advert

JOURNAL OF RESEARCH IN NATIONAL DEVELOPMENT VOLUME 8 NO 1, JUNE, 2010


THE RELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENT AND ECONOMIC GROWTH IN NIGERIA (1986-2007

A.J.C.Onu
Department of Business Administration
E-mail: foajconu@yahoo.co.uk
and
P. P. Njiforti
Department of Economics, Ahmadu Bello University, Zaria

Abstract

This study investigates the causal relationship between foreign direct investment (FDI) and Economic Growth in Nigeria within the period 1986-2007. The objective of this study is to examine the causal relationship between FDI and Economic Growth Strategy in Nigeria within the period 1986-2007. The study employed Granger causality test to determine the causal relationship between FDI and economic growth in Nigeria. The study used time series data to determine the nature of causation between FDI economic growth in Nigeria. The study found that there is a unidirectional relationship between GDP and FDI. The direction of causation ran from GDP to FDI. The study concluded that GDP caused FDI and not otherwise. The study recommended improvement in the investment climate for all kinds of capital to enhance competitiveness and strengthen the bargaining position of the country in the emerging globalized economy.

Keywords: Causal, relationship, foreign, investment, growth


 

 

Introduction

Foreign direct investment (FDI), has become very crucial to both developed industrial and developing economies. FDI introduces foreign capital and skilled labor into an economy. It also brings in technological know-how, raises efficiency and competitiveness, enhances export earnings and improves international marketing activities. Most neoclassical economists believe that foreign investments do not only accelerate the rate of economic growth and development in developing countries, but insufficient foreign investment would lead to a “sudden death”. Consequently, host country governments ensure that enabling environment for foreign investment is created.

 

The flow of foreign private investment or capital was the earliest form of resource transfer to developing countries. Historical antecedents indicate that until the First World War, capital to developing countries came directly mainly from Great Britain, France and United States of America to their former colonies.  The USA,

 

other industrial nations and multinational agencies started official assistance to less developed countries (LDCS) by the 1950s.  Shortly after the World War II and up to the period of the oil shocks starting from the 1970s, there was a surge in bank lending to LDCs (Gabmi, 2000).  Bank lending, however, dwindled in the wake of the debt crisis in 1982.  Thus, official assistance and capital flows were re-directed towards developed nations and the securitization of international finance started in developing countries.  The beginning of the 1990s witnessed an upsurge of emerging market economies and the revival of private finance in the form of FDI flows.
Foreign investment can play a major role in stimulating the economic growth of Nigeria. Foreign investors, through the establishment of multinational corporations, could help meet the country’s local demands, create job opportunities and act as mobilizers of local capital and entrepreneurs. Through research and adaptation, they could also help to harness and refine local raw materials as inputs of production. With further expansion, they could create the necessary technological and industrial base for the country and the necessary base for the country’s export trade.

 

Empirical studies of the impact of FDI on growth are concerned with either the overall effect on growth (or net welfare) or with specific aspects of the FDI impact on employment, technology, trade, entrepreneurship and other areas of the economy. Nevertheless, the nature of causation between FDI and economic growth remain unclear. It is, therefore, necessary to ascertain the link between FDI and economic growth in Nigeria.


The objective of this study, therefore, is to examine the causal relationship between FDI and economic growth in Nigeria within the period 1986-2007.

 

Literature review
Nigeria is a country endowed with arable land and abundant natural resources.  Government policies have been directed towards ensuring that what nature has provided is harnessed and utilized to the fullest for the benefit of the citizenry. Thus, Government policies and strategies towards foreign investments in Nigeria are usually shaped by two principal objectives:  the desire for economic independence and the demand for economic development (Garba, 1998). 

Economic independence is a situation in which a country does not have to rely on developed-country domestic and international economic policy to stimulate her own economic growth (Todaro, 1994). This implies that Nigeria develops her education system, technology, economic and political systems, attitudes, consumption patterns, dress, etc. to attain economic independence. Economic independence presupposes self-reliance and sustenance. Generally, the greater the emphasis on economic independence, the less generous the government would be in its incentive policies at attracting and promoting FDI.  Emphasis on accelerated economic development, on the other hand, would dictate a wider opening of the door for foreign investors to come in.

Since Nigeria is yet to attain her desire for economic independence, there is need for FDI to enhance economic growth. Odozi, (1995) classified into three broad aspects Nigeria’s dire need for foreign investment: to fill the savings and foreign exchange gaps and thereby enable the country to achieve its economic potential; to stimulate the acquisition of technology, transform the structure of domestic output and diversify and expand the non-oil export sector; and the effective management of external liabilities, both currently and in the medium- to long- term requires the injection of non-debt creating external resources.

