1.1 BACKGROUND OF THE STUDY
The rate of growth in Nigeria economy
cannot be fully analyzed without a closer look at the contribution of
capital formation to Nigeria’s economic growth. This is in the
understanding that capital formation has been recognized as an important
factor that determines the growth of Nigerian economy. According to
Bakare (2011), Capital formation refers to the proportion of present
income saved and invested in order to augment future output and income.
It usually results from acquisition of new factory along with machinery,
equipment and all productive capital goods. Capital formation is
equivalent to an increase in physical capital stock of a nation with
investment in social and economic infrastructure. Continuing on the
matter he noted that Gross fixed capital formation can be classified
into gross private domestic investment and gross public domestic
investment. The gross public investment includes investment by
government and public enterprises while gross private domestic
investment is investment by private enterprises. Gross domestic
investment is equivalent to gross fixed capital formation plus net
changes in the level of inventories. Economic theories have shown that
capital formation plays a crucial role in the models of economic growth
(Beddies 1999; Gbura and THadjimichael 1996, Gbura, 1997). This view
called capital fundamentalism however was supported by the work of
Youopoulos and Nugent (1976) as sited in Bakare (2011). Growth models
like the ones developed by Romer (1986) and Lucas (1988) predict that
increased capital accumulation can result in a permanent increase in
growth rates. Capital naturally plays an important role in the economic
growth and development process. It has always been seen as potential
growth enhancing player. Capital formation determines the national
capacity to produce, which in turn, affects economic growth. Deficiency
of capital has been cited as the most serious constraint to sustainable
economic growth. Meanwhile, an understanding of the impact of capital
formation is a crucial prerequisite in designing a policy intervention
towards achieving economic growth. The process of capital formation
according to Jhingan, (2006) involves three inter-related conditions;
(a) the existence of real savings and rise in them; (b) the existence of
credit and financial institutions to mobilize savings and to direct
them to desired channels; and (c) to use these savings for investment in
capital goods. The government of Nigeria in 1986 considered the need
for improvement in capital formation and pursued an economic reform that
shifted emphasis to private sector. The public sector reforms were
expected to ensure that interest rates were positive in real terms and
to encourage savings, thereby ensuring that investment funds would be
readily available to the real sector. Besides this, the reforms were
expected to lead to efficiency and productivity of labor; efficient
utilization of economic resources, increase aggregate supply, reduces
unemployment and generate low inflation rate. For example, during 1980s,
gross fixed capital information average 21.3 percent of GDP in Nigeria.
This proportion increased to 23.3 percent of GDP in 1991 and declined
to 14.2 percent of GDP in 1996. It picked and increased to 17.4
percentage in 1997 and average 21.7 during 1997 to 2000. The gross
capital formation rose from 22.3 percent of GDP in 2000 to 26.2 percent
in 2002 and declined drastically to 21.3 percent in 2005 (Bakare 2011).
Economic theories have
shown that capital formation plays a crucial role in the models of
economic growth (Beddies 1999; Gbura and THadjimichael 1996, Gbura,
1997). This view called capital fundamentalism by Youopoulos and Nugent
(1976) has been reflected in the macroeconomic performances of many
countries. It is clear that even mildly robust growth rates can be
sustained over long periods only when countries are able to maintain
capital formation at a sizeable proportion of GDP. It has been
discovered that any proportion less than 27 percent cannot sustain
economic growth. It is estimated that the ratio of gross capital
formation to GDP in the sub-saharan African countries which has
experienced poor growth in the 1990s was less than 17 percent compared
to 28 percent in advanced countries (Hernandez-Cata 2000).
justifies the strong linkage between capital formation and economic
growth. In order to trace the linkage between capital formation and
growth, the gross capital formation of each year is normally scaled to
the gross domestic product (GDP). Thus, fluctuations in capital
formation is said to have considerable effect on economic growth.
However, the proportion of capital formation to GDP that can sustain a
robust economic growth must not be less than 27 percent and in some
cases, it must go as high as 37 percent (Gillis et al 1987).
In 1986, the government of Nigeria
considered the need for improvement in capital formation and pursued an
economic reform that shifted emphasis on private sector. The public
sector reforms were expected to ensure that interest rates were positive
in real terms and to encourage savings, thereby ensuring that
investment funds would be readily available to the real sector. Besides
this, the reforms were expected to lead to efficiency and productivity
of labor; efficient utilization of economic resources, increase
aggregate supply, reduce unemployment and generate low inflation rate.
For example, during the 1980s, gross fixed capital formation was an
average 21.3 percent of GDP in Nigeria. This proportion increased to
23.3 percent of GDP in 1991 and declined to 14.2 percent of GDP in 1996.
