CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND OF THE STUDY

Fundamentally, two opposing views have emerged in development economics on the topic of macroeconomic effect of foreign aid on savings. On the one hand, from the early theoretical development, it was learnt that the traditional pro-aid view, advocated aid on the premise that it complements domestic resources, eases foreign exchange constraints, transfers modern know-how and managerial skills, and facilitates easy access to foreign markets, all of which contribute to economic growth (Chenery and Strout, 1966, Papanek 1972, 1973 etc.). On the other hand, based on the empirical evidence, the radical anti-aid view criticizes aid on grounds that it supplants domestic savings, worsens income inequality, funds the transfer of inappropriate technology, finances ineffective projects, and in general, helps sustain bigger, more corrupt and inefficient governments in the recipient countries (Griffin and Enos 1970, Weisskoff 1972 etc).

After World War II and until recently, Official Development Assistance (ODA) from developed countries was the principal source of external finance for developing countries. The principal aim of foreign aid was to help alleviate poverty, provide emergency relief, assist with peacekeeping efforts and to increase infrastructural development. Recent shifts in the global economic and political environment, notably the collapse of the Soviet Union and surge in private capital flows to developing countries, have impacted on ODA in a way that has left some

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questioning the viability of foreign aid. In fact, foreign aid to developing countries declined by one -third in real terms in the 1990s (world bank 1998), perhaps because donor countries assumed that it no longer achieves its desired objectives.

One of the development challenges facing Nigeria today is how to reduce the high Poverty level prevailing among her population. At the centre of the challenge is how the country will sustainably feed her over 140million people. However, observers’ opinions differ on the efficacy of foreign aid in fast tracking the process. It is noted that a prominent argument for foreign aid is that it tends to promote reduction of poverty. The importance of the development challenge of poverty reduction and hunger is aptly demonstrated as the number one goal of the eight Millennium Development Goals (MDGs).

Heller and Gupta (2002) express worry about the call by international community that to enable developing countries achieve the MDGs by 2015, there should be increase in foreign aid to 0.7 percent of industrialized countries’ GNP from 0.24 percent of GNP at present. Nevertheless, they argue that a large increase in aid flows could pose a number of challenges for the poorest countries. For example, if the industrial world is to be successful in meeting its ODA targets, financial aid will increase to about $175 billion, slightly more than three times current levels. To ensure that enhanced ODA is used efficiently in the fight against global poverty, they argue that donors need to examine closely the different possible approaches it could take in deciding how to allocate aid, both among countries and among complementary global poverty reduction programmes.

While there are many reasons for giving foreign aid, a major argument for such aid is that this assistance will increase the rate of economic growth in countries, which are recipient of aid. These expectations of aid induced growth

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however have often been unrealistic. The explanation is that aid largely goes to consumption rather than productive activities which crowd-out domestic savings and investment.

Recent years have seen a surge in calls for more foreign aid to Nigeria in order to eliminate the country’s poverty. Developed countries, international organizations and other Philanthropists have all made renewed pleas for a massive infusion of development aid to Nigeria. Experts who argued in favour of more aid are of the view that injecting more foreign aid would materially benefit the people of the recipient country.

The role of western assistance in alleviating Africa’s extreme poverty depends on various theories on why Africa is poor of which Nigeria is inclusive. Economists overtime have insinuated different models of poverty that have different implications for foreign aid. These include the big push models and foreign aid, project intervention (education, health and infrastructure), models of policies and growth as well as aid, institutions and development. Based on these theories and others, several researchers have examined empirically the impact of foreign aid inflow on growth as well as savings. Most studies regarding the connection between foreign aid and growth as well as domestic savings have been more of panel data analysis or cross country analysis. The main thrust of this study is to examine this connection in a specific country time series analysis specifically in Nigeria.

