CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

The slow rate of or stagnation in economic growth as a feature of most developing countries is said to be traceable to low level of investment in these countries. Studies in this area show that this is caused by savings and foreign exchange gaps as developed by Mckinnon (1964). To this end, quite a number of literature abound pointing to the need for developing economies to attract foreign investment in other to come out of this predicament. Foreign investment will provide an important source of foreign exchange that will supplement domestic savings and hence the level of investment. It will also serve as import substitute investment, reducing import bill as investment in export industries will lead to increase in a country’s foreign exchange earnings Chete (1998), Dunning (1981). In this respect, a country stands to gain in two ways with respect to foreign exchange. One, the foreign direct investors would bring into the country physical capita equipment in addition to working capital that will be engaged in the production of goods. If local investors are to set up a physical production outfit (given that they have the required resources), they will have to import the needed capital equipment in addition to other logistical costs that must be incurred for the installation of the equipments. Secondly, all things being equal, FDI will necessarily generate foreign exchange for the host country through the exports of some of the goods and services it produced. However, a country’s customs authority, local joint venture partners and the government (by way of efficient tax and property law) must be up and doing so that it can achieve positive net gains from FDI in view of the tendencies for Transnational Corporations (TNCs) to manipulate transfer prices in their own interest.

Foreign Direct Investment (FDI) is basically productive resources accumulated from foreign savings transferred into another economy (a host country) to be engaged in productive activities at profit. It is one of the opportunities open to the developing economies to enable them transfer resources from the developed countries. The flow of private foreign capital was the earliest form of resource transfer to developing countries and has been in existence before the post-war emergence of Overseas Development Assistance (ODA) from Europe to the developing countries or the more recent attempt to transfer resources through preferences Heinz (1996).

Private foreign investment takes two main forms: portfolio investment and direct investment. Portfolio investment is in the form of equity capital (shares or bond holding) in enterprises in developing countries and entitles the owner to flow of dividends. On the other hand, direct foreign investment entitles the foreigner to the ownership of physical productive assets, which he operates directly.

The history of FDI the world over can be divided into three major periods: the earliest period of investment in raw materials and extractive industry; the post-war period of investment in raw materials, extractive industries and import substituting industries; and most recently, investment in manufactures and semi-manufactures for export Meier (1974). For instance, in Nigeria the colonial rule created an opportunity for investment in the rail transport sub-sector through the development of rail system, which was for conveying raw materials like cocoa, groundnut, rubber for onward shipment to Britain. Consequently, Colonial governments invested in the extractive and agricultural industries in the colonies.

When Nigeria got her independence the need to depend less on import and to make the country economically independent led to the establishment of some import substituting industries most of which were being financed by the government and foreign investors alike creating significant employment opportunities and in some cases earning foreign exchange for the country. Moreover most of the manufacturing outfits in the country today started as foreign multi-national companies (MNCs) manufacturing the bulk of consumables in the economy. These MNCs, such as, SHELL BP, AGIP, UAC, LEVENTIS to mention but a few have invested Billions of Naira in the oil and manufacturing sectors of the economy. This has benefited the country at least in the area of employment, technology and managerial skills.

In Nigeria and as the case has been in most developing countries, foreign direct investment has moved mainly into extractive, processing and consumer manufacturing industries. Foreign direct investment is therefore linked to the possession of natural resources or a large domestic market. In addition, with the shift towards globalize production and trade, competitiveness, (as a location for investment and exporting) has become a major consideration with respect to FDI (IFC, 1997).

Foreign direct investment could have far-reaching effect on the economy of the recipient country. It involves the transfer of the complete productive and organizational complex, embracing a set of factors of production: capital, knowledge, technology, management and marketing skills. These constitute significant transfer of non-monetary resources that may be considered as equivalent to ‘private technical assistance with important know how effect extending elsewhere in the host economy beyond the immediate foreign enterprise Meier (1974).

Benjamin Higgins (1959) observed that domestic investment in developing countries has been too low to promote rapid economic growth. He doubted if these countries could raise capital resources enough for their economic growth without foreign assistance in one form or the other. He therefore argued that even where enough capital resources are available internally, through domestic savings, the foreign exchange requirements could constitute major constraints.

