CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

It has been a common knowledge from time past that- for adequate investment needed for economic growth and development, every economy needs to accumulate high level of capital for investors to borrow. This is because, borrowing from outside is not a proper strategy for growth and development since it does not only have adverse effect on the balance of payment as these loans will be serviced in the future with the use of their domestic resources, but it equally carries a foreign exchange risk such as devaluation of their currency which is one of the specific conditional ties for borrowing from International Monetary Fund (IMF). Hence, domestic investment through capital formation is not just paramount, but serves as a prerequisite for the geometric acceleration of growth and development of every economy as it provides domestic resources that can be used to fund the investment effort of the economy.

The essence of this economic growth is for the creation of economic and social overhead capitals (or costs), which leads to increase in national output and income through creation of employment opportunities and reduction of vicious circle of poverty both from the demand side and supply side. Economic growth is sine qua non and where the citizenries of per se country could match up with the 21st century trends relatively to economies of the world. The discovered problem (s) that is responsible for the emerging economies is resulting from low capital formation (or base) (Jhingan, 2006; Ainabor, et. al., 2014). The emerging countries of the World have no opportunity costs or the attitude of sacrificing present consumption or investment in order to augment future national output and income (Ainabor, et. al., 2014). Gross capital formation leads to technical progress which helps realize the economies of large scale of production (or economies of scale or operation) and increases specialization, in terms of providing machines, tools and equipments for growing labour force. Thus, the accumulated capital enables the acquisition of new factories alongside with machinery, equipment and all productive capital goods. In addition, to the construction of capital or mega projects and utilize the gross capital formation into educational sectors, health sectors, etc (Jhingan, 2006).

Capital formation is analogous to an increase in physical capital stock of a nation with investment in social and economic infrastructures. Gross fixed capital formation can be classified into gross private domestic investment and gross public domestic investment. The gross public investment includes investment by government and/or public enterprises. Gross domestic investment is equivalent to gross fixed capital formation plus net changes in the level of inventories (Jhingan, 2006). Capital formation perhaps leads to production of tangible goods (i.e., plants, tools & machinery, etc) and intangible goods (i.e., qualitative & high standard of education, health, scientific tradition and research) in a country. 

A lot of economies depend on investments to resolve several economic problems, crisis and challenges. Less developed countries in Africa such as Nigeria is introducing various economic policies that will attract as well as keep hold of private investors. This is due to the fact that investments in certain sectors of the economy can rapidly transform the numerous economic challenges we are facing as a nation. Therefore, the Nigerian government at any given opportunity works a lot to attract investments into various sectors of the economy. The motive for this is not farfetched. Investment both private and public comes with a lot of benefits such as job creation, increase in per capita income, reduction in the level of poverty, increase in standard of living, increase in GDP, etc..

Real investment in the economy as an acceptable way of increasing capital formation in the economy has been known to increase productivity and output generally. Investment of this type can be undertaken by the public or private sectors, with the government being involved mainly with autonomous investments which act as the main drivers of other investment in the economy. Autonomous investment had dwindled drastically while the expenditure being made by the public sector are not delivering value where rightly conceived. A simple analysis of the capital formation statistics from the Central Bank of Nigerian shows that the nominal investment in capital formation is going down and has fallen in real terms. Investment could be social or soft in outlook (housing, health and education), while others are infrastructural or hard (transport, power and water), and yet others are purely economic, which the private sector undertakes for private capital accumulation. While financial investment is an avenue to increase wealth, real investment should be more emphasized to increase productivity and growth in the economy.

The importance of investment has been realized by successive administration long time ago. Rather than to take concrete steps to implement policies formulated and establish a culture of continuous domestic investments, the government is gradually transferring this functions by encouraging a hybrid way of investment with the use of Private Public Partnership (PPP) in the country.

The nature and stability of domestic private investment (DPI) have attracted enormous debate in the literature of applied economics, particularly in the advanced market economies. To emphasize the preponderance of studies on this subject, Uremadu (2006), Adegbite and Owualla (2007) argues that although foreign direct investment (FDI) is beneficial to host countries by speeding up the process of economic growth and development, its multiplier effect is greater. In other words, developing countries should depend greatly on domestic investment rather than foreign direct investment (FDI). 

