CHAPTER ONE
INTRODUCTION
1.1
BACKGROUND TO THE STUDY
Theoretically, both fiscal and monetary policies aim at achieving macroeconomic
stability (Folawewo and Osinubi, 2006). Over the years, two issues have been subjects
of debate in this regard. First is the effectiveness of each of these policies in the
achievement of macroeconomic stability. While Keynesians (1956) argued that fiscal
policy is more potent than monetary policy, the monetarists led by Milton Friedman
(1968) on the other hand believed the other way round. Although the focus of this
study is neither to join in nor extend the debate, but based on the country’s
experience and the fact that fiscal policy plays a vital role in preventing the occurrence
of fundamental disequilibrium in the economy, the study will analyze the impact of
fiscal policy in tackling macroeconomic stability in Nigeria.
The second relates to the issue of macroeconomic stability. Ocampo (2005), in
his study, recommends a broad concept of macroeconomic stability, whereby “sound
macroeconomic frameworks” include not only price stability and sound fiscal policies,
but also a well-functioning economy, sustainable debt ratios and healthy public and
private sector balance sheets. These multiple dimensions imply using multiple policy
1
instruments that involves active use of counter-cyclical macroeconomic policies (fiscal
and monetary), together with capital management techniques (capital account
regulations and prudential rules incorporating macroeconomic dimensions). It also
explores the role of international financial institutions in facilitating developing
countries’ use of counter-cyclical macroeconomic policies.
In his words, Ocampo (2005) posited that the concept of macroeconomic stability
has undergone considerable changes in the economic discourse over the past decades.
During the post-war years dominated by Keynesian thinking, macroeconomic stability
basically meant a mix of external and internal balance, which in turn implied, in the
second case, full employment and stable economic growth, accompanied by low
inflation. Over time, fiscal balance and price stability moved to centre stage,
supplanting the Keynesian emphasis on real economic activity. This policy shift led to
the downplaying and even, in the most radical views, the complete suppression of the
counter-cyclical role of macroeconomic policy. Although this shift recognized that high
inflation and unsustainable fiscal deficits have costs, and that “fine-tuning” of
macroeconomic policies to smooth out the business cycle has limits, it also led to an
underestimation of both the costs of real macroeconomic stability and the
effectiveness of Keynesian aggregate demand management.
2
This shift was particularly sharp in the developing world, where capital account and
domestic financial liberalization exposed developing countries to the highly pro-cyclical
financial swings characteristic of assets that are perceived by financial markets as risky,
and thus subject to sharp changes in the “appetite for risk”. In the words of Stiglitz
(2002), such exposure replaced Keynesian automatic stabilizers with automatic
destabilizers. Thus, contrary to the view that financial markets would play a disciplining
role, dependence on financial swings actually encouraged the adoption of pro-cyclical
monetary and fiscal policies that increased both real macroeconomic instability and
the accumulation of risky balance sheets during periods of financial euphoria which
led, in several cases, to financial meltdowns
Thus, the goal of macroeconomic policies has broadened in recent years. We have
only come part of the way, however, to the full recognition that macroeconomic
stability involves multiple dimensions, including not only price stability and sound fiscal
policies, but also a well-functioning real economy (Ocampo, 2005). A well-functioning
real economy requires, in turn, smoother business cycles, moderate long-term interest
rates and competitive exchange rates, all of which may be considered intermediate
goals of the ultimate Keynesian objective: full employment. Such a broad view of
macroeconomic stability should recognize, in any case, that there is no simple
correlation between its various dimensions and, thus, that multiple objectives and
3
significant trade-offs are intrinsic to the design of “sound” macroeconomic
frameworks. This view would lead to the recognition of the role played by two sets of
policy packages, whose relative importance will vary depending on the structural
characteristics, the macroeconomic policy tradition and the institutional capacity of
the country.
The first package involves a mix of counter-cyclical fiscal and monetary policies
with appropriate (and, as we will argue, generally intermediate) exchange-rate
regimes. The second includes a set of capital management techniques designed to
reduce the unsustainable accumulation of public and private sector risks in the face of
pro-cyclical access to international capital markets. To encourage economic growth,
such interventions through the business cycle would lead to sound fiscal systems that
provide the necessary resources for the public sector to do its job, a competitive
exchange rate and moderate long-term real interest rates. These conditions, together
with deep financial markets that provide suitably priced investment finance in the
domestic currency with sufficiently long maturities, are the best contribution that
macroeconomics can make to growth (Ocampo, 2005).
According to the National Economic Intelligence Committee (1998), fiscal policy
measures should aim at achieving an optimal balance between government revenue
4
and government expenditure and at complementing monetary policy in the
attainment of macroeconomic stability. Fiscal incentive in support of the policy should
be so structured as to promote growth in the various sectors of the economy. Olaloye
and Ikhide (1995), in their study concluded that fiscal policy has been more effective in
Nigeria, at least for the period of the depression i.e., between 1980 and 1989, and the
appropriate fiscal policy variable that the government should act upon is the
government expenditure. The total government spending might be more useful as a
policy tool rather than the fiscal deficit and the lag in the effect of fiscal policy are
shorter than for monetary policy. In other words, a reduction in the public expenditure
will take a shorter time (three to six months) to cause a fall in GDP than a similar
reduction in money supply.
Therefore, judging from the existing literature, it is desirable to undertake an
assessment of the impact of the fiscal policy measures (expenditure programmes) on
macroeconomic stability indicators (such as output and inflation rate) in order to
provide a guide to the restructuring and coordination of fiscal policy instruments
(government revenue and expenditure) and monetary policy variable proxy by money
supply on the macroeconomy.
5
1.2 STATEMENT OF THE PROBLEM
Nigeria witnessed a long history of macroeconomic instability, occasioned by large
fiscal deficits to GDP. For instance, this averaged 7.7% in 1994, 8.9% in 1999, 4.0% in
2001, 3.4% in 2005 and 2.9% in 2006. These deficits were accompanied by high level of
inflation rate; poor productive public sector investment and considerable debt
overhang. More specifically, prior to the recent economic reforms, Nigeria’s economic
performance was characterized by large macroeconomic instability for variables such
as inflation, exchange rates, etc; hostile business environment for private sector
growth and poor governance. The public sector was grossly mismanaged and overbloated (Babalola, 2007). Overall, most economic and social indicators were generally
poor, thus, there is wastage and misplacement of priorities (Olofin, 2001). Likewise,
the need to bring to recognition that during any fiscal period, numerous policies are
jointly implemented and there is a need for the harmonization of these policies (fiscal
policy coordination) so as to prevent policy conflicts (Iyoha and Itsede, 2003).
Usman (2008) reveals the adverse impact of fiscal policy on the Nigerian economy
in the past. He posited that the past failure of fiscal policy in Nigeria has been analyzed
within the framework of a commonly known term “Natural Resource Curse”. Where a
country endowed with verse amounts of natural resources fails to translate such
wealth into meaningful economic growth and development. The fiscal policy failure to
6
insulate the economy from the volatility of oil revenues has led to undue real exchange
rate appreciation and pro-cyclical fiscal policy with detrimental effects on investment
and growth. Other factors include dead-weight loss from taxes that finance public
spending, unproductive public spending on wages and salaries of unproductive
employees, and rent-seeking incentives reduce growth by diverting higher human
capital away from productive activities.
The question of sustainability has become an important issue not because current
unsustainable policies must later be reversed, but also because unsustainability
becomes a more and more important problem as time goes on and as deficits increase
because of debt accumulation (Anyanwu, 1997). Masson (1985) and World Bank
(1988) state that “It is precisely a conviction that the government is shortsighted in its
policies and biased towards overspending because of the nature of her political
economy, that makes sustainability an issue”. Anyanwu (1997) also posited that “with
unsustainable deficit, macroeconomic stabilization becomes a top priority but
structural economic adjustment cannot occur alongside major macroeconomic
imbalances just as stabilization without structural measures to support growth may
itself prove unsustainable”. Thus, stabilization and structural adjustment must be
coordinated to avoid inconsistency in policy. In this sense, adjustment should allow for
complementary fiscal reforms to replace any lost revenue (World Bank, 1988).
7
Olofin (2001) refers to “Stabilization” as an attempt by the government to regulate
the overall level of economic activity through definite measures or policies. Essentially,
stabilization of the Nigerian economy is the core of macroeconomic stability. Usman
(2008) in the 2nd Clement Isong annual memorial lecture said that “Macroeconomic
stability yields greater benefits through higher rates of investment and educational
attainment as expected rates of return can better be achieved in an environment of
low inflation”. He postulated that “Prudent fiscal policy can help enhance factor
productivity through the use of endogenous growth theory suggests that fiscal policy
can either promote or retard economic growth by its impact on decisions regarding
investment in physical and human capital, increased spending on education, health,
infrastructure, research and development can boost long-term growth”.
