INTRODUCTION
1.1 Brief Overview
Explaining the reason behind why there is growth in an economy and the determinants that affect it has been a topic of debate in most economic literature. To be emphatic, the research into this topic has been one of the inspirations of the subject of economics. The father of economics, Adam Smith has attempted to explain the reasons and different sources of wealth in a country in his book called "An Enquiry into the nature and causes of the wealth of nations". The relevance of this question can be shown by the simple data represented in the below figure 1.1. This figure effectively illustrates the wide gap in living standards and differences in the range of income between countries. For example, the per capita GDP of Nigeria is 358US dollars in 1990 in comparison to China of 391US dollars. Comparing this to recent years like 2011 in which both countries have had a significant growth over the years, Nigeria stands at 565dollars, and China stands at 2,639dollars. This shows that despite the increased growth level not much has change as there is still great disparity in income between Nigeria and China. In fact, one may have to conclude that the gap is wider. The huge difference in GDP per capita income across countries is evident enough to show that some countries are growing and have been maintaining their growth rates while others are not growing at all (Barro 1991).
A notable illustration of economic growth is given by Durlaf et al. (2004) who emphasized the division of the world population into minority of rich and the majority of poor, this result in the fact that UK and other western countries managed to sustain their positive growth rates and others did not. For instance, United States GDP per capita as at 2011 is 37,691dollars. This sustained growth was what increase per capita GDP and gradually these countries outperformed others resulting in the wide income gap between developed and developing countries.
Figure: 1.1 Income Levels of Nigeria and United States
Source: World Development Indicators 201
However, some countries have shown exceptional performances in economic growth. In literature, they are termed as growth miracles and growth disasters. Countries that have shown growth miracles include Botswana, China, Singapore, and South Korea etc. like South Korea whose level of income increased from 12.25% to 47.03%. Also, other countries of growth disasters include Liberia, Niger, and Republic of Congo etc. For example, in the Republic of Congo the income level dropped from 2.99% to 0.32% in 2005. The examples of growth miracles and disasters make it clear to economist that a clearer understanding of what determines growth could contribute significantly to improving the standard of living. In response to this economic literature has shown great interest in quantifying various theories of growth (Temple 1999) and in studying deeper the determinants of economic growth. Several variables have been proposed by recent literature such as financial development, economic policy, population growth etc. (Temple 1999). In respect to this aspect, the study tries to fill the gap in economic literature by exploring the dimensions of interaction between one important aspects of integration into the world economy namely, Foreign Direct Investment (FDI) and its linkage with economic growth. Furthermore, the most crucial factor inducing economic growth in a country is investment which is important to increase the level of productivity. A strong correlation between investment and economic growth has been revealed by theoretical and empirical studies by development economists in both developing and developed economies of the world. In Less developing countries; especially Nigeria there has been low level of capital accumulation, and this is needed to increase investment (Adofu 2010). This results from high level of poverty, pathetic financial system, which cannot properly mobilize funds to generate enough capital for investment. Consequently, the desired rate of economic growth has not been achieved due to the lacking domestic investment and therefore Foreign Direct Investment (FDI) has to be given due consideration. Particularly it is necessary for FDI to complement domestic investment in order to generate an increase in output which is necessary to promote growth in whole but specifically to reduce the rate of inflation, improve growth in the industrial sector and stimulate acquisition of foreign technology. FDI is a core element for growth in developing economies in order for such countries to have access to the benefits derived from globalization (Azim and Uddin 2001). Furthermore, in the past years, FDI has attracted considerable attention in many developing countries like Brazil, China, Russia and India. Different countries have been able to open up various and new ways of investment to help attract FDI, political, social, economic and technological factors play a determining role for the climate of investment which has a bearing on the operations of the business. Laying emphasis in the Nigerian economy, there has been progress in the inflow of FDI in Nigeria. This is as a result of privatization of banks, energy and telecommunication sectors and the improving macroeconomic policy framework although this has not been felt largely on the economy. The net FDI has increased to 4,982,533,937dollars in 2005 compared to past years and has been increasing since then (World Bank 2012). Recently, domestic investments have improved the economy of Nigeria as the government has made effort through allocation of resources especially in the areas of finance to help growth. There has been a growing consensus that FDI is yet to realize its enormous potentials. Also, few studies that have examined the determinants of FDI and relationship between economic growths. FDI in Nigeria was based on surveys with the exception of Dimowo and Edo (2002) and Akinlo (2004), while others studies model the relationships between FDI and growth for a broad cross section of countries. Some studies on developing countries found a positive relationship between FDI and growth and other studies laid emphasis on availability of infrastructure, favorable macroeconomics conditions and governance as a determinant for FDI.
