|Home Instructors Journals ContactUs|
FISCAL POLICY AND NIGERIAN ECONOMIC GROWTH
Omitogun Olawunmi and Ayinla, Tajudeen A.
There exists a consensus in the literature that an adequate and effective macroeconomic policy is critical to any successful development process aimed at achieving high employment, sustainable economic growth, price stability, long – viability of the balance of payments and external equilibrium. This, therefore, suggests that the significance of stabilization policy (fiscal and monetary policies) cannot be overemphasized in any growth oriented economy. Growth and poverty alleviation have received attention in Nigeria (see, for example, Aigbokhan, 1985, 1998; Obadan, 1997; Ogwumike and Ekpenyong,1995; among several of such studies). However, none of these studies have attempted to examine the work analytically. Furthermore, previous works on Nigeria have relied on partial frameworks. The differential effects of fiscal policy on various productive sectors and on the different income groups are neither explored nor captured. Most of these studies have preoccupied themselves with presenting poverty profiles in Nigeria. Some of them have attempted to examine the impact of growth on inequality. But it is quite clear from the literature that growth, inequality and poverty can influence, and in turn influenced by, fiscal policy.
The remainder of this paper is organized into six basic sections. Section two presents the conceptualization of fiscal policy, section three provides theoretical framework on the links between economic policy and the achievement of macroeconomic objectives, while section four focuses on review of relevant empirical literature. In section five, we examine issues on the Nigerian fiscal policies and macroeconomic performance. Section six centres on empirical analysis. Under this section, we consider model building, estimation techniques, and discussion of results. Finally, policy recommendations and conclusions are presented in section seven.
Conceptualization of Fiscal Policy
The term fiscal policy has conventionally been associated with the use of taxation and public expenditure to influence the level of economic activities. The implementation of fiscal policy is essentially routed through government’s budget. The budget is, therefore, more than a plan for administering the government sector. It (budget) both reflects and shapes a country’s economic life. In fact, the most important aspect of a public budget is its use as a tool in the management of a nation’s economy.
In designing and implementing fiscal policy, government plans for budget deficit, budget surplus or balanced budget. Budget deficit is a type of budget plan in which government expenditure outweighs its revenue while budget surplus is a budget plan where government revenue is proposed to be greater than government expenditure. Balanced budget, however, arises when government expenditure equals government revenue.
When there is economic recession or depression, government plans for budget deficit which is often referred to as expansionary fiscal policy. In this situation, taxes (i.e. compulsory levies imposed by the government on individuals and corporate bodies) are reduced and government expenditure is increased. The implication of this is that by reducing taxes, the purchasing power of individuals is enhanced and the cost of production by corporate bodies reduces thereby improving their scale of operations. Similarly, increases in public expenditure if efficiently utilized could translate into improved infrastructural developments and consequently enhance general welfare and also put the economy on the path of growth.
The bone of contention, however, on the use of this type of fiscal policy (i.e. expansionary fiscal policy) is how the proposed increase in public expenditure over its revenue should be financed. The two contending options have been money printing and borrowing. Money printing is an exclusive right of relevant monetary authority (usually the Central Bank) which involves raising money supply to match demand in the economy. However, where the rate of increase in money supply (usually called Seignorage rate) rises above the rate of growth of economic activity, and given a stable demand function for base money, inflation will result (see Ndung’u, 1995). Easterly and Fischer (1990) argue that where governments print money to cover budget deficits, it is unlikely that rapid money supply growth takes place without fiscal imbalances.
The second contending option of deficit financing is borrowing. The use of borrowing (from both domestic economy and foreign countries) particularly since the World War II has been an inevitable and veritable source of macroeconomic financing most especially in such situations where domestic resources are inadequate to put the economy on the path of sustainable economic growth and development. However, borrowing which may result in debt crisis may lead to high real interest rates in the domestic economy and crowd out private sector investments (see Easterly and Schmidt, 1990, 1993; Ndung’u, 1995).
