THE IMPACT OF CAPITAL FORMATION VIA SAVINGS AND INVESTMENT ON GROWTH OF THE NIGERIAN ECONOMY 1980-2013

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THE IMPACT OF CAPITAL FORMATION VIA SAVINGS AND INVESTMENT ON GROWTH OF THE NIGERIAN ECONOMY 1980-2013

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The rate of growth in Nigeria economy cannot be fully analyzed without a closer look at the contribution of capital formation to Nigeria’s economic growth. This is in the understanding that capital formation has been recognized as an important factor that determines the growth of Nigerian economy. According to Bakare (2011), Capital formation refers to the proportion of present income saved and invested in order to augment future output and income. It usually results from acquisition of new factory along with machinery, equipment and all productive capital goods. Capital formation is equivalent to an increase in physical capital stock of a nation with investment in social and economic infrastructure. Continuing on the matter he noted that Gross fixed capital formation can be classified into gross private domestic investment and gross public domestic investment. The gross public investment includes investment by government and public enterprises while gross private domestic investment is investment by private enterprises. Gross domestic investment is equivalent to gross fixed capital formation plus net changes in the level of inventories. Economic theories have shown that capital formation plays a crucial role in the models of economic growth (Beddies 1999; Gbura and THadjimichael 1996, Gbura, 1997). This view called capital fundamentalism however was supported by the work of Youopoulos and Nugent (1976) as sited in Bakare (2011). Growth models like the ones developed by Romer (1986) and Lucas (1988) predict that increased capital accumulation can result in a permanent increase in growth rates. Capital naturally plays an important role in the economic growth and development process. It has always been seen as potential growth enhancing player. Capital formation determines the national capacity to produce, which in turn, affects economic growth. Deficiency of capital has been cited as the most serious constraint to sustainable economic growth. Meanwhile, an understanding of the impact of capital formation is a crucial prerequisite in designing a policy intervention towards achieving economic growth. The process of capital formation according to Jhingan, (2006) involves three inter-related conditions; (a) the existence of real savings and rise in them; (b) the existence of credit and financial institutions to mobilize savings and to direct them to desired channels; and (c) to use these savings for investment in capital goods. The government of Nigeria in 1986 considered the need for improvement in capital formation and pursued an economic reform that shifted emphasis to private sector. The public sector reforms were expected to ensure that interest rates were positive in real terms and to encourage savings, thereby ensuring that investment funds would be readily available to the real sector. Besides this, the reforms were expected to lead to efficiency and productivity of labor; efficient utilization of economic resources, increase aggregate supply, reduces unemployment and generate low inflation rate. For example, during 1980s, gross fixed capital information average 21.3 percent of GDP in Nigeria. This proportion increased to 23.3 percent of GDP in 1991 and declined to 14.2 percent of GDP in 1996. It picked and increased to 17.4 percentage in 1997 and average 21.7 during 1997 to 2000. The gross capital formation rose from 22.3 percent of GDP in 2000 to 26.2 percent in 2002 and declined drastically to 21.3 percent in 2005 (Bakare 2011).

Economic theories have shown that capital formation plays a crucial role in the models of economic growth (Beddies 1999; Gbura and THadjimichael 1996, Gbura, 1997). This view called capital fundamentalism by Youopoulos and Nugent (1976) has been reflected in the macroeconomic performances of many countries. It is clear that even mildly robust growth rates can be sustained over long periods only when countries are able to maintain capital formation at a sizeable proportion of GDP. It has been discovered that any proportion less than 27 percent cannot sustain economic growth. It is estimated that the ratio of gross capital formation to GDP in the sub-saharan African countries which has experienced poor growth in the 1990s was less than 17 percent compared to 28 percent in advanced countries (Hernandez-Cata 2000).

This phenomenon justifies the strong linkage between capital formation and economic growth. In order to trace the linkage between capital formation and growth, the gross capital formation of each year is normally scaled to the gross domestic product (GDP). Thus, fluctuations in capital formation is said to have considerable effect on economic growth. However, the proportion of capital formation to GDP that can sustain a robust economic growth must not be less than 27 percent and in some cases, it must go as high as 37 percent (Gillis et al 1987).

In 1986, the government of Nigeria considered the need for improvement in capital formation and pursued an economic reform that shifted emphasis on private sector. The public sector reforms were expected to ensure that interest rates were positive in real terms and to encourage savings, thereby ensuring that investment funds would be readily available to the real sector. Besides this, the reforms were expected to lead to efficiency and productivity of labor; efficient utilization of economic resources, increase aggregate supply, reduce unemployment and generate low inflation rate. For example, during the 1980s, gross fixed capital formation was an average 21.3 percent of GDP in Nigeria. This proportion increased to 23.3 percent of GDP in 1991 and declined to 14.2 percent of GDP in 1996. It picked and increased to 17.4 percent in 1997 and an average of 21.7 percent during 1997 to 2000. The gross capital formation rose from 22.3 percent of GDP in 2000 to 26.2 percent in 2002 and declined drastically to 21.3 percent in 2005.

