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OSU, ANGELINAH KURUBO
PG/Ph.D/04/35646
INVESTIGATING THE EFFECTIVENESS OF FOREIGN DIRECT INVESTMENT (FDI) POLICIES IN NIGERIA 1985 –
2009
SOCIAL SCIENCES
A THESIS SUBMITTED TO THE DEPARTMENT OF ECONOMICS, FACULTY OF SOCIAL SCIENCES, UNIVERSITY OF NIGERIA NSUKKA
IJEOMAH CLARA
Digitally Signed by: Content manager’s Name
DN : CN = Webmaster’s name
O= University of Nigeria, Nsukka
OU = Innovation Centre
MAY, 2013
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INVESTIGATING THE EFFECTIVENESS OF FOREIGN DIRECT
INVESTMENT (FDI) POLICIES IN NIGERIA 1985 – 2009
BY
OSU, ANGELINAH KURUBO
PG/Ph.D/04/35646
DEPARTMENT OF ECONOMICS
FACULITY OF SOCIAL SCIENCES
UNIVERSITY OF NIGERIA,
NSUKKA.
May 27, 2013
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APPROVAL PAGE
This thesis has been approved for the Department of Economics,
University of Nigeria, Nsukka.
By
_______________ __________________
Prof. F. E Onah Internal Examiner
Supervisor
_________________ _________________
External Examiner Dr. (Mrs.) G.C Aneke
Head, Dept. of Economics
__________________
Prof. C.O.T Ugwu
Dean, Faculty of Social Sciences
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CERTIFICATION
The Candidate Angelinah Kurubo Osu a postgraduate student of the Department of
Economics with Registration Number PG/P.h.D/04/35646 has satisfactorily completed
the requirements for the Degree of Doctor of Philosophy in International Economics of
the University of Nigeria, Nsukka. The work embodied in this thesis is original and
has not been submitted in part or full for any other diploma or degree of this
University or any other University.
________________ ___________________
Internal Examiner Dr. (Mrs) G.C Aneke
Head, Dept. of Economics
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Dedication
This research work is dedicated to my Daddy (Husband) Hon. Justice Tayo Kilegbu
Osu for his unlimited effort to see me acquire higher education through the Grace of
God.
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Acknowledgements
In life, there are series of journeys which are undertaken by a man or woman with
different purposes. One of such journeys is what I can conveniently describe as an
“academic journey”, principally conceived and put into progress by an individual to
achieve a higher knowledge. However, in course of such a journey, many other people
are co-opted and the number of participants becomes enlarged. I conceived and
started the journey, made appreciable progress and successfully ended it.
This has been made possible by the Grace of Our Lord Jesus Christ, who took total
control by creating in me the spirit of focus, sound health and strong guidance.
Therefore, I immensely appreciate the non-quantifiable glory of God.
I can only do justice to those I came across by showing adequate or appreciable
gratitude for what each of them has done to make the journey become a success. I am
extremely grateful to Prof. F. E. Onah, who was my supervisor. He is indeed a father,
possessing extra ordinary patience. He did not show any degree of annoyance
concerning errors which he discovered from one stage of the work to another. He was
calm, amiable and accommodating. Thank you very much, Sir. I also appreciate the
magnanimous contributions of the lecturers in the department. My showing of
gratitude will not be complete if I fail to mention Mr. Felix M. Jebbin, a co-lecturer in
the same department at the Ignatius Ajuru University of Education, Rumuolumeni,
Port Harcourt, Rivers State, who devoted a lot of his precious time to proof-read the
work and shared valuable ideas with me. I owe him a lot of gratitude.
I also hereby express my utmost gratitude to my loving and caring daddy (husband)
Hon. Justice Tayo Kilegbu Osu (Retired) and my children and grandchildren for
staying by me throughout the long and boring hours, days, weeks, months and years
that I dedicated to carry out this research work to acquire higher academic knowledge.
They were completely or totally involved. They sang and prayed for my safety during
each trip I made from Port Harcourt to Nsukka and back. This emboldened me to
work harder to conquer the challenge. I do not also in the slightest way forget the
contribution of my colleagues who through verbal discussions or advice enriched my
writing.
Finally to all my well wishers whom I have not mentioned their names above and who
had one way or the other, directly or indirectly contributed to the success of my
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research, particularly my siblings, in-laws, family members and friends, I say thank
you very much.
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TABLE OF CONTENTS
Page
Title Page … … … … … … … … … i
Approval … … … … … … … … … ii
Certification … … … … … … … … … iii
Dedication … … … … … … … … … iv
Acknowledgments … … … … … … … … v
Table of Contents … … … … … … … … vi
Lists of Tables … … … … … … … … vii
Abstract … … … … … … … … … viii
CHAPTER ONE:
1.0 INTRODUCTION:
1.1 Background of the study … … … … … … 1
1.2 Statement of the problem … … … … … … 3
1.2.1 Research Questions … … … … … … 4
1.3 Objectives of the study … … … … … … 4
1.4 Research Hypotheses … … … … … … 4
1.5 Significance of the study … … … … … … 5
1.6 Scope of the study … … … … … … … 5
1.7 Organization of the study … … … … … … 6
CHAPTER TWO:
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THEORETICAL FRAMEWORK AND LITERATURE REVIEW:
2.1 Theoretical Framework … … … … … 7
2.2 Theoretical Literature … … … … … 9
2.2.1 The Production Cycle Theory of Vernon … … … 9
2.2.2 The Theory of Exchange Rates on Imperfect Markets … … 10
2.2.3 The Internalization Theory … … … … … 10
2.2.4 An Assignment Theory of Foreign Direct Investment (FDI) … 11
2.3 Empirical Literature … … … … … 18
2.3.1 Impact of Different policy Option on FDI … … … 18
2.3.2 FDI and Productivity Spillover Benefits … … … … 23
2.3.3 FDI, Economic Growth and Development … … … 30
2.4 Shortcomings of Previous Works … … … … 32
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CHAPTER THREE:
OVERVIEW OF FOREIGN DIRECT INVESTMENT POLICIES
AND THE MAGNITUDE OF INFLOW IN NIGERIA 1985 - 2009
3.1 Introduction … … … … … … … … 34
3.2 Policy Instruments … … … … … … … 35
3.2.1 Aid to Pioneer Industries … … … … … … 35
3.2.2 Depreciation Allowances … … … … … … 39
3.2.3 Import Duty Relief … … … … … … … 40
3.3 Other forms of Incentives (Double Taxation Relief) … … 42
3.4 Exchange and Investment Guarantee … … … … 43
3.5 Industrial Estates … … … … … … … 43
3.6 Foreign Exchange (Monitoring and Miscellaneous) Acts 1995 44
3.7 Trend in Foreign Direct Investment in Nigeria … … … 46
3.8 Inflow and Outflow of Foreign Direct Investment in Nigeria … 47
3.9 Components of Foreign Net Capital Flow … … … 50
3.10 Cumulative Foreign Direct Investment by Origin … … 51
3.11 Cumulative Foreign Direct Investment by Sectors … … 52
3.12 Significance of Foreign Direct Investment Inflow in Nigeria … 53
3.12.1 FDI and Performance of Manufacturing Industries in Nigeria 54
CHAPTER FOUR:
METHODOLOGY:
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4.1 Methodological Framework … … … … … 57
4.2 Macroeconomic model … … … … … … 57
4.3 THE Model Specification … … … … … 59
4.3.1 Aggregate Demand (AGD) Block … … … … … 59
4.3.2 Private Consumption Expenditure (CONs) … … … 60
4.3.3 Private Investment (INV) … … … … … … 60
4.4 Supply Block … … … … … … … 61
4.5 External Block … … … … … … … 62
4.5.1 Exports (EXP) … … … … … … 62
4.5.2 Imports (IMP) … … … … … … 63
4.5.3 Foreign Direct Investment (FDI) … … … … … 63
4.6 Government Block (GB) … … … … … 64
4.6.1 Government Expenditure (GE) … … … … … 65
4.6.2 Government Revenue (GVR) … … … … 65
4.6.3 Oil Revenue (GVRo) … … … … … … … 66
4.6.4 Non-Oil Revenue (GVRN) … … … … … … 66
4.7 Monetary and Financial Block … … … … 66
CHAPTER FIVE
PRESENTATION AND ANALYSIS OF RESEARCH FINDINGS
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5.1 Empirical Analysis … … … … … … 68
5.2 Co-integration … … … … … … … 68
5.3 Parsimonious Estimation of the Reduced Form Equations … 68 5.3.1
Consumption Expenditure … … … … … … 68
5.3.2 Investment … … … … … … … … 70
5.3.3 Production … … … … … … … 75
5.3.4 Government Expenditure and Revenue … … … … 79
5.3.5 External Sector … … … … … … … 82
5.3.6 Monetary Sector … … … … … … … 88
5.4 Policy Simulation and FDI Transmission Effects … … 92
5.4.1 Corporate Tax Burden Policy Simulation … … … … 93
5.4.2 Macroeconomic Volatility and FDI … … … … 93
5.4.3 Exchange Rate Policy Simulation Experiment … … … 94
5.4.4 Trade Protection Effect … … … … … … 95
5.4.5 Size of the Public Sector Effect … … … … … 95
5.4.6 Capital Allowance … … … … … … … 96
5.4.7 Combined Effects of Policy Change and (CTB) … … … 97
5.5 Factors Militating against the Inflow of FDI … … … 99
CHAPTER SIX:
SUMMARY, RECOMMENDATIONS AND CONCLUSION
6.1 Summary of Findings … … … … … … 116
6.2 Recommendations … …. … … … … 118
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6.3 Limitations … … … … … … … 118
6.5 Conclusion … … … … … … … 119
References … … … … … … … … … 120
Appendices
Appendix 1: Long run unit root estimates … … … … 129
Appendix 2: Model forecast and tracking … … … … 136
Appendix 3: Historical tracking of variables in the model … … 137
Appendix 4: Table 3.1 - Flow of non-oil foreign private capital … 142
Appendix 5: Table 3.2 - Flow of non-oil foreign private capita: Four Major 143
Regions
Appendix 6: Table 3.3a - Components of net capital flow by origin:
Unremitted Profit … … … … … … 145
Appendix 7: Table 3.3b - Components of net capital flow by origin:
Trade and Supplies Credit (Net) … … … … 146
Appendix 8: Table 3.3c - Components of net capital flow by origin:
Changes in Foreign Share Capital (Net) … … … 147
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Appendix 9: Table 3.3d - Components of net capital flow by origin:
Other Foreign Liabilities (Net) … … … … 148
Appendix 10: Table 3.3e - Components of net capital flow by origin:
Liabilities to Head Office (Net) … … … … 149
Appendix 11: Table 3.4 - Components of net capital flow by origin: Totals 150
Appendix 12: Table 3.5a - Cumulative foreign private investment in
Nigeria by origin … … … … … … 151
Appendix 13: Table 3.5b - Cumulative foreign private investment
in Nigeria analyzed by type of activity … … … 152
Appendix 14: Table 5.1- Summary of administrative procedures … 153
Appendix 15: Table 5.2 - Summary of main results per country … 154
Appendix 16: Table 5.3 - The sample: Country rankings according to their
transparency … … … … … … 155
Appendix 17: Table 5.4 - GCI component indexes ranking comparison 156
Appendix 18: Table 5.5 - Corruption perceptions index … … 157
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ABSTRACT
The primary objective of the study is to investigate the Effectiveness of Foreign Direct
Investment Policies in Nigeria from 1985 to 2009, while the secondary objectives are to provide
an overview of FDI policies, examine the magnitude of the inflow and identify the factors
militating against the effectiveness of the policies. There are two applied methods in this study,
empirical and descriptive method. The empirical method used a macroeconomic model, while the
descriptive method used trend analysis and policy simulation to evaluate FDI policy catalyst
over the study period. The macroeconomic model followed the Keynesian paradigm, and has five
blocks, namely, aggregate demand, aggregate supply, government, external, and monetary
blocks. The regression analysis was done by first examining the time series characteristics of the
variables used in the study. Accordingly, unit root and, Johansen’s co-integration test were
examined after which error correction models were adopted in each of the equations in the five
blocks. The null hypotheses were tested and the result of the estimate showed that decrease in
corporate tax burden attracted FDI inflow, while overvalued exchange rate and macroeconomic
volatility were repellents of FDI. Four baseline policy scenarios, namely 0%, 20%, 30% and
50% were used for six policy simulation experiments to validate the a priori relationship of the
six policy variables: corporate tax burden, exchange rate, macroeconomic volatility, trade
protection, size of the private sector and capital allowance. The outcome confirmed the priori
relationship, but with some mixed effects as investors reacted to initial shocks and adjusted in
the long run. The results of the six policy variables as shown in Table 6.14 showed that tax
policy alone may not address the issue of FDI inflow. This was evident from the replication of
negative growth rate inspite of zero tax or tax holiday granted. Exchange rate appreciation
discouraged FDI inflow more specifically in the non-oil FDI. The initial reaction of FDI to
capital allowance was a steady increase in FDI inflow, equally turning negative growth to
positive growth before declining again between 2008 and 2009. The result confirmed that
investment inflow would always react to incentives while its sustainability depended on the
combination of other policies. The size of the public sector represents the degree of government
involvement in the economy. The initial effect of trade protection proxied by the level of tariff on
imported goods at zero percent resulted in a reduction in the inflow of FDI. This low tariff level
(zero percent) affected negatively the inflow of FDI. But the reverse was the case with high
percent of tariff level. The conclusion therefore is that there is need for policy combination to
drive the inflow of FDI in Nigeria if the government can adopt the following recommendations:
adequate tax treaties network because as corporate tax burden increases, there is a fall in FDI
inflow, well-enforced competition law, intellectual property protection, modern and well-
enforced laws, exchange rate policy that is determined by the forces of demand and supply,
expatriate work and residence permit policy, policy that does not place strict conditionality on
repatriation of profit.
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Considering the import dependent nature of the Nigerian economy, the
need for capital inflow is imperative. CBN (1999) Economic and financial
Review showed that the overall balance of payment in 1999 deteriorated
mainly due to increased outflow from the capital account. Much of the
outflow could be attributed to external debt servicing. Essien and
Onwioduokit (1999) had identified debt servicing and reserve creation as
certain variables that determine dependence on foreign capital. This
dependence on foreign capital was worsening with the monocultural
economic character of Nigeria (i.e. dependence on oil) and the conspicuous
consumption pattern of our political leaders.
Oil, which is the bedrock of the Nigerian economy is subject to the vagaries of
production and prices, hence revenue generated from the source is also subject to
fluctuation. This has posed a major setback in fiscal planning and implementation.
Development plans in the country have been adversely affected as ex-post revenue
deviated by a very wide margin from ex-ante revenue. The end result is deficiency
in investment capital. In order to bridge the gap between the ex-post revenue and
ex-ante revenue, and remedy the problem of deficiency in capital, a few options
are open to the economy or the authorities concerned. Either they attract foreign
investors, borrow from outside or borrow within. Consequent upon the
narrowness of Nigerian financial markets, the dwindling economy, and the brazen
corruption perpetuated by our political leaders and top government functionaries,
the government cannot cope with the huge capital needed in the prime sector of
the economy.
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Based on the above, the only option open to the country is either through
foreign direct investment or by borrowing from foreign institutions
(external borrowing). External borrowing carries with it some stringent
conditionalities, which the country has found extremely difficult to meet,
hence, the only cheaper option available is through foreign investment.
Foreign investment is made up of two components, foreign direct
investment and portfolio investment. Portfolio investment can be
susceptible not only to the decisions of the big institutions that determine
the volume and timing of the flows but also to the manipulative activities of
some global speculative players, therefore, foreign direct investment is the
cheapest option. In line with this, government has adopted several policies
as inducement to attract foreign direct investment motivated by the
expectation of spillover benefits to augment the primary benefits of a boost
to national income from new investment and help in the economic growth
of the country.
The Industrial Development Income Tax Relief Act of 1958 was enacted and
became very effective as it provided reliefs to foreign companies in Nigeria,
by granting them pioneer status. The status qualified the foreign firms for a
tax holiday of maximum of five years from the commencement date.
Flexible responsive policy with regard to expatriate work and residence
permits was adopted, which warranted the renewal of the severe labour
market tests as expatriate were once subjected to arbitrary and
unpredictable treatment. Modern and well-enforced laws, compatible with
the agreement on trade-related aspect of intellectusal property right policy
were enacted. Rule of law (impartial and efficient Judicial) processes were
put in place, transparency was instituted through the establishment of
Independent Corrupt Practice Commission and Economic and Financial
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Crime Commission. Modern Commercial Laws and International
Accounting Standard were adopted (Aremu, 2003.)
1.2 Statement of the Problem
Several arguments have been put forward in support of foreign direct
investment in Less Developed Countries (LDCs). Prominent among them
are the filling of the gaps (i) between targeted or desired investment and
locally mobilized savings, (ii) between targeted foreign-exchange
requirements and those desired from net export earnings plus net public
foreign aid (foreign-exchange gap), (iii) between targeted government tax
revenue and locally raised taxes, and (iv) between management,
entrepreneurship, technology and skill.
By taxing Multinational Corporations’ (MNCs) profits and participating
financially in their local operations, LDCs’ governments are thought to be
able to mobilize better public financial resources for development projects.
In addition to the above arguments in support of Foreign Direct Investment
(FDI), is its capacity to improve total factor productivity and the potential
spillover benefits from foreign direct investment.
Given the above arguments / reasons, government has put in place some
foreign investment policies: foreign exchange rate (nominal exchange rate),
government tax (corporate tax burden, tax holiday), business environment
(macroeconomic uncertainty), trade protection zone (level of tariff on
import), private sector investment (size of the private sector in the economy
via privatization), capital allowance and interest rate to attract foreign
investors. The major questions are: are these policies actually effective in
attracting foreign investors to Nigeria? And at what rate are the inflows of
these investors to Nigeria? This is what this research work tends to
investigate.
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1.2.1 Research Questions
Given the generous policy stance of the Nigerian government and the
inflow of FDI into the economy one is poised to ask the following
questions.
i. What constitute these policies?
ii. What is the magnitude of the inflow of FDI into the economy?
iii. How effective are these policies in attracting the needed FDI into the
economy?
iv. What are the factors militating against the effectiveness of these
policies.
1.3 Objectives of the Study
The general objective of the study is to examine the effectiveness of foreign
direct investment policies in Nigeria. The specific objectives of the study are
to:
i. To provide an overview of foreign direct investment policies in
Nigeria, 1985 – 2009.
ii. examine the magnitude and significance of the inflow of FDI in
Nigeria,
iii. investigate the effectiveness of FDI policies (exchange rate, corporate
tax holiday, size of private sector, macroeconomic volatility, capital
allowance etc.) in promoting FDI in Nigeria,
iv. identify the factors militating against the effectiveness of these
policies.
1.4 Research Hypotheses
The following research hypotheses are tested in order to validate the study.
i. There are no foreign direct investment policies in Nigeria.
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ii The magnitude of FDI inflow is insignificant.
iii. Government policies are not effective in promoting (FDI) in Nigeria.
iv. There are no militating factors against the effectiveness of FDI
policies.
1.5 Significance of the study
The benefits derived from dividends of democracy includes the following:-
Increase in the total capital flow into the country. Increase private sector
present in the economy via the country privatization exercise and the
relatively political stability. A study of how government policies impact on
the volume of FDI flow into Nigeria form an interesting subject for policy
makers and academic debate. It will also serves as an eye opener to the
government or mirror through which the government will test the
popularity of their FDI policies. Past studies used insufficient variables but
this study tries to explore more avenues to contribute to the debate in
expanding the body of knowledge on the subject matter. The study will
equally close the gap between FDI determinants and FDI policy attractors.
It is hope that this work will spark-off debate about the need for right
policies and the examination of relative policies on FDI. The study will also
help to bring to the fore of government the magnitude of the inflow of FDI
to the various sectors of the economy as to enable the government carry out
a sector by sector analysis.
1.6 Scope of the Study
The study investigates the effectiveness of foreign direct investment
policies adopted by the government of Nigeria – foreign exchange rate,
government tax, business environment, trade protection, capital allowance
and interest rate covering the period 1985 – 2009. This period caught across
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the military and civilian era and as such ex-rayed the various policies to
ascertain their effectiveness in attracting foreign investors into the country.
The study makes use of two applied methods, empirical and descriptive.
The empirical method used a macroeconomic model, while the descriptive
method used trend analysis and policy simulation to evaluate FDI policy
catalyst over the study period.
1.7 Organization of the Study
This thesis is organized into seven chapters. Chapter one forms the
background for the research problem. In subsequent sections of the chapter,
the study objectives and the statement of the problem are discussed.
Chapter two focuses on the theoretical and the empirical literature review
while Chapter three examines an overview of foreign direct investment
policies in Nigeria.
Chapter four is on the magnitude and significance of foreign direct
investment in Nigeria. Chapter five is the research methodology. In chapter
six, the crux of the research, the empirical findings of the study are
presented using econometric analysis (the least square regression
techniques). The t – test and the f – ratio statistical test have been used to
test the significance of the coefficients of the explanatory variables.
Chapter seven is the concluding chapter which summarizes the findings,
considers their implications for policy-making and makes
recommendations.
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CHAPTER TWO
THEORETICAL FRAMEWORK AND LITERATURE REVIEW
2.1 Theoretical Framework – Dunning’s Eclectic Theory
The theoretical framework for this study is drawn from Dunning’s eclectic
theory. Dunning (1977) suggested an eclectic theory of foreign direct
investment often referred to as the O, L, I paradigm.
The O, L, and I paradigm refers to three groups of conditions that
determine whether a firm, industry or company will be a source or a host of
FDI (or neither of course). These groups are: Ownership advantages (O),
Locational considerations (L) and Internalization gains (I).
Ownership advantages are specific to the firm. It may enjoy such
advantages over domestic as well as foreign competitors, so that expansion
in the domestic market may be an alternative strategy.
Locational considerations encompass such things as transport costs facing
both finished products and raw materials, import restrictions, the ease with
which the ownership advantages may be combined with factor
endowments in other countries, the tax policies in both source and host
countries, and political stability in the host country.
Internalization gains concern those factors which make them more
profitable to carry out transactions within the firm than to rely on external
market. The existence of internalization gains obviously depends to some
extent on the existence of ownership advantages.
The essential element in the eclectic theory is that all three types of
conditions must be met before there will be foreign direct investment. That
is, all three conditions are necessary, and no one is sufficient. For example,
if a firm has ownership advantage but the locational considerations indicate
that production within a foreign market would be more profitable than
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producing at home and exporting, but there are no internalization
advantages (the product could be made by a foreign firm with equal
efficiency and without jeopardizing the home firm’s ownership
advantages), then the most profitable course for the home firm would be to
license its ownership advantages to the foreign firm. If, on the other hand,
there were internalization gains but no locational advantage to be gained
by operating in another country then the firm would choose to expand
production in its home market and export to the foreign market.
The eclectic theory argues that FDI is determined by three sets of
advantages namely:-
i. Firms Specific (or ownership) advantages (Hymer, 1960): This set
of advantages gives a firm competitive advantage in global
markets, including technological assets, product differentiation,
management skills, production efficiencies, size and
concentration.
ii. Internalization advantages (Buckley and Casson, 1976): These
advantages exist when the internalization of cross-border
transactions within a firm becomes more efficient form of
servicing markets than arm’s length transactions. Put differently,,
it is the sum of commercial benefits accruing from an FDI or
intra-firm activity rather than an arm’s length or licensing
relationship.
iii. Locational advantages (Vernon, 1966): These occur when the local
conditions of potential host countries make them more attractive
site for FDI operations than the home country. These advantages
include large markets, lower costs of resources or superior
infrastructure, among others.