In specific terms, Olanrewaju (1993) gave the benefits of FDI to the host country as follows:

i.                   “Foreign savings are made available to the host country and these Supplement domestic resources.

ii.                 The country’s capacity to import expands as Foreign exchange grows.

iii.              Foreign investment provides managerial knowledge and skills including organizational expertise and access to foreign market.

iv.               It provides not only employment opportunities for local labour force, but also, training and opportunities for labour to learn by doing.

v.                 It makes possible the transfer of technology from advanced to developing countries.

vi.               It has spillover effects of advanced management, increased technology and a trained labour force beyond the immediate foreign enterprise, leading to increase in general efficiency in the domestic economy.

vii.            Expansion of local industries, which supply inputs to the plants that would be established.”

1.2     An Overview of Sectoral Performance in Nigeria

Given the current situation in the Nigerian economy in which as high as 70 per cent of the population live below poverty line, it becomes expedient to take conscious steps at addressing the state of growth of the economy. One way to do this is by attracting foreign capital into the economy to compliment the low domestic savings arising from low income in order to sustain a high rate of economic growth.

The Nigerian economy has been heavily dependent on the oil sector. Oil exports over the period 1999 to 2004 accounted for 97.3 percent of total foreign earning. This contrasted sharply with 58.3 percent recorded in 1970. Conversely, the non-oil sector contribution to foreign exchange earnings shrunk from 41.7 to 4.6 percent during the period 1970 — 1998 and further to 2.92 per cent over the period 1999 to 2004. By contrast and during the same period, consumer goods dominated total imports, accounting for 79.0 percent. The balance of payment position worsened with a deficit of N326.6 million in 1998 from the N220.7 million in 1997 (CBN, 2000). In addition, the Balances of payment as a percentage of GDP were -10.2, 6.9, 0.5, -10.5, -2.3 and 13.7 per cents in 1999 to 2004 respectively (CBN, 2004). The pattern and trend of external trade and balance of payments positions underscored the high degree of external dependence of the Nigerian economy and the need to reverse the trend. The welfare of the people as measured by Human Development Indicators (HDI) such as life expectancy and GNP per capita need to improve. In addition, the foreign exchange contents of domestic production and consumption were very high, rendering the economy highly vulnerable to external shocks. The economy also experienced decline in the later part of the 1 970s, witnessed stagnation in the 1980s followed by slight growth in the 1990s. The average GDP growth rate was 0.2 percent between 1979 and 1989, and 2.7 percent between 1989 and 1999. Given Nigeria’s estimated population growth rate of 2.8 percent per annum during the 1980-1995 periods, the annual growth rate in per capita income was zero in 1992 and negative between 1993 and 1996. In 1997, per capita income increased at the rate of 0.27 percent while average GDP growth rate was 0.07 over the period 1999 to 2004 (CBN, 1997 and 2004).

Ezenwe et all (1999) noted that between 1970 and 1985, GDP registered an average annual growth rate of 3.4 per cent, while the agriculture component of GDP rose by 1.6 per cent. The share of agriculture in total GDP stood at 36.0 per cent, while manufacturing and crude oil accounted for 6.3 and 18.8 per cent respectively in the same period. The value of agricultural exports dropped from N265.2 million in 1970 to N192.1 million in 1985, indicating a negative growth of 4.6 per cent during the period and representing 3.4 per cent of the value of total exports.

The performance of the agricultural sector during this period was undermined mainly by disincentives created by the macro-economic environment. Notable among these were:

i.        The overvaluation of the naira exchange rate and the sharp increases in foreign exchange earnings from oil revenues, which encouraged large- scale food imports. The changing taste arising from importation resulted in low demand for traditional food crops such as local rice, yams and beans, with the adverse consequence of reduction in production of these crops by farmers in spite of the huge subsidy on domestic production. The over- valuation of the naira also put agricultural exports at a disadvantage.

ii.       The increased inflow of “petro-naira”, which encouraged increased wages in the public sector, also drained labour from the rural areas, thereby depriving the agricultural sector of the much-needed farm labour.

