This section discusses the impact of FDI in the Nigerian economy and the impact is grouped into three which include the following:
3.1.1 Foreign Direct Investment Impact on Trade
The Nigerian external trade industry especially the service sector is one of the most recognized that has expanded greatly because of the contributions of FDI to that sector. Under the general assumption of laissez faire, there is a belief that countries that engage in free trade will definitely benefit from it thereby leading to welfare improvements of those countries. Present-day theoretical studies have shown that international trade and investment complements each other rather than substituting one for the other if trade between two economies is based on their absolute advantage (Aizeman and Noy, 2005; Ayodele, 2007). However, if the trade between the two countries is established on their absolute advantage, trade and investment may be substituted for each other and business firms would resolve to supply goods and services through exports or FDI. Then the degree of complementarity between trade and investment will remain an empirical question.
Numerous cross-country studies found support for the hypothesis of a negative relationship between FDI and export. In contrast, other studies indicated that FDI actually has a positive effect on export performance of host countries. This is based on the available empirical studies of the role of FDI on export performance of host countries (Cabral, 1995; Blake and Pain, 1994). The performance of the Nigeria trade sector has been relatively been impressive in recent time. The value of total trade in 2010 was 151,571dollars compared to the last ten years of just 32,982dollars in 2000. However, the export sector has been impressive, but the import sector is growing faster than the export sector, but still effort has been made to improve the export products in the country and much more effort still have to be put in place for improvement.
3.1.2. Impact on Economic Transition
Another often neglected impact of FDI is the impact on economic transition of Nigeria. Neoclassical have said the market is a better way to organize an economy. Nigeria has been a capitalist economy which is controlled by the market and less interference from the state, thereby allowing FDI inflow to have positive effects on the economy (Zhang, 2001 and Ali and Guo, 2005). The change and diversification of the ownership of businesses also change the inflow of FDI. After the privatization of the telecommunication sector, the inflow of direct investment has been high as the service industry has experienced large investment inflow till this present year. Furthermore, with the FDI inflow the emergence of a market oriented institutions had been developed. Many Special Purpose Enterprises (SPEs) were joint ventures with Foreign-Invested Enterprises (FIE) and could benefit from various management systems, incentive schemes or risk management. Domestic as well as international competitiveness has been improved by FDI by breaking oligopolistic structures or state monopolies. Fascinated by the high rates of return, investors from all over the world have now placed their interest on The Federal Republic of Nigeria.
3.1.3. Impact of FDI on GDP
According to standard neoclassical theories the most recognizable impact of FDI is on economic growth. Although it is difficult to say whether the increase in FDI is what increases economic growth or it is the rate of increased growth that stimulates more FDI. However, the United Nations Conference on Trade and Development, UNCTAD (2007) reports that FDI flow to Africa had increased from $9.68 million in 2000 to $1.3 trillion in 2006. The UNCTAD World Investment Report shows FDI inflow to West Africa has also increased from $33060 in 2000 to $110394.5 which is almost triple the figure. It was realized that the inflow was dominated by Nigeria, who received 70% of the sub regional total and 11% of Africa's total.
Nevertheless, FDI is supposed to contribute to the growth rate either indirectly or directly in different ways, which includes,
• Taxation revenues, earnings from foreign enterprises and tariffs increase the government's income. Also, FDI has enhanced capital formation and has become a vital part of capital accumulation.
• Inward FDI augmented the total factor productivity of the host country as new inputs and ideas increase the productivity parameter of the production function. According to Whalley and Xin (2006) Foreign-Invested Enterprises have labor productivity that is about nine times higher than the one in domestic enterprises.
• Foreign investments have created lots of spill-overs for local businesses due to the adoption of advanced technology and know-how from western investors. As for the spillovers, the transfer of advanced technology represents one of the main reasons why developing countries favor FDI from industrial advanced countries.
