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DEBT AND ECONOMIC DEVELOPMENT IN NIGERIA
Keyword: Debts, Economic Development, Debt Overhang, Crowding out effects.
To provide economic development, four schools of thought came into existence following World War II – structuralism, the linear – stages – growth model, the neo-Marxist or dependency theory, and the neoclassical revival of the 1980s. The structuralist school believes that development must be state-led. This means that development must be achieved through internal expansion of the local economy. The deficiencies of this approach include major inefficiencies associated with government. The linear-stages-of-growth model is the Western European view of economic development.
Of all these approaches, many developing countries, including Nigeria, relied on the linear – stages growth model. Based on this and the fact that savings have been less than the required level of investment, Nigeria borrowed heavily, both externally and internally.
There is, in the light of the foregoing, the problem of heavy debt burden, with questionable impact on economic development of Nigeria. The over-dependence of Nigeria on loan capital for the economic development of Nigeria has led to serious debt overhang.
OBjectives of the Study
Debts and Economic Development
One of the theories connecting external debt and economic development is the debt overhang theory. Krugman (1989) sees debt overhang as a situation in which the expected repayment on foreign debt falls short of the contractual value of the debt and showed that there is a limit at which accumulated debt stimulates investment and growth. The same way, Borenszten (1990) argued that the debt overhang crisis is a situation in which the debtor country benefits very little from the returns on any additional investment because of the debt service obligation. In line with these, Desta (2005) found that a negative relationship existed between external debt and economic growth which justified the existence of the debt overhang hypothesis. Similarly, Iyoha (1999) found that in sub-Saharan African countries the external debt to GNP (EDTGNP) ratio is high and creates debt overhang problems which consequently affect investment and growth negatively. It is based on the premise that, if debt will exceed the countries repayment ability, there is a probability that in future, expected debts service is likely to have an increasing function of the country’s output level. As a result of this, since part of the future return on any investment will accrue to the creditor as bigger debt service payments, it discourages capital accumulation and promotes capital flight. (Elbadawi et al, 1997; Koeda, 2006).
According to Elbadawi et al (1997) external debt affects economic growth through direct and indirect channels. Through direct way, debt accumulation expressed as a ratio of debt to GDP stimulates debt initially, while past debt accumulation impacts negatively on growth. These two channels produce a debt-laffer curve, which shows that there is a limit at which debt accumulation stimulates growth. When this limit is reached, further debt accumulation impacts negatively on growth. In addition, the third channel works through a liquidity constraint where debt service obligations reduce export earnings available for expenditures and so impacts negatively on growth. The indirect channel is one in which as a result of the reduction in available resources, governments’ ability to expand the economy is constrained and growth is therefore compromised.
Capital flight, in the context of external indebtedness has three major consequences, according to Ajayi and Khan (2000). In the first instance, any amount of money set away to foreign countries cannot contribute to domestic investment. In this way, capital flight is a diversion of domestic savings away from domestic real investment. In addition, income and wealth, which are held abroad, is outside the purview of domestic authorities and therefore cannot be taxed. This means that potential government revenue is reduced as well as the capacity of government to service its debts.
For internal debt, Lerner’s model postulates that internal debt creates no burden for the future generation members as the future generation simply owes it to each other. When the debt is paid off, there is a transfer of income from one group of citizens to another. However, the future generation as a whole is not worse off in the sense that its consumption level is the same as it would have been. This is different for the external debt because if borrowed fund is used to finance current consumption, the future generation certainly bears a burden. This is because its consumption level is reduced by an amount equal to the loan plus the accrued interest that must be paid to the foreign lender. If, however, the loan is used to finance capital accumulation, the outcome depends on the projects’ productivity. If the marginal return on the investment is greater than the marginal cost of funds obtained abroad, the combination of the debt and capital expenditure actually makes the future generation better off. If, however the projects return is less than the marginal cost, the future generation is worse off.
Okonjo-Iwuala (2001) in her article – Managing Nigeria’s debt: Institutional and Governance aspects – noted that while a great deal of attention has been paid to the size, structure, repayment profile and economic impact of Nigeria’s debt, until recent relatively little attention has been accorded to the institutional arrangements for proper management of the debt. Yet institutional arrangement and governance structure or the lack thereof can themselves significantly affect the size and structure of a country’s debt and its economic development in general.
In scope, the study covers the period 1980 – 2002 for internal debts, external debts and gross domestic product of Nigeria.
For the purpose of finding out the impact of internal debts and the external debts on economic development of Nigeria, the multiple regression analysis method was used. The regression analysis measures the relationship between one variable (dependent variables) and other variables (independent variables). (GDP dependent variable) is represented in the research with the letter (Y). Internal debts and external debts were collectively and individually used as the independent variables for assessment of the debts’ impact (explanatory variables) on Gross Domestic Product of Nigeria.