Therefore, a concerted effort to institutionalize fiscal policy operations towards
achieving macroeconomic stability would eliminate or minimize public sector deficit
(Itsede, 2003). To survive and restore sustainable growth and development, Nigeria
must ensure sound fiscal discipline that would aid the attainment of macroeconomic
stability. Therefore, the forgoing problems make raising the following conceptual and
policy questions a necessary exercise: What are the effects of fiscal policy measures
(fiscal spending) on the macroeconomic stability indices (GDP growth rate and inflation
rate)? How productive is the fiscal policy instruments? And what are the channels
8
through which the impact of fiscal policy measures (expenditure policy) get
transmitted within the economy? Pursuit of these issues leads to thorough
understanding of fiscal institutions with a careful analysis of the economic principles
which underlie budget policy.
1.3
OBJECTIVES OF THE STUDY
Broadly, this study seeks to assess the impact of fiscal policy measures (fiscal
spending) on macroeconomic stability indices (such as output and consumer price
index) in Nigeria. To achieve this, the following specific objectives are to be pursued:
(1) Examining the trends of the fiscal operations (expenditure programmes) in the
Nigerian economy (1970-2007);
(2) Investigating the effect of public expenditure on GDP growth rate and inflation
rate in Nigeria; and
(3) Identifying the channels through which the effect of fiscal policy measures
(expenditure policy) is transmitted in the Nigerian economy.
1.4
JUSTIFICATION FOR THE STUDY
Nigeria’s economic performance in the two decades prior to economic reforms was
generally poor. Over the period 1992 to 2002, annual GDP growth had averaged about
2.25 percent. With an estimated population growth of 2.80 percent per annum, this
implied a contraction in per capita GDP over the years that had resulted in a
9
deterioration of living standards for most citizens. Inflation levels were high averaging
about 28.94 percent per annum over the same period. By 1999, most of Nigeria’s
human development indicators were worse than, or comparable to, that of any other
least developed country (Okonjo-Iweala and Osafo-Kwaako, 2007).
Public expenditure profile is highly oil-dependent (Iwayemi, 2009). The Federal,
State and local governments that derive the bulk of their revenues from what they get
from the Federation Account, budget on the basis of what the price of oil and the
volume of oil production are expected to be in the budget year. Consequently,
whenever the price or volume assumptions behind the budget turns out to be
inaccurate, government experiences serious fiscal disequilibria either in the form of
sharp fiscal contraction or overspending. Ariyo (1993) provided an assessment of the
sustainability of fiscal deficit in Nigeria between 1970 and 1990.
Fiscal policy should be conducted so as to satisfy potentially conflicting policy
objectives. Efficient expenditure policy or resource allocation among private and public
uses was to be based on a full employment level of output while leaving it to the
stabilization branch-acting through tax and transfer measures-to ensure that this level
of output is provided. In the case of recession, this procedure will obviate calling for
additional expenditures to generate a higher level of employment, if such use of
10
resources would be undesirable at full employment. Under inflationary conditions, it
will avoid cutbacks in programmes merely to restrain demand. Although the public
sector should contribute its share when expansion or restraint in the total level of
expenditure is needed, there is no good reason why the entire adjustment should be in
that sector. Priority therefore goes to the tax-adjustment route. Pairing the tax
instrument with the stabilization and the expenditure instrument with the allocation
target has much merit in principle but must be qualified in practice (Musgrave and
Musgrave, 2004).
Government expenditure should serve as a form of compensatory financing
which implies that when the economy is in a depression and undesirable
consequences such as increased unemployment sets in, it needs some compensatory
financing to pull it out of depression either by way of increasing government
expenditure or reduction in taxes or a combination of both. On the other hand, when
the economy is in a boom and inflation among other ills threatens, the government
would need to apply necessary breaks on the economy, dampening the boom effect
either by reducing direct government expenditure or increasing taxes. This in a
nutshell sums up the basic principle involved in conventional government fiscal policy
control and how they are expected to work (Olofin, 2001).
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Public expenditure issues have risen to the top of the agenda of international
public finance since the 1980s. Irresponsible expenditure in unproductive activities had
stunted growth- this fell in real terms from 4.7 percent in 1991 to 1 percent in 1994
and 2.2 percent in 1995 and to 3.3 percent in 1996. The excess or irresponsible public
expenditure has been blamed in good part for the assortment of ills that beset the
economy in the 1980s, over-spending leading to over-indebtedness while overindebtedness in turn led to the debt crisis beginning in 1982. Today, these issues
occupy the centre stage in the massive adjustment programmes in many developing
nations and the reform programmes sweeping Eastern Europe. Public expenditure can
simply be seen as the absorption of resource by the public sector (Anyanwu, 1997). On
the other hand, public expenditure programming is a comprehensive set of
expenditure policy measures designed to achieve a given set of macroeconomic goals,
including the restoration of equilibrium between aggregate domestic demand and
supply (IMF Institute, 1993).
In addressing the issue of fiscal policy and macroeconomic stability, most studies
have been carried out on the effectiveness of fiscal policy on macroeconomic variables
in Nigeria. Hence, this study is necessitated by the poor performance of
macroeconomic stability indicators before, during and after the Structural Adjustment
Programmes (SAP) that was introduced in 1986. This study also differs considerably
12
from other studies by developing a small macro econometric model of the Nigerian
economy using stochastic equations. Therefore, the structural form of Barro
Endogenous Growth Model would be employed to show the relationship between the
macroeconomic variables (output, inflation rate, for the purpose of this study) and
fiscal policy instruments (government revenue and expenditure) and monetary policy
variable proxy by money supply.
1.5
SCOPE OF THE STUDY
This study will focus on the effect of fiscal policy and macroeconomic stability on
the Nigerian economy over the period spanning 1970-2007. The choice of the period is
as a result of data availability and this helps to capture the various fiscal regimes under
the different government regimes experienced in Nigeria. Also, this has being informed
by the availability of uniform time series data on the variables of interest to the study.
Annual time series data will be employed by this study to conduct the investigation.
1.6
METHODOLOGY
This study employs secondary data. These were sourced from the various issues of
the publications of the Central Bank of Nigeria (CBN) such as Statistical Bulletin,
Bullion, Economics and Financial Review and CBN’s Annual Report and Statement of
Accounts for various years. Also, other relevant publications from the Federation
13
Ministry of Finance, Federal Office of Statistics, World Bank, IMF Institutes and elibrary were used as sources for data.
Therefore, with the use of time series data, the research work employed the
methodology which tests for stationarity and co-integration as well as error correction
model (ECM).
1.7
PLAN OF THE STUDY
The study would be structured into five chapters, with the first chapter being
introductory;
Chapter two reviews the literature and brief overview on fiscal policy and
macroeconomic stability as well as its policy implications for the Nigerian economy;
The third chapter devolves on the theoretical framework and methodological
issues;
The fourth chapter specifies the empirical models and the results coming from
the analyses were discussed in the chapter; and
The fifth chapter concludes the study with the summary of findings, policy
recommendations and suggestion for further research.
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CHAPTER TWO
LITERATURE REVIEW
2.1 THEORETICAL REVIEW
Fiscal policy involves the use of taxes and changes in government expenditure to
influence the level of economic activity. On the the hand, monetary policy is
concerned with the use of changes in money supply and/or interest rates to influence
the level of economic activity (Ekpo, 2003). Fiscal and monetary policies are
inextricably linked in macroeconomic management as development in one sector
directly affects developments in the other. Undoubtedly, fiscal policy is central to the
health of any economy, as government’s power to tax and to spend affects the
disposable income of citizens and corporations, as well as the general business climate
(Okonjo-Iweala, 2003).
Fiscal policy is that part of government policy concerning the raising of revenue
through taxation and other means and deciding on the level and pattern of
expenditure for the purpose of influencing economic activities or attaining some
desirable macroeconomic goals. In essence, the primary objective of fiscal policy is to
balance the use of resources of the public and private sectors and, by so doing, to
avoid inflation, unemployment, balance of payment pressures, and income inequity
15
(Anyanwu, 1997). To attain these objectives, budget must be seen as exhibiting certain
features. It is a plan (a financial plan of operation), it is for a fixed period, it must be an
authorization to collect revenue and incur expenditure, it must be a mechanism of
control of both revenue and expenditure, and it must be objective-oriented.
On a broader basis, the budget is not only an instrument of economic and social
policies but also as planning tool, instrument for coordination, and an instrument for
communication. Therefore, a good budget requires comprehensiveness, a meaningful
presentation of the state of budgetary balance and an appropriate grouping of
expenditure items (Anyanwu, 1997). There are thus two sides to the effects of the
public budget on economic growth. On the one side, there is concern with the impact
of taxation upon private capital formation, but on the other, and no less important,
there is the strategic contribution made by capital formation in the public sector
(Musgrave and Musgrave, 2004).
A history of fiscal policy in recent decades cannot be written in a few pages.
Indeed, it cannot be undertaken without also examining the changing performance
and structure of the economy at large, and without giving equal time to monetary
policy as partner in the conduct of stabilization. Nevertheless, the changing role and
tasks of fiscal policy have become apparent even from this cursory survey. Bursting on
the scene in the great depression of the thirties, fiscal policy had its heyday in the war
16
economy of the forties and once more came into its own in the earlier half of the
sixties. Thereafter, the problems of stagflation arose, greatly complicating the task of
stabilization by aggregate demand management, be it fiscal or monetary in approach.
