Chapter 2: The business environment in Nigeria.Indirect Costs of Doing Business in Nigeria Are High
An adverse business environment can increase production costs substantially. It is estimated that the manufacturing sector in Nigeria has to bear additional indirect costs amounting to 16 percent of sales because of bottlenecks in the business environment. Losses due to power outages amount to 10 percent of sales, and production lost while in transit (4 percent of sales) is also significant (see table 2.1). These losses affect different types of firms in different ways. Electricity is more of a problem for small and medium-size firms. Production lost while in transit affects large firms to a greater extent.
In comparison with other countries, we can see from figure 2.1 that firms in Nigeria face higher indirect costs than firms in all other comparators. This is due largely to electricity-related losses. By contrast, Nigerian firms have similar indirect costs resulting from corruption and crime.
Electricity, Finance, and Transport Are the Major Perceived Constraints
To identify the main bottlenecks the Investment Climate Survey asked Nigeria's managers about the major constraints to doing business. Three major constraints emerged; electricity, finance, and transportation. (figure 2.2) The perception of other obstacles varies across firms. Although electricity appears to be a challenge for all firms, its impact is more significant in the manufacturing sector. Access to and the cost of finance appear to affect small and medium firms more significantly than they affect large firms, as well as firms located in the less industrialized states. Domestic firms complain significantly more of access to finance than do foreign firms.
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In the manufacturing sector, more than 50 percent of firms perceive electricity, access to finance, and cost of finance as the three most important constraints to their operations; transportation, the macroeconomic environment, access to land, tax rates, corruption, and crime appear as second-tier concerns (table 2.2).
In benchmarking Nigeria internationally, figure 2.3 shows that electricity, finance, transport, and access to land appear to be serious constraints when compared with other countries. By contrast, Nigeria's entrepreneurs do not perceive corruption, crime, and tax rates to be obstacles.
Electricity: The Main Bottleneck
In Nigeria power outages result in losses equivalent to 10 percent of total sales. Almost all Nigerian firms (97 percent) experience power outages. On average, such outages lasted some 196 hours per month, that is, approximately 8 days. Large firms and firms in the manufacturing sector are more adversely affected by such outages.
Faced with this situation, 86 percent of firms have their own generators, which produce, on average, 61 percent of their electricity needs. (table 2.3) Large firms have lower electricity-related indirect costs although they face the most significant outages. This is explained by the fact that 97 percent of them have their own generators. Power outages vary by state. In Kano, total outage duration averages 393 hours per month, equivalent to 16 days. In Abuja, total outage duration averages 127 hours per month, equivalent to 5 days.
In comparison with other countries (table 2.4), we can see that the percentage of firms experiencing power outages is highest in Nigeria. As a consequence, generator ownership is also higher in Nigeria than in all other comparators.
Transportation and Customs
Transportation emerged as the third most important major constraint to business. Transportation problems generate indirect costs due to breakage, spoilage, or theft, in the order of 4 percent of total sales (see table 2.1), making it the second most important indirect cost driver behind electricity. The main cause of such costs is breakage or spoilage (3.2 percent) while in transit. This should not be surprising given the very small share of roads in Nigeria that are paved (estimated at about 15 percent in 2004 compared with 80 percent of China). And yet road transport remains a major means to supply factories. Almost 70 percent of manufacturing firms in Nigeria have their inputs delivered by road.
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Nigerian firms import 10 percent of their inputs, with large firms (15 percent) and particularly foreign firms (39 percent) importing more. Efficient customs are important for firms that use a significant proportion of inputs from abroad. Only 16 percent of firms import directly, and it takes them approximately 13 days for imports to clear customs. Exporting is a speedier process taking on average seven days to clear customs. In comparison with other countries, the number of days needed to clear customs is clearly high. Brazil and India report waiting times to clear customs approximately equivalent to that of Nigeria, whereas Indonesia, South Africa, and China report clearly lower waiting times (less than eight days) (figure 2.4).