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Akinkugbe (2003) argues that the locational advantages constitute what
earlier theoretical and empirical studies classified as pull-factor. The pull-
factor examines the relationship between host country specific conditions
and the inflow of FDI. At the centre of locational advantages is the belief
that, there are some specific advantages to the investor, which make the
return in investment sufficient to warrant the additional risk and
uncertainty that accompany investment outside the familiar home
environment.
2.2 THEORETICAL LITERATURE
2.2.1 The Production Cycle Theory of Vernon.
Production cycle theory developed by Vernon (1966) was to explain certain
types of foreign direct investment made by U.S Companies in Western
Europe after the Second World War in the manufacturing industry.
Vernon (1966) believes that there are four stages of production, innovation,
growth, maturity and decline. According to Vernon (1966) in the first stage,
the United State (U.S) transnational companies create innovative products
for local consumption and export the surplus in order to serve also the
foreign markets. According to the theory of the production cycles, after the
Second World War in Europe had increased demand for manufacturing
products like those produced in U.S.A, American firms began to export,
having the advantage of technology on international competitors.
If in the first stage of the production cycle, manufacturers have an
advantage by possessing new technologies, as the product develops also
the technology becomes known. Manufacturers will standardize the
product, but there will be companies that will copy it. Thereby firms have
started imitating products that the firms were exporting to these countries.
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Based on this, companies were forced on the local markets to maintain their
market shares in those areas.
2.2.2 The Theory of Exchange Rates on Imperfect Capital Markets:
This is another theory which tried to explain FDI. Initially the foreign
exchange rate has been analyzed from the perspective of international
trade. Hagaki (1981) and Cushman (1985) analyzed the influence of
uncertainty as a factor of FDI. In the only empirical analysis made so far,
Cushman (1985) shows that real exchange rate increase stimulated FDI
made by USD, while a foreign currency appreciation has led to a reduction
in U.S FDI by 25%. However, currency risk rate theory cannot explain
simultaneous foreign direct investment between countries with different
currencies.
2.2.3 The Internalization Theory:
This theory tries to explain the growth of transnational companies and their
motivations for achieving foreign direct investment. Theory was developed
by Buckley and Casson (1976) and then by Hennart (1982). Initially, the
theory was launched by Couse in 1937 in a National Context and Hymer in
1976 in an International Context. In his Doctorate Dissertation, Hymer
(1976) identified two major determinants of FDI. One was the removal of
competition. The other was the advantages which some firms possessed in
a particular activity (Hymer 1976).
Buckley and Casson (1976) who founded the theory demonstrate that
transnational companies are organizing their internal activities so as to
develop specific advantages, which are to be exploited. Internalization
theory is considered very important by Dunning (1977) who uses it in the
eclectic theory, but also argues that this explains only part of FDI flows.
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Hennart (1982) develops the idea of internalization by developing models
between the two types of integration: vertical and horizontal.
Hymer (1976) propounded the concept of firm-specific advantages and
demonstrates that FDI takes place only if the benefit of exploiting firm-
specific advantages out-weighs the relative costs of the operations abroad.
According to Hymer (1976) the MNC appears due to the market
imperfections that lead to a divergence from perfect competition in the final
product market. Hymer (1976) has discussed the problem of information
costs for foreign firms with respect to local firms, different treatment of
governments and currency risk (Eden and Miller 2004). The result means
the same conclusion that transnational companies face some adjustment
costs when the investments are made abroad. Hymer recognized that FDI is
a firm-level strategy decision rather than a capital-market financial
decision.
2.2.4. An Assignment Theory of FDI:
The assignment theory analyzes both the volume of foreign direct
investment and its composition between cross border acquisitions and
Greenfield Investment (Nocke and Yeaple, 2004). In their model, a firm
consists of a bundle of heterogeneous and complementary corporate assets.
The merger market allows firm to trade these corporate assets to exploit
complementarities. A cross-border acquisition involves purchasing foreign
corporate assets, while Greenfield FDI involves building production
capacity in the foreign country to allow the firm to deploy its corporate
assets abroad. Equilibrium in the merger market is the solution to the
associated assignment problem.
According to the theory, there are two countries that can freely trade with
one another. Factor price differences between countries give rise to
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Greenfield FDI and to cross-border acquisitions, while cross-country
differences in entrepreneurial abilities give rise only to cross-border
acquisitions. In equilibrium, Greenfield FDI is always one way: from the
high-cost to the low-cost country, while cross-border acquisitions are
always two-ways. Hence, the assignment theory model can generate two-
ways FDI flows even in the absence of transport costs and factor price
differences. Firm’s choice between the two models of FDI and the re-
assignment of corporate assets on the international merger market has an
important impact on aggregate productivity while FDI may positively
affect the distribution of firm efficiencies in one country, it may have the
opposite effect in another country. Indeed, if productivity is measured at
the plant level, cross-border acquisitions tend to reduce the observed
productivity of the plant in high-cost country.
The following predictions were derived from the theory (i) Firms engaged
in Greenfield FDI are systematically more efficient than those engaging in
cross-border acquisitions. (ii) As factor price differences between countries
vanish, all FDI take the form of cross-border acquisitions. (iii) As the
relative supply of corporate assets in the low-wage country decreases, firms
in high-wage country substitute away from cross-border acquisitions in
favour of Greenfield FDI.
The role of policy in influencing the level and composition of foreign direct
investment has been reviewed extensively. According to Bala
Subramanyam et.al. (1996), economies of countries with more open trade
regimes had done better in attracting foreign direct investment and benefit
from it than countries with inward-oriented regimes. Foreign direct
investment (FDI) could be attracted by low tax levels on foreign firms or by
the aggressive use of subsidies (Wei 1997). However, competing for foreign
- 13 -
direct investment by lowering taxes or offering subsidies could lead to
what several authors had called a “race to the bottom”, where the foreign
firms end up appropriating all the benefits associated with their
investment.
Alternatively, countries could try to make themselves more attractive by
educating their labour force or improving the quality of their infrastructure
or institutions. Oman (2000b) had called this type of competition a “beauty
contest”. The variables amenable to policy action include tax rates on
foreign corporations, and the quality of the labour force, infrastructure and
in particular, public institutions.
The fact that tax reductions or incentives are effective in attracting FDI does
not automatically mean that governments should pursue these policies. As
such policies can ultimately have negative effects if competition for FDI
leads to a “race to the bottom”. It would have been interesting to explore as
well the effect of subsidies and other financial and fiscal incentives on the
location of FDI but unfortunately, given the fact that incentives are usually
negotiated on a case-by-case basis and often lack transparency, the effects
of subsidies cannot be systematically studied (Stein and Daude, 2001).
Governments may seek to make their countries more attractive to foreign
investors by improving the business environment. One dimension of this
environment often emphasized in business surveys is the quality of labour
force. For example, together with Costa Rica’s proximity to the United
States, the country’s highly educated labour force was a key determinant in
the decision by Intel to locate there. (Larrian et.al. 1998).
Countries may become more attractive to foreign investors by improving
the quality of the institution and environment in which business operates.
- 14 -
Excessive regulation, corruption or political instability can discourage
foreign investors, while respect for the rule of law, a government that
honours its commitments, and or competent civil service may encourage
such investment.
Institutions are important for two closely related reasons. They can reduce
the cost of doing business, but beyond the ‘expected’ effect, good
institutions can substantially increase the predictability of the rules of the
game within which firms conduct their business. Foreign investors may be
discouraged by unpredictable rules, if these are found to be costly ones.
Political stability, the credibility of the government and respect for rule of
law all clearly affect that predictability, so does corruption, (which just like
a tax if it were predictable, yet it is infact “much more taxing than a tax”
precisely) because of its unpredictability (Wei, 1997). According to Melo
(2001a), macroeconomic instability and restrictions on some sectors of FDI
and on the repatriation of profits and capital hinder the flow of FDI into the
country. He therefore suggested that for a country to benefit from the flow
of FDI the economy should be deregulated and the repatriation of profit
and capital encouraged.
Greenway (1992) asserted that trade-related investment measures, such as
local content requirements and minimum export requirements, were often
introduced to recapture some of the rents that accrued to multinational
firms. Although these measures could have positive welfare effects on the
host country, the evidence did not point out the major effects on levels of
inward investment in developing economies.
The quality of local infrastructure was virtually important, in particular
communication and transportation facilities, both in attracting initial
- 15 -
investments and in sustaining clusters were referred to by (Coughlin et.al
1991; Coughlin and Segev, 2000).
It had also been argued that host countries were more likely to benefit from
spillovers if they had a large supply of skilled labour (Keller, 1996) and if
domestic firms had a high level of technological capacity (Glass and Saggi,
1998). The evidence on spillovers reported here was mixed at best. There
were no clear results that domestic firms always and unambiguously gain
from the presence of multinational firms. Several factors could be at play.
Under the optimistic view that spillovers occurred but measuring
instruments were not fine enough to identify them, the question was
whether governments could implement policies to maximize the prospects
of extracting benefits from multinational firms. General policies designed to
change the environment within which multinationals operated included:
industrial policy, infrastructural development, trade policy, exchange rate
policy and so on. There was evidence to suggest that such policies were
related to the overall level of inward investment in an economy over a
period of time. General policies may turn out to be the most effective means
of boosting the probability of positive spillovers. If for example, absorptive
capacity is the critical drive, education and training policies are likely to be
the key to facilitating spillovers (Gorg and Greenway, 2004).
As for specific policies, many Trade-Related Investment Measures (TRIMS)
were targeted at encouraging spillovers. Local content requirements, which
had been widely used, intended to raise the share of local value added in
subsidiary production and in the process encouraged upstream
development, with the intention of stimulating inter-industry spillovers.
- 16 -
Aremu (2003) stated that in formulating policy objective towards foreign
direct investment (FDI), three basic issues were of paramount importance
particularly to developing countries like Nigeria. Firstly, it must be
understood that developing countries differ remarkably from developed
countries with regard to the possible role and impact of FDI in their
economies. While the former are typically net importers of FDI, the
developed countries in most cases present a more balance pattern of inward
and outward flows of FDI. To this end, in the context of FDI and
International Investment Agreements (IIAs), the primary focus of most
developing countries is usually on issues related to their ability to attract
FDI and benefit from it, while improving their access to foreign market for
outward investment like what operate in developed countries are of little or
secondary importance. Secondly, the technological distance between
domestic and foreign enterprises is generally more accentuated in
developing countries than in developed countries. This, on one hand,
suggests that developing countries should be interested in FDI so as to
attract the much needed capital technology and skill. However, on the other
hand, the weak domestic capabilities do hinder the ability of developing
countries to fully enjoy the expected benefits of FDI inflow. Thirdly, IIAs
usually involve binding commitments that may lead to convergence of
national policies that would eventually limit the policy autonomy of the
contracting parties to an agreement. It is thus important that developing
countries deepen their understanding of what FDI policies as well as policy
instruments they want to implement and what commitments can be sought
from home countries of the foreign investors to support their development
objectives. In formulating FDI policy objectives and strategies, the overall
question with regards to IIAs is how it would assist developing countries to
- 17 -
attract appropriate FDI inflow while simultaneously allowing sufficient
policy space for these countries to regulate them in the interest of benefiting
as much as possible from such FDI inflow. To encourage such inflow, the
Nigerian government had adopted some policy measures which include:
fiscal policy, competition policy, expatriate work and residence permit
policy, intellectual property protection policy, exchange rate policy etc.
Each of these policies will be examined in turns.
Fiscal policy thus, has to do with competitive and well-defined general
regime with variations based on sectoral and strategic needs. Adequate tax
treaties network will help to encourage the inflow of FDI and help in the
growth of the domestic economy. Competition policy or strong well-
enforced competition law will help to increase the inflow of FDI and help in
the economic growth of the host economy. Expatriate work and residence
permit policy, flexible response to investor’s needs, policy that places
restriction on expatriate quota will inhibit the inflow of FDI, while policy
that encourages the influx of expatriates will encourage the inflow of FDI.
Intellectual property protection, modern and well-enforced laws,
compatible with the agreement on trade-related aspect of intellectual
property rights will help to stimulate the inflow of FDI into the economy.
Exchange rate policy that is determined by the forces of demand and
supply (floating exchange rate) will help in encouraging the inflow of FDI
than fixed exchange rate. Policy that does not place strict conditionality on
repatriation of profit will help to stimulate the inflow of FDI. Lastly,
investment incentives, as pricing techniques, were used in Nigeria to attract
foreign investors. Unfortunately, these incentives were made available to all
investors despite the fact that particular incentive was effective in
influencing decisions only for certain types of project (Wells, 1986).
- 18 -
2.3 Empirical Literature
The various empirical literatures related to FDI policies, its effects on
productivity, spillover benefits, economic growth and development were
reviewed.
2.3.1 Impact of Different Policy Option on FDI
Evaluating the impact of the different policy options on the location of FDI
requires having an effective benchmark against which the success or failure
of countries in this regard could be measured. In order to establish such
benchmark, which controls factors related to actual policies, we use the
gravity model. Borrowed from the empirical trade literature, this model
had enormous degree of success in explaining bilateral trade flows. In its
simplest formulation, the gravity model states that bilateral trade flows
depend positively on the size of both economies, measured by their GDPs
and negatively on the distance between them (Agosin and Mayer, 2000).
Although most applications of the gravity model had involved bilateral
trade flows, they have recently been used for FDI as well (Stein and Daude,
2001).
Empirical exercise by Stein and Daude (2001) showed that the gravity
variables had the expected effects and were statistically significant.
According to the results, which were based on bilateral FDI stocks for 1996,
the coefficient for the host country size was close to one, suggesting that all
things being equal, an increase in the host country’s GDP led to
proportional increase in FDI. Consistent with the gravity idea, while size
increased attraction, distance decreased it. The coefficient estimated for
distance suggested that a 10 percent increase in distance between the source
and the host country reduced bilateral stock of FDI by about 7 percent.
Combining both effects, Mexico and Brazil were almost equally attractive as
- 19 -
destinations for FDI from Canada. Although Brazil was a larger economy,
that effect was offset by the greater distance to Canada. Common language,
colonial links and adjacency all had positive effects that were also
economically significant (Stein and Daude, 2001).
Effectiveness of incentives became popular with the study conducted by
Fujita (1972) to test the relationship between tax-savings rate and growth
rates of investments. From the study, the correlation coefficient was seen to
be positive and significant for some industries (e.g. chemicals, iron and
steel, and machinery) classified as growing but positively insignificant in
some other industries classified as declining (e.g. textiles). On the
aggregate, when all the industries used in the study were pooled together,
the correlation coefficient came out positive but sufficiently significant to
establish the effectiveness of incentives on investment. The study appeared
to suggest that incentives played a very marginal role in investment
decisions, and the role was only relevant in growing economic activities.
Isolating the influence of these variables allows for moving on to the main
question. What can countries do to attract FDI? The variables amenable to
policy actions include tax rates on foreign Corporations and the quality of
the labour force, infrastructure and, in particular public institutions.
An analysis of data on withholding tax rates on dividends of foreign
corporations suggested that higher tax rates on foreign Corporations
indeed had a negative effect on FDI (Waterhouse, 1997). The Barro-Lee
(2000) data-base contained several indicators of human capital stock, of
which he used the percentage of the population older than 25 years of age
with some post-secondary education. The conjecture was that foreign firms
may locate based on the availability of skilled workers, but the results
- 20 -
regarding the effect of this variable were not conclusive. While the
education of the labour force seems to have positive effect on FDI, these
effects were not particularly robust and infact disappear when certain
institutional variables were included, or when alternative measures of
human capital were used.
Similar inconclusive results were obtained with regard to the quality of
infrastructure. In this case, a subjective indicator taken from the Global
Competitiveness Report was used. It showed high Correlations with several
indicators of the availability and quality of infrastructure services
(Kaufmann, et.al. 1999).
The governance indicators developed by Kaufmann, Kraay and Zoido –
Lobatin (1999a and 1999b) were used to explore the role of institutional
variables as determinants of location of FDI. These indicators were
constructed on the basis of information gathered through a wide variety of
cross-country surveys as well as polls of experts, and were available for a
large cross-section of countries. Each indicator represented a different
dimension of governance: political voice and accountability, political
instability, government effectiveness, regulatory body, rule of law, and
graft (Larrain et.al. (1998).
Political voice and accountability, as well as political instability and
violence, aggregate those aspects related to the way authorities are selected
and replaced. The first variable focused on different indicators related to
political process, civil rights, enforceability of the judiciary, as well as the
enforceability of contract, while the second aggregates depended upon
different indicators of corruption, while improvements in governance
indicators would be expected to make countries more attractive for foreign
- 21 -
investors, not all of these dimensions are likely to have similar effects. A
foreign investor may be more worried about excessive regulation,
corruption or disregard for the rule of law, and less worried about the
independence of the media or the ability of citizens to hold their lenders
accountable.
The results regarding the role of institutional quality were striking. The
inflows of FDI as shares of Gross Domestic Product (GDP) of the recipient
countries for 1997 – 1999 against the summary variable of institutions,
defined as the average of the six individual indicators. The correlation was
0.49 and was highly significant (IMF, 2000; Kauffmann and Lobatin, 1999a).
The results of more systematic empirical exercises on all the government
indicators, with the exception of political voice and accountability, had
positive effect on FDI location and were statistically significant. More
importantly, their impact was quite large. The largest impact was the
regulatory burden, which captured the quality and market friendliness of
government policies. An improvement of one standard deviation in
regulatory burden increased the stock of FDI by a factor of 4.7. The
magnitude of this potential impact was substantial, to say the least. For
example, a one standard deviation improvement in this variable would take
the quality of government policies in Mexico to the level of Australia (IMF,
2000).
Similarly, an improvement of one standard deviation in government
effectiveness increased FDI by a factor of nearly three. Such an
improvement would, for example increase the index of Russia to that of
Argentina, or the index of Morocco to that of Chile. Finally, improvements
of one standard deviation for graft, the rule of law, and political instability
- 22 -
would increase FDI by 140 percent, 100 percent and 57 percent,
respectively. The corresponding impact of an improvement in the summary
indicator of governance was an increase in FDI of nearly 130 percent (IMF,
2000).
Oman (2000a) reported evidence from business surveys and interviews
with foreign investors that foreign firms often take a two-stage approach to
deciding where to locate their large long-term investments. Competition in
providing incentives only became relevant during the second stage of the
decision process, after the firm had narrowed down the list of potential
locations by looking primarily at “fundamentals” such as the quality of the
institutional environment, political and macroeconomic stability, market
access, availability of skilled workers, and the quality of infrastructure.
Other possible problems associated with incentive-based competition
included temporary erosion of the tax base, particularly since the incentives
typically were available to both foreign and domestic companies (World
Bank, 1999). If it were costly for existing firms to qualify for the incentives,
fiscal problems could be reduced, but the introduction of new incentives
could put those firms at a disadvantage relative to new ones. In addition,
since the negotiations were rarely transparent and open to public scrutiny,
they could lead to arbitrariness and corruption.
Given the rules of the games, however, it was hard to imagine countries
refraining from competition for FDI. Infact, even if foreign firms were to
appropriate most of the externalities directly associated with their activities
(such as knowledge externalities, training, development of suppliers, etc),
there would remain other benefits of FDI that were less directly related to
the productive activities of the firm.
- 23 -
One is the positive feedback discussed above. Foreign investors could
become a major constituent in favour of reform and tip the balance in that
direction. Secondly, attracting a major investment may have a signal effect
by reducing the cost of marketing the location to other potential investors.
Thirdly, to the extent that there were economies of agglomeration, landing
a large investment make the location more attractive for other potential
investors (Oman, 2000).
2.3.2 FDI and Productivity Spillover Benefits
Empirical studies on spillovers from foreign direct investment were
pioneered by Caves (1974) for Australia, Globerman (1979) for Canada and
Blomstrom (1986) for Mexico. Since then, their empirical models had been
extended and refined, although the basic approach remains. Most
econometric analysis used a framework that regresses the labour
productivity or total factor productivity of domestic firms on a range of
independent variables. To measure productivity spillovers from
multinational firms, a variable is included that proxy the extent of foreign
firm’s penetration, usually calculated as the Multinational share of total
employment or sales in a given sector. In other words, the regression allows
for an effect of foreign direct investment on the productivity of domestic
firms in the same industry. If the regression analysis yields a positive and
statistically significant coefficient on the foreign direct investment variable,
this is taken as evidence that spillovers had occurred from multinational
firms to domestic firms (Rashmi, 2003). Most studies use either the
contemporary’s level of foreign penetration or relatively short lags (most
often one year) as their explanatory variables. These studies usually
measure short-run effects of foreign presence on domestic productivity.
- 24 -
Gorg and Strobl (2001) argued that panel data using firm-level data was the
most appropriate estimating framework for the reasons. First, they
permitted investigation of the development of domestic firms’ productivity
over a longer time period, rather than at one point in time. Second, they
allowed investigation of spillovers after controlling other factors. Cross-
section data, particularly if aggregated at the sectoral level, failed to control
for time-invariant differences in productivity, a cross-sector that might be
correlated with foreign presence without being caused by it. Thus,
coefficients on cross-section estimates were likely to be biased.
There were only eight studies employing panel-data that find
unambiguously positive evidence in the aggregate and almost all of these
were for developed economies. Liu, et.al. (2000), and Haskel, et.al. (2002)
for the United Kingdom, Castellani and Zanfei (2002b) for Italy, Keller and
Yeaple (2003) for the United States, Ruane and Ugur (2002), Gorg and
Strobl (2003) for Ireland, Damijan et.al. (2001) for Romania, however, used
industry-level data that aggregated over heterogeneous firms, which could
lead to biased results. This left only seven studies using appropriate data
and estimation techniques that reported positive evidence for aggregate
spillovers.
Several studies using firm-level panel data found some evidence of
negative effects of the presence of multinationals on domestic firms in the
aggregate. These included Aitken and Harrison (1990) for Venezuela, Lopez
and Exnestor (2002) for Mexico, Czech Republic, Konings (2001) for
Bulgaria, Zukowska – Gagelmann (2000) for Poland, Damijan et.al. (2001)
for seven countries in Central and Eastern Europe, Gorg and Strobl (2003)
for Ireland. They had several explanations for the negative results found by
- 25 -
some studies. The most plausible was that foreign firms reduced the
productivity of domestic firms through competitive effects, as suggested by
Aitken and Harrison (1999) and Konings (2001). They argued that
multinationals had lower marginal cost due to some firm specific
advantage, which allowed them to attract demand away from domestic
firms, thus forcing the domestic firms to reduce production and move up
their (given) average cost curve.
There were also other explanations for a failure to find evidence of positive
aggregate spillovers in the short–run. Holger and David (2004) argued that
there might be lags in domestic firms learning from multinationals, which
short-run analysis did not pick up. Multinational firms may be able to
guard their – specific advantages closely, preventing leakage to domestic
firms and therefore spillovers as well. Positive spillovers may affect only
subsets of firms, so that aggregate studies under-estimate the true
significance of such effects. Spillovers may occur not horizontally (intra
industry) but vertically through relationships that are missed in
conventional spillover studies.
Girma et.al (2001), using firm-level panel data, found no evidence of
productivity spillovers in United Kingdom (UK) manufacturing on average
– under the assumption that spillovers were homogeneous across different
type of domestic firms. Girma and Gorg (2002) used conditional quartile
regression techniques to allow for different effects of foreign direct
investment on establishments at different quartile of the productivity
distribution. Both studies found support for the hypothesis that only firms
with some minimum level of absorptive capacity benefited from
productivity spillovers.
- 26 -
In the same vein, Barrios and Strobl (2002), in firm-level panel data for
Spanish manufacturing, found little evidence for any aggregate horizontal
spillovers from multinational firm. There was evidence for positive
spillovers from foreign presence to domestic exporters but not to non-
exporters, which they interpreted as evidence that absorptive capacity
mattered.