1.2 Problem Statement
In most developing countries, FDI is a tool to improve growth in the country. Nigeria, a country with a growing population was last reported in 2011 by World Bank 2012 to have approximately 163million people. The standard of living of its citizens has not improved despite the flow of FDI into the country and the immense investment government has added in improving growth. Other countries such as South Korea, Thailand, China, Singapore, Costa Rica, and Chile amongst others have shown an upward movement in growth of the economy has a result of the inflow of FDI (Nagesh Kumar 2001). The Nigerian government has been striving to promote FDI, but due to the challenges such as government and macroeconomic instability, low growth, weak infrastructure, poor governance, inhospitable regulatory environments and ill-conceived investment marketing strategies have affected the inflow of FDI (Dupasquier and Osakwe 2006). Despite the challenges surrounding the economy, opportunities to have improved the inflow of FDI has not been fully utilized. Several studies have shown a high degree of success in the inflow of FDI, many of this studies state the need to look at some factors, particularly available infrastructure of the country in question of which some of this has been addressed to an extent and others still currently being addressed in Nigeria. Like the case of power availability, the government has been undergoing reforms to help increase distribution of power. Also, construction of roads and other social amenities have improved. While macroeconomic factors such as inflation, exchange rate has been relatively stable in recent years and also the political system remains volatile but better. As a result of this general improvement, it is necessary to determine if the inflow of FDI in recent years has increased economic development in Nigeria. Therefore, we critically need to analyze the impact of FDI on economic growth at this time.
1.3 Research Questions/Objectives of the study
The contribution of this proposed study is both at an empirical level and factual assessment of the role of Foreign Direct Investment inflows into the country, and its positive effects on Nigerian economic growth. Emphasis will be on recent years where the FDI inflows were the highest and the country experienced robust economic growth. Particularly, concentration will be on the following research questions:
1. Do FDI have a positive effect on the Nigerian economic growth? And
2. How can the inflow of FDI be used to improve economic growth in Nigeria? If s
3. What can the government do to attract more FDI to facilitate growth in the economy?
Broadly this study seeks to examine the motivations for FDI in Nigeria and the extent to which FDI contributes to economic growth; specifically, the research:
1. Examine the relationship between FDI and economic growth
2. Analyze the effect of FDI on economic growth and
3. Shed light on appropriate policies to pursue in order to encourage higher volume of FDI and their anticipated implications for economic growth.
1.4 Justification of the study
The role of FDI in an economy may be seen as beneficial for development even for other sectors. Therefore, it is necessary for the determinants that influence FDI not to be overlooked in order to boost growth in the economy. The diverse way has been considered is to create an enabling environment for the inflow of FD. The success of the inflow of FDI is on the basis on the prevailing situations in the economy and factors that can enhance and improve the flow of FDI. The study is to examine why Nigeria a country in West Africa is endowed with natural resources such as oil and others have not been able to attract huge foreign direct investment, and also with government investment, not leading to a significant growth. Furthermore like any other investor even Nigerians in the diaspora will only invest in an economy that has made provisions for an enabling and enhancing environment that promotes investment. A rational investor would not invest in an economy that does not have the necessary drivers for investment. Certainly, not in Nigeria where unemployment is so high, and the largest percentage of people are not educated. In past year, the minister of Education, lamented the decay in the country's educational system, revealed seventy percent of the graduates of Nigerian Institutions are unemployed, underemployed and unemployable. Even the previous Governor of the Central Bank, commented along similar lines when he said that over sixty percent of the people who apply for jobs in Nigeria are unemployable. This means the economy has not been able to absorb Nigerians at home let alone attracting foreign investors.
In addition, the real sector has been terribly incapacitated by lack of available infrastructure, which led to low productivity and capacity utilization. The revenue that the country is making from the high price of crude oil in the international market is not being translated into accelerated industrialization. More so a large percentage of the population especially the poor cannot feel that there is much dynamism in the economy. Therefore the economy has not induced vast FDI. Other developing countries have been able to attract foreign investors to improve growth. Of which, Nigeria has not. By doing this, we need to analyze investment in the Nigeria economy and see what role the various determinant for growth can play in determining FDI and how it can aid growth in the economy.
1.5 Literature Review
1.5.1 Theoretical Literature
This section describes how FDI is incorporated as a factor that influences growth. The intention is further to identify the circumstances in which FDI stimulates economic growth. Several studies have expressed theoretically and empirically the ways FDI can add to the improvement of growth of the host countries and its significance coupled with institutional and policy reforms for growth in developing economies (Krishna and Artur 2009).