Nigeria does not compare well with other countries in regard to customs clearance, and more specifically for both the import licensing process and the time taken to clear customs. No comparator country requires more documents for both importing and exporting than does Nigeria (figure 2.5)
Finally of all comparator countries Nigeria remains the most expensive location from which to ship imports or exports. To ship a 40-foot container for export, it costs $1,730 and for import it costs $2,450 (see figure 2.6).
In summary, transportation emerges as an important constraint because it generates significant indirect costs of doing business. Although customs and trade regulations are perceived by only 5 percent of firms to be a major or very severe obstacle, this is in all likelihood connected with the relatively low number of firms in Nigeria that are familiar with the customs procedures. For those that do trade, customs appears to be a significant obstacle to business, in both costs and time.
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All around the world, businesses tend to complain about tax rates. Nevertheless in Nigeria, complaints about tax rates are not at the top of the list. About one in five Nigerian firms identified tax rates as a significant constraint to business, ranking it the fourth most important constraint. In international comparisons a higher percentage of firms complain about tax rates in other countries. However, by using the Doing Business database we can see that the overall tax rate paid by firms in Nigeria is the lowest of our comparator countries. And the profit tax rate is lower only in Venezuela (12 percent) (figure 2.7). Hence it appears that tax rates in Nigeria are not a major bottleneck. The reason they appear in the top part of our ranking is that most of our sample is composed by small firms, which enjoy fewer exemptions and have a higher effective marginal rate of taxation.
Access to Land
Access to land was identified by 25 percent of firms as a significant constraint to business, particularly for small firms as well as for foreign firms. Table 2.5 takes a closer look at the reasons that may justify this perception. The two main reasons that land is perceived a constraint are, first, the cost of land and, second, the procurement process.
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According to the survey, 25 percent of firms have tried to acquire new land in the previous three years, and 39 percent of those firms have identified access to land as a major or very severe obstacle. Furthermore, almost a third of firms that successfully purchased land still report access to land as a major or very severe obstacle. This suggests that access to land may indeed be an obstacle; even firms successful in acquiring land identify it as a major or very severe constraint. Although the cost of land (which is the primary reason that access to land is an obstacle) is an area in which intervention is difficult, the procurement process could be significantly improved.
Corruption and Crime
Corruption is perceived to be a serious constraint by 25 percent of firms. In an international comparison, we found that a higher percentage of comparator countries' firms report corruption to be a serious constraint. Bribes account for some 2 percent of total sales, which is more or less in line with the same indicator in comparator countries (see figure 2.1).
Looking in more detail at corruption, table 2.6 shows that only 44 percent of firms believe that government officials have a consistent and predictable interpretation of the law. This uncertainty may be closely linked to corruption. As shown above, small and medium firms perceive corruption to be more of a problem. We can see in table 2.6 that overall some 33 percent of firms report informal payments or gifts to be common to "get things done" in customs, taxes, licenses, regulations, and so on, and only 25 percent know in advance the amount of payment needed. When a government contract is at stake, firms expect to have to pay some 5 percent of its value in such informal gifts or payments to secure it.
Table 2.7 shows the percentage of firms that have been asked for informal payments when making certain requests, such as a telephone or electrical connection or permits and licenses. More than half of all firms have been asked for such informal payments when requesting construction permits and 40 percent when requesting operating licenses. With the exception of construction permits, this problem affects small and medium firms to a greater extent, which may justify their higher perceptions of corruption.
The court system is another institution in which corruption may be a problem. Table 2.8 shows that firms do not have much confidence in it: only half of all firms believe the system to be fair, impartial, and uncorrupted, and only three of four believe the courts to be able to enforce decisions. Clearly, the problem appears to be not so much at the postdecision stage, but at the predecision stage, with almost 60 percent of firms considering the process slow and expensive. This conclusion is reinforced by the fact that although 4 percent of firms had payment disputes in the past two years, only just over half of them were taken to court.
