Effect Of Foreign Direct Investment On Economy Growth Of Nigeria

Project and Seminar Material for Economics

Abstract

This study set out to empirically examine the effect of Foreign Direct Investment (FDI) on the economic growth in Nigeria between for 1981-2013. FDI has become a debatable and topical issue across the globe because of its key role in bridging the savings gap in Least Developed Countries (LDCs). Theoretical argument that savings translate to investment is well documented in literature. Two fundamental issues concerning the potential importance of FDI in LDCs development process has remain unresolved. Firstly, does FDI really contribute to attainment of economic growth in host country as argued by the proponents of the modernization theory? Secondly, as the dependency theorists assert that FDI, although may spur short term economic growth, will generate and accelerate internal distortions that will it ultimately depress or even retard the host country’s economic growth? Based on these arguments, the study investigated the impact of foreign direct investment on Nigerian economy by analyzing in addition the composition and trend of FDI inflow to Nigeria from 1981 to 2013. Using the dual gap and Solow growth models as theoretical framework, the quantile regression analysis was used to examine the behavior of the variables of interest; such as fiscal deficit, openness, investment in infrastructure, net foreign indebtedness and external reserve. From the result, using the two models; all the variables were statistically significant at upper quantiles which implies that high GDP motivates inflow of FDI to Nigeria at different levels (1%, 5% and 10%) except external reserve which is not statistically significant in q95 with coefficient value of 2.530. In addition, on the impact of FDI, the result revealed that FDI is not statistically significant in q5, q25,and q50 with coefficient values of 2.0351, 1.3403 and -0.9472 respectively. The result in the last two quantiles (q75 and q95) shows that FDI is statistically significant with coefficient values of -1.1307 and -8.0836 at 5% level of significance. Finally, it was found that FDI inflows are mainly in the mining and manufacturing sectors as shown by the composition and trend analysis, others sectors such as agriculture, building and constructions are yet to benefit from the FDI inflows significantly. Based on these key findings, it is therefore recommended that government should relax preinvestment laws and implement tax concession policy so as to attract FDI to these sectors.

Chapter One

Introduction

1.1 Background to the Study

The focus of this project is to study the effects of FDI on the Nigerian economy, identifying factors and conditions that promote or retard development. Developing countries are in a dilemma arising from the desire for foreign capital for internal economic development, yet there is the fear that foreign investors (which are already said to be at commanding heights of some sectors of the economy) may wrest complete control of the international economy and render it an appendage of the western economic hegemony.

However, most of the economic blueprints that have been recommended for developing economics are in agreement on the need for foreign capital. Thus, a developing country may have to determine the actual sectors which have to attract foreign private investment and also determine the optimum level of foreign investment that is necessary in order to supplement its internal resources. Thereby, maintaining a balance between economic development and economic independence. (IMF, 2009).

The impact of foreign direct investment has never been as important as it is now in the early 21stcentury, nations are more linked through trade in goods and services flow of money and investment. Owing to the enormous benefit accrued, most countries strive to attract foreign direct investment (FDI) as it is a proven tool of economic development. African and Nigeria in particular joined the rest of the world in seeking FDI as evidenced by the formation of the New partnership for Africa’s Development (NEPAD), which has the attraction of foreign investment to Africa as a major component (Funke and Nsouli 2003).

In the literature of Caves (1996), it was observed that the rationale for increased efforts to attract more FDI stems from the belief that FDI has several positive effects. Among these are productivity gains, technology introduction of new processes, managerial skills and know- how in the domestic market, employee training, international production networks and access to markets.

An agreed framework definition of foreign direct investment (FDI) exists in the literature, that is, FDI refers to the net inflows of investment to acquire a lasting management interest (10percent) or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of equity, other long- term capital, and short-term capital as shown in the balance of payments. It usually involves participation in management, joint- venture, transfer of technology and expertise. There are two types of FDI: Inward foreign direct investment and Outward foreign direct investment; resulting in a net FDI inflow (positive or negative) and “stock of foreign direct investment”, which the cumulative number for a given period.

