Full Project – THE DETERMINANTS OF INVESTMENT IN THE NIGERIAN ECONOMY

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CHAPTER ONE

INTRODUCTION

1.1. Background of Study

Investment expenditure in economic analysis is both a component of aggregate demand and an injection into the circular flow of national income.   It is a crucial variable on the supply side of the economy as it is the means by which changes in the real capital stock are brought about, thereby adding to country’s productive capacity.

Investment is spending devoted to increasing or maintaining the stock of capital. The stock of capital consists of the factories, machines, offices, and other durable products used in the process of production. The capital stock also includes residential housing as well as inventories. Gross domestic investment, therefore, represents total additions to a country’s capital stock. If the capital stock grows larger overtime, the increase in capital stock per period of time is known as net investment. Gross domestic investment, therefore, is made up replacement investment or depreciation and net investment. Gross domestic investment can also be classified into public and private. While private investment refers to expenditure in acquisition of machinery and equipment to increase the firm’s output, public investment comprises social and economic infrastructure.        The need to investigate the determinants of gross domestic investment stems from two main reasons. First, investment is more volatile than any other components of aggregate demand. Such volatility therefore affects the level of output and employment in the economy (P.A Olomola 2002). Second, investment has been regarded as the key to economic growth. Recent empirical studies conducted in Africa, Asia and Latin America have established beyond a doubt, the critical linkage between investment and the rate of growth (M.I. Obadan 2001).

In the light of the foregoing, this study investigates the main determinants of gross domestic investment in Nigeria, and the determinants of investment to be looked at include interest rate, inflation, exchange rate, financial savings, and external debt. All this determinants have the impact on the Investment of the nations and this research work is going to find the relationship between all these determinants and investment.

These determinant have their apriori specification (what it’s suppose to be) and they are as follows: Inflation is supposed to have a negative relationship with investment. Interest rate is supposed to have a negative relationship with investment. External debt is supposed to have a negative relationship with investment. Exchange rate and investment would have a positive relationship between them, so also would be the relationship between savings and investment It is believed that this study will provide necessary insights into the behaviour of gross domestic investment and the necessary steps in rekindling it in the Nigerian economy.

Some  empirical work has been carried out on this research and one says empirical determinants of private investment in developing countries he identified macroeconomic and institutional factors, such as financial repression, foreign exchange shortages, lack of infrastructure, economic instability, aggregate demand, public investment, relative factor prices and credit availability as important variables that explains private investment (Rama 1980).

Khatkhate (1988) adopted non-parametric methodology in his study on the relationship between interest rates and other macroeconomic variables, including savings and investments. He grouped 64 countries (including Nigeria) into three, based on the level of their real interest rates. He then computed economic ratios, among which were gross savings-income and investment-income, for the countries. Applying the Mann-Whitney test, he found that the impact of real interest rate was not significant for the three groups.

1.2. Statement of the Problem

Development economists have identified a strong correlation between investment and economic growth (Bamidele and Englama, 1998). Modern growth theory takes the view that economic growth is particularly the result of capital accumulation, as it is generally accepted that more capital goods will be required if there is to be growth.

In Nigeria, like most developing countries, public investment was dominant from the 1960s to1980s, within this period, particularly from the 1970s through the 1980s, the Nigerian economy witnessed a tremendous growth as a result of the oil boom Ajakaiye and Odusola (1997). Following the unprecedented oil earnings, there was an investment boom, especially in the public sector.  This is because when windfall savings were relatively high, investment expanded significantly. When domestic savings fall short of the desired level of investment, government resorted to foreign savings as a means of complementing domestic savings to finance investment. This consequently led, not only to debt overhang but also to poor growth performance of the economy.

Despite the adoption of Structural Adjustment Programme, Bamidele and Englama (1998) maintained that the rate of growth in gross domestic investment has been rather low. Iyoha (1998) also stressed that “the decline in investment in the late 1980s and the low investment-GDP ratio which persisted into the 1990s, no doubt, partly explains the slow growth rate of output during this period.”

In the light of the slow growth in gross domestic investment since the 1980s, the basic research questions which this study intends to address include: what are the key determinants of gross domestic investment in the Nigerian economy? What policy measures could be adopted to rekindle investment in Nigeria? This study sets out to empirically investigate these questions.

