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EFFECT OF PUBLIC EXPENDITURE ON ECONOMIC GROWTH IN NIGERIA (1981-2013)

CHAPTER ONE

INTRODUCTION

• BACKGROUND TO THE STUDY

The subject of government involvement in resource allocation stems from the failure of market mechanism to effectively and efficiently perform this task. From the very inception, government is not to be involved in the day-to-day running of an economy as propounded in the doctrine of laizzez-faire by Adam Smith, but to provide an enabling environment for the economy to operate, while maintaining law and order and protecting the nation from external aggression. The market mechanism could to a greater extent cater for the allocation of private goods based on exchange and competition but certainly not reliable for public goods. Public goods according to Wikipedia encyclopaedia is non-rivalry and non-excludable. Non-rivalry implies consumption of good by one individual which does not reduce its availability for consumption by others; while non-excludability means, no person can be effectively excluded from using the good. In reality, it might be difficult to absolutely come across non-rivalled and non-excludable good, however, economists reason that some goods such as defence, health, roads and others approximate the concept closely enough for analysis to be economically useful.

Consequent upon the precedent of Musgrave (1959), governmental activity can be broken into three parts or branches, namely allocation, distribution and stabilization and growth. Broken down further, directly or indirectly, the various governments provide education, health care, national defence, police and fire protection, and provide or support a substantial amount of housing, recreation facilities, and parks. They set health standards and ensure adequate water supplies, transportation and other public facilities. They seek to attain a reasonably equitable distribution of income, to stabilize the economy, and to ensure adequate rate of growth. Therefore, they affect innumerable decisions of individuals by the large amount of revenue they collect in oil proceeds and taxes to finance these various activities. Huge amount of resources are required to fund these activities of government.

The size of government expenditures and its effect on long-run economic growth, and vice versa, has been an issue of persistent interest, analysis and debate for decades. Lopzides and Vamvoukas (2005) identified two levels of empirical literature on the subject matter. One set of studies has explored the principal causes of growth in the public sector while the other has been directed towards assessing the effects of the general flow of government services on private decision making and, more specifically, on the impact of government spending on long-run economic growth. In the late 19^th century, Adolph Wagner, the German economist made an in-depth study relating to rise in government expenditure. Based on his study, he propounded a law called “The Law of Increasing State Activity”. According to Wagner (1893), as the economy develops over time, the activities and functions of government increase. Wagner’s Law indeed is one of the first efforts at emphasising economic growth as the basic cause of public sector growth. Empirical tests of this hypothesis have yielded diverse results differing from country to country (Eberts & Gronberg, 1992). Concentrating on inter-country cross-section comparison have been bedevilled with shortcomings. Besides the obvious problem of comparability of data, especially between advanced and developing countries, cultural and institutional dissimilarities also compound the analysis. Works that have used either standard regression analysis (Ganti & Kolluri, 1970; Georgakopoulos & Loizides, 1994) or error-correlation regression (Kolluri, Panik, & Wahab, 2000) have not only encountered these but other problems.

Evidences from Nigeria show that the total government expenditure in terms of capital and recurrent expenditures have continued to rise in the last three decades. Expenditures on defence, internal security, education, health, agriculture, construction, transport and communication are rising over time. For instance, government total recurrent expenditure increased from N4,846.70 million in 1981 to N36,219.60 million in 1990 and further to N461,600.00 in 2000 and later to N3,310,343.38 in 2010 while government capital expenditure rose from N6,567.00 million in 1981 to N24, 048.60 million in 1990. Capital expenditure stood at N239, 450.90 million and N883,874.50 million in 2000 and 2010 respectively and by 2011, it was N1,934,524.20 (Central Bank of Nigeria Statistical Bulletin, 2012). The various components of capital expenditure have risen between 1981 and 2011. The expanding public expenditures is not peculiar to Nigeria, as it applies to any other country of the world. As Akpan (2005) observes that the perceived growth in government expenditure appears to apply to most countries notwithstanding their level of economic development. Consequently, the need to ascertain whether the behaviour of Nigerian public spending and the economy can be hinged on the Wagner’s (1883) Law of Ever-increasing State Activity, or the Keynesian (1936) theory and Friedman (1978) or Peacock and Wiseman’s (1979) hypotheses.

