Current Research Journal of Social Sciences 4(5): 338-342,2012ISSN: 2041-3246© Maxwell Scientific Organization, 2012Submitted: August 16,2011 Accepted: March 02,2012 Published: September 25,2012

Measuring the Impact of Fdi on Economic Growth in Nigeria

IM.S. Ogunmuyiwa and 20.1. OgunleyeIDepartment of Economics, Olabisi Onabanjo University, Ago-Iwoye, Nigeria

2Department of Accounting, University of Lagos, Lagos, Nigeria

Abstract: This study investigates the impact ofFDI on Nigeria's economic growth process. In an attempt todo this, the paper tests the validity of the modernization or depending hypothesis by employing variouseconometric tools such as Augmented Dickey Fuller (ADF) and Phillips Perron (PP) tests, Johansen Co-integration test, the Error Correction Mechanism (ECM) and Granger Causality test on time series data from1970-2008. The results reveal that a long run relationship exists between the variables and a unidirectionalcausality from Fl)] to growth was also established. Thus, empirical findings support the modernizationhypothesis that Fm is growth promoting in Nigeria.

Keywords: Co-integration, economic growth, error correction, FmJEL CLASSIFICATION: F21, F30, F23,040.

(Oyinlola, 1995; Adelegan, 2000; Akinlo, 2004;Ayanwale, 2007). Close examinations of previous studies

Within policy circles, there is a widespread belief that reveal that conscious effort has not been made to take careForeign Direct Investment (FDI) enhances the of the fact that more than 60% of the Fm inflows intoproductivity of host countries and promotes economic Nigeria is directed towards the extractive (oil) industry.development. This notion stems from the fact that FDI Finally, empirical literature indicates that a country'smay not only provide direct capital financing, but also capacity to take advantage ofFDI externalities might becreate positive externalities via the adoption of foreign limited by local conditions. Further, there is increasingtechnology and know-how (AIfaro et al., 2009). However, resistance to further liberalization within the economy.the empirical evidence on the existence of such positive This thus limits the options available to the government toproductivity externalities is sobering (Alfaro and source funds for development purposes and makes theRodriguez-Claire, 2004). option of seeking Fm much more critical.

During the past two decades, Fm has become This study contributes to existing literature byincreasingly important in the developing world, with a examining the relationship between FDl inflows andgrowing number of developing countries succeeding in Nigeria's economic growth; hence it addresses theattracting substantial and rising amounts of inward FDI. I country's specific dimension to the FDI growth debate.Economic theory has identified number ofvchannels . The main objective of this study is to examine thethrough which Fm flows may be beneficial to the host relationship between Fm inflows and economic growtheconomy. Yet, the empirical literature has logged behind in Nigeria by testing the validity of the two contendingand has had more trouble identifying these advantages in hypothesis (modernization and depending) hypothesis inpractice. Most prominently, a large number of applied Nigeria. While the modernization hypothesis posits thatpapers have looked at the Fm- Growth nexus, but their Fm could be growth promoting, the depending hypothesisresults have been far from conclusive. However, with the opine that FDI could have deleterious long term impact onavailability of better data, the last few years have seen an growth. The study considers more scope (between 1970especially large number of empirical papers devoted to the and 2008) as well as tries to ascertain the long-runquestion (Khaliq and Noy, 2007). sustainabilisy of the FDI- induced growth process in the

Nigeria as a country, given her natural resource base country.,and large market size, qualifies to be a major recipient ofFm in Africa and indeed is one of the top three leadingAfrican countries that constituently received FDI in thepast decade. However, the empirical linkage between FDIand economic growth in Nigeria is unclear, despitenumerous studies that have examined the influence ofFDIon Nigeria's economic growth with varying outcomes

INTRODUCTION

REVIEW OF LITERATURE ANDTHEORETICAL UNDERPINNING

Until recently, empirical literatures had perceivedFDI has been parasitic and retarding for the developmentof domestic industries for export promotion. Hence,

Corresponding Author: M.S. Ogunrnuyiwa, Department of Economics, OIabisi Onabanjo University, Ago-lwoye, Nigeria P.O.Box, 285, Ota Ogun state, Nigeria, TeI.: +2348055430044

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research interest in FDI stems from the change ofperspectives among policy makers from hostility toconscious encouragement, especially among developingcountries. Caves (1996) observes that the rational forincreased efforts to attract more FDI by host countriesemerges from the belief that FDI are productivity gains,technology transfers, introduction of new processes,management skills, and know how in the domesticmarket, employee training, international productionnetworks and access to markets.

