Effects Of FDI On Economic Growth Of Nigeria

There are various measures of economic development in which the rate of growth of an economy is one. The economic growth of a country has been acknowledged to be affected by the amount of both foreign and domestic investment available for its socio-economic use. Such foreign investment could either be foreign direct investment (FDI) or foreign portfolio investment (FPI).

Foreign Direct Investment can be defined as investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, for the purpose of having effective voice in the management of the enterprise. The parent enterprise through its FDI effort seeks to exercise substantial control (ownership of greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated firm) over the foreign affiliate company. Ownership share amounting to less than 10% is termed as portfolio investment.

The parent enterprise are referred to as Multinational Enterprises (MNEs) or Transnational Corporations (TNCs) and they are defined as firms that own in some way, or controls value – added activities in two or more countries (Dunning and Lundan, 2008). It can also be defined as an enterprise that controls and manages production establishments plants located in at least two countries which is simply one subspecies of multi- plant firm (Caves 1996).

The FDI go along with technology transfer and capital inflow. While FDI may be said to have an adverse impact on some countries in terms of capital flight, it can be theoretically argued that there are favourable impacts on the host country receiving FDI in terms of increased growth and development due to increase in technology and infrastructure.

Some studies on the effects of FDI on economic growth have shown various results depending on the country of study and other determinants of FDI. Studies on Nigeria however does not show a common agreement on the influence of FDI on economic growth, therefore FDI would be looked at to determine if it has a positive or negative impact on the economic growth of Nigeria. There is no vast literature on the impact of FDI on the oil sector vis-à-vis economic growth, hence, the need to determine the effect of oil sector FDI on the economic growth of Nigeria is appropriate.

There is in general, a positive relationship between flows of FDI and growth in world GDP, and as a share of world GDP, the importance of the FDI stock has increased significantly over the past two decades (Dunning and Lundan, 2008).

Objectives of the study

The broad objective of this study is to examine the relationship between FDI inflows and economic growth in Nigeria.

The specific objectives are to:

1) Investigate the empirical relationship between FDI and GDP growth in Nigeria.

2) Examine the effects of oil sector FDI on economic growth in Nigeria

3) Show the percentage of FDI accounted for by the oil sector on the economic growth of Nigeria.

Justification of the study

Although many studies have been carried out on FDI and economic growth, its percentage on GDP is still very low. The reason for its low contribution to GDP may be linked to government policies and political instability and this explains why it is still a common topic for lectures, discussions as well as issue of primary concern to the general public.

Scope of the study

The research work would be limited to the aggregate study of the time series data covering real GDP per capita growth, exports as a percentage of GDP, FDI as a percentage of GDP, exchange rate and gross domestic capital formation in the Nigerian economy from the period 1970 to 2008.

Organisation of study

Following this introductory chapter is the section on background of the study which gives a brief background of FDI on the Sub – Saharan Africa, West Africa and the Nigerian Economy. The literature review is the next chapter which shows both the theoretical and empirical review of literatures on FDI and economic growth. Chapter three which is the research methodology contains the theoretical/analytical framework, the model to be used as well as estimation techniques and sources of data. Followed by this is the empirical analysis which features the presentation and discussion of results. The study is rounded up in chapter five with summary of findings, policy recommendations, conclusion, and limitation of study with suggestions for further research.

General Background

The Nigerian economy was dominated by agriculture and manufacturing sector until the late 1960s after the discovery of crude oil. Since then, there has been a shift from agriculture to the oil sector. The decline of the manufacturing sector following an energy discovery has been termed the “Dutch disease” and has been investigated in many recent studies (Bruno and Sachs, 1982).

Due to the discovery of oil, there has been a surge of foreign investors in the country. Transnational Corporations such as Total (France), British Petroleum (United Kingdom) and ChevronTexaco (America) invest in projects to develop undersea oil fields off the coast of Nigeria.

Nigeria is richly endowed with natural resources mainly oil and gas, mineral deposits, and vegetation (Dinda, 2009). Nigeria remains one of the largest recipients of FDI in Sub – Saharan Africa.

According to United Nations Conference on Trade and Development (UNCTAD) World Investment Report, 2006, Nigeria received 11% of Africa’s total inflow of FDI in 2006 and 70% of West Africa’s total inflow of FDI. Oil however accounted for 80% of the total inflow of FDI into Nigeria.