Other sources appear to confirm that although corruption may be perceived as a major bottleneck in Nigeria, it is not much worse than in comparator countries. Transparency International's corruption perceptions index (CPI), which attempts to quantify the degree of corruption as seen by businesspeople and country analysts, ranges between 10 (highly clean) and 0 (highly corrupt). Table 2.9 shows that Nigeria ranks 147th (of 180 countries), close to Indonesia; Kenya and Venezuela appear to be slightly worse.
These results may, at first sight, seem intriguing. Internationally, Nigeria is perceived to be a country in which corruption is a major problem. In fact, the data from table 2.9 do suggest that corruption is (in relative terms) problematic because it ranks Nigeria 147th of 180 countries. However, a closer look at the data shows that corruption does not appear to be much worse in Nigeria than in the other comparator countries, especially Kenya, Venezuela, and Indonesia. According to the investment climate survey data fewer firms in Nigeria perceive corruption to be a major or very severe constraint when compared with Kenya, Venezuela, and Indonesia, which is in line with the perceptions reported by Transparency International.
It can be argued that managers internalize corruption and hence report a lower level of corruption even though the problem is actually higher than perceived. To address this concern we looked instead at objective indicators of corruption, such as the amount of bribes paid "to get things done." Even in this case, as shown earlier, objective indicators of corruption show that the amount of bribes paid by firms in Nigeria is lower than that paid in Kenya and similar to the amount paid in Indonesia. Furthermore if we look at the evolution of corruption over time we notice that in the past few years Nigeria's corruption level has been improving. This finding is confirmed by other sources and is a result of the significant effort taken by the Nigerian government to fight corruption through enacting the Corrupt Practices Act and establishing the Independent Corrupt Practices and Other Related Offences Commission (figure 2.8).
Finally, Transparency International's report on the Global Corruption Barometer (2007) confirms this assessment. Nigeria appears as a country in which corruption is (in relative terms) a problem. However, respondents are broadly optimistic and expect corruption to become less of a problem in the future, and they consider the government's efforts to fight corruption to be effective.
Hence, our conclusion is that although corruption in Nigeria is a problem (it continues to rank in the bottom deciles in international comparisons), a significant effort has been made to address it, as objective indicators as well as changes in perception over time (both CPI and governance indicators) have shown.
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Crime was also reported to be a serious constraint to business by 23 percent of firms. However, crime generates indirect costs of only 0.8 percent of sales, clearly lower than those associated with electricity or even corruption. According to the ICA survey, 20 percent of firms in the formal sector experienced losses as a result of theft, robbery, vandalism, or arson. In an international comparison, with the exception of India, crime is perceived to be a more serious constraint everywhere else than in Nigeria. However, crime generates more or less similar indirect costs as in Nigeria (see figure 2.1).
A side effect of crime is yet another direct cost that would otherwise not be borne by firms: security. In Nigeria almost 70 percent of firms have to pay for security services, and they spend on average 1.8 percent of their annual sales for such services. Large firms appear to bear higher security costs than do small and medium firms (see table 2.10).
In an international comparison, although the share of firms that use security services is pretty much similar across countries, with the exception of only Indonesia and China, the overall cost burden of security services paid by Nigerian firms is among the highest, at the same level as Kenya, in which security is a major concern. Venezuela is an outlier (see table 2.11).
This leads us to conclude that although crime is not in the group of the most important constraints, survey data show that it remains a significant obstacle to doing business in Nigeria with significant cost implications.
