The federalism that promotes productivity (1), By Dipo Baruwa

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Development does not begin with money alone. It begins with the allocation of authority and responsibility. Authority creates the space for action. Incentives shape the behaviour of those entrusted with that authority. Sustained and purposeful action builds capabilities. Those capabilities raise productivity, expand the revenue base and generate the wealth that makes redistribution possible. When this sequence is disrupted, distribution gradually becomes detached from production, and the developmental foundation of the federation weakens.

In my last two articles, I argue that Nigeria’s developmental challenge is less about the absence of ideas than the organisation of incentives. The first article contends that many of our governance failures are symptoms of a deeper organisational misalignment between authority, incentives and capability. The second traces the evolution of Nigeria’s fiscal federalism, showing how the gradual shift from rewarding production towards prioritising distribution weakened the incentive for governments to expand their productive base.

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The third in the series has been divided into two parts: the first (the present one) continues on the incentive argument and lays the ingredients for productive rivalry among states, while the second attempts a definition of productive federalism and how it can be engineered in Nigeria.

Has the Nigerian Incentive Evolved in the Right Direction?

These arguments naturally raise another question: if Nigeria’s incentive structure has evolved in the present direction, where should reform begin?

For many, the answer lies in restructuring the federation, rewriting the Constitution or renegotiating the revenue-sharing formula. These debates are legitimate and important. However, I take a somewhat different view. The task before Nigeria, and indeed before the country’s next generation of leaders, is not principally one of constitutional engineering. It is one of governance. More specifically, it is about aligning authority, incentives and institutional capability in ways that encourage every level of government to build productive capabilities, rather than compete principally for distributable revenues.

This is not to suggest that the 1999 Constitution, as amended, is without imperfections. No constitution is perfect. Nor does it mean that constitutional amendments may never be necessary. The argument is simply that Nigeria does not need to await constitutional perfection before creating a more productive federation. Indeed, whether Nigeria can presently be regarded as a productive federation is itself open to question. The nominal size of the gross domestic product tells us relatively little about the depth of the country’s productive capabilities; a closer examination of the underlying structure of the economy is far more revealing.

Back to the main argument. A considerable part of the developmental work could begin within the present structure if the authority already distributed across the federation is matched with responsibility, appropriate incentives and the institutional capability required to achieve results.

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The Constitution itself provides a more balanced fiscal philosophy than contemporary political debates often acknowledge. Section 162 identifies several principles to guide revenue allocation, including population, equality of states, land mass, terrain, population density, internal revenue generation, and derivation. These principles represent an attempt to reconcile two legitimate objectives of every federation: maintaining national cohesion through redistribution, while preserving incentives for economic productivity.

Global experience shows that even the most generous revenue-sharing formula cannot produce development where governments lack the incentive and institutional capability to expand their economies. A state may receive more revenue without becoming more productive. It may spend more without building lasting capabilities. It may construct visible projects without improving the underlying conditions that allow firms, workers and communities to become more productive.

One of the least-discussed features of the Constitution is its explicit recognition of internal revenue generation as a principle to be considered in revenue allocation. This area, however, deserves greater constitutional clarity, particularly regarding its relationship with the derivation principle. Although it recognises internal revenue generation as a principle of revenue allocation, it neither defines the concept nor explains how it should be reflected in the allocation formula. This omission has contributed to a disproportionate focus on derivation, with comparatively little attention paid to the productive incentives that the internal revenue generation principle was arguably intended to create.

The Derivation Dilemma – and the Forgotten Incentive

The thirteen per cent derivation provision is a constitutional floor, not a ceiling, for any approved formula for the distribution of revenue accruing to the Federation Account directly from natural resources. More importantly, derivation should not be read in isolation from internal revenue generation. Taken together, both principles show that the Constitution does not compel Nigeria to choose between production and distribution. It recognises the need for both.

This raises the central governance question: Has the federation maintained an appropriate balance between redistribution and production, and do the incentives created by the system encourage states to expand their productive capabilities?