While the danger of rapid inflation had abated and a reasonable high level of
employment had been secured, the trade repercussions of a sustained budget deficit
continued, and a faulty mix of stabilization policy remained to be corrected (Musgrave
and Musgrave, 2004).
A major challenge for the Nigeria economy was its macroeconomic volatility driven
largely by external terms of trade shocks and the country’s large reliance on oil export
earnings. By some measures, Nigeria’s economy ranked among the most volatile in the
world for the period 1960 to 2000 (World Bank, 2003). Public expenditures also closely
followed current revenues, implying fluctuations in oil earnings were transferred
directly into the domestic economy. Fluctuations in public expenditure reflected both
the over-reliance on oil earnings and weak fiscal discipline by previous governments.
Volatile fiscal spending also tended to cause real exchange rate volatility. In particular,
fiscal expansions financed by oil revenues often resulted in domestic currency
appreciation, creating Dutch-disease concerns and reducing competitiveness of the
non-oil economy (Barnett and Ossowski, 2002).
17
Public expenditure, while stressing the end product, is designed to consider the
pursuit of policy objectives of government in light of all economic costs of the
programmes. Public expenditure programmes stress the relationship between various
outputs and the inputs necessary to produce them, facilitating the use of techniques to
analyze alternative programmes that will attain the goals and various alternative
means of implementing them. This approach seeks to be all-inclusive, recognizing all
contributions that the activity makes and all costs incurred, regardless of
organizational structure (Due, 1968). The correct measure of public expenditure is
therefore an important prerequisite for macroeconomic management. How the public
expenditure is measured has an important bearing on an analysis of the
macroeconomic implications of deficits (Fischer and Easterly, 1990).
2.2
REVIEW OF EMPIRICAL LITERATURE
This sub-section presents a review of the empirical literatures on the linkage
between fiscal policy and the macroeconomic stability. The debate on fiscal policy
measures in developing countries for sustainable development, especially Nigeria, is
not a new issue, as there are studies that have examined it. Sloman (1995) ascribed
two main roles to fiscal policy. The first was to remove any deflationary or inflationary
gap, that is, to prevent the occurrence of fundamental disequilibrium in the economy.
18
The second role was to smoothen out the fluctuations in the economy associated with
the trade cycle. This would involve reducing government expenditure or raising taxes.
Prasad and others (2003) posited that there is now overwhelming evidence that
pro-cyclical macroeconomic policies and pro-cyclical financial markets have not
encouraged growth; they have in fact increased growth volatility in developing
countries that have integrated to a larger extent in international financial markets. This
has generated a renewed but still incomplete interest in the role that counter-cyclical
macroeconomic policies can play in smoothing out, that is, in reducing the intensity of
business cycles in the developing world. At the same time, since the Asian crisis,
recognition has grown that liberalized capital accounts and financial markets tend to
generate excessively risky private sector balance sheets, and that an excessive reliance
on short-term external financing enhances the risks of currency crises. Preventive
(prudential) macroeconomic and financial policies, which aim to avoid the
accumulation of unsustainable public and private sector debts and balance sheets
during periods of financial euphoria, have thus become part of the standard recipe
since the Asian crisis. This represents, however, only a partial return to a countercyclical macroeconomic framework, for no equally strong consensus has yet emerged
on the role of expansionary policies in facilitating recovery from crises.
19
Empirically, a number of studies have investigated the effect of government
infrastructure investments on private sector productivity and growth. Using time series
data for the United States, Siegel (1976) reported significant and positive values for the
elasticity of public infrastructure investment and growth on the order of 0.3 to 0.4.
Smith (1978) estimated an elasticity of 0.45 from their cross sectional data on nine
OECD countries. He also studied 38 developing countries in 1985 using data covering
the period 1980-84 and found that capital expenditure on infrastructure had a
significant positive impact on output growth.
Teriba and Ajayi (1975) studied the effects of fiscal policy on macro economic
variables between October 1967 and May/June 1969. In their study, they discovered
that government expenditure as well as fiscal deficit has a negative impact on both
inflation and balance of payment. In the case of economic recession and
unemployment, the two fiscal policy variables were highly effective to restore them
back to equilibrium.
Omoruyi (2000) in his study showed that the major cause of macroeconomic
instability and low growth in national output were the unsustainable level of fiscal
deficits, financed through borrowing from the banking system and poor management
of deficit finance which gave little attention to the heavy scheduled debt service
obligations. He highlighted that a prudent fiscal policy can contribute to the
20
achievement of macroeconomic stability and growth. However, deficit financing by
borrowing from the banking system and poor management of deficit finance can also
lead to instability and poor economic performance.
Oyejide (1972) believed that rapid economic development is tied to a rapid rate of
capital formation and he demonstrated with the aid of data that the methods of
financing government deficit in Nigeria have been inflationary. To him, deficit financing
may be defined as an increase in the amount of money in circulation where such an
excess results from a conscious governmental policy designed to encourage economic
activities which would otherwise not have taken place. He said further that deficit
financing could be defined as domestic credit creation, which is not offset, by
increased taxation, more restrictive bank credit policy and similar deflationary
measure. He explained that the most obvious measure of deficit financing is the fiscal
deficit on current account, which represents the gap between current expenditure and
current revenue.
Oyejide explained further in his analysis that fiscal deficit of the government have
been finance by drawing upon past and current savings of the economy, foreign
assistance and increase simply by borrowing from the banking system. He formulated
a regression model with the view to establishing the theoretical relationship between
money supply and government expenditure and to be able to quantify the domestic
21
price level, deficit and the rate of capital formation. He concluded that the policy of
deficit financing in Nigeria gained strength rapidly between 1957 and 1970. The policy
was used as a means of financing capital formation for economic development and
was accompanied by a phenomenal increased in the domestic price level, even though
the policy of deficit financing also encouraged the process of capital formation as listed
in pre-war period. The policy implication, he said, is that in a less developed country,
sustained growth of deficit financing can hardly take place without some amount of
inflation.
Therefore, judging from the existing literature, there seems to be economic
problems of stabilization and this requires solution of the macroeconomic
disequilibrium phenomenon in Nigeria. Indeed, it is desirable to undertake an
assessment of the impact of the fiscal policy measures (expenditure policy) on
macroeconomic stability indicators (such as output and inflation rate) in order to
provide a guide to the restructuring and coordination of fiscal policy instruments as
well as monetary policy measures proxy by money supply on the macroeconomy.
2.3
FISCAL POLICY AND MACROECONOMIC STABILITY
2.3.1
Review of Basic Concepts
Macroeconomics is the study of a whole economy. In the study, we are
interested in the determination of broad aggregate in the economy such as national
22
output, inflation, money supply, unemployment, balance of payment etc. The present
day Macroeconomics has its origin in John Maynard Keynes (1936), in his “General
Theory of Employment, Interest and Money”. Keynes repudiated traditional and
Orthodox economics which had been built up over a century and which dominated
economic thought and policy before and during the Great Depression (see Jhingan,
2001) for its instability to tackle the prevailing problems of unemployment and chronic
inflation in Great Britain and USA, particularly in 1930.
The main premises of the neoclassical economists (such as Mill, J. S., Alfred
Marshall, A. C. Pigou, J. B. Say, etc.) are that market works and price signals bring
about the necessary adjustment in the economy in response to economic changes.
That is, full-employment of labour, output and price stability would result from the
interaction of aggregate supply of labour and aggregate demand for labour such that
full employment output generally would be produced and purchased. Thus, market
forces of demand and supply generally would ensure equilibrium in the economy and
that in the line with marginal physical theory and pricing of inputs, the income
distribution would reflect in labour and other inputs’ productivity.
Keynes on the other hand, argued that once an economy had moved into a
situation of high unemployment, the price mechanism would not work to adjust the
economy back to the level of employment. Keynes posited that the government could
23
only raise the demand for output by increasing only government expenditure. Once
demand has increased, firms will supply more output and employed more people
which would lead to higher demand.
In the light of Keynesian revolutionary thinking, they advocated the necessity of
government management of the economy by the use of fiscal policy to achieve
macroeconomic objectives. Thus, Keynesian economics is sometimes called “demand
side economics” because of the central role that the demand (or expenditure) plays in
the analysis.
However, the theory of increasing government fiscal activities which is based
on two schools of thought need to be considered because of the interventionist
economy. The first school led by Adolph Wagner (1890), postulated that the expansion
in government fiscal activities was as a result of economics, technical and social
development. The second school of thought led by Peacock and Wiseman (1961)
argued that the expansion was as a result of social upheavals notably wars, epidemic,
etc. Considering the proposition by Peacock and Wiseman, it could be seen that it
cannot play much significant relevance for our study relative to that of Wagner (1890
and 1893).
According to Wagner (1893), there are inherent tendencies for the activities of
governments to increase both intensively and extensively. He attributes this to the
24
traditional functions of the State in providing and expanding sphere of public goods.
Thus, the traditional functions given by Adolph Wagner’s theory are: the rapidly
changing role of the government and the intervention of the state in free market in
order to ensure the re-distributive justice (see Bhatia, 2002).