Generally, it is believed that government plays a significant role in the development of a country and public expenditure is a principal means for a government to manage the economy. Economists have been well aware of its impact in promoting economic growth. The general belief is that public expenditure whether recurrent or capital expenditure, notably on social and economic infrastructure can engender growth. In the view of Omoke (2009), an increase in government expenditure will yield a positive increase in the growth of the economy by increasing the national income, especially when it is injected into development programmes. For instance, government expenditure on health and education is capable of raising the productivity of labour and increase the growth of national output (Oni, 2014). Likewise, expenditure on infrastructure such as roads, communications, power, etc., reduces production costs, increases private sector investment and profitability of firms, thus promoting economic growth. Macroeconomics, notably the Keynesian school of thought, upholds that total spending in the economy affects output and inflation. In order words, this school suggests that government spending accelerates economic growth. It is therefore asserted that government expenditure is the exogenous factor that changes aggregate output.

On the whole, what has emerged from this investigation is significant as far as the new evidence suggests that public spending (i.e. in whatever form this is envisaged) can also be thought of as a mechanism for the promotion of growth as well as a mechanism for the resolution of social and economic issues such as social cohesion, poverty reduction, social conflicts, income disparities between various groups, regions etc. Creating a stable environment, fuelled by government spending, might be an option for high levels of economic growth (Alexiou, 2009).

However, some scholars are not in support of the assertion that increasing government expenditure promotes economic growth, instead they claim that higher government expenditure may slowdown overall performance of the economy. For instance, in an attempt to finance rising expenditure, government may increase taxes and/or borrowing. Higher income tax discourages individuals from working for long hours or even searching for jobs. This in turn reduces income and aggregate demand. In the same vein, higher profit tax tends to increase production costs and reduce investment expenditure as well as profitability of firms, (Landau, 1983; Engen & Skinner, 1991), and Folster and Henrekson (2001) obtained negative evidence.

However, following the Keynesian’s view that government expenditures boost economic growth and supported by (Ram, 1986; Kormendi & Meguire, 1986; Akpan, 2011; Olabisi & Funlayo, 2012); it is expected that the rising government expenditure in Nigeria should translate into significant growth and development. That would not be, rather the country is still ranked among the poorest countries in the world, with human development index (HDI) of 0.504 (UNDP, 2013), about 63.1 per cent (in 2004) and 68 per cent (in 2010) citizens living on less than US$1.25 a day (Poverty & Equity Databank and PovcalNet, povertydata.worldbank.org/poverty/country/NGA).Even when GDP grew from 4.3 per cent in 2012 to 5.4 per cent in 2013 less than 2 per cent are super rich. Furthermore, decayed infrastructure is prevalent in bad roads and epileptic power supply leading to the collapse of many industries. Subsequently associated with high level of unemployment and abandonment of projects. In addition, the macroeconomic indicators such as balance of payments, import obligations, inflation rate, exchange rate, national savings, foreign reserves, debt profile and mortality rate are all hallmark that Nigeria has not been doing well economically in the last couple of years.

In view of the forgoing, this study sets to investigate empirically the effect of public expenditure on economic growth in Nigeria. The variables of public expenditure are total capital expenditure and total recurrent expenditure at disaggregated level. Other variables considered in the review of related literature are human capital (education and health) and expenditure on national defence (Mann, 1994; Usman, Mobolaji, Kilishi, Yaru, & Yajuku, 2011). Economic growth is measured by real gross domestic product (GDP). The study which covers a period of 33 years (1981-2013) is carried out to compliment the work of other researchers who have not considered the variable combination considered in this work. Another reason for focusing this study on Nigeria is because of the impressive growth rate of real gross domestic product that have averaged 5.15 per cent (IMF World Economic Outlook, October 2013).

 

• STATEMENT OF THE RESEARCH PROBLEM

In the last two decades, government expenditure in Nigeria has been rising rapidly, with the structure now tilted toward recurrent expenditure. Between 1997 and 2012, consolidated government (Federal, States & Local government) expenditure rose from N551bn to N9.5tn, a massive 683 per cent jump in 15 years, increasing at an annual average rate of 22 per cent. Recurrent expenditure grew by 742 per cent during this period, while capital spending grew by 586 per cent (CBN Statistical Bulletin, 2012).

Equally important is the composition of government expenditures, which reflects government spending priorities. The top three expenditures for Nigeria in 2013 were education, defence, and police formations and command. It is noteworthy that among the top ten priority on the spending list, security related departments appear three times.