Also, government can plan for budget surplus (which is also referred to as contractionary fiscal policy) particularly in such a situation where the government deems it necessary to reduce her participation in terms of production in the domestic economy. The government does this by reducing public expenditure and increasing taxes. This type of fiscal policy rarely attracts attention of policy makers and researchers because of the fact that the development of World economy particularly in the developing part, is an on-going process and as such majority of governments World over often engage in massive investment activities (fiscal deficit) which they believe will not only enhance the development of the domestic economy but also situate the economy on the path of sustainable growth ( although there are controversies in literature on how government should invest in the economy).
Economic Policy and the Achievement of Macroeconomic Objectives: A Theoretical Review
The role of economic policy in the achievement of macroeconomic objectives has been extensively dealt with in Keynesian analysis of an activist macroeconomic policy. The Keynesian analysis leads to the conclusion that demand management policies can and should be used to improve macroeconomic performance.
An activist macroeconomic policy involves setting monetary and fiscal variables in each time period at the values which are thought necessary to achieve the government’s objectives. A basic premise of Keynesian economics is that the private sector is inherently unstable. It is subject to frequent and quantitatively important disturbances in the components of aggregate demand. It is the task of counter cyclical or stabilization policies to offset these private sector disturbances and so keep real output close to its market – clearing equilibrium time path. Activist stabilization policy can take two forms: it can either be discretionary or determined by some feedback rules which relate policy to current and lagged output. Discretionary policy involves the government or other authorities, such as the Central Bank, deciding in each period what the appropriate policy response should be given current circumstances. A feed back policy rule would establish some fixed formula for deciding what values the policy variables should take. This formula would remain unchanged over a considerable time span. An example of such a policy rule is one which states that the money supply is expanded at a rate equal to some fixed proportion, λ, of the deviation of current and lagged output from its market clearing equilibrium level. In contrast, a discretionary policy involves the authorities being able continually to vary their choice of λ and other policy parameters. (Levacic and Rebman, 1976: p 426)
The broad objectives of Keynesian macroeconomic policy are not in dispute, these objectives are full employment, a stable price level, the absence of significant deviations of output from its equilibrium time path, a satisfactory rate of economic growth, an equitable distribution of income, and balance of payment equilibrium. There exist, however, differing opinions, regarding the priorities accorded to these objectives. Infact, there is an even greater divergence of views on the means by which such objectives can be actualized.
Keynesian activist policy has come under increasing attack from the monetarist and classical schools, which regard the private sector as inherently stable. They do not deny that random disturbances occur in the private sector but they do not think that these are either large or further amplified by quantifying adjustments. Aggregate supply shocks are seen to be equally significant as the aggregate demand shocks emphasized by Keynesian. The private sector adjusts via relative price changes to such disturbances quite adequately, so active stabilization policy is not required. Furthermore, it (stabilization policy) may, if implemented increase rather than diminish fluctuations in output and employment.
Nevertheless, stabilization policy requires that policy makers can determine feasible targets, have a reasonable knowledge of the workings of instrumental variables and can effectively control the instrumental variables. The targets are those variables for which the government seeks desirable values. The targets are set with a view to maximizing social welfare. Instrumental variables, however, are those variables those variables which the government can manipulate to achieve its economic objectives. Instrumental variables are necessarily exogenous variable as the government must be able to determine their values independently of the other variables, whereas tax revenues are not since their values are determined not only by the tax rates set by the government but also by the level of national income. Similarly, “high – powered” money is, in principle, an instrumental variable whereas the money supply is not. The quantity of money depends not only on the volume of high – powered money but also on the volume of Bank lending which is not directly under government control. The money supply is therefore regarded as an intermediate target. In order to estimate the levels at which the instrumental variables must be set, the policy makers need to know the model of the economy whose structure relates the endogenous variables to the exogenous variables, some of which are amenable to government control. (See Levacic and Rebman, 1976: p 426-428) A further important point to note is that since the economy is made up of interdependent behavioral relationship one cannot in general set one instrumental variable to determine the target. The whole set of target and instrumental variables have to be looked at as a whole.
