Effects of Government Expenditure on Private Investment in Nigerian Economy (1980

Abstract

This study examined the effect of government expenditure on private investment in Nigeria during the period 1980–2016. The error correction model analysis was used in the study to analyze the relationship between the two variables. The study found that there is a long-run relationship among the variables and that the interest rate and inflation have negative but significant impact on private investment in the long run. On the other hand, government expenditure has positive but insignificant impact on private investment in the long run. In the short run, government expenditure and interest rate have a significant positive impact on private investment in Nigeria, while GDP per capita and inflation negatively impact private investment. The study concluded that there is the need for the government to increase its expenditure particularly on the provision of more infrastructural facilities as this will attract more investment from within and outside the country.

Keywords

Government expenditure investment ECM inflation

Introduction

For decades, it has been emphasized both by theoretical and empirical studies that private investment is one of the main contributors in achieving economic growth (Lucas, 1988; Solow, 1956). This recognition of the role of private ownership of economic resources is reflected in most of the developing economies, Nigeria inclusive, partly by employing liberalization policy to attract international investors to their economies. However, the major driving force of private investment in any economy is the public spending. Generally, fiscal policy is defined as the means by which a government adjusts its levels of spending and revenue in order to monitor and influence a nation’s economy. A sound fiscal policy is important to enhance price stability, sustain growth in output, employment generation, and equilibrium balance of payment achievement. Therefore, public spending is regarded as a policy thrust that can be used to lessen short-run fluctuations in output and employment in many debates of macroeconomic policy (Lipsey, 2001). It can also be used to bring the economy to its potential growth level.

Again, private investment is an important channel for the effectiveness of the fiscal policy in terms of being capable of generating economic activities’ growth. Expansionary fiscal policy is capable of positively affecting private investment (crowding in) which leads to growth in total income of the country. However, the reverse may hold (crowding out), thereby decreasing private investment by leading to an increase in interest rates. Thus, the effect of fiscal policy on private investment becomes crucial due to its relevance to sustained economic growth. The views of most of the authors on the validity of public spending on private investment in crowding out or crowding in hypothesis are divergent. While the neoclassical school advocates crowding out, the Keynesian model argues that an increase in the government spending stimulates domestic economic activity and therefore crowds in private investment. According to the Ricardian Equivalence theorem, increase in deficit financed by fiscal spending will be matched with a future increase in taxes and so they leave interest rates and private investment unchanged (Bahmani-Oskooee, 1999).

A relevant feature of the Nigerian economy was a series of abrupt changes in the government’s share of expenditures. As a percentage of gross domestic products (GDP), national government expenditures rose from 9 per cent in 1962 to 44 per cent in 1979, but fell to 17 per cent in 1988. In the aftermath of the 1967–1970 of Civil War, Nigeria’s government became more centralized. The oil boom of the 1970s provided the tax revenue to strengthen the Central Government further. Prior to the adoption of the Structural Adjustment Program (SAP) in 1986, the Nigerian economy was characterized by excessive government control of production, financial intermediation processes, and foreign trade variables through the administrative determination of interest rates, commodity prices, and exchange rates.

The adoption of Keynesian economic doctrine was premised on the need to sustain the pace of economic growth and development within the environment of a shallow and weak private entrepreneurial class. However, the country’s enthusiasm with this strategy progressively lost momentum, principally because it failed to deliver its most important promise of sustained economic growth and development. This resulted to an adverse economic performance (Ndebbio & Ekpo, 1991).

Among the various studies that examined the relationship between government expenditure and private investment both in developing and developed countries, there is no consensus. Some of the studies found a positive relationship, that is, Greene and Villanuva (1991), Munnell (1992), Shafik (1992), Oshikaya (1994) while others found negative relationship, that is, Wai and Wong (1982), Williams and Darius (1998), Pereira and Sagales (2001) and Akkina and Celibi (2002). Therefore, there is a need for more comprehensive analysis of the effects of government expenditures on private investment particularly in Nigeria as evidence shows that government expenditure has increased tremendously in the last decade.

The objective of this study is to examine empirically the relationship between government spending and private investment in Nigeria from 1980 to 2016. The rest of the article is organized as follows: the second section presents the review of literature, the third three shows the methodology and the data while the fourth section gives the analysis and lastly the fifth section hosts the summary and conclusion.