The afore-mentioned brought about functional relationship between the
growth of an economy and the growth of government expenditure such that the latter
grows faster than the former. Nitti (1903) concluded with empirical evidence that the
‘Law of increasing Government activities’ was not only applicable to Germany as
posited by Wagner, but to various governments which differed widely from each
other. Wagner also distinguished functional government expenditure, which were
administrative, economic, services as well as social and community services. Whereas,
Enwenze (1974) in his own contribution reported that developing countries tend to
increase their expenditure on administration as well as social and community services.
However, Lotz (1970), Philips (1971), and Faforiji (1984) did not address the
components of total expenditure. Thus, none of the above studies did address the
concept of transfer payments. A possible justifiable argument for the omission could
be that deficit financing accumulation of which is public debt overhang which transfer
payments is directed at servicing was relatively at its low ebb as at that time.
25
In fact, the debt services component of total expenditure relatively to its nondebt component has become a topical issue in Nigeria and other LDCs. The rationale
behind this has been the economic implication of relationship. A situation whereby the
debt component of total expenditure is substantial will no doubt impede economic
growth. This will be better appreciated if we realize that the government through the
public sector is the chief agent of economic development in most LDCs including
Nigeria.
However, there was no clear clarification of the concept that Wagner
employed. This made it rather difficult to ascertain whether he was referring to an
increase in: (i) absolute level of public expenditure; (ii) proportion of public sector to
the total economy, and (iii) the ratio of government expenditure to Gross Domestic
Product (GDP). Since any interpretation given to the concept has influenced on
whatever results obtained, hence, we adopted the third option with some variation for
the purpose of our study. This is because option (i) did not address inflation, which
could bias the absolute figures, while option (ii) could run into the difficulty of
qualification. However, option (iii) is not only easier but also addresses the
shortcomings of the other options.
26
Theoretically, it is argued that total government expenditure adjusts more
rapidly than revenue to price level variation in such a way that bank-financed
budgetary deficit set in (Aghevli and Khan, 1970). There are several reasons why
government expenditure in any developing country (Nigeria is not exempted) is
expected to adjust faster than revenue in the face of nominal income increase arising
from inflation, and they include: the fact that even if the government in any
developing country fully recognizes the need to control its expenditure during period
of inflation and the country’s low nominal income elasticities and long lags in tax
collection. It should be noted that Aghevli and Khan (1977), using the above reasons
developed a model to study Brazil, Columbia, the Dominican Republic, and Thailand (
all developing countries) as closed economies. It is our expectation that these reasons
could also be applied in Nigeria as an open economy thereby creating a variant of
Aghevli and Khan Model.
2.3.2 Evidence from Developed Nations
This sub-section basically serves as an insight into various arguments, views and
empirical works that have been developed for fiscal policy analysis both in developed
and developing countries.
27
Empirically, a number of studies have examined the impact of public
infrastructure investments on private sector productivity and growth. Barro (1979), in
the analysis of Swedish data, found that infrastructure investment has a significant
productivity effect, leading to lower labour requirements for firms. However,
Chowdhury (1991) found no statistically significant relation between infrastructure
capital and output growth in the United States.
Using data from American States, Mundell (1962), and Jorgen (1973) reported
positive, but smaller, elasticity on the order of 0.15 to 0.5. Schlessinger (1986) adopted
a more disaggregate approach, drawing on data from American States covering the
period 1956-86, to look at the effect of public infrastructure investment not on
aggregate productivity but rather on productivity in 12 different two-digit industries. In
theory, this approach would allow for the possibility that public infrastructure
investment is important for some industries but not other, which could explain the low
aggregate elasticity found in the studies. They found that infrastructure investment
has a positive effect on total factor productivity in each of manufacturing industries
they study, but that the elasticity tends to be small. Asegaer (1988), however, using
data on Mexican industries between 1970 and 1983, found that public infrastructure
spending has a significant, positive, but small effect on output.
28
In another study, the impact of tax incentives (fiscal instrument) on investment
also shed some light on the impact of tax policy on the investment decision. Snyder
(1970) review a number of studies that have attempted to analyze the impact of tax
incentives for investors in Brazil, Malaysia, Mexico, Korea, the ASIAN Countries as a
group, the Philippines, Sri Lanka, Columbia and Thailand. They found that most of
these studies concluded that tax incentives in place in these countries do not stimulate
new investment but instead provide windfalls for investments that would have
occurred anyway. Vashist (1991) examined the impact of tax incentives (specifically
the rebate of direct and indirect taxes on exports, investment tax credits, and tax
holiday) in Korea and found that tax policy accounted for less than one tenth of
Korea’s growth between 1962 and 1982. David and Ansariu (1995) carried out a
number of studies on the impact of tax incentives typically resulted in more lost
revenue than additional investment, and that the elimination of non-tax disincentive
to investment. For example, a lack of adequate infrastructure would do more to
stimulate investment than would tax incentives.
In addition, Handa (1970) examined the extent to which the pattern of foreign
investment in American States was affected by their corporate income tax rates. He
found that the higher a states corporate income tax rate, the high is the share of
investment that originates from firms located in countries that grant domestic tax
29
credits for taxes paid to American States, and suggesting that states taxes significantly
affected the pattern of foreign direct investment.
In the study of Darrat (1986), he worked with cross section data from a sample
of 20 countries spanning a range of per capital national incomes. He found that tax
ratio has significant, negative impact on growth. However, when he included the
growth rate of gross domestic investment and the labor force among the independent
variables, he found that the coefficient on the tax ratio, while still negative, is
significant only at the 10 per cent level. He did not include initial per capital GDP as a
control variable. However, when he divided his sample into ten higher-income and ten
lower-income countries, he found that the tax ratio had a significant, negative impact
on growth rates in low income countries but not in the higher-income countries. For
the sample as a whole, he also found that the tax ratio had a significant, negative
effect on the growth rate of investment, although among individual categories of taxes
only domestic taxes on goods and services and not corporate taxes, personal income
taxes, or taxes on foreign trade had a significant effect. He found that only social
security taxes have a significant (negative) effect on labor force growth and
productivity growth. The negative effect of social security taxes may be due to more
generous pension benefits including earlier retirement.
30
Shaw (1986) used data from 107 countries over period 1970-85 and found that
changes in the aggregate average tax rate did not have a significant effect on output
growth. He did find, however, that increase in the aggregate average tax rate had a
negative effect on the marginal productivity of investment in physical capital and to a
lesser extent, on labour.
Jorgen (1973) used cross-sectional data based on period averages for 1970-73
and observed that the marginal rate of income tax (calculated by regressing a time
series data of income tax revenues on a time series data of GDP for each country) had
a significant, negative effect on per capita GDP growth, but that no other tax measures
did. He did find those income taxes, the ratio of domestic taxes to GDP, and the ratio
of domestic taxes to consumption plus investment had significant, negative effects on
the share of private investment in GDP.
2.3.3 Evidence from Developing Nations
Chowdhury (1991) suggested that growth in government expenditure has a
greater impact on changes in nominal income than the growth in monetary base. He
added that the effect of a change in the growth rate of government expenditure on
nominal income last for a relatively longer period of time, compared to a change in the
growth rate of monetary base. Moreover, the magnitude of the effect is also greater
31
in case of the fiscal policy variable. The estimated equation was also found to exhibit
structural stability implying its usefulness for the purpose of forecasting and policy
analysis.
Blejer and Khan (1984) provided a comprehensive attempt at understanding
the impact of different types of public investment expenditure on private investment
and growth. This study confirmed the hypothesis that investment on infrastructure has
a positive effect on private investment and economic growth, whereas a noninfrastructure investment has a negative impact. As was observed by Chibber and
Danlami (1990), the results of this study were not conclusive because of the absence of
a detailed breakdown of public investment expenditure.
Manas-Anton (1986) in his study observed the effect of income taxes on per
capital output growth, using a sample of period average data for 39 developing
countries over the period of 1973-1982. He discovered that both the ratio of income
taxes to GDP and the ratio of income taxes to total taxes collected had significant
negative effect on per capita GDP. However, when he included each of the ratios of
personal and corporate income taxes to total tax collections in his regression, he
observed that while the coefficient on each remained negative neither was significant.
Thus, while his results provided some indications that relevance on income taxes
32
tended to correlate with lower output growth, this relationship cannot asserted with
confidence (see Packard 1966).
2.3.4 Evidence from Nigeria
Ghosh (1972) supported the relative effectiveness of fiscal policy in an
economy. He argued that budgetary policy has a significant effect on income,
employment, and output in the long run, even if there is no new money in supply.
Public debt is, in fact, as crucial as the stock of money. A rise in the growth of interestbearing debt would lead to a rise in the equilibrium growth of nominal income,
without a corresponding rise in the rate of money expansion. Government debt is
expansionary and balance budget multiplier can give the economy substantial leadway for growth. He further stated that fiscalists have a non-monetary theory of price.