Empirical literature on growth has consistently shown that the rate of accumulation of physical capital or investment is an important determinant of economic growth. Results provide evidence that public capital investments are a key input in the private sector production process for they affect both the steady state level of income per capita and the rate of economic growth on the transition path towards equilibrium (Nair, 2005). Furthermore, there are other important empirical evidences why private investment should be at the centre of the debate on how to promote growth and raise employment. Ndikuman (2005), while accepting that investment is a robust determinant of growth, especially investment on equipment, believe that private investment is a key determinant of cross-country difference in long run economic growth. This has led observers to identify low investment as one of the leading causes of the slow growth in developing countries in general and in African countries in particular. The UN Millennium Project (2005) has re-emphasized the need for a big push strategy in investment to help poor countries break out of their poverty trap and achieve the Millennium Development Goals (MDGs). The report argues further that, to enable all countries achieve the MDGs, there should be identification of priority of private investments to empower poor people, and these should be built into MDG-based strategies that anchor the scaling-up of private investment.

Economic theory shows that economic growth can be realized in two ways- increase in the amount of factors of production; and increase in the efficiency with which those factors are used. Thus, growth is induced by the increases in investment (i.e. capital accumulation) and the efficiency of investments (De-Gregorio, 1998). None of these indicators of growth has however been sufficient in achieving a substantial level of growth in most developing countries. In the late 1970s and early 1980s, most developing countries of Africa experienced unprecedented and severe economic crises. These crises manifested in several ways such as persistent macro-economic imbalances, widening savings-investment gap, high rates of domestic inflation, chronic balance of payment problems and huge budget deficit (Akpokodje, 1998).

The Nigerian growth experience has however been very pathetic. In more than five decades of independence; Nigeria has never grown at 7 percent or more for more than three consecutive years (NEEDS, 2004). Between 1975 and 2000, Nigeria’s broad based macroeconomic aggregate-growth, the terms of trade, the exchange rates, government revenue and spending – were among the most volatile in the developing world. The economy has been caught in a low growth trap, characterized by a low savings – investment equilibrium (at less than 20 percent). With an average annual investment rate of barely 16 percent of GDP, Nigeria is far below the minimum investment rate of about 30 percent of GDP required to unleash a poverty reduction rate of at least 7–8 percent per year (NEEDS, 2004). In providing what is perhaps one of the best reviews of literature, Collier and Gunning (1999) zero in on several important factors whose impact on African growth performance is mediated through their negative implications for investment, particularly private investment. In their view, “cumulatively” the variables have contributed to a capital hostile environment. This in turn has reduced the rate of return on private investment. These factors include: high risk, capital hostile environment, poor finance and low savings.

The decline in capital formation can be as a result of macroeconomic imbalances such as deteriorating foreign exchange rate and corruption in public sector. The inadequacy in economic infrastructure such as poor power supply, bad road network as well as poor health facilities were equally responsible for the decline in capital formation over time. Overall, the speed and the strength of economic growth in Nigeria have not been satisfactory.

Prescription of solutions to the poor performance of private investment that characterized a growing economy like Nigeria is of great policy concern; it is against the backdrop of the foregoing that this study investigates capital formation via savings and investment as it impacts growth of Nigerian economy using time series data.

1.2 STATEMENT OF PROBLEM

Capital accumulation is a catalyst to economic growth. Empirical studies like (Hernandez-Cata, 2000; Elenog and Jayaraman, 2001; Ndikumana, 2005) conducted in Africa have established beyond doubt, the critical linkage between investment and the rate of growth.

Viewed against the background of growing evidence of a strong link between high investment and sustainable growth, the Nigerian policy makers pursued a structural adjustment program about three decades ago which shifted emphasis from public sector to private sector. The public sector reforms were expected to ensure that interest rates were positive in real terms and to encourage savings, thereby ensuring that investment fund would be readily available to the real sector. Besides this, the reforms were expected to lead to efficiency and productivity of labour, efficient utilization of economic resources, increase aggregate supply, reduces unemployment, and generate low inflation rate. But unfortunately, the initial optimism expressed about public sector reforms has not been met. This is evident in the steady decline since 1980s of private fixed investment in Nigeria which has adversely affected our growth rate (Bakare, 2011). The reform program led to the privatization and commercialization of many state-owned enterprises; there have been some disappointing performances. For instance, Nigeria continued to be confronted with low rate of economic growth. Besides, the aggregate supply continued to diminish leading to demand-pull inflation. One worrisome aspect of the result of public sector reforms in Nigeria is the extent of distress in the sector including high rate of unemployment which has greatly hampered the growth rate. Hence, the need for a better understanding of the extent and the implication of these problems becomes crucial and it is the focus of this study.