Review of Literature

The theoretical framework of this study is based on the marginal efficiency theory of investment, the accelerator theory, and the causal relationship between private and public investment. The marginal efficiency theory of investment maintains that there is an inverse relationship between private investment and the rate of interest. This is the oldest theory of investment in which the interest cost of financing has an adverse effect on private investment. The accelerator theory of investment assumes that change in sales is an important determinant of private investment. However, Erenburg and Wohar (1995), in the context of the neoclassical theory, assumed that the demand for capital is a function of cost of capital and other factors. The influence of other factors is taken into account by including a proxy for sales or output. This form of the neoclassical theory of investment is similar to the accelerator theory.

It should be noted that series of researches have been conducted to verify the validity of the theories in line with empirical evidence. Aschauer (1989) examined the impact of the public capital stock on productivity, using US annual and state level data. The empirical results indicated that nonmilitary public capital stock, particularly in core infrastructure, is more important in determining productivity than is on either flow of nonmilitary or military spending. Monadjemi and Huh (1998) examined the relationship between private investment and government spending in Australia, Britain, and the United States. Using error correction model, variance decomposition, and impulse response functions to investigate the effects of government spending on private investment, the empirical results provide limited support for ‘crowding out’ effects of government investment on private investment. Kustepeli (2005) analyzed the effectiveness of fiscal policy in the context of crowding out hypothesis for Turkey. Johansen co-integration test results confirm both the Keynesian and neoclassical views for Turkey while increase in government spending is found to crowd in private investment, government deficit is found to crowd it out.

Laopodis (2001) investigated the effects of military and nonmilitary public expenditures on gross private investment using co-integration and error-correction analysis. Though public spending was disaggregated into expenditures of infrastructure, consumption, and other general government expenditures, the empirical evidence from four emerging European countries, namely, Greece, Ireland, Portugal, and Spain suggested that in some cases public capital spending stimulated investment, while in others it depressed it. Erdal (2001) investigated whether disaggregated measures of government expenditure (government consumption and public investment) exerted a positive or negative effect on private investment in Turkey over the period 1968–2000. A co-integration analysis of a multivariate system of equations was applied in estimating empirically the long-run relationship between different measures of government expenditures and private investment. Their estimation result indicated that public investment and government consumption tended to crowd out private investment.

Ahmad and Qayyum (2008) examined the effect of government spending and macroeconomic uncertainty on private fixed investment in the service sector of Pakistan for the period 1972 to 2005. He estimated the long-run model using co-integration technique. The results showed that government spending and interest rate affected private investment in service sector in Pakistan. The author’s preferred short-run dynamic investment function indicates that increase in government current spending and interest rate discourages private investment and similarly macroeconomic instability and uncertainty affect the private investment negatively.

Udoh (2011) estimated the relationship between public expenditure, private investment, and agricultural output growth in Nigeria over the period 1970–2008. The bounds test autoregressive distributed lag (ARDL) modeling approach was used to analyze both short-run and long-run impacts of public expenditure and private investment (both domestic investment and foreign direct investment) on agricultural output growth in Nigeria. The results showed that increase in public expenditure had a positive influence on the growth of the agricultural output. However, foreign investment had insignificant impact in the short run.

Bogunjoko (1998) examined private and public investment nexus, and growth and policy reforms in Nigeria. He used vector autoregressive (VAR) framework to simulate and project, in an intertemporal manner, private investment response to its principal shocks, namely, public investment, domestic credit, and output shocks. The results of the VAR showed that government policies that produced sustainable output growth, steady public investment, and encouraged the availability of domestic credit to the private sector would promote investment in the long and short term.

Methodology and Data

This study follows the approach adopted by Aschauer (1989) and Serven (1998) by specifying the model to be estimated as:

P I = β_{O} + β_{1} G O V E + β_{2} G D P + β_{3} I N T + ε_{t,}

where PI is the domestic credit to private sector used to proxy private investment, GOVE denotes general government expenditure, GDP represents gross domestic per capita, INT is the interest rates, INF represents inflation, and $ε_{t}$ is the disturbance term.

