MONETARY POLICY AND INFLATION IN NIGERIA ( A CASE STUDY OF CENTRAL BANK OF NIGERIA)

CHAPTER ONE

1.1    Background to the Study

The relationship between government expenditure and economic growth has continued series of debate among scholars. Keynes (1936) argues that the solution to economic depression is to induce the firms to invest through some combination of reduction in interest rates and government capital investment including infrastructure.

This claim that increasing government expenditure promotes economic growth is not supported by all scholars. A number of prominent authors especially of the neoclassical school argue that increased government expenditure may slow down the aggregate performance of the economy because in an attempt to finance raising expenditure, government may have to increase taxes and or borrowing. The higher income tax may discourage or may be a disincentive to additional work which in turn may reduce income and aggregate demand. In the same manner, high corporate tax leads to increase in production costs and reduce profitability of firms and their capital to incur investment expenditure.  On the other hand, increased government borrowing (from the banks) required to finance its expenditure may compete and crowds-out private sector and this reduce private investment in the economy. Sachs (2006) argues that among the developed countries, those with high rates of taxation and high social welfare spending perform better on most measures of economic performance compared with countries with low tax low rates of taxation and low social services spending. Hayek (1989) however countered this argument saying that high levels of government spending in addition to harming, does not, through social welfare engendered fairness, economic equality and international competitiveness. This argument is in line with Sudha (2007) who points out that countries with large public sectors have grown slowly. Thus, there is no general consensus among scholar on the impact of increasing government expenditure on economic growth.

According to the Revenue Mobilization Allocation and Fiscal Commission – RMFC (2011) the federal government of Nigeria spends 52.2% of total government revenues. The remaining revenues are shared among the Federating States and Local Government Areas (LGAs) on the basis of detailed sharing formula.

The level of increase of government revenue from oil revenue and non-oil revenues including borrowing from internal and external sources has significantly affected the level of government expenditure in Nigeria over the years under review. For instance, the total recurrent expenditure increased from ₦716.1 million in 1970 to ₦4.8 billion naira in 1980 and further to ₦3.3 trillion in 2010. The government capital expenditure rose from ₦187.8 million in 1970 to ₦10.163 billion in 1980 and further to ₦1.76 trillion in 2010 (CBN, 2010, 2012).

The Gross Domestic Product (GDP) per capita of Nigeria expanded by 132% between 1960 and 1969 and rose to a peak growth of 283% between 1970 and 1979 (National Bureau of Statistics – NBS, 2010). The high levels of inflation and unemployment rates resulted in fiscal imbalance between 1979 and 1983 with negative consequences on balance of payment. The level of increase in external loans further accelerated the debt over-hand situation and other problems. The problems were so severe that restructuring of the economy was inevitable. As a result, a comprehensive economic reform programme was introduced in 1986. In the period between 1988 and 1997 – a period of structural adjustment and economic liberalization, the GDP responded to economic adjustment policies and grew at a positive rate of 4% (Onakaya et al, 2013). The real GDP growth shows that on aggregate basis, when measured by the Real Gross Domestic Product (RGDP) grew by 7.8% in 2010 (NBS, 2010; CBN, 1980, 2010, 2012).

The mismatch between the performance of the Nigerian economy and massive increase in government total expenditure over the years raises a critical question on its role in promoting economic growth and development. Some authors contend that the link between public expenditure and economic growth is weak while others report varying degree of causality relationship in Nigeria (Onokaya et al, 2012). The question which arises therefore is what is the relative contribution of capital expenditure and recurrent expenditure on economic growth in Nigeria? This thesis aims at investigating the impact of government expenditure (recurrent expenditure and capital expenditure) on economic growth in Nigeria from 1970 – 2012.

1.2    Statement of the Problem

The relationship between government expenditure and economic growth has continued to generate series of debate among scholars. Government performs two functions – protection (and security) and provision of certain public goods (Abdullahi, 2000; Yousif, 2000; Nurudeen and Usman, 2008). Protection function consists of the creation of rule of law and enforcement of property rights. This helps to minimize risks to criminality, protect life and property and the nation from external aggression, defense, roads, education, health, power and communication to mention but a few.

Some scholars argue that increase in government expenditure on socio-economic and physical structures encourages economic growth. For example, government expenditure on health and education raises the productivity of labour and increase the growth of national output. Similarly, expenditure on infrastructure such as roads, communications, power etc reduces production costs, increases private sector investment and profitability of firms, thus fostering economic growth. Supporting this view, scholars such as Keynes (1936), Ram (1986), Barro (1990), Sachs (2006), Ranjah and Sharma (2008), Cooray (2009) conclude that expansion of government expenditure contributes positively to economic growth.

