The impact of foreign private investment (FPI) on capital formation in Nigeria, 1980-2004: an empirical analysis

AuthorSebastian Ofumbia Uremadu
PositionPh.D. (Department of Banking and Finance Covenant University Ota Km10, Idi-Iroko Road P.M.B. 1023, Ota Ogun StateNigeria)
Pages166-182

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1. Introduction

In the late 1970s and early 1980s, most developing countries of Africa (including Nigeria) experienced unprecedented and severe economic crisis. These crisis manifested itself in several ways such as persistent macroeconomic imbalances, widening saving-investment gap, high rates of domestic inflation, chronic balance of payment problems and huge budget deficit (Akpokodje, 1998).

Although different reasons have been adduced for the slowdown of these economies, Greene and Villannueva (1991) attribute the problem to the decline in investment rates in the affected economies. In Nigeria, for example, Akpokodje (1998), maintained that domestic investment as a ratio of gross domestic product (GDP) declined from an average of 24.4% during the 1973-1981 period to 13.57% during 1982-1996 period. The average investment rate during the 1982-1996 period implied that the country barely replaced its dwindling capital. In the same vein, private investment rate depreciated from 8.6% in 1973-1981 period to 4.2% in the 1982- 1996 era. Due to the fact that investment determines the rate of accumulation of physical capital (otherwise called capital formation), it then becomes a vital factor in the growth of productive capacity of the nation and contributes to growth generally. It is in the light of this that prominence is being attached to increasing the magnitude of real asset investment in the economy.

In particular, central to the less than satisfactory growth registered by countries of sub-

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Saharan Africa is low level of investment as a result of low domestic savings. Attracting foreign investment is therefore crucial from a number of standpoints and of course, there is never shortage of theoretical arguments (Chete, 1998). First, consistent and regulated inflow of foreign investment provides an important source of foreign exchange earnings needed to supplement domestic savings and raise investment levels. Second, import substituting investment would serve to reduce the import bills as investment in export industries will directly increase the country's foreign exchange earnings.

Some other benefits might also accrue from increased foreign investment. These include the creation or rather expansion of local industries to supply inputs to the newly established plants; a rise in the overall level of domestic demand to boost incomes and, through taxation, state revenues; and the transference of labour (human capital) skills and technology. Yet another set of benefits arises from the forecasting of efficiency in the domestic economy, an effect that might even occur prior to the anticipated investment flows (Chete, 1998).

Most probably due to these overwhelmingly attractive theoretical arguments in support of foreign investment, government authorities in Nigeria have often articulated a plethora of incentives aimed at attracting foreign investment. For example, the New Industrial Policy published in 1988 embodies some Foreign Direct Investment (FDI) provisions which represent a dramatic departure from the past policy (see Chete, 1998, for details) Besides, the need for external capital inflow arises, when desired investment exceeds actual savings. They are necessary also owing to investments with long gestation periods that generate non-monetary returns; growing government expenditures that are not tax-financed and when actual savings are lower than potential savings owing to repressed financial markets, and even capital market flight (Ogamba, 2003).

Several variables which create dependence on foreign capital have been identified in the literature. They could be classified into fluctuating variables such as exports, imports and invisible; offsetting variables like debt service and reserve creation, and rigid variables which include minimum level of imports, stage of economic development and exportable surplus (Ogamba, 2003).

External capital flows could also be non-debts creating flows (as in official transfers or grant in aids and direct investment flows), debt creating flows (as in official development finance), commercial bank loans and international bond offerings; or could equally be a hybrid, for example, foreign portfolio investments and international equity offerings. Of late, Nigeria has embarked upon several trade liberalisation policies so as to free FDI flows into the country (Adegbite and Owuallah, 2007).

The literature is replete with evidence that private investment in most developing countries is more directly related to growth than public investment (see Akpokadje, 1991; Serven and Salimano, 1991; Khan and Reinhart, 1990). Accordingly, it is now widely accepted that the expansion of private investment should be the added impetus for economic growth in developing economies (Chhibber and Dailami, 1990).

Many developing countries have over the years relied very much on the inflow of financial resources from outside in various forms, official and private capital flows as well as direct foreign investment, as a means of speeding up their economic development (Olaniyi; 1988, Odozi, 1995; Ekpo, 1997 and Uremadu, 2006). However, these countries have shown preference for direct foreign investment because they regard direct foreign investment as a means of counteracting the sluggish trend in official and private portfolio capital flows.

Generally, capital from outside can be very helpful in speeding up the pace of economic development and can act as a catalytic agent in making it possible to harness domestic resources particularly in a developing country. But foreign capital, no matter how large the inflow, cannot absolve a recipient country from the task of mobilising domestic resources. Foreign inflows can,

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at best, be complementary to domestic savings. In developing economies experience has shown that foreign capital alone cannot create any permanent basis for a higher standard of living in the future. Rather it complements domestic savings. Therefore greater dependence on internal sources of finance facilitates the successful implementation of any planned economic development in a country (Agu, 1988 and Uremadu, 2006).

But after over two decades of economic adjustment, all relevant indicators have suggested that the recovery of private investment in Nigeria has been sluggish and slow. The figures in Table 1 of Appendix I, for example, show that cumulative foreign private investment as a percentage of GDP, has been fluctuating over the years 1980-2004. It has also followed a downward trend from the position of 7.12% (1980) to a peak of 12.79% (1986) and to its current status of 3.73% in 2004. The same low and fluctuating trend has been exhibited by the gross domestic investment also known as Gross Fixed Capital Formation (GFCF). Certainly, macroeconomic policies: monetary, fiscal and exchange rate, have a bearing on the investment behaviour in a country (Likewelile, 1997, Ghuma and Hadjmichael, 1996; World Bank, 1994 and Akpokodje, 1998), but the impact of these policies on private investment behaviour in Nigeria is still largely unclear.

This paper therefore explores the association existing between capital formation and other macroeconomic indicators of interest in the pursuant of macroeconomic policies in Nigeria. Specifically, it seeks to determine the impact of cumulative foreign private investment on capital formation and growth in Nigeria. It will also highlight the complementary role played by it to gross domestic savings towards filling the existing savings - investment gap in a bid to achieve desired investment goals and/or growth objectives in Nigeria in the years ahead.

2. Literature Review and Theoretical Framework

This section will attempt to review some outstanding existing related studies on the topic of research and finally, review relevant theoretical framework on the main issue of study.

2. 1 Review of Related Works

The preponderance1 of empirical studies that have explored quantitatively the determinants of foreign direct investment have concentrated more on economic than other factors. In particular, each of the authors, in his regression equations included those determinants he or she considered personally appealing. In what follows, we survey some of these empirical investigations.

A leading proponent of the economic approach to the determinants of foreign direct investment is found in (Dunning, 1973). On the strength of studies by scholars based on international production, he identifies three sets of influences on foreign direct investment to include the following;

i. market factors such as the size and growth of the market measured by the gross national product (GNP) of the recipient country;

ii. cost factors such as the availability of labour, low labour costs and inflation; and

iii. the investment climate as measured by the degree of foreign indebtedness and the state of the balance of payments (Chete, 1998). In another study, Dunning (1981), develops an eclectic theory of international direct investment based on the theories of industrial organisation of location of a firm. Nonetheless, the treatise of this later study does not directly concern the subject in hand (see Chete, 1998, p.4).

Agarwal (1980), clarifies the determinants of foreign direct investments using...

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