Nigeria has initiated economic reforms aimed at increasing the role of the private sector and creating an enabling environment for FDI. Aremu (2003) observes that attempts at attracting FDI into Nigeria have been based on the need to maximize the potential benefits derived from them; and to minimize the negative effects their operations could impose on the country.  Foreign firms can raise the level of capital formation, promote exports and generate foreign exchange. They can provide the much needed market for domestic supplier and support industries and, in the process, transfer technology, increase industrial linkages and stimulate industry as a whole, while providing direct and indirect employment. They can disseminate best practices through the demonstration of higher production efficiencies, labor standards, wages and environmental protection. In addition, competition between foreign and domestic firms in a market dominated by a few large local firms can improve the competitiveness and efficiency of domestic firms.

Osaghale and Amenkhieman (1987) conducted an investigation to determine whether foreign capital inflows, oil revenues and foreign borrowing had any positive impact on the economic growth of Nigeria. They found that Nigeria’s revenue from oil export increased between 1970 and 1982 and that there was a substantial growth in her total foreign debts and foreign direct investment. The study also showed that there was a positive relationship between foreign direct investment (FDI) and Gross Domestic Product (GDP). The study concluded that the economy would perform better with greater inflow of FDI; and recommended that less developed countries (LDCs) should create more conducive environments for foreign direct investment.

Edozien (1968) stresses the linkages generated by foreign investment and its impact on the economic growth of Nigeria. He contends that FDI induces the inflow of capital, technical know-how and managerial capacity which accelerate the pace of economic growth. He also observed the pains and uncertainties that come with FDI. Specifically, he noted that foreign investment could be counter productive if the linkages it spurs are neither needed nor affordable by the host country; and concluded that a good test of the impact of FDI on Nigeria’s economic growth is how rapidly and effectively it fosters, innovates or modernizes local enterprises.
The role of FDI in capital formation in Nigeria has been increasing over the years. FDI/GCF (Gross Capital Formation) rose from 7.3% in 1974 to about 17% in 1985, although it was generally low in the late 1970s and early 1980s. For example, FDI only contributed 1.5% to GDP growth in 1976 and 0.5% in 1982. The relatively low level of FDI in total capital formation in these periods was similar to that of Korea and Taiwan, which had emphasized minimal levels of reliance on foreign investment. In contrast to this, were some South East Asian countries which had the policy of attracting FDI, for example, Indonesia. Nigeria retarded the contribution of FDI to gross capital formation during this period using infant industry protection, local content rules, FDI restrictions and other restrictive policies. The relative rise in the share of FDI in capital formation since 1993 has been due to rapid loosening of controls and regulations on the activities of multinational corporations in Nigeria. As a result, FDI/GCF ratio rose from 6.4% in 1986 to 32% in 1993 and 49% in 1998 (Fabayo, 2003).

Apart from its direct contribution to capital formation, FDI may also influence investment by domestic firms and by other foreign affiliates. An econometric exercise based on 39 countries over the period 1970–1996 showed that neutral effects dominated while the number of crowding out and crowding in cases was equal (UNCTAD, 1999:173). On the other hand, an IMF study based on 69 countries over the period 1970–1989 found that FDI from developed countries stimulated domestic investment (Borensztein et al, 1998).

The results of Garba (1997)’s study on direct foreign investment and economic growth in Nigeria for the period 1970–1994 show that the coefficient of FDI was positive with high values indicating the sensitivity of FDI to GDP. The results obtained from the second model show a good measure of the elasticity of foreign direct investment with respect to change in gross domestic product. The study found that changes in the gross domestic product were the most important explanatory variable in terms of its statistical significance.

Langley (1968) posits that FDI has both benefits and costs in the context of Nigeria’s economic growth. While foreign direct investment could engineer or accelerate GDP growth through the infusion of new techniques and managerial efficiency, Langley cautions that it could also worsen the balance of payments position. Foreign aid in the form of direct and portfolio investments generally impose a burden of repayment (capital outflow) on the recipient country.