FDI an indispensable factor to the economic growth of an economy is evident in the United States which is the world’s largest recipient of FDI and is consequently the world’s strongest economy. In the last 6 years America has benefited from the FDI through the establishment of over 4000 new projects and 630,000 new jobs have been created by foreign companies, resulting in .close to $314 billion in investment. Foreign companies has in the past supported an annual US payroll of billion with an average annual compensation of $68,000 per employee (UNCTAD, 2010)

Sub-Saharan Africa as a region now has to depend very much on FDI for so many reasons, some of which is amplified by Asiedu (2001). The preference for FDI stems from its acknowledged advantages (Sjoholm, 1999; Obwonba, 2001, 2004). The effort by several African countries to improve their business climate stems from the desire to attract FDI. In fact, one of the pillars on which the New partnership for Africa’s development (NEPAD) was launched was to increase available capital to US$64billion through a combination of reforms, resource mobilization and a conducive environment for FDI (Funke and Nsouli 2003).

Recently, TNCs from developed and transition economies have increasingly been investing in Africa over the past few years. They accounted for 22 percent of flows to the region over the 2005-2008 period, compared to 18 percent in 1995-1999 investors from China. Malaysia India and the Gulf Cooperation Council (GCC) are among the most active-although Africa still makes up only a fraction of their FDI. Investors from Southern Africa and North Africa have also raised their profile in the region. These new sources of Investment not only provide additional development opportunities, but are also expected to be more resilient than traditional ones, providing a potential buffer against crises (UNCTAD, 2009).

Nigeria receives the largest amount of FDI in Africa. FDI inflows have been on the increase over the course of the last decade; from USD$1.14billion in 2001 and USD$2.1billion in 2004, Nigeria’s FDI reached USD11billion in 2009 according to UNCTAD, making the country the nineteenth greatest recipient of FDI in the world.

Hence, since FDI is seen a promising device for driving the economy to desired heights, it is only rationale for Nigeria to increase her revenues by increasing her efforts in attracting more of it.

1.2 Statement of Problem

Unfortunately, the efforts of most countries in Africa to attract FDI have been futile. This is in spite of the perceived and obvious need for FDI in the continent, the development is disturbing, sending very little hope of economic development and growth for these countries. Nigeria as a nation has not been able to fully tap from her resources.
Recent report has shown that Nigeria due to her over-dependency on oil is fast loosing its leading role in terms of attracting FDI in Africa to Egypt and South Africa, which were successful in attracting FDI in diverse sectors of their economies (UNCTAD, 2009).

Nigeria’s poor FDI record can be further adduced due to the following reasons:

Uncertainty:

One of the reasons why foreign investors are reluctant to invest in Nigeria, despite its enormous profitable opportunities, is the relatively high degree of uncertainty in the region, which exposes firms to significant risks. Uncertainty in the Nigeria manifests itself in three different ways:

Political Instability:

The region is politically unstable because of the high incidence of wars, frequent military interventions in politics, and religious and ethnic conflicts. Sachs and Sievers (1998) have also argued that political stability is one of the most important determinants of FDI in Africa. Example is the Bokoharam and Niger Delta menace which have been reported to scare away investors (World Bank 2011).

Macroeconomic Instability:

Instability in Macroeconomic indicators as evidenced by the high incidence of currency crashes, double digit inflation, and excessive budget deficits, has also limited the regions ability to attract foreign investment. Recent evidence based on African data suggests that countries with high inflation tend to attract less FDI (Onyeiwu and Shrestha, 2004).

Lack of Policy Transparency:

In Nigeria it is often difficult to tell what specific aspects of government policies are in operation. This is due in part to the high frequency of government as well as policy changes in the region and the lack of transparency in macroeconomic policy. The lack of transparency in economic policy is of concern because it increases transaction costs thereby reducing the incentives for foreign investment.

Inhospitable Regulatory Environment:

The lack of a favourable investment climate also contributed to the low FDI trend observed in the region. In the past, domestic investment policies––for example on profit repatriation as well as on entry into some sectors of the economy––were not conducive to the attraction of FDI (Basu and Srinivasan, 2002).

GDP Growth and Market Size:

Relative to several regions of the world, growth rates of real per capital output in Africa are low and domestic markets are quite small. This makes it difficult for foreign firms toexploit economies of scale and so discourages entry. (Elbadawi and Mwega,1997), show that economic growth is an important determinant of FDI flows to the region.