1.3          Objectives of the Study

The broad objective of this study is to empirically investigate the main determinants of gross domestic investment in the Nigerian economy.  The specific objectives of this study according to the following Molho (1986), Uchendu (1993), Iyoha (1998).include:

1. To examines the trend of gross domestic investment in Nigeria.
2. To find out the impact of interest rate (traditional lending rate) on gross real domestic investment in Nigeria
3. To investigate the impact of inflation on gross real domestic investment in Nigeria.
4. To find impact of exchange rate on gross real investment in Nigeria.
5. To find the impact of external debt on gross real investment in Nigeria
6. To find the impact of savings on gross real investment in Nigeria.
7. To provide necessary insight into measures that could be adopted to rekindle investment in Nigeria.

1.4          Justification of the Study

One belief that is fast becoming a dogma is the development orthodoxy that economic development depends critically on investment (see Kindleberger, 1965, pp. 83-102).

Despite the importance of investment in the growth process, evidence from the Nigerian economy indicates that the growth of this macroeconomic variable has not been impressive over the years. Even the negative real GDP growth in the early and mid-1980s could be attributed mainly to the collapse of investment (Iyoha, 1998) Recognizing the role of gross domestic investment in the nation’s economic growth process, several policies have been implemented over the years. Incidentally, these policies have not been yielding the expected results.

In the past years Nigeria used administrative control and before (SAP) in 1986 government used policy of low interest rate where nominal interest rate was fixed irrespective of the inflation rate, this caused saving deposit to be largely negative Ajakaiye and Odusola (1997) and the automatically reduced the amount of investment  funds.

The Structural Adjustment Programme (SAP) was brought in 1986 and the programme relied on market forces as well as the corresponding relaxation of the administrative controls. The major distortion of this programme was the regulation of interest rate given the above backdrops, it becomes crucial to investigate the main determinants of gross domestic investment in Nigeria.

1.5          Research Hypotheses

The hypotheses to be tested in this study include:

Ho:  There is no significant relationship between interest rate, and gross real investment in Nigeria.

H0:   There is no significant relationship between savings, and gross investment in Nigeria.

H0:               There is no significant relationship between inflation and Investment in Nigeria.

H0:          There is no significant relationship between external debt and Investment in Nigeria

H0:          There is no significant relationship between exchange rate and investment in Nigeria.

1.6          Scope of the Study

This study sets out to investigate the main determinants of gross domestic investment in the Nigerian economy. Gross domestic investment is made up of private investment and public investment. While private investment refers to expenditure in acquisition of machinery and equipment to increase the firm’s output, public investment comprises social and economic infrastructure.

In achieving the objective of this study, attention will be focused on the period 1970-2003.

1.7. Definition of Terms

Gross Fixed Capital Formation

This is the expenditure on fixed assets (such as building, machinery) either for replacing or adding to the stock of existing fixed assets.

Gross Capital Formation

This is often referred to as gross domestic investment. It is the total change in the value of fixed assets plus change in stocks.

Government Capital expenditure

This is the expenditure of the government on assets of permanent nature such as roads, building of dams, electricity etc. Expenditure on infrastructural facilities is capital expenditure.

Investment

This refers to the accumulation of real capital goods (that is, those which will yield a future flow of goods and services). We can distinguish between several kinds of investments, depending on the economic agents involved and the type of investment.

1.8          Plan of the Study

To facilitate proper analysis and adequate coverage, this study will be divided into five chapters, each dealing with the different aspects of the study. Chapter one of this study, focuses on the general introduction. It discusses the background of the study, statement of the problem, justification for the study, research objectives, research hypothesis, and scope of the study, plan of the study, definition of terms and expected contribution to knowledge.

In chapter two, the theoretical framework as well as literature review is considered. In this chapter, previous empirical studies on the determinants and trend of gross domestic investment in Nigeria will be reviewed. Chapter three of this study deals with the research methodology. Chapter four focuses on data analysis and interpretation of results.  Chapter five, on the other hand, deals with the summary, recommendations and conclusion drawn from this study.

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