Full Project – Effect of foreign direct investment on the performance of manufacturing companies in Nigeria

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ABSTRACT

This research work empirically explored the effect of foreign direct investment on performance of manufacturing companies in South West Nigeria. The objectives of this study were to examine the effect of Foreign Direct Investment on manufacturing companies output in South West Nigeria, evaluate the effectiveness of Foreign Direct Investment in addressing fluctuation in manufacturing company’s output in South West Nigeria, to use econometrics models to investigate if a long-run relationship exists between Foreign Direct Investment and manufacturing companies output in South West Nigeria. The scope of the study was restricted to the use of Vector Error Correction Model (VECM). The variables affecting FDI that were examined are real interest rate (INT), real exchange rate (EXC), and inflation rate (INF) then manufacturing output (MAO) as the dependent variable. The period of coverage for the study was thirty-three years, from 1986 to 2019. The findings from the study revealed that in Nigeria, manufacturing output is affected by the level of Foreign Direct Investment (interest rate, exchange rate and inflation rate) investigated over the period of study.  However, the inflation rate channel has more effect on determining FDI when compared to other variables. Following the findings, it was recommended that government should embark on policy measures to balance the inflation rate, exchange rate and interest rate since they have significant impact on Nigeria manufacturing sector growth under the period reviewed, government should embark on policy measures to maintain macroeconomic stability and improve infrastructural facilities so as to encourage FDI, government should embark on policy measures to expand product markets so as to increase FDI level.

Keyword: foreign direct investment, manufacturing companies, Nigeria.

CHAPTER ONE

GENERAL INTRODUCTION AND BACKGROUND OF THE STUDY

• Introduction

Over the past decades, one of the objectives of policy makers in Nigeria has been the maintenance of economic stability that supports the growth of the real sector of her economy. Many scholars have argued that Foreign Direct Investment (FDI) is one of the most important factors for the promotion of economic growth and development, FDI is seen as an engine of growth to developing countries, by increasing the opportunities for capital flow, globalization, technology transfer which is often referred to as “spillover effect”, expansion of exports and employment opportunities which increase the potential of host countries. FDI creates employment opportunities and increases welfare by enabling build-up of physical capital, developing productive capacity, enhancing skills of local labour through technology transfer and managerial know-how, and integrating the domestic economy with the global economy (Liang, 2017; Melane-Lavado, Álvarez-Herranz and González-González, 2018). One of the most salient features of today’s globalization drive is conscious encouragement of cross-border investments, especially by transnational corporations and firms (TNCs). Many countries and continents (especially developing) now see attracting FDI as an important element in their strategy for economic development. This is most probably because FDI is seen as an amalgamation of capital, technology, marketing and management.

An increase in investment is crucial to the achievement of sustained growth and development in the country. This requires the mobilization of both domestic and international finances. Most countries strive to attract FDI to their manufacturing sector because of its acknowledged advantages as a tool of economic development. Many developing countries such as Nigeria have undertaken programs of external economic liberalization in recent decades (Wacziarg and Welch, 2008; Bascom, 2016; Picciotto and Mayne, 2016; Bhagwati, 2017; Dzorgbo, 2017; Salacuse, 2017; Seteolu, 2017; Blanton, Early and Peksen, 2018; Haggard and Kaufman, 2018; Njinyah, 2018; Shalev, 2018). Africa and Nigeria in particular joined the rest of the world to seek FDI as evidenced from the formation of New Partnership for Africa’s Development (NEPAD). One of the pillars on which the New Partnership for Africa’s Development (NEPAD) was launched was to increase available capital to US$64 billion through a combination of reforms, resource mobilization and a conducive environment for FDI (Funke and Nsouli, 2003).

Until recently, FDI was not fully embraced by Nigeria and other African leaders as an essential feature of growth in the manufacturing sector, reflecting largely to fears that it could lead to the loss of political sovereignty, push domestic firms into bankruptcy due to increased competition and, if entry is predominant in the natural resource sector accelerate the risk of environment degradation. Akinlo (2004) argue that much of African skepticism toward foreign investment is rooted in history, ideology, and the politics of the post – independence period. They also argue that the prevailing attitudes and concerns in the region are due in part to the fact that policy – makers in the region are not convinced that the potential benefit of FDI could be fully realized. In 1960, only 22 percent of all countries had such openness, but by 2016, 56 percent of countries were open to international trade (World Bank, 2018). Indeed, in recent decades, countries are not only open to trade, but also to other international flows such as foreign direct investment (FDI). The increasing openness has been fuelled by the desire of many developing countries to harness not only the growth effects but also the welfare benefits of such foreign flows (Klobodu and Adams, 2016; Magombeyi and Odhiambo, 2017; Evans, 2018).