Poor Infrastructure:

The absence of adequate supporting infrastructure: telecommunication; transport; power supply; skilled labour, discourage foreign investment because it increases transaction costs.

Furthermore poor infrastructure reduces the productivity of investments thereby discouraging inflows. Asiedu (2002b) and Morrisset (2000) provide evidence that good infrastructure has a positive impact on FDI flows to Africa.
Other factors that account for the low FDI flows to the region but are rarely included in empirical studies––presumably due to data limitations–– include:

High Dependence on Commodities:

Several African countries rely on the export of a few primary commodities for foreign exchange earnings. Because the prices of these commodities are highly volatile, they are highly vulnerable to terms of trade shocks, which results in high country risk thereby discouraging foreign investment.

Corruption and Weak Governance:

Weak law enforcement stemming from corruption and the lack of a credible mechanism for the protection of property rights are possible deterrents to FDI in the region.

Foreign investors prefer to make investments in countries with very good legal and judicial systems to guarantee the security of their investments.

Poor and Ineffective Marketing Strategy:

In the past, African governments set up agencies to promote foreign investment without taking adequate steps to lift the constraints on foreign direct investment in the region. It is therefore not surprising that investment promotion activities in the region have not been as successful as expected. For example, in Nigeria, FDI promotion in the 1990s was accompanied by increased political risk: frequent and abrupt changes in government; religious and ethnic conflicts and border disputes. Also, FDI flows to Nigeria fell to $6.1billion (N933.3billion) in 2010, a decline of 29% from the $8.65billion (N1.33trillion) recorded in 2009 due to security treat in Niger Delta (World Bank, 2011).

Apart from the idea that promotion activities in Africa started earlier than necessary, there is also the problem that Investment Promotion Agencies (IPA) created by domestic governments were highly bureaucratic, expensive to maintain, and have not been successful in reversing the declining trend in FDI flows to Nigeria.

1.3 Research Questions

While the potential importance of FDI in least developed countries (LDCS) development process is getting appreciated, two fundamental issues concerning FDI remain unresolved. Firstly, does FDI really contribute to the attainment of economic growth in the host country as argued by the proponents of the modernization approach?

On the other hand as the dependency theorists assert that FDI, although may spur short-term economic growth, will generate and accelerate internal distortions that will ultimately depress or even retard the host country’s economic growth. Base on the foregoing, a number of interesting questions come to mind such as:

What are the determinants of FDI in Nigeria?
What is the impact of FDI on Nigerian economy?
What is the composition and trend of FDI in the Nigerian economic sectors?

1.4 Objectives of the Study

The broad objective is to examine the effect of FDI on economic growth in Nigeria. The specific objectives are:

To analyze the determinants of FDI inflow in Nigeria.

The specific objectives include:

To determine the impact of FDI on economic growth in Nigeria.
To analyze the composition and trend in the inflow of FDI in Nigeria.

1.5 Research Hypothesis

The following hypothesis will be tested:

Ho: Macroeconomic indicators do not determine the inflow of FDI into Nigerian economy.
H1: Macroeconomic indicators do determine the inflow of FDI into Nigerian economy.
Ho: FDI do not have significant impact on economic growth in Nigeria.
H2: FDI have significant impact on economic growth in Nigeria

1.6 Justification of the Study

Economic growth and development in a market economy is expected to be private sector driven and be propelled by private investment. The keen interest in this study is explained by this fact. Hence, the relevance and timeliness of this thesis can hardly be in doubt. The strong positive correlation between investment/savings and growth has been well established in the literature.

This work is anchored on the dual gap theory which provides adequate explanation on how saving and trade gaps can be filled by FDI. Many countries now see attracting FDI as an important element in their strategy for economic development. This is because FDI is seen as an amalgamation of capital, technology, marketing and management which is inadequate in LDCS.

Sub-Saharan Africa as a region has to depend very much on FDI for so many reasons, like technological spill over, creation of employment opportunities, improvement in balance of payment position, and management skills as emphasized by Asiedu (2002). The preference for FDI stems from its acknowledged advantages (Sjoholm, 1999, Obwona, 2001, 2004). In fact, one of the pillars on which the New Partnership for Africa’s Development (NEPAD) was launched was to increase available capital to US $64 billion through a combination of reforms, resource mobilization and conducive environment for FDI (Funke and Nsouli, 2003).Attempts will be made to use quantile regression to estimate result and base on results, recommendation will be made.