Aggregate output growth measure by the Gross Domestic Product (GDP), according to the Central Bank of Nigeria (CBN) 2007 economic report for the third quarter of 2007, was estimated at 6.05% compared with 5.73% in the second quarter. This has immensely contributed to the positive growth of the economy. Though, Foreign Direct Investment (FDI) inflows to Nigeria dropped considerably between 2009 and 2010 by $3.7bn from $6bn in 2009 to $2.3bn in 2010 (UNCTAD, 1999, 2006, 2007). This is also likely as a result of the present situation (insecurity) in the country and has therefore reflected the social, economic legal and cultural environment of the country which raises several questions and anxiety from prospective foreign investors. This enormous fall of 60.4 percent shows the need for Nigerian government to begin thoroughly and bravely address the challenges to foreign investment and other business interests in the country. Government has made some commitment to ongoing reform in the financial sector that can ensure the stability of the economy. As there seemed to be some renewed confidence in investing in the country as Nigeria is secure for FDI notwithstanding recent happenings in some parts of the country. This is because investments are expenditure on physical assets, which are not for immediate consumption but for the production of consumer and capital goods and services. Business firms make investments which are administered by the desire to maximize profit in the long-run. Therefore, the result of the FDI inflow in the economy has been of great benefit to some extent. Although the annual GDP growth rate has fallen and stands at 7.8% in 2010 to 6.6% in 2011 (World Bank 2012).
3.2 Analytical Framework
This section explains the methodology which is used to study the effects of FDI on economic growth. This is important because the role of FDI as a handmaiden of growth and development is now well recognized and largely appreciated.
3.2.1 Data Source and Method of Construction
We focus our attention on econometrics techniques, this deal with the estimation of the multiple regression equation. However, some time series alone presents some problems which will be systematically addressed. Many economic models entail co-integration relationship. The rationale behind it is that many economic theories imply that a linear combination of certain non-stationary variables must be made stationary, and the Unit root test (Augmented Dickey-Fuller test) is used to examine the stationarity of the time series. We will also apply the granger approach to test whether FDI causes economic growth to see how much of current economic growth is explained by past economic growth and then to see whether adding lagged values of FDI can improve the explanation and finally the Error Correction Model provides a relation of short or long term dynamics between the co-integrated variables. In chapter one, section 1.7, a brief discussion has been given to where the data were retrieved from, and we will now give a short description of the relevance of each of the variables.
Dependent variable:
Economic growth: the yearly GDP per capita is used as a proxy for economic growth (e.g. Borensztein et al., 1998). The GDP per capita enables comparisons between accession countries of different sizes as well as analyzing the development of GDP over time.
Independent variables:
Foreign Direct Investment: FDI is regarded as an important determinant for economic growth, especially for those countries that lack financial or competitive capabilities, it is expected that FDI has a positive significant influence on GDP growth.
Infrastructure Development: Good infrastructure facilitates production reduces operating costs and thereby promotes FDI (Wheeler and Mody, 1992). Infrastructure increases the productivity of investment and thereby enhances economic growth. Given the availability of data we will use electricity production as a proxy for this variable, we expect a positive direct relationship between this measure and economic growth.
Openness of the Host Economy to Trade: The total trade (imports and exports) is used to capture this variable. FDI inflows are projected to lead to enhanced competitiveness of host countries exports. As exports and investment increase, they will have a multiplier effect on GDP. We expect an a prior positive relationship between trade and economic growth.
Government size: This is measured as the final government expenditure. It is expected to bear a positive direct relationship to economic growth. This is because a higher level of government expenditure should translate into the provision of more social capital that should encourage production and growth.
Human capital: The importance of education to economic growth is proxied by the labor participation rate among the whole population in the country. Barro and Lee (1994) and Akinlo (2004) included this variable in their growth equation and results showed a direct relationship. Borensztein et al. (1998), however, found a conditional relationship, which was inverse and positive thereafter. We expect a direct positive relationship between the two variables.
Inflation: inflation rate is included as a measure of overall economic stability of the country. We expect an indirect relation between inflation and economic growth
3.3 Model Specification and Estimation and Technique
In this part of the thesis, a complete growth model is set up empirically to investigate the relationship between FDI and GDP growth as shown below:
RGDP = β0 + β1FDI + β2XM +β3GS + β4INFL +β5INFRA + β6HUMCAP + U
The ordinary least squares equation technique is the estimation procedure chosen for this study. It will be used for estimating the equation specified. As a justification for this method, Maddala (1977) identified that ordinary lest squares is more robust against specification errors that many of simultaneous equation methods and also that predictions from equation estimated by ordinary least squares often compare favorably with those obtained from equations estimated by the simultaneous equation method. Our methodology will help us in estimating our empirical model and produced empirical analysis. The software Eviews 7.1 will be used for analysis and result outputs and interpretation will be discussed in the next chapter.
