L., (2011): “Trading Dynamics in Decentralized Markets with Adverse Selection,”
Sao Paulo School of Economics, Mimeo.
Claassen M. E, (1996): Global Monetary Economics, Oxford University Press.

Davis J, Ossowski R, Fedelino A. (2003): Fiscal Challenges in Oil Producing Countries: An Overview.
International Monetary Fund
DeMarzo, Peter and Darrell Duffie, (1999): “A Liquidity-Based Model of Security Design,” Econometrica
Downing, Chris, Dwight Jaffee, and Nancy Wallace (2009): “Is the Market for Mortgage-Backed Securities a
Market for Lemons?” Review of Financial Studies, 2009, 22 (7), 2457–2494.
Emil M.S, Baunsgaard T, and Simard D. (2003): Revenue from oil and gas sector: Issues and Country
Experience, Intenational Monetary Fund.

Go S.D and Page J (Ed) (2008): Africa at a Turning Point? Growth, Aid and External Shocks, The World Bank.
Finkelstein, A. and J. Poterba (2002): “Selection Effects in the United Kingdom Individual Annuities Market”,
The Economic Journal 112: 28-50.
Finkelstein, A. and J. Poterba (2004): “Adverse Selection in Insurance Markets: Policyholder Evidence from
U.K. Annuity Market”, Journal of Political Economy 112.1:183-208.

Ghadir M. (2004): Advantageous Selection versus Adverse Selection in Life Insurance Market, Graduate
School of Economics, Kyoto University, Japan.

Hinkle E.L and Montiel J.P, (Ed) (1999): Exchange rate misalignment: Concept and Measurement for
Developing Countries, The World Bank / International Bank for Reconstruction and Development.

Ikeji, C.C (2011): Politics of revenue allocation in Nigeria: A Reconsideration of some contending issues,
Sacha Journal of Policy and Strategic Studies Volume 1 Number 1 (2011), pp. 121-136
Jhingan M.L. (2002): Economics of Development and Planning (Thirty fifth edition), Vrinda Publication,
Delhi.

Kakwani N, (1986): Analysing Redistribution Policies, a study using Australia Data, Cambridge University
Press.

Kenen P.B, Papadia F and Saccomanni (1996): The International Monetary System, Cambridge University
Press.

Kenen P.B and Allen R.P, (1985): Asset Market and Exchange Rates, Cambridge University Press.

Mirrlees, J. (1971): “An Exploration in the Theory of Optimum Income Taxation,” Review of Economic Studies
38, 175-20
Mises, L.V, (1955): Buck Hills Lectures. Irvington-on-Hudson: The Foundation for Economic Education.
Nicholas C. (2012): Adverse selection and the rational expectations critique of the Mises-Hayek business cycle
theory, Suffolk University.
Nigam S, Hitesh M. (2009): Investment Technology Group, Inc.
Olusegun O, Borisade T. A, Muhammad A. (2004): Risk impacts on the economic performance of oil and gas
projects in Nigeria, Organization of Petroleum Exporting Countries.
Rock, K. (1986): Why new issues are underpriced? Journal of Financial Economics 15, 187–212.
Rothschild, M. and J. Stiglitz (1976): “Equilibrium in Competitive Insurance Markets: An Essay on the
Economics of Imperfect Information”, Quarterly Journal of Economics, 90.4: 630--649.
Shah .A (Ed) (1995): Fiscal incentives for Investment and Innovation, The World Bank / International Bank for
Reconstruction and Development.
Siegelman, P. (2004): “Adverse Selection in Insurance Markets: An Exaggerated Threat”. The Yale Law
Journal 113.6:1223-77.
Welch, I., (1992): Sequential sales, learning, and cascades. Journal of Finance 47, 695–732.
Wlodzimierz B. (1992): The Compatibility of Planning and Market reconsidered, Stockholm Institute of Soviet
and Eastern European Economics.

Wright C.J and Gallun R.A (2008): Fundamentals of oil and Gas Accounting (Fifth edition), Penwell
Corporation, Oklahoma.

Vickrey, W. (1961):“Counterspeculation, Auctions and Competitive Sealed Tenders,” Journal of Finance 16,
8-37.

Veronica G, Robert S. (2012): Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to
Quality, University of Chicago, Booth School of Business.
Yakov A, Shmuel H, Amir K.(2003): Allocations, adverse selection, and cascades in IPOs: Evidence from the
Tel Aviv Stock Exchange, Journal of Financial Economics 68 (2003) 137–158