Many studies of African economies, especially Nigeria, indicate that the impact of FDI is limited or even negative sometimes. In a study of Nigeria, Onimode et al (1983) found that where FDI was directed at import substituting firms, the value of imports was observed to be greater than the value added produced. This type of FDI would give rise to outflows of investment income and high cost of imported inputs which adversely affect growth. Ohiorheman (1993) asserts that with the research and development (R&D) concentrated in the head offices of multinational corporations (MNCs), technology transfer was limited. He added that even though the MNCs provided local training programs, Nigerians were neither exposed to the development stage of a product or process nor were they made to know the intricacies of machinery construction or installation. Consequently, their innovative ability was not enhanced. He noted that the research efforts of private enterprises (local and foreign) in Nigeria were minimal. He concluded that to the extent the MNCs dominated the manufacturing sector, their activities generated little multiplier effects and the linkage effects were generally low in the (manufacturing) sector.
The linkage between investment and growth do not mean that capital accumulation is the sole determination of economic growth in Nigeria. Easterly (1990); Benhabid and Javanovic (1991), and King and Levine (1994) have found that increases in investment are neither necessary nor sufficient for increasing growth over the medium run. Fischer and Easterly (1994) identify degree of distortions in an economy as the primary determinant of the social productivity of investment. They observe that if distortions are severe, increased investment may do more harm than good – it may actually lower social welfare and reduce growth. For similar reasons, Ogiogio (1996) also reports a negative contribution of public investment to GDP growth in Nigeria.

Using indices of dependence and development as a mirror of Nigeria’s economic performance, Oyaide (1977) concluded that FDI engineer both economic dependence and growth. In his opinion, FDI causes and catalyzes a level of growth that would have been impossible without such investment. This is, however, at the cost of economic dependence.
Although a lot of studies indicate that there exists a positive relationship between FDI and economic growth in Nigeria, there is a consensus among economists that the country’s growth rate would have a positive impact on FDI. The prospect that FDI will be profitable is brighter if the nation’s economic health is better and the growth rate of GDP is higher.

The growth of the economy using GDP growth rate as a proxy exerts positive effect on FDI. Chete (1997) confirms this with a model developed on the determination of FDI in Nigeria. The results obtained reveal that all the coefficients have their hypothesized signs and are statistically significant at 5 percent level. He noted specifically that inflation rate, external debt burden, gross capital formation and coup d’etat have negative coefficients which signify a negative relationship between the variable and FDI.

In examining the causal relationship between gross domestic investment and economic growth in Nigeria for the period 1975–1996, Obadan (1999) conducted a granger causality test. The result shows that the relationship between gross domestic investment and economic growth is unidirectional running from investment to growth. Evidence from the findings supports the crucial role of capital formation in the growth process.

Odozi (1995) posits that FDI appears to be the most crucial component of capital inflow Nigeria should seek to attract in the light of her current economic circumstances. He asserts that there is urgent need to stimulate the growth of domestic output, minimize the rate of inflation and unemployment and maintain a stable exchange rate in order to permit meaningful FDI to take place.

To optimize the impact of FDI, UNCTAD (1999) suggests that government of developing countries like Nigeria, need to address the issues of information and coordination failures in the international investment process, infant industry considerations in the development of local enterprises, the static nature of advantages transferred by trans-national corporations (TNCs) in situations where domestic capabilities are low and do not improve over time, or where TNCs fail to invest sufficiently in improving the relevant capabilities, and weak bargaining and regulatory capabilities on the part of host country governments, which can result in an unfavorable distribution of benefits from perspectives of the society.


 

Methodology

The Granger causality test will be applied to determine the causal relationship or the direction of causality between GDP and FDI. This test is necessary because the direction of causation between GDP and FDI is not certain. While some economic theorists believe that economic growth (GDP) causes FDI, others opine that FDI causes economic growth. The test assumes that the information relevant to the prediction of the respective variables, GDP and FDI, is contained solely in the time series data on these variables. The test involves estimating the following regressions:

     
Where it is assumed that the disturbances  are uncorrelated.

 

Equation 3.1 postulates that current GDP is related to past values of GDP itself as well as of FDI. Equation 3.2 also postulates a similar behavior for FDIt.

Generally, since the future cannot predict the past, if variable X (Granger) causes variable Y, then changes in X should precede changes in Y. Therefore, in a regression of Y on other variables (including its own past values), if we include past or lagged values of X and it significantly improves the prediction of Y, then we can say that X (Granger) causes Y. A similar definition applies if Y (Granger) causes X.

The study employed Time Series data to determine the causal relationship between FDI and economic growth in Nigeria within the period 1986 and 2007. The major sources of these data are the publications of the Central Bank of Nigeria (Statistical Journals published annually and quarterly, that is, Annual Reports and Statement of Accounts, The Bullion and the Economic and Financial Review), Nigerian Investment Promotion Commission (NIPC), Securities and Exchange Commission (SEC), Federal Ministry of Finance, Bureau for Public Enterprises (BPE), World Bank Reports, Seminar Papers, Journals, other Periodicals and the Internet.