The performance of agricultural sector under the structural adjustment program (SAP) showed an improvement over the preceding period. For instance, aggregate agricultural production grew at an average annual rate of 4.1 per cent between 1986 and 1993 compared with the growth of 1.6 per cent recorded between 1970 and 1985. This was particularly due to one of the key elements of SAP, that is, the liberalization of domestic prices, market and trade. Prior to the SAP, price distortions in agriculture were major determinants of the sharp decline in domestic and traditional export production. As a result, the six existing agricultural commodity boards were scraped. This was to give private individuals, groups, companies and processors access to the internal and external markets for all agricultural commodities Rasheed (1996). All the sub-sectors of agriculture (crops, livestock, fishery and forestry) contributed to this improvement as they all recorded positive growth rates, unlike in the previous period where only three sub-sectors recorded positive growth rates. GDP grew at an annual average of 4.8 per cent and the share of agricultural output was 40.0 per cent of the total, compared with 36.0 per cent in the preceding period. As a reflection of the increase in agricultural output and the trade liberalization

policy of SAP, the value of agricultural exports rose on the average by 9.4 per cent, while its share of total exports stood at 3.4 per cent. In addition, the value of food imports during the period rose by 35.0 percent, while the value of food import as a ratio of GDP was 1.9 percent, reflecting largely the depreciation in the naira exchange rate because of deregulation. The profitability of some agricultural enterprises increased considerably resulting in expansion in their scale of operation while others with high foreign components in their inputs became less profitable, owing to high cost of procuring foreign exchange.

The 1994 — 1996 periods represented the shift in policy of deregulation to one of guided deregulation. The growth in the output of agricultural products during this period was slower as aggregate output rose on the average by 3.3 percent and agriculture’s GDP grew on the average by 2.3 percent. Its share of total GDP was 38.7 percent. Other sectors of the economy also grew at a lower rate. For instance, crude oil output recorded a 2.3 percent growth, while the manufacturing sub-sector recorded a negative growth of 1.9 percent. Food imports rose to an average of N60, 492.6 million, representing an annual growth of 151.3 percent or 11.8 percent of total imports and 3.7 percent of GDP, reflecting the depreciation in the naira exchange rate and the low output in the agricultural sector. The low rate of growth was due to sub-optimal performance of agricultural research and extension agencies. This was mainly because of inadequate funding, late release of approved funds, shortage and frequent turnover of skilled labour, insufficient and deplorable infrastructural facilities as well as slow pace of commercialization. However, the agricultural sector witnessed a slight improvement over the period 1998 to 2003 with respect to its contribution to the GDP as result of government’s policies directed at reviving the sector. The performance of the industrial sector between 1981 and 1986 was considerably lower than the level attained in the late 1970s. For instance, manufacturing output recorded a negative growth of 0.6 percent annually, with a share of only 7.1 percent of the total GDP compared to the annual growth rate of 5.8 percent between 1975 and 1980. The large fall in the supply of raw materials and spare parts to the import-dependent industries resulted in plant closures, large lay-off of industrial labour and much reduced capacity utilization. For instance, the capacity utilization rate, which averaged over 70 percent annually in the 1970s, dropped to 4.6 percent during the period.

In the light of the SAP measures, the industrial sector generated sustainable supply responses. There were clear signs of forward and backward linkages and capacity utilization, which stood at 36.4 percent in 1986, rose to 40.4 percent in 1987 and was 38.8 percent in the first quarter of 1988. Between 1986 and 1999, manufacturing output grew at 3.0 percent in contrast to a decline of 0.6 percent in the period 1981-1985, while its share in total GDP rose to 8.2 percent from 7.1 percent. However, owing to high costs, firms have become selective in the use of inputs. Investment expenditure stood disproportionately on spares and maintenance. High cost of credit and liquidity squeeze constrained investment expenditure, while the prices of finished goods remained high. Industries like paper manufacturing, beer and stout, textiles, leather products, soap and detergents and food processing (which had made significant progress in the use of local raw materials) experienced a boost in their activities due to their improved competitiveness. This was to satisfy local and export demands. On the other hand, industries like auto assembly plants and chemicals that traditionally depend on imported inputs and could not immediately shift to the use of local inputs experienced substantial increase in production costs, increased competition from imported finished goods and dull demand for their overpriced products. Consequently, many of these plants closed down with mass retrenchment of workers Ezenwe et all (1999).

