CHAPTER ONE

INTRODUCTION

1.1        Background of the study

Economic analysis of public expenditure growth is all about how growth of public expenditure over time influences overall welfare of the economy. It involves a critical examination of trends over time and across components of public sector spending within the economy. According to Brown and Jackson (1990), economic analysis is necessary for effective evaluation of government performance in the course of carrying out its obligation in modern economies. This argument anchors on the premise that public expenditure reflects the policy choices of government, which directly or indirectly shapes the fortune of entire economy. For Edame (2014), public expenditure refers to the expenses government incurs for its own maintenance, society and the overall economy. It varies and ranges from defence, general administration, health, education, electricity generation and supply, roads, telecommunications and water supply among others.

Before 1936, the classical economic thinking that characterized most nation states was heavily built around laissez faire ideology. This ideology placed minimum government interference on economic affairs of individuals and state. It restricted the growth of government expenditure to the need for maintenance of law and order, and defence against external aggression. Public expenditure however, witnessed unprecedented growth immediately after the emergence of Keynesian macroeconomic revolution in late 1930s. For instance, Brown and Jackson (1990) quoted Peacock and Wiseman (1961) as revealing that government expenditure as percentage of gross domestic product (GDP) in the United Kingdom hovered around 9% and 15% between 1890 and 1914. It subsequently reached about 48% during World War I (1914-1918) and declined to average of about 27%, until 1937 when it started rising astronomically. Following the outbreak of World War II (1939-1945), government expenditure rose to about 60% of GDP in the U.K but declined to average of about 44.9% from 1948 to 1987. The trend was similar across major economies, including the U.S.A (Musgrave & Musgrave, 2004).

Existence of rapid growth of public expenditure and the need for its regulation led to some theoretical postulations. Some of them include political instability inducing government expenditure, also known as Peacock and Wiseman Displacement theory (Peacock and

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Wiseman, 1961); stages of development growth theory of public expenditure (Musgrave, 1969; 1974 and Rostow, 1971); economic growth inducing government expenditure or Wagner’s law (Bird, 1971); government decentralisation inducing government expenditure which is also known as the Leviathan theory (Rodden, 2003); and revenue-spend theory which suggests that the spending level in an economy should adjust equivalently to the volume of revenue generated in the economy. All these were rooted in traditional economic thinking of the classical, Keynesian, and Wagnerian schools of thought.

Economists recently however, observed potential consequences of unregulated rise in government expenditure on economic growth. So far, a number of seasoned theoretical studies support the claim that rapid increase in democratic institution and rising demand for welfare state positively correlate with high profile growth in relative size of public sector spending. In their inquiries, Barro (1989), Scully (1994 & 2003), Armey and Armey (1995) and Rahn and Fox (1996) came up with similar argument that long-run relationship between size of government sector and economic growth has a concave shape. It implies that when government sector is very small, long-term economic growth can be accelerated through increase in provision of public goods. The marginal economic growth will be positive but decreasing as the size of government sector increases. It will become negative when additional charges from increment of government sector became harmful to the benefits resulting from increasing the productivity. The turning point at which increase in government expenditure leads to maximum increase in economic growth is therefore known as the optimal size (level) of public sector. According to Vedder and Gallaway (1998) and Facchini and Melki (2011), it is the point at which increase in government spending (as proportion of GDP) results to maximum increase in economic growth. However, exact position of this turning point remains unknown and contentious among researchers. Mutascu and Milos (2009) argue that whatever becomes an economy’s optimal size of public sector depends largely on structural factors such as economic cycle, structure of public expenditure and fiscal pressure. This fact notwithstanding, the importance of knowledge of optimal size of public sector cannot be overstated in the face of increasing need for effective macroeconomic stabilization policy in contemporary time. At the peak of its benefit remains provision of insight to the government on how to strike balance between supply of public goods and achievement of sustainable economic growth (Chobanov & Maldenova, 2009).

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As a case study, Nigeria is a middle income country and mixed economy. She is an emerging market with expanding financial, service, communications, technological and entertainment sectors. According to Worldometers (2015), Nigeria worth about $568.51 billion in 2014 GDP and represents about 0.92% of world economy. She ranks 26th in the world and 1st in Africa. In similar way, her population is estimated at about 177.8 million in 2014 as she ranks 7th in the world (Worldometers, 2015). The country has however witnessed unusual high growth in government expenditure in the last two and half decades. From 1960 to 2013 for example, government expenditure has grown from $291.48 million to $57.49 billion respectively. This growth however, is yet to be translated into citizens’ welfare as more Nigerians are poor today as was never before (Nasiru, 2012). Interested analysts such as Omotoso (2010) and Ikeji (2011) blame this unwanted outcome on regular change in revenue allocation and expenditure policy, which was widely accused of benefiting the federal government at the expense of her federating units. Hence, justification for high growth in federal government spending becomes a source of unending socio-political and economic development debate in Nigeria.