The warning that active demand – management policies could be destabilizing was made by Friedman as early as 1948. Friedman’s basic argument is that government intervention can make the fluctuations in national output larger than they would otherwise have been. To explain this argument, we need to define two types of output fluctuations. The first is the difference between the market clearing equilibrium on target value of output, Yt(e), and the actual value of output, Xt that would occur without government intervention. This difference is known as the pure cycle deviation in output and is Xt - Yt(e). To know whether policy improves, matters by reducing the size of output fluctuations. We need to compare the pure cycle deviation with the actual output deviation that occurs when demand – management policies are in operation. This is measured as Xt - Yt(e), where Yt is national output with activist policy and is obtained by adding a policy induced amount of output, ut to the pure cycle level, Xi.
That is, Yt = Xt + Ut……………… .. (1)
For perfectly stabilization policy, we require that the deviation of actual output with policy from its equilibrium level is zero that is
Yt - Yt (e) = Xt + Yt - Yt (e) = 0 …………………… (2)
Ut = - [Xt - Yt (e)] …………………………… (3)
Equation (2) states that, for perfect stabilization, the policy – induced change in output, Ut, must be of the same absolute size but opposite in sign to the pure cycle deviation.
The mistiming of policy occurs because of lags and uncertainties in the implementation of policy measures. The policy lag can be split into two types. The inside lag is the time taken between the deviations of actual Gross Domestic Product (GDP) from its desired path and the implementation of counter – cyclical policy. First, it takes time for policy – makers to recognize that deviation of GDP from its desired time path has occurred. This lag can be reduced by increasing the speed with which statistics are gathered and improving forecasting techniques. The second components of the inside lag is due to institutional and political factors which cause delay in the implementation of policy. The outside lag refers to the time taken for the target variables to be affected by the policy measure once this has been implemented. The longer is the lag, the greater is period of time over which the effect of a policy change on Gross Domestic Product (GDP) are extended. The shorter are the pure cyclical fluctuations, the more likely it is that the policy – induced deviation in GDP, implemented to counteract a negative (positive ) pure cycle, will still be in existence when the pure cycle in income turns upwards. (Levacic and Rebman, 1976: p 426)
However, long lags do not by themselves make for destabilizing counter – cyclical policy. So long as these lags are known the required amount of corrective action can be calculated. The important element in making counter – cyclical policy unstable is uncertainty. When the exact response over time of GDP to change in an instrument variable is unknowns, there is some probability that counter cyclical policy will be destabilizing (Fischer and Cooper, 1973).
In addition to the controversies among the different schools of thought on the possible linkage between fiscal policy and economic growth, efforts have also been made by researchers to authenticate or refute the arguments of these prominent schools of thought.
Ndung’u (1995:p 19-34) attempts to establish whether there is a link between budget deficit, the rate of inflation and money supply growth, on the one hand, and money printing and the rate of inflation on the other. Using multivariate Granger Non-Causality tests, it was found that, at least in the case of the Kenyan economy, budget deficits affect monetary base growth. It was also found that there are both direct and indirect links between money printing and the rate of inflation. It was, therefore, concluded in this paper that budget deficits affect growth in the monetary base, money printing affects the rate of interest and hence the rate of inflation and in addition, excess money printing affects the rate of inflation.
Phillips (1997: p 23-25) critically analyses the Nigerian fiscal policy between 1960 and 1997 with a view to suggesting workable ways for the effective implementation of Vision 2010. He observes that budget deficits have been an abiding feature in Nigeria for decades. He notes that expect for the period 1971 to 1974, and 1979, there has been an overall deficit in the federal Government budgets each year since 1960 to date. The chronic budget deficits and their financing largely by borrowing, he asserts, have resulted in excessive money supply, worsened inflationary pressures, and complicated macroeconomic instability, resulting in negative impact on external balance, investment, employment and growth. He, however, contends that fiscal policy will be an effective tool for moving Nigeria towards the desired state in 2010 only if it is substantially cured of the chronic budget deficit syndrome it has suffered for decades.