Unfortunately, the efforts of most countries in Africa to attract FDI have been futile. This is in spite of the perceived and obvious need for FDI in the continent. Nigeria as a country, given her natural resource base and large market size, qualifies to be a major recipient of FDI in Africa and indeed is one of the top three leading African countries that consistently received FDI in the past decade, however, the level of FDI attracted by Nigeria is mediocre compared with the resource base and potential need (Asiedu, 2003). The UNCTAD World Investment Report (2003) showed Nigeria as the country second top FDI recipient after Angola in 2001 and 2002 in Africa also in 2006 UNCTAD shows that FDI inflow to West Africa is mainly dominated by inflow to Nigeria, who received 70% of the sub-regional total. However, despite the enormous flow of FDI to Nigeria and the theoretical assumption that it contributes to developmental effort of the recipient country, her economy has been characterized by low manufacturing capacity utilization, high level of inflation, heavy debt burden, high unemployment rate, high level of income inequality, poverty to mention a few. Yaqub (2010) characterised Nigeria economy to be sluggish in term of growth while Sola (2009) shown that the Nigerian economy is characterised by prolonged period of economic stagnation, rising poverty level and decline of it public institutions also Olukemi (2009) reveal that Nigeria was one of the richest 50 countries in the early 1970s has retrogressed to becomes one of the 25 poorest countries at the threshold of the twenty first century. This is accredited to poor performance of the economic sector and the sub sectors. Given the unpredictability of aid flows, the low share of the country in world trade, the high volatility of short-term capital flows, and the low savings rate of the country, the desired increase in investment has to be achieved through an increase in FDI flows, at least in the short – run (De Gregorio, 2003).

The empirical linkage between FDI and economic growth in Nigeria is yet unclear, despite numerous studies that have examined the influence of FDI on Nigeria’s economic growth with varying outcomes (Oseghale and Amonkhienan, 1987; Odozi, 1995; Oyinlola, 1995; Adelegan, 2000; Akinlo, 2004, Evans and Kelikume, 2018, Agbarakwe, 2019, Uwubanmwen and Ogiemudia, 2016, Lawrence and Mohammed, 2014). Most of the previous influential studies on FDI and growth in sub-Saharan Africa are multi country studies. However, recent evidence affirms that the relationship between FDI and growth may be country and period specific. Asiedu (2003) submits that the determinants of FDI in one region may not be the same for other regions. In the same vein, the determinants of FDI in countries within a region may be different from one another, and from one period to another.

Apart from the seeming difficulty associated with a clear-cut identification of the effect of FDI, the issue of an acceptably appropriate technique of measuring the effect has divided the researchers. Thus, over the years, several methodological techniques including Causality Approach, Vector Error Correction Model (VECM), Johansen Co-integration test, Structural Vector Autoregression (SVAR) and Chow Test Approach have been adopted to modeling the effect of foreign direct investment on manufacturing sector.

Against this backdrop, an evaluation of the effectiveness of foreign direct investment in manufacturing sector output especially the Nigerian economy has recently received attention in the literature. This is because a proper understanding of these effects will usefully informed the setting of trade policy targets and helps the authority to interpret with relative precision the effect in both macroeconomic and financial variables.

• Statement of the problem

Despite the various policy regimes adopted by Nigeria government, macroeconomic challenges such as inflation, exchange rate volatility, low manufacturing output continued to threaten the Nigeria’s economic growth. In the 1990`s, Nigeria embarked on policies and structural reforms leading to increased openness, lowered barrier to trade, liberalized its domestic financial markets and removed restrictions on capital movements, including the open war against corruption with the sole aim of attracting foreign direct investment inflow. One of the main objectives of Structural Adjustment Programme was to reduce the high dependence of the economy on crude petroleum, as a major foreign exchange earner by promoting non-oil export particularly manufactured goods. However, the manufacturing sector in Nigeria has benefited less from the increased volume of foreign direct investment inflow just as the sector`s contribution to GDP has not been significant.

In effect, the Oversea Development Initiative, (Odi,1997) noted that by the end of 1990s, Nigeria was the second largest recipient of Foreign Direct Investment among low income countries. However, despite the increase in foreign direct investment inflow, the output of the manufacturing sector has declined steadily, meaning that Nigeria is yet to fully tap its potentials from this sector. The persistent decline of the manufacturing sectors contributions to Gross Domestic Product fell steadily and could not play any leading role in exports expansion programme and employment generation to the army of unemployed youths in Nigeria.