Several studies have investigated the geographical dimension of horizontal
spillovers. Calculating proxies for foreign presence at regional level and
using cross sectional data, of Indonesia, Sjoholm (2003) failed to find
evidence of a regional component.
Aitken and Harrison (1999) using firm-level panel data for Venezuela, also
failed to find positive spillovers from multinationals to domestic firms in
the same region, though they found negative spillovers from multinationals
in the same sector in any region in the country.
Girma and Wakelin (2002) found evidence for positive spillovers from
foreign direct investment in the same region and sector as domestic firms in
the United Kingdom, but the results were significant only for firms that had
a low technology gap vis-à-vis multinationals.
Several recent studies have empirically investigated vertical spillovers,
Kugler (2001) worked with industry – level panel data for 10 Colombian
Manufacturing Industries during 1974 – 98, using estimate framework that
distinguished Intra- industry and Inter-industry spillovers. He found
widespread evidence for positive inter-industry spillovers, but found
evidence for intra-industry spillovers only in one sector (machinery
equipment).
- 27 -
Blalock and Gertler (2002) also found results suggesting positive
productivity spillovers through backward linkages in their analysis of
Indonesian plant-level panel data; Harrison and Robinson (2004) used
plant-level panel data to estimate productivity separately. Like Kugler
(2001), they distinguished only horizontal and vertical spillovers. They did
not separate vertical spillovers into backward or forward linkages. Their
results suggested that inter-industry spillovers were much more prevalent
than intra-industry spillovers. None of the spillovers was always positive;
however there was evidence of negative spillovers in many sectors. Girma
et.al. (2002), using UK firm – level data, also found substantial differences
in whether domestic firms benefited from vertical linkages, depending on
their export activities.
Aitken et.al. (1999) used industry level data for manufacturing industries
for Mexico (1984-90), Venezuela (1977-89), and the United States (1987), and
found positive effects in the United States, but negative effects in Mexico
and Venezuela. Lipsey and Sjoholm (2001) studied the same effect for the
Indonesian manufacturing sector using plant-level cross-sectional data for
1996 and found that higher foreign presence in a sector led to higher wages
in domestic firms in the same sector.
Girma et.al. (2001), using firm-level data for UK manufacturing for 1991-96
found no effect on average of multinationals in a sector on the wage level in
domestic firms but weak evidence of a negative effect on wage growth.
Barrios and Strobl, (2002) also focused on export information externalities
and on demonstration effects through research and development spillovers.
Using firm-level panel data for Spanish manufacturing for 1990-98, they
estimated Probit model to explain the firms export and Tobit model to
- 28 -
estimate what determined the firm’s export ratio. They found no evidence
that either research or development activity or export activity by
multinational in a sector affected the domestic firms’ export, although they
found spillover from both types of activity on other foreign-owned firms. In
an extension Barrios et.al. (2002) discovered that research and development
spillover increased the domestic firms’ exports only to other developed
economies, which generally had markets with a superior technical
capability.
Fujita (1972) tested the relationship between tax-savings rate and growth
rates of investments. The result showed that incentives played a very
marginal role in investment decisions, and the role was only relevant in
growing economic activities. Trust (2000) in his study on the effect of
capital and profit repatriation on the inflow of FDI, stated that there was a
strong positive relationship between the inflow of FDI and capital and
profit repatriation by multinationals. The policy that encouraged capital
and profit repatriation stimulated the inflow of FDI.
Knor (2003) stated that a high exchange rate against a nation’s currency led
to inflow of FDI. This was to show that exchange rate policy was a
determining factor in the inflow of FDI in an economy.
Konings (2001) investigated empirically the effects of foreign direct
investment on the productivity performance of domestic firms in three
emerging economies of Central and Eastern Europe, namely Bulgaria,
Romania and Poland. Konings found that they were negative to domestic
firms in Poland. There have been several UK studies, using newly available
data on the UK manufacturing sector.
- 29 -
Liu et.al. (2000), using 48, 3-digit UK industries of the period 1991 – 1996,
found that the presence of multinational firms had a significant positive
impact on the productivity of the local UK manufacturing firms.
Using 2-digit industry level panel data for 1983 – 1992, Hanson and Gordon
(2001) investigated the impact of direct investment by foreign firms on the
technical progress and labour productivity in the UK and found that
foreign firms had a significant positive effect on the level of technical
efficiency in domestic firms.
Girms et.al. (2001) investigated whether the presence of foreign firms in a
sector raised the productivity of domestic firms, using a firm-level panel
data set in the UK manufacturing industry for the period 1991 – 1996. They
found no evidence of productivity spillovers on average. However, their
results showed evidence of productivity spillovers on average where firms
were in industries with high levels of import competitions or skills.
Overall, the empirical evidence on productivity spillovers were mixed,
while some studies had positive spillover effects, others showed negative
effects or no spillovers at all. However, a careful analysis of the pattern of
results, as set out in Gorg and Greenway (2001), showed that in the case of
panel data, the preponderance of results indicate negative rather than
positive spillovers, while the results from sectoral studies and especially
cross-sectional studies suggested positive spillovers.
Blomstrom, Kokko and Zejan (1994) found that FDI was significant for the
upper half of the distribution of developing countries but not for the lower
half. In a study of 69 developing countries for the period 1970 – 1998,
Borensztein, De Gregorio and Lee (1998) found that FDI contributed to
- 30 -
growth as long as the host country had a minimum threshold stock of
human capital sufficient to absorb advanced technology. A study of FDI in
China also found a significant positive interaction between education and
FDI. However, the co-efficient on foreign investment becomes negative
when the interaction term is introduced; implying that much of the power
of foreign knowledge may come through the local base of human capital
(Mody and Wang, 1997).
Turning now to FDI’s impact on the manufacturing sector, a World Bank
study of the Moroccan manufacturing sector rejected the hypothesis that
foreign presence had accelerated productivity growth in domestic firms
during the second half of the 1980’s (Haddad and Harrison, 1993). Even
though, the dispersion of productivity was smaller in sub-sectors with more
foreign firms, they concluded that there were no positive technology
transfer spillovers from foreign to domestic firms.
2.3.3 FDI, Economic Growth and Development
As for the macroeconomic effects of FDI, a study of Thailand suggested that
FDI could continue to have adverse balance of payments consequences
even though recent FDI are concentrated in export production (Jansen,
1995). A 1999 World Bank assessment of the long-term sustainability of FDI
in Bangladesh concluded that FDI and private debt inflows had not helped
in augmenting foreign exchange reserves so far and were not expected to
do so for the next ten years. It calculated that higher inflows would lead to
higher outflows in the medium to long-term. Growing repayment
obligations thus presented the prospects of negative transfers in the future
and posed major challenges to generate additional foreign exchange (World
Bank, 1999:19).
- 31 -
Nevertheless, most developing countries now compete to attract FDI in the
belief that it will significantly contribute to economic development. They
often provide subsidies and special incentives in the hope that the total
benefits will exceed the total costs of attracting FDI, pointing to the
following potential benefits. Foreign firms can raise the level of capital
formation, promote exports and generate foreign exchange. They can
provide a much needed market for domestic spillover and support
industries and, in the process, transfer technology, increase industrial
linkages and stimulate industry as a whole, while providing direct and
indirect employment. They can disseminate best practices through the
demonstration of higher production efficiencies, labour standards, wages
and environmental protection. In addition, competition between foreign
and domestic firms in a market dominated by a few large local firms can
improve the competitiveness and efficiency of domestic firms.
Some studies showed that Africa have continued to lag behind other
developing regions of the world in attracting foreign capital inflows,
especially in absolute terms. World Bank estimates based on capital account
and debt/equity inflows indicates that during 1990 – 1994, inflows averaged
more than $180billion a year, of these only $16billion a year went to Sub-
Saharan Africa (World Bank, IECIF data-base 2001). This is also very close
to the estimates by Dilyond and Gray (2004) which showed that of about
$163,4billion foreign direct investment to developing countries in 1997, only
about $5.2billion accrued to Sub-Sahara Africa. Indeed, the performance of
foreign private capital in any economy is perceived in terms of relative
degree of inflows when compared to other countries.
- 32 -
The literature has also identified some of the core impediments to foreign
private investment inflows into an economy in general. According to
Kasekende and Bhundia (2000) these can be classified into two groups:
external and domestic. Among the external factors identified were lack of
confidence in the economy by would be foreign investors epitomized by
deep seated economic maladjustment and political instability, huge external
debts overhang which reflects total lack of financial credibility, foreign
exchange shortages and regulations which includes rationing, pervasive
bureaucratic constraints, and on private sector borrowing from abroad. The
domestic constraints identified include: existence of interest rates structure
that is un-competitive and negative in real terms when compared to
international interest rates (mostly US dollar rates), booms in economic out-
turns of developed economies which make international investment un-
attractive and un-willingness by international economies and the limited
interaction of the financial markets of the developing countries with the rest
of the World. Kasekende and Bhundia (2000) recommended a set of policies
described as the “push factors” for overcoming any economy.
2.4 SHORT COMINGS OF PREVIOUS WORKS:
The model used by Oman (2000a) was a mechanical process and did not
sufficiently explain causal effects. It did not test the statistical significance of
the relationship between FDI and incentive-based competition.
Some of the previous works using multi-regression analysis have higher
possibility of specification errors which make their results doubtful. There was
absence of battery tests to indicate the order through which the explanatory
variables were to enter into the model.
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The previous works were unable to trace long-run relationships between FDI
policies and the inflow of FDI. The results may be biased because of the absence of
battery tests.
Stein and Daude (2001) in their work, “Institutions, Integration and the Location of
Foreign Direct Investment”, adopted the Granger Causality Approach to test the
direction of causality between the explanatory variables and the explained
variable. Econometric research has shown that such tests (Granger Causality)
focus on time precedence, rather than causality in the usual sense, hence they are
weak for establishing the relationship between forward-looking variables – taken
literally, they can lead us to conclude that Birthday cards “cause birthday”
(Chuwhurry and Mavrotea, 2003).
It is the above identified gaps that this study strives to fill. In doing that, we
subjected the macroeconomic model and policy simulation to battery tests as to
avoid the pitfall of the previous works.
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CHAPTER THREE
OVERVIEW OF FOREIGN DIRECT INVESTMENT POLICIES AND
THE MAGNITUDE OF INFLOW IN NIGERIA 1985 – 2009*
3.1 Introduction
Attempts at attracting FDI into Nigeria have been based on the need to maximize
the potential benefits derived from them, and to minimize the negative effects
their operations could impose on the country. The desire of the government to
intervene in the FDI operations in the country was motivated by two primary
types of market failure, (i) information or co-ordination failures in the investment
process, and (ii) the divergence of private interests of investors (foreign and/or
domestic) from the economic and social interest of the country. To optimize the
impact of FDI, UNCTAD (1999) suggested that government of developing
countries like Nigeria need to address the following issues, (a) information and co-
ordination failures in the international investment process, (b) infant industry
considerations in the development of local enterprises which can be jeopardized if
inward FDI crowds out those enterprises, (c) the static nature or advantages of
transfer by MNCs in situations where domestic capabilities are low and do not
improve over time or where MNCs fail to invest sufficiently in improving the
relevant capabilities (an issue that is particularly relevant in the contest of linkages
between foreign affiliates and local firms), and (d) weak bargaining and regulatory
capabilities on the part of host country government, which can result in an
unfavourable distribution of benefits from prospective of the society. In order to
address these issues and to attract foreign capital and technical skills on a large
scale, the Nigerian government has periodically declared its policy on FDI and has
taken measures to promote it.
When some of the policy measures were first initiated, the government had the
manufacturing sector primarily in view. It was then believed, though wrongly as
inter policy changes suggest, that the primary industries,
*Sections 3.1 - 3.6 have been culled from F. E. Onah (1973). The Impact of Direct Foreign Investment in the Nigerian Economy, 1961-1973 (University of Liverpool).
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mining, agriculture, and raw material processing, had been firmly established and
that their further expansion would, as a matter of course, be hastened if there were
secondary industries to provide a market for their products. Incentives were
therefore addressed to investors in the manufacturing industries. Over the years,
however, the scope of the instruments has been broadened to include primary
industries.
Another point worth mentioning is that a number of measures are applicable to
domestic, as well as to foreign investment since their objective is the promotion of
industrial development, irrespective of who brings it about. It would nevertheless
be borne in mind that foreign interests account for the bulk of investment in the
modern sector of the economy so that impact was centred largely on external
sources of funds.
3.2 Policy Instruments
In pursuance of the policy out-lined in the above section, the government of
Nigeria has, from time to time, encouraged FDI in priority areas of the national
economy through appropriate selective incentive measures. Some of the incentives
are not, however aimed at promoting investment in any specific industries that
encourage general industrial development. The various instruments, fiscal and
non-fiscal are discussed below.
3.2.1 Aid to Pioneer Industries
In 1952, private industrial development was given legislative encouragement
through the enactment of the Aid Pioneer Industries Ordinance. The legislation
provided for tax relief for limited public companies engaged in pioneer industries
for a period varying from two to five years according to the size of fixed capital
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investment. Under the provisions of the law a company which qualifies for a
pioneer status would be given an initial two years tax holiday, which could be
extended for one year if its fixed capital expenditure was at least N30,000.00 and
for three years if the capital expenditure exceeded N200,000.00. (Onah, 1979)
Under this ordinance and the ones that have succeeded it for a company to qualify
for this tax holiday the industry in which it proposes to engage must have been
declared a pioneer industry and the company must have obtained a pioneer
certificate. A pioneer industry is one not being carried on in Nigeria, or not being
conducted on a commercial scale sufficient for Nigeria’s economic development.
The Minister responsible for industrial development also has to be satisfied that
there are favourable prospects for further development of the industry and that it
is expedient in the public interest to encourage development. For this reason, the
government publishes from time to time, a list of industries which have been
accorded pioneer status. There is also the condition that the company seeking to be
granted a pioneer certificate should be incorporated in Nigeria.
The World Bank Mission to Nigeria in 1953 was critical of the provisions of the
1952 ordinance on a number of grounds. These include the broad discretionary
power exercised by the Governor in Council on the advice of the Minister of
Commerce and Industries on deciding whether it was expedient to develop or
establish a given industry. It also expressed the view that the administration of the
Pioneer Incentive Scheme was, to say the least, not liberal enough. The
inducements offered by the ordinance were less generous than those of other
countries and that in view of the world wide demand for foreign capital; Nigeria
would do well to review the scope of the benefits offered by the ordinance.
Another shortcoming was its positive discrimination against agricultural activities;
it was intended to apply to mining and manufacturing only.
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Following the recommendations of the Bank Mission, the industrial development
(Income Tax Relief) Act of 1958 (which was later amended remained in force to
date) was enacted to supersede the 1952 ordinance. It liberalized most of the
provisions of the earlier ordinance and also set objective criteria for local
participation in foreign – owned pioneer enterprises. (Onah, 1979)
The Act like its predecessor, provides for a tax holiday of up to 5 years to qualified
companies according to capital expenditures, but also has provision for an
extension of the period, should a company sustain a loss during the relief period,
provided a company engaged in a pioneer industry incurred a minimum capital
expenditure of N100,000.00 by its production day, if qualified under the Act, for a
tax holiday for the initial period of two years. If by the end of this period it
incurred total expenditure (including the initial expenditure) up to the following
amounts, its relief period could be extended as follows:
N30,000.00 … … … one year
N100,000.00 … … … two years
N200,000.00 … … … three years
Any losses suffered by the company during the relief period may be carried
forward to be offset against tax liability after the expiry of the tax holiday. (Onah,
1979)
In 1971, the Act was amended by a decree. In the amendment, a distinction was
made for the first time between indigenous and foreign enterprises. In the case of
the former, the qualifying capital expenditure is N25,000.00 and for the later it is
N150,000.00. The initial tax holiday period in either case has been raised to 3 years.
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At the end of this period, the relief period may be extended for one year and
thereafter for another period of one year.
Alternatively, an extension of one period of two years can be granted. Factors to be
taken into account when granting the extension include, the rate of expansion,
standard of efficiency and the level of development of the company concerned, the
utilization of raw materials in the production processes of the company, the
training and development of Nigerian personnel in the relevant industry, the
relative importance of the industry in the economy of the country and the need for
further expansion of the industry having regard to its location. (Onah, 1979)
If a company sustained losses during the period of tax relief, a further extension of
tax holiday equal to the accounting period during which the losses had been
suffered may be granted. There is also provision for capital expenditure incurred
during the tax holiday period to be written off wholly from taxable profits arising
after the period, provided that the expenditure was of the type normally attracting
relief from income tax.
The 1971 amendment is an improvement on the 1958 Act at least in one respect. It
has abolished the situation in which the level of capital expenditure alone
qualified a company for an extension of tax holiday beyond the initial 3 year
period. Instead, extension depends upon the extent to which a company is judged
to be contributing to the aims of the country’s industrial development.
Nevertheless, there is this shortcoming that some of the criteria for making
judgments are basically sensible, they are by no means standardized and there are
elements of arbitrariness in interpretation. Another point to be made against the
1958 and 1971 is that the provision for carrying forward losses sustained during
the tax relief period may tend to create loophole enabling unscrupulous
- 39 -
companies to evade payments of income taxes for unjustifiably long periods of
time in respect of bogus losses. (Onah, 1979)
3.2.2 Depreciation Allowances
Another measure to encourage the inflow of FDI is the granting of depreciation
allowances. This is done by giving generous initial as well as annual allowances,
thus permitting private and public companies to compute taxable income after
writing off a large proportion of their investment in fixed assets during the early
years of business. This enables a company to amortize its capital very quickly, and
to build up liquid reserves which could be used for further investment.
The first relevant legislation was the income tax (Amendment) ordinance of 1952.
This raised the initial allowance (the percentage of capital to be written off from
profit in the first year of business) in respect of machinery from zero to 40 percent
in addition to the ordinary annual allowance which was raised from 5 to 15
percent. Thus, in the first year of its existence, a company would be enabled to
write off over 50 percent of the capital value of the machinery employed in its
operations. Where the taxable income of the company was not enough to absorb
the full capital allowance claimed, the unabsorbed balance could be carried
forward indefinitely against future taxable profit. There was also provision for
unabsorbed losses to be carried forward against future taxable profits for up to a
limited period of ten years. Companies registered in Nigeria or abroad could
qualify. Where a company received a pioneer certificate, the write-down of capital
assets could be claimed in total at the end of the tax holiday. (Onah, 1979)
The ordinance has been superseded by the companies Income Tax Act of 1961 and
its amendments. Under this Act, capital expenditure on plant, machinery and
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fixtures, industrial buildings, structures and works of permanent nature, and on
the development of mines and plantations attracts both initial and annual
allowances. Initial allowances vary from 20 percent in the case of buildings to 40
percent in the case of machinery and plant. Annual allowances vary from 10
percent to 33.3 percent depending upon the type of assets and the amount of wear
and use in each case. (Onah, 1979)
3.2.3 Import Duty Relief
Following the recommendations of the World Bank Mission and that of the
Customs Tariff Advisory Committee, the Federal Government of Nigeria set up a
Committee in 1955 to advice on the stimulation of industrial development through
import duty relief and protection. The Committee reported in 1956 and the
industrial development (Import Duties Relief) ordinance of 1957 is as follows.
Under the ordinance and its amendment, enterprises in Nigeria were exempted,
wholly or in part, from customs duty on capital equipment as well as raw
materials and components imported for use in Nigerian industries. (Onah, 1979)
To qualify for concessions, the importing firm had to satisfy the government that
the raw materials or components were for use in the manufacture or processing of
goods or in the provision of services. The government would also have to be
satisfied that without the concession, the prospective recipient would be unable to
provide the goods in question at prices which would be competitive with prices of
comparable imported goods, or would be unable to provide the goods and
services at which an adequate market for them could be found in Nigeria. The
1964 statement of government policy on industrial development added the
requirement that the importing firm should have up to 45 percent Nigerian
component in its product. Furthermore, the government should be satisfied as to
the benefits of the industry concerned to the Nigerian economy, although what
these benefits should be were not been spelt out.
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If a company satisfied the above conditions, the duty could be paid first and a
refund claim later, on application, from the government. The amount to be
refunded need not, however, necessarily equal the amount of duty paid. It
depends on the amount of duty involved, the nature of the manufacturing or
processing, or services in which the imported were going to be used, and on the
needs of individual firm. Where the imported materials and the finished article in
the production of which they were to be used, were both liable to the payment of
import duty, a refund of the excess of duty could be made, if the ad alorem rate on
the former was greater than that on the later. It was not necessary that a firm
should demonstrate the need for relief before the refund was given. This was
because the purpose of the refund was to avoid unwitting discrimination against
Nigerian industries rather than to place them in a favoured position.
Statement on Industrial Policy loc. C.t, p. 3 (1957)
According to the recommendation of the committee set up to advise
the government on granting of import duty relief to Nigerian
enterprises, benefits were to be related to both the capacity of existing
local ventures to satisfy the demand for the products of the industry
concerned and the economic desirability of encouraging the
development of the industry. If existing local ventures already
operating profitably and economically were capable of satisfying fully
the demand for the products without further expansion it would, the
committee recommended, be wasteful of scarce economic resources to
encourage the expansion of these ventures or the establishment of
new ones. (Onah, 1979)
If, however, it appeared that this relief was insufficient to render a particular
industry economically, a further refund of import duties paid on imported
materials used in the industry could be granted up to a maximum of 100 percent
of the duties paid. This means that applications for further relief would have to
establish both the existence and the extent of the need for it.
- 42 -
Exemption from the payment of duty or the granting of a concessionary rate of
duty did not, however, apply to any commodity which could be obtained locally
but which an approved manufacturer or user chose to import. This condition was
designed to protect local industries producing primary or semi-processed
materials. On the other hand relief in whole or part from import duties did not
preclude relief from the payment of profit tax; companies were free to apply for
both form of relief on appropriate basis. (Onah, 1979)
In 1971, the Industrial Development (Import Duties Relief) ordinance was repealed
with effect from March that same year. Presumably, one reason for this was to
enable the government use import duty relief much more selectively than had
hitherto been possible. Another reason though of less importance, might have
been to eliminate a situation in which the Federal Government could make net
losses on account of import duty refunds. A certain proportion of the revenue
from import duties was (and still is) transferred to the various state governments
of the country but the burden of making the refunds was borne by the Federal
Government. It is therefore reasonable to suggest that in order to avoid the
possibility of making net losses; the Federal Government might decide to abolish
the provision for refunding. (Onah, 1979)
3.3 Other Forms of Incentives (Double Taxation Relief)
One form of income tax relief which provided exclusively to foreign investment is
that of double taxation. A rate of tax equivalent to 40 percent is payable on
company profits in Nigeria. However, Nigeria has double taxation agreement with
a number of countries whereby tax deductions are allowed on the profits of
companies for foreign taxes. The level of relief however depends on the terms of
agreement between Nigeria and the respective home governments of the
companies.
- 43 -
In the case of Commonwealth countries, for example, if the company proves that it
has paid by deduction or otherwise or is liable to pay tax on profits arising from
Nigeria, it is allowed relief of one-half of the Commonwealth rate of tax if that rate
does not exceed that payable in Nigeria. If on the other hand, the Commonwealth
rate of tax exceeds the rate payable in Nigeria, the company allowed a relief equal
to the amount by which the Nigerian rate exceeds one-half of the Commonwealth
rate.
3.4 Exchange and Investment Guarantee
Following an application to the Ministry of Finance by a prospective foreign
investor, capital directly invested in Nigeria is granted Approved Status after a
careful assessment of its economic benefits to the country. This approval confers a
guarantee that subject to Nigeria’s exchange control regulations, profits and
dividends arising from capital investment in the country may be freely transferred
to the country of origin of the capital. Capital may also be freely repatriated with
exchange control permission.