Egwaikhide (1998) appraises the implication of Nigeria budget deficit profile for inflation and the current account balance. Evidence indicates that fiscal indiscipline in terms of lack of control over expenditure is the major determinant of budget deficit in Nigeria, while its mode of financing has aggravated inflation in the country. Most importantly, it is revealed that budget deficit correlates highly with current account deficit, implying that external disequilibrium is partly attributable to endogenous factors.
Adenikinju and Olofin (2000: p 1-14) focus on the role of economic policy in the growth performance of the manufacturing sectors in African countries. They utilize panel data for seventeen African countries over the period 1976 to 1993. Their econometric evidence indicates that government policies aimed at encouraging foreign direct investment, enhancing the external competitiveness of the economy, and maintaining macroeconomic balance have significant effects on manufacturing growth performance in Africa.
Folorunsho and Abiola (2000: p 37-52) examine the long –run determinants of inflation in Nigeria between 1970 and 1998, using the econometric methods of cointegration and error correction mechanism. They find that inflation in Nigeria could be caused by the level of income, money supply, and public sector balance. The results also indicate that in the long –run, exchange rate, money supply, income and fiscal balance determine the inflation spiral in Nigeria. The study, therefore, concludes that a reduction in fiscal deficits, an increase in domestic production and a stable exchange rate should be pursued as means of controlling inflation in Nigeria.
Olaniyan (2000: p 23-36) measures the effects of economic instability on aggregate investment in Nigeria. Using a typical reduced form of investment equation with measures of instability among which include, fiscal deficits, it was found that these measures of instability have depressed investment in Nigeria.
Bogunjoko (2004) examines the growth performance in Nigeria. He adopted a linear equation of the production function as suggested by Ram (1989) and adopted by Aigbokhan (1996). In order to complement the single equation model and account for the interdependency of expenditure and growth in Nigeria, a vector autoregressive model of three variables namely real output, federal government expenditure and state government expenditure was employed. Based on the Ram – type production function, the empirical results show that while the externality of the alternative expenditure (i.e. federal and state) is positive, the overall impact of the expenditure is growth retarding. This finding complements the argument that federal and state expenditures are made without due reference to the absorptive capacity of the economy. His VAR model shows that, inter – temporally, the response of real output to state and federal expenditures is weak in the short run. Aigbokhan (1996) opined that federal government spending if employed efficiently could boost private investment and promote economic growth. Ekpo (1994) contended that the role of the public sector should be limited to the continuous creation of an enabling environment to allow and enhance private sector – induced development. Ogiogio (1996), however, notes that the economy does not have the productive capacity to support growth in the absence of new (government) investment. In particular, it was agreed that government expenditure was necessary for the maintenance of existing infrastructure and the implementation of policies / projects in the economic and social sectors of the economy.
Fiscal Policy in Nigeria
Disheartening, however, is the fact that budget deficits in Nigeria hardly comply with these principles. The unproductive performance of ever increasing government expenditure is also reflected in the level of economic growth proxied by real GDP growth rate which was, in fact, negative between 1981 and 1985 and 1987 and suggested an average of 2.6 percent over the period under consideration (1981 - 2004). Also, the high degree of instability became more obvious with the inflationary trends maintaining two digits for seventeen (17) years out of the twenty five years of study coverage.
Table 1: Selected Macroeconomic Variables and Fiscal Policy Performance in Nigeria (1981 – 2004)
Source: Computed from CBN Statistical Bulletin and Annual Report and
Where Q is the national output, K represents capital resources employed and L for unit of labour employed in the production process.
