Financial Development And Industrial Output Performance

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Financial Development And Industrial Output Performance


Abstract


The study examines the causal relationship between financial development and industrial output performance in Nigeria for the period of 1970 to 2008 using Error Correction Model. Granger causality is tested between financial development and industrial output performance. The empirical findings provide evidence that there is a stable negative long run relationship between financial development and industrial output performance. The result further showed that financial development granger causes industrial output performance in Nigeria. Hence it is recommended that government should ensure strong and efficient financial system capable of increasing industry output performance.


Chapter One


Introduction

1.1 Background to the Study

Beginning from the industrial revolution in the Great Britain to the rapid economic transformation in the East Asian countries (especially the Asian Tigers), the role of manufacturing sub-sector as an engine of economic growth and development cannot be undermined. Basically, Digby, Feinstein and Jenkins (1992) ascribed the increasing economic growth rate of the British economy during the industrial revolution to an increase in investment in fixed capital and labour productivity growth (see also Deane and Cole, 1962; Crafts, 1985). Similarly, the economic miracle of the Asian Tigers has been attributed to development in the manufacturing sub-sector and exports of goods and services (Gulati, 1992; Park, 2011; Pham and Lipscy, 2015, Asien, 2015). As stated by Kaldor (1966) and Mike (2010), a functioning manufacturing subsector is a precursor to rapid economic growth, solution to high rate of unemployment and mechanism for sustainable economic development over a long period of time.

Over the years, successive governments in Nigeria have made several concerted efforts to spur the industrial sector of the economy, particularly manufacturing subsector. In the 1970s, government formulated and implemented several industry-enhancing policies such as indigenisation policy, import substitution industrialisation (ISI) policy, import duties, tax reliefs and depreciation allowances. The objective of these policies is to increase local ownership and control of industries and to encourage foreign investors so that they can invest in the industrial sector of the economy (Ekpo, 2014). In the 1980s, after the adoption of Structural Adjustment Programme (SAP), the financial sector was liberalised by easing credit condition with the main objective of ensuring adequate supply of funds to the manufacturing subsector of the economy. Besides, due to the failure of pre-SAP industrial policy, particularly ISI, government pursued export promotion industrialisation (EPI) policy during the SAP era with the aim of expanding the export-base of manufacturing subsector in terms of value-added creation that could enhance the contribution of manufacturing output to GDP (Banjoko, Iwuji, and Bagshaw, 2012).

Despite the concerted efforts exerted by the government, the growth of manufacturing subsector has been abysmal over the years, although some achievements were recorded in the 1970s. For instance, available statistics on manufacturing subsector as shown in Figure 1 reveals that the sector recorded a significant growth of about 39.04% between the period 1971 and 1975. This could be attributed to the aforementioned industry-related policies and renewed efforts by the government to reconstruct the economy after 3 years of Civil War that ended in 1969. However, after the initial surge in manufacturing output, the 1980s and 1990s’ decades were characterised by a general deterioration of manufacturing subsector. Specifically, during the 1981-1985 and 1986-1990 periods, manufacturing output growth rates were 1.42% and 3.54%, respectively. These slow growth rates turned negative throughout the 1990s. In the 2000s, the subsector witnessed resurgence from the abysmal performance of the previous years. The significant growth rate in the manufacturing subsector output in the 2000s could be associated with the restoration of the country to democratic government in 1999 coupled with some economic reforms such as exchange rate controls, deregulation and privatisation policies. All these restored the investors’ confidence in the economy considered to be hostile to their investment interests.

The abysmal performance of manufacturing subsector recorded in some years has been attributed to many factors. Aside from the inconsistent government policies, enterprise survey conducted in 2002 and 2004 by United Nations Industrial Development Organisation (UNIDO) in conjunction with the Nigerian Ministry of Industry and Centre for the Study of African Economies shows that poor physical infrastructure (poor road networks, epileptic electricity supply, poor water supply and unreliable telephone and internet services), lack of access to credit, insufficient consumer demand, high cost of imported raw materials, multiple tax regimes at different levels of government, lack of needed skilled workers and poor governance were the major impediments to manufacturing sector performance in Nigeria.(Soderborn and Teal, 2002; Malik, Teal and Baptist, 2004).

Of all the problems confronting manufacturing subsector, lack of access to finance appears to be rampant in developing countries including Nigeria, aside from the infrastructural constraints (OECD, 2006; Fowowe, 2013). Many firms, particularly the small scale firms, often find it difficult to access finance domestically and internationally compared with the big domestic or foreign firms. The lack of willingness of banks and other financial institutions to make credit available to these categories of firms may arise from asymmetric information characterising the small firms and the level of financial development in developing countries (Fowowe, 2017).
However, a well-functioning financial system has been described as a forerunner of economic growth (Malik, Teal and Baptist, 2004). This has been demonstrated theoretically and empirically in the literature (Bagehot, 1873; Schumpeter, 1911). According to Schumpeter (1911), innovative entrepreneurship can only lead to technological progress and economic growth if adequately supported by the services of financial markets. However, the theoretical validation of Schumpeter’s proposition is mixed as there are different schools of thought on the relationship between financial market development and the economy. In specific terms, there are three schools of thought, namely: positive school of thought, negative school of thought and irrelevant school of thought.