Nigeria dominated the increase of FDI inflows into West Africa in 2005 to $4.5billion from $3.2billion in 2004, a 40% increase which represented 15% of Africa’s total value (UNCTAD, 2006).

Nigeria was one of the top 10 recipients of high petroleum share in FDI inflows with the 80% inflow of FDI into the oil and gas industry in 2006 (UNCTAD, 2006). The oil sector is the largest receiving FDI (World Investment Report, 2006)

By and large, global FDI increased in the 1980s and ever since then, FDI has remained the largest component of net resources flows to developing countries compared to other capital flows.

Africa had a rise of 78% in FDI inflows from 2004 to 2005 (UNCTAD World Investment Report, 2006). This has actually led some countries to either promote or reduce the extent of FDI by introducing policies to regulate FDI.

Recently, some countries in Sub – Saharan Africa have introduced policy measures to promote investment, for example Gambia lowered corporate taxes while some tightened regulatory framework like Nigeria, by adding local content requirement. Other African countries such as Morocco lowered corporate taxes and Algeria introduced new foreign ownership limitations in specific sectors (UNCTAD, 2010).

Chapter 2 – Literature Review

There has been a lot of research on the relationship between FDI and economic growth although most of these researches were not on Sub – Saharan Africa.

Some studies on the effects of FDI on economic growth have shown various results depending on the country of study and other determinants of FDI. Both positive and negative effects have been reported for FDI and economic growth in several countries in previous literatures.

In theory, it is expected that FDI would increase the growth of an economy due to increased technology transfer and capital inflow (Dunning and Lundan, 2008).

However, research carried out on this has showed otherwise that there is no common agreement in the linkage between FDI and economic growth.

Blomstrom et al. (1994) reported that FDI exerts a positive effect on economic growth but this is dependent on the level of income. Borensztein, De Gregorio and Lee, (1998) stated that ‘FDI contributes to economic growth only when a sufficient absorptive capability of the advanced technologies is available in the economy’.

Obamwa (2001) in his study of FDI in Uganda found that FDI affects growth positively but insignificantly. He stated that macroeconomic and political instability and policy consistency are important parameters determining the flow of FDI into Uganda.

It was noted by Akinlo, (2004) that exports have a positive and statistically significant effect on growth and noted further that extractive FDI might not be growth enhancing as much as manufacturing FDI. He found that foreign capital has a small and not statistically significant effect on economic growth in Nigeria.

According to Johnson, (2006) he finds in his empirical analysis that FDI inflows enhance economic growth in developing economies but not in developed economies.

In the exploration of FDI on economic growth in Nigeria, Adelegan, (2000) found that FDI is negatively related to gross domestic investment; and Carkovic and Levine, (2002) stated that the predictions of the effects of economic growth on FDI are ambiguous as some models suggest that FDI will promote growth only under certain policy conditions.

The natural resources of a country attracts FDI into that country (Asiedu, 2003) and in the case of Nigeria, it is the Petroleum industry that receives the greatest portion of the FDI inflow (UNCTAD, 2006).

The studies on FDI and Economic Growth in Sub – Saharan Africa, and Nigeria in particular showed that the oil industry accounted for 80% of the total FDI on per capita GDP in 2005 (UNCTAD, 2006).

From the above, the attraction of FDI inflow into the Nigerian Economy is mostly natural resource based, in which the oil sector is the greatest receiving FDI into the country.

There is no vast literature on the impact of FDI on the oil sector vis-à-vis economic growth, hence, the need to determine the effect of oil sector FDI on the economic growth of Nigeria is appropriate.

Chapter 3 – Research Methodology

The evidence for the impact of FDI on economic growth is far from conclusive, but basically, FDI is expected to increase economic growth through increase in the production of capital.

Since the primary objective of this study is to investigate the empirical relationship between FDI and economic growth in Nigeria using real GDP to measure growth, the analysis would be done using the Ordinary Least Square (OLS) regression analysis on the time series data from the period 1970 to 2008.

Analytical Framework

The methodology involves estimating an econometric model as well as simple calculations such as average and percentage. The model to investigate the impact of FDI on growth, we use a simple Cobb-Douglas production function.