 

However, the rising government expenditure has not translated into meaningful growth and development, as Nigeria ranks among the poorest countries in the world. In addition, many Nigerians have continued to wallow in abject poverty, because nearly 70 per cent of over 160 million of the population are poor. To worsen the situation is the dilapidated state of infrastructure (particularly public transport, power supply and roads) that has led to the collapse of many industries, exacerbating unemployment (Nurudeen & Usman, 2010). For a rich country, it is contradictory having nearly 70 per cent of its population living in poor conditions, its infrastructures in a state of degeneration, its education, health and other growth-promoting and welfare-enhancing institutions in near state of collapse. In the same vein, the roads (virtually all) have become deadly to drive on because of their state, and the power sector is moribund (Nurudeen & Usman).

 

On this basis, it is expected that the share of capital expenditure in the total expenditure dominates that of recurrent expenditure, considering the role it plays in economic growth and human development, but this has not been the case in Nigeria. The high and increasing rate of unemployment, illiteracy, poverty (expressed as the number of people living in shanties and ghettos, with little or no access to quality education, medicare, potable water, low human development index, do not correspond with the ever rising expenditures dominated by recurrent expenditure.

In the light of this, it is appropriate to reason that increase in government spending and change in expenditure composition help or hinder economic growth. Also, whether an increase in spending in capital and recurrent expenditure effective in improving human development outcomes and complementing private sector investment; whether such public expenditure boost long-term growth given the weakness in public budget administration that plague the country.

Given the issues raised above, it is important to examine the effect of public expenditure on economic growth in Nigeria using GDP as dependent variable, and capital expenditure and recurrent expenditure as independent variables adopting time series data.

• RESEARCH QUESTIONS

This research will seek answers to the following questions:

1. How far does capital expenditure affect economic growth in Nigeria?
2. How far does recurrent expenditure impact on economic growth in Nigeria?
3. To what degree does a cointegrating relationship exist between government expenditure and economic growth?
4. Would a causal relationship exist between government expenditure and economic growth in Nigeria?
5. How far does total government expenditure impact on economic growth?

• OBJECTIVES OF THE STUDY

The main focus of this paper is to examine the effect of public expenditure on economic growth in Nigeria. The specific objectives, however, include:

1. To examine the effect of capital expenditure on economic growth in Nigeria.
2. To analyse the impact of recurrent expenditure on economic growth in Nigeria.
3. To investigate whether a cointegrating relationship exists between government expenditure and economic growth
4. To find out the direction of causality between government expenditure and economic growth in Nigeria.
5. To examine the effect of total government expenditure on economic growth.

• RESEARCH HYPOTHESES

The following research hypotheses were tested in this study:

1. Capital expenditure did not have a positive and significant effect on economic growth in Nigeria.
2. Recurrent expenditure did not have a positive and significant effect on economic growth in Nigeria.
3. Aggregate government expenditure did not have during the period a cointegrating relationship with economic growth in Nigeria.
4. Capital expenditure and recurrent expenditure did not have a causal relationship with economic growth in Nigeria.
5. Aggregate public expenditure did not have during the period a positive and significant effect on economic growth in Nigeria.

 

 

• SCOPE OF THE STUDY

This study examined the relationship between public expenditure and economic growth in Nigeria, with a view to establishing the existence or otherwise of any long-term relationship and direction of causality among the variables. Public expenditure was considered in disaggregated form – capital expenditure and recurrent expenditure, they acting as independent variable while real gross domestic product proxied economic growth. Time series data from 1981 to 2013 was utilised indicating the period before, during and after the structural adjustment (SAP) periods; while applying Ordinary Least Square (OLS) technique.

 

• SIGNIFICANCE OF THE STUDY

This study will be most significant to the following groups.

1. Policy Makers/Government Authorities:

The empirical findings should help in determining appropriate policy measures to address some of the fiscal challenges facing Nigeria. According to Sanni (2007), Nigeria’s fiscal processes over the years have resulted in varying degrees of deficit; the financing of which has had remarkable implications for the economy. The study makes a modest contribution to the body of knowledge on the nexus between government expenditure and economic growth, using time series data.

Several lessons can be drawn from this study. It was established that various types of government spending have differential impacts on economic growth, implying greater potential to improve efficiency of government spending by reallocation among sectors. Furthermore, governments should reduce their spending in unproductive sectors such as defence (results show defence spending does not impact growth), and curtail excessive spending in those areas that do not provoke economic chain reaction in the aggregate economy. Rather, government should increase spending on production-enhancing and human capital development investments such as health, education and agriculture. This type of spending will not only yield high returns to agricultural production, but will also have a large impact on poverty reduction since most of the poor still reside in rural areas and their main source of livelihood is agriculture (Olufeagba, 2014).