It picked and increased to 17.4 percent in 1997 and an average of 21.7
percent during 1997 to 2000. The gross capital formation rose from 22.3
percent of GDP in 2000 to 26.2 percent in 2002 and declined drastically
to 21.3 percent in 2005.
Empirical literature on growth has
consistently shown that the rate of accumulation of physical capital or
investment is an important determinant of economic growth. Results
provide evidence that public capital investments are a key input in the
private sector production process for they affect both the steady state
level of income per capita and the rate of economic growth on the
transition path towards equilibrium (Nair, 2005). Furthermore, there
are other important empirical evidences why private investment should be
at the centre of the debate on how to promote growth and raise
employment. Ndikuman (2005), while accepting that investment is a robust
determinant of growth, especially investment on equipment, believe that
private investment is a key determinant of cross-country difference in
long run economic growth. This has led observers to identify low
investment as one of the leading causes of the slow growth in developing
countries in general and in African countries in particular. The UN
Millennium Project (2005) has re-emphasized the need for a big push
strategy in investment to help poor countries break out of their poverty
trap and achieve the Millennium Development Goals (MDGs). The report
argues further that, to enable all countries achieve the MDGs, there
should be identification of priority of private investments to empower
poor people, and these should be built into MDG-based strategies that
anchor the scaling-up of private investment.
Economic theory shows that economic
growth can be realized in two ways- increase in the amount of factors of
production; and increase in the efficiency with which those factors are
used. Thus, growth is induced by the increases in investment (i.e.
capital accumulation) and the efficiency of investments (De-Gregorio,
1998). None of these indicators of growth has however been sufficient in
achieving a substantial level of growth in most developing countries.
In the late 1970s and early 1980s, most developing countries of Africa
experienced unprecedented and severe economic crises. These crises
manifested in several ways such as persistent macro-economic imbalances,
widening savings-investment gap, high rates of domestic inflation,
chronic balance of payment problems and huge budget deficit (Akpokodje,
The Nigerian growth experience has
however been very pathetic. In more than five decades of independence;
Nigeria has never grown at 7 percent or more for more than three
consecutive years (NEEDS, 2004). Between 1975 and 2000, Nigeria’s broad
based macroeconomic aggregate-growth, the terms of trade, the exchange
rates, government revenue and spending – were among the most volatile in
the developing world. The economy has been caught in a low growth
trap, characterized by a low savings – investment equilibrium (at less
than 20 percent). With an average annual investment rate of barely 16
percent of GDP, Nigeria is far below the minimum investment rate of
about 30 percent of GDP required to unleash a poverty reduction rate of
at least 7–8 percent per year (NEEDS, 2004). In providing what is
perhaps one of the best reviews of literature, Collier and Gunning
(1999) zero in on several important factors whose impact on African
growth performance is mediated through their negative implications for
investment, particularly private investment. In their view,
“cumulatively” the variables have contributed to a capital hostile
environment. This in turn has reduced the rate of return on private
investment. These factors include: high risk, capital hostile
environment, poor finance and low savings.
The decline in capital formation can be
as a result of macroeconomic imbalances such as deteriorating foreign
exchange rate and corruption in public sector. The inadequacy in
economic infrastructure such as poor power supply, bad road network as
well as poor health facilities were equally responsible for the decline
in capital formation over time. Overall, the speed and the strength of
economic growth in Nigeria have not been satisfactory.
Prescription of solutions to the poor
performance of private investment that characterized a growing economy
like Nigeria is of great policy concern; it is against the backdrop of
the foregoing that this study investigates capital formation via savings
and investment as it impacts growth of Nigerian economy using time
1.2 STATEMENT OF PROBLEM
Capital accumulation is a
catalyst to economic growth. Empirical studies like (Hernandez-Cata,
2000; Elenog and Jayaraman, 2001; Ndikumana, 2005) conducted in Africa
have established beyond doubt, the critical linkage between investment
and the rate of growth.
Viewed against the
background of growing evidence of a strong link between high investment
and sustainable growth, the Nigerian policy makers pursued a structural
adjustment program about three decades ago which shifted emphasis from
public sector to private sector. The public sector reforms were expected
to ensure that interest rates were positive in real terms and to
encourage savings, thereby ensuring that investment fund would be
readily available to the real sector. Besides this, the reforms were
expected to lead to efficiency and productivity of labour, efficient
utilization of economic resources, increase aggregate supply, reduces
unemployment, and generate low inflation rate. But unfortunately, the
initial optimism expressed about public sector reforms has not been met.
