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EFFECT OF FOREIGN DIRECT INVESTMENT ON ECONOMY GROWTH OF NIGERIA

ABSTRACT

This study set out to empirically examine the effect of Foreign Direct Investment (FDI) on the economic growth in Nigeria between 1970 and 2010. The paper makes the proposition that there exists controversies over the effect of FDI on the economic growth of developing nations. However, the results obtained showed that FDI has some positive spillovers on the Nigerian economy hence the need to embark on the policies that would help to bring about greater FDI inflows.

CHAPTER ONE

INTRODUCTION

1.0       Background of the Study

The focus of this project is to study the effects of FDI on the Nigerian economy, identifying factors and conditions that promote or retard development. Developing countries are in a dilemma arising from the desire for foreign capital for internal economic development, yet there is the fear that foreign investors (which are already said to be at commanding heights of some sectors of the economy) may wrest complete control of the international economy and render it an appendage of the western economic hegemony.

However, most of the economic blueprints that have been recommended for developing economics are in agreement on the need for foreign capital. Thus, a developing country may have to determine the actual sectors which have to attract foreign private investment and also determine the optimum level of foreign investment that is necessary in order to supplement its internal resources. Thereby, maintaining a balance between economic development and economic independence. (IMF,  2009).

The impact of foreign direct investment has never been as important as it is now in the early 21stcentury, nations are more linked through trade in goods and services flow of money and investment. Owing to the enormous benefit accrued, most countries strive to attract foreign direct investment (FDI) as it is a proven tool of economic development. African and Nigeria in particular joined the rest of the world in seeking FDI as evidenced by the formation of the New partnership for Africa’s Development (NEPAD), which has the attraction of foreign investment to Africa as a major component (Funke and Nsouli 2003).     

In the literature of Caves (1996), it was observed that the rationale for increased efforts to attract more FDI stems from the belief that FDI has several positive effects. Among these are productivity gains, technology introduction of new processes, managerial skills and know- how in the domestic market, employee training, international production networks and access to markets.

An agreed framework definition of foreign direct investment (FDI) exists in the literature, that is, FDI refers to the net inflows of investment to acquire a lasting management interest (10percent) or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of equity, other long- term capital, and short-term capital as shown in the balance of payments. It usually involves participation in management, joint- venture, transfer of technology and expertise. There are two types of FDI: Inward foreign direct investment and Outward foreign direct investment; resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment”, which the cumulative number for a given period.

FDI an indispensable factor to the economic growth of an economy is evident in the United States which is the world's largest recipient of FDI and is consequently the world's strongest economy. In the last 6 years America has benefited from the FDI through the establishment of over 4000 new projects and 630,000 new jobs have been created by foreign companies, resulting in .close to $314 billion in investment. Foreign companies has in the past supported an annual US payroll of billion with an average annual compensation of $68,000 per employee (UNCTAD, 2010)

Sub-Saharan Africa as a region now has to depend very much on FDI for so many reasons, some of which is amplified by Asiedu (2001). The preference for FDI stems from its acknowledged advantages (Sjoholm, 1999; Obwonba, 2001, 2004). The effort by several African countries to improve their business climate stems from the desire to attract FDI. In fact, one of the pillars on which the New partnership for Africa's development (NEPAD) was launched was to increase available capital to US$64billion through a combination of reforms, resource mobilization and a conducive environment for FDI (Funke and Nsouli 2003).

Recently, TNCs from developed and transition economies have increasingly been investing in Africa over the past few years. They accounted for 22 percent of flows to the region over the 2005-2008 period, compared to 18 percent in 1995-1999 investors from China. Malaysia India and the Gulf Cooperation Council (GCC) are among the most active-although Africa still makes up only a fraction of their FDI. Investors from Southern Africa and North Africa have also raised their profile in the region. These new sources of Investment not only provide additional development opportunities, but are also expected to be more resilient than traditional ones, providing a potential buffer against crises (UNCTAD,  2009).

Nigeria receives the largest amount of FDI in Africa. FDI inflows have been on the increase over the course of the last decade; from USD$1.14billion in 2001 and USD$2.1billion in 2004, Nigeria’s FDI reached USD11billion in 2009 according to UNCTAD, making the country the nineteenth greatest recipient of FDI in the world. Hence, since FDI is seen a promising device for driving the economy to desired heights, it is only rationale for Nigeria to increase her revenues by increasing her efforts in attracting more of it.