Results and discussions
The nature of causation between FDI and economic growth (GDP) is unclear. While some economic theorists believe that FDI causes GDP, others are of the opinion that GDP causes FDI.  To test whether GDP causes FDI or FDI causes GDP in Nigeria, the data in Table 1 is used to run a Granger causality test to determine the direction of causation between the variables.

Table 1            GDP and FDI inflow for the period 1986-2007 (N’ million)

YEAR

GDP

FDI INFLOW

1986

70,806.4

4,024.0

1987

71,194.9

5,110.8

1988

77,733.2

6,236.7

1989

83,179.0

4,692.7

1990

92,238.5

10,450.2

1991

94,235.3

5,610.2

1992

97,019.9

11,730.7

1993

99,604.2

42,624.9

1994

100,936.7

7,825.5

1995

103,078.6

55,999.3

1996

106,600.6

5,672.9

1997

109,972.5

10,004.0

1998

113,509.0

32,434.5

1999

116,655.5

4,035.5

2000

121,207.8

16,453.6

2001

126,323.8

4,937.0

2002

131,489.8

8,988.5

2003

136,460.0

13,531.2

2004

527,576.0

20,064.4

2005

561,931.4

26,083.7

2006

595,821.6

41,734.0

2007

634,656.6

54,254.2

Source:      Computed from CBN Statistical Bulletin, Vol. 18, December 2007.
           

 

The Granger causality test statisticsis is presented in Table 4.2.

Table 2:           Pairwise Granger causality tests


Null Hypothesis

Lags: 1
Obs.  F-Stat    Prob

Lags: 2
Obs.  F-Stat   Prob

Lags: 3
Obs.  F-Stat    Prob

Lags: 4
Obs.  F-Stat  Prob

GDP does not Granger Cause FDI Inflow

21   9.12405 0.00735

20   3.99959 0.04054

19  2.52806  0.10663

18  1.26991  0.35019

FDI Inflow does not Granger Cause GDP

      0.01728  0.89687   

      0.11386   0.89315

      0.23555   0.86987

       0.51054  0.73002


We examine the Pairwise Granger Causality Tests using Table 2. The table shows the results in respect of one, two, three and four (that is, Lags: 1, Lags: 2, Lags: 3 and Lags: 4) respectively. The number of years the past behavior of the variables takes to impact significantly on the current period is indicated by the lags. One lags, two lags, three lags and four lags are used respectively. This enables us to determine how past records of the variables for a short period of one year and a medium period of two to four years affect their current value.

We rely on the test results in Lags: 1 (Table 2) to accept the null hypothesis that FDI does not cause economic growth. The results reveal that there is a unidirectional relationship between FDI Inflow and GDP. Based on Table.2, the F-value of 9.12 is statistically significant at 1 percent level of probability. Consequently, the null hypothesis that GDP does not Granger cause FDI inflow is rejected. However, the hypothesis that FDI inflow does not Granger cause GDP is accepted as judged by the low F-value of 0.02. Hence, the Granger causality test confirms a unidirectional causality from GDP to FDI inflow.

The results in Table 2 further show that the direction of causation runs from GDP to FDI. The direction of causation that runs from GDP to FDI can be justified by the increase in the level of economic activities, increase in income levels (particularly between 1999 and 2003), stable government, economic reforms such as bank consolidation, improvement in Information and Communication Technology (ICT), removal of trade barriers and privatization and commercialization of public enterprises. All these attract FDI.             

The Granger causality test results confirm the consensus among economists that the country’s growth rate would have a positive impact on FDI. The results also support Tambunlertchai (1994), Chete (1997), Garba (1997) and Saggi (2002) which indicate that the prospects that FDI will be profitable is brighter if the nation’s economic health is better and the growth rate of GDP is higher. Thus, the growth of the economy, using GDP growth rate as a proxy exerts, positive effect on FDI.

Conclusion

Evidence from the study showed a positive relationship between FDI and GDP during the period under review. The Granger causality test indicated that FDI did not granger cause GDP; rather, GDP granger caused FDI. The causality analysis indicated a unidirectional causal effect running from GDP to FDI contrary to the a priori expectation. Though FDI exhibited a positive relationship, its contribution to economic growth in Nigeria during the study period was not statistically significant. This was due to poor economic performance which made the domestic economy less competitive to attract FDI. Political instability, poor macroeconomic management, the threat of crime, violence and personal security problems throughout the Niger Delta oil-producing region also accounted for the decline in FDI inflow to Nigeria during the study period.

The study found that FDI did not Granger cause GDP; rather, GDP Granger caused FDI for the period 1986-2007. Thus, GDP stimulates FDI. Also, there was a unidirectional relationship between FDI and GDP. The results contradicted our a priori expectation that there was a bi-directional relationship between FDI and GDP. The results in table 2 further showed that the direction of causation ran from GDP to FDI. This implied that the growth of the economy using GDP growth rate as a proxy exerted positive effect on FDI.