For the purpose of this paper, the capital component of the model is broken down into public and private capital (expenditure) at least for a mixed economy like Nigeria where both the public and the private sectors interrelate in virtually all facets of economic life. Since our focus is on the public sector influence, the model is restricted to public capital. Consequent upon the fact that public sector capital is determined in every fiscal year through a mechanism called budget, the budgetary balance (deficit/surplus) can be used as a measure of public capital. This budgetary balance indeed represents a tool of assessing fiscal policy effectiveness (see Tanzi et.al. 1987; Tchokote, 2001). Since the yearly published annual reports in Nigeria revealed fiscal deficits for federal government finances, at least for the period under study, the policy variable (fiscal deficit) is used as a measure of fiscal policy effectiveness.
Also, the financing of fiscal deficits has gained prominence in empirical literature particularly in terms of how it can affect the effectiveness of fiscal policy in the area of private consumption, savings , investment, and in promoting sustainable economic growth (see Ndung’u, 1995; Tchokote, 2001). Fiscal deficits can be financed through borrowing or money printing (see Easterly and Fischer, 1990 and Easterly and Schmidt-Hebbel, 1993). The following identity, therefore, represents the methods of financing fiscal deficits:
DF = FB + DB + MP ………………………………………….. (ii)
Where DF is deficits financing, FB represents foreign borrowing, DB for domestic borrowing and MP is money printing. Of course, there are debatable issues associated with the macroeconomics of deficits financing, ranging from inflationary or non-inflationary to crowding in or crowding out effect of debt or money printing financed deficits, the focus of this paper, however, is limited to how debt financed deficits and money printing financed deficits can affect growth drawing experience from Nigeria in which to the knowledge of the author, there seems to be no comprehensive empirical study in this respect.
From the foregoing, therefore, a reduced form of the economic growth model is hypothesized in functional form below:
Q = f (FDR, DFD, MPFD) ………………………………………. (iii)
Q is the level of economic growth; FDR is fiscal deficits ratio; DFD represents debt financed deficits and MPFD represents money printing financed deficits. From the derivations [i.e. (iii a, b &c)], FD is fiscal deficits, DEBT is total debt, GDP represents gross domestic product and MS is Money Supply.
Presentation and Discussion of Results
Table 2: Effect of Fiscal Policy on Economic Growth in Nigeria
R – Squared =0.17
Table 3 : Effect of Fiscal Policy on Economic Growth in Nigeria (SAP era)
R – Squared =0.088
The empirical results generated from the estimation as presented in tables 2 and 3 above are revealing and in fact instructive. It was found that deficit financing recorded over the years, at least for the period under study (1980-2004), has no statistically significant impact on economic growth in Nigeria. The sign of the estimated coefficient on deficit financing is in fact negative suggesting that fiscal deficit has depressed economic growth in Nigeria. This is an indication that fiscal policy pursued by the Nigerian government has not achieved its aim particularly in the area of promoting sustainable economic growth in the country More worrisome is the fact that the economic reform package tagged Structural Adjustment Programme (SAP) pursed in 1986 further worsened the behaviour of fiscal policy in Nigeria as evident in the post-SAP estimation particularly judging by the results of the t- statistic f-statistic and coefficient of determination which are lower (compared to the overall estimation) and statistically insignificant too. The disturbing behaviour of fiscal policy during the SAP era may be due in part to poor implementation or lack of feedback mechanism.
Of course, one might one to suggest that this finding invalidates the Keynesian school of thought stressing the need for an active macroeconomic policy to stimulate economic activities, this may, however, be erroneous based on the fact that the problems of policy inconsistencies, high level of corruption, wasteful spending, poor policy implementation and lack of feedback mechanism for implemented policies evident in Nigeria are indeed capable of hampering the effectiveness of fiscal policy.
Cooper, J.P. and Fisher, S (1973): Stabilization Policy and Lags. Journal of Political Economy, Volume 81, No 1.
Easterly, W. and Fischer, S. (1990). The Economic of Government Budget Constraint. The World Bank Observer, Vol. 5, No. 2, July 1990.