Measurement of Variables and Data Source

The main objective of this study is to examine the effect of government expenditure on private investment in Nigeria during the period of 1980–2016. The data set was sourced from World Bank Development Indicator. Data on GDP per capita, real interest rates, general government consumption expenditure, inflation, and private investment were obtained from World Bank data base. The summary of statistics is provided in Table 1. The correlation Matrix is presented in Table A1 while the summary of the measurement, source, and definition of the variable included in the study are presented in Table A2

Empirical Analysis

The analysis of this study starts by testing for the existence of a unit root using Augmented Dickey Fuller (ADF) and Phillips–Perron (PP) tests. The two tests are performed on the variables in the model at levels and difference. The null hypothesis of the presence of a unit root is rejected if both tests confirm the hypothesis simultaneously. The results of the unit root tests are presented in Table 2. According to the ADF test, all the variables are stationary at level. However, according to PP test variables such as private investment, GDP per capita, and government expenditure are not stationary at level but they are stationary at first difference while interest rate and inflation are stationary at level. Based on the results of the tests, we can conclude that at first difference all the variables have no unit root at 1 per cent level.

Having established that the variables are stationary at first difference, we perform co-integration test using Johansen and Juselius (1990) techniques to determine whether there is at least one linear combination of the variables that is I (0). The results of the Maximum Eigenvalue (λ – Max) and Trace test are presented in panel A of Table 3. Maximum Eigenvalue (λ – Max) test shows that there is one co-integrating relationship among the variables while Trace test indicated at most three co-integrating relationships among the variables. The conclusion from both tests is that there is a long relationship among the variables included in the study.

The panel B of Table 3 consists of the results of co-integrating equation (normalized on the private investment variable). From this result, GDP per capita has insignificant negative impact on private investment in Nigeria during the study period. The negative impact of GDP per capita on private investment could be a result of low per capita income. The GDP per capita is very low in Nigeria compared to developed countries. This therefore affects the level of investment. General government expenditure has an insignificant positive relationship with private investment in the long run. Based on the insignificant coefficient of general government consumption, conclusion cannot be drawn. The coefficient of interest rate is negative and significant at 1 per cent. This implies that 1 per cent increase in interest rate will reduce private investment by 1.33 per cent. This finding is consistent with Nwosa, Adebiyi, and Adedeji (2013). High interest rate will reduce the level of investment as it discourages investors from borrowing. Inflation has inverse relationship with private investment. The coefficient of inflation is significant at 1 per cent. This finding is in line with studies of Bakare (2011) and Léonce (2000) who found inverse relationship between inflation and private investment.

Table 1.

Summary of Statistics

	Mean	Maximum	Minimum	Standard Deviation	Observations
PI	1.1532	1.5841	0.9400	0.1392	35
GDP	3.2013	3.4087	3.0611	0.1144	35
INF	1.1654	1.8623	0.7309	0.3173	35
GOVE	0.9439	1.2539	0.6842	0.1615	35
INT	0.0894	26.3877	–43.5883	16.7567	35

Source: The author.

Table 2.

Unit Root Test Results

Series	ADF		PP
Series	Level	1st Difference	Level	1st Difference
PI (Constant)–9.2410^***	–2.6677^*	–5.2602^**	–2.4900	–
Constant & Linear	–3.2261^*	–5.1736^**	–2.4255	–9.5607^***
GDP (Constant)	–0.1659^*	–4.8505^**	–0.5239	–4.8472^**
Constant & Linear	–3.0745	–5.0566^**	–3.0117	–5.0618^**
GOVE (Constant)	–5.1035^**	–6.4131^***	–2.5435	–6.4391^***
Constant & Linear	–5.1807^**	–6.3198^***	–2.6244	–6.3448^***
INT (Constant)	–6.1396^***	–7.4059^***	–6.1506^***	–37.6287^***
Constant & Linear	–6.5464^***	–7.2970^***	–7.4031^**	–37.0438^***
INF (Constant)	–3.3548^**	–6.0298^***	–3.2398^**	13.0307^***
Constant & Linear	–3.8031^**	–5.9196^***	–3.2482^**	–12.5807^***

Source: The author.

Note: ^***, ^**, and ^* denote significance at 1%, 5%, and 10% levels, respectively.

Table 3.

Co-integration Results (with a Linear) where r is the Number of Co-integrating Vectors

Null	Alternative r	λ Max	Critical Values 95%	Trace	Critical Values 95%
0	1	53.3389	33.8768	110.3827	69.8188
≤ 1	2	27.0345	27.5843	57.0436	47.8561
≤ 2	3	21.8012	21.1316	30.0090	29.7970
≤ 3	4	8.2048	14.2646	8.2078	15.4947
≤ 4	5	0.0029	3.8414	0.0029	3.8414

Panel B.