Foreign investments are also protected against expropriation. In the event of
nationalization, however, investors are assured of their compensation to be
assessed by an independent arbitration. (Onah, 1979)
3.5 Industrial Estates
As a further incentive to private industrial enterprise, the governments of Nigeria
established at major centres industrial estates and layouts, provided with all the
infrastructural facilities needed by industry. Sites at these places are then leased to
enterprises at moderate rates for periods of up to 99 years. (Onah, 1979)
- 44 -
The establishment of these estates and layouts is most likely to provide some
incentives to investors in a developing country like Nigeria where the basic
infrastructure is still inadequately developed and where legislation forbids
acquisition of land by foreigners. Moreover, the most successful of estates are
located in the vicinity of large population centres such as Lagos and its environs,
Kano, Kaduna, Port Harcourt, Ibadan, Enugu, Aba and Abuja. There are therefore
bound to be locational economies arising from the presence of neighbouring firms,
with comparable supply, production and marketing structures, and from nearness
to large markets.
3.6 Foreign Exchange (Monitoring and Miscellaneous) Acts 1995
The Foreign Exchange (Monitoring and Miscellaneous Provisions) Act (FEMAMP)
was enacted in 1995 to liberalize transactions involving foreign exchange and
thereby command a free flow of FDI. With its establishment, the following
enactments became corollarily repealed: the Exchange Control Act (1962) as
amended by the Exchange Control (Anti Sabotage) Act, 1984, the Foreign
Currency (Domiciliary Account) Act, 1995 and the Second-Tier Foreign Exchange
Market Act, 1986. The 1995 Act is divided into seven parts. Part I deals with the
establishment of the autonomous foreign exchange market and dealings in the
market, where transactions in the market shall be conducted in accordance with
the provisions of this Act. The Central Bank of Nigeria may with the approval of
the Minister, issue, from time to time, guidelines to regulate the procedures for
transactions in the market and for such other matters as may be deemed
appropriate for the effective operation of the market. Transactions in the market
are to be conducted in any convertible instruments of foreign currency. There is
non- disclosure of sources of imported foreign currency. The CBN appoints
authorized dealers and buyers and also revokes these appointments. It also
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supervises and monitors the operation of the market to ensure the efficient
performance of the market. (Aremu, 2003)
Part II is on operation of foreign currency Domiciliary Accounts. In this sub-
section any person may open, maintain and operate a domiciliary account
designated in foreign currency with an authorized dealer. The foreign currency in
which a domiciliary account may be opened, maintained and operated shall be
internationally convertible. A person may open more than one domiciliary account
under the Act designated in the same or different foreign currencies at the same or
different banks. A bank shall pay to the credit of a domiciliary accounts interest at
such rate as the CBN may from time to time specify. (Aremu, 2003)
Part III has to do with securities, any person, whether resident in or outside
Nigeria or a citizen of Nigeria or not can deal in, invest in, acquire or dispose of,
create or transfer any interest in securities and other money market instruments
whether denominated in foreign currencies in Nigeria or not. A person may invest
in securities traded on the Nigeria Capital Market or by private placement in
Nigeria.
Part IV deals on exports of goods and services. A person may export goods and
services from Nigeria if (a) the goods or services are not prohibited by law in
Nigeria (b) payment for the goods and services is made by means of letter of credit
or any other internationally acceptable mode for payments (c) the amount of the
payment made or to be made is such as to represent a fair return for the goods or
services.
Part V centers on collection of debts and no government agency is authorized except with
the permission of the Minister, to receive any foreign currency or receive from person
resident outside Nigeria a payment in Naira, shall do or refrain from doing any act with
intent to secure or do any act which involves or which is in association with or is
preparatory to any transaction securing (a) the delay in receipt by the agency of the
government, of the whole or any part of the foreign currency, or of the payment, as the
- 46 -
case may be or (b) that the foreign currency or payment, as the case may be shall cease in
whole or in part to be receivable by the agency of the government. Part VI specifies
offences, while Part VII is on miscellaneous matters and states that where there is a
seizure of foreign currency connected with the contravention of this Act, the foreign
currency shall be lodged in a blocked account with the Central Bank. Where the foreign
currency remains in the blocked account for a period of more than three years and in the
absence of any action by the person from whom the foreign currency was sized to
retrieve the foreign currency within the period, the Minister shall direct the Central Bank
to transfer the foreign currency into the Consolidated Revenue Fund. (Aremu, 2003)
3.7 Trend in Foreign Direct Investment in Nigeria
Foreign Direct Investment inflow to developing countries has grown
astronomically for the past five decades. Unfortunately, Nigerian economy
has continuously missed this extraordinary surge in Private International
Investment. The problem is not lack of international contacts as the
economy has long established trading and investment relationships with
the industrialized countries of the world since 19th centuries. A look at the
trend of Foreign Direct Investment (FDI) in Nigeria since 1961 will provide
reasons why the economy has lagged in FDI inflows. As would be
discussed, sectoral composition of FDI inflows into Nigerian economy lacks
production-oriented composition that could help integrate the economy
into International Production Chains. The partner composition of the
foreign investors also lacks those with factor proportions relatively close to
what occur in other developing economies of South East Asia and Latin
American developing countries. These gaps tended to limit the benefit of
investment inflows into the country from the view point of technology
transfer and export market development. Flows of FDI into Nigerian
economy has undergone tremendous shift since independence in terms of
- 47 -
the level of inflow and outflow, the components of the net flow, the sources
of the flows and the economic sectors where the flows are concentrated.
3.8 Inflows and Outflows of Foreign Direct Investment in Nigeria
Table 3.1, Appendix 4; shows annual aggregate inflows and outflows of FDI
in Nigeria between 1961 and 2009. The flows equally show the
corresponding net flows (i.e inflow minus outflow) from the four major
sources where the FDI came from. The major sources are United Kingdom
(UK), United States of America (USA), Western Europe and Others. We
have negative net flows in 1969, 1974, 1979, while other years show positive
net flows (i.e inflow greater than outflow) from the United Kingdom. The
highest inflow is in 2007 (N19.541.9million). In the United States of
America, we have negative net flows in 1972, 1976, 1981, 1983, 1984, 1985,
1987, 1989, 1996, 1999, and 2001. In Western Europe, we have negative net
flows in 1984, 1989, 1990, and 1994 while in others we have negative net
flows in 1968, 1985, and 1994 with the highest negative net flow in United
States of America and Western Europe.
The aggregate inflows, outflows and net flows from these four major
sources are shown in Table 3.2, Appendix 5. We have the highest net flow
in 2007 (N53,924.8m), followed by 2008 (N49,456.2m), this may be
attributed to the economic reforms embarked upon by the civilian
government. The huge net flow shown in Table 3.2, Appendix 5; was due to
substantial unremitted profit from foreign companies operating in Nigeria
as well as due to other foreign liabilities which Transnational Companies
(TNCs) affiliates operating in Nigeria from United Kingdom and United
States of America were to pay as overseas commitments, but inadequate
foreign exchange made such accrued payment impossible. This is
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buttressed by Table 3.3a, Appendix 6; which shows unremitted profit from
the four major sources of FDI in Nigeria.
A further analysis of the flows revealed that for two consecutive years (i.e
1989 and 1990), activities of foreign investors on the whole, resulted in
Nigeria becoming a net exporter of capital resources (i.e making more
outflows than inflows) to the tune of N439.4m and N464.3m respectively,
Table 3.2, Appendix 5. On the global scene, these period coincided with the
Gulf Crisis time as well as the dying years of Bi-Polarism, suggesting that
American and Western European Companies operating in Nigeria, and
accounting for these net outflows of FDI were reacting to the political and
economic implications of these two major developments within the global
arena. United States TNCs were making their customers to make down
payments for goods to be supplied (later) after 1989. With the exception of
those from the other unspecified countries, all other affiliates of TNC’s from
the other three regions made net outflows of FDI via Intra-System Transfer
(liabilities and head office). This suggested that, in their reaction to Gulf
Crisis, TNCs used their parent companies to siphon substantial investment
out of the country.
During the Pre-Structural Adjustment Programme (SAP) period, the
aggregate level of net inflow of FDI ranged between a low level of
N14,137.8million and a high level of N141,624.9million. This was the period
when some foreign investors had lost confidence in the economy of
Nigeria, due to over-valued Naira exchange rate, high external debt
burden, political instability and ineffective macroeconomic policies.
However, with the introduction of SAP in 1986, some of these foreign
investors regained interest in the country’s economy. Consequently, in
1986, the total net inflow of FDI increased to N142,499.6million Table 3.2,
- 49 -
Appendix 5. However, in 1989, for the first time ever the aggregate outflow
of FDI of N5,132.1million exceeded the gross inflow of N4,692.7million by a
net outflow of N439.4million. This was against a net flow of
N1,345.6million recorded in 1998.
According to the Statistical Survey Office of the Central Bank of Nigeria
1991, p.342), this development was a welcome one. This is because of the
easy access to foreign exchange which led to a net capital outflow of
N439.4million was made possible through the creation of new outfits for
the purchase of foreign exchange introduced in 1989. In addition, the
Bureaux de Change which took off in mid-1989 was put in place by the
Federal Government to compete with the Informal Parallel Market and thus
expanded the foreign exchange market. Added to these measures was the
Unified Exchange Rate System which emerged through the fusion of the
Dutch Auction Foreign Exchange Market and the Autonomous Market
Rates. This state of affairs put great confidence into the foreign exchange
management operations.
According to the Statistical Survey Office of the (CBN 2003), these reforms
accounted in no small measure for the outflow of pent-up liabilities of the
foreign investors in Nigeria. The level of inflow which was N4,035.5million
in 1999 rose to N54,254.2million in 2007 because of the dosage of economic
reform packages of the civilian administration.
Regional analysis of the flows pointed to the fact that American foreign
investors were the most inconsistent in Nigerian economies. During 49 year
FDI report, they recorded 16 years of net outflow of net capital flows
beginning from 1962. Both the United Kingdom and Western European
foreign investors recorded 4 years and 5 years of net outflow of FDI.
Investors from other unspecified countries appeared most consistent as
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their inflow of capital always exceeded their outflows except for 3 years (i.e
civil war years of 1967, 1985, and 1993). This trend should not in any way
be interpreted to mean that foreign investors from the other unspecified
countries maintain a higher stake in FDI in Nigeria, until the level of
cumulative investments from them say so.
3.9 Components of Foreign Net Capital Flow
The net flow of FDI is further broken down into various net flows
components of FDI Table 3.3a, b, c, d and e, Appendices 6 - 10. Again the
five main sources (or components) of FDI are: Unremitted Profit, Changes
in Foreign Share Capital, Trade and Suppliers Credit, Other Foreign
Liabilities, and Liabilities to Head Office. On the aggregate, trade and
suppliers credit accounted for 41 percent of total net flow of FDI as at 2009;
followed by unremitted profit at 35 percent. The relatively high proportion
of unremitted profit components of FDI flow into Nigeria, at 35 percent,
support the recent claim of IMF (2002) that in most developing countries,
the largest part of FDI is reinvested within the host country. Knowing that
these two components are most susceptible to a host economies foreign
exchange situation, one is left with no option than to suggest that 76
percent of total net flow of FDI into Nigeria up till year 2009 were affected
by involuntary investment arising from unavailability of foreign exchange.
This explanation is not conclusive as it is made purely on the believe that
foreign investors, if afforded alternative would not have invested such
capital. As could be discovered from Table 3.3a, b, c, d and e, Appendices 6
–10; the level of changes in foreign share capital, as a component of FDI
flow is merely 14 percent of the cumulative FDI by year 2009. Since changes
in foreign share capital is the most effective component suggest that, it is
not a major component of FDI net flow into Nigerian economy. Greenfield
Table 4.3a
Components of Net Capital Flow by Origin
(N’ Million)
- 51 -
investment must have accounted for most of the flow by the component.
While there is no evidence from the computation to validate this
appropriately, the 21 percent of componential share of changes in foreign
share capital coming from companies from other unspecified countries
suggest that Greenfield Investments are common among foreign investors
from this region. As at year 2009, only 14 percent of the total net FDI flow to
date since independence was channeled towards increasing the foreign
investors paid up capital. It is disappointing that foreign investors engaged
in using other foreign liabilities component for about 49 years to siphon
money out of Nigerian economy. This development is a signal to
appropriate Nigerian Regulatory Agency - Nigeria Investment Promotion
Council (NIPC) to further probe into what constitute these other foreign
liabilities as it appeared an easier component for foreign investors to siphon
money out of the economy.
3.10 Cumulative Foreign Direct Investment by origin
Earlier discussions had analyzed the various components of FDI, what
needed to be said hereby is that (a) the paid-up capital plus reserves was
generated by summing up the first two components of net capital flow (i.e
unremitted profit and changes in foreign share capital), while (b) the other
liabilities are made up of the last three components (i.e trade and suppliers
credit, other foreign liabilities, and liabilities to head offices for foreign
investors Table 3.4 Appendix 11. The summation of the two items (i.e paid
up capital plus reserves and the other liabilities) is obviously equal to the
summation of all the 5 items. Consequently, their cumulative figures are as
the year 2009. For instance, the cumulative paid-up capital plus reserves for
the year 2009 of UK companies in Nigeria is N72,741.1million (which is the
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summation of unremitted profit as well as changes in foreign share capital
from 1985 to 2009). In the same way, the cumulative paid up capital plus
reserves and the other liabilities for the year 2009 of all foreign investors
from USA from origin is N93,864.5million. From the above explanation,
Table 3.5a, Appendix 12; depicts the cumulative share of foreign capital
inflow by sources of origin into Nigeria. UK companies had continued to
maintain the lead, accounting for 40 percent of the entire cumulative net
flow since 1961 till 2009, followed by Western European companies 34
percent, USA companies 14 percent and companies from other unspecified
countries 12 percent. This was due to the effect of naira exchange
fluctuation.
3.11 Cumulative Foreign Investment by Sectors
Cumulative foreign direct investment in the seven main economic sectors in
Nigeria stood at N614,858.1million by the year 2009 Table 3.5b, Appendix
13. The breakdown by sectoral distribution revealed the insensitivity of
foreign investors to the various incentives put in place to lure them into the
manufacturing and processing sector. This may have equally been due to
huge investment outlay in mining and quarrying operations. With only 17
percent volume of FDI in the manufacturing and processing sector, there
are indications that NIPC must do more than what they are currently
doing, as the level of investment in the sector (manufacturing and
processing) is a strong signal of insensitivity and of course inelasticity of
foreign investors and the incentives applied respectively to
industrialization progress of the economy. The sad thing about the
revelation is that the relative contributions of Trading and Business
Services, Manufacturing and Processing, and Mining and Quarrying have
virtually not changed between 1962 and year 2009. Respective shares of
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mining and quarrying, manufacturing and processing, and trading and
business services in cumulative foreign investment in 1962 were 36.6%,
17.4% and 37.6%. By year 2009, they stood at 37%, 16.7% and 38.3%. Despite
the comparative advantage that the country possesses in agriculture,
forestry and fishing sector, foreign investors are yet to show appreciable
presence.
3.12 Significance of Foreign Direct Investment in Nigeria
The role of FDI in capital formation in Nigeria has been increasing over the
years. FDI/GCF (where GCF is the Gross Capital Formation) rose from 7.3%
in 1974 to about 17% in 1985, although it was generally low in the late 1970s
and 1980s. The relative low level of FDI in total capital formation in these
periods was similar to that of Korea and Taiwan, which had emphasized
minimal levels of reliance on foreign investment. In contrasts to this, were
some South East Asian countries which had the policy of attracting FDI, for
example, Indonesia. Nigeria used infant industry protection, local content
rules, and FDI restrictions coupled with other restrictive policies to retard
the contribution of FDI to gross capital formation. The relative rise in the
share of FDI in capital formation since 1993 has been due to rapid loosening
of controls and regulations on the activities of TNCs in Nigeria. As a result,
FDI/GCF ratio rose from 6.4% in 1986 to 32% in 1993, 49% in 1998 and 68%
in 2009.
Apart from its direct contribution to capital formation, FDI may also
influence investment by domestic firms and by other foreign affiliates. If a
domestic firm gives up on investment projects to avoid the prospect of
competing against more efficient and established foreign competitors, and
if they do not invest in alternative activities, there will be crowding out of
investment as a whole. In contrast, crowding in will occur if FDI stimulates
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new investment in downstream or upstream production. However, all
empirical evidence on this issue in developing countries remains
inconclusive.
3.12.1 FDI and Performance of Manufacturing Industries in Nigeria.
Sectoral composition of FDI in Nigeria has been altered over the years and
FDI is no longer concentrated exclusively in the primary sector. The service
and manufacturing sectors now attract more FDI than other sectors within
the Nigerian economy, for example, primary sector (agriculture) accounted
for only 30 percent of the total FDI stock in 1992 while manufacturing sub-
sector accounted for almost 50 percent and service sub-sector (trading)
closing to 20 percent.
The rapid expansion witnessed during the oil boom (as manifested by a 12
percent growth) and increase in the contribution of the sub-sector to the
GDP from 4% in 1973 to 13% by 1983 as proved to be unsustainable. The
average annual growth rate has also drastically reduced from over 20
percent recorded in the 1975 – 1979 period to negative figures of 2.6 and 0.9
percent in the 1990 – 1994 and 1995 – 1999 period respectively, and 7
percent in the period 2001 – 2005. The combination of an over valued
currency, highly levels of protection and heavy government investments in
capital-intensive strategic industries (in the late 1970s and early 1980s)
deterred private investment in those industries in Nigeria might have been
able to build competitive advantage (UNIDO, 2006). The oil boom era, for
example, witnessed relative neglect of natural resource-based
manufacturing such as food processing and textiles to relatively low value-
added durable goods such as assembling industries. Thus, the policies and
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actions pursued during the oil boom era provided a weak base and
unhealthy pattern for future growth in the manufacturing sector in Nigeria.
In general, the performance of the manufacturing sub-sector in the 1990s
has progressively worsened. The capacity utilization has reduced from 75.4
percent in 1975 – 1979 periods to an all time low of about 75 percent in the
2000s. The Manufacturing Value Added (MVA) has also been declining by
almost 1% annually between 1980 and 2006, a sharp contrast to the situation
in the 1970s when MVA grew about 12% annually (UNIDO, 2006). Even in
the 1990s, the average MVA share of GDP has reduced from the average of
7.9 percent for the first half (1990 – 1994) compared to the 6.4 percent in the
latter period of 2000 – 2008.
Five sub-sectors – food, beverages, textile, chemicals and non-metallic
minerals – accounted for a significant proportion of the total MVA in
Nigeria. In 2000 and 2006, they were jointly responsible for about 60 percent
of the total MVA. The trend in the relative performance of these sub-
sectors, however, varied considerably. Textile’s contribution to the MVA,
for example reduced by more than half between 1980 and 2007, while that
of chemicals doubled during the same period. In recent years, the textile
industry has also been adversely affected by the competition coming from
both cheaper imports and smuggled products.
The pattern of the index of manufacturing which covers a period of three
decades assumes a bi-modal shape with a peak value of 132.8 in the period
of (1978 – 1984) and a second peak in 1998 with index value of 191 (for the
1985 to 1998 period). The period of 1983 to 1986 recorded the lowest index
of manufacturing between 1980 and 1990 while SAP era witnessed modest
revival in the sub-sector and overall economic growth. The reform favoured
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domestic resource-based industries while producing inverse impact of
import intensive, low value-added units. The reform also led to increased
industrial efficiency as measured by the domestic resource ratio (UNIDO,
2006). The index of manufacturing has become largely stable in the late
2005 at the average of about 136 (1985 = 100). The above analysis is in line
with Meier (1995:254) which states that of the U.S $ 35,895million FDI to
developing countries in 1994, 66.7 percent went to ten countries and
Nigeria was not one of them.
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CHAPTER FOUR
METHODOLOGY
4.1 Methodological Framework
There are two applied methods in this study: empirical and descriptive methods.
The empirical method used a macroeconomic model based on the Keynesian
macromodel framework, while the descriptive method made use of trend analysis
to evaluate FDI policy catalyst over the study period.
4.2 Macroeconomic Model
Macroeconomic models are systems of equations that summarize the interactions
among different sectors in the economy. It links various macroeconomic variables
of interest from different sectors so as to be able to evaluate how a shock in
identified variables transmits to various sectors of the economy. This has become
justified in a general equilibrium sense, unlike the partial equilibrium analysis that
seeks to know the direct or immediate impact of a particular shock on the
immediate variable.
These models can be grouped into four. These are the traditional structural models
of the Keynesian origin; rational expectations structural models that attempt to
incorporate the household behavior into a macromodel; the equilibrium business-
cycle models that assume the equilibra of labour and product market; and the a
theoretical Vector Autoregressive (VAR) model.
The Keynesian paradigm features the sluggish adjustment of prices - the non-
market clearing theory-based models. These models usually assume that
expectations are adaptive but subsume them in the general dynamic structure of
specific equations in such a way that the contribution of expectations alone is not
identified.
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Rational expectations structural models explicitly incorporate expectations
that are consistent with the model’s structure. The after effect of the Lucas
critique was the incorporation of expectations into macroeconomic models,
beginning with the adaptive expectation and latter rational expectation. The
model simply seeks to make adjustments for long run economic
optimization of various economic units in a system. Today, the backward
and forward-looking models have become major contributions to modern
macroeconomic forecasts. The development of macroeconomic models to
reflect country-specific macroeconomic conditions influenced the
emergence of other group of macro-econometric models void of any known
theory – the a theoretical macroeconomic models.
Vector auto-regression (VAR) models employ a small number of estimated
equations to summarize the dynamic behavior of the entire macroeconomy, with
few restrictions from economic theory beyond the choice of variables to include in
the model. Sims is the original proponent of this type of model. It is based on the
representation of an economic structure without following any known theory – it
is a theoretical.
This is closed-tied to the Structuralists Approach which argues that developing
economies exhibit particular characteristics that sometimes are devoid of any
economic theory. As such, modelling developing economies require that the
structure of the economy be mimicked irrespective of any theoretical
underpinning.
Equilibrium business-cycle models assume that labour and goods market are
always in equilibrium and that expectations are rational. All equations are closely
based on assumptions that households maximize their own welfare and firms
maximize profits. Examples are models developed by Kydland and Prescott and
by Christiano and Eichenbaum.
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Nevertheless, the Keynesian model has remained the benchmark of macro-models
in the world. It continually incorporates the dynamisms in world economies
giving modellers room to adapt to structural changes in country-specific models.
Currently, the New Keynesian –Augmented Philips Curve, (NKAPC) model has
addressed the monetary policy challenges in various economies, adopting
inflation targeting (IT). It links the nominal and the real side of the economy by
introducing the output gap equation and the Monetary Policy Rule of monetary
authorities,(MPR). Therefore, the IS-MPR replaces the traditional IS-LM frame
critiqued for not linking the demand to the supply side of the economy. The New
Philips Curve equation (NPC) has provided that link for the Keynesian
framework.
The current model follows the Keynesian approach (demand-side model) since
Foreign Direct Investment is a demand shock. FDI is expected to affect the
productive base of the Nigerian economy via aggregate investment. The approach
here is to represent the Nigerian economy in a small scale macroeconomic model
with five blocks: the demand block, government block, external block, supply
block and monetary block but because of the skew-ness of the study to FDI, four
blocks are of interest to generate results for the study. These are: the aggregate
demand block, government block, the external block, and the supply block.
4.3 The Model Specification: There is no known theory that can capture in its totality
the Nigeria’s scenario. Therefore, this model (Keynesian macromodel) follows the eclectic
theory, which comprises of the traditional Keynesian theory, rational expectation theory,
the structural and the new Keynesian theory.