Endogenous growth theory treats technology as an endogenous factor, which stimulates the path way of FDI that accelerates a country's economic growth in the long run. FDI induces new technology used in production process to accelerate economic growth by fueling capital accumulation. Secondly, FDI contributes to the accumulation of human capital through new management techniques introduced and labor training that enhances economic growth.
management techniques. On the contrary, the neo-classical growth model views FDI as a factor to have an effect in the short run also through technology. The variable is been treated as an intrinsic factor and have only short run effects.
Theoretically, Nigeria has to a large extent attracted FDI supposedly because of its vast natural resources especially oil, which has attracted foreign investors into the country precisely in the export sector. Although, Ekperiware (2011) in his findings revealed that NONOIL FDI has a more positive effect on the Nigerian economy on average compared to OILFDI. Policies should be put in place, to encourage FDI in the non-oil sector, which has more effect on economic growth, contrary to the extractive sector that has higher FDI in the Nigeria economy, and has less impact on economic growth. The attraction of foreign investor to this particular sector has been increasing because of the revenue that is generated from it, despite the macroeconomic factors and other hindering factors such as unstable political system.
However, the scope to which foreign investor are attracted to invest depends on how attractive the environment is that is the quality of the environment which depends on the rate of savings, the degree of openness and the level of technological development. Economies would benefit on high rate of savings, open trade regime and high technological product through increased FDI (Buckley et al., 2002). Samuel (2009) in his findings discovered that FDI helps to improve the economic development of the host country by augmenting the domestic capital through transfer of technology, managerial skills, marketing, innovation and other best practices introduced. He made mention that FDI has its own cost and benefit and its impact in the host country depends on the prevailing condition and policy environment in terms of the ability to diversify and absorb the opportunities for the linkages between FDI and economic growth. Further emphases were laid (Macaulay 2011) that policies to improve macroeconomic stability in the country should be implemented to improve FDI.
1.5.2 Empirical Evidence
Having identified principal factors that determine growth and how FDI is incorporated as a factor to influence growth, this section reviews the associated empirical literature. Empirical results on the intricate relationship between economic growth and FDI have been a repeated issue of deliberation even in international economies and development economies (Zhang 2006). Many empirical works have shown the relationship between FDI and growth at various levels, which include sectors, provinces, and regions and across countries. Studies investigated this relationship at a sectorial level like the case of Indonesia (Abdul and Ilan 2007). They examined different impacts of FDI across sectors; results showed that the composition of FDI is important for its effect on economic growth. Only few sectors showed a positive impact of FDI and one other sector showed a robust negative impact of FDI inflows (mining and quarrying). Also, (Ping Yu et al., 2010) analyzed the interrelationship in terms of inter-sectorial externalities in China for the period of 14 years for 30 provinces using panel data analysis, and suggested that foreign capital has abated spillover effect over time, which added positively to China's economic growth. Therefore, foreign capital adds to the formation of social capital with the path way flow domestic capital and contributes to the formation of social capital.
Furthermore, Eke et al., (2003) used causality test to examine the relationship by investigating foreign private investment to GDP. Results indicated that causality runs in both directions concluding that foreign direct investment is a relevant determinant for real development in Nigeria. However, foreign capital inflow is growth - path dependent. Haitao (2011) from his findings discovered that there is a long term stable equilibrium relationship between FDI and economic growth at first-order co-integration, and the granger causality test shows that a rise in FDI can promote growth, but it is not always the result. Also, (Ogundipe et al., 2011) explored the use of granger causality and showed that there is a causal relationship between FDI and economic growth. Likewise in the case of Pakistan (Ahmad 2010) in his findings realized that FDI plays a role in influencing domestic investment, which promotes growth when results showed a long run relationship and a positive correlation between both variables. Akinlo (2004) in his empirical studies indicated that private capital and lagged foreign capital has little effect on economic growth in Nigeria. However, Adofu (2009) recognized the sensitive role of FDI in Nigeria which plays an important role in economic growth as there is a positive relationship. Also, Adeolu (2007) concludes on the same result, but the whole effect of FDI on economic growth might be insignificant, though the constituents of FDI have a positive impact. He found out that the manufacturing sector FDI affects the economy negatively because of the poor business environment in the country unlike the communication sector which has the highest potential to grow the economy and the oil sector.
Jayachandran and Seilan (2010) found a positive relationship between economic growth, trade and FDI for India over the period 1970-2007. Further emphasized by Sam (2011), showed that there is still a great link between FDI and export growth. Policies should be channeled towards improving export oriented FDI and at the same time, geared towards improving basic infrastructure, which will lower production costs thereby improving the competitiveness of the economy and invariably attract more foreign direct investment into the economy (Abu and Achegbulu 2011).