This study is justified based on the technique of estimation which is different from ones used by other studies on determinants and impact on economic growth in Nigeria. The country has set year 2020 in which it intends to be one of the twenty (20) largest economies in the world. This is the right time to eradicate these economic problems. Hence the starting point is to get the right policy framework in order to get there.

1.7 Scope and Limitations

The period to be covered by this research thesis is from 1981 and 2013. The choice of this period is to critically examine what happened before and after the introduction of SAP policy. IMF and World Bank structural adjustment program was adopted in 1986 with the aim of reducing the dominance of the public sector, improve its efficiency and to tap the growth potentials of the private sector. Successive government has tried to put in place measures that would attract the much needed foreign direct investment. The fundamental limitation of this research work is the poor quality and inadequacy of data. Therefore it would be important to point out that some of the information supplied by the Central Bank of Nigeria, World Bank reports and the National Bureau of statistics are sometimes conflicting. Also, the issue of non Macroeconomic indicator such as corporate governance which deals mainly with the country’s corruption record is another important factor that determines the inflow of FDI. However, the impact and the effect on FDI has been done subject to these limitations.

1.8 Organization of the Chapters

This dissertation contains five chapters.

Chapter one which is the introductory chapter shall cover background to the study, statement of the research problem, objectives of the study, research hypothesis, justification of the study and scope and limitation as well as organization of the chapters.
Chapter two contains the review of literature. The various sections are the conceptual literature, theoretical literature, empirical literature and an overview of foreign direct investment in Nigeria.
The methodology for the thesis is presented in chapter three. The model specification and estimation techniques are in this chapter.
Chapter four focuses on data presentation, estimation and interpretation (analysis) of empirical results.
Chapter five contains the summary, conclusion and recommendations.

Chapter Five

Summary, Conclusion and Recommendations

5.1 Summary

The primary intent of this dissertation is to test the popular hypothesis of determinants of FDI and its impact on economic growth in Nigeria using quantile regression. The emphasis on QR is to get a much more subtle inference when compared to the use of OLS analysis. The use of quantile regression allows one to overcome problems usually encountered when using OLS such as constancy of error terms across a distribution, sensitivity to extreme outliers, and loss of information about the tails.

The empirical result of the quantile regression shows that FDI has significantly negative relationship at the 5th and 25th quantiles and significantly positive coefficient at the 75th and 95th quantiles.

The Quantile Regression estimates for the determinants of FDI shows that there are variables that have significant coefficient at different quantiles e.g. external reserve (EXTR), openness (OPEN) and fiscal deficit (FDEF).

Official remittance (OR) enters the OLS regression with significant and negative coefficient across all quantiles (5th, 25th, 50th, 75th, and 95th).

FDI does not exert positive and significant impact on economic growth in the OLS regression. This result is consistent with Carkovit and Levine (2005). For the quantile regression, the empirical result shows high and positive coefficient at q5 of 2.0352 and q25 of 1.3403 but not statistically significant, it shows a low and negative coefficient in the median quantile but statistically significant but negative at q75 and q95 which corresponds to the period of privatization and commercialization of public enterprises in the country. The high and negative coefficients but statistically significant result shows that the privatization/commercialization policy was poorly carried out.

Finally the composition and trend table shows that FDI inflows are mainly in the mining and manufacturing sectors. The table also shows significant improvement in the transport and communication sector in recent time. This is not unconnected with the complete deregulation of the sector.

5.2 Conclusion

The study investigates the effect of Foreign Direct Investment (FDI) on the economic growth in Nigeria. The role of FDI in host country’s economy has remained controversial. Firstly, are there factors under the control of the host country that can be manipulated to attract FDI? Some researchers claim that, by and large, LDCS have fewer roles to play in determining the direction and size of FDI (PanLong 1987). Secondly, does FDI really contribute to attaining the object of economic growth in the host country as argued by the proponent of the modernization approach? On the other hand, the dependency theorists argued that FDI may spur short-term economic growth, but will eventually generate and accelerate internal distortions that will ultimately depress or retard host country’s economic growth.
Given the practical importance of these two issues in terms of policy formulation and implementation, empirical works about the determinants of FDI and its impact on Nigerian economy is carried out using quantile regression so as to get much more subtle inference than using OLS framework alone. The study also investigates the trend and pattern of FDI inflow into Nigerian economic sector. The study reveals that most FDI are resource seeking and market seeking FDI as most of them are in mining and quarrying and manufacturing.