Table 2.1 Indirect Costs-Manufacturing Sector Exporting zone Firm size Indirect costs as % sales TOTAL Yes No Small Med. Large Electricity 9.8 9.3 9.9 10.2 9.3 5.3 Bribes 1.7 2.8 1.5 1.5 2.2 0.9 Production lost while in transit 4.1 7.3 3.6 3.3 5.2 11.6 Theft, robbery, or arson 0.3 0.3 0.4 0.3 0.4 0.4 Total indirect costs 15.9 19.7 15.3 15.3 17.2 18.3 Ownership Indirect costs as % sales Foreign Domestic Electricity 10.3 9.8 Bribes 0.4 1.7 Production lost while in transit 1.7 4.2 Theft, robbery, or arson 0.3 0.3 Total indirect costs 12.7 16.0 State More Less Indirect costs as % sales industrialized industrialized Electricity 9.8 9.7 Bribes 1.7 1.6 Production lost while in transit 3.8 4.9 Theft, robbery, or arson 0.3 0.5 Total indirect costs 15.6 16.8 Source: ICA Survey Table 2.2 Percentage of Firms Reporting Major or Very Severe Constraints--Manufacturing Sector Exporting zone Constraint TOTAL Yes No Electricity 81% 78% 81% Access to finance (e.g., collateral) 56% 33% 60% Cost of finance (e.g., interest rates) 50% 36% 53% Transportation 33% 24% 35% Macroeconomic environment 30% 28% 30% Access to land for expansion/ relocation 29% 19% 30% Tax rates 27% 18% 28% Corruption 24% 8% 27% Crime, theft, and disorder 20% 17% 21% Practices of competitors in informal sector 19% 20% 19% Tax administration 18% 20% 17% Business licensing and permits 14% 14% 14% Political environment 13% 9% 13% Inadequately educated workforce 6% 10% 5% Telecommunications 5% 2% 6% Labor regulations 5% 9% 5% customs and trade regulations 4% 10% 3% Firm size Ownership Constraint Small Med. Large Foreign Dom. Electricity 82% 79% 76% 100% 81% Access to finance (e.g., collateral) 65% 37% 14% 32% 56% Cost of finance (e.g., interest rates) 58% 34% 23% 66% 50% Transportation 32% 35% 29% 70% 33% Macroeconomic environment 27% 37% 25% 25% 30% Access to land for expansion/ relocation 32% 21% 19% 58% 28% Tax rates 27% 27% 13% 32% 26% Corruption 28% 17% 9% 36% 24% Crime, theft, and disorder 22% 17% 11% 25% 20% Practices of competitors in informal sector 21% 15% 9% 34% 19% Tax administration 18% 18% 2% 32% 17% Business licensing and permits 16% 12% 0% 13% 14% Political environment 13% 13% 0% 25% 13% Inadequately educated workforce 6% 6% 2% 20% 5% Telecommunications 6% 5% 3% 20% 5% Labor regulations 5% 6% 0% 13% 5% customs and trade regulations 3% 7% 1% 13% 4% State More Less Constraint industrialized industrialized Electricity 79% 84% Access to finance (e.g., collateral) 53% 63% Cost of finance (e.g., interest rates) 48% 57% Transportation 30% 40% Macroeconomic environment 33% 22% Access to land for expansion/ relocation 27% 33% Tax rates 26% 29% Corruption 24% 26% Crime, theft, and disorder 19% 24% Practices of competitors in informal sector 20% 18% Tax administration 17% 18% Business licensing and permits 11% 22% Political environment 13% 12% Inadequately educated workforce 5% 8% Telecommunications 3% 11% Labor regulations 5% 5% customs and trade regulations 5% 4% State Better Worse regulatory regulatory Constraint environment environment Electricity 85% 76% Access to finance (e.g., collateral) 59% 52% Cost of finance (e.g., interest rates) 55% 45% Transportation 28% 39% Macroeconomic environment 29% 31% Access to land for expansion/ relocation 32% 25% Tax rates 36% 16% Corruption 33% 14% Crime, theft, and disorder 20% 20% Practices of competitors in informal sector 22% 16% Tax administration 22% 13% Business licensing and permits 17% 12% Political environment 20% 5% Inadequately educated workforce 7% 4% Telecommunications 7% 3% Labor regulations 9% 2% customs and trade regulations 5% 3% Source: ICA Survey. Table 2.3 Infrastructure Indicators-All Formal Sectors Indicator Firm size TOTAL Small Med. Large % firms experienced power outages 96 96 95 100 Average duration of outages per month (hours) 196 198 186 223 % firms with own generator 86 84 99 97 % electricity coming from own generator 61 61 61 61 