1.1 STATEMENT OF PROBLEM

Unfortunately, the efforts of most countries in Africa to attract FDI have been futile. This is in spite of the perceived and obvious need for FDI in the continent, the development is disturbing, sending very little hope of economic development and growth for these countries. Nigeria as a nation has not been able to fully tap from her resources.

Recent report has shown that Nigeria due to her over-dependency on oil is fast loosing its leading role in terms of attracting FDI in Africa to Egypt and South Africa, which were successful in attracting FDI in diverse sectors of their economies (UNCTAD, 2009).

Nigeria’s poor FDI record can be further adduced due to the following reasons:

Uncertainty: One of the reasons why foreign investors are reluctant to invest in Nigeria, despite its enormous profitable opportunities, is the relatively high degree of uncertainty in the region, which exposes firms to significant risks. Uncertainty in the Nigeria manifests itself in three different ways:

• Political instability: The region is politically unstable because of the high incidence of wars, frequent military interventions in politics, and religious and ethnic conflicts. Sachs and Sievers (1998) have also argued that political stability is one of the most important determinants of FDI in Africa. Example is the Bokoharam and Niger Delta menace which have been reported to scare away investors (World Bank 2011).

• Macroeconomic instability: Instability in macroeconomic variables as evidenced by the high incidence of currency crashes, double digit inflation, and excessive budget deficits, has also limited the regions ability to attract foreign investment. Recent evidence based on African data suggests that countries with high inflation tend to attract less FDI (Onyeiwu and Shrestha, 2004).

• Lack of policy transparency: In Nigeria it is often difficult to tell what specific aspects of government policies are in operation. This is due in part to the high frequency of government as well as policy changes in the region and the lack of transparency in macroeconomic policy. The lack of transparency in economic policy is of concern because it increases transaction costs thereby reducing the incentives for foreign investment.

Inhospitable regulatory environment: The lack of a favourable investment climate also contributed to the low FDI trend observed in the region. In the past, domestic investment policies––for example on profit repatriation as well as on entry into some sectors of the economy––were not conducive to the attraction of FDI (Basu and Srinivasan, 2002).

GDP growth and market size: Relative to several regions of the world, growth rates of real per capital output in Africa are low and domestic markets are quite small. This makes it difficult for foreign firms to

exploit economies of scale and so discourages entry. (Elbadawi and Mwega ,1997), show that economic growth is an important determinant of FDI flows to the region.

Poor infrastructure: The absence of adequate supporting infrastructure: telecommunication; transport; power supply; skilled labour, discourage foreign investment because it increases transaction costs.

Furthermore poor infrastructure reduces the productivity of investments thereby discouraging inflows. Asiedu (2002b) and Morrisset (2000) provide evidence that good infrastructure has a positive impact on FDI flows to Africa.

Other factors that account for the low FDI flows to the region but are rarely included in empirical studies––presumably due to data limitations–– include:

High dependence on commodities: Several African countries rely on the export of a few primary commodities for foreign exchange earnings. Because the prices of these commodities are highly volatile, they are highly vulnerable to terms of trade shocks, which results in high country risk thereby discouraging foreign investment.

Corruption and weak governance: Weak law enforcement stemming from corruption and the lack of a credible mechanism for the protection of property rights are possible deterrents to FDI in the region.

Foreign investors prefer to make investments in countries with very good legal and judicial systems to guarantee the security of their investments.

Poor and ineffective marketing strategy: In the past, African governments set up agencies to promote foreign investment without taking adequate steps to lift the constraints on foreign direct investment in the region. It is therefore not surprising that investment promotion activities in the region have not been as successful as expected. For example, in Nigeria, FDI promotion in the 1990s was accompanied by increased political risk: frequent and abrupt changes in government; religious and ethnic conflicts and border disputes. Also, FDI flows to Nigeria fell to $6.1billion (N933.3billion) in 2010, a decline of 29% from the $8.65billion (N1.33trillion) recorded in 2009 due to security treat in Niger Delta (World Bank, 2011).

Apart from the idea that promotion activities in Africa started earlier than necessary, there is also the problem that Investment Promotion Agencies (IPA) created by domestic governments were highly bureaucratic, expensive to maintain, and have not been successful in reversing the declining trend in FDI flows to Nigeria.

1.2       OBJECTIVE OF THE STUDY

The broad objective is to examine the effect of FDI on economic growth in Nigeria.

The specific objectives are to :

1. Examine the nature and trend of FDI in relation to the Nigerian economy.

2.Examine the impact of FDI on the economic growth in Nigeria.

3. Investigate  the effect of  some  macro-economic indicators on FDI

4.Identify the constraints inhibiting the flow of FDI, and how to alleviate these problems.