Curiously, the empirical evidence ofthe benefits bothat the firm level and at the national level has beenambiguous. De Gregorio (2003), while contributing to thedebate on the importance of FDI, notes that FDI mayallow a country to bring in technologies and knowledgethat are not readily available to domestic investors, and inthis way increases productivity growth throughout theeconomy. FDI may also bring in expertise that the countrydoes not possess, and foreign investors may have accessto global markets.

The vast majority of research work on therelationship between FDI and economic growth are notsituated in Africa; however, there have been some studieson investment and growth in Nigeria with varying resultsand submissions. Odozi (1995) reports in his study on thefactors affecting FDI inflow into Nigeria in both the Preand Post- Structural Adjustment Programme (SAP) erasfound that the macro policies in place before the SAPwere discouraging foreign investors. This policyenvironment led to the proliferation and growth of parallelmarkets and sustained capital flight.

Ariyo (J998) studied the investment trend and itsimpact on Nigeria's economy growth over the years. Hefound that only private domestic capital consistentlycontributed to raising GDP growth rates during the periodconsidered (1970-1995). Furthermore, there is no reliableevidence that all the investment variables considered inhis analysis have any perceptible influence on economicgrowth. He therefore suggested the need for aninstitutional rearrangement that recognizes and protectsthe interest of major partners in the development ofNigerian economy.

Adelegan (2000) explored the seemingly unrelatedregression model to examine the impact of FDI oneconomic growth in Nigeria and formal out that FDI ispro-consumption and pro-import and negatively related togross domestic investment. Akinlo (2004) found thatforeign capital has a small and not statistically significanteffect on economic growth in Nigeria.

Furthermore, Odozi (1995) in his examination of thenature, determinants and potentials of FDI in Nigerianoted that foreign investment in igeria was made up ofmostly Greenfield, that is, it is mostly utilized for theestablishment of new enterprises and some through theexisting enterprises. Anyanwu (1998) identified changesin domestic investment, change in domestic output ormarket size, indigenization policy and change in openness

of the economy is the major determinants of FDl.Anyanwu further noted that abrogation of theindigenization policy in 1995 encouraged FDI inflow intoNigeria and that effort must be made to raise the nation'seconomic growth so as to be able to attract more FDl.

Finally, Ayanwale (2007) in his study on FDI andNigeria economic growth assert that FDI oncommunication ha~ the highest potential for contributingto growth; hence, It needs to be properly channeled intothe main stream of the economy. He noted thatcommunication FDl's potential contribution is severaltimes more than that of oil FDl.

METHODOLOGYThis study makes use of time series data sourced

from statistical Bulletin, Economic and Financial Reviewand Annual Reports and Statement of Accounts of theCentral Bank of Nigeria (CBN) and the Federal Office ofStatistics (FOS). The macroeconomic data cover GrossDomestic Product (RGDP) and Foreign Direct Investmentbetween 1970 and 2008.

The model: The model for this study uses Grangercausality test to ascertain the direction of causalitybetween GDP and external debt in Nigeria between 1970and 2008. Other econometric tests such as unit root testeo integration test and error correction mechanism wer~also performed to determine the stationarity of the dataand the long run relationship between the variables.The test procedure as described by (Granger, 1969) isillustrated below:

K

RGDP,= Ij-'K

Aj FDI ,.i+ Bj L RGDP ,..j+ Vi, (I)j=!

K KFDI, = '" C, FDI ,..,+" D RGDPt.- L. j ,.j+ V2,

i=) j=!(2)

Equation (1) postulates that current RGDP is relatedto past values of itself as well as that of FDl and vice-versa for Eq. (2). Unidirectional causality from FDl toRGDP is indicated if the estimated coefficient on thelagged FDI in Eq. (1) are statistically different from zeroas a group (i.e L Ai *- 0) and the set of estimatedcoefficients on "the lagged RGDP in Eq. (2) is notstatistically different from 0 (i.e LDj = O).The converse isthe case for unidirectional causality from RGDP to FDI.Feedback or bilateral causality exists when the sets ofFDIand RGDP coefficients are statistically different from 0 inboth regressions (Gujarati, 2004).