In the early 1960s and up to 1985, Nigerian government was involved in direct productive activities while encouraging private sector investment. During that period, government took control of the commanding height of the economy with the hope of hastening the growth process. The windfall from petroleum in the middle of 1970s brought in the needed financial resources. Government, therefore, went beyond the role of providing an enabling environment by establishing and owning companies in all sectors of the economy. In 1986, the Structural Adjustment Programme (SAP) was put in place, with the objective among others of facilitating the development of the private sector, whose role could determine the level of economic growth of the Nigerian economy. However, the expected investment boom after the structural adjustment programme was not feasible and not much was recorded in terms of domestic investment. The DPI share of the gross domestic product (GDP) is still below 10 percent and the ratio has since been declining (Akpokodije, 1998). Government’s policy response in form of trade reforms and other macroeconomic reforms with the hope of promoting and encouraging domestic private investment still remains disappointing.

During Structural Adjustment Programme (SAP) of 1986, the government of Nigeria considered the need for improvement in capital formation and pursued an economic reform that shifted emphasis on private sector. The public sector reforms were expected to ensure that interest rates were reduced (or positive) in real terms and/or to encourage savings, thereby ensuring that investible funds would be readily available to the real sectors. Besides, the reforms were expected to lead to efficiency and productivity of labour; efficient utilization of economic resources, increase aggregate supply, reduces unemployment and generate single digit inflation rate. For example, during 1980s till date, the percentage of gross fixed capital formation had dwindling or fluctuating in Nigeria, inspite of SAP programme. The fluctuations in capital formation from 1980 to 2013 resulted from macroeconomic imbalances (or problems) such as deteriorating foreign exchange rate, increase in general price level, high real interest rate, double digit inflation, and high rate of corruption in public sector. In addition, inadequacy in economic infrastructures such as epileptic power generation, deplorable road networks as well as poor health and educational facilities were equally responsible for the decline in capital formation (Bakare, 2011; Ainabor, et. al., 2014).

In Nigeria for instance, capital formation is low resulting from the fact that capita income is low. As a result, the marginal or average propensity to save is low, while the marginal or average propensity to consume is so high, this leads to un attainment of economic development. For economic development to be achieved in Nigeria, then there should be increase of domestic saving from 4% to there about 12% in national income, expansion of market, investment in capital equipment, decrease in population rate, correcting of imbalance of payments, declining of foreign debts, control of inflationary pressure, etc. These stated points are possible only and only if there is a rapid rate of capital formation in the country, that is, if smaller proportion of the community’s current income or output is partly devoted to consumption and/or the other part is saved and/or invested in capital or industrial equipment.

Recently, the percentage of domestic investment and public investment has reduced drastically, which resulting from macroeconomic variables disequilibria—such as, inflation rate; exchange rate fluctuations; balance of payment problems; High external debt ratio; increase in population, corruption, etc. it was worsened when most recently there was a significant drop of crude oil prices in OPEC. This has had inverse relationship with countries that depended on crude oil or agriculture (mono-economy)—such as Nigeria. In other words, in Nigeria growth rate has dropped from 7% to 4.2%. This has led to devaluation of currencies and/or other stringent fiscal and monetary policies—such as reduction in taxes and deliberate attempt to make a mismatching of the unit of domestic currency and another currency (most especially American dollar as the commonest currency for exchange for goods and services) (Ainabor, et.al, 2014).

1.2 Statement of the Problem

A number of studies have illustrated that there exist a correlation between private investment and public investment. Everhart and Sumlinski (2011), Odedokun (1997), are amongst scholars who have investigated this statement with different results. In less developed countries, government plays a vital function in capital formation. Specifically, public investment makes up a significant part of total investment. Hence, the effect of public investment on private investment is indefinite. That is to say, public investment can work as a substitute (negative impact on private investment) to or a complement (positive impact on private investment) for private investment. The level of the impact depends on the sector in which the government carries out the investment projects. Public investment may promote private investment when it assists in increasing the productivity of private-owned firms.