1.2 Statement of the Problem

The conflicting views about the role of FD in economic growth or development raise a number of questions as to why FD leads to economic growth in some countries and fails to do the same in other countries (Levine, 2001). In other words, what factors make financial systems to be efficient in one country and inefficient in other country? One of the factors identified in the literature is the role of institutions.1 It is argued that some countries have institutions that help foster FD while others do not have, which may account to a certain extent for the differences in the effects of FD on economic growth. The proponents of the role of institutions in FD-growth nexus are of the opinion that countries characterised by institutions of high quality will have higher levels of FD and economic growth because property rights are highly protected and enforced (La Porter et al. 2000, Levine and Zervos, 1998). Fernandez and Tamayo, (2015) show that financial markets are characterised by asymmetric information and moral hazard problem that require higher levels of institutions that can ensure the enforcement of contracts between economic agents. Acemoglu, Aghion and Zilibotti, (2006) argue that a stiff legal environment in some countries, particularly developing economies is deleterious to FD and may therefore have negative effects on their economic progress. Thus, better institutions have been adjudged to enhance the impact of FD on economic growth (Levine, 1998).

Empirically, several studies have been conducted to examine the impact of financial development on the economy both at aggregate and disaggregate levels (Demirgüç-Kunt and Levine, 2008). In addition to this, a considerable amount of studies have been devoted to analysing the role of institutional quality in the relationship between financial development and the economy. These studies are, however, carried out at country or cross-country level (Nabi and Suliman, 2009; Akpan and Effiong, 2012; Effiong, 2015). At sectoral level, most of the studies, particularly in developing countries, only examine the nexus between financial development and manufacturing growth or performance. For instance, most of the extant studies in Nigeria that examine the link between FD and industrial or manufacturing output using different measures of FD reach mixed conclusions(see Ekor and Adeniyi, 2012; Udoh and Ogbuadu, 2012; Okon and Nathan, 2014; Raphael and Gabriel, 2015; Campbell and Asaleye, 2016; Ebele and Iorember, 2016). While Raphael and Gabriel (2015) and Ebele and Iorember (2016), find a positive effect of FD on manufacturing output, Udoh and Oghuadu, (2012) find a negative effect of FD on manufacturing output. It is, however, interesting to note that Ekor and Adeniyi, (2012) does not find any significant relationship between FD and manufacturing output.

The inconsistent findings emanating from studies on Nigeria can be attributed to several factors such as scope of study, the choice of indicator of FD and method of implementation of the study. Of particular relevance is the fact that none of the studies (on Nigeria) examines the role of institutional quality in FD-industrial or manufacturing output nexus. It is this gap that this current study has attempted to fill. The main motivation is to investigate whether the interaction of institutional quality variables with FD will or will not enhance the relationship between FD and manufacturing output in Nigeria. The study contributes to the existing studies by examining the mediating role of some specific institutional factors such as control of corruption, democratic accountability and bureaucratic quality in FD- manufacturing output nexus. In addition to this, the study uses three different measures of FD indicators such as broad money as a percentage age of GDP, credit supply to private sector scaled by GDP and loans and advances to manufacturing sector with the goal to ascertain the financial sector indicator that is appropriate for the Nigerian economy.


1.3 Objectives of the Study

The broad objective of this study is to investigate the financial development and industrial output performance, using Nigeria as a case study.

The study specifically seeks to:

  1. Examine if there is a long-run relationship between financial development and industrial output performance in Nigeria
  2. Investigate the direction of causality between industrial output performance and the financial development in Nigeria.
  3. Examine the policy implications of long run relationship for Nigeria

1.4 Research Question

The following questions then arise

  1. Is there any long-run relationship between financial development and industrial output performance in Nigeria?
  2. What is the direction of causality between financial development and industrial output performance in Nigeria?
  3. Does long run relationship between financial development and industrial output performance have any policy implication for Nigeria?

1.5 Research Hypotheses

This study will be guided by the following hypotheses;

  1. There is no long run relationship between industrial output performance and financial development.
  2. There is no causality between financial development and industrial output performance in Nigeria
  3. The long run relationship does not have any policy implication for Nigeria

1.6 Significance of the Study

The role of the financial factor in curbing industrial output performance in Nigeria has not been well researched so far. This study is an attempt to fill the gap. The present study examines the relationship between financial development and industrial output performance in Nigeria between the years 1970-2018.