Easterly, W. and Schmidt-Hebbel, K. (1991). The Macroeconomics of Public Sector Deficits: A Synthesis. The World Bank Working Paper Series No. 775, Oct. 1991.
Egwaikhide, F.O. (1998): Budget Deficit and Macroeconomic Management in Nigeria. In Post – Structural Adjustment Programme. The Nigerian Journal of Economic and Social Studies, Vol. 38 Nos. 1, 2 and 3.
Ekpo, A. H. (1994): Public Expenditure and Economic Growth in Nigeria, 1960 – 1992. Final Report :African Economic Research Consortium (AERC), Nairobi, Kenya.
Fakiyesi, T. (1996). Interest Rate Management in Nigeria: An Overview. In Post – Structural Adjustment Programme. The Nigerian Journal of Economic and Social Studies, Vol 38, Nos. 1, 2, and 3.
Folorunso, B. A and Abiola, A. G. (2000): The Long – run Determinants of inflation in Nigeria (1970 - 1998). The Nigerian Journal of Economic and Social Studies, Vol 42, Vol. 1 pages 37 - 52.
Fullerton, T. M. and Ikhide, S.I. (2000): Inflationary Dynamics in Nigeria. The Nigerian Journal of Economic and Social Studies, Vol 42, No. 1 pages 205 -217.
Garba, A. G. (1995): The Determinants of Nigerian Federal Government Expenditure, 1970 – 1993. Final Report, African Economic Research Consortium (AERC), Research Workshop, Nairobi.
Jhingan M. L. (2000): The Economics of Development and Planning (33rd Edition), Delhi: Vrinda Publications
Komolafe, O. S. (1996): Exchange Rate Policy and Nigeria’s External Sector Performance: Implications for the future. Nigeria Journal of Economics and Social Studies, Vol. 38 No 1, page 65 – 85.
Levaice Rosalind and Rebman Alexander (1976). Macroeconomics: An Introduction to Keynesian – Neoclassical Controversies (Second Edition), Hong –Kong; Pintail Studios
Ndung’u, Njuguna ( 1995 ). Government Budget Deficit and Inflation in Kenya. African Journal of Economic Policy, Vol. 2, No. 2, p 19-34.
Ogiogio, G. O (1996). Planning Horizon, Government Expenditure and Economic Growth in Nigeria. in Economic Reform and Macroeconomic Management in Nigeria, Ariyo, (ed )Ibadan: University Press, Ibadan.
Okongwu, Chu S. P. (`1986). The Nigerian Economy: Being an Anatomy of a Traumatized Economy with some Proposals for Stabilization, Enugu: Fourth Dimension Publishers
Olaniyan, Olanrewaju (2000): The effects of Economic Instability on Aggregate Investment in Nigeria. The Nigerian Journal of Economic and Social Studies, Vol 42, No. 1 pages 23 - 36.
Olaniyan, Olanrewaju (1997). Macroeconomic Policy Framework for Poverty Alleviation. NES 1997 Annual Conference, p 214-217.
Olashore, Oladele (1991). Challenges of Nigeria’s Economic Reform. Ibadan: Fountain Publications.
Philips, A. O (1997): Nigerian Fiscal Policy, 1998 -2010. Nigerian Institute of Social Economic Research (NISER), Monograph Series No. 17, Ibadan.
Ram, R. (1989). Government size and economic growth: A new framework and evidence from cross -section and time – series data. American Economic Review 76 91: 191 -203, March.
Tanzi, V., M.I. Blejer and M.O. Teijeiro (1987). Inflation and the Measurement of Fiscal Deficits. IMF Staff Papers 34 (Dec.), 711-738.
Tchokote, Joseph (2001). Macroeconomics of Fiscal Deficits in Cameroon. Being a Ph.D. Thesis Proposal presented to the Department of Economics, University of Ibadan, Ibadan – Nigeria.
World Bank (1996): India: Five years of Stabilization and Reforms and the Challenges Ahead. The Work Bank.