1.3 OBJECTIVES OF THE STUDY

The broad objective of this study is to investigate the impact of capital formation via savings and investment on growth of the Nigerian economy.

Thus, the specific objectives include;

i. To examine if there is any significant relationship between capital formation and growth in Nigeria.

ii. To determine the effect of other macroeconomic indicators on economic growth in Nigeria.

iii. To proffer policy recommendation for sustainable growth in Nigeria

1.4 RESEARCH QUESTIONS

The following questions are to be answered, if the stated objectives are to be achieved;

i. To what extent does capital formation impact on the growth rate of Nigerian economy?

ii. Are there any significant relationship between capital formation and economic growth in the Nigerian economy?

1.5 RESEARCH HYPOTHESES

H0: There is no significant relationship between capital formation and economic growth in Nigeria.

H1: There is a significant relationship between capital formation and economic growth in Nigeria.

1.6 JUSTIFICATION OF THE STUDY

Nigeria is a richly endowed country with abundant human and natural resources. The country is blessed with a variety of mineral deposits including petroleum, natural gas, uranium, tin, columbite, coal, precious metals and gemstones. Over the last three decades, the country has earned over US$300 billion from oil sales. In spite of this wealth, the country’s economy has tended to fluctuate widely over the years. The average GDP growth was 1.2 percent between 1979 and 1989, 2.7 percent between 1989 and 1999 and 3.5 percent between 2000 and 2008. Inflation rate continued to increase with the purchasing power of the naira declining steadily over the years (Bakare, 2011).

Understanding the relationship between capital formation and economic growth would have significant implication to the state of the Nigerian economy. This study is set up to cover the lapses of previous studies on this subject matter. It is worthy to note that previous studies of the impact of capital formation on economic growth have basically been the study of the situation in advanced economies. Isolated instances of the study in less developed countries have always been a cross-country analysis. This study therefore hopes to study what the situation is in the Nigeria case. The study looked further into the determinants of capital formation in Nigeria.

This work is set to determine the impact of capital formation in Nigeria. Since economic literature has established that investment is a remedy to economic growth, a work of this nature is indeed expedient. This work by providing a deeper understanding of the relationship between capital formation and economic growth in Nigeria will expose impediments to investment growth in Nigeria.

Moreover, previous studies were based on simple regression analysis and at other cases, a cross sectional data analysis. But this study will be using the Augmented dickey fuller unit root test, the Johansen test of co-integration, and the error correction mechanism analysis using time series data. Also, previous studies covered the periods between 1970 and 2010 but this study captures the trend between 1980 and 2013.

1.7 SOURCE OF DATA AND RESEARCH METHODOLOGY

This study covers thirty four years of observation (1980 to 2013). The study is principally limited to the analysis of the Nigerian economy. The data over these years of study are regressed and the research findings obtained are explored statistically and econometrically.

However, this work is limited to the use of secondary data sourced from secondary source; Statistical Bulletin, Annual Reports and Statement of Accounts of the Central Bank of Nigeria (CBN). And also the publications of National Bureau of Statistics (NBS) are employed.

The analysis will be carried out with the use of Ordinary Least Squares technique (OLS), Augmented Dickey Fuller Unit Root Test, the Johansen test of co-integration, and the error correction mechanism analysis using time series data. Test of statistical adequacy such as T-test, standard error test, coefficient of determination and Durbin-Watson will be carried out. To facilitate the estimation process, a statistical package known as “E-VIEWS” will be employed.

1.8 SCOPE AND PLAN OF THE STUDY

This study will cover the period 1980-2013; a sample size of 34 years is necessary in order to have enough observation for computation.

The study will be organized into five chapters. Chapter one contains the background of the study, statement of problem, objectives of the study, research questions and hypothesis, the justification of the study, and scope and plan of the study. Chapter two consists of empirical reviews as well as the theoretical reviews. Chapter three covers theoretical framework, nature and sources of data, model specification, a priori expectation, restatement of hypothesis, method of analysis and the decision criteria. Chapter four is on the presentation and analysis of data. While Chapter five covers the summary of findings, conclusion and policy recommendation.

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