Indicator Ownership Industry Foreign Dom. Manuf. Retail Other % firms experienced power outages 92 96 98 96 93 Average duration of outages per month (hours) 125 197 238 188 150 % firms with own generator 86 86 86 85 92 % electricity coming from own generator 70 61 61 N/A N/A State Indicator More Less industrialized industrialized % firms experienced power outages 97 93 Average duration of outages per month (hours) 212 169 % firms with own generator 87 84 % electricity coming from own generator 63 55 Source: ICA Survey. Table 2.4 Nigerian Businesses Face the Most Serious Electricity Constraints Nigeria Kenya Venezuela Brazil Indonesia Indicator 2006 2007 2006 2003 2003 % firms experienced power outages 96 85 21 64 48 % firms with own generator 86 70 N/A 17 39 South Africa India China Indicator 2003 2005 2003 % firms experienced power outages N/A 77 N/A % firms with own generator 10 59 19 Source: ICA Surveys. Table 2.5 Reasons for Perceiving Access to Land for Expansion/ Relocation to Be a Major or Very Severe Constraint--All Formal Sectors Percentage of firms that identify this as reason for access to land for Firm size expansion/relocation to be an obstacle TOTAL Small Med. Large Cost of land 92 92 90 100 Procurement process 70 71 68 67 Availability of infrastructure 47 46 51 29 Small size of land ownership 39 37 47 49 Government ownership of land 39 37 45 80 Disputed ownership 35 33 42 69 Percentage of firms that identify this as reason for access to land for Ownership expansion/relocation to be an obstacle Foreign Dom. Cost of land 89 92 Procurement process 89 70 Availability of infrastructure 46 47 Small size of land ownership 51 39 Government ownership of land 18 39 Disputed ownership 53 34 Percentage of firms that identify this as reason for access to land for Industry expansion/relocation to be an obstacle Manuf. Retail Other Cost of land 97 85 88 Procurement process 68 72 72 Availability of infrastructure 47 46 46 Small size of land ownership 32 44 48 Government ownership of land 38 37 43 Disputed ownership 28 32 48 Percentage of firms that identify this as reason State for access to land for expansion/relocation to More Less be an obstacle industrialized industrialized Cost of land 92 91 Procurement process 69 72 Availability of infrastructure 45 49 Small size of land ownership 34 46 Government ownership of land 45 31 Disputed ownership 32 39 Source: Investment Climate Survey in Nigeria. Note: Table includes only firms that perceived access to land to be major or very severe constraint. Table 2.6 Perception of Government and Regulations--All Formal Sectors State Firm size % firms that agree with statement TOTAL Small Med. Large Consistent and predictable interpretation of the law 44 39 58 74 Informal payments/gifts commonplace 33 35 29 24 Advance knowledge of informal payment/gift 25 26 21 19 Percentage of annual sales spent on informal payments/gifts 2.0 2.0 2.3 0.7 Percentage of contract value paid to secure contract 5.3 5.6 4.7 2.0 State Ownership % firms that agree with statement Foreign Dom. Consistent and predictable interpretation of the law 40 44 Informal payments/gifts commonplace 45 33 Advance knowledge of informal payment/gift 26 25 Percentage of annual sales spent on informal payments/gifts 0.7 2.0 Percentage of contract value paid to secure contract 4.8 5.3 State Industry % firms that agree with statement Manuf. Retail Other Consistent and predictable interpretation of the law 43 46 42 Informal payments/gifts commonplace 31 31 38 Advance knowledge of informal payment/gift 26 22 25 Percentage of annual sales spent on informal payments/gifts 1.7 2.0 2.4 Percentage of contract value paid to secure contract 5.5 4.0 6.0 State State % firms that agree with More Less statement industrialized industrialized Consistent and predictable interpretation of the law 46 39 Informal payments/gifts commonplace 31 37 Advance knowledge of informal payment/gift 