Also, the methodology adopted in this study followsthe study of Ayanwale (2007). He noted that investmentin a foreign country is categorized into two; market-seeking and non-market-seeking, which are both

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Curr. Res. J. Soc. Sci., 4(5): 338-342, 2012

motivated by characteristics of the host country. Themarkets seeking investments aim at serving domesticmarkets by selling goods produced in host markets inthose markets. For non market seeking, FDI aim to sellthe good produced in the host economy on marketsabroad. Since Nigeria is a beneficiary of both types ofFDI it will likely influence the nation's economic growth.Although, the evidence for the impact of -FDI oneconomic growth is far from conclusive, there seems to besome agreement as to the main determinants of growth. Inthe past, two main hypothesis on the influence ofFDI oneconomic growth has been identified; the modernizationhypothesis and the depending hypothesis (Ayanwale,2007).

The modernization hypothesis points that FDIpromotes economic growth by providing external capitaland through growth, it spreads the benefits throughout theeconomy. On the other hand, the depending thoughtinsists that there is deleterious long term impact ofFDI ongrowth. However, the foregoing suggests that a generalempirical model of FDI on Nigeria's economic growthcan be formulated. Hence, following the theoreticaldiscussion above and Ayanwale (2007) specification, thestandard long-run growth-FDI function written inlogarithm form is presented as:

~lnRGDP = ~o + ~16.InFDI + Ej

where, In is natural logarithm, RGDP is the real grossdomestic product. A proxy for growth, FDI is the foreigndirect investment, ~o is the constant term ~I is the slopewhile is the error term. The neoclassical aggregateproduction function (Ram, 1985) serves as a basis for theabove postulated equation. Also, on the basis of the earlierdiscussion, the expected sign for the efficiency ofFDI ispositive according to the modernization hypothesis i.e.,~I > o·

Table I: Unit root test result (1970-2008)

RESUL TS AND DISCUSSION

(3)

In modeling the Growth-FDI relationship, each oftheseries entering the model is estimated to determinewhether it is stationary and the order of their integration.The results of the Augmented-Dickey Fuller (ADF),Dickey and Fuller (1979) and Philips-Peron (PP) unit rotstests are reported in the Table 1:

The test result in Table 1 reveals the presence of unitroot in the properties of each series at their respectivelevels. However, after taking their first differences, theADF test statistics reveals stationary in the series. The PPtest on the other shows level stationarity in InRGDP whileInFDI is stationary at its first difference. The level ofsignificance for the tests is given at 1%.

Studies have shown that these tests lack power insmall samples; however, other studies give more credenceto the PP test because of its validity even if thedisturbances are serially correlated and heterogeneouswhile the ADF tests require that the error term be seriallyuncorrelated and homogeneous. Despite the shortcomingsof these tests, we cannot over-emphasize their importancefor empirical modeling because they show the order ofintegration among variables. Given the unit-rootproperties of the variables, we proceeded to establishwhether or not there is a long-run eo-integratingrelationship among the variables by using the Johansenfull information maximum likelihood method (Johansenand Juselius, 1990; Johansen, 1995).

The result of the eo-integration test is presented inTable 2. The result reported for the trace test andmaximum eigen value statistics shows that the nullhypothesis of no eo-integrating relation linking InFDI andInGDP is rejected at the 5% level of significance. The twotests indicate one eo-integrating equation between the twosenes.

Levels Order of integrationLag length: I

First differences

Variables ADF pp ADF pp ADF ppInRGDP -2.437421 -5.353636 -4.455327 1(1) 1(0)InFDI 0.165695 0.183199 -4.598377 -8.234240 1(1) 1(1)Critical values1% -3.639407 -3.626784 -3.653730 -3.6394075% -2.95 1125 -2.945842 -2.9571 10 -2.95112510% -2.614300 -2.61 I 531 -2.617434 -2.614300

Table 2: Johansen maximum likelihood co-integration test result (1970-2008)Panel A: Maximum eigenvalue and trace tests

HypothesizedNo ofCE(s)

Max-eigenstatistics

5% criticalvalueEigenvalue Prob.

Tracestaistics Prob.

5% criticalvalue

0.453690 14.26460 0.0109None*

19.34617At most I

0.010877 0.349977 3.841466*: Indicates rejection of the null hypothesis at 5% significarice level,<p ~

0.0072 19.69615 15.49471

0.554 I 0.349977 3.841466 0.5541

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Table 3: Error correction model result (1970-2008)

Curr. Res. 1. Soc. Sci., 4(5): 338-342, 2012

Variable Coefficient t-statistic ProbabilityConstant 0.027837 3.800068 0.0010O(GOP(-I» 0.330915 5.980689 0.0000O(GOP( -4» -0.122017 -2.324299 0.0302O(FOI) 0.014628 0.781707 0.4431O(FDI( -2» -0.034290 -1.842107 0.0796O(FDl(-4» -0.042218 -2.281505 0.0331ECT(-I) -0.035893 -1.406184 0.1743R-squared: 0.776896; F-statistics: 12.18778; Adjusted R-squared:0.713152; Probability (F-stat.): 0.000007; Akaike 1nfo Criterion:4.345781; Schwarz lnfo Crit.: -4.012730