Y = A Kα Lβ ——————— (1)

Where Y is output; Gross Domestic Product (GDP), L is labour and K is capital stock. The variable A captures the total factor productivity of growth in output not accounted for by the growth in factor inputs (K and L). Capital stock is assumed to consist of two components: domestic and foreign owned capital stock.

Kt = Kdt + Kft

The two components of capital stock is substituted for Kα in equation 1 and the augmented Solow production function is adopted that makes output a function of stocks of both domestic and foreign owned capital, labour, human capital and productivity (Mankiw et al 1992).

Yt = At + Kαdt + Kλft + Lβ+ Hγ ——————– (2)

Taking logs and differentiating equation 2 with respect to time, we obtain the growth equation:

yit = ait + αkdit + λkfit + βlit + γhit ——————– (3)

where lower case letters represent the growth rates of output, domestic capital stock, foreign capital stock, labour and human skill capital stock, and α, λ, β, γ represent the elasticity of output, domestic capital stock, foreign capital stock, labour and human skill capital respectively.

Equation 3 is a fundamental growth accounting equation, which decomposes the growth rate of output into growth rate of total factor productivity plus a weighted sum of the growth rates of capital stocks, human capital stock and the growth rate of labour. Theoretically, α, β, γ, are expected to be positive while the sign of λ would depend on the relative strength of competition and linkage effects and other externalities that FDI generates in the development process.

Following the established practice in the literature, according to (Ayanwale, 2007) Kd and Kf are proxied by domestic investment to GDP ratio (Id) and FDI to GDP ratio (If), respectively in view of problems associated with measurement of capital stock. The use of rate of investment is hinged on the assumption of a steady state situation or a linearization around a steady state. The effect of trade liberalization on economic growth is operating through Total Export and Import to GDP (TP).

The final form of Equation 3 therefore is:

yit = ai + αIdit + λIfit + γhit + εit ——————– (4)

where εit is an error term.

Equation 4 therefore is the basis for the empirical model estimation in the next section.

Model Specification and analytical framework

Following the above, the empirical model of Ayanwale, 2007 is adapted with some variations.

The Dependent variable is Gross Domestic Product (GDP) per capita (in log form). This is the ratio of real GDP to the population.

The independent variables included in the model are:

* Lag of Gross Domestic Product

* Foreign direct investment (FDI) in Nigeria (in percentage form) that is (FDI/GDP*100)

* Domestic investment (in log form) –

* Openness of the host economy to trade. The ratio of trade (total exports plus imports) to

GDP (in log form)

* Human capital – Importance of education to economic growth is proxied by the ratio of

secondary and tertiary institution enrolment in the population.

* Exchange rates – the real effective exchange rate (REER) is used.

* Oil production – the oil production in barrels is used here.

The above suggests that a general empirical model of FDI on Nigeria’s economic growth can be expressed as:

GDP = f(LagGDP, FDI, DI, XM, HC, EXR, OP) ——————— (5)

Where GDP = Gross Domestic Product per capita

LagGDP = lag of Gross Domestic Product

FDI = Foreign Direct Investment

DI = Domestic Investment

XM = Exports plus imports

HC = Human Capital

EXR = Exchange rate

OP = Oil production

The equation for the above expression is shown as:

LGDP = α + LGDPt-1 + β1LFDI + β2LDI + β3ΔXM + β4ΔHC + β5ΔEXR + β6OP + εi ——- (6)

+/- + + +/- – +

Where LGDP, LFDI, LDI are logs of all the variables defined above

α = constant

β1, β2, β3, β4, β5, β6, are coefficients

Δ = difference; and

εi = stochastic disturbance / error term

The a priori expectations of the GDP and the other variables are shown with signs below the variables in equation 6 above.

It is expected that GDP and FDI move in the same direction. In other words, an increase in the level of FDI into the host country would apriori lead to an increase in the real GDP. As FDI increases, GDP will tend to reduce relative to it thereby making the relationship ambiguous.

The descriptive method of data analysis is used with simple statistical tools such as graphs and charts in analysing the percentage FDI contributes to GDP. The OLS estimation technique is used to determine the relationship between FDI and economic growth in Nigeria over the past 39years.

The source of data used in this study is basically secondary data and they are sourced from the Central Bank of Nigeria (CBN) Statistical Bulletin, CBN Annual Report and Statement of Account, World Development Indicators, 2010 and paper presentation by experts.