Nigeria is a monoproduct economy, over depending on the oil sector. This has also been seen to be responsible for deficiency in investment capital in the country. Amadi (2002) opined, “With oil as the main source of foreign exchange, a one-product economy must be continuously deficient in investment capital. Oil is

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subject to the vagaries of international capitalism. Therefore, revenue from it must be subject to serious fluctuations”. The above situation in the country has created savings and foreign exchange gap. This culminates in a wide gap between the actual domestic investment fund and the required investment for accelerating economic growth. So, foreign capital has been regarded as an alternative to bridging the gap. Consequently, for any country, like Nigeria, with this investment gap to achieve a desired rate of economic growth, foreign aid has to be given due consideration. This is because foreign aid provides funds from other parts of the world to bridge the investment gap.

1.2       STATEMENT OF PROBLEM

A dominant feature of the relationship between industrial and developing countries since the 1960s is foreign aid. Foreign aid has been a major source of external finance for the majority of countries in Africa and Asia since they gained independence.

From a development viewpoint, aid was originally conceived in the post-world war II environment in the context of a particular “development paradigm” where poor countries were perceived to be caught in a low-income equilibrium trap, unable to generate adequate savings to promote capital formation and rapid growth. At the low €€m of foreign aid. The general belief was that capital from developed countries was needed to provide the required growth that would make economic take-off possible. This was the core of the two-gap model of Chenery and Strout (1966). Although the predominant nature of foreign aid has changed considerably, from project finance in the 1960s to adjustment support in the 1980s, its economic importance to recipients has remained considerable.

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The critical role of foreign aid to Sub-Saharan Africa (SSA) was put succinctly by United Nations Conference on Trade and Development (UNCTAD), thus: “an increase in official flows of $20 billion could trigger a virtuous circle of rising national savings and investment and faster growth in SSA. Doubling the current amount of aid to give a big push to African economies today could end their dependence within a decade”. This resulted in the commitment by donors and aid users at the World Summit for Social Development (WSSD) in Copenhagen to reduce the world population living in extreme absolute poverty by 2015. The World Bank showed that African economy must grow at an annual rate of 7% if the preceding is to be achieved. A productive investment of an amount equivalent to 30% of African GDP each year is required. Given the regions low savings rates and limited immediate prospects of attracting private capital, this would imply about 20% increase in African aid budget, assuming the additional resources were fully invested. Developed countries were to make efforts to raise their level of aid flows to 0.7% of GNP as soon as possible (World Bank, 2000). Recent discussions on the effectiveness of foreign aid have focused on Africa because it has received the greatest amount of aid on a per capita basis of any world region. Nigeria has received less foreign aid on a per capita basis than other developing countries in Sub-Saharan Africa (SSA). While average net real Official Development Assistance (ODA) for African countries in 1990-96 was $52 per person, Nigeria received just $2.20 per person (Holmgren and Torgney, 1998). As a percentage of Gross National Product (GNP), net ODA for SSA averaged 14%, while for Nigeria; it was less than 1%. Nevertheless, aid is still significant to Nigeria, in particular the agricultural sector, a major recipient of aid. Out of a total net ODA of $350 million in 1990, about 25% of this went to the agricultural sector. (Herbst et al., 2001)

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Despite the Copenhagen commitment, aid flows to Nigeria and indeed other developing countries have been on the decline. In the view of Lensink et al. (2001), this is simply a manifestation of the frequently proclaimed aid fatigue.

Meanwhile, in Africa, there is a high degree of indebtedness, high unemployment and absolute poverty .Though foreign aid has continued to play an important role in developing countries, especially Sub-Saharan Africa, it is interesting to note that after half a century of channeling resources to the Third World, little development has taken place. Poor institutional development, corruption, inefficiencies and bureaucratic failures in the developing countries are often cited as reasons for the result (Alesina and Dollar, 1998; Furuoka, 2008).

Besides, a wide gap exists between savings and investment in most LDCs including Nigeria. Without savings there cannot be investment (Umoh, 2003) and savings equals investments ex-post according to Keynesian view. Keynes maintains that, on the aggregate, the excess of income over consumption (that is, savings) cannot differ from the addition to capital equipment otherwise called gross domestic investment or capital formation ( CBN, 2004; Uchendu, 1993; and Uremadu, 2006). Savings is therefore a mere residual; and the decision to consume and the decision to invest between them determine volume of national income accumulated (rather called gross national savings) in a period (Uremadu, 2006, 2007).