25 24 Percentage of annual sales spent on informal payments/gifts 1.7 2.4 Percentage of contract value paid to secure contract 4.0 7.5 Source: Investment Climate Survey in Nigeria. Table 2.7 Percentage of Firms Asked for Informal Payments When Making Requests-All Formal Sectors Firm size % firms that have been asked for informal payments when requesting TOTAL Small Med. Large Telephone connection 24 27 20 11 Electrical connection 39 42 32 10 Water connection 33 35 30 11 Construction permit 53 51 56 67 Import license 33 48 12 35 Operating license 40 47 28 10 Ownership % firms that have been asked for informal payments when requesting Foreign Dom. Telephone connection 58 24 Electrical connection 57 39 Water connection 68 32 Construction permit 79 52 Import license 71 31 Operating license 53 40 Industry % firms that have been asked for informal payments when requesting Manuf. Retail Other Telephone connection 15 32 29 Electrical connection 35 40 43 Water connection 24 42 37 Construction permit 51 42 59 Import license 24 26 65 Operating license 36 42 45 State % firms that have been asked for More Less informal payments when requesting industrialized industrialized Telephone connection 19 36 Electrical connection 38 42 Water connection 29 39 Construction permit 50 57 Import license 23 52 Operating license 37 46 Source: Investment Climate Survey in Nigeria. Table 2.8 Court System--All Formal Sectors Firm size Characteristics of the court system TOTAL Small Med. Large Fair, impartial, and uncorrupted 53 52 57 61 Quick 41 41 41 54 Affordable 41 38 49 67 Able to enforce decisions 75 75 77 84 Percentage of firms with payment disputes in the past 2 years settled by third parties 4 3 6 6 Ownership Characteristics of the court system Foreign Dom. Fair, impartial, and uncorrupted 48 54 Quick 46 41 Affordable 58 41 Able to enforce decisions 75 75 Percentage of firms with payment disputes in the past 2 years settled by third parties 8 4 Industry Characteristics of the court system Manuf. Retail Other Fair, impartial, and uncorrupted 53 46 59 Quick 38 39 47 Affordable 38 40 45 Able to enforce decisions 75 79 74 Percentage of firms with payment disputes in the past 2 years settled by third parties 3 5 4 State Characteristics of the More Less court system industrialized industrialized Fair, impartial, and uncorrupted 53 55 Quick 42 40 Affordable 43 38 Able to enforce decisions 75 76 Percentage of firms with payment disputes in the past 2 years settled by third parties 4 4 Source: Investment Climate Survey in Nigeria. Table 2.9 Corruption Perceptions Index, 2007 Country Rank (180 countries) Index Nigeria 147 2.2 Kenya 150 2.1 Venezuela 162 2.0 Brazil 72 3.5 Indonesia 143 2.3 South Africa 43 5.1 India 72 3.5 China 72 3.5 Source: Transparency International. Table 2.10 Security Services and Security Expenditure--All Formal Sectors Firm size TOTAL Small Med. Large Percentage of firms that paid for security services 69 65 84 100 Security cost as % annual sales 1.8 1.8 1.8 2.6 Ownership Foreign Dom. Percentage of firms that paid for security services 100 69 Security cost as % annual sales 2.6 1.8 Industry Manuf. Retail Other Percentage of firms that paid for security services 72 66 68 Security cost as % annual sales 2.1 1.3 1.9 State More Less industrialized industrialized Percentage of firms that paid for security services 72 65 Security cost as % annual sales 1.8 1.9 Source: Investment Climate Survey in Nigeria. Table 2.11 Security Services and Security Expenditure--Comparison across Countries-All Formal Sectors Nigeria Kenya Venezuela Brazil 2006 2007 2006 2003 Percentage of firms that paid for security services 69 70 75 81 Security cost as % annual sales 1.8 1.9 6.6 1.6 South Indonesia Africa India China 2003 2003 2005 2002 Percentage of firms that paid for security services 46 81 66 48 Security cost as % annual sales 1.1 0.9 1.3 0.7 Source: Investment Climate Survey in Nigeria.