Abstract
The link between public expenditure and economic growth has attracted considerable interest on the part of both economic researchers and policy makers both at the theoretical as well as empirical levels. Two strong but opposing views exist in the public expenditure literature, namely, the Keynesians – government spending is an important policy tool to be used to ensure a reasonable level of economic activity, correct short-term cyclical fluctuations in aggregate expenditure, and the opposite view – that excessive government intervention in economic activities crowds out and distorts the activities of other economic agents. The size of the public sector keeps expanding day by day and one wonders if such continuous expansion is accompanied by expansion and growth of national output. This research work is set out to estimate the determinants of public expenditure; determine the impact of public expenditure on output growth
in Nigeria; determine the direction of causality between public expenditures and output growth; investigate if output growth responds significantly to public expenditures shocks in Nigeria; determine the impact of public expenditure by sector on economic growth. To achieve these, four models were applied both for the short run dynamics and the long run relationships. From the results, it was found that the size of revenue, national output growth (national income), external debts and domestic debts are the determinants of the size of public sector in Nigeria. The result also showed that public expenditure has strong (but positive) and significant impact on output growth in the short run but insignificant in the longer period. It was also found that both the recurrent and capital expenditures granger cause output changes, and also that the shocks from them cause fluctuation in output of Nigeria. This research discovered that, in the short run, public expenditures on education, agriculture, all have both positive and significant impact on output growth, while expenditures on health and building and construction have negative and significant relationship and defence has both positive and insignificant link with output growth. In the long run, however, defence, education and agriculture expenditures are positive and significant, whereas health and building and construction are negative and significant. The recommendations in this research are that public debts should be curtailed, revenue base should be expanded, price moderation is important, more social infrastructures should be provided to create avenues for private investment to increase, restraining from the use of recurrent expenditure because it is inflationary and can worsen the economic situation, policies for the health and building and construction sectors should be reviewed to check why they retard economic growth of Nigeria.
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Many developing countries are currently undergoing substantial macroeconomic adjustment. It is not clear how such programmes are affecting government expenditures and hence longer-term economic growth and poverty reduction. Thus, it is important to monitor trends in the levels and composition of government expenditures, and to assess the causes of change over time. It is even more important to analyze the relative contribution of various expenditures to production growth and poverty reduction, as this will provide important information for more efficient targeting of these limited and often declining financial resources in the future.
The link between public expenditure and economic growth has attracted considerable interests on the part of economic researchers both at the theoretical as well as empirical level. Roughly speaking, one may distinguish between two opposing views: On the one hand, there is the Keynesian approach according to which government spending is an important policy tool to be used to ensure a reasonable level of economic activity; correct short-term cyclical fluctuations in aggregate expenditure (Singh and Sahni, 1984); and secure an increase in productive investment, thus providing a socially optimal direction for growth and development (Ram, 1986). The opposite view is that excessive state intervention in economic life affects growth performance in a negative way for two reasons: first, because government operations are often conducted less efficiently, they reduce the overall productivity of the economic system, second, because excessive government expenditure (usually
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accompanied by high taxation levels) distorts economic incentives and results in suboptimal economic decisions (Barro 1990; King and Rebelo 1990).
Those who support larger size of the government give credence to the provision of certain goods and services that would otherwise not be provided by the private sector. They assert that government comes into economic activities due to failure of the market and externalities to establish a predetermined growth path. Government exists so as to provide social and physical infrastructure, by undertaking some investment and expenditures. By these ways, the government can directly or indirectly improve the productivity of the private sector by efficient and effective allocation of resources. The existence of government is correctly justified when one looks at the legal functions of the government, in terms of property rights (Atkinson and Stiglitz 1980:5), provision of security, maintenance of law and order, etc. In this sense, government expenditures have become expedient and necessary to overcome the obstacles of economic development.
However, when the size of the public sector becomes very large it can impinge on economic growth and development (Peden and Bradley (1989: 239), Vedder and Gallaway (1998), Folster and Henrekson (2001), etc). The larger the size of the public sector, the more difficult it becomes to coordinate the activities of the key players in the system. Larger governments tend to crowd out private investment, which invariably impinges on domestic output (Ahmed and Miller, 1999). Larger sizes of government can also create output volatility (Acemoglu and Ziliboti, 1997; and Koskela and Viren, 2003).