Estimates of Co-integrating Vector

Dlog (PI)	Dlog (GDP)	Dlog (GOVE)	Dlog (INT)	Dlog (INF)
–1.0000	–0.4017(1.7004)	0.1342(0.7776)	–0.0133^***(4.7857)	–0.1300^***(10.1172)

Source: The author.

Note: t ratios are in parentheses; ^*** and ^* denote significance at 1% and 10% levels, respectively.

Based on the co-integrating relationship that exists among the variables, we therefore estimate error correction model. Error correction model combines both the short-run properties of the economic relationship in the first difference form as well as the long-run information provided by the data in level form. The information provided by the likelihood ratio test is used to generate a set of the models that capture the short- and long-run behavior of the output relationship. The changes in the relevant variables represent elasticities, while the coefficient of the ECM term represents the speed of adjustment back to the long-run relationship among variables. The short-run results are provided under the error correction model as shown in Table 4.

The error correction model produced interesting results as some of the coefficients are significant and some are not. The adjusted R-squared (R–2) in Models 1, 2, 3, 4, and 5 are 0.60, 0.67, 0.59, 0.65, and 0.58, respectively. This indicates that the independent variables (GDP per capital, general government expenditure, inflation, and interest rate) accounts for about 58 per cent to 67 per cent of the total changes in the dependent variable (private investment). The F-statistics which test for the overall significance of the model is very high and show a good fit for the model. Durbin–Watson statistics is satisfactory and shows that there is no autocorrelation in the model. The coefficient of ECM is negative as expected and statistically significant between 5 per cent and 10 per cent. The speed of adjustment of the variables to equilibrium ranges between 0.22 per cent and 0.35 per cent in the short run. This suggests that for any deviation due to shock will take about two years to converge to equilibrium. Therefore, the ECM is able to correct any deviations in the relationship between the dependent variable and explanatory variables.

GDP per capita has negative impact on private investment and significant at 10 per cent in Models 1, 2, and 3. However, in Models 4 and 5 it is not significant. Model 5 which contains lagged GDP per capita shows that the coefficient of lagged GDP per capita is negative but not significant. The current government consumption is positive and significant at 5 per cent in all the models apart from Model 5 where it significant at 1 per cent. This result implies that government expenditure contributes to the growth of private investment in Nigeria. Taking Model 5 as the lead model, it shows that 1 per cent increase in government expenditure will increase private investment by 58 per cent. This finding is consistent with Sinevičienė (2015) who found a positive relationship between government expenditure and private investment.

Table 4.

Error Correction Model (Dependent Variable △logPI)

Variables	Model 1	Model 2	Model 3	Model 4	Model 5
C	0.0400^*(0.7244)	0.0311(0.5148)	0.0545(0.8856)	0.1279^**(2.3802)	0.1721^**(2.2788)
∆log (GDP)	–0.9892^*(–0.9810)	–0.9866^*(–0.9457)	–0.9803^*(–0.7543)	–0.6777(–0.2691)	–0.2051(–0.3367)
∆log (GDP_1)					–0.02388(–0.3828)
∆log (GOVE)	0.4202^**(3.8104)	0.4162^**(3.7036)	0.4368^**(3.7477)	0.4561^**(4.4033)	0.5882^***(4.7167)
∆log (GOVE_1)			0.1247(1.0844)	0.1524(1.4612)	0.2077(1.3381)
∆log (GOVE_2)			0.0528(0.4803)	0.1342(1.2616)
log (INF)	–0.0273(–0.5947)	–0.0196(–0.3888)	–0.0364(–0.7098)		–0.1385^**(–0.2489)
log (INF_1)				–0.0988^**(–0.2245)
log (INT)	0.0031^**(3.1108)	0.0032^**(3.0795)	0.0033^**(3.0448)	0.0030^**(3.2042)	–0.0009(–0.7633)
log (INF_1)		0.0003(0.4010)
ECM_1	–0.2265^*(–0.7421)	–0.2287^*(–0.7306)	–0.2346^*(–0.7184)	–0.3131^**(–0.4255)	–0.3517^**(–0.3667)
R–2	0.60	0.67	0.59	0.65	0.58
SE	0.072	0.073	0.075	0.069	0.085
F-statistics	11.24	9.11	7.56	9.56	4.93
Pro (F-statistics)	0.0000	0.0000	0.0000	0.000	0.0013
D–W	1.61	1.64	1.63	1.65	1.82

Source: The author.