They put forward the view that money is not neutral. In fact, it is possible to change
the rate of interest in several ways. The price of money, to a non-monetarist, is
thought to be the rate of interest. Due to variations in velocity and output, moneyprice proportionality is not possible in the short run. The acceptance of Philips curve
relation depicting a permanent trade-off between unemployment is clear indication of
fiscalist proposition of non-neutrality of money. When it is difficult for monetary policy
33
to counteract short run cyclical fluctuations, fiscal policy may prove to be a better
device for it has a shorter lag. It is not proper to rely simply on the central bank for
controlling the money supply, which is incapable for solving macroeconomic
imbalances.
Ekeoku (1974) argued that the effective policy instruments in the system
relative to the tax rates (that is, personal tax, company tax, and excise duties and
others), is the government external borrowing. However, since government capital
expenditure as a whole are usually financed by external loans, and government deficits
are worsened by these capital expenditures, this may seems to deviate from prior
expectations. A point to be clarified here is that only an aspect of total government
expenditure is considered and a mere relative strength of the instruments, from the
simulation, is being put forward. Thus, in the light of the results, it is expected that the
government can bring about increases in the output of different sectors by adequately
utilizing this policy instrument (fiscal policy).
Gbosi (1995) pointed out that with particular reference to government finances
available data indicated that there was a remarkable decline in government revenue
for the period. This adversely affected execution of various economic and social
programmes. The analysis also highlighted that the Nigeria economy performed fairly
34
well under the deregulation as oppose to regulation. This was seen in the impressive
growth in real output under deregulation.
Adeyeye and Fakiyesi (1980) regressed prices on money and government
expenditure, and obtained a coefficient of 0.84, through which the price level was
regressed on individual variable, they obtained no significant result. They concluded
that the evidence supported their thesis that inflation in Nigeria is due to the factors of
money supply and government expenditure. Madan (1961) made a strong case for
fiscal policy because monetary expansion-contraction (brought about by monetary
controls) may induce growth. This reason was strengthen by the belief that fiscal
investment was much more powerful than monetary tools in the area control
consumption and investment, which were the important components of the GDP.
Others like Nwachukwu and Adeleke (1992) believed that despite the observed merit
of fiscal policy, it should not be seen at the mutually exclusive but as complement
policy to monetary policy.
Ojo (1982) regressed the rate of inflation on both structural and monetary
variables such as shift in demand, variability of exports, foreign exchange scarcity,
excess demand, money supply and budget deficit. His useful conclusion is that neither
35
the monetarists nor the structuralists’ model is good enough to be able to explain
completely the cause of inflation in Nigeria.
Ndebbio(1998) established that an increase in money supply (M2) by 10%
resulted in an increased in endogenous variables like government expenditure,
government revenue and import, means annual growth rates stood at 23.9 per cent,
12.3 per cent and 9.3 per cent respectively. The result also established a two-way
system in which simultaneously, fiscal deficit is caused by inflation and inflation is also
caused by fiscal deficit. The simulated results of Ndebbio in the same study for Nigeria,
confirmed the fact that government expenditure in less developed countries usually
adjust faster than government revenue in the face of nominal income increase arising
from inflation [Aghevli and Khan, 1977].
2.3.5 Fiscal and Monetary Policies Practice in Nigeria
Oil has turned Nigeria from revenue generating to a revenue sharing nation.
This has led to immense difficulties in enshrining fiscal discipline at all levels of
government. Given the underdeveloped nature of the country’s securities market, it is
not surprising that monetary policies have consistently been ineffective in this
environment of fiscal dominance. Given the fact that both monetary and fiscal policies
impact on economic growth and development, it is not surprising that they are
36
entwined. Fiscal and monetary policies are inextricably linked in macroeconomic
management as development in one sector directly affects developments in the other.
Undoubtedly, fiscal policy is central to the health of any economy, as government’s
power to tax and to spend affects the disposable income of citizens and corporations,
as well as the general business climate (Ezeoha and Uche, 2006).
In this regard, the interrelationship between fiscal spending and private sector
performance is of paramount importance. On one hand, Government expenditure can
provide an impulse for private sector growth, while on the other, it can be harmful if it
results in budget deficits and leads to competition for scarce financial resources from
the banking sector as the government seeks to finance the deficit. In such
circumstances, the crowding out of the private sector by the Government sector can
outweigh any short-term benefits of an expansionary fiscal policy. The key to all theses
therefore lies in striking a good balance in fiscal management. Having enough
expenditure outlays to meet the needs of Government and support growth, but not so
much as to deny the private sector the resources it needs to invest and develop
(Okonjo-Iweala, 2003). Furthermore, Government fiscal recklessness resulting in deficit
financing can also cause inflation, which contradicts the fundamental monetary policy
objective of price stability. This has the potentials of destabilizing the macroeconomic
environment thereby retarding economic productivity and development.
37
There is no doubt that the failure of government fiscal policies, rather than the
failure of monetary policies, is the main reason why most of the past developmental
programmes undertaken by the Government has come to naught (Ezeoha and Uche,
2006). This is so despite the fact that the conventional theory tends to suggest that a
central bank uses monetary policy instruments to predominantly influence the general
price level. This broadly translates into the monetary theory of the price level, which
implies monetary dominance in the determination of the price level. In reality
however, fiscal policy is sometimes dominant. This is especially so in countries with
underdeveloped securities markets which essentially limit the ability of a central bank
to effectively develop and use monetary policy instruments.
This has been explicitly explained by Oyejide (2003) thus, “In principle fiscal
dominance occurs when fiscal policy is set exogenously to monetary policy in an
environment where there is a limit to the amount of government debt that can be held
by the public. Hence if the inter-temporal budget constraint must be satisfied, fiscal
deficits would have to be magnetized, sooner or later. In fact when the size of the
financial system is small relative to the size of the fiscal deficits, a central bank may
have no choice but to magnetize the deficits. Thus, in countries with shallow financial
systems, monetary policy is the reverse side of the coin of fiscal policy and can only
play an accommodative role. In such low income countries, government securities
38
markets are underdeveloped and central banks do not hold sufficient amounts of
tangible securities and the central bank’s lack of suitable and adequate instruments of
monetary control constitutes one of the factors that induce fiscal dominance. Where
fiscal dominance applies, the country’s economic policy is only as good as its fiscal
policy and institutionalized central bank independence may not necessarily bring
about an independent monetary policy”.
There is no doubt that Nigeria clearly meets all the requirements for fiscal
dominance. In fact, concerns about the fiscal dominance nature of the country,
especially the underdeveloped securities market predates the advent of central
banking in Nigeria. Monetary activities in the country have been based on the control
of inflation and the need to create a stable macroeconomic environment. Government
has, in their desperate measure to control inflation undertaken monetary policies that
have had disastrous long-term consequences. For instance the sudden change of
currency colour during the Buhari regime in the 1980s. This no doubt reduced the
amount of money in circulation and thus impacted on inflation. However, it led to a
major loss of confidence in the Naira and damaged its ability to serve as a regional
currency for West Africa. This was because huge Naira reserves held outside the
country, especially in the West African sub-region, were essentially demonetized in the
process (Uche, 2001). The failure of the monetary policy variants to engender the
39
stable macroeconomic environment necessary for economic growth and development
in the face of fiscal dominance led to the adoption of The Structural Adjustment
Programme (SAP) in 1986.
Undoubtedly, the most important factor that has impacted on both the level
and character of fiscal policy in the country is the advent of oil as the main stay of our
economy. Over dependence on oil resources and the volatility of the oil market has
been transmitted to the rest of the economy. This has been explained by Baunsgaard
(2003) thus: “With about 75 percent of revenue from oil and gas, fiscal policy in Nigeria
has been heavily influenced by oil driven volatility impacting both revenue and
expenditure. Since 1970, both revenue and expenditure have been very volatile while
increasing over time. In periods with high oil prices, such as in 1979- 82, 1991-92, and
more recently in 2000-02, revenue and expenditure have increased sharply. This has
typically been followed by the scaling back of expenditure as oil prices subsequently
decline, though at times with a lag. The implications of such boom-bust fiscal policies
include the transmission of oil volatility to the rest of the economy as well as
disruptions to the stable provision of government services. This has added to the
failure over the years of public spending, neither facilitating the diversification and
growth of the non-oil sector nor reducing poverty”.
40
Aside from the negative impact of the transmission of oil volatility to the rest of
the economy, the enormous oil windfalls have helped alter the country’s revenue
allocation formula by facilitating the change in focus from revenue generation to
revenue sharing. The implication of this is that Nigeria has essentially become a rentier
state where sharing of assets is based not on economic justification but political
control. The consequence has been the development and growth of an unproductive
civil service, proliferation of local governments, states and government agencies and
institutions with doubtful productivity value (Ezeoha and Uche, 2006).
2.4
IMPLEMENTATION OF ECONOMIC REFORMS IN NIGERIA
Nigeria’s public revenues structure has been dominated by oil revenues since
the early 1970s. Oil revenues rose sharply from 26.3% of total revenues in 1970 to
reach 82.1% in 1974. The share of oil in government revenues has remained at more
than four out of every five naira of government revenue inflow (Iwayemi, 2009). Rapid
oil revenue inflows, which accrued largely to the government, underpinned rapid
expansion in government fiscal operations. Also of important is the legacy of the
military governments, whose philosophy was more centrist/unitary than federalist, has
compounded the inefficiencies and inequity in fiscal governance and fiscal
sustainability.