Maintaining law and order, in particular, securing property rights is probably the most acceptable rationale for government intervention. Theoretically, it is argued that
enforcement of property rights being a public good, its provision can only be 18
materialized through collective action (Gradstein, 2004). The rationale for the existence of government anywhere, including Nigeria, can be viewed from the perspective of the institutions of property rights, rule of law, governance, security, enforcement of the rule of law, etc. Nigeria is a Federal state with three tiers, with multiple and diverse ethnic and other socio-political differences, which most often determine the volume and rate of spending. The nature of public spending (in Nigeria) depends majorly on the revenue – of which oil controls a greater percentage – and which is also determined by the vagaries of world market interactions. The other institutional factors which can influence the public spending and economic growth include institutional quality (the enforcement of property rights), political instability (riots, coups, civil unrests, civil wars, etc), characteristics of political regimes (elections, constitutions, executive powers), social capital (the extent of civic – private
- activity and organizations) and social characteristics (differences in income and in ethnic, religious, and historical background) (Aron, 2000:100). All these affect nations’ investment directly as they create harsh environment and insecurity, which increases transaction costs and mar the private investment for growth.
According to North (1990:110), “Third World countries are poor because the institutional constraints define a set of payoffs to political/economic activities that do not encourage productive activity”. Such rules affect both individuals and organizations, defined as political organizations (city councils, regulatory agencies, political parties, tribal councils), economic organizations (firms, trade unions, family farms, cooperatives, etc), educational bodies (schools, universities, vocational training centres), and social organizations (churches, clubs, civic associations) (Aron, 2000). The inability of the government to enforce the rule of law affects the economies of
developing countries, including Nigeria, and as such, rent-seeking behaviours, 19
corruption, bribery and protection of individuals and organizations connected with highly placed people become the common phenomenon. These behavioural attitudes raise the transaction costs and costs of information in the production process and make the rule of law unreliable.
Bearing all these in mind, it is necessary to verify the impact of the growth of government expenditure. Research is therefore needed to examine the source of shocks and how they influence the economy. Output volatility in Nigeria is another area that we need to find whether it is caused by public expenditure rise.
1.2 Statement of the Problem
It is a fact that no society throughout history has ever obtained a high level of economic affluence without a government. Government is a necessary, though by no means sufficient, condition for prosperity (Vedder and Gallaway, 1998). Where governments did not exist, anarchy reigned and little wealth was accumulated by productive economic activity. We should note, however, that where governments, on the other hand, have monopolized the allocation of resources and other economic decisions, societies have not been successful in attaining relatively high levels of economic affluence. Economic progress is limited when government is zero percent of the economy, and also when it is at or near 100 percent. Too much government stifles the spirit of enterprise and lowers the rate of economic growth.
The recent revival of interest in growth theory has also revived interest among researchers in verifying and understanding the linkages between fiscal policies and economic growth. Government spending can stimulate particular sectors as well as increase aggregate demand taken globally. Over some past two decades, a substantial 20
volume of empirical research has been directed towards identifying the elements of public expenditure (at its aggregate and disaggregate levels) that bear significant association with economic growth. Recent literature on endogenous growth theory predicts that fiscal policy changes can affect the long-term growth rate by influencing the determinants of growth (physical and human capital, technological changes, employment and savings) (Hjerppe, et. al. 2006).