According to Makwembere (2014), despite the widely publicized theory linking FDI to economic growth, it is on record that FDI inflows have not really translated to growth in developing nations. With the substantial rise in FDI into Nigeria in years past, little or no impact has been seen on job creation, technology transfer and economic growth.

Although, findings of many studies, such as Uwubanmwen and Ogiemudia (2016) and Agbarakwe (2019) on effect of foreign direct investment in manufacturing output revealed that the major determinant of FDI were the interest rate, the exchange rate, export level and inflation rate, the subject of which is more effective in generating FDI to manufacturing sector of the economy remained unresolved and had continued to generate much research.

Economists have employed a variety of techniques to solving the co-linearity problem, but none was entirely satisfactory. One of the techniques was the Solow production function, which approximate output as a function of stocks of capital, labour, human capital and productivity, and another was the Cobb – Douglas Production Function approach deployed, in assessing the nature of Foreign Direct Investment and its impact on sustainable economic growth in Nigeria, by Lawrence and Mohammed (2014). But these approaches are not free from endogeneity problem, particularly when relationships with domestic and foreign capital are involved.

There is also the problem of choice of appropriate techniques of modeling the effect of FDI. Perhaps the most common technique, and one employed by several studies, including this research, is the Vector Error Correction Model (VECM). However, the use of VECM in this research differed from previous studies in that it is complemented by robust least square regression model which previous studies seemed to have overlooked. This is to enable the researcher makes a comparison of the results from the estimated models.

On the basis of the aforementioned problems, the following research questions were raised for the study:

• What is the effect of Foreign Direct Investment on manufacturing companies output in South West Nigeria?
• How effective is Foreign Direct Investment in addressing fluctuation in manufacturing company’s output in South West Nigeria?
• Does a long-run relationship exist between Foreign Direct Investment and manufacturing companies output in South West Nigeria?
  • Objectives of the Study

The broad objective of the study is to evaluate the effect of Foreign Direct Investment on the performance of manufacturing companies in South West Nigeria. The specific objectives are as follows:

• To examine the effect of Foreign Direct Investment on manufacturing companies output in South West Nigeria.
• To evaluate the effectiveness of Foreign Direct Investment in addressing fluctuation in manufacturing company’s output in South West Nigeria.
• To use econometrics models to investigate if a long-run relationship exists between Foreign Direct Investment and manufacturing companies output in South West Nigeria.

• Research Hypothesis

The following null hypotheses were formulated to guide the study in achieving its objectives.

H₀₁: Foreign Direct Investment have not been effective in addressing fluctuation in manufacturing company’s output in South West Nigeria.

H₀₂: There is no significant long-run relationship between Foreign Direct Investment and manufacturing companies output in South West Nigeria.

• Justification of the Study

The effectiveness of Foreign Direct Investment critically depends on a proper understanding of the macroeconomic variables that affect the economy and in particular, interest rate, exchange rate and export level. The significance of Foreign Direct Investment in addressing manufacturing sector challenges had led to a wide range of research on the effect of Foreign Direct Investment on manufacturing sector performance.

This study provides a clear, sound and functional understanding of trade policy in Nigeria and this could help policy makers in the country to interpret with relative precision, the movements in both economic and financial variables. The outcome of study also revealed the strengths and weaknesses of the various policy regimes that have been adopted by the policy makers over the years, to address economic fluctuation in the country.

In addition, the study provides a link of causation between FDI and the manufacturing sector. This is very crucial to growth stimulation given that the manufacturing sector of the Nigerian economy is one of the most patronized sectors of the economy.

• Scope of the Study

In evaluating the effect of Foreign Direct Investment on manufacturing company’s performance in South West Nigeria, the scope of the study was restricted to the use of Vector Error Correction Model (VECM). The variables affecting FDI that were examined are real interest rate (INT), real exchange rate (EXC), and inflation rate (INF) then manufacturing output (MAO) as the dependent variable.

The period of coverage for the study was thirty-three years, from 1986 to 2019. The choice of the period of coverage was informed by the fact that most developments in trade policy shift in Nigeria happened between1986 and 2019. Such policy regimes include Structural Adjustment Programme of 1985, among others.

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Full Project – Effect of foreign direct investment on the performance of manufacturing companies in Nigeria