41
The issue of fiscal inequalities has generated considerable debate and tension
among the federating units. The issue has been highly contentious in the country
because the bulk of the intergovernmental transfers are derived from taxation of nonrenewable natural resources that are often concentrated in a few sections of the
country because of the inequity in the political redistribution of such centrally
collected revenues. Most often, the ‘cake-sharing’ grossly undervalues the serious
impact of the negative externalities of natural resource production on the economy
and society of the producing areas. In addition, and of importance is the politics of
revenue sharing arrangements which neglects or abstracts from the negative incentive
effects of intergovernmental transfers on fiscal sustainability of the sub- the transfer
system negatively affect fiscal performance at both national and sub-national units,
and Nigeria is a case in point. Intergovernmental transfer arrangement is at the heart
of Nigeria’s fiscal federalism. Thus, the impact of the of the neglect of the incentive
problems created among the different jurisdiction which creates significant economic
inefficiency at the expedience of satisfying the narrower political objectives of the
dominant ethnic groups should be of analytical and policy interest (Iwayemi, 2009).
The current revenue sharing system produces inefficient fiscal and economic
outcomes (Iwayemi, 2009). This is hardly contentious among analysts. The design of a
more robust revenue sharing system and efficient intergovernmental transfer
42
mechanism is central to long term economic and political stability of federal systems
especially in natural resource dependent developing countries. Two issues are often
considered important in the design of a robust revenue sharing arrangement. First, the
transfer system should provide a risk-pooling mechanism for states or region in the
federal system as they alternately experience economic booms and shocks. Economic
theory suggests that such risk-sharing mechanism is welfare improving. Second, given
that horizontal and vertical inequalities characterize most federal system, such
transfers are essential in minimizing inter-state social and economic disparities and
support weak fiscal bases. However, weak fiscal bases are not necessarily due to low
revenue generating capacity of states and local governments. In Nigeria, the key causal
factor efficiency and equity reasons, such free-rider and opportunistic behavior should
be minimized, and better still, discouraged (Iwayemi, 2009).
2.4.1 Fiscal Federalism Reform
The advent of oil has eroded fiscal federalism systematically in favour of fiscal
centralism. The demand for resource control has intensified against the distributional
inequity in the sharing of oil rent which has not really favoured the oil producing
communities and their lack of basic infrastructure and general state of
underdevelopment (Iwayemi, 2009). Oil exploitation has yielded enormous revenue
43
gains to non-oil producing regions which have not been exposed to the devastating
environmental externalities of oil and gas communities despite the social and
environmental effects of petroleum exploitation and their economic deprivation for
almost four decades has and continues to fuel the destabilizing tendencies in the
federation. The federal grip over access of the oil the main source of government
revenues has been at hearts of Nigeria politics, economics and governance in the last
three decades (Phillips, 1991; Ikporukpo, 1996; and Onimode, 2001).
More importantly, the political process has absorbed a large amount of oil
resources to satisfy conflicting regional and ethnic interests in an underdeveloped
economy operating a psendo federal political system. The creation of new states
funded from oil wealth became a political solution to appease a people with rising
expectations about their share of the “national oil cake.” The financial implications of
their administrative and infrastructure development combined with the activist
political and social roles of the government have systematically imposed politically
sensitive burdens on public finances (Iwayemi, 2009).
The major problems identified with the incentive implications of the Nigerian
fiscal system are: first, the lack of fiscal correspondence between revenue generation
and expenditure at the sub-national levels. So, public spending is not connected in any
44
significant way to internally generated revenue based on local tax effort encourages
most state and local governments to believe they do not face a hard budget constraint.
Second is the fiscal behaviour at the sub-national level which is highly procyclical and is determined in most states and local government by tax revenue sharing.
The sharing of Excess Crude Oil Revenues and the bi-monthly sharing of revenues from
the Federation Account continues to pose significant monetary policy challenges for
the Central Bank of Nigeria whose key mandates is to keep inflation in check.
Thirdly, the issues of optimal mix of taxation, greater efficiency in expenditure
and procurement becomes unimportant for the governments when the bulk of their
revenue for a tier of government comes from transfer from other tiers, fiscal efficiency
will be of low priority. Finally, there is lack of equity and fairness and inefficiency
associated with the politically redistributed revenues when the formula is loaded with
factors which reflect the preferences of those states with weak tax effort. These
factors that are used in sharing revenue have entrenched the imbalance and cheap oil
revenues from have encouraged poor tax compliance, weak tax base and tax
administration. This has served as a disincentive to fiscal prudence and sustainability
(Iwayemi, 2009).
45
Given the foregoing, there are problems associated with revenue sharing that
generate significant Pareto inferior revenue distribution with considerable impact on
political and economic stability. It is therefore important to explore how some of these
emerging problems can be addressed. Thus, there is need to implement Paretoimproving revenue allocation policy. At Pareto-optimal, the revenue allocation formula
will provide incentives for any tier of government that want to exert more tax effort to
generate more revenues in their specific areas of jurisdiction rather than being a freerider as is currently the case. The revenue sharing problem should be reformulated as
a classic principal-agent paradigm under moral hazard conditions (Iwayemi, 2009).
Also, the government should overhaul the Nigeria’s fractious revenue sharing
arrangement to minimize the anomalies identified in the system. And more
importantly, properly design an inter-governmental transfer system that compensates
federating units for tax effort are necessary (sine qua non) for both long-term political
and economic stability. The bearing of such an approach to fiscal transfer on fiscal
prudence, sustainability and political stability of the federation and social harmony
should be evident. Enough of opportunistic fiscal behaviour otherwise the ultimate
economic and social outcomes may be against the long-term of the federation
(Iwayemi, 2009).
46
Therefore, governments are expected to address resource distribution inequity
and the associated fiscal imbalances in the environment. Also, they must use transfers
to induce some sub-national units to internalize social and economic externalities
through the adoption of certain socio-economic programmes, such as the Millennium
Development Goals, education, health, environmental quality, and infrastructure.
2.4.2 Macroeconomic Reform
The main function of government either democratic or military is to protect
and promote the welfare of its citizens. In performing this, government must choose
the most suitable economic policy to pursue. Whatever form of the objectives that the
government pursued, fiscal and monetary policies play a key role in the promotion of
the government macroeconomic goals of promoting the welfare of its citizens. In his
budget speech shortly before independence in 1960, the then Finance Minister, late
Chief Festus Okotie-Eboh made it explicit that the financial and economic policies of
government would be directed towards “the achievement and maintenance of the
highest possible rate of increase in the standard of living” (CBN Annual Report, 1960).
In 2006 Appropriation Bill, President Olusegun Obasanjo in his speech
presented at the Joint Session of the National Assembly stipulated that the budget has
been prepared in the context of a Medium-Term Expenditure Framework that looks at
47
projections for years 2007 and 2008 with a focus on “Building Physical and Human
Infrastructure for Job Creation and Poverty Eradication”. In addition, the budget pays
special attention to social safety nets, and to other important national priorities such
as provision for the population census #9billion, modern voting and electoral
equipment and techniques #55billion, cushioning the impact of public service reforms
#50billlion, and provision for restructuring and monetising parastatals #50billion. The
budget also explicitly provides #75billion to cushion the impact of petroleum prices
which we expect will be matched by the states and local governments for a total of
#150billion.
Simply put the budget 2006 gives priority to investments in power, water,
roads, security, education and health so that the basic elements needed to make life
more comfortable for citizens and provide the essential building blocks for
diversification of the economy can continue to be put in place. The budget continues
our tradition of more careful and effective management of our financial resources
paying due regard to the need to maintain macroeconomic stability and achieved a
good fiscal stance in order to avoid unduly heating up the economy.
Given the investments in infrastructure, and the relative macroeconomic
stability, we expect strong GDP growth of 7% getting closer to our medium term target
48
of 10% per annum compared to the GDP growth of 6% for the year 2005. We expect
the exchange rate to be relatively stable with some possibility of minor appreciation of
the Naira even experiencing some nominal appreciation from about #132 to $1 in
2004, to #128 to $1 by the end of 2005. With regard to inflation, the objective is to
maintain a prudent fiscal stance so that monetary policy will have a chance to work
through CBN as it did under the 2004 budget to help bring inflation from the relatively
high double digits now to about 9%. The CBN is designing an effective liquidity
management system that will mop up excess liquidity and help maintain stability.
According to President Umaru Musa Yar’Adua the reforms agenda constitute
elements of a larger reform programme, the National Economic Empowerment and
Development Strategy (NEEDS-2), and the pronouncement of 7-Point Agenda at the
inception of his Administration in 2007. The NEEDS-2 focuses on poverty reduction
through employment generation and wealth creation, promoting inclusive growth by
concentrating on sectors where the poor and the vulnerable groups are dominant such
as agriculture, small- and medium- scale enterprises, and informal sector operation.