4.3.1 Aggregate Demand Block (AGD)
Traditionally, demand block follows four-sector Keynesian expenditure model in
an open economy: private consumption expenditure, private investment
expenditure, government consumption expenditure and import-export demand
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(net export). Private consumption expenditure represents household sector,
investment expenditure accounts for firms’ demand, government consumption
expenditure represents the public sector, while the net export is the external sector
demand. For the sake of our analysis the trade (rest of the world) and government
components are transferred to the external sector and government block
respectively. This gives room for unambiguous evaluation of government policies
on FDI.
4.3.2 Private Consumption Expenditure (CONS)
Private consumption expenditure in Nigeria is disaggregated into consumption of
durables and non-durables. This follows the National Bureau of Statistics (NBS)
which over the years attached higher weight to non-durables (food) in the
computation of CPI signifying that general price level in Nigeria is driven by food
items. But with the rising profile of the middle class in Nigeria resulting to high
demand for durables and the subsequent rise in the price of durables (Oduh,
2009), consequently, rise in general price level is currently accounted for by prices
of durables and non-durables. The current study is not interested in such
classification since the interest is not focused on price determination but on how
FDI policies will affect the aggregate demand block. In line with inter temporal
optimizing model, private consumption expenditure (CONS) is modelled as a
function of income (Y), General price level (GPL), Remittances (RMT), government
expenditure (TGE) and the opportunity cost of foregoing current consumption
(deposit rate RD). The model is specified as:
01 1 2 3 4 5 0CONS=α +α Y+α CPI+ α RD+α RMT+α TGE+e (1)
4.3.3 Private Investment (INV)
Given Nigeria’s history of macroeconomic instability, the irreversibility of
investment decision theory is considered more suitable than the other orthodox
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theories of investment. Thus, private investment demand is modelled according to
the uncertainty, irreversibility investment theory which adds macroeconomic
policy environment (macroeconomic volatility or variability) to the traditional
investment determinants. In addition, in an open economy we expect that FDI will
affect the domestic private investment. According to the CBN annual report and
statement of account, FDI accounts for about 21 percent of the total investment in
2007.
To accommodate the study objectives, private investment expenditure (INV) is
disaggregated into (investment oil and investment non-oil). Investment in the oil
sector (INVO) is dependent on oil output (YO), output variability in oil sector
(YVO), corporate tax burden (CTB) measured as the ratio of corporate tax revenue
to total gross domestic output (Y), and foreign direct investment in the oil sector
(FDIO).
O 02 6 O 7 O 8 9 1INV =α +α Y +α FDI -α YVO-α CTB+e (2)
Investment in the non-oil sector (INVN) is modeled as a function of non-oil output
(YN), maximum lending rate (Rm), output variability in the non-oil sector (YVN)
proxied for macroeconomic policy environment in the non-sector, domestic output
in the oil sector (YO) and non-oil sector (YN), Foreign Direct Investment in the oil
and non-oil sector (FDIN), and corporate tax burden (CTB). The equation is
specified as:
N 03 10 11 vn 12 N 13 N 14 2INV =α -α Rm-α Y +α Y +α FDI -α CTB+e (3)
Demand block identities
INV=INVO+INVN (4)
4.4 Supply Block
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Traditionally, modeling the supply block should include the labour market. As a
result of lack or reliable data on employment the study ignored the employment
sector. The supply block is disaggregated into oil (YO) and non-oil (YN) output.
The oil output is dependent on the crude oil prices (PO), OPEC quota (opec), and
foreign direct investment in the oil sector (FDIO); while the output of the non-oil
sector is determined by Core credit to the private sector (CPS), maximum lending
rate (Rm), and foreign direct investment in the non-oil sector (FDIN).
YN=α04+ α15PO+ α16OPEC + α17FDIo+e3 (5)
YN=α05+ α18CPS+ α19RM + α20FDIN+e4 (6)
Supply block Identities
Y=YO+YN (7)
4.5 External Block
The external block comprises export (X), import (M) and Foreign Direct
Investment (FDI). FDI is also disaggregated into oil FDI and non-oil FDI to account
for the study objectives.
4.5.1 Exports (EXP)
Total exports (X) comprise of both oil and non-oil exports. Oil export is primarily
driven by domestic production and output of the country’s trading partners as
well as price and OPEC quota. It is also significantly affected by security in the
Niger-Delta. In addition to the regular price and output variables, non-oil exports
are equally affected by relative prices. Thus, the oil exports (XO) are explained by
oil output (YO), oil price (PO), OPEC quota (OPEC), income of trading partners
proxied with and income of the OECD (YOECD). The non-oil export (XN) is
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affected by nominal exchange rate, output of the non-oil sector (YN), nominal
exchange rate (NER), and credit to the private sector (CPS).
05 21 22 23 O 24 25 5X + Y+ Y(oecd) P CPS NER (8)e
4.5.2 Imports (IMP)
Imports could also be disaggregated into imports of intermediate goods and other
imports. In Nigeria, imports constitute a significant share of inputs (raw materials)
for both domestic production and final consumption. Import demand is
traditionally a function of output, disposal income (theoretically) and price. Also,
given that a number of importers rely on Deposit Money Banks’ (DMB) loans and
guarantees for their operating capital, the domestic lending rates (RM) become an
important factor in the determination of import demand. We also use implicit
tariff rate (TAR) to control for import prices. Considering that the bulk of items
under “other imports” consist of consumption items, but domestic income (Y) is
used as an explanatory variable. Nominal exchange rate (NER) captures relative
prices for components of imports.
06 26 27 28 29 06IMP=α +α Y+α NER+α RM+α TAR+e (9)
4.5.3 Foreign Direct Investment (FDI)
FDI in Nigeria can be broadly categorized into oil and non-oil. FDI into the oil
sector historically predominates; but recent reforms in the telecommunications
and financial sectors have led to increases in FDI into the non-oil sector. As in
standard theory, FDI is treated in the same way as other components of aggregate
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demand. FDI in the oil sector reflects demand by the rest of the world for Nigeria’s
oil as well as the constraints and incentives provided by domestic production risks
and product price, respectively. In addition to domestic output and
macroeconomic stability considerations, FDI in the non-oil sector is also affected
by relative prices and relative cost of funds.
FDI in the oil sector is therefore modelled to depend on domestic policy
unfavourable to private sector investment, reflected on the size of the public sector
(SZG), macroeconomic variability in the oil sector (YVO); petroleum profit tax (PPT)
and oil output (YO). Crude prices and OPEC quota were dropped as they
correlated with domestic oil output.
07 30 O 31 VO 32 33 07FDI =α +α Y +α Y +α PPT+α SZG+e (10)O
The non-oil FDI in non-oil is influenced by interest rate differential (IRD), real
exchange rate (RER), non-oil output (YN), and macroeconomic stability or
variability (YVN).
Government policy tax proxied with corporate tax burden (CTB), private sector
led growth policy (SZG) are FDI attractor. The intuition here is that government
tax policy such as tax holidays or tax rebate has a pull effect on FDI. To
accommodate these policies, we introduced corporate tax burden (measured as
total corporate tax revenue as a ratio of GDP) as proxy for tax policy, size of the
public sector (measured as the ratio of total government expenditure to GDP) to
capture private led sector policy and nominal exchange rate (NER) as measure of
exchange rate policy.
N 07 34 N 35 36 37 38 08FDI =α + Y -α YVN-α IRD-α CTB+α SZG+e (11)
External block identities
FDI+FDIO+FDIN (12)
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4.6 Government Block (GB)
In developing economies, the specification of the government block usually takes
into consideration the Keynesian approach. Historically, Nigeria like most
developing economies is government-sector driven. With a lapidated
infrastructure and high cost of doing business, government keeps being relevant
in providing the enabling environment. Though, efforts have been made by
various regimes to evolve a private sector-led growth but in spite of these, the
proportion of government expenditure and its role as employer of labour is still
substantial. The specification of the government block is divided into government
expenditure on oil and non-oil revenue.
4.6.1 Government Expenditure (GE)
Government expenditure is broken down into recurrent expenditure, capital
expenditure and debt service and accounts for Federal, State and Local
Governments. Only government recurrent expenditure is endogenized; capital
expenditure is treated as a policy variable. Variations in size and components of
capital expenditure are important fiscal policy tools in terms of complementing
private investment as well as determining deficits and financing options. We also
considered the incremental nature of government budget system in Nigeria (past
government expenditures).
Government expenditure is generally constrained by its revenue (GVR), size of the
public sector and the changes in the general price level (INF).
4
n
i
09 39 t-i 40 41 42 09GRE = α + α GRE + α INF + α GVR+α SZG+e (13)
4.6.2 Government Revenue (GVR)
Nigeria as a monoculture nation depended on oil economy with a gradual shift
from agriculture in 1958 to full oil dependent economy till date. Today, it has
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become conventional to characterize the government revenue into oil and non-oil.
Oil revenue includes proceeds from crude oil/gas sales (domestic and exports),
petroleum profit tax and royalties and others, while the non-oil revenue includes
company income tax, custom and excise duties, value-added tax, independent
revenue of the Federal and state governments, and others. While the volume of
imports influences the revenue derivable from custom duties, oil revenue is, to a
large extent, determined by the volume of exports (also constrained by OPEC
quota). We therefore specify the determinants of oil and non-oil revenue.
4.6.3 Oil Revenue (GVRO)
Government oil revenue (GRVO) is influenced by oil output YO, oil exports (XO),
and crude oil price (PO) and OPEC. We however, excluded the Niger Delta Crises
(NDC) variable since there is no historical part good enough to form the NDC
dummy. The impact is accommodated with introduction of crude oil production
since Niger Delta Crisis is expected to be a transmission effect – through the
volume of production. That is, the crisis a priori is expected to indirectly affect
crude production and directly crude prices.
010 43 44 010GR =α + α X +α OPEC+e (14)O O
4.6.4 Non-Oil Revenue (GVRN)
Government non-oil revenue (GVRN) is determined by non-oil domestic output
(YN), non-oil exports (XN), customs and excise duties (CED), and value added tax
(VAT). Determinants of non-oil revenue in the model are specified as:
GVRN=α011+ α45Y+ α46XN+ α47VAT+ α48CED+e011 (15)
Government Block Identities
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O NGVR=GVR + GVR (16)
4.7 Monetary and Financial Block
The standard approach of modelling money demand has, in recent times,
come under strong criticisms due to perceived instability in the velocity of
demand for money in an economy. Although the debate on money demand
in Nigeria is inconclusive, it is an acknowledged fact that currency outside
banks is relatively high. Therefore, the modelling of the monetary block
adopts the supply approach, but because we want to use money supply as a
policy variable, the demand side is applied and equilibrated in the money
market (equating money demand with money supply).
Money demand (Md) is modelled to follow the Keynesian demand for real
balances, income (Y), opportunity cost of holding idle cash, in our case
deposit rate (Rd), and general price level (CPI).
012 49 50 d 51 012Md Y+ R CPI ..................(17) e
Domestic Lending Rate
Cost of investment maximum lending rate (Rm) is modeled as a function of
monetary policy rate (MPR), inflation rate (INF), and expected changes in price
level (INFE).
m 013 52 53 54 013R MPR INF INFE .........(18) e
Monetary Block Identities
Md=M2 (19)
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CHAPTER FIVE
PRESENTATION AND ANALYSIS OF RESEARCH FINDINGS
5.1 Empirical Analysis
Unit root tests were performed on all the variables using the Augmented Dickey-
Fuller (ADF) test, and the results are presented in appendix 1. The test shows that
ADF statistics for all the variables in levels do not exceed their critical values
except maximum lending rate (Rm) and deposit rate (Rd) that are I(0), and (Yoecd)
and gross domestic product (Y) that are I(2) process, while all other variables are
I(1) series.
5.2 Co-integration
This study employs the Engle-Granger two step algorithm procedures. Under this
approach, each of the stochastic equations is estimated in levels (static model) and
their respective residuals generated. Unit root tests were then performed on the
residuals in level using ADF test. If the residual is stationary in level, it implies the
existence of co-integration or long run relations. Thus, each existing linear
combination is represented as error correction model (ECM).
5.3 Parsimonious Estimation of the Reduced form Equations
All the equations were over parameterized and nuisance variables and lags were
gradually eliminated following the Granger Marginalization Rule.
5.3.1 Consumption expenditure
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The original specification of the consumption equation follows a standard
consumption function of inter temporal optimization models, remittances,
government expenditure, opportunity cost of current consumption (interest rate)
and income as key explanatory variables. However, while past expenditures on
consumption (lag of consumption expenditure), remittances and government
consumption expenditure were significant in the final equation, estimates of co-
efficient of price variables and income were not. Interest rate was also
marginalized after it was found to have the wrong sign confirming the fact that
Nigerians do not consider interest rate as an important catalyst to forego
consumption. The parsimonious version of the model in Table 5.1 indicates that all
the variables except deposit rate are important in determining consumption in the
country, namely, remittances, government expenditure, income and the lag of
consumption. In part, this is an indication of the importance of remittances which
are currently assuming an important dimension in both consumption and poverty
reduction in Nigeria; the poor performance of deposit rate as an inducement for
future consumption also indicate the relative low premium placed on financial
policies for consumption. With the rudimentary development of and poor access
to effective credit system in the economy, there is little reference to money and the
financial market in determining consumption.
The result is instructive and shows that the Nigerian consumption function does
not follow the absolute income hypothesis. The consumption equation is shown in
Table 5.1.
The test statistics for the model indicate that 44 percent of the variations in
consumption are explained by the explanatory variables and the Durbin-Watson
statistic at 1.99 indicates the absence of autocorrelation among the explanatory
variables. Adjustment to short term disequilibrium in consumption is significant at
the rate of 8.7 percent per quarter.
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Table 5.1: Parsimonious error correction model of consumption
Dependent Variable: D(LOG(CONS))
Method: Least Squares
Date: 07/04/10 Time: 21:25
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Coefficient Std. Error t-Statistic Prob.
D(LOG(CONS(-1))) 0.502780 0.084264 5.966698 0.0000
D(LOG(Y),2) 0.204637 0.110774 1.847347 0.0681
D(LOG(Y(-1)),2) 0.224203 0.114048 1.965876 0.0525
D(LOG(Y(-2)),2) 0.216277 0.116297 1.859705 0.0663
D(LOG(Y(-3)),2) 0.277333 0.119382 2.323072 0.0225
D(LOG(RMT(-4))) 0.036383 0.015938 2.282744 0.0249
D(LOG(TGE)) 0.103544 0.044034 2.351483 0.0210
ECM_CONS(-1) -0.087261 0.034790 -2.508217 0.0140
R-squared 0.439914 Mean dependent var 0.007463
Adjusted R-squared 0.394850 S.D. dependent var 0.049695
S.E. of regression 0.038659 Akaike info criterion -3.587647
Sum squared resid 0.130020 Schwarz criterion -3.372584
Log likelihood 178.4132 Hannan-Quinn criter. 1.993655
5.3.2 Investment
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Investment is sub-divided into investment in the oil and non-oil sectors and
modelled to follow the irreversibility theory of investment. The theory looks
beyond the traditional investment determinants (interest rate) in addition
considers investment climate and cost of doing business especially in the
developing countries like Nigeria.
Oil Investment
Mirroring the production sector, investment in the oil sector is driven by external
and domestic economy’s environmental factors mainly direct investment in the oil
sector, oil price and macroeconomic uncertainty surrounding the oil sector. The oil
sector in Nigeria is primarily foreign-driven and this characteristic reflects in both
the formulation and final estimates obtained from the oil investment equation.
Apart from the lag of the dependent variable, four variables – oil output,
macroeconomic variability in the oil sector, foreign direct investment in the oil
sector and corporate tax burden – seem to drive investment in the oil sector.
Expectedly, the impact of oil output indicates rationality on the part of investors
who plough back a sizable chunk of output from the sector. Oil investment is
responsive to output from the sector but is only significant in the first and fourth
quarters. However, as an indicator of domestic instability, the primacy of oil
output volatility in the model confirms the place of uncertainty in investment
decisions – even in the oil sector. The co-efficient is significant and confirms the
irreversibility theory assertion that what drives investment is the level of
uncertainty in the host economy irrespective of the cost of investment fund. It
accounts for 88.9 percent of the total investment decision or 0.89 percent of 1.0
percent change in investment decision. The irreversibility and permanence of
investment decisions theory is also confirm when one considers the non-
- 72 -
significant of maximum lending rate in the model1. The first-quarter lag of foreign
direct investment has significant impact on oil investment. The fourth-lag, though
positively signed, is less significant. It could not be confirmed that oil prices have
significant impact on the determination of investment in the oil sector. This
implies that investors in the sector are not particularly influenced in their decisions
to invest or not by the direction of movements of market prices at any point in
time, but look at long term profitability which may not be directly related to
immediate prices. It implies that even when oil prices are low, previous
investments continue to be serviced and a fall in the price of oil may not
necessarily lead to fall in investment in the sector.
Besides output volatility, oil output and foreign direct investment, specific
indicators of corporate tax burden, in the sector could not be proven to have
impact on oil investment. It was however, retained in the model since it has the
accurate sign and used as a policy variable. Correction for short term
disequilibrium in oil investment is about 28 percent per quarter in the model. The
parsimonious representation of the oil investment model is in Table 5.2
1 Maximum lending was eliminated in parsimonious marginalization process because it has the
wrong sign and insignificant.
- 73 -
Table 5.2: Parsimonious error correction model of investment oil
Dependent Variable: D(LOG(INVO))
Method: Least Squares
Date: 06/22/10 Time: 08:43
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(LOG(INVO(-4))) 0.263504 0.092364 2.852891 0.0054
D(LOG(YO)) 0.281691 0.108956 2.585351 0.0114
D(LOG(FDIO(-4))) 0.044378 0.020254 2.191116 0.0311
D(YVO(-4)) -0.868380 0.299294 -2.901429 0.0047
D(CTB(-3)) -11.43392 8.293321 -1.378690 0.1714
ECM_INVO(-1) -0.283333 0.081291 -3.485425 0.0008
R-squared 0.265134 Mean dependent var 0.003543
Adjusted R-squared 0.223849 S.D. dependent var 0.151717
S.E. of regression 0.133662 Akaike info criterion -1.125932
Sum squared resid 1.590028 Schwarz criterion -0.964635
Log likelihood 59.48178 Durbin-Watson stat 1.915019
Non-oil Investment
Estimates from the non-oil investment equation confirm that risk is an important
factor in investment decisions. Consistently, investment climate i.e output
volatility is proved to be the most important consideration in investment decision-
making in Nigeria. Three out of the four lags and the contemporaneous value
were significant in determining investment in the sector. Again, this confirms risk
as an important factor in investment decisions in the non-oil sector.
- 74 -
In addition to risk, output, the lag of the dependent variable, foreign direct
investment, corporate tax burden and cost of investment (interest rate) were
equally significant at 1 percent and 10 percent respectively in the determination of
non-oil investment. This indicates inter-temporal dependence of investment; with
the level of investment at any one period determining that in another and the
volume of output being important in indicating the share of investment. Foreign
direct investment is also critical to the determination of investment in Nigeria,
indicating the exposure of the domestic economy to the external sector. Domestic
maximum lending rate in particular was significant at 10 percent with a very weak
parameter (0.01 percent of change in investment decision), and does not have
enough weight in investment decision like investment climate considerations such
as corporate tax burden and macroeconomic uncertainty. Table 5.3 shows the
estimated coefficients of non-oil investment in the model.
The equilibrium error correction is about 18 percent every quarter. The DW
statistics is about 1.94 showing lack of autocorrelation amongst the explanatory
variables. The test statistics indicated that 41.2 percent of the variations in
consumption is explained by the explanatory variables.
- 75 -
Table 5.3: Parsimonious error correction model of non-oil investment
Dependent Variable: D(LOG(INVN))
Method: Least Squares
Date: 07/03/10 Time: 10:11
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Coefficient Std. Error t-Statistic Prob.
D(LOG(INVN(-3))) 0.249539 0.131689 1.894911 0.0615
D(LOG(YN(-4))) 0.603641 0.196769 3.067765 0.0029
D(LOG(FDIN(-4))) 0.027628 0.015338 1.801246 0.0752
D(YVN) -3.247966 1.181981 -2.747899 0.0073
D(YVN(-1)) -4.626006 1.284603 -3.601117 0.0005
D(YVN(-2)) -4.436514 1.425538 -3.112168 0.0025
D(YVN(-3)) -2.984524 1.285346 -2.321961 0.0226
D(CTB(-3)) -16.02421 9.037473 -1.773086 0.0798
D(RM(-3)) -0.006635 0.004146 -1.600145 0.1133
ECM_INVN(-1) -0.181880 0.074425 -2.443793 0.0166
R-squared 0.419824 Mean dependent var 0.011380
Adjusted R-squared 0.358394 S.D. dependent var 0.124595
S.E. of regression 0.099801 Akaike info criterion -1.671980
Sum squared resid 0.846617 Schwarz criterion -1.403151
Log likelihood 89.41906 Hannan-Quinn criter. -1.563353
Durbin-Watson stat 1.945376
5.3.3 Production
- 76 -
To address the two objectives of FDI impact on domestic output, production is
disaggregated into oil and non-oil output. As a result of data constraint, the
estimation did not follow the traditional inclusion of the labour market
(employment sector).
Oil output
Oil GDP was traditionally specified to be a function of a number of variables
incorporating both foreign and domestic factors, including foreign direct
investment, crude oil price and OPEC quota. All the co-efficient in the original
equations were either significant at 1 percent or 10 percent respectively, for FDI
oil. The magnitudes of the estimated co-efficient and their statistical properties
suggest the plausibility of the result skewed to the fact that oil output is driven by
factors of OPEC administrative fiat and natural factors of uncertainty. Value
Added in the oil sector (Yo) are highly responsive to OPEC quota (OPEC), which
are determined mainly by factors exogenous to the economy. The results also
show that a 10% change in crude oil price would produce about approximately
0.1% change in value added in the short run. The magnitude of the output change
with respect to OPEC quota is far larger than the price effect. In other words, the
result suggests that oil GDP is more sensitive to OPEC quota than oil price. Long
run error correction co-efficient (ECM_YO (-1)), which is the speed of adjustment,
indicates that 26 per cent disequilibrium in the previous quarter is corrected in the
current quarter.
Different test statistics for the model confirm the robustness of the estimates. The
model explains about 85 percent of the variations in output of oil and the Durbin-
Watson autocorrelation coefficient at 2.11 indicates the absence of autocorrelation
- 77 -
among the explanatory variables. See Table 5.4 for results of the parsimonious
error correction estimates.
Table 5.4: Parsimonious error correction model of oil output
Dependent Variable: D(LOG(YO))
Method: Least Squares
Date: 06/27/10 Time: 20:30
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(LOG(YO(-4))) 0.772707 0.051879 14.89429 0.0000
D(LOG(PO)) 0.069049 0.041453 1.665727 0.0992
D(LOG(FDIO(-3))) 0.006387 0.009652 0.661739 0.5098
D(LOG(OPEC)) 0.469201 0.180790 2.595275 0.0110
ECM_YO(-1) -0.261228 0.068840 -3.794689 0.0003
R-squared 0.851244 Mean dependent var 0.004181
Adjusted R-squared 0.844633 S.D. dependent var 0.162164
S.E. of regression 0.063920 Akaike info criterion -2.611185
Sum squared resid 0.367714 Schwarz criterion -2.476771
Log likelihood 129.0313 Durbin-Watson stat 2.110445
Non-oil output
- 78 -
An attempt to specify and model non-oil output to closely follow conventional
Cobb-Douglas production function was not successful as labour data was not
available. Attention was paid to the Nigerian non-oil output determinants, credit
to the private sector, lending rate and foreign direct investment. All the variables
were not proven to be significant. It was revealed that firms rely on incremental
output method by considering last period output. The only significant variable is
the lag of non-oil output. This is consistent with widely-held notion by Nigeria as
an import-dependent economy. It could not be confirmed that monetary (and
monetary policy) variables have impact on non-oil output showing the long age
opinion about the weak linkage between the monetary and real sector in the
traditional Keynesian model. Lending rate appears in the equation with the right
sign but is not significant, implying that as in the credit to the private cost of funds
does not have impact on non-oil output in Nigeria. This tends to put a limit on the
use of monetary instruments for the control of non-oil output. Disequilibrium in
the model is corrected at the rate of about 6 percent per quarter, considerably low.