The multiple regression model was used to test the joint effect or impact and individual contribution of the independent variables to GDP. Here F – test is used to test the overall significance of the explanatory variables taken together. Student t test was used to test for the significance of each explanatory variable contributing to the impact of debts on Nigerian Economy.
The term mt is the stochastic term of the regression introduced to represent the unexplained variation encountered in the modeling since in real life situation chance events to occur which can make the model not to record 100% success. However, the principal assumption here is that mt is a random variable with a normal distribution, zero mean and constant variance
Data Presentation and Analysis
Table 1: Profile of Nigeria’s Internal /External Debts and her Gross Domestic Product (GDP).
Table 2: ANOVA b
Table 3: regression Outputs of Debt Types Against GDP
Table 4: Model summary b
Test of Model Significance
In testing the model significance, we compare the computed F-ratio. Here from Table 2, the calculated F-ratio, degrees of freedom (K,1; N-K or 3-1; 23-3 = 2, 20) is given as
Recalling that F-test only tested the extent of significance of the model as a whole, there is therefore, the need to carry out a test on the influence of the individual explanatory variables on economic development. This means that the t-test tests the extent of contribution of each explanatory variable to changes in the gross domestic product, used as a proxy for economic development.
In this study, we were able to establish the following facts:
1. A strong and significant relationship exists between internally sourced debts and Nigeria’s Gross Domestic Product. This result is in tandem with already held belief. Internal or domestic debts, as we know are public debts owned to individuals, organizations, and institutions within an economy. It simply connotes the fact that an economy owes itself. Upon maturity of any debt instrument payment of interest or income is simply transferred from one citizen to another including corporate citizens. Apparently, the net transfer of income is quite small. Servicing of internal debts, does not alter the national income. Thus, the net effect of domestic debt is that it adds value to the economic growth/development of any nation, if utilized well.
Simply put, domestic debts maintain a positive and significant relationship with the workings of the economy as it enhances the economic growth, maturity profile and development of any given nation.
This result appears to be inconsistent with already held belief, but in line with results of what obtained in Kenya and Malaysia (Were, 2001; Ariff and Cheen, 2001). Some explanations and analysis are necessary at this juncture, to drive home this point.
The liquidity constraint hypothesis or the crowding out effect applies here. This simply implies here that the resources utilized to service debt reduce the amount of resources available for investment purposes. Thus, binding liquidity constraints on external debt would produce a negative effect on investment/economic growth and development.
Even the so-called borrowed funds are not spared. They are not judiciously utilized on projects that can take care of their principal / interest repayments. Most of these external loans, which were obtained at unreasonable terms and interest rates, still find their way back to foreign accounts. This, is itself a major source of drain to our economy.
Conclusion and Recommendations
Ajayi, Si Ibi and M. Khan (2000). External Debt and Capital Flight in Sub-Sahara Africa. Washington
Akujuobi, L.E. (2006). Investment Analysis. Owerri: Osprey Publication Center.
Ariff, Mohamed and Lim Chze Cheen (2001). “Mobilizing Domestic and External Resources for Economic Development: Lessons from Malaysian Experience”. Asia-Pacific Development Journal,
Borensten (1990) Cited in Desta, Melese Gizaw (2005). “External Debt and Economic Growth in Ethiopia”. African Institute for Economic Development and Planning (IDEP). http://www.unidep.org.
Desta, Melese Gizaw (2005). “External Debt and Economic Growth in Ethiopia”. African Institute for Economic Development and Planning (IDEP) http://www.unidep.org.
Elbadawi, et al (1996). Cited in Desta, Melese Gizaw (2005). “External Debt and Economic Growth in Ethiopia”. African Institute for Economic Development and Planning (IDEP) http://www.unidep.org.
King, David T. (2003). USAID/Nigeria Economic Growth Activities Assessment (Transition Summary Report). Arlington: IBM Business Consulting Services.
Koeda, Junko (2006). “A Debt Overhang Model for Low-Income Countries: Implications for Debt Relief”. IMF Working Paper No. WP/06/224.
Krugman (1989). Cited in Desta, Melese Gizaw (2005). “External Debt and Economic Growth in Ethiopia” African Institute for Economic Growth in Ethiopia (IDEP). http://www.unidep.org.
Okoujo-Iwuala, Ngozi (2003). The Debt Trap in Nigeria: Towards a Sustainable Debt Strategy. Asmara: African World Press incorporated.
Were, Manreen (2001). “The Impact of External Debt on Economic Growth and Private Investments in Kenya: An Empirical Assessment”, Paper Presented at the Wider Development Conference on Debt