The Yar’Adua administration has thus focused on setting up the building blocks for a
future acceleration of reform. It’s also keen to reach broad consensus on key decisions
requiring a more consultative process. This approach holds the promise for more
durable reforms.
49
2.4.3. The Reforms Agenda/Fiscal Strategies
In order to enhance economic reform in Nigeria, Usman (2007) states the
reasons why fiscal responsibility and public procurement legislations should be
enacted in the economy. He posited that “fiscal responsibility legislation strengthens
fiscal policy design and implementation, and changes from the tradition of short term
fiscal perspective to medium/long term fiscal sustainability and Improve budgetary
process”. On the other hand, he asserted that “public procurement legislation
improves public sector spending behaviour, value for money, reduce corrupt practices
and inefficiency, and track down public sector investment spending”. He further
defined ‘fiscal rules’ in macroeconomic context, as institutional mechanisms that are
intended to permanently shape fiscal policy design and implementation.
Fiscal responsibility legislation has been implemented by different countries,
thus: Alberta in 1990; Venezuela in 1999; Norway in 2001; Ecuador in 2002; Mexico in
2006 and Nigeria in 2007? The Fiscal Responsibility Bill (FRB) consists of 16 parts, but
some of these are discussed in this subsection. Briefly, the medium-term fiscal
framework contains- a macroeconomic framework setting out macroeconomic outlook
for a medium term horizon (3 years), stating the underlying key assumptions for the 3year forecast, In-depth analysis and evaluation of the 3-year forecast. A fiscal strategy
detailing- the government’s financial objectives, the government’s policy under the
50
medium term expenditure and revenue frameworks, and the fiscal risks. For the
Annual Budget, the FRB states that, the medium-term fiscal framework shall be the
basis for the annual budget, these consist of: medium term expenditure framework,
medium term revenue framework, and medium term sector strategies. The key
assumptions variables are: fiscal oil price rule, Inflation rate, Exchange rate, GDP
growth rate, Target fiscal account balance and fiscal risk evaluation (Usman, 2007).
The Public Procurement Bill is responsible for the monitoring and oversight of
public procurement, and harmonising the existing government policies on
procurement. The Act outlined in greater detail the procedures in government
procurement and disposal of property, including the need to: Install due process,
monitor and track down investment in public goods, maintain strict adherence to
budget provisions by ministries, departments and agencies (MDA). Overall, the Bill and
the Act are aimed at ensuring fiscal sustainability and quality of spending for economic
growth (Usman, 2007).
The macroeconomic reform packages embarked on by the immediate past
administration had as its key objectives the need to provide macroeconomic stability
for private sector growth, improve planning and implementation of government
capital expenditures, increase public savings and reduce public debt (Babalola, 2007).
The key policy measures introduced include prudent oil price-based fiscal rule,
51
improved implementation of government budgets, improved implementation of
monetary policy by the Central Bank of Nigeria and greater coordination between
fiscal and monetary authorities. A significant policy measure that achieved
considerable success was an improved debt management system that led to Nigeria’s
successful exit from Paris Club and London Club Debts through the issuance of par
bonds, promissory notes, oil warrants, etc. On the domestic debt front, there were
regular bond issuance programmes and contractor arrears and pension arrears issues
were addressed. As at now, the savings from debt relief is being used for MDG-based
programmes.
At the Federal level, various legislative initiatives were embarked upon. The
two significant ones as mentioned earlier were the Fiscal Responsibility Act and the
Public Procurement Act. Overall, the aims of the two Acts were to ensure fiscal
sustainability and quality of spending for economic growth (Babalola, 2007). The Fiscal
Responsibility Act was particularly aimed at strengthening fiscal policy design and
implementation, by moving from the tradition of short term fiscal perspective, to
medium/long term fiscal sustainability, thereby improving the budgetary process. It is
meant to ensure prudent management of the nation’s resources, ensure long-term
macroeconomic stability, accountability and transparency in fiscal operations (Usman,
2007 and Babalola, 2007).
52
The Bill, as originally conceived by the Executive, was meant to apply to the
three tiers of government in the conduct of their economic activities. The Bill as passed
by the National Assembly, however, makes it applicable to only the Federal
Government, with exceptions in the areas of oil-based fiscal rule, framework for debt
management and public borrowing. These exceptions are equally applicable to the
states and local governments. The provisions in respect of the Medium-Term
Expenditure Framework (MTEF) and Fiscal Transparency and Accountability are not
applicable to the States and Local Governments in the passed Bill (Usman, 2007 and
Babalola, 2007). It is, however, settled that it is in the overall interest of public
governance in Nigeria that all sub-national units adopt the features of these Acts and
incorporate them in their own legislations (Babalola, 2007).
The issue of fiscal coordination between the Federal and State Governments in
Nigeria is of paramount important. Although the 1999 Constitution provides for fiscal
Federalism, meaning that, States are independent in all areas of fiscal policy: revenue
allocation; expenditure choices; and other financial decisions. The Constitution also
charges Mr. President with stewardship of the Nation’s economy. To achieve this will
require a relationship with States based on: transparency; adherence to the rule of
law; and full cooperation between the three tiers of government in achieving
53
economic development and wealth creation, as well as macroeconomic stability
(Usman, 2007).
A number of major challenges hinder the attainment of the sound fiscal policy
management in Nigeria. These include: lack of coordination among the three tiers of
government; lack of agreement over broad macroeconomic objectives to be achieved;
and the issue of management of oil windfall. Effectively, about 50 per cent of total
revenue goes to State and Local Governments. This means that all tiers of governance
have at their disposal considerable financial resources that determine fiscal policy in
Nigeria. At this moment, it is important for all of us to realise that there is only ONE
economy (Babalola, 2007).
To achieve fiscal and macroeconomic coordination among the three tiers of
government, there is need for adoption of fiscal responsibility legislation by all tiers of
government, adherence to budget implementation, public procurement legislation,
due process, accountability and transparency. At the Federal level, efforts are being
made to include subnational governments in the process of setting the key
assumptions underpinning the national budget. This is expected to engender a sense
of ownership, commitment to decision outcome and instilling discipline at micro level.
The National Economic Council (NEC) plays the coordinating function in the economy.
NEC at its meeting on September 4, 2007 agreed to initiate and facilitate the passage
54
of similar legislations in each state. This would assist in integrating the states’ fiscal
strategy into the overall fiscal framework, improve transmission mechanism of policy
initiatives, increase policy feedback, accountability, transparency and due diligence,
and enhance long run macroeconomic stability. The Debt Management Office (DMO),
as regard coordination strategy, held a Sub-National Debt Management Workshop
with Development Partners and State Governments in October 2007. This was part of
DMO’s strategic focus to inculcate responsible debt management in all States of the
federation. The main objective is to eventually have debt management offices in all
the States of the federation. Also, the use of the Irrevocable Standing Payment Order
(ISPO) that supports borrowing by the State Goovernments from the banking system
has been stopped by President Umaru Musa Yar’Adua.
There is a positive correlation between effective/good governance and
development (Babalola, 2007). Nigeria has been recognised in a report by Goldman
Sachs as one of the 11 countries in the world with the people and resources that have
the potential of being one of the 20 biggest economies by the year 2020, hence the tag
Vision 2020. To achieve this strategic objective, there is need for efforts aimed at:
poverty reduction; instituting strategic national fiscal framework; development of
national institutions; enhancing the human development agenda; investments in
55
education and health; and continuous focus on the millennium development goals
(MDGs).
2.4.4 Reform Measures
The central objective of the macroeconomic reform was to stabilize the
Nigerian economy, to improve budgetary planning and execution, and to provide a
platform for sustained economic diversification and non-oil growth. A major challenge
was to de-link public expenditures from oil revenue earnings by introducing an
appropriate fiscal rule. In addition, as has been the practice in other countries, the
adoption of such a rule could enable the accumulation of government savings, which
would be valuable, whether for precautionary reasons, for smoothening public
expenditures or for ensuring intergenerational equity (Barnett and Ossowski, 2006;
IMF 2005a).
In the case of Nigeria, an oil price-based fiscal rule was introduced in which
government expenditure was based on a prudent oil price benchmark. Any revenues
that accumulated above the reference prices were saved in a special excess crude
account. In recent years, government budgeting has been based on conservative oil
prices of $25 per barrel in 2004, $30 per barrel in 2005, and $35 per barrel in 2006,
despite higher realized prices of $38.3 and $54.2 in 2004 and 2005, respectively, and
an estimated average price of $68 for 2006. Adoption of this rule has ensured that
56
government expenditures are de-linked from oil revenue earnings, thereby limiting the
transmission of external shocks into the domestic economy. There was a marked
improvement in the government’s fiscal balance, with the previous deficit of 3.5
percent of GDP in 2003 turning to consolidated surpluses of about 10 percent of GDP
in 2004 and 11 percent of GDP in 2005 (Government of Nigeria and IMF, 2005b).
Adoption of the fiscal rule also resulted in significant public savings for the
government. Gross excess crude savings totaled about $6.35 billion at the end of 2004
and about $17.68 billion by the end of 2005. Over the period 2003 to 2006, foreign
reserves also increased by more than fivefold, from $7.5 billion at the end of 2003 to
about $38 billion in July 2006 (Okonjo-Iweala and Osafo-Kwaako, 2007).