- 79 -
Table 5.5: Parsimonious error correction model of non-oil output
Dependent Variable: D(LOG(YN))
Method: Least Squares
Date: 06/27/10 Time: 20:58
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(LOG(YN(-4))) 0.955892 0.050056 19.09632 0.0000
D(LOG(CCPS(-2))) 0.022939 0.038602 0.594245 0.5538
D(LOG(FDIN(-4))) 0.005955 0.006219 0.957405 0.3409
D(RM(-2)) -0.000211 0.001787 -0.117852 0.9064
ECM_YN(-1) -0.063438 0.031790 -1.995509 0.0490
R-squared 0.820272 Mean dependent var 0.018146
Adjusted R-squared 0.812284 S.D. dependent var 0.096364
S.E. of regression 0.041751 Akaike info criterion -3.462999
Sum squared resid 0.156882 Schwarz criterion -3.328585
Log likelihood 169.4925 Durbin-Watson stat 1.849429
5.3.4 Government expenditure and revenue
Government is a significant component of gross output in the Nigerian economy,
being second only to private consumption. In this study, capital expenditure is
exogenized as a policy variable, while government recurrent expenditure and
revenues are endogenized.
Government ostensibly survives despite the fact that it relies only marginally (if at
all) on the real sector.
- 80 -
Government recurrent expenditure
The specification of the recurrent expenditure equation - seems to justify the policy
argument that the Nigerian government budget estimates rely heavily on revenue
and partly on incremental bases. Being independent and a policy driver,
government expenditure is not found to be related to (or determined by) gross
output. Neither could it be confirmed that credit to government is important in
determining how much government ultimately spends on recurrent issues.
Government revenue, on the other hand, tops the list of important factors that
determine its expenditure. Interestingly, given Nigeria’s fiscal federalist structure,
the bulk of the revenue is from oil sales and therefore is weakly linked to the real
economy, particularly the non-oil sector. Historical factor in government recurrent
expenditure in Nigeria is the racketing up of recurrent expenditure in times of
boom, treating such booms as permanent phenomena, while treating busts as
temporary. Expectedly, inflation increases overall government expenditure, but is
significant at 10 percent. Adjustment rate to disequilibrium of government
expenditure is rather low in the model at 7 percent as shown in Table 5.6.
- 81 -
Table 5.6: Parsimonious error correction model of government non-oil revenue
Dependent Variable: D(LOG(GRE))
Method: Least Squares
Date: 06/28/10 Time: 21:20
Sample (adjusted): 1985Q3 2009Q4
Included observations: 98 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(LOG(GRE(-1))) 0.276546 0.059301 4.663444 0.0000
D(INF) 0.001178 0.000720 1.635642 0.1053
D(LOG(GVR)) 0.534502 0.045907 11.64318 0.0000
ECM_GRE(-2) -0.070654 0.034984 -2.019589 0.0463
R-squared 0.640088 Mean dependent var 0.058440
Adjusted R-squared 0.628601 S.D. dependent var 0.094688
S.E. of regression 0.057705 Akaike info criterion -2.826983
Sum squared resid 0.313009 Schwarz criterion -2.721474
Log likelihood 142.5221 Durbin-Watson stat 1.445878
Government revenue
Over time, oil revenue constitutes no less than 85 percent of all total revenue,
while the remaining is the non-oil revenue. Government revenue is specified to be
a function of output export (incorporating oil and non-oil sectors), and oil price
and nominal exchange rate. OPEC was dropped because it is correlated with oil
export and oil price. Consistent with a priori expectations and the monoculture
nature of Nigeria’s economy, government revenue was found to be driven to a
large extent by oil-related factors such as: oil export and oil prices. The non-oil
export is not significant. The lag of revenue from oil is not only highly significant
- 82 -
but also has a high co-efficient indicating serial dependence on the value of any
quarter’s earnings from oil on previous quarter’s earnings. Adjustment rate for
short run disequilibrium in the long run relationship between oil revenue and its
determinants is about 8 percent per quarter as indicated in Table 5.7.
Table 5.7: Parsimonious error correction model of government oil revenue
Dependent Variable: D(LOG(GRV))
Method: Least Squares
Date: 07/03/10 Time: 13:49
Sample (adjusted): 1986Q1 2009Q4
Included observations: 96 after adjustments
Coefficient Std. Error t-Statistic Prob.
D(LOG(GRV(-1))) 0.459755 0.090389 5.086382 0.0000
D(LOG(XO)) 0.135900 0.044421 3.059383 0.0029
D(LOG(PO(-3))) 0.126730 0.073115 1.733283 0.0864
D(LOG(NER)) 0.119574 0.067588 1.769162 0.0802
ECM_GRV(-1) -0.079988 0.039198 -2.040582 0.0442
R-squared 0.327863 Mean dependent var 0.053711
Adjusted R-squared 0.298319 S.D. dependent var 0.134985
S.E. of regression 0.113072 Akaike info criterion -1.470902
Sum squared resid 1.163465 Schwarz criterion -1.337342
Log likelihood 75.60330 Hannan-Quinn criter. -1.416915
Durbin-Watson stat 1.949321
5.3.5 External sector
The external block consists of four equations: export and import, oil foreign direct
investment and non-oil foreign direct investment. Export is explained by domestic
output, foreign income, OPEC quota (in the case of oil) credit to the private sector
- 83 -
and nominal exchange rate, while import is determined by domestic income,
nominal exchange rate and implicit tariff rate. The oil foreign direct investment is
modelled as a function of host economy’s favourable private sector policies (size of
government), investment climate (output variability in the non-oil sector),
petroleum profit tax and oil output, while the non-oil FDI is explained by size of
government, non-oil output and corporate tax burden.
Export
Nigeria’s export demand is principally driven by four major factors – domestic
output, nominal exchange rate, credit to the private sector, and crude oil prices. As
expected, oil price has the highest influence on export with oil export as the
transmission mechanism. Given the structure of production and export of oil in
Nigeria, this result is hardly surprising. Increased oil prices induce higher
production and export, while foreign income is not proven to impact on Nigerian’s
export, though it has appropriate sign for any theoretical evaluation.
Nominal exchange rate is another strong determinant of export demand. The
result shows that increase in exchange rate (depreciation) increases the demand
for Nigeria’s export. It also accounted for about 37 percent of change in export
demand and 0.4 percent of the variation in 1.0 percent change in export. The
argument for private sector driven economy is also showcased in the result and
suggests that a 1.0 percent increase in credit to the private sector will increase
value of export by 0.4 percent.
The model explains about 35 percent of the variations in export and the Durbin-
Watson autocorrelation co-efficient at 1.98 indicates the absence of autocorrelation
among the explanatory variables. Probability function statistics among the
different explanatory variables are also low enough to make for consistent and
- 84 -
reliable estimates; and the adjustment rate to disequilibrium of export demand is
at a modest rate of about 13.5 percent as indicated in Table 5.8.
Table 5.8: Parsimonious error correction model of export demand
Dependent Variable: D(LOG(X))
Method: Least Squares
Date: 07/04/10 Time: 07:02
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Coefficient Std. Error t-Statistic Prob.
D(LOG(Y(-1)),2) 0.437684 0.183185 2.389304 0.0190
D(LOG(CPS(-4))) 0.389978 0.184659 2.111879 0.0375
D(LOG(NER)) 0.373763 0.114034 3.277631 0.0015
D(LOG(PO)) 0.676579 0.136249 4.965737 0.0000
D(LOG(YFOECD(-2)),2) 4.336209 3.577330 1.212136 0.2287
ECM_X(-1) -0.135078 0.059097 -2.285705 0.0246
R-squared 0.348777 Mean dependent var 0.078071
Adjusted R-squared 0.312191 S.D. dependent var 0.248358
S.E. of regression 0.205974 Akaike info criterion -0.261061
Sum squared resid 3.775842 Schwarz criterion -0.099763
Log likelihood 18.40038 Hannan-Quinn criter. -0.195884
Durbin-Watson stat 1.980645
Import
Import demand comprises of intermediate and other imports. The model is
specified to respond mainly to price variables. Some of the identified price
variables include the nominal exchange rate, implicit tariff rate and domestic
maximum lending rate. Other controlled variables include lag of import and
income. In all, tariff rate is proven to be the highest determinant of import. Other
- 85 -
determinants were not significant but show the expected relationship between
them and import demand. While the lag of import is significant at 5 percent,
lending rate was dropped through marginalization as a result of wrong sign in the
mode.
Test statistics show that about 62 percent of the determinants of import demand
were captured in the model, while the DW statistics is 1.79. Equilibrium
adjustment is about 10 percent every quarter as indicated in Table 5.9. The relative
low tariff rate on import will affect the inflow of FDI into the country.
Table 5.9: Parsimonious error correction model of import demand
Dependent Variable: D(LOG(M))
Method: Least Squares
Date: 07/04/10 Time: 07:45
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Coefficient Std. Error t-Statistic Prob.
D(LOG(M(-2))) 0.102986 0.064042 1.608103 0.1113
D(LOG(Y(-3)),2) 0.226370 0.156165 1.449552 0.1507
D(TAR) -0.101754 0.008206 -12.39957 0.0000
D(LOG(NER(-4))) -0.042849 0.094171 -0.455016 0.6502
ECM_M(-1) -0.103105 0.043732 -2.357675 0.0206
R-squared 0.621323 Mean dependent var 0.075502
Adjusted R-squared 0.604493 S.D. dependent var 0.268943
S.E. of regression 0.169136 Akaike info criterion -0.665029
Sum squared resid 2.574635 Schwarz criterion -0.530614
Log likelihood 36.58887 Hannan-Quinn criter. -0.610715
Durbin-Watson stat 1.796699
- 86 -
Foreign Direct Investment
Foreign direct investment is sub divided into oil and non-oil. This follows the
near-sharp division of economic activities in Nigeria into oil and non-oil.
Foreign Direct Investment (FDI) oil
As in the rest of the oil sector models (production, export, etc), it is evident from
the regression that foreign direct investment into the oil sector seems to follow
conducive business environment, reduced corporate tax burden and oil output.
While the lag of foreign direct investment in oil is not significant like size of
government, oil output variability, petroleum profit tax and oil output.
The result shows that foreign direct investment in the oil sector is attracted into
the economy by the government’s reduced activities in economic activities and
certainty of the domestic macroeconomic environment. All these will cumulate
into increased output in the oil sector which is also another positive attractor of
foreign direct investment. Petroleum profit tax, a measure of corporate tax burden
in the oil sector has a negative impact on foreign direct investment.
As shown in Table 5.10, adjustment rate for short run disequilibrium in the long
run relationship between foreign direct investment in oil and its determinants is
high at 39 percent per quarter.
- 87 -
Table 5.10: Parsimonious error correction model of oil foreign direct investment
Dependent Variable: D(LOG(FDIO))
Method: Least Squares
Date: 06/27/10 Time: 19:13
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(SZG(-2)) -0.211763 0.074269 -2.851279 0.0054
D(YVO(-3)) -3.871998 1.593749 -2.429490 0.0171
D(LOG(PPT(-4))) -2.034228 0.326714 -6.226328 0.0000
D(LOG(YO(-3))) 1.639426 0.566923 2.891800 0.0048
ECM_FDIO(-1) -0.392245 0.063098 -6.216458 0.0000
C 0.211837 0.059006 3.590086 0.0005
R-squared 0.447024 Mean dependent var 0.072924
Adjusted R-squared 0.415957 S.D. dependent var 0.695813
S.E. of regression 0.531759 Akaike info criterion 1.635821
Sum squared resid 25.16628 Schwarz criterion 1.797118
Log likelihood -71.70149 F-statistic 14.38944
Durbin-Watson stat 2.044534 Prob(F-statistic) 0.000000
Foreign Direct Investment (FDI) non-oil
Non-oil foreign direct investment is quite strongly linked to output volatility;
quite unlike foreign direct investment in the oil sector which depended only on its
own lag. Both the first- and second-quarter lags of output volatility impact on
foreign direct investment in the non-oil sector, with high co-efficient and
probability levels. At 11 percent probability, the impact of the real exchange rate is
only marginal. While the Durbin-Watson test statistic indicates the absence of
- 88 -
autocorrelation among the explanatory variables, variation in foreign direct
investment explained by the model is low (23 percent).
Though weak, the relevance of real exchange rate in determining foreign direct
investment in the non-oil sector points to relevance of domestic macroeconomic
factors in attracting foreign direct investment in the non-oil sector. The coefficient
estimates are shown in Table 5.11.
Table 5.11: Parsimonious error correction model of non-oil foreign direct investment
Dependent Variable: D(LOG(FDIN))
Method: Least Squares
Date: 07/03/10 Time: 18:47
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(SZG(-2)) -0.324556 0.109878 -2.953784 0.0040
D(CTB) -51.30764 41.46699 -1.237313 0.2192
D(LOG(YN(-4))) 2.501691 0.940168 2.660898 0.0092
ECM_FDIN(-1) -0.220238 0.064644 -3.406922 0.0010
R-squared 0.177193 Mean dependent var 0.072926
Adjusted R-squared 0.150068 S.D. dependent var 0.696037
S.E. of regression 0.641689 Akaike info criterion 1.991767
Sum squared resid 37.47059 Schwarz criterion 2.099299
Log likelihood -90.60894 Durbin-Watson stat 2.149312
5.3.6 Monetary sector
Real Money demand
- 89 -
Money demand is modelled by considering the Keynesian real balances.
According to the liquidity preference theory, increase in income leads to increase
in the transaction demand for money and decrease in speculative demand.
However, an increase in interest rate forces consumers to postpone current
consumption to make fund available for investment with interest rate as the
inducement.
All the money determinants conform to a priori and show that a 1% increase in
income increases demand for money by about 0.25%. Again, interest rate (deposit)
rate is shown not to be relevant in consumption decision making in Nigeria and
was dropped from the model. It tends to suggest that the deposit rate is not
reasonable enough to act as an inducement for funds to flow from the households
to private investment thus, causing an increase in lending rate; and the capital
market development is not strong enough to act as an alternative channel of fund
transmission between households and firms. Summarily, there is the tendency for
lending rate to rise in the future as the interest rate spread is not narrowed. Also,
increase in general prices level decreases real balances by 0.33% leaving real
balances and money demand to be a one-to-one relationship.
The equilibrium adjustment of money demand function is about 12% every
quarter as indicated in Table 5.12.
- 90 -
Table 5.12: Parsimonious error correction model of money demand
Dependent Variable: D(LOG(M2))
Method: Least Squares
Date: 07/03/10 Time: 19:07
Sample (adjusted): 1986Q2 2009Q4
Included observations: 95 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
D(LOG(M2(-4))) 0.391669 0.092172 4.249352 0.0001
D(LOG(Y(-4))) 0.258915 0.125345 2.065626 0.0417
D(LOG(CPI)) -0.331473 0.112217 -2.953866 0.0040
ECM_M2(-1) -0.124081 0.041601 -2.982673 0.0037
R-squared 0.266283 Mean dependent var 0.014333
Adjusted R-squared 0.242094 S.D. dependent var 0.099481
S.E. of regression 0.086606 Akaike info criterion -2.013713
Sum squared resid 0.682547 Schwarz criterion -1.906181
Log likelihood 99.65137 Durbin-Watson stat 2.178008
Domestic Maximum lending rate
- 91 -
Two variables were dropped from the original model for determination of
maximum lending rate: the cost of doing business on account of data limitation
and nominal exchange rate for correlation with other variables and wrong signs.
The duo of inflation, inflation expectation and monetary policy rate satisfied a
priori signs; however only the monetary policy rate is statistically significant.
Conversely, inflation and inflation expectation are statistically weak in explaining
movements in maximum lending rate in Nigeria.
The results are quite instructive in indicating that monetary policy really drives
maximum lending rate, signalling possibilities for policy in influencing lending
rates. However, other non-policy variables do not matter. Adjustment to
temporary disequilibrium in the long run relationship between the dependent and
explanatory variables is at the rate of 22 percent per quarter. See Table 5.13 for the
detailed results.
Table 5.13: Parsimonious error correction model of Domestic maximum lending rate
Dependent Variable: RM
Method: Least Squares
Date: 07/03/10 Time: 21:12
Sample (adjusted): 1986Q2 2009Q3
Included observations: 94 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
RM(-1) 1.002051 0.010488 95.54520 0.0000
D(MPR) 0.615190 0.151533 4.059759 0.0001
D(INF(-4)) 0.043758 0.027639 1.583196 0.1169
D(INFE(1)) 0.054514 0.044817 1.216389 0.2271
ECM_RM(-1) -0.222080 0.087280 -2.544464 0.0127
R-squared 0.796638 Mean dependent var 22.19415
Adjusted R-squared 0.787498 S.D. dependent var 4.954502
S.E. of regression 2.283922 Akaike info criterion 4.541390
- 92 -
Sum squared resid 464.2508 Schwarz criterion 4.676672
Log likelihood -208.4453 Durbin-Watson stat 1.625834
5.4 Policy Simulation and FDI Transmission Effects, 2005 - 2009
Table 5.14: Policy simulation experiment (case one)
Foreign Direct
Investment component
s
Corporate Tax Burden (CTB)
(R1)
Non-oil output
variability
(R2)
Exchange Rate
(R3)
Petroleum Profit
Tax
(R4)
Trade protection Index
(R5)
Size of public sector
(R6)
Capital Allowanc
e
(R7)
0% 30% 20% 20% 20% 0% 20% 50%
2005 2005 2005 2005 2005 2005 2005 2005
Total FDI 75.8 55.19 75.8 75.1 75.8 83.5 73.9 85.0 Non-oil
FDI 55.2 55.19 55.0 55.5 NA 77.4 54.7 83.3
Oil FDI NA NA NA NA 86.3 NA 56.3 61.3
2006 2006 2006 2006 2006 2006 2006 2006
Total FDI 5.3 3.79 5.3 5.2 5.3 3.5 4.6 3.4
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Non-oil FDI 5.6 3.79 5.6 5.3 NA (0.5) 3.6 1.1
Oil FDI NA NA NA NA 5.1 NA 4.11 48.51
2007 2007 2007 2007 2007 2007 2007 2007
Total FDI 14.5 0.90 13.5 4.5 14.5 14.5 13.1 15.3 Non-oil
FDI 7.5 0.90 3.5 8.3 NA 7.1 4.9 12.5
Oil FDI NA NA NA 17.4 17.4 17.4 17.4 17.4
2008 2008 2008 2008 2008 2008 2008 2008
Total FDI (4.1) (19.42
) (4.1) (5.0) (4.1) (2.8) (6.0) (8.7) Non-oil
FDI (24.3
) (19.42
) (24.3) (24.8) NA (20.7) (26.6
) (26.7)
Oil FDI NA NA NA 3.7 3.7 3.7 3.7 3.7
2009 2009 2009 2009 2009 2009 2009 2009
Total FDI (5.0) (10.29
) (5.0) (5.8) (5.0) (6.2) (1.00
) (3.7) Non-oil
FDI (10.3
) (10.29
) (10.3) (13.1) NA (0.3) 6.6 (4.2)
Oil FDI NA NA NA NA (3.5) (2.5) (4.13)
Source: Author computation based on macro-econometric model simulation
There are six policy simulations corresponding to the research objectives. These are
exchange rate policy (nominal exchange rate), tax (corporate tax burden), business
environment, (macroeconomic uncertainty), private sector investment driven policy (size
of the public sector in the economy), trade protection zone (level of tariff on imported
goods), and capital allowance. The percentages used for simulations were collected from
NIPC list of incentives in box 1, aside exchange rate, size of the public sector, and output
variability that were selected at random. The six scenarios are in Table 5.14.
5.4.1 Scenario one:- Corporate Tax Burden Policy Simulation
Table 5.14 column (R1), is a demonstration of the argument that increased tax
burden is not an attractor of foreign direct investment. World Bank grouped
Nigeria as one of the countries with multiple tax rates; and going by that
revelation, it means that the poor performance inflow of FDI could be reversed by
examining the tax implication of FDI inflow. The argument however, is that for
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new FDI inflow, certain percentage of tax cut could be applied or at the extreme,
grants of tax holidays within a specified number of years. The tax holiday
component is under the zero tax regime in Table 5.14 and this shows that FDI
inflow will increase by 81.4% driven by the non-oil2 sector and 64.37% in the oil
sector. The trend however suggested that in the long run tax policy alone may not
address the issue of FDI inflow. This is evident from the replication of negative
growth rate in spite of zero tax or tax holidays granted. Secondly between 1999
and 2008, non-oil FDI maintained a constant growth rate irrespective of the tax
rate applied, another evidence of the inability of tax policy driving FDI inflow.
The foregoing therefore means that combinations of policies are catalysts for
effective FDI-tax policy response at least in the long run, after what looks like
initial FDI response to tax adjustments.
5.4.2 Scenario two:- Macroeconomic Volatility and FDI
Results of our estimates have already confirmed the negative impact of output
variability of not only FDI, but other investment decision. To explore this
relationship, and knowing that its impact is of a transmission effect; we use FDI as
its transmission by combining it with corporate tax burden.
Table 5.14 is a confirmation of the argument that reduction in tax base of
corporation with a high degree of macroeconomic uncertainty does not improve or
increase the inflow of FDI. The policy experiment shows that FDI stagnated
between 1999 and 2008. This is in tandem with the argument of the uncertainty –
irreversibility theory of investment. The argument is that irrespective of business
and investment incentive, example of low interest rate in a highly volatile
investment climate cannot attract investment. One can therefore conclude that
2 Note that the corporate tax rate excludes the petroleum profit tax applied to the oil sector. This
accounted for the constancy of the oil FDI in the table though, not presented.
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incentives to attract FDI might as well be combined with government provision of
enabling business environment. As such, what works is a policy combination
rather than one directional approach of investment incentives.
5.4.3 Scenario three: - Exchange Rate Policy Simulation Experiment
Another extreme case like tax holidays is the assumption that exchange rate is
fully adjusted to 100 % appreciation or zero percent increase in exchange rate.
Table 5.15 shows that the initial shock of exchange rate over valuation in 1986 is to
decrease FDI inflow by reducing non-oil FDI from 69.5% to about 22.87%. This
perhaps justifies the argument by the World Bank that all the SAP countries,
including Nigeria need to devalue their currency as much as possible, thus
warranting the 1986 devaluation of Naira by over 100% by the then military
government of Ibrahim Babangida.
Although, this paper is specifically addressing the SAP policy, but it has shown
that exchange rate appreciation discourages FDI inflow (more specifically non-oil
FDI). After the initial period, a rise in exchange rate from 20% running through
25% shows a steady increase in FDI inflow at an average of 71.7% in 1986. Like the
issue raised in granting tax holidays, the issue of exchange rate and FDI also
shows some level of mix reaction; which may suggest the use of multiple
instrument to drive FDI policy in Nigeria.
5.4.4 Scenario four:- Trade Protection Effect
Table 5.14, column (R5), shows that the initial reaction of trade protection (level of
tariff on import) at zero percent level is a reduction in the inflow of FDI into the
country. An increase in the level of tariff on import will discourage importation of
goods and induces the inflow of FDI into the country, as investors move into the
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domestic economy (Nigeria) to produce what was initially imported at the zero
percent base tariff level. But the result shows a mixed reaction between 2005 and
2009 which may suggest the use of multiple instruments to drive FDI policy in
Nigeria. From the result, it can be deduced that a zero level of tariff on imported
goods militates against the effectiveness of FDI policies.