However, some scholars did not support the claim that increasing government expenditure promotes economic growth, instead they assert that high government expenditure may slow down overall aggregate performance of the economy in that in the bid to finance rising expenditure, government may have to increase taxes and/or borrowing. The higher income tax may discourage or be a disincentive to individual working for long hours or searching for additional work which in turn may reduce income and aggregate demand. In the same way, higher corporate tax (profit tax) tends to increase production costs and reduces the profitability of firms and their capacity to incur investment expenditure. Moreover, if government increases borrowing (especially from the banks) in order to finance its expenditure, it will compete (crowds-out) away the private sector, thus reducing private investment. It was further argued that in a bid to score cheap popularity and ensure that they continue to remain in power, politicians and government officials sometimes increase expenditure and investment in unproductive projects or in goods that the private sector can produce more efficiently. Thus, government activity sometimes produces misallocation of resources and impedes the growth of national output. In fact, the studies by Laudau (1986), Hayek (1989), Henrekson (2001), Mitchell (2005) and Sudha (2007) suggested that large government expenditure has negative impact on economic growth.

In Nigeria, the government expenditure has continued to rise due to receipts from oil revenue (Petroleum profit tax and royalties) and non oil revenue (company income tax, custom and excise duties, value added tax [VAT] and others) (CBN Statistical Bulletin, 2012). And increased demand for public (utilities) goods like roads, communication, power, education and health. Besides there is increasing need to provide both internal and external security for the people and the nation.

Available statistics show that total government expenditure (capital and recurrent) and its components have continued to rise in the last few decades under review. For instance, government recurrent expenditure increased from ₦716.1 million in 1970 to ₦4,805.2 million in 1980 and ₦3,310,343.38 million in 2010 (see appendix 1). In the same manner, the composition of government recurrent expenditure shows that expenditure on general administration, defense, National Assembly, internal security, agriculture, construction, transportation and communication, education and health increased during the period under review. Moreover, government capital expenditure rose from ₦187.8 million in 1970 to ₦883,874.75 million in 2010 (see appendix 1). Furthermore, the various components of capital expenditure (that is economic services, social service, defense, agriculture, transport and communication, education and health) also show a rising trend between 1970 – 2012.

Unfortunately, rising government expenditure has not translated to meaningful growth and development, as Nigeria ranks among the poorest countries of the world. In addition, many Nigerians have continued to wallow in abject poverty, while more than 60.9% of over 163 million population poor. The Business Day Newspaper of Tuesday 14 February, 2012 reported that the percentage of Nigerians living in abject poverty – those who can afford only the bare essentials of food, shelter and clothing – rose to 60.9% in 2010 as compared to 54.7% in 2004. Although the Nigerian economy is projected to be growing, poverty is likely to get worse as the gap between the rich and the poor continues to widen. Couple with this, is dilapidated infrastructure (especially roads and power supply) that has led to the collapse of many industries, including high level of unemployment. Moreover, macroeconomic indicators like balance of payments, imports obligations, inflation rates, exchange rate, and national savings reveal that Nigeria has not fared well in the last couple of decades under review. Given the issues raised above, this research seeks to examine the impact of government expenditure on economic growth in Nigeria using GDP as dependent variable, and recurrent expenditure, capital expenditure and other controlling variables such as import, export, foreign direct investment  to examine the impact of government expenditure on economic growth in Nigeria from 1970 to 2012.

1.2       Research Questions

The research questions formulated to guide this study are:

                     i.        Does government consumption expenditure exert any significant impact on economic growth in Nigeria?

                    ii.        Has government investments spending contributed to economic growth in Nigeria?

                   iii.        Has government investment on human capital development influenced economic growth?

                  iv.        Does capital stock in Nigeria impact significantly on economic in Nigeria?

                   v.        Has labour force influenced economic growth in Nigeria?

                  vi.        Has private investment any significant impact on economic growth in Nigeria?

1.4    Statements of Research Objectives

Government expenditure is a crucial instrument for economic growth at the disposal of policy makers in a developing country like Nigeria. Current circumstances obliged the proper allocation and efficient utilization of government expenditure as the reward is greater likewise, the penalty for bad policy in this respect is greater than ever before in the realm of globalization. In a nutshell, government expenditure could adversely affect economic growth, if its allocation and utilization are not properly addressed.