Professional analysis of public expenditure growth and optimal size of the public sector now becomes more relevant at a time when development challenges such as poor infrastructure, high level of unemployment, insecurity of life and property are very common. These challenges persist despite huge government expenditure budgeted annually to solve them. Among several others, Okafor and Eiya (2011) argue that urbanization, degree of trade openness, government revenue, inflation, external reserves, population density, type of government regime, policy instability and public debt remain key growth drivers of public expenditure in Nigeria. Sequel to this argument, diverse fiscal policy measures were adopted by Nigerian government in the course of managing public expenditure. Some of these policies were channelled towards reduction in total expenditure and diversification of revenue mobilization strategy. Others include promotion of transparency cum accountability in management of national resources. The quest for effective fiscal framework culminated in enactment of Nigeria’s Fiscal Responsibility Act of 2007. This Act was aimed at minimizing wasteful government spending, encouragement of transparency, consolidation of accountability and promotion of overall fiscal discipline.

The problem of increasing government spending however remains with us despite above control measures. For example, within the periods 1967-1970, 1973-1975, and 1980-1981,

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public expenditure growth rate varied from 1.12% to 58.96%, 4.48% to 116.84%, and 102.09% to -23.75%; while economic growth rate fluctuated between -4.25% and -1.25%, 5.8% and 6.2%, and -3.2% and -2.9% respectively (Central Bank of Nigeria, 2009; 2012). In recent time, growth in government expenditure declined from 21.48% in 2010 to -2.27% in 2012 and rose to 14.23% in 2013, while the economy grew at the rate of 7.84%, 6.75% and 7.31% at the same time. Correspondingly, if the claim by Vedder and Gallaway (1998) holds that “no government is too little, but all-encompassing government is too much,” the question that comes to mind becomes ‘what is the right size of government from the standpoint of maximizing economic welfare in Nigeria?’ ‘Has the growth of public sector in Nigeria proceeded too little, too much, or about right from the standpoint of increasing the output of goods and services?’ ‘Should Nigeria expand government financial activities faster or slower than growth rate of the economy so as to expand output of goods and services?’

These questions are yet to receive desired response from researchers. Apart from few studies like Okafor and Eiya (2011) which estimated the determinants of growth in government expenditure; Ekeoch and Oduh (2012), Oriakhi and Arodoye (2013), Olaleye, Edun, Bello and Taiwo (2014) and Alimi (2014) which examined the optimal size of the public sector in Nigeria, dozens of other studies were more interested and focused on impact of government expenditure on economic growth. Interestingly enough, none of the above few studies care to estimate the rate at which public expenditure grows in Nigeria. This knowledge gap makes it difficult to establish dependable link between actual and expected rate of government expenditure growth in the economy. Again, little or no attention was paid to the issue of possible ways of checkmating growth of public expenditure. For this reason, the marginal efficiency of rising components of government spending cannot be equally predicted. In addition, detailed study on optimal size of public sector in Nigeria is scarce.

1.2        Statement of the problem

Nigeria has witnessed continuous rise in government expenditure due to growing receipts from oil revenue, increased demand for public utilities and general effect of inflation on the economy (Nurudeen & Usman, 2010). Again, the increasing need for security in the face of rising civil unrest from militancy to terrorism also increased government expenditure. For example, Central Bank of Nigeria (2012) and Budget Office of the Federation (2014) reveal that government expenditure on defense were N444.6 billion, N233 billion, N264 billion,

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N348 billion, N921.91 billion, N1,055 billion and N968.127 billion from 2008 to 2014 respectively. In addition, public sector analysts believed that steady rise in government expenditure in Nigeria was underpinned by persistent rise in cost of general administration, emolument of public office holders, misallocation of resources, government inefficiencies, personal interest of politicians and bureaucrats, debt services and debt repayment. Available statistics from Central Bank of Nigeria (2009; 2012) shows that total government expenditure rose significantly in the last five decades. For instance, total recurrent expenditure rose from N716.10 million, N4,085.20 million, N36,219.60 million, N416,600 million, N3,109,378.51 million to N3,365,760.00 million. While total capital expenditure was N187.80 million, N10,163.30 million, N24,048.60 million, N239,450.90 million, N883,874.50 million and N1,621,480.00 in 1970, 1980, 1990, 2000, 2010 and 2013 respectively. The image was clearly painted in Figure 1.1 below.

Figure 1.1: Federal government annual expenditure 1961-2013

Source: Plotted by the researcher from CBN Statistical Bulletin, 2009 and 2012

Despite continuous rise in annual government spending as shown in Figure 1.1 above, Nigeria still faces rising incidence of poverty and ranks among the poorest countries in the world. Many Nigerians continued to wallow in abject poverty, while more than 50% live on less than US$2 per day (Nurudeen & Usman, 2010). Apart from inadequate infrastructure

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(especially roads and power supply) which impedes industrialization and promotes high level of unemployment, macroeconomic indicators like balance of payments, inflation rate, exchange rate, and national savings reveal that Nigeria has not fared well in the last couple of years (Central Bank of Nigeria, 2009).

In attempt to finance rising expenditure given above situation, government may increase taxes (borrowing) for instance. Higher income tax tends to discourage individual from working for long hours or even searching for jobs. This, in turn, reduces income and aggregate demand (Nurudeen & Usman, 2010). Similarly, higher profit tax may lead to increased production costs and decreased investment expenditure as well as profitability of firms. When firms faced downward trend in their profitability, they usually shut down beyond their breakeven point. This action may result to reduction in national output, followed by rise in unemployment rate. Risen unemployment rate will on the other hand, translate into reduction in household income and leads to deterioration in standard of living among citizenry. Furthermore, if growth in public sector spending is finance through borrowings from the banks, such borrowings culminates in rising interest rate which will consequently lead to