5.4.5 Scenario five: - Size of the Public Sector Effect
There are two ways of looking at the size of the public sector. One is by seeing the
increasing function of government as representing a play-down on privatization;
secondly, the increasing size of government generates distortions in the economy,
either by X-inefficiency, or poor investment enabling environment. As enabler of
growth, government should have no business being in business, as such a market
driven economy attracts huge investment flow. Like incentives, privatization
witnessed a first shock of response from 2005- 2007, only to decline in 2008 and
2009. The size of the public sector represents the degree of government
involvement in the economy. This generates distortion in the economy and thus
adversely affects the inflow of FDI.
5.4.6 Scenario six:- Capital Allowance Effect
Capital allowance is another mirror image of negative tax. Currently capital
allowance for manufacturing export firms is 50%. In Table 5.14, column (R7), the
allowance was added to FDI as a form of returns and the result of its impact on
FDI is in column (R7). The initial reaction to that shock was a steady increase in
FDI inflow, equally turning negative growth to positive growth before declining
again between 2008 and 2009. The negative reaction in scenario 6 raises the same
question of using a single policy as an FDI incentive. Despite this later negative
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reaction, the result confirms that investment flow will always react to incentives,
while its sustainability depends on combination of other policies.
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Table 5.15: Average combined effect of tax holiday and selected policies (case two)
FDI
Components
%ΔCTB
(Volatility effect)
%ΔCTB (Exchange rate effect)
%ΔCTB (Petroleum Profit Tax effect)
%ΔCTB (Trade policy effect)
%ΔCTB
( Size of public sector effect)
%ΔCTB (Capital allowance effect)
2005
Total FDI (22.5) (23.2) (22.5) (14.8) (24.4) (13.3)
Non-oil FDI (41.8) (41.5) NA (19.6) (42.3) (13.7)
Oil FDI (15.11) NA (23.7) NA (20.7) (15.7)
2006
Total FDI 20.3 20.2 20.3 18.5 19.6 18.4
Non-oil FDI 19.8 19.5 NA 13.7 17.8 15.3
Oil FDI NA NA 26.1 NA 16.1 12.05
2007
Total FDI 31.1 31.1 31.1 31.1 29.7 31.9
Non-oil FDI 23.6 24.4 NA 23.2 21 28.6
Oil FDI 13.0 NA 38.4 NA 28.01 8.4
2008
Total FDI (14.9) (15.8) (14.9) (13.6) (16.8) (19.5)
Non-oil FDI (18.3) (18.8) NA (14.7) (20.6) (20.7)
Oil FDI (174.3) NA (10.37) NA (14.3) (28.43)
2009
Total FDI (25.7) (26.5) (25.7) (26.9) (21.7) (24.4)
Non-oil FDI (15.5) (18.3) NA (5.5) 1.4 (9.4)
Oil FDI (76.5) NA (6.5) NA (16.5) (70.17)
Source: Author’s computation based on simulation
5.4.7 Scenario seven:- Combined Effects of Policy Change and CTB
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Table 5.15, is evidence to suggest that single policy is incapable of driving FDI inflow. The
results show the net effect of granting tax holiday (zero tax) in an environment with 30%
volatility, 20% petroleum profit tax, 20% increase in the size of public sector (weak
privatization), 50% capital allowance for plants, and non-trade protection of the domestic
economy.
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BOX 1: INCENTIVES FOR INVESTING IN NIGERIA
a. Pioneer Status
Pioneer status takes the form of five-year tax holiday to qualifying industries anywhere in the federation.
b. Capital Allowances
The amount of capital allowance to be enjoyed in any year of assessment is restricted in Nigeria to a percentage of assessable profit. The following is a schedule for the sectors:
c. Incentives in the Power Sector?
The Federal Government of Nigeria has set-up several incentives to attract foreign direct investment into the power sector. The incentives include:
· Tax Holidays of up to 5 years
· Exemption from Duty Taxes on imported equipment
· Capital & Investment Allowance which can be carried forward and used after tax holiday period
· Manufacture of transformers, meters, control panels, switchgears, cables and other electrical related equipment are considered as pioneer products/industries. As a result, there is tax holiday of 5 to 7 years for investors who invest in these areas.
· Power plants using gas are assessed under the companies income tax act at a reduced rate of 30%
· 100% foreign ownership of Electricity plants
· Repatriation of profit with a 5% withholding tax
· Instituting a politically independent, and transparent regulatory agent for the power sector that will effectively enforce the established regulatory framework
· Putting in place the necessary foundations e.g. reliable transmission infrastructure that would create a level playing field for efficient private sector participation in the electricity supply
· Implementing a transparent and predicated tariff adjustment mechanism that will cover cost of production and provide adequate returns on investment at all times.
c. Incentives in the Agriculture sector?
The government within the past few years has introduced a number of measures designed to promote investment. Some of these measures include:
i. Fiscal measures on taxation
ii. Effective protection of local industries with import tariff or outright ban on importation of locally available substitutes;
iii. Export promotion of Nigerian-made products; and
iv. Foreign currency facility for international trade.
i. Export Incentives: Retention of export proceeds in foreign currency:
Exporters of Nigerian commodities are obliged to open a foreign currency domiciliary account (D/A) with an authorized bank of its choice in which 100% of the proceeds of such exports may be credited in foreign currency.
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Capital allowance for plant as published by NIPC in Table 5.15. While one can
make case for reduction in CTB so as to attract FDI it does not seem to suggest
sufficient condition. This is unlikely to succeed in countries with high level of
macroeconomic volatility, like Nigeria. Evidence and common sense too, suggest
that the traditional determinants of investment (foreign or domestic) may no
longer be attractive. Example of such findings is the Irreversibility-Uncertainty
Theory of Investment which suggests that even if interest rate is set at the lowest
level, the proportion of risk attached to macroeconomic uncertainty out weighs the
traditional cost of investment. High volatile investment climate (macroeconomic
uncertainty) hinders the volume of FDI inflow into the country.
5.5 Factors militating against the inflow of Foreign Direct Investment (FDI)
In trying to attract and regulate the activities of foreign investors, it must be
understood that Nigeria lacks the required human capital, no strong and effective
administrative system to negotiate with the Transnational Corporations (TNCs),
and inappropriate macroeconomic policy design and management. Consequently,
what the economy had tried to do over the years was to attract TNCs by offering a
wide range of incentives – from tax holidays to government credits which usually
cannot offset her disadvantages to locations for investment. When the economy
succeeds at attracting sizeable flow of investment, it has always being a trade-off
of some development policy objectives. This kind of opportunity cost has been due
to lack of consideration to the following five factors: the paramount importance of
general and sectoral policies toward the question of achieving macroeconomic
policy objectives through the use of ownership structure in the FDI; and the
importance of clear procedures as well as a smoothly working entry condition for
FDI.
i. The Paramount Importance of General and Sectoral Policies
BOX 1: INCENTIVES FOR INVESTING IN NIGERIA
a. Pioneer Status
Pioneer status takes the form of five-year tax holiday to qualifying industries anywhere in the federation.
b. Capital Allowances
The amount of capital allowance to be enjoyed in any year of assessment is restricted in Nigeria to a percentage of assessable profit. The following is a schedule for the sectors:
c. Incentives in the Power Sector?
The Federal Government of Nigeria has set-up several incentives to attract foreign direct investment into the power sector. The incentives include:
· Tax Holidays of up to 5 years
· Exemption from Duty Taxes on imported equipment
· Capital & Investment Allowance which can be carried forward and used after tax holiday period
· Manufacture of transformers, meters, control panels, switchgears, cables and other electrical related equipment are considered as pioneer products/industries. As a result, there is tax holiday of 5 to 7 years for investors who invest in these areas.
· Power plants using gas are assessed under the companies income tax act at a reduced rate of 30%
· 100% foreign ownership of Electricity plants
· Repatriation of profit with a 5% withholding tax
· Instituting a politically independent, and transparent regulatory agent for the power sector that will effectively enforce the established regulatory framework
· Putting in place the necessary foundations e.g. reliable transmission infrastructure that would create a level playing field for efficient private sector participation in the electricity supply
· Implementing a transparent and predicated tariff adjustment mechanism that will cover cost of production and provide adequate returns on investment at all times.
c. Incentives in the Agriculture sector?
The government within the past few years has introduced a number of measures designed to promote investment. Some of these measures include:
i. Fiscal measures on taxation
ii. Effective protection of local industries with import tariff or outright ban on importation of locally available substitutes;
iii. Export promotion of Nigerian-made products; and
iv. Foreign currency facility for international trade.
i. Export Incentives: Retention of export proceeds in foreign currency:
Exporters of Nigerian commodities are obliged to open a foreign currency domiciliary account (D/A) with an authorized bank of its choice in which 100% of the proceeds of such exports may be credited in foreign currency.
ii. Export Development Fund (EDF)
The Export Development Fund (EDF) is a special fund set up by the government to provide financial assistance to private sector exporting companies to off-set part of their initial expenses in respect of certain export promotion activities. These are promotional activities and the conditions for eligibility are as outlined by the Nigerian Export Promotion Council (NEPC).
iii. Export Adjustment Fund Scheme:
This scheme serves as supplementary export subsidy to compensate exporters for the high cost of local production arising mainly from infrastruactural deficiencies and also other natural and negative factors beyond the control of the exporter.
iv. Tax and Other Incentives:
· Export oriented industries:
Export oriented industries that export not less than 60% of their product can enjoy 10 percent tax concession for five years.
· Excise duty:
In order to boost local industries, stimulate trade and reduce cost, government abolished most excise duties since 1st January 1998.
· Capital Assets Depreciation Allowance:
The Law in Nigeria provides an additional annual depreciation allowance of 50% on plant and machinery to manufacturing exporters who exports at least 50% of the value of their annual turnover provided that the product has at least 40% local raw materials content or 35% value added.
· Pioneer Status:
The provision of the Industrial Development (Income Tax Relief) Act with respect to Pioneer Status tax holidays applied to any manufacturing exporter who exports at least 50% of his annual turnover.
· Companies with small or no profits in Agro allied business are exempted from paying minimum tax of 20%
Incentives in the Telecommunications Sector?
· Good tariff structure, which ensures that investors recover their investment over a reasonable period of time.
· Import duty on all telecoms equipment reduced from 25% to 5%.
· Measures on speedy clearance of goods at the ports
· Exclusivity period for licences, e.g. 5 years for the GSM licences, 3 years for long distance international gateway operators.
· Pioneer status for five years (under industrial Development (Income Tax Relief) Act 1990) is offered to interested investors who want to set plants for the manufacture of telecoms equipment in the country
Iincentives in the Free Trade Zones
Locating in any Free Trade zone in Nigeria automatically confers on the investor, certain locational advantages as well as very generous incentives. These include:
· Relative proximity to major markets of Africa, Europe and America.
· Large domestic market for the 25% of production that FTZ producers can sell in the Customs Territory.
· Favourable quotas on certain products from Nigeria export to the European Union (EU) and the United States.
· Made in Nigeria products enjoy preferential tariffs concessions in EU.
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Various regimes of governance in Nigeria have not been able to appropriately
understand the close relationship between the costs and benefits of FDI when
designing their general economic policies. Yet, sensible general economic policies
could be used both to reduce the windfall profits to TNCs in the country as well as
losses to the country arising from policies having exclusively high tariffs or
overvalued exchange rate (particularly before the SAP in 1986). For instance,
during the era of fixed interest rates (pre-SAP era) when the country’s financial
policies were based on artificially low interest rates; foreign investors were able to
avail themselves to the subsidized local credit markets for financing.
Using the inappropriate policy opportunities, many TNCs under the mechanics of
transfer pricing have been charging their subsidiaries in Nigeria exorbitant prices
for components products as well as for other accrued payments (such as royalties
on intellectual property rights) as means of transferring profits to their home
countries. Nigerian government could have avoided these negative developments
by putting in place economic policies that allow prices of products and resources
to reflect real scarcities more closely. Such sound economic policies could have
helped to build a good image for the country as opposed the hitherto frequent
policy swings which created severe penumbra around investment decisions.
Also, the rate which private investment could play in helping to achieve the
development objectives of Nigeria also depends on the policies pursued at the
sectoral level and on sectoral development programmes. A sectoral development
programme is capable of being used to determine which investments can be
envisaged and what the concrete investment opportunities are. The more
comprehensive and detailed the programmes, the easier it will be for government
to decide in advance about the need for foreign investors for individual projects at
their various stages of their preparation and to decide on the number and size of
projects and the backward and forward vertical integration among them, giving
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attention to economies of scale. Unfortunately however, instead of Nigerian
government to have put in place sectoral development programmes towards
foreign investors and be in a better position to obtain and constrain private
investment based on national priorities, various governments merely waited and
reacted to projects proposals after they had discovered the initial ones imposed
greater negative externalities on the political economy.
If appropriate sectoral programmes were in place, they would have allowed the
government to predetermine the import requirements as well as the export
potentials connected with the individual FDI project. A well elaborated sectoral
development investment opportunity and complementary industries and such
information could reduce programme on FDI and provide basic information to
TNCs in advance of the risks of obtaining required inputs and finding outputs for
by-products. In an uncertain environment like Nigeria, such advance information
would in most cases be a greater inducement than financial and fiscal incentives.
ii. The Limited Efficacy of Incentive Policies
Most countries around the world striving to create a favourable climate to attract
FDI, have taken steps to liberalize their FDI regimes by reducing distortions
regarding FDI, adhering to certain standards of treatment for TNCs and ensuring
the proper functioning of the market. In addition, in their efforts to influence the
locational decisions of TNCs, many governments offer incentives to attract them.
Incentives are any measurable economic advantage given to certain enterprises by
a government in order to encourage them to behave in a certain manner. Such
measures are either to increase the rate of return of a particular FDI undertaking or
to reduce (or redistribute) its costs or risks.
As a result of competition among the developing countries for foreign investors,
Nigeria has over the years offered a wide range of incentives to investors
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unconditionally without special sectoral or much of performance requirements. In
most instances, most of the incentives ended up introducing further economic
distortions by mainly compensating for disincentives. It is yet to be understood in
Nigeria that the structure and stage of economic development of a country affect
substantially the investment decisions of TNCs. Secondly, investment decisions of
TNCs are more influenced by the general and sectoral policies pursued by the host
economy than the general offer of incentives granted by the past and present
Nigerian Regulatory Agencies. Thirdly, until recently when NIPC became
operational, a smooth working investment approval mechanism was not in
existence in Nigeria. Due to these reasons, the actual impact of incentive policies at
attracting sizeable FDI seems to be somehow ineffective and inefficient. They are
ineffective because since many other countries use the same measures, these
incentives in Nigeria had little impact on the distribution of FDI among competing
developing countries.
Also, they are inefficient because with improved general economic policies in
place in the country, the same amount of investment could be attracted, now at
lower opportunity costs.
There are good reasons for Nigeria to be cautious in granting incentives that focus
exclusively on foreign investors. First, it is not easy to determine where and how
the position spill-over from FDI occurs. This creates problem of how to pick best
foreign investment that could yield the best spill-over to the economy. Secondly, it
is also difficult to calculate the value of the positive externalities and this is crucial
because incentives granted FDI at the opportunity cost of Nigerian citizens; and
national welfare will only increase if the amounts forgone as costs of the incentives
are smaller than the externally generated from FDI. Nigeria has been loosing
revenue for many years as the concrete benefits from FDI could not be clearly seen
and calculated against the costs of administering the incentives. Thirdly, following
what was earlier mentioned about corruption, application of FDI incentives has
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merely prepared a fertile ground for rent seekers. The selective approach by
approval giving institutions of these incentives, coupled with lack of transparency
in the approval process has increased the risk for rent seeking and corrupt
government officials (Bhagwati, 2000).
In addition, TNCs as we earlier discussed are likely to engage in transfer pricing
as well as other malpractices so as to shift many of their transactions to sector or
activity with low or no taxes or set up new firms as the tax preferences of existing
firms expire (Mc Lure, 1999). This was what actually happened in the country.
Despite, perception to the contrary, foreign investors engaged in dubious practices
to externally qualify for available incentives in Nigeria. Fourthly, competition
among countries to attract FDI usually creates problems (Oman, 2000). During the
period under study, most governments of developing nations, including Nigeria
employing similar incentive measures, competed actively for the available FDI,
since it was difficult for any of them to stay out of the bidding contests, which
effectively shifted profits from host economies of FDI to TNCs, the impact of the
incentives cancelled out across these countries. Apart from their cancelling out, the
‘rat race’ in the use of incentives equally resulting in a tendency for one country to
over-bid the others to the extent that the costs of the incentives surpassed the level
of possible spill-over benefits, with welfare losses to the nation as a result.
iii. The Question of Goal/Achievement by Ownership Policies
It is believed that the reduction in the share of foreign ownership in FDI do play
an important role in host economies. For instance, in Central America or Andean
Common Markets, it is difficult for a foreign enterprise to secure “Integration”
without foreign ownership being relatively low. In Nigeria, all the emphasis of the
Indigenization Acts has made the country to gain ownership rather than control of
FDI. Thus, the country has not been able to use foreign investment to achieve its
broad macroeconomic policy objectives as expected. Local managers are not
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competent enough and are even unable to provide internal checks on the alleged
transfer-pricing practices of foreign investors. What is being understood from this
development is that while reduction of foreign ownership is an objective to be
considered within the context of National Independence and Identity, it must be
recognized that ownership objective may require a trade-off with some degree of
economic efficiency (Safari, 1973 and Vernon 1977). Nigeria has since recognized
after the Indigenization Acts that concentrating on ownership policies alone have
not in any way led to the achievement of national objectives towards
industrialization. This was because the Indigenization Policies were not couched
within a framework of general economic policies and other complementary
policies that directly regulate the performance of foreign enterprises.
iv. The Costs and Benefits of Performance-Oriented Policies
Usually, performance-oriented policies are put in place by FDI host countries to
shift part of the benefits from home countries of FDI to host countries; minimize
the cost of private investments, and to encourage foreign investors to contribute
their quota towards the host countries developmental aspirations. In Nigeria, over
the years, these measures were intended to (a) encourage foreign investment firms
to use as many domestic inputs as possible (e.g by reducing the shares of imported
inputs step by step) so as to increase national income, save foreign exchange and
increase employment opportunities; (b) control the firms access to Nigerian
Financial market (so to crowd out indigenous entrepreneurs) and increase the
share of exports year by year, thus increasing the earnings of foreign exchange, (c)
reduce tax-evasion and transfer pricing, (d) maximize quantitatively and
qualitatively the direct effect on employment by fixing quotas for the various
levels of the employment pyramid, including the management level, by requiring
the training of domestic employees, the provision of health services etc, (e) use a
set of technology-oriented policies in order to restrict the inflow of undesirable
technologies, minimize the direct financial costs of technology transferred and
achieve greater R&D activities over a certain period of time, along with the firms
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access to the technology of their parent companies; (f) prevent the creation of
excessive market power or influence Nigerian institutions e.g by finding the right
balance between, on the one hand, promoting domestic enterprise and fostering its
growth against the competitive power of TNCs and, on the other hand, keeping a
reasonably efficient industrial structure which permits competition but allows for
the increasing size of individual firms in response to technological and
organizational progress, and (g) limit restrictive business practices especially,
restrictions on exports sources from which imports can be purchased, and the use
of development of technology.
Unfortunately, the above seven measures have over the years contradicted one
another (i.e some of them may have negative effects on the achievement of the
other national objectives) in Nigeria. For example, the developments of
‘manpower elite’ in the country have negative effect on income and regional
distribution in Nigeria. Apart from this, the implementation of many of these
policies has resulted into a lot of pitfalls because the required administrative
capacity is often insufficient for effective importation. Over the years their
implementations have not only ended up into policy backslashes, but in many
instances, counter-productive but not only in failing to meet the desired objects
but ended up in pushing many foreign firms out of the country. Why? This is
because the effects of some of them are not confined to Nigeria alone (e.g
requirement for export and performance, local content, advance technology and
high export subsidies), but they do lead to serious repercussions on the home
economies to TNCs operating in Nigeria. For instance, under TNCs network
systemic arrangement, policies like subsidies do distort international division of
production and consequently reducing global welfare. It is therefore important for
NIPC to enter into appropriate bilateral investment discussions that would lead to
agreements comprising not only investment protection and the avoidance of
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excessive requirement, but also to a core co-coordinated approach with respect to
incentive and regulatory policies by both countries.
v. The Importance of Clear Procedure and Smoothly Working Entry and
Administrative Systems
In line with recent literature (Morisset, 2000 and Dollar, 2001) that investment
climate plays an important role in the locational decision of foreign investors,
severe administrative barrier has created negative impact on Nigeria’s investment
image under the period of this study. Since time matters to investors, a country
where it takes excessive time and costs to accomplish all the procedures necessary
to establish and operate a business will definitely see its potential investors loose
money and they may decide to locate or re-locate elsewhere or cancel their
investment projects. While the magnitude of financial cost of the “red tape” in
administrative procedures for business approval and operation in Nigeria has not
been quantitatively calculated, it is yet a truism that has been very expensive for
foreign investors to start and even operate their businesses operations in Nigeria.
It is accepted within international law for governments to legitimately control
economic literature which equally justified government’s intervention in the
public interest theory of regulation as developed by Pigou (1939), so as to reduce
or eliminate the FDI impact of market failure.
However, excessive regulation can lead to substantial delay and costs to firms. In a
study by Morisset and Neso (2002), the current practices in terms of administrative
procedures towards FDI 32 developing countries were compared. The study
identified 26 core administrative procedures that are generally required to set up
businesses in the countries Table 5.1, Appendix 14; Nigeria was included in the
study and the statistics of year 2008 was used for the country Table 5.2 and 5.3,
Appendices 15 - 16. For simplicity, the study grouped the 26 core administrative
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procedures into three: (a) entry approvals, (b) access to land, site development and
utility connections, and (c) operational requirements, Table 5.1, Appendix 14. This
data revealed considerable variations in the number of administrative procedures
as well as the time and monetary costs associated to them across the countries. The
overall results for every country are summarized in Table 5.2, Appendix 15. The
report of the study showed that the costs faced by foreign investors appear
sufficient to explain why investors are influenced in their decisions to circumvent
administrative procedures by locating elsewhere or remaining in the non-official
economy. Among the procedures, the most expensive to foreign investors is the
category B, (i.e land, site development and utility), particularly in Nigeria where
this category costs as much as $13,750.00 compared to mere $47.00 in Madagascar
Table 5.2, Appendix 15. From the tables, the variation in the aggregate costs
between worst and best performer economies suggest the necessary explanations
for the pattern of FDI across the developing countries.
A further striking revelation from the study was that countries with the highest
number of procedures are not necessarily the ones with the largest delay or
greatest cost. For instance, Nigeria does not have many numbers of procedures, as
NIPC has shortened this compared to other African countries, but her costs to
foreign investors exceed 3 to 4 times those identified in Senegal, Mali and Ghana.
Latvia has more procedures for foreign investors to go through than Nigeria but
equally poses a greater capacity to deal efficiently with these procedures. This
appears to suggest that the delays and costs are either indicators of the
government’s capacity or willingness to respond to foreign investor’s requests or
due to inefficiency of the government bureaucracy. This development suggests
that, it is not-step agency per-se that constitutes a problem to foreign investor’s
entry into a country but rather inefficient regulatory agency charged with the
administration of foreign investments procedural arrangement in the country.
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In support of this claim, Morisset and Neso (2002) discovered that the level of
corruption or the lack of good governance do influence administrative costs as
bureaucrats and politicians are more likely to capture the consequent extra rents.