This study shall identify the extent of impact of financial development on industrial output performance. Therefore the results of this study will also be helpful to the National Planning Commission, the private and the public sectors and the financial sector of the economy. Finally, it will add to the scanty literature on the effect of financial development and industrial output performance and open further doors of research in this area and will also serve as reference materials for researchers in similar studies.


1.7 Scope of the Study

This study is limited to the Nigerian economy between the period of 1970 and 2018. This range of 48 years is chosen based on data availability and accessibility.


1.8 Limitation of the Study

There are some limitations to this study and they include;

  1. Time Constraint
  2. Inadequate finance
  3. Lack of access to data and other related materials

1.9 Organization of the Study

This study will be divided into five chapters. The research shall commence by providing a background to the study in chapter one. Chapter two shall present related literatures. The research methodology shall be outlined in chapter three while the data presentation and analyse shall be presented in chapter four as well as highlights of the implications of the findings. Concluding comments in chapter five shall reflect on the findings of the study and recommendations based on the findings.


Chapter Five


Summary of Findings and Recommendations

5.1 Summary of Findings

The broad objective of this study is to investigate the financial development and industrial output performance, using Nigeria as a case study from 1970 to 2018. Specifically the study examined the relationship between financial development and output and its direction of causality.

However, such impact cannot be explained unless variables like financial development which measures the efficiency and competitiveness of the financial sector in ensuring that more of the population gain access to the financial services, inflation which explains and captures macroeconomic stability, exchange rate that explains the rate at which the domestic currency is exchanged for others, and other variables like investment and openness are duly considered.

Furthermore, following the behavioral pattern of the variables of this study we adopted an error correction model. The long run model shows that most of the explanatory variables were statistically significant. Also, the coefficient of determination (R2) was found to be high which indicated that the explanatory variables were able to account for the total variation of the dependent variable i.e. industrial output performance.

The summary of the major empirical findings can be stated as follows:-

There was an evidence of co integration between financial development and industrial output performance. The implication of this is the existence of a stable long-run equilibrium relationship between financial development and industrial output performance. And the long-run relationship between financial development and industrial output performance was also found to be negative.

The magnitude of the estimated coefficients shows that financial development contributes significantly in determining the magnitude of industrial output performance in the long-run.

  • Logged exchange rate (LEXR) has a positive relationship with logged industrial output performance (LINDSOUT).
  • Inflation rate (INF) at its level form has a positive relationship with logged industrial output performance (LINDSOUT).
  • Investment at its log form (LINV) has a positive relationship with the logged industrial output performance (LINDSOUT).
  • Logged openness (LOPN) has a negative relationship with the logged industrial output performance (LINDSOUT)

Error Correction Mechanism that measures the speed of adjustment to equilibrium has the economic expected negative relationship with the dependent variable. This shows that any presence of error in the model will be corrected.

There is unidirectional causality from financial development to industrial output performance.


5.2 Policy Recommendations

The result obtained in the study suggests that generally, financial development has negative impact on industrial output performance in Nigeria. However, the significance of the various variables such as financial development, exchange rate, investment, openness, inflation suggests that Nigeria has to ensure their smooth operation.

The government should ensure a stable exchange rate through a stable balance of payment and the encouragement of domestic investment through the promotion of entrepreneurship and self employment as well as encouraging infant industries. This includes vocational training and research and development. It also involves the sustainability of the present democracy.

To curb this volatility, the element will be to strengthen the economy’s shocks absorbers. The financial development plays a strategic role as a shock absorber.

Government can help by reducing financial fragilities and deepening financial market through the elimination of implicit contingent liabilities and insurance schemes (such as fixed exchange rate regime)

Also, the establishments of modern, efficient and strong financial system can reduce the volatility of the Nigerian economy: This can be achieved by deepening the financial sector especially the microfinance system in Nigeria. Strengthening of supervisory and regulatory bodies in the financial system in Nigeria will be of immense help.

The critical infrastructures – power, transport, water etc should be developed as this will reduce the industrial output performance of the economy

Inflation is seen to have a positive long run effect on the volatility of output in the economy, the Nigerian government and other developing economies should therefore try to put their inflation rate at the one digit level.


5.3 Conclusion

Studying financial development and its impact on the industrial output performance of developing economies Nigeria as a case study is imperative considering the damaging effects of macroeconomic volatility” Therefore it is important that its impact is looked into, especially, on the developing nations.

A good number of literatures were reviewed in this regard, both local and international as well as theoretical and empirical to really see what others either said or found on this area. It is important to assert that there is no better view on this than to take a time series approach to ascertain the impact, thus, the dynamic long run and error correction model was used.