Going by the result from the study, openness of the economy has high statistical coefficient value but insignificant in determining the inflow of FDI into Nigeria using OLS. This contradicts the result estimates of positive and statistically significant result at 10% level of significance in q25, q50, q75, and q95. This shows that openness of the economy draws in more FDI into the country. Fiscal deficit if use in the provision infrastructure such as roads, railways and stable power supply it will draw in more FDI as the result estimates of both OLS and quantile regression are positive and statistically significant in all quantiles. Also, investment in infrastructure is statistically significant in OLS and all quantiles except q5. This draws in more FDI as it will reduce cost of production and increase profitability.

Going by our result on the impact of FDI on economic growth, the coefficient of 0.3128 is low and statistically not significant in the OLS. By our quantile regression, it has high and positive coefficient but not statistically significant in the q5 and q25. It is even negative in the median (q50) quantile. The result is different in the last two quantiles as FDI exhibit high and negative coefficient but statistically significant at 5% level of significance. This result shows that FDI alone cannot lead economic growth without other variables such as macroeconomic, political stability and addressing the problem of corporate governance.

For the QR result, it shows a high and positive relationship at the 5th and 25th quantile and negatively significant coefficient at 75th and 95th quantiles.

In the light of the above, attention should be paid by policy makers on policies that can make Nigeria harness the economic gains of FDI. The policy on openness should be pursued with caution as one without some level of restriction can be counterproductive. This way, the problem of unemployment and high level of poverty in the country can be reduced to the barest minimum.

In fact, one of the pillars on which New Partnership for Africa’s Development (NEPAD) was launched was to create conducive environment for FDI (Funke and Nsouli, 2003).

5.3 Recommendations

Base on the research objectives and findings, the following recommendations are proffered: To encourage FDI inflows much of government expenditure should be used in financing capital projects such good road networks, rail lines across the country and stable power supply which are not for current consumption. This will no doubt reduce the cost of doing business in Nigeria and increase profitability. From our result, FDI alone cannot lead to economic growth, with the availability of other factor such conducive environment and simplified pre-investment procedures, more FDI will be attracted to key economic sectors and contribute to economic growth.

Also, the privatization exercise of the government should be handled in a transparent manner. This will convince foreign investors that their money will not go down the drain. If the approach and zeal exhibited in the deregulation process of telecommunication sector is extended to the power sector, similar success will be achieved. This will lower the cost of doing business in Nigeria and allow manufacturing FDI to contribute significantly to economic growth.

Institutions such as the anti-graft agencies of the government (EFCC and ICPC) should be strengthen in order to give more bites in their war against corruption. This will redeem the image of the country before the outside world.

The policy of openness should be sustained but must well guided as unguided one can lead to massive importation of intermediate goods which can seriously affect the balance of payment position of the country. Other factors like investment in human capital (IHC) which contributed positively to growth rate at both lower and upper quantile could be improved upon which could further increase growth rate of GDP. There is need for government to invest more in education for the country’s population and routine training of the country’s work force. This will enhance productivity and increase growth.

Finally, the Nigeria Investment Promotion Commission can still do more by showing foreign investors the potentials that abound in other sectors so as to give room for diversification of the economy.

5.4 Contribution to Knowledge

This research work shows the analysis of determinants and impact of foreign direct investments on economic growth in Nigeria using quantile regression approach. This approach enable us to trace the distribution of Y, conditional on X, and obtain a much more complete view of the effects of explanatory variables on the dependent variables at different quantiles as opposed to other methodologies employed in understanding the relationship between FDI and economic growth in Nigeria. Areas of further research in understanding the nexus between FDI cum economic growth in Nigeria is to capture the effect of endogeneity through the use of instrumental variables, a method known as instrumental variable quantile regression (IVQR).

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