Quite rightly, much of the national conversation has centred on whether thirteen per cent derivation is sufficient, whether producing states should retain a greater proportion of resource revenues, or whether the vertical allocation formula should be fundamentally altered. These are important political questions. However, they can obscure a more fundamental developmental issue — and indeed, they have done so for years. As Nigerians, we need to interrogate the system more deeply rather than remain trapped in its symptoms.

Global experience shows that even the most generous revenue-sharing formula cannot produce development where governments lack the incentive and institutional capability to expand their economies. A state may receive more revenue without becoming more productive. It may spend more without building lasting capabilities. It may construct visible projects without improving the underlying conditions that allow firms, workers and communities to become more productive. This is, arguably, the lived experience of many subnational governments in Nigeria.

Conversely, even within the existing constitutional framework, a state that deliberately invests in electricity, transportation, technical education, investment facilitation, agricultural productivity, industrial infrastructure and capable public institutions can progressively transform its economy. The critical issue is not only how much revenue a government receives, but what behaviour the fiscal and political systems encourage after that revenue has been received. This is how locational comparative advantage is strategically constructed; not inherited but deliberately built through sustained public and private investment.

Development does not begin with money alone. It begins with the allocation of authority and responsibility. Authority creates the space for action. Incentives shape the behaviour of those entrusted with that authority. Sustained and purposeful action builds capabilities. Those capabilities raise productivity, expand the revenue base and generate the wealth that makes redistribution possible. When this sequence is disrupted, distribution gradually becomes detached from production, and the developmental foundation of the federation weakens.

Recent constitutional and legislative reforms in the electricity sector illustrate that where additional authority is devolved, it must still be matched by capability and incentives if developmental outcomes are to follow. Greater authority has now been devolved to states, creating new opportunities to shape their productive environments. Whether these opportunities translate into development, however, depends less on the reform itself than on how states organise the authority, incentives and institutional capabilities now available to them.

Recent constitutional and legislative reforms in the electricity sector illustrate that where additional authority is devolved, it must still be matched by capability and incentives if developmental outcomes are to follow. Greater authority has now been devolved to states, creating new opportunities to shape their productive environments. Whether these opportunities translate into development, however, depends less on the reform itself than on how states organise the authority, incentives and institutional capabilities now available to them.

The experience of other federations reinforces this argument, although none offers a model that Nigeria can simply copy. Germany and India demonstrate that states operating within the same constitutional framework can produce markedly different developmental outcomes. In both countries, subnational success has depended less on constitutional advantage than on sustained investment in industrial capability, infrastructure, skilled labour and effective public institutions.

Australia and Canada make a complementary point. Both operate equalisation systems that promote national cohesion, yet their states and provinces remain active economic actors competing for investment, innovation, skills and enterprise. Redistribution therefore coexists with productive responsibility rather than replacing it.

These experiences point to a common lesson: successful federations do not rely on revenue distribution as a substitute for development. They align authority, accountability and incentives in ways that encourage subnational governments to build long-term productive capabilities.

What, then, would productive rivalry look like in Nigeria?

It would mean states competing not merely over who receives the largest federal allocation, but over who can provide the most reliable environment for enterprise. It would mean competition over the quality of technical colleges, the reliability of industrial infrastructure, the efficiency of investment approvals and the strength of agricultural extension systems. States would seek to distinguish themselves through logistics, electricity, digital connectivity, skilled labour, security, research partnerships and the quality of their public institutions.

Such rivalry would not require every state to pursue the same industries; states will inevitably follow different developmental pathways. One may build competitive agricultural-processing industries around existing crops; another may specialise in mining, logistics or energy services; while others may develop strengths in healthcare, education, financial services or digital industries.

While states may begin by building on the resources and economic activities already present within their territories, more ambitious ones can construct new advantages through deliberate investment, skills development and partnerships with businesses and development institutions, thereby creating entirely new areas of competitiveness.

To be continued.

Dipo Baruwa is a business climate development analyst.