This is evident in the steady decline since 1980s of private fixed
investment in Nigeria which has adversely affected our growth rate
(Bakare, 2011). The reform program led to the privatization and
commercialization of many state-owned enterprises; there have been some
disappointing performances. For instance, Nigeria continued to be
confronted with low rate of economic growth. Besides, the aggregate
supply continued to diminish leading to demand-pull inflation. One
worrisome aspect of the result of public sector reforms in Nigeria is
the extent of distress in the sector including high rate of unemployment
which has greatly hampered the growth rate. Hence, the need for a
better understanding of the extent and the implication of these problems
becomes crucial and it is the focus of this study.
1.3 OBJECTIVES OF THE STUDY
The broad objective of this
study is to investigate the impact of capital formation via savings and
investment on growth of the Nigerian economy.
Thus, the specific objectives include;
i. To examine if there is any significant relationship between capital formation and growth in Nigeria.
ii. To determine the effect of other macroeconomic indicators on economic growth in Nigeria.
iii. To proffer policy recommendation for sustainable growth in Nigeria
1.4 RESEARCH QUESTIONS
The following questions are to be answered, if the stated objectives are to be achieved;
i. To what extent does capital formation impact on the growth rate of Nigerian economy?
ii. Are there any
significant relationship between capital formation and economic growth
in the Nigerian economy?
1.5 RESEARCH HYPOTHESES
H0: There is no significant relationship between capital formation and economic growth in Nigeria.
H1: There is a significant relationship between capital formation and economic growth in Nigeria.
1.6 JUSTIFICATION OF THE STUDY
Nigeria is a richly endowed country with
abundant human and natural resources. The country is blessed with a
variety of mineral deposits including petroleum, natural gas, uranium,
tin, columbite, coal, precious metals and gemstones. Over the last three
decades, the country has earned over US$300 billion from oil sales. In
spite of this wealth, the country’s economy has tended to fluctuate
widely over the years. The average GDP growth was 1.2 percent between
1979 and 1989, 2.7 percent between 1989 and 1999 and 3.5 percent between
2000 and 2008. Inflation rate continued to increase with the purchasing
power of the naira declining steadily over the years (Bakare, 2011).
Understanding the relationship between
capital formation and economic growth would have significant implication
to the state of the Nigerian economy. This study is set up to cover the
lapses of previous studies on this subject matter. It is worthy to note
that previous studies of the impact of capital formation on economic growth
have basically been the study of the situation in advanced economies.
Isolated instances of the study in less developed countries have always
been a cross-country analysis. This study therefore hopes to study what
the situation is in the Nigeria case. The study looked further into the
determinants of capital formation in Nigeria.
This work is set to determine the impact
of capital formation in Nigeria. Since economic literature has
established that investment is a remedy to economic growth, a work of
this nature is indeed expedient. This work by providing a deeper
understanding of the relationship between capital formation and economic
growth in Nigeria will expose impediments to investment growth in
Moreover, previous studies were based on
simple regression analysis and at other cases, a cross sectional data
analysis. But this study will be using the Augmented dickey fuller unit
root test, the Johansen test of co-integration, and the error
correction mechanism analysis using time series data. Also, previous
studies covered the periods between 1970 and 2010 but this study
captures the trend between 1980 and 2013.
1.7 SOURCE OF DATA AND RESEARCH METHODOLOGY
This study covers thirty four years of observation (1980 to 2013). The
study is principally limited to the analysis of the Nigerian economy.
The data over these years of study are regressed and the research
findings obtained are explored statistically and econometrically.
However, this work is limited to the use
of secondary data sourced from secondary source; Statistical Bulletin,
Annual Reports and Statement of Accounts of the Central Bank of Nigeria
(CBN). And also the publications of National Bureau of Statistics (NBS)
The analysis will be carried out with
the use of Ordinary Least Squares technique (OLS), Augmented Dickey
Fuller Unit Root Test, the Johansen test of co-integration, and the
error correction mechanism analysis using time series data. Test of
statistical adequacy such as T-test, standard error test, coefficient of
determination and Durbin-Watson will be carried out. To facilitate the
estimation process, a statistical package known as “E-VIEWS” will be
1.8 SCOPE AND PLAN OF THE STUDY
This study will cover the period
1980-2013; a sample size of 34 years is necessary in order to have
enough observation for computation.
The study will be organized into five
chapters. Chapter one contains the background of the study, statement of
problem, objectives of the study, research questions and hypothesis,
the justification of the study, and scope and plan of the study. Chapter
two consists of empirical reviews as well as the theoretical reviews.
Chapter three covers theoretical framework, nature and sources of data,
model specification, a priori expectation, restatement of hypothesis,
method of analysis and the decision criteria. Chapter four is on the
presentation and analysis of data. While Chapter five covers the summary
of findings, conclusion and policy recommendation.