In 2009, other studies have shown that foreign direct investments have a positive impact on current account balance in Balance of payment and exchange rate while inflation was seen not to have a significant impact on foreign direct investment inflows. Sound economic policies should be implemented to attract the desired level of FDI and make the country investor friendly. Principally, the above reviewed empirical studies suggest that ways in which FDI affect growth depends on the economic and technological conditions of the host country. However, in general most of the existing studies were focused mainly on economies with leading manufacturing FDI.
1.6 Scope of the Study
This study will use Nigeria to examine the impact of FDI on economic growth and will cover a time period of 21 years from 1990 to 2010. Also a proper analysis of the path way of FDI inflow in previous years into the country will be evaluated and its impact on different aspects of the economy.
1.7 Theoretical Framework and Research Methodology
The main purpose of the study is to assess/quantify the impact of FDI on economic growth in Nigeria. The data in this thesis starts from year 1990 to 2010, based on the grounds that Nigeria started receiving a significant amount of FDI inflows after the 1990s. The dataset will encompass 21 years of annual data. Secondary data will be obtained in order to achieve the identified objectives of the project; the data to be collected is an annual time series data. The data for GDP, FDI, government size and trade openness will be sourced from Central Bank of Nigeria's Statistical Bulletin and infrastructure and human capital is sourced from World Development Indicators 2004. Access to necessary data has been granted. The theoretical framework is going to be based on the theoretical models of the neoclassical and endogenous growth. We adopt an augmented Solow production function (Solow 1956) that makes the output a function of stocks of capital and labor. The model has been extensively used in econometrics studies to estimate the impacts of trade and FDI inflow. It assumes that 'conventional inputs' of capital and labor are used in the neoclassical production function and 'unconventional input's like FDI and trade can be incorporated into the model to examine their impact on economic growth. So we also include trade as Nigeria has had an active trading activities and FDI is introduced as an additional input. Further, other exogenous factors are included. The augmented production function has the following form:
Yt= At Ktα Ltβ
Yt= At Ktα Ltβ FDItλ XMtγ
Where Yt is the flow of output, K represent capital and L represent labor, XM is total trade and FDI is Foreign Direct Investment.
An explicit function is specified after taking the natural logs as follows:
In Yt = c + α InKt +β InLt + λ In FDIt + γ InXMt + εt
Often included determinant of growth will be added. The model is based on the endogenous growth theory, as developed by (Balasubramanyam, Salisu, and Sapsford, 1996) and (Borensztein, Gregorio, & Lee 1998). The model is based on the assumption that FDI contributes to economic growth directly through new technologies and other inputs as well as indirectly through improving human capital, infrastructure, and institutions and the level of a country's productivity depends on the FDI, trade, domestic investment.
The Methodology will be used in order to achieve the research objectives, and it would be based on quantitative research through the use of appropriate statistical tools that will be used for the presentation, interpretation and analysis of collected data. The methodology to be employed is a regression model which is specified to examine the effects of FDI on the growth of the economy. We estimate these effects of by ordinary least squares (OLS) method and the data will be tested for unit root (nonstationarity) by using the Augmented Dickey-Fuller (ADF). Further, if the variables are not stationary at the level or it will be stationary at different levels then co-integration will be used to apply the OLS Then, to capture the impact of most of the critical variables, it does not account for the possibility of bidirectional relationship between growth and FDI highlighted in the recent literature. The technique of Granger-causality is employed to capture these possible temporal causality relationships (Granger, 1969, 1980). First, we test the effect of FDI on economic growth in the period 1990-2010 using the method of bi-variate regression. The empirical growth literature has identified a number of variables that are typically correlated with economic growth. This includes Infrastructure development, Openness of the host economy to trade, Government size, Human capital and Inflation rate. The specification of the model is :
RGDP = β0 + β1FDI + β2XM +β3GS + β4INFL +β5INFRA + β6HUMCAP + U
RGDP = Real GDP per capita,
FDI = inflow of foreign direct investment inflows
XM = the sum of total export and import (trade openness)
GS = government final expenditure consumption
INFL = rate of inflation
INFRA= measured as electricity production per kilowatts
HUMCAP= measured as total labor force
Error term =U.
Our methodology will help us in estimating our empirical model and produced empirical analysis
1.8 Organization of study
This paper is structured as follows: in chapter two the stylized fact about FDI sector in Nigeria is briefly discussed giving background knowledge and a discrete analysis of the performance of FDI on the Nigerian economy. Chapter three explains the impact of FDI on trade, transition in the economy and economic growth following the theories and methodology to be used is explained. Chapter four gives detailed analysis and interpretation of results. The paper ends in chapter five where some concluding remarks are drawn from the main findings.