This study is aimed at establishing empirically, the relationship between the following components of aggregate production function and economic growth in Nigeria using Barro’s (1990) model:

             i.        The impact of government consumption expenditure on economic growth in Nigeria.

            ii.        The impact of government investment expenditure in Nigeria.

           iii.        The influence of government investment expenditure on human capital development on economic growth in Nigeria.

          iv.        The impact of capital stock on economic growth in Nigeria.

           v.        The impact of labour force on economic growth in Nigeria.

          vi.        The impact of private investment on economic growth in Nigeria.

1.5    Significance of the Study

The study investigates the impact of government expenditure on economic growth in Nigeria. Many people have carried out studies on government expenditure and how it affects economic growth in Nigeria. But we are trying to add a new dimension to it by breaking down the explanatory variables into government consumption expenditure, government investment, and government investment expenditure on human capital development, stock of capital, Labour force and private investment. The most closely related works are outlined below.  Nurudeen and Usman (2010) studied the impact of government expenditure in Nigeria using data from 1977-2007 and ECM method. The variables used are recurrent expenditure and capital expenditure on defense, agriculture, education, transport and communication. He did not make use of aggregate production function since labour and capital are excluded. This study consolidates expenditures on human capital (education and health). It also fails to aggregate the other government investment and consumption spending in Nigeria. Usman, Mobolaji, Kilishi, Yaru and Yakubu (2011) examine the impact of public expenditure on economic growth in Nigeria for the period of 1970-2008 using aggregate production function of Barro (1990). The study classified government expenditure into administration, education, transport and communication. Just like Nurudeen and Usman (2010), they did not aggregate government expenditure on human capital. The study also did not consolidate government investment and government consumption expenditure into separate categories.

Maku (2009) examines the link between government spending and economic growth from 1970-2006 using Ram (1986) production function. The study classified government expenditure into education, health, government consumption spending and private investment. In the course of the analysis, the study kept both education and health spending separately but analyses them jointly as if they were consolidated. Our study is an improvement over these studies since our study integrates both education spending and health spending to indicate human capital development.

This study is distinct from all other studies because it classifies government expenditure into non-productive and productive government expenditures based on Barro (1990) classifications. The non-productive expenditure relates to all government consumption expenditure excluding health and education. The productive government expenditure relates to government expenditures on human capital development and government investment.

Secondly, the study is based on long period of analysis from 1970-2010, which is a sufficient time frame for the analysis of the problem of the study.

Thirdly, we believe that this study will provoke and pave a way for further studies in the area as it reveals the difficulty in resolving the empirical question of the impact of government spending on growth.

Fourthly, this study incorporates the most recent data and employs both qualitative analysis and a more advanced econometric technique (vector error correction) model to study the impact of government spending on economic growth. Thus the outcome of this study will provide result and policy implication to policy makers by bridging the aforementioned gap.

1.6    Statement of Research Hypothesis

The hypotheses formulated to guide this study are:

i)             Government consumption expenditure has no significant impact on economic growth in Nigeria.

ii)            Government investments do not impact on economic growth in Nigeria.

iii)          Government investments on human capital development do not influence economic growth.

iv)          Capital stock in Nigeria does not have significant impact on economic in Nigeria.

v)           Labour forces do not contribute significantly to economic growth in Nigeria.

vi)          Private investments do not have any significant impact on economic growth in Nigeria.

1.7    Scope and Limitations of the Study

This study is restricted to the impact of government expenditure on economic growth in Nigeria from 1970-2010.

One of the limitations of this study arises from lack of agreement on the causes of economic growth. Economists are not yet certain about the relative importance of elements which influence economic growth. Without such knowledge, it is difficult to make a meaningful conclusion on the impact of government expenditure on economic growth.

          Another limitation of the study is that it does not explicitly consider the quality of government spending, which is probably the most important factor. The calibers of the civil servants and the conditions in which they function have impact on creative and efficient use of public resources. Unproductive public spending can take various forms, including spending on wages and salaries of unproductive or ghost workers. Public spending is also unproductive when government expenditures do not reach designated spending objectives. This happens for example when government officials are corrupt and seek bribes for preferentially selecting beneficiaries of government programmes, for authorizing private investment projects etc.