Based on the findings, it is suggested that financial development is capable of taming the volatility of output but Nigeria should go the extra mile to consolidate her financial system by harnessing the economy toward achieving the millennium development goals.


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Frequently Asked Questions


What is meant by financial sector development?

Financial development Financial sector is the set of institutions, instruments, markets, as well as the legal and regulatory framework that permit transactions to be made by extending credit. Fundamentally, financial sector development is about overcoming “costs” incurred in the financial system.

Does financial development contribute to economic growth?

Countries with better-developed financial systems tend to grow faster over long periods of time, and a large body of evidence suggests that this effect is causal: financial development is not simply an outcome of economic growth; it contributes to this growth.

What are the measures of financial development in a country?

For instance, ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, and ratio of deposits to GDP. Nevertheless, as the financial sector of a country comprises a variety of financial institutions, markets, and products, these measures are rough estimation and do not capture all aspects of financial development.

Why is it difficult to measure financial development?

A good measurement of financial development is crucial to assess the development of the financial sector and understand the impact of financial development on economic growth and poverty reduction. In practice, however, it is difficult to measure financial development as it is a vast concept and has several dimensions. 

What is financial sector development in developing countries?

From Wikipedia, the free encyclopedia Financial sector development in developing countries and emerging markets is part of the private sector development strategy to stimulate economic growth and reduce poverty. The Financial sector is the set of institutions, instruments, and markets.

What is the financial sector?

Financial sector is the set of institutions, instruments, markets, as well as the legal and regulatory framework that permit transactions to be made by extending credit. Fundamentally, financial sector development is about overcoming “costs” incurred in the financial system.

What is financial development?

Financial development refers to the fulfilment of the functions of the financial system in the best manner by eliminating the market distortions. Learn more in: Foreign Direct Investment, Financial Development and Economic Growth: The Case of Turkey.

Does a more developed financial sector drive growth?

Economists have long debated whether a more developed financial sector helps drive economic growth. King and Levine (1993) claimed “the predetermined component of financial development was a good indicator of long term growth.”Since then, changing circumstances have fueled arguments on both sides.

Does Too Much Finance harm economic growth?

The impact of finance on growth will turn negative if the financial development exceeds the threshold. More finance is not always better and it tends to harm economic growth after a point. This study provides new evidence on the relationship between finance and economic growth using an innovative dynamic panel threshold technique.

What are the four stages of economic development?

Michael Hecht, CEO of economic development organization at Greater New Orleans … Load Error Louisiana is ranked number four in the country for offshore wind and the American Clean Power Association said the construction of two windfarms off the coasts …

What is the link between fiscal deficit and economic growth?

When fiscal deficit finances capital components of the budget, public investment encourages economic growth. This stimulates private investment in the states, adding momentum to the growth. Capital spending is expected to augment output and improve outcomes, binding fiscal deficit to economic growth.

How do you measure financial development in a country?

In the existing literature, a country’s overall financial development is measured by the ratio of stock market capitalization plus domestic credit to gross domestic product (GDP) (e.g., Rajan and Zingales, 1998 ).

What are the subindexes for constructing the quality measure of financial development?

Subindexes for constructing the quality measure of financial development: Diversity, liquidity, efficiency and the institutional environment The quality of financial development can be measured by four subindexes, i.e., financial market breadth or diversity, market liquidity, market efficiency, and the institutional envi- ronment.

What is the 4×2 framework for measuring financial development?

The World Bank’s Global Financial Development Database developed a comprehensive yet relatively simple conceptual 4×2 framework to measure financial development around the world. This framework identifies four sets of proxy variables characterizing a well-functioning financial system: financial depth, access, efficiency, and stability.

What is the global financial development database?

The Global Financial Development Database extends, updates and recalculates these country-by-country indicators, many of which are based on underlying data for individual institutions and markets. The database is being updated on an ongoing basis as financial systems evolve, and its coverage will increase as more data are compiled.

Is it possible to measure financial development?

In practice, however, it is difficult to measure financial development as it is a vast concept and has several dimensions. Empirical work done so far is usually based on standard quantitative indicators available for a long time series for a broad range of countries.

Does financial development contribute to economic growth?

Countries with better-developed financial systems tend to grow faster over long periods of time, and a large body of evidence suggests that this effect is causal: financial development is not simply an outcome of economic growth; it contributes to this growth.

What is the importance of non-financial measures?

Following points help in understanding the importance of non-financial measures; These measures support the financial measures or KPI (key performance indicators). Most financial measures are lagging indicators, which means they reflect what has already happened. For example, revenue that a company earns from selling the product last year.

Why GDP is not an accurate measure of economic growth?

Why GDP is not an accurate measure of economic growth. The real economy includes our natural capital assets – all of the gifts from nature that we do not have to produce – and the immensely valuable, but non-marketed, ecosystem services those assets provide. 

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