The relationship between economic growth and government spending, or more generally the size of the public sector, is an important subject of analysis and debate. A central question is whether or not public sector spending increases the long run steady state growth rate of the economy. The general view is that public expenditure, notably on physical infrastructure or human capital, can be growth-enhancing although the financing of such expenditures can be growth-retarding. Existing literature in Nigeria has not been in agreement on the nature and impact of government expenditure on economic growth. Ekpo (1995) finds that capital expenditure on construction and manufacturing crowds out private investment. Ogiogio (1995) observed a long run relationship between economic growth and government expenditure. Aigbokhan (1996) reported a bi-directional causality between government total expenditure and national income. Essien (1997) using data from 1960-1994 found no causality between public expenditure and national income. Odusola (1996) and, Nurudeen & Usman (2010) find that military expenditure has no significant relationship with economic growth in Nigeria. However, Adewara and Oloni (2012) found that expenditure on defence is positively related with economic growth
Akpan (2005) used Error Correction Model (ECM) in his study of the impact of government expenditure on economic growth in Nigeria with two lags. Aregbeyen, 21
(2006); Babatunde, (2009) showed that government capital expenditure has a significant positive effect on real output, but that real government recurrent expenditure has insignificant effect on growth. Olorunfemi (2008) in a study on the relationship between economic growth and public expenditure in Nigeria surprisingly concluded that there is no link between gross fixed capital formation and GDP and that public expenditure affects GDP without elaborating the type of relationship. Nurudeen and Usman (2010) studied the impact of government expenditure on economic growth by disaggregating the government expenditures into capital expenditure, recurrent expenditure, defence, education, health, transport and communication and fiscal balance, using cointegration method, and found that all the variables except defence and agriculture are statistically significant. From this review, there is no consensus among researchers on the nature and impact of public expenditure on the performance of Nigeria (and indeed other countries). Further investigation into the matter is of ultimate necessity for Nigeria.
Nigeria has consistently had deficit spending over the years without equivalent rate of economic growth. Data shows that output of Nigeria has been fluctuating for some years and the sources of these shocks may not be clear. The growth rate (real GDP growth) of output was 3.2, 2.4, 2.8, 3.8 and 4.7 respectively, in 1997, 1998, 1999, 2000 and 2001, while the total expenditure growth was 12.1, 15.6, 28.1, 15.6, and 19.3 per cent in 1997, 1998, 1999, 2000, and 2001, respectively (CBN, 2001). This implies that the growth rate of public expenditure was far higher than that of economic growth.
The aggregate expenditure of the Federal Government, in nominal terms, increased by 32.2 per cent to N3,240.8 billion in 2008 (CBN, 2008). As a proportion of GDP, total expenditure increased by 13.5 per cent, from 11.7 per cent in 2007, while the GDP 22
growth rate was 6.4 percent, almost the same as the 6.5 per cent recorded in 2007 and the average annual projected growth rate for the period 2004 – 2008. This implies that the public expenditure is growing faster than the rate at which the output is growing. As a percentage of GDP, recurrent expenditure increased from 1.2 percentage points to 8.8 per cent. Most of the components of recurrent expenditure increased relative to their levels in 2007. As a proportion of Federal Government revenue, capital expenditure was 30.1 per cent, exceeding the stipulated minimum target of 20.0 per cent under the WAMZ secondary convergence criteria. The data speaks volume that the economy does not grow at a fast rate as the growth rate of government expenditures. It is expected that as the public expenditure expands output is expected to expand also, because public expenditure should be translated into output growth. Or does it imply that much of the public expenditure find their ways into some other paths different from the intended routes?
However, in 2009, the aggregate expenditure of general government fell by 5.1% from its level in 2008, which represented 29.4% as compared with 31.5% in 2008, while GDP growth rate, at 1990 constant prices, was 6.7%, which exceeded the 6.0% recorded in 2008 and annual growth rate of 6.4% for the period of 2005 – 2009 (CBN Annual Report, 2009:74). In 2010, the aggregate expenditure of general government increased by 15.3% from the level in 2009. As a proportion of GDP, it represented 28.4% as compared with 28.8% in 2009, while the growth rate of GDP was 7.9% which exceeded the 7.0% recorded in 2009 and the average annual growth rate of 6.7% but lower than the target growth rate of 10% for the year (CBN, 2010).
From these data, the rate at which the output grows has been lower than that of the
growth of public expenditure. This simply means that there is need to investigate 23
whether the rises in public expenditure have been accompanied by rise in the output
of Nigerian economy. The data on the fluctuations of the GDP and public
(government) expenditure are inexhaustible. This makes it expedient to understand
the nature of such fluctuations in the macroeconomic variables and how they impact
on the output of the economy.
1.2.1 Research Questions
The following research questions formed the central focus of this study:
- What are the determinants of public expenditures?
- What is the impact of the public expenditures on economic growth of Nigeria?
- Are public expenditures causing the output changes?
- Are shocks from public expenditures distorting the output growth in Nigeria?
- What are the impacts of sectoral public expenditures on the output growth in Nigeria?