Note: ^***, ^** and ^* denote significant at 1%, 5% and 10%, respectively.

The results of government expenditure lagged one and two years are positive but not significant. Based on the insignificant coefficients of lagged one and two years, we cannot draw Many conclusive inference from it. The coefficient of current inflation is negative in Models 1–3 but it is statistically insignificant in any of the three models. However, in Model 5, the coefficient of inflation is statistically significant at 5 per cent. This is in line with Rahman, Ullah, and Jebran (2015). Stockman (1981) stated that inflation increases the cost of acquiring capital which therefore lowers the rate of capital accumulation. He further explained that high level of inflation causes the investors to misallocate the available resources due to their inability to extort the right relative price. The coefficient of inflation lagged by one year is negative and significant at 5 per cent. Interest rate has positive significant impact on private investment during the study period.

The coefficient of interest rate is significant at 5 per cent in Models 1, 2, 3, and 4. In Model 5, the coefficient of interest rate is negative, however, it is not significant. The interest rate lagged by one period is positive in Model 2 but not significant. This positive impact of interest rate is contrary to the expectation and studies such as Kustepeli (2005) and Forgha and Mbella (2013). The positive impact of interest rate on private investment could be linked to the interest rate liberalization that started in 1986 which probably enhanced the efficiency of investment in Nigeria.

Implications of Findings

The study found a positive relationship between government expenditure and private investment during the study period. This implies that there is a need for the government to concentrate more on the provision and expansion of the existing infrastructure. Availability of infrastructure is capable of attracting more investment from within and outside the countries. Infrastructure decadence is one of the major obstacles to investment as the structures are not available which makes the cost of investment high and discourages investors. In addition, government need to spend more in education, research, security, and other incentives that can provide conducive environment for investment.

The negative impact of GDP per capita calls for the need to increase the GDP per capita in the economy as the private investment is directly related to the GDP per capita in any country. This is based on the fact that the people in the countries with higher income per capita level have the opportunity to allocate more of their wealth to domestic savings which could be then used to help in financing private investment.

The finding of inverse relationship between inflation and private investment calls for the attention of the government to keep inflation rate low. Government needs to adopt appropriate monetary and fiscal policies to ensure price stability in the economy.

Appendix

Table A1.

Correlation Matrix

Variable	PI	GDP	INF	GOVC	INT
PI	1
GDP	0.3658	1
INF	–0.2757	–0.3930	1
GOVE	0.4599	–0.0715	0.0211	1
INT	0.2348	0.2534	–0.4335	–0.0050	1

Source: The author.

Table A2.

Data Sources, Definitions, and Descriptive Statistics

Variable	Definition	Source	Average	Standard Deviation
PI	Domestic credit to private sector	WDI	1.1532	0.1392
GDP	GDP per capita constant (2010)	WDI	3.2013	0.1144
GOVE	General government consumption	WDI	0.9439	0.1615
INF	Consumer prices (Annual %)	WDI	1.1654	0.3173
INT	Real interest rate	WDI	0.0894	16.7567

Source: The author.

Conclusion

The purpose of this study is to examine the relationship between private investment and government expenditure in Nigeria as government expenditure has significant influence on private investment. Having this relationship using error correction model, this study found that government expenditure is positive and significantly impacted private investment in Nigeria. In addition, this study found that interest rate increases the level of private investment which might be due to the interest rate liberalization. However, inflation and GDP per capita have a negative and significant impact on private investment.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship, and/or publication of this article.

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Effects of Government Expenditure on Private Investment in Nigerian Economy (1980–2016)

Abstract

Keywords

Introduction

Review of Literature

Methodology and Data

Measurement of Variables and Data Source

Empirical Analysis

Summary of Statistics

Unit Root Test Results

Co-integration Results (with a Linear) where r is the Number of Co-integrating Vectors

Estimates of Co-integrating Vector

Error Correction Model (Dependent Variable △logPI)

Implications of Findings

Appendix

Correlation Matrix

Data Sources, Definitions, and Descriptive Statistics

Conclusion

Declaration of Conflicting Interests

Funding

References