Table 4: Granger causality test result (1970-2008)Lags: 4FOI does not granger cause GOP 3.19307GOP does not granger cause FDl 1.65918

0.033870.19698

Dynamic error correction specification: So far, theresult of the eo-integration shows that the variables in thespecified model tend to move together in the long-run.The short-run deviations from this relationship couldoccur due to shocks to any of the variables. The short-runinteraction and adjustment to long-run equilibriumbetween the variable is obtained through the Engle-Granger method. According to Engel and Granger (1987),if eo-integration exists between non-stationary variables,then an error-correction representation of the typespecified by equation below exists for these variables.

k=1

/::'InRG~ = I ol/::'InRG~_11=1

(4)k=1

+ I 02/::,InFDI1_1 + 0JECT;_I + J-l11=1

ECT'_I is the error correction term, which is the fittedresiduals from the eo-integrating equation and f.L, is awhite noise error term.

The error correction term shows how the systemadjusts to the long-run equilibrium implied by the eo-integration equation. In choosing the optimal lag for theright-hand side variable, the general-to-specific method ofeliminating insignificant lags is employed. Accordingly,we initially estimated an error correction model with fourlagged differences in the explanatory variables, oneconstant term and one Error Correction (ECT'_I) term. Thedimension of the over- parameterized model was thenreduced to a parsimonious ECM specification by usingsequential F tests, Akaike information criterion andSchwarz information criterion to exclude the statisticallyinsignificant lags. The result of the reduced short-rundynamic model is presented in Table 3. As expected, theError Correction Term (ECT'_I) is ofthe expected negativesign and highly significant. this result substantiate thefinding of the eo-integration test earlier reported more

importantly, the absolute value of the coefficient of theerror correction term indicates that 4% of disequilibriumin growth in offset by short-run adjustment each year.

The result further show that RGDP is influenced byits previous period values as well as current and previousvalues of foreign direct investment. The coefficient ofdetermination (adjusted r-squared) used to measure thegoodness-of-fit of the estimated model, indicates that themodel in accurate in prediction as it shows that 71% ofvariation in the endogenous variables is accounted for bythe included explanatory variables. The probability valueof the F-statistics further revealed that there is jointsignificance of the explanatory at 1% level.Causality test:

The Granger causality test as shown in Table 4 iscarried out to determine causality between lnRGDP andInFdl. The test result shows that the null hypothesis thatInFDl does not Granger cause InRGDP is rejected at 5%level of significance. While the null hypothesis thatInGDP does not Granger cause lnFDl is accepted Thisimplies that a unidirectional causality emanates fromforeign direct investment to real GDP. This thus explainsthat an increase in amount of foreign capital inflow couldlead to an increase in the growth of the economy.

CONCLUSION AND POLICY IMPLICATION

The objective of this study is to explore therelationship between FDl and GDP growth in Nigeria bytesting the validity of modernization or dependinghypothesis in the pre-policy reform (StructuralAdjustment Programme) and post-policy reform era inNigeria. The findings of the study support themodernization hypothesis and this indicates that FDlcontributes positively to Nigeria's economic growthdespite the structural change in the flow of FDl to theeconomy.

However, there is a strong need for the improvementin the nation's business environment in order to attractmore foreign investors, by consciously curbing corruptionthrough intensified and improved efforts of the two anti-graft agencies (EFCC and ICPC). Further, there is need toliberalize and improve the energy sector, such thatadequate electricity is supplied to organizations at lowercost in order to reduce the cost of doing business in thecountry to the minimum.

Finally, there is a critical need for the integration ofthe nation's human resources through improved educationand training to enable them contribute significantly intothe growth process especially by competing with theirforeign counter-parts that invest in home country. Theavailability of high quality personnel in the country willmotivate and foster the inflow of foreign capital into thedomestic economy.

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BIOGRAPHY: OGUNMUYIWA, M.S lectureseconomics at Olabisi Onabanjo University. He hasauthored and co-authored several books, published inreputable journals and has attended some learnedconferences.

OGUNLEYE, 0.1 also lectures accounting in thefaculty of business administration, university of Lagos.She has published some articles in journal and hasattended some conferences.

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