1.3 Objectives of Study
The broad objective of the research work is to determine the macroeconomic impact of the Nigerian public (government) expenditures. It is also of interest to ascertain which expenditure item of the government affects the output. However, the specific objectives are as follows:
- To estimate the determinants of public expenditure
- To determine the impact of public expenditure on output growth in Nigeria.
- To determine the direction of causality between public expenditures and output growth.
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- To investigate if output growth responds significantly to public expenditures shocks in Nigeria.
- To determine the impact of public expenditure by sector on economic growth.
1.4 The Hypotheses
The hypotheses of this research work are tacitly stated as follows:
- Ho1: The determinants of the public expenditures cannot be determined.
- Ho2: The Public expenditure has no significant impact on economic growth in Nigeria.
- Ho3: Public expenditures do not Granger cause output changes.
- Ho4: The shocks from public expenditures do not significantly affect output growth in Nigeria.
- Ho5: The sectoral spending of the government does not impact significantly on output growth.
1.5 Justification of the Study
Even though the public expenditure has increased rapidly in the last two centuries in every nation and even though its growing role and importance cannot be neglected in national economies, the area of public (government) expenditure remains a complex and debated area of study. This is true especially when we look at the existing literature in Nigeria and other countries. Existing studies have produced conflicting results and no consensus has been reached about the nature of the relationships between public expenditure and economic performance.
Nigerian government expenditure has been consistently rising and after each year, the budget would increase and so, the expenditure would do the same. One might be tempted to assume that the public expenditure is consistent with Wagner’s law. Does it mean that the expenditure of the government of Nigeria is rising because
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the economy is improving? What are the determinants of the rising trend of the public sector? To answer these questions entails a lot of insights and investigation into the nature of the links between public expenditure and the performance of the Nigerian economy. This means that there should be a thorough investigation into the government spending attitude and methods and their relationships with national growth.
In spite of huge expenditure programmes undertaken by the government, most of our infrastructures are in decay. The roads are bad, hospitals poorly rehabilitated and equipped with the necessary resources; the schools are in disrepair and in poor conditions, etc. the energy sector is not optimally supplied to support and boost the industrialization strategies designed by the government. We need to investigate which of these sectoral expenditure programmes that are significantly affected by the public expenditure programmes. A great effort has been made to carry out an in-depth study of what determines the size of government in Nigeria and the impact of public expenditure on economic growth. There is also the need to find the how shocks from public expenditures transmit to other macroeconomic variables. The capacity of the models used in this research to determine these areas of research interests in the links between public expenditures and economic growth justifies the strength of this research for policy advocacy and policy making.
1.6. Scope of the Study
The research is basically for the economy of Nigeria. The study dwelt mainly on the public expenditure of Nigeria – aggregate expenditure of all tiers of government in Nigeria; output growth – measured from the supply side and not 26 from the demand side. In some of the analysis, there was the need to divide the aggregate expenditure into capital and recurrent and in some others, the disaggregation of public expenditure into sectors became germane (the sectors include defence, health, education, agriculture, building and construction, transport and communication). Where it became necessary, other macroeconomic variables were introduced as may be required at a particular point in time. The time frame for the study ranged from 1961 – 2012.
1.7 Organisation of the Study
This thesis is divided into chapters. This thesis is divided into six chapters. Chapter one serves as introduction, with background of the study, statement of the problem, objectives of study, hypotheses, the significance of the study, and scope of study following one another. Chapter two dwelt on literature review. Detailed discussion of both theoretical literature and empirical literature were reviewed, while the chapter ended with the limitations of the previous studies.
Chapter three dwells on the theoretical framework of public expenditure, which discussed in details the theories of government expenditure, factors that influence government expenditure, theories of economic growth, and the links between economic growth and government expenditure. In chapter four, the methodology for this study was discussed. Four models were used for this thesis which corresponded with the research questions and objectives of the study. In chapter five, a detailed discussion of the research findings was done. The results of stationarity tests, determinants of public expenditure, the impact of public spending on economic growth, the result of the vector autoregressive (VAR) model, the impact 27 of public expenditure by sector on output growth of Nigeria and their interpretations were all discussed extensively here. The evaluation of the hypotheses and the policy implications of the research findings were also discussed. Finally, in chapter six the summary of research findings, conclusion and policy recommendations were all discussed. The contributions of this thesis to the body of knowledge and suggestions for further studies were the last sections of the thesis