To them, corruption can be both the cause and the consequence of high
administrative barriers, and that under this double causality, it is always easier for
government to reduce or remove administrative procedures than to alter the
extent of corruption in a country (Bai and Wei, 2001). In the same way, it is
possible to argue that the degree of political freedom do affect the capacity of
regulatory agency to exploit rents derived from administrative procedures. For
instance, under the despositic regime of Babangida, Industrial Development Co-
ordinating Committee (IDCC) could not effectively function because of the
divergence of interest of the relevant ministers that constituted the committee.
(Aremu, 1991) exposed the resultant implications reflected in round tripping of
approvals, excessive delays and the use of the committee to granting of expatriate
quotas among interested members of the IDCC. Such a high level of corruption
was associated with high administrative costs as well as longer delays for
investors as resistance to improve what was resisted by both the bureaucrats,
incumbent enterprises as well as the corrupt civilian administration.
It is however disheartening that the recent study of Morisset and Neso (2002)
using 2001 information about Nigeria still saw the country’s ranking 4th among 26
countries of the world under the study in terms of excessive administrative
barriers towards local investment and 7th towards foreign investors. This again is
an indictment of the new NIPC as it is seen to be following the paths of its
predecessor, IDCC (Aremu, 1991) Table 5.3, Appendix 16.
Perhaps, it is equally crucial to mention here that transparent economic policies
are vital to foreign investors. In Nigerian economy, non transparent economic
policies had over the years imposed additional costs on doing businesses in the
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country. These additional costs arose as foreign investors have to resolve the lack
of information that should have been provided by the relevant governmental
agencies through other extra costs. Such additional costs also occurred because of
corruption which is another element of non transparency Table 5.4, Appendix 17.
Secondly, transparent economic policies could have facilitated cross-border
mergers and acquisitions into the economy. Thirdly, lack of transparency of the
national legal code towards the protection of property rights deterred many
investors into the country during period of this study (Table 5.4, Appendix 17.
Fourthly, transparent economic policies usually exert positive influence on
business attitudes as companies based their decisions to invest abroad on their
perception of what the economists like to call fundamentals (Hoekman and Saggi,
1999) among which are a clear, open and predictable economic policies to
minimize the risks of unpleasant and costly surprises. Lastly, countries policy
performance and transparency are monitored by outside agencies, and these
agencies provide information for prospective foreign investors. Clearly, many of
the information provided about Nigeria had negative repercussion about the
country’s investment climate. Such agencies include IMF, World Bank, WTO and
various private credit rating agencies. The lack of competitiveness of Nigeria’s
investment environment was again blown open in the recent report by the
Cornelius (2002). By using Growth Competitive Index (GCI) and the
Macroeconomic Competitive Index (MCI), the report was able to rank 80 countries
of the world selected for the study. While the GCI was based on three broad
categories of variables that are found to derive economic growth in the medium
and long term (i.e technology, public institution, and macroeconomic
environment), the MCI examines the underlying conditions defining the
sustainable level of productivity (such as the sophistication of companies and
operating practices as well as the quality of the microeconomic business
environment) in each of the 80 countries covered, Nigeria ranked poorly (78 out of
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80 countries) on the basis of public institutions index ranking while South Africa
was the 30th position, (Table 5.4, Appendix 17. With this revelation, NIPC is
performing woefully and must brace up, if it has any offer for Nigeria, to change
the negative image and climate investment in the country.
Customarily, potential foreign investors are usually attracted by having, from the
beginning, a clear idea of entry and operational conditions into a prospective host
economy. Such conditions are embodied within a general framework of laws, rules
or regulations required in attracting and controlling foreign investment. Such a
general framework in addition to providing sound economic policies as well as
direct assistance in the pre-investment phase offers potential investors clear,
unambiguous and reliable information about conditions well in advance and
avoiding zigzag policies.
Currently, NIPC is expected to perform this function in Nigeria. However, before
this time, a case-by-case approach in which numerous regulatory agencies were in
place and different approvals required at different governmental agencies
resulting in over lapping of jurisdiction. Apart from the serious strain this
approach imposed on the limited administrative capacity of the country, it led to
delays, and corruption which seriously impeded the process of obtaining
substantial inflow of FDI into the country. In addition, the approach was open to
discrimination (often concealed) among foreign investors and between foreign and
Nigerian investments Table 5.5, Appendix 18.
As earlier stated considerable gap existed between the rules set by law and official
policies implemented in Nigeria. This has explained the many administrative steps
and ministries and other governmental units involved in foreign investment
approval process before IDCC was set up, as well as, possible domestic pressure
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groups (particularly local industrialists who felt threatened by competition from
entrants of TNCs) delays were not surprising. It is crucial that NIPC engages
multilateral or bilateral technical assistance as well as domestic or foreign
consultants to overcome such bottlenecks. This perhaps is the secret of Costa Rica
in attracting sizeable FDI despite her geographical and economic size.
Looking beyond the immediate situation however, there is concern about the
possibility that the prevailing economic climate of the country may become one of
the low growths, worsening domestic conditions and bleak prospects for future in
relation to other developing countries. Inspite of the various government records
about improvements in the economy, international investors continued to be
increasingly risk-averse. Investors caution has equally hurt financial inflows to the
domestic capital market which has in recent years been depressing the local stock
indexes. The lingering pessimism about Nigeria’s economy is affecting the flow of
FDI into the country despite its vast competitive market vis-à-vis other African
economies. The possibility of the low level of FDI confidence index is perhaps one
of the greatest problems that the Nigerian authority is battling with. The
confidence index is constructed to gain the likelihood of investment in specific
market in order to gain insights into likely trends in global FDI. It is usually
computed as weighted average of a number of a high, medium, and low interest
response to a question about the likelihood of direct investment in a market over
the next one to three-year period.
The index values, for objectivity purpose, are based on one-source country
responses about various markets. All index values are usually calculated on a scale
of zero to three, with three representing highly attractive and zero not attractive.
In calculating FDI confidence index, the main secondary sources are UNCTAD,
the World Bank, IMF, the OECD, and an Economist Intelligence Unit. The primary
sources are of course from a proprietary survey administered to senior executives
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of the World 100 largest TNCs. The largest edition of FDI confidence index was
published by the Global Business Policy Council (2002). In the edition, China led
all the other countries of the world as the most attractive site for FDI. She was
followed by United States, while UK followed in third position.
vi. Impact of a Transparency on Foreign Direct Investment
To be able to describe transparency of policy, it is convenient to start with what
the word is not. Non-transparent policies are subject to corruption and bribery.
This is because non-transparency strengthens bargaining positions of the
beneficiaries from illicit payments accompanying bribery and corruption. This is
why Tansi (1997, and 1999) revealed that corruption distorts public investment.
Secondly, non-transparency features in era of property rights and their protection
within a given economy. The lack of copy right protection, the existence of patent
infringement and lack of enforcement of contracts are all examples of what
constitute poor protection of property rights. The protection of property rights is
vital for firms to pursue new investment and research in order to ensure that firms
will secure returns from their investments. Without this profit incentive, there is
little motivation to take risks in investing.
Apart from the absence of property rights, existence of weak property right laws
could also result in sub-optimal allocation of assets. Thirdly, and fourthly aspects
of non-transparency involve the level of bureaucratic inefficiency within the
government and poor enforcement of the rule of law. These two factors depose
severe barriers to business. If the quality of government service is unpredictable,
companies’ exposure to additional risks is increased. This is why OECD (1997)
report shows that bureaucratic inefficiency and weak rule of law impede economic
activities by imposing additional costs on economic agents. Delays in licensing
and approval procedures, the inability of the courts to enforce contracts and
capricious and arbitrary enforcement of rules and regulations all combine to
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reduce economic efficiency as well as effectiveness of foreign investor’s activities.
Finally, a non-transparent economic policy is another source. Economic policies
are seen as non-transparent if they are subject to unpredictable policy reversals.
This tends to put foreign investors off-limits as they are likely to demonstrate
extreme caution to invest and for capital flight.
Clearly, the period under study showed that the various interpretations of non-
transparency were well manifested in the country. Bribery and corruption,
inappropriate property right laws, bureaucratic inefficiency, poor enforcement of
rule of law and frequent policy swings were all common. Non-transparency in the
economy had imposed additional costs of doing business in the country. This
arose as firms were forced to tackle the lack of information that could have been
provided by appropriate Nigerian authorities through unorthodox means (such as
through bribing the relevant officials). In most instances, when bribes and
corruption occurred in Nigeria, it often led to selection and promotion of
investments that had little to do with the rational choices of the economy.
Consequently, majority of law-abiding foreign investors avoided coming to do
business in the country as they saw bribery as an inseparable part and parcel of
Nigerian business operations. The lack of transparency deterred FDI that would
have been attracted into the country via cross border mergers and acquisitions.
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CHAPTER SIX
SUMMARY, RECOMMENDATIONS AND CONCLUSION
6.1 Summary of Findings
The study examined the effectiveness of foreign direct investment policies in
Nigeria from 1985 to 2009, using evidence from a Keynesian Macroeconomic
Model. The model has five blocks, namely aggregate demand, aggregate supply,
government, external, and monetary block. These blocks were linked as structural
equations and then used to examine the six proposed FDI policies. These policies
include exchange rate policy (nominal exchange rate), government tax (corporate
tax burden / tax holiday), business environment (macroeconomic uncertainty),
private sector investment (size of the public sector in the economy), trade
protection zone (level of tariff on import), capital allowance and interest rate. The
percentages used for simulations were collected from Nigeria Investment
Promotion Council (NIPC) list of incentives in Box 1, aside exchange rate, size of
the public sector and output variability that were selected at random.
The results in Table 5.14 on policy simulation experiment (case one) show the
following: Firstly, that in the short run, corporate tax burden increase attracts FDI
as the result shows that FDI increase by 81.4% driven by the non oil sector and
64.37% in the oil sector. The trend however suggested that in the long run, tax
policy alone may not address the issue of FDI inflow. This is evident from the
replication of negative growth rate inspite of zero tax or tax holidays granted.
Secondly, between 1999 and 2008 non-oil FDI maintained a constant growth rate
irrespective of the tax rate applied as evident in Table 5.14. This is another
evidence of the inability of tax policy driving FDI inflow. The policy experiment in
Table 5.14 shows that FDI stagnated between 1999 and 2008. This is in agreement
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with the argument of the Irreversibility-Uncertainty Theory of Investment. The
argument is that irrespective of business and investment incentive, a high volatile
investment climate cannot attract investment.
Table 5.15 shows that the initial shock of exchange rate over valuation in 1986
decreased FDI inflow by reducing non-oil FDI from 69.5% to about 22.87%. After
the initial period, a rise in exchange rate from 20% running through 25% shows a
steady increase in FDI inflow at an average rate of 71.7% (Table 5.15). This shows
some level of mix reaction which may suggest the use of multiple instruments to
drive FDI policy in Nigeria. Privatization witnessed a first shock of response from
2005 – 2007, only to decline in 2008 and 2009. The increasing size of government
(size of the public sector effect) generates distortions in the economy, either
through X-inefficiency, or poor investment enabling environment.
Capital allowance in Table 5.14 brings about a steady increase in FDI inflow,
equally turning negative growth to positive growth before declining again
between 2008 and 2009. This negative reaction raises the same question of using a
single policy as an FDI incentive.
Table 5.9 shows that tariff rate is proven to be the highest determinant of import.
The implication is that if the rate of import is high as a result of low tariff, it will
limit to some extent the inflow of FDI into the country. This shows that
unrestricted importation militate against the inflow of FDI.
Table 5.15 suggests that single policy is incapable of driving FDI inflow. The
results show the net effect of granting tax holiday (zero tax) in an environment
with 30% volatility, 20% petroleum profit tax, 20% increase in the size of public
sector (weak privatization), 50% capital allowance for plants, and non trade
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protection of the domestic capital allowance for plant as published by NIPC in
Table 5.15. While one can make case for reduction in corporate tax burden (CTB)
so as to attract FDI, it does not seem to suggest sufficient condition.
6.2 Recommendations
Based on our research findings, the following recommendations are made.
i Adequate tax treaties network will help to encourage the inflow of FDI and
help in the growth of the domestic economy because as corporate tax burden
increases, there is a fall in FDI inflow.
ii Well-enforced competition law will help to increase the inflow of FDI.
iii Intellectual property protection, modern and well-enforced laws will
help to stimulate the inflow of FDI into the economy.
iv Exchange rate policy that is determined by the forces of demand and
supply will help in encouraging the inflow of FDI.
v Expatriate work and residence permit policy, flexible responses to
investor’s need will encourage the inflow of FDI.
vi Policy that does not place strict conditionality on repatriation of profit
will help to stimulate the inflow of FDI.
vii Government should limit her involvement in the economy and
encourage a market driven economy. Such a market driven economy
encourages inflow of FDI. A case at hand is that of the privatization
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exercise (2005 – 2007) that witnessed a first shock. The market driven
economy as proxy by privatization exercise in Nigeria increased the
inflow of FDI within the stated period.
6.3 Limitations of the study
The major problem of this research work is the inconsistency of data. Data
collected from the Central Bank of Nigeria and the National Bureau of Statistics
and even data from various volumes of Statistical Bulletins, sometimes conflict
with one another. Also, combining domestic chores with this research and
financial constraint posed a limitation to this study. Irrespective of the above
stated limitations, the accuracy and significance of the study are not affected, and
the concepts and analytical procedures employed in this study are those deemed
adequate to handle the problem at hand within the confines of the type of data.
6.4 Conclusion
Given the result on the policy simulation captured in Table 5.14, the study
concludes that the FDI policies adopted fulfil the necessary condition for attracting
FDI into the country but do not fulfil sufficient condition for attracting FDI into the
country. This is because there is no single policy that can sufficiently attract the
much needed FDI, hence the need for a combination of policies.
Contribution to Knowledge
Past studies used insufficient variables but this study tries to explore more
avenues to contribute to the debate in expanding the body of knowledge on the
subject matter. Also, the application of policy simulation isolates the effect of the
various policies separately for the discovery of a single policy not capable enough
in attracting the much needed FDI into the country.
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Suggestions for further studies
The following area is suggested for further study – The Regulatory Environment
and Foreign Direct Investment in Nigeria: Issues and Challenges.
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- 130 -
APPENDICES
Appendix 1: Long run unit root estimates
Consumption
Null Hypothesis: ECM_CONS has a unit root
Exogenous: None
Lag Length: 8 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -2.378633 0.0176
Test critical values: 1% level -2.590622
5% level -1.944404
10% level -1.614417
*MacKinnon (1996) one-sided p-values.
Investment
1) Investment oil
Null Hypothesis: ECM_INVO has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -4.493155 0.0000
Test critical values: 1% level -2.588530
5% level -1.944105
- 131 -
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
2) Investment non-oil
Null Hypothesis: ECM_INVN has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.311066 0.0011
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
Foreign Direct Investment
1) Foreign Direct Investment, oil
- 132 -
2) Foreign Direct Investment, non-oil
Null Hypothesis: ECM_FDIN has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -4.047880 0.0001
Null Hypothesis: ECM_FDIO has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.703924 0.0003
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
- 133 -
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
Oil output
Null Hypothesis: ECM_YO has a unit root
Exogenous: None
Lag Length: 4 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.260578 0.0014
Test critical values: 1% level -2.589531
5% level -1.944248
10% level -1.614510
*MacKinnon (1996) one-sided p-values.
- 134 -
Non-oil output
Null Hypothesis: ECM_YN has a unit root
Exogenous: None
Lag Length: 4 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -2.187046 0.0284
Test critical values: 1% level -2.589531
5% level -1.944248
10% level -1.614510
*MacKinnon (1996) one-sided p-values.
Export
Null Hypothesis: ECM_XN has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -7.443449 0.0000
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
- 135 -
Import
Null Hypothesis: ECM_M has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.612254 0.0004
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
Government recurrent expenditure
Null Hypothesis: ECM_GRE has a unit root
Exogenous: None
Lag Length: 1 (Automatic based on SIC, MAXLAG=12)
- 136 -
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -2.577344 0.0103
Test critical values: 1% level -2.588772
5% level -1.944140
10% level -1.614575
*MacKinnon (1996) one-sided p-values.
Government revenue
Null Hypothesis: ECM_GRV has a unit root
Exogenous: None
Lag Length: 1 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.588910 0.0004
- 137 -
Test critical values: 1% level -2.588772
5% level -1.944140
10% level -1.614575
*MacKinnon (1996) one-sided p-values.
Real balances
Null Hypothesis: ECM_M2 has a unit root
Exogenous: None
Lag Length: 4 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.529430 0.0006
Test critical values: 1% level -2.589531
5% level -1.944248
10% level -1.614510
*MacKinnon (1996) one-sided p-values.
- 138 -
Maximum lending rate
Null Hypothesis: ECM_RM has a unit root
Exogenous: None
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.974094 0.0001
Test critical values: 1% level -2.588530
5% level -1.944105
10% level -1.614596
*MacKinnon (1996) one-sided p-values.
- 139 -
Appendix 2: Model Forecast and Tracking
Appendix 3: Historical tracking of variables in the model
0
40000
80000
120000
160000
200000
1985 1990 1995 2000 2005
YN
15000
20000
25000
30000
35000
40000
45000
1985 1990 1995 2000 2005
YO
40000
80000
120000
160000
200000
240000
1985 1990 1995 2000 2005
Y
0
500000
1000000
1500000
2000000
2500000
3000000
3500000
1985 1990 1995 2000 2005
X
0
400000
800000
1200000
1600000
2000000
1985 1990 1995 2000 2005
TGE
10
15
20
25
30
35
40
1985 1990 1995 2000 2005
RM
0
50000
100000
150000
200000
250000
300000
1985 1990 1995 2000 2005
M2
0
400000
800000
1200000
1600000
2000000
1985 1990 1995 2000 2005
M
1000
1500
2000
2500
3000
3500
4000
1985 1990 1995 2000 2005
INVO
2000
4000
6000
8000
10000
12000
14000
16000
18000
1985 1990 1995 2000 2005
INVN
4000
8000
12000
16000
20000
24000
1985 1990 1995 2000 2005
INV
0
400000
800000
1200000
1600000
2000000
2400000
1985 1990 1995 2000 2005
GRV
0
200000
400000
600000
800000
1000000
1200000
1985 1990 1995 2000 2005
GRE
0
40000
80000
120000
160000
200000
240000
1985 1990 1995 2000 2005
FDIO
0
10000
20000
30000
40000
50000
60000
1985 1990 1995 2000 2005
FDIN
0
50000
100000
150000
200000
250000
300000
1985 1990 1995 2000 2005
FDI
.005
.010
.015
.020
.025
1985 1990 1995 2000 2005
CTB
30000
40000
50000
60000
70000
80000
90000
100000
110000
120000
1985 1990 1995 2000 2005
CONS
Baseline
- 140 -
.005
.010
.015
.020
.025
1985 1990 1995 2000 2005
CTB CTB (Baseline)
0
200000
400000
600000
800000
1000000
1200000
1985 1990 1995 2000 2005
GRE GRE (Baseline)
30000
40000
50000
60000
70000
80000
90000
100000
110000
120000
1985 1990 1995 2000 2005
CONS CONS (Baseline)
0
200000
400000
600000
800000
1000000
1200000
1985 1990 1995 2000 2005
GRE GRE (Baseline)
0
50000
100000
150000
200000
250000
300000
1985 1990 1995 2000 2005
FDI FDI (Baseline)
0
10000
20000
30000
40000
50000
60000
1985 1990 1995 2000 2005
FDIN FDIN (Baseline)
- 141 -
0
40000
80000
120000
160000
200000
240000
1985 1990 1995 2000 2005
FDIO FDIO (Baseline)
0
400000
800000
1200000
1600000
2000000
2400000
1985 1990 1995 2000 2005
GRV GRV (Baseline)
4000
8000
12000
16000
20000
24000
1985 1990 1995 2000 2005
INV INV (Baseline)
0
200000
400000
600000
800000
1000000
1200000
1985 1990 1995 2000 2005
GRE GRE (Baseline)
1000
1500
2000
2500
3000
3500
4000
1985 1990 1995 2000 2005
INVO INVO (Baseline)
- 142 -
0
400000
800000
1200000
1600000
2000000
1985 1990 1995 2000 2005
M M (Baseline)
0
50000
100000
150000
200000
250000
300000
1985 1990 1995 2000 2005
M2 M2 (Baseline)
0
400000
800000
1200000
1600000
2000000
2400000
1985 1990 1995 2000 2005
TGE TGE (Baseline)
2000
4000
6000
8000
10000
12000
14000
16000
18000
1985 1990 1995 2000 2005
INVN INVN (Baseline)
- 143 -
10
15
20
25
30
35
40
1990 1995 2000 2005
RM RM (Baseline)
0
500000
1000000
1500000
2000000
2500000
3000000
3500000
1985 1990 1995 2000 2005
X X (Baseline)
40000
80000
120000
160000
200000
240000
1985 1990 1995 2000 2005
Y Y (Baseline)
- 144 -
0
40000
80000
120000
160000
200000
1985 1990 1995 2000 2005
YN YN (Baseline)
15000
20000
25000
30000
35000
40000
45000
1985 1990 1995 2000 2005
YO YO (Baseline)
- 145 -
Appendix 4, Table 3.1:
Flow of non-oil foreign private capital (N’Million)
Source: Central Bank of Nigeria
Notes: 1/Provisional
**The FPI Survey was not started until 1962 and the maiden survey collected information for 1961
*Western Europe excludes UK
Source: Central Bank of Nigeria
Notes 1: Provisional
*** The FPI Survey was not started was not started until 1962 and the maiden survey collected information for 1961
* Western Europe excludes UK
- 146 -
Appendix 5, Table 3.2:
Flow of Non-Oil Foreign Private Capital (N’Million) Four Major Regions
- 147 -
- 148 -
Table 3.2 cont’d
- 149 -
Source: Central Bank of Nigeria
Notes: 1/Provisional
Appendix 6: Table 3:3a
Components of Net Capital Flow by Origin (N’Million): Unremitted Profit
- 150 -
Appendix 7: Table 3.3b
Components of Net Capital Flow by Origin (N’Million): Trade and Suppliers Credit (Net)
- 151 -
Appendix 8: Table 3.3c
Component of Net Capital Flow by Origin (N’Million): Changes in Foreign Share Capital (Net)
- 152 -
Appendix 9: Table 3.3d
Component of Net Capital Flow by Origin (N’ Million): Other Foreign Liabilities (Net)
- 153 -
Appendix 10, Table 3.3e:
Component of Net Capital flow by Origin (N’ Million): Liabilities to Head Office (Net)
- 154 -
Appendix 11, Table 3.4:
Component of Net Capital flow by Origin (N’ Million): Total
- 155 -
So
urce: C
entra
l Ba
nk
of N
igeria
No
tes: 1/P
rov
ision
al
**
Th
e FP
I Su
rvey
wa
s no
t started
un
til 19
62
an
d th
e ma
iden
surv
ey co
llected in
form
atio
n fo
r 196
1
*W
estern E
uro
pe ex
clud
es UK
- 156 -
Ap
pe
nd
ix 13
: Table
3.5
b
- 157 -
Appendix 14, Table 5.1
Summary of Administrative Procedures Categories
Source: Drabek (1998)
- 158 -
Appendix 15, Table 5.2:
Summary of Main Results per Country
- 159 -
Source: Drabek (1998)
- 160 -
Appendix 16, Table 5.3:
The Sample: Country Rankings According to their Transparency
- 161 -
Source: Drabek, Z (1998)
Source: Drabek (1998)
- 162 -
Appendix 17, Table 5.4:
GCI component indexes ranking comparison
Sour
ce:
Drab
ek
(1998
)
- 163 -
Appendix 18, Table 5.5:
Corruption Perceptions Index
- 164 -
Source: Drabek (1998)
- 165 -
Source: Drabek (1998)
Table 4.2 cont’d
Table 5.5 cont’d