1.3       RESEARCH QUESTIONS

1. What is the nature and trend of FDI in Nigeria?

2.  Has there been a positive or negative impact of FDI on economic growth in Nigeria?

3.  How has  the macroeconomic indicators  affected the level of  FDI?

4.  What are the factors inhibiting the flow of FDI in Nigeria?

1.4 METHODOLOGY

The quantitative technique that will be adopted in analyzing the data collected is ordinary least square (OLS) method using economic view package (E-View) to analyze the impact of Foreign Direct Investment on Economic Growth in Nigeria. Multiple regression equations will also be adopted because multiple equations provide a better representation of the real world which is relatively richer than a single equation model.

Descriptive analysis, will in this research work also be adopted in analyzing the trend of the different variables mentioned above over the time period specified.

1.5 MODEL SPECIFICATION

The following model would be adapted.

GDP = µ0 + µ1 INV + µ2 EXP + µ3 FDI + µ4 INF + U1t  . . . (I)

FDI = bo + b1 GDP + b2 EXR + b3 EXD + b4 PI + U2t  . . . (II)

Where,

GDP = Growth Rate of GDP   

INV = Domestic Investment Growth  (Proxy for Domestic Capital Stock) 

EXP = Exports Growth

FDI = Foreign Direct Investment Growth

INF = Inflation Rate

EXR = Exchange rate

EXD = External debt

PI = Political Instability (dummy variable: 1 for democratic rule, 0      for militarily rule)

U1t = Error term for model 1

U2t = Error term for model 2

The a priori expectation patterns of the behaviour of the independent variables in terms of their parameters to be estimated are:  

µ1>0,  µ2>0,  µ3>0 and µ4<0

b1>0,   b2<0, b3>0 and b4<0

1.6 STATEMENT OF HYPOTHESIS

H0: There is no significant relationship between Foreign Direct Investment and Economic Growth in Nigeria.

H1: There is a significant relationship between Foreign Direct Investment and Economic Growth in Nigeria.

1.7 SOURCES OF DATA

Data used in the course of this work will majorly be sourced from secondary sources of varied organizations and individuals. Some of the sources include:

- The Central Bank of Nigeria, which is the apex bank in the country, relevant information will be gathered here.

-  UNCTAD, OECD and IMF publications.

- World Bank Reports

1.8 JUSTIFICATION OF STUDY

The observation of dwindling Foreign Direct Investments and its impact on the economy over the years are the major reasons why this study is pertinent and therefore a justification for embarking on it.

The reasons are as follows:  

- Policy  makers will know the level of damage done

-  They will then know the importance of effective policy making, knowing that lack of it is what has led us to where we are today.

- The awareness that the need for conducive environment for FDI to thrive in, helps to bring about development.

-  Finally, the realization that development often comes through the diversification of the productive capacity of the economy.

1.9 SCOPE OF THE STUDY

This project will have as its scope and time period, the years between 1970-2010 because 1970 marks the beginning of the oil boom period (Anyanwu 1998) which had a serious impact on the Nigerian economy. For the years 1970-2010, we will be looking at the development plans, policies, programmes and reforms that have been in place and how the economy has responded in these varying times.

1.10 LIMITATIONS OF THE STUDY

One of the major constraints is the problem of consistent and accurate data. Another, is the problem of making assumptions which are necessary building blocks for any model to derive logical conclusions but may not conform to reality, example is the dummy variable assigned to political instability in the model.

1.11 PLAN OF THE STUDY

The plan of the study shall be organized into five chapters for easy presentations:

The chapter one contains the introduction of the study which deals with the background of the study, the problems that have hindered FDI impact to growth of the Nigerian Economy from 1980-2010, the objectives on why the study is being carried out, the research questions looks at various important questions  this study will be attempting to answer on the level of the impact of FDI on the Nigerian Economy, the methodology that is the quantitative and descriptive technique that would be used in analyzing data collected, the statement of hypothesis to ascertain whether there is any significant relationship between Foreign Direct Investment and Economic growth, the areas from where the data will be sourced, a justifications on why the research is being carried out, the scope and time period that the project would cover.

Chapter two is the literature review that looks at the various scholars and schooling articles that have contributed immensely to the subject  in question, Review of theories and trends of FDI that reflect the need for FDI.

The chapter three contains the Methodology and theoretical framework which gives a descriptive and quantitative analysis of the data collected.

The chapter four involves the Empirical Results and Discussions that explains the various data results and their implications.

The chapter five gives a brief summary, conclusion and recommendations of the project.

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