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Full Project – EFFECT OF FOREIGN DIRECT INVESTMENT ON ECONOMY GROWTH OF NIGERIA

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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 mayspur 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.

TABLE OF CONTENTS

ABSTRACT

CHAPTER ONE: INTRODUCTION

1.1 Background to the Study

1.2 Statement of problem

1.3 Research Questions

1.4 Objectives of the Study

1.5 Research Hypothesis

1.6 Justification of the Study

1.7 Scope and Limitations

1.8 Organization of the Chapters

CHAPTER TWO: LITERATURE REVIEW

2.1 Conceptual Literature

2.2 Types and Rationales for Foreign Direct Investment

2.3 Overview and Trend of FDI Inflow to Nigeria and its Impact

2.4 Overview of Government Polices on FDI in Nigeria

2.5 Sect oral Analysis of FDI Inflow to Nigeria

2.6 Trend Analysis of Macroeconomic indicators in the Study

2.7 Empirical Literature

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Theoretical Framework

3.2 Empirical Framework

3.3 Model Specification

3.4 Technique of Estimation

3.5 Sources of Data

CHAPTER FOUR: PRESENTATION OF RESULT AND DISCUSSIONS

4.1 Empirical Result of Determinants of FDI in Nigeria

4.2 Empirical Result of Impact of FDI on Growth on Nigerian Economy

4.3 Interpretation of Results on Determinants of FDI in the Model

4.4 Interpretation of Result on Impact of FDI

4.5 Composition and Trend of FDI Inflow to Nigeria

4.6 Summary of Key Findings

CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Summary

5.2 Conclusion

5.3 Recommendations

5.4 Contribution to Knowledge

REFERENCES

APPENDIX

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 (LDC_S) 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 LDC_S.

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.

Model Specification

Specifically the model in the case of Nigeria base on the objective which the studyintends to achieve is stated as below:

Model 1

The study adapted the model of Yen Li Chi (2010) which gave clear understanding of the relationship between FDI and growth relative to other sources of foreign capital. The Yen Li Chi (2010) equation is shown below:

GDP = β_O+β₁FDI+β₂SCH+β₃GEXP+β₄POP+β₅INF+β₆BMP +β₇OP+ ε_{0 ..}(3.3.1)

Where,

FDI represent size of foreign direct investment, SCH is schooling, GEXP is government expenditure, POP is population, INF is inflation, BMP is black market premium, and OP is openness. The above model is modified to suit the objective which the study intends to achieve

as:

GDP = α0 + α1FDI + α2IHC + α3TOT + α4OR +α5OPP + µ……………….(3.3.2)

Where,

GDP is the growth rate, FDI is the size of foreign direct investment, IHC is the investment in human capital, TOT is terms of trade, OR is official remittance, and OPP is openness of the economy.

Model 2

In the literature, it is important to understand that Macroeconomic indicators are the major determinants of FDI inflow. This means that FDI are drawn by available infrastructure, exchange rate, interest rate, external reserve etc. Hence, we state our FDI model as:

FDI = βo + β₁OPP + β₂FDEF + β₃EXTR. + β₄NFI + β₅INF + µ………..(3.3.3) Where,

FDI = Foreign direct investment

OR = Official remittance

GDP	=	Gross domestic product
OPP	=	Openness of the economy
EXTR	=	External reserves
NFI	=	Net foreign indebtedness
FDEF	=	Fiscal deficit

TOT = Terms of trade

IHC = Investment in human capital proxy as government expenditure in health and education.

INF = Level of infrastructure proxy as power generation capacity.

The basic quantile regression model specifies conditional quantile as a linear function of explanatory variables and is given by

Y = X’β + ε…………………………………………………..(3.4.1)

Q_θ (Y/X = x) = X’β (θ) and 0<θ<1………………………….(3.4.2)

Where Y is a dependent variable, X is a set of explanatory variables, ε is the error term and Q_θ

(Y/X = x) denotes the θ^th quantile conditional on X=x. The distribution of the error term ε is left unspecified. Since it is assumed that

Q_θ (ε/X = x) = 0……………………………………………….(3.4.3)

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1.3 Research Questions

1.4 Objectives of the Study

1.5 Research Hypothesis

1.6 Justification of the Study

1.7 Scope and Limitations

1.8 Organization of the Chapters

Model Specification

Full Project – EFFECT OF FOREIGN DIRECT INVESTMENT ON ECONOMY GROWTH OF NIGERIA

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