The paper recommends improvement in the investment climate for all kinds of capital whether domestic or foreign to enhance competitiveness and strengthen the bargaining position of the country in the emerging globalized economy. There is need for the establishment of stable and credible governments that would be committed to policy reforms and avoiding frequent policy reversals which signal uncertainty and discourage foreign investment.

 

References

Aremu, J.A. (2003); Foreign Direct Investment: Determinants and Performance; National Centre for Economic Management and Administration (NCEMA), Macro-economic Policy Analysis and Management Program, designed for Research Staff of the Central Bank of Nigeria.

Benhabid, J. and B. Javanovic (1991); “Externalities and Growth Accounting”; American Economic Review, Vol. 18, No. 1, P. 82-113.

Borensztein, E.; J. DeGregorio and J. Lee (1998); “How Does Foreign Direct Investment Affect Economic Growth?” Journal of International Economics; Vol. 45, P. 115-135.

Chete, L. N. (1997); “Determinants of Foreign Direct Investment in Nigeria: An Error Correction Specification for Economic Development in Nigeria”; Nigerian Economic Society.

Easterly, W. R. (1990); “Endogenous Growth in Developing Countries with Government Induced Distortions”; Unpublished World Bank, August.

Edozien, E. C. (1968); “Linkages, Direct Foreign Investment and Nigeria’s Economic Development”; Nigeria Journal of Economic and Social Studies; Vol. 10, No. 2, P. 191-203.

Fabayo, J. A. (2003); “Foreign Direct Investment and Manufacturing Industries in Nigeria: Performance, Prospects and Problems” in Nnanna, O.J.; Okafor, C.M. & Odoko, F.O. (eds.): Foreign Private Investment in Nigeria; Proceedings of the 12th Annual Conference of the Regional Research Units, Central Bank of Nigeria.

Fisher, S. and W. R. Easterly (1994); “The Soviet Economic Decline: Historical and Republican Data”; World Bank Processed Policy Research Working Paper, Washington DC, No. 1284.

Gabmi, I. I. (2000); “The Impact of Government Policies on the Flow of Foreign Direct Investment in Nigeria”; (Unpublished M.Sc. Research Proposal), Department of Economics, Ahmadu Bello University, Zaria.

Garba, S. T. (1998); “Direct Private Foreign Investment and Economic Growth in Nigeria (1980-1996): An Empirical Investigation”; (Unpublished Ph.D. Thesis) submitted to the Postgraduate School, ABU, Zaria.

Langley, K. M. (1968); “The External Reserve Factor in Nigerian Economic Development”; The Nigerian Journal of Economics and Social Studies; Vol. 10; P. 151-160.

Obadan, M. I. (1999); “Savings, Investment and Growth in Developed and Developing Countries”; A Paper Presented at Annual Conference of the Zonal Research Unit on Evaluating Investment Performance for Re-invigorating Growth and Development in Nigeria; Organized by C.B.N.

Odozi, V. A. (1995); “An Overview of Foreign Investment in Nigeria: 1960 to Date”; A Paper Presented at the National Conference Organized by Securities and Exchange Commission, Abuja; May 30th –June 1st.

Ogiogio, G. O. (1996); “Planning Horizon, Government Expenditure and Economic Growth in Nigeria”; in Ariyo, A. (ed.): Economic Reform and Macro-economic Management in Nigeria; The Centre for Public-Private Cooperation, Ibadan.

Ohiorheman, J. F. (1993); “Multinational Corporation and the Nigerian Political Economy”; The Nigerian Journal of Economic and Social Studies (NJESS); Vol. 35.

Onimode, B. et al (1983); Multinational Corporations in Nigeria; Skyraden, Ibadan.

Osaghale, B. D. and F. Amenkhieman (1987); “Foreign Debt, Oil Exports, Direct Foreign Investment and Economic Performance in Nigeria (1960-1984)”; The Nigerian Journal of Economic and Social Studies; Vol. 29, No. 3.

Oyaide, W. J. (1977); The Role of Direct Private Investment: A Case Study of Nigeria, 1963-1973; United Press of America, Washington.

Todaro, M.P. (1994); Economic Development; 5th Edition, Longman, New York and London.

UNCTAD (1999); “Foreign Portfolio Investment (FPI): Characteristics, Similarities, Complementaries and Differences”; Commission on Investment, Technology and Related Financial Issues; Expert Meeting, Geneva, June 28-30.