In spite of various structural changes and reforms in Nigeria, the country remains entangled with a number of economic maladies, which so far has proven to be overwhelming. Among these difficulties are high unemployment and poverty levels. The planned withdrawal of the government from the investment scene, and leaving it to the private sector to play its function has not been too promising for the nation. Nigeria’s macroeconomic indicators show the pitiable performance of private investment in Nigeria for the period 1986 to date (CBN, 2010). For example, private investment declined from 12.3% of GDP in 1991 to 8.3% of GDP in 1992, this may be partly due to the reduced public investment, which fell during the same period. Private investment then increased to 12.5% in 1993 and to 16% in 1994. Later, it fell continuously to 8.9% in 1996. Between 2001 and 2005, the ratio averaged 13%; it peaked at 16.2% in 2002 but fell again to 12% in 2005 (CBN, 2010). It was found from the CBN statistical bulletin that the growth rate of domestic investment in 1980 was 133.1% while gross fixed capital formation was 11.7%. In the same year, the gross domestic product growth rate was 18.2%. This implies that the growth rate of domestic investment was greater than GDP growth rate while GDP Growth rate was greater than gross fixed capital formation (GFCF). In 1990, the growth rate of domestic investment (51.6%) was still greater than GDP growth rate (23.7%) while GDP growth rate was still less than gross fixed capital formation (38.8%). However, it was observed that between 1980 and 1990, GDP growth rate and gross fixed capital formation were on the increase while domestic investment growth rate was on the decrease.

 Considering the Accelerator theory of investment which states that as  income or capital formation increases in an economy, so does the investment made by firms as well as GDP growth rate, one observes that in the year 2000 and 2010, GDP growth rate decreased from 43.5% to 37.1%. Domestic investment growth rate also decreased from 67.9% to 5.2% while gross fixed capital formation growth rate increased from 9.% to 11.1%. This implies that while the growth rate of GDP and domestic investment were on the decrease, gross fixed capital formation growth rate was on the increase. It was also found that between 2013 and 2014, GDP growth rate decreased from 4.6% to 3.02%, domestic investment also decreased from 12.6% to

5.6% while growth rate of gross fixed capital formation was on the increase from 3.01% to 11.2%(CBN,2014). On the average, it was gathered from the trend that if growth rate of domestic investment falls while gross fixed capital formation growth rate increases, GDP growth rate falls which is against the Accelerator theory of investment. Therefore, this study is embarked on, to evaluate the relationship existing among the variables in Nigeria. 

1.3 Research Questions

In the course to examine the study, the following questions were considered. They are stated below as follows:

•                     To what extent does long run significant relationship exist among domestic investment, capital formation and economic growth in Nigeria within 1987 and 2017?

•                     Is there significant causal relationship among domestic investment, capital formation and economic growth in Nigeria within the period under study?

1.4 Objectives of the Study

The general objective of this study is to evaluate the link existing among domestic investment, capital formation and economic growth while the specific objectives are to;

•                     Ascertain if there is long run significant relationship that exist among domestic investment, capital formation and economic growth in Nigeria within 1987 and 2017.

•                     Find out if there is significant causal relationship between domestic investment, capital formation and economic growth within the period under study.

1.5 Hypotheses of the Study

1.                  There is no long run significant relationship that exists among domestic investment, capital formation and economic growth in Nigeria within 1987 and 2017

2.                  There is no significant causal relationship between domestic investment, capital formation and economic growth in Nigeria within the period under study.

1.6 Significance of the Study

This research empirically appraises the domestic investment, capital formation and economic growth in Nigeria. It is significant to individuals, government and academia in the following ways;

•                     To the individual, the study will throw more light on domestic investment, capital formation and economic growth. Thus, individuals will be acquainted with the activities regarding the domestic investment and formation of capital and its implication to the economy.   

•                     To the government, the study recommends policies that will assist the concerned agencies in formulating policies towards improving performance and efficacy of economic growth.

•                     To the academia, this study contributes to knowledge and literature to be referred to by researchers. 

1.7 Scope of the Study     

This study is on the relationship among capital formation and economic growth in Nigeria. It determines the existence or otherwise, of any significant impact of capital formation on economic growth in Nigeria. However, the data range covers from 1987-2017. The analysis is only restricted by the variables specified in the model such as domestic investment (DIN), capital formation (CFO) captured by gross fixed capital formation and gross domestic product (GDP). The geographical boundary of the location is Nigeria

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