          The econometric result of this study is also limited by the quality of the data. This limitation arises from the problem of inconsistency of data as reported by different institutions and even by different departments in the same institutions.

The limitations of this study lies in the following areas:

The data used for the study covers only the period of 1970-2010, no matter the relevance of time series data for any period before or after this period for this analysis, are not considered

The variables included in the study are nominal gross domestic product (NGDP), government consumption expenditure (GCE), government investment (GI), government investment on human capital development (GIHC), capital stock (KAP), labour force (LAB) and private investment (PI). NGDP is used as explained variable while GCE, GI, GIHC, KAP, LAB and PI are the explanatory variables. No matter the relevance of other variables in explaining the impact of government expenditure on economic growth, they are not included.

1.8    Definition of Terms

Aggregate demand: A schedule or curve which shows the total quantity of goods and services, demanded at different prices.

Aggregate production function: this is a function showing the maximum output of a country given a set of inputs, assuming that these inputs are used efficiently.

Capital expenditure: Refers to spending on fixed assets such as roads, schools, hospitals, building, plant and machinery etc, the benefits of which are durable and lasting for several years.

Capital stock: Means the total value of the fiscal capital of an economy; including inventories as well as equipments.

Capital: Human made resources (machinery and equipment) used to produce goods and services.

Classical economics: The macroeconomic generalizations accepted by most economists before the 1930s which led to the conclusion that a capitalistic economy would employ its resources fully.

Current expenditure: Refers to spending on wages and salaries, supplies and services, rent, pension, interest payment, social security payment. These are broadly considered as consumable items, the benefits of which are consumed within each financial year. 

Dependent variable: A variable in which changes as a con sequence of a change in some other (independent) variables.

Direct relationship: The relationship between variables which change in the same direction.

Economic growth: Increase in real output or in real output per capita.

Economic growth: Means increase in an economic variable, normally persisting over successive periods. The variable concerned may be real or nominal GDP.

Economic model: A simplified picture of reality representing an economic situation.

Economic policy: Course of action intended to correct or avoid a problem.

Economic resources: Land, labour, capital and entrepreneur which are used in the production of goods and services.

Expanding economy: An economy in which the net domestic investment is greater than zero.

Fiscal policy: The use of taxation and government spending to influence the economy.

Government expenditure: Refers to the expenses that government incurs for its maintenance, for the society and the economy as a whole.

Government expenditure: Spending by government at any level. It consists of spending on real goods, and services purchased from outside suppliers; spending on employment in state services such as administration, defense and education; spending on transfer payment to pensioners; spending on community services; spending on economic services.

Gross Domestic Product (GDP): Refers to the money value of goods and services produced in an economy during a period of time irrespective of the people.

Growth model: It is a simplified system used to stimulate some aspects of the real economy.

Growth rate: The proportional or percentage rate of increase of any economic variable over a unit period, normally a year.

Independent variable: The variable causing a change in another variable.

Industrially Advanced Countries (IACs): Countries such as the US, Canada, Germany, Japan and Nations of Western Europe which have developed market economies based on large stocks of technologically advanced capital goods and skilled labour force.

International Monetary Fund (IMF): The international association of nations which was formed after the World War II to make loans of foreign monies to nations with temporary payment deficits and to administer adjustable pegs.

Investment: Spending for capital goods and addition to inventories.

Keynesian economics: The macroeconomic generalization which lead to the conclusion that a capitalistic economy does not always employ resources fully.

Labour productivity: Total output divided by the quantity of labour employed to produce the output.

Market failure: Refers to a label for the view that the market does not provide panacea for all economic problems.

Market forces: The forces of supply and demand, which determine equilibrium quantity and price in market.

Monetarism: An alternative to Keynesianism; the macroeconomic view that the main cause of changes in aggregate output and the price level fluctuations is the money supply.

Neo-classical economics: The theory that, although unanticipated price level changes may create macroeconomic instability in the short-run, the economy is stable at the full employment level of domestic output in the long-run because of price and wages flexibility.

Nominal GDP: Means GDP at current basic prices less indirect taxes net of subsidies.

Poverty: Inability to afford an adequate standard of consumption.

Price level: The weighted average of prices paid for the final goods and services produced in an economy.

Rate of interest: Prices paid for the use of money of for the use of capital.

Transfer expenditures: refer to expenditures on pension, subsidies, debt interest, disaster relief packages, etc. transfers are seen as redistribution of resources between individuals in the society, with the resources flowing through public sector as intermediary.