This study incorporates the most recent data and employs both qualitative and a more advanced econometric technique model to study the effect of public expenditure on economic growth. Thus the outcome of this study will provide result and policy implication to policy makers by bridging the aforementioned gap – the gap existing between sectorial budgetary allocation and real growth.

2. Academia

This work is aimed at contributing in enriching empirical literature in the area of public finance, specifically the effect of public spending on economic growth for a developing economy like Nigeria. Despite its importance, though some work has been done, there is still more need for empirical work in the area of economic growth and development in Nigeria. Furthermore, this study will likely provoke and pave a way for further studies in the area as it reveals the difficulty in resolving the empirical question of the effect of government spending on growth.

3. General Public

The outcome of this study, it is hoped will be of immense benefit to the general public, particularly those interested in public finance. Politicians will also benefit from this research.

• LIMITATIONS OF THE STUDY

One of the limitations of this study arises from lack of consensus on the causes of economic growth. Economists are not yet certain about the relative importance of factors which affect economic growth. With such knowledge lacking, it becomes difficult to draw any meaningful conclusion on the effect of government expenditure on economic growth.

Another limitation of the study is that it does not explicitly consider the quality of government spending, which is probably the most important factor. The calibres of civil servants and the conditions in which they function have impact on creative and efficient use of public resources. Unproductive public spending can take various forms, including spending on wages and salaries of unproductive or ghost workers. Public spending is also unproductive when government expenditure does not reach designated spending objectives. This happens for example when government officials are corrupt and seek bribeor preferentially selecting beneficiaries of government programmes, and for authorising private investment projects.

The data used for this study covers only the period 1981 to 2013, no matter the relevance of time series data for any period before or after this period for this analysis, are not considered. The variables included in the study are real gross domestic product (RGDP), capital expenditure (CAPEXP) and recurrent expenditure (RECEXP). No matter the relevance of other variables in explaining the effect of public expenditure on economic growth, they are not included.

• OPERATIONAL DEFINITION OF TERMS

Capital expenditure. Refers to expenditure on fixed assets such as roads, schools, hospitals, building, plant and machinery etc., the benefits of which are durable and lasting for several years (nairaproject.com/m/projects/458.html).

Classical economics. The macroeconomic generalizations accepted by most economists before 1930s which led to the conclusion that a capitalist economy could employ its resources fully (https://www.studyblue.com).

Current (Recurrent) Expenditure. Refers to spending on wages and salaries, supplies and services, rent, pension, interest payment, social security payment. These are broadly considered as consumable items, the benefits of which are consumed within each financial year (Anyafor, 1996).

Economic Growth represents the expansion of a country’s potential GDP or output. Growth means an increase in economic activities. According to Kuznets (1971), a country’s economic growth may be defined as a long-term rise in capacity to supply increasingly diverse economic goods to its population, this growing capacity based on advancing technology and the institutional and ideological adjustments that it demands. Increase in an economic variable, normally persisting over successive periods. Increase in real output or in real output per capita. The variable concerned may be real or nominal GDP (Kuznets, 1971).

Government Expenditure. Spending by government at any level. It consists of spending on real goods and services purchased from outside suppliers; spending on employment in state services such as administration, defence, education and health; spending on transfer payment to pensioner; spending on community services; spending on economic services (Ekpo, 1994).

Gross Domestic Product. Refers to the money value of goods and services produced in an economy during a period of time irrespective of the people (Erkin, 1988).

Health Financing. The World Health Organization (WHO) defines health financing as the function of a health system concerned with the mobilization, accumulation and allocation of money to cover the health needs of the people, individually and collectively, in the health system. It states that the purpose of health financing is to make funding available, as well as to set the right financial incentives to providers, to ensure that all individuals have access to effective public health and personal health care (WHO, 2000).

Human Development Index (HDI). A comparative measure of life expectancy, literacy, education, and living standards. It is a standard means of measuring well-being. It is used to distinguish whether the country is a developed, developing, or underdeveloped country, and also measures the impact of economic policies on quality of life (UNDP, 2013).

Keynesian Economics. The macroeconomic generalization that lead to the conclusion that a capitalistic economy does not always employ resources fully (Keynes, 1936).

Market Failure. Refers to a label for the view that the market does not provide panacea for all economic problems (Anyafor, 1996).

Neo-Classical Economics. The theory that, although unanticipated price level changes may create macroeconomic instability in the short-run, the economy is stable at full employment level of domestic output in the long-run because of price and wages flexibility (Kalio, 2000).