The tempo of activities in the industrial sector however, slowed down from 1999 - 2002 owing largely to increased costs of production. Manufacturing output dropped persistently recording negative annual growth rate of 1.6 percent. Its contribution to the total GDP dropped to 6.8 percent. Average capacity utilization rate fluctuated between 29 and 34 percent. A noticeable development in the industrial sector was the question of non- performing bank loans especially with the small and medium scale enterprises. The high fatal rate of such industries existed side by side with non-repayment of loans. Evidences abound of the high rate of default under the portfolio of specialized development banks and organizations such as NIDB and NERFUND.

In general, it could be said that the Nigerian economy, since the 70s has not only been battered by military rule and the attendant corruption and mismanagement of scarce resources, but also gross inadequacy, if not lack of the right kind of resource transfer or FDI. This has lead to the collapse of most of the social infrastructures and the productive sector. The resultant effect was that unemployment and underemployment rates heightened, and poverty level increased considerably. Over 13 million Nigerians lacked employment and almost a fifth (18.5 percent) of the labour force was underemployed in 1998 (FOS, 1999). Data indicated that 34.7 million Nigerians, representing 46.3 percent of the 1991 population lived below the national poverty level. But this increased to over 67 million people (65.6 percent) by 1996 (FOS, 1999) and by 2003 it was estimated that over 70 percent of Nigerians lived below the poverty line with most families spending about two-third of the household revenue on food alone and the poorest households spending up to 90 percent of their income on food (FOS, 2003). The gap between the poor and the rich also widened over the decade with the share of the poorest 20 percent of the population in national consumption amounting to only 4.4 percent (UNDP, 2003).

1.3     FDI Policy Framework in Nigeria

Given the scenario above, it became necessary for government to package incentives aimed at attracting foreign investment into the country. For instance, the Industrial Policy of 1988 included certain Foreign Direct Investment provisions that marked a dramatic turn from the previous policy. More so, the policy provided documents, which enabled prospective local and foreign investors to appreciate the enormous potentials for investment in Nigeria. The documents, by approving a wide range of fiscal concessions, demonstrated the determination of the Federal Government of Nigeria to promote local resource utilization. The policy lead to the establishment of a data bank which provided such documents as: the investors guide, investment opportunities and various incentives to investment in Nigeria Olanrewaju (1993).

In addition, the Industrial Development Coordination Committee (IDCC) of Decree 36 of 1988 was promulgated to approve pre-investment agreements, fiscal incentives, employment permits for foreigners, foreign capital imports and to advice the government on related policies (Official gazette, 1989). In other to remove bottlenecks and to permit broader scope for new foreign investment, Decree No. 7 of 1995 replaced the Nigerian Enterprise Promotion Decree No 54 of 1989.

Before the overhaul of the Nigerian industrial policy in 1989, the years preceding Nigerian independence and indeed up to the early 1 970s, the predominance of foreigners in the industrial and commercial activities in the country was very evident. With time, it became imperative to encourage Nigerians to get more involved in the economic activities of the country in order to maximize local retention of profit, increase the net industrial contribution to the national economy and avoid unnecessary socio-political problems of absentee control of nation’s industrial and commercial sector. It was therefore necessary to attract foreign investments on mutually beneficial terms, while at the same time ensuring greater indigenous participation in the economy. Consequently, the Nigeria Enterprise promotion decree took effect in 1972 (amended 1977). The so-called “indigenization Act” was to involve Nigerians in the ownership, control and management of certain enterprises.

The process of promoting increased participation in the economy by indigenes was quite complicated and cautious. Unlike some other countries in similar position, the Nigerian government avoided the temptation to nationalized or expropriate the assets (for example, shares, stock Ct cetera) of foreigners without adequate compensation. A transition period began whereby foreigners who were obliged to divest some of their investments to Nigerians had many opportunities to do so either by private treaty or by public offers for sale, the proceeds of which were remittable overseas. Government was at pains to explain the philosophy behind the “indigenization Acts” and to reassure foreigners of a continued role in the nation’s economy.

The NEP Act 1977, (which repealed the earlier one of 1972) categorized and grouped areas of economic activities under three broad schedules. While enterp

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