The implementation of monetary policy was similarly fairly disciplined, with the
central bank adhering to various monetary targets and reducing inflation. End-year
inflation declined from 21.8 percent in 2003 to 10 percent in 2004 but increased
slightly to 11.6 percent at the end of 2005 and reduced sharply to a single digit in 2006
and 2007 with 8.2 percent and 5.4 percent respectively. Similarly, interest rates,
although relatively high, are gradually declining: prime lending rates have declined
from about 21.3 percent at the end of 1999 to 17.6 percent at the end of 2005. Finally,
the adoption of the Wholesale Dutch Auction System facilitated the convergence of
foreign exchange markets and the elimination of a previous black market premium.
57
The improved implementation of fiscal and monetary policies has provided a
stable macroeconomic environment, which is crowding in private sector participation
in the domestic economy (Okonjo-Iweala and Osafo-Kwaako, 2007). As an example, in
2005, credit to the private sector grew by 30.8 percent to N2.01 trillion (US$15.1
billion), exceeding the target growth rate of 22.5 percent. In addition, net credit to the
federal government declined by 37 percent to N306.0 billion (US$2.3 billion) compared
with the target decline of 10.9 percent. The fall in lending to the federal government
was attributed mainly to a decline in the central bank’s holding of treasury securities.
Overall, the attainment of macroeconomic stability has provided a platform for
improved growth performance in recent years. Growth rates have averaged about 7.1
percent annually for the period 2003 to 2006. This is a notable improvement on the
performance over the decade before reform when annual growth rates averaged
about 2.3 percent. More importantly, the recent strong growth rates have been driven
by strong growth in the non-oil sectors, which is needed for employment creation.
Growth in the non-oil sector for 2003, 2004, and 2005 was 4.4, 7.4, and 8.26 percent,
respectively.
Progress in oil revenue management and implementation of monetary policy
was complemented by improvements in debt management and the budget
preparation process. Public debt declined substantially from about 74.8 percent of
58
GDP in 2003 to about 14.2 percent in 2006, largely because of a successful debt relief
agreement with the Paris Club. Nigeria paid its outstanding arrears of $6.4 billion,
received a debt write-off of $16 billion on the remaining debt stock (under Naples
terms), and purchased its outstanding $8 billion debt under a buyback agreement at
25 percent discount for $6 billion. The entire debt relief package totaled $18 billion, or
a 60 percent write-off in return for a $12.4 billion payment of arrears and buyback. The
exercise involving the buyback was unprecedented in the Paris Club for a low-income
country and was the second largest debt relief operation in the club’s 50-year history.
Other external debt, particularly debt owed to London Club commercial creditors, are
similarly being restructured and paid off.
Strengthening the budget preparation and execution process was also urgently
needed in order to improve the efficiency of government spending and improve
service delivery to the Nigerian public. In the past, weaknesses in budget
implementation and monitoring had resulted in a low quality of government
expenditures and many incomplete projects. The current improvements are being
supported by the preparation of a fiscal strategy paper laying out options and tradeoffs for budgetary spending, as well as improved management of government finances
by a Cash Management Committee chaired by the finance minister. In addition,
medium term expenditure frameworks (MTEF) and medium term sector strategies
59
(MTSS) have been introduced to ensure that sectoral spending programmes reflect
government development priorities and also remain within projected resource
envelopes (Okonjo-Iweala and Osafo-Kwaako, 2007).
2.5
APPRAISAL OF ECONOMIC POLICY MEASURES
From the foregoing review, it is clear that the Nigerian experience confirms the
problems of uncertainty and unpredictability which the developed countries central
banks have found to beset the task of fiscal and monetary policies formulation and
implementation. In theory, it is expected that the manipulation of fiscal and monetary
policy instruments will help ensure that the ultimate macroeconomic goals pursued by
the society are attained. In practice, however, several factors militate against the
effectiveness of monetary policy. Those operating in the Nigerian case are thus: the
perennial problem of monetary policy lags usually involving recognition, action and
effect lags. The linkage between monetary policy actions and results are far from
direct and immediate and not precisely known. Because of this, and the fact that
other economic policies also influence the pace and direction of change of major
macroeconomics variables that form the targets of official policies, it is a frustrating
60
exercise to seek to isolate the impact of monetary policy on the economy (CBN 20
Years of Central Banking: 1959-1979).
Far from being traceable to any fundamental mistakes in policy formulation,
the specific problems facing monetary policy in Nigeria are largely attributable to
strong exogenous factors. The first factor is the inability to use the conventional
techniques of monetary policy because of the lack of financial markets of the required
breadth and depth. For example, open market operations cannot be applied because
the volume of eligible securities in the economy is inadequate.
In addition,
transactions in government t securities which represent the bulk of money market
securities are not fully exposed to money market forces since the CBN is required to
guarantee their repurchase at par. Thus, as long as this guarantee is operative,
effective open market operations which require market sensitive interest rates are
precluded.
As a second-best approach, monetary policy performance is generally
evaluated by concentrating on its impact on the financial sector since the measures
are expected to work through the financial markets. For instance an increase in
money supply, given less than full employment, is expected to lead to expansion in
output and employment by lowering interest rate (where the financial markets are
61
sensitive) and stimulating investment. Interest being a cost of investible funds is
assumed to have an inverse relationship to investment spending although investment
decisions are influenced more by the expected rate of return than the cost of
borrowing per se. However, where growth is considered the focus of policy, the
implication for monetary policy would be to maintain relative price stability (CBN 20
Years of Central Banking: 1959-1979).
Closely associated with the above factor are the rigidity and the conservatively
low level of the structure of interest rates in the country arising from government
interventionist policies in the operations of the money market. The attempts to use
interest rate changes as a tool of monetary policy did not make any significant impact
largely, because the changes were small and infrequent. The structure of interest rates
has persisted at an unrealistically low level and hence does not reflect the scarcity
value of capital funds in Nigeria. The deposit rates for all types of financial institutions
have maintained the most unrealistically low level which could be expected to
stimulate saving mobilization. Furthermore, the low interest rates on government debt
instruments (treasury bills, certificate, stocks and bonds) have largely been conducive
to inflationary monetary expansion, partly because they failed to attract enough
private sector savers and more importantly because the CBN is required by law to
62
absorb the unsubscribed proportion of government debt instruments (CBN 20 Years of
Central Banking: 1959-1979).
Also, interlocking with the phenomenon of low and inflexible interest rate
structure is government fiscal operations which have preponderantly determined the
rate of monetary expansion in the Nigerian economy. In particular, movement in
government expenditure especially in the 1980s represented the single most
important factor influencing the growth of the money stock. In the 1970s when
government budgetary deficits were financed largely by borrowing from the CBN, the
need to borrow cheap and minimize debt service burden dominated monetary policy
and influenced the low level of interest rates than administered by the monetary
authorities.
For most of the 1990s excessive liquidity characterized both the public and
private sectors of the economy as a result of increased oil revenue. A
disproportionately large part of government revenue comes from tax on mining
industry especially oil and is earned in the form of foreign exchange. The rapid
monetization of such inflow of funds to finance an unsustainable level of government
expenditure has posed the greatest threat to economic stability in the 21 st century. In
between 1999 to 2007, when the flow of oil funds began to descend from its
63
unprecedented heights, the government has reverted to the earlier practice of
financing a growing budgetary deficit by excessive borrowing from the central bank– a
practice which has serious inflationary implications.
The ever present conflict between the objectives of fiscal as well as monetary
stability and growth constituted an important challenge to macroeconomic
management throughout the decades under review. It would appear that the tradeoff between growth and inflation was usually resolved in favour of the former in view
of the fact that the process of agrarian and industrial revolution of the economy is yet
to reach a take-off stage. Similarly, in pursuit of the objective of fostering the growth
of a sound financial system to mobilize adequate development oriented finance, the
CBN has been obliged to be less restraining on the credit operations of the banking
system than it otherwise would have been.
One final challenges facing monetary management that should be mentioned
here is the shortcomings of the most popular instrument of monetary regulation in
Nigeria- Credit guidelines. Apart from the fact that the banking system failed on a
number of occasions to attain full compliance with the various CBN credit guidelines,
the problem of “window dressing” the figures of their credit operations cannot be
ignored. More importantly, there is the problem of inability to control the ultimate use
64
into which a borrowed fund may be put. The more prescription of a sectoral
distribution of credit may not ensure that funds borrowed for production cannot be
applied for consumption expenditures (See Parliamentary Debate on CBN Draft Act,
1958).
A popular solution for putting an end to Nigeria’s fiscal policy recklessness,
which has been championed by World Bank Economists, is that what Nigeria needs is a
fiscal policy rule, which would commit the government to a certain level of conduct in
fiscal and budgetary management. Along these lines, it has been asserted that “Better
management of the oil revenue cycle would have to be a central element of any effort
to put Nigeria on a part of fiscal sustainability”. Historically, fiscal policy in Nigeria has
been extremely pro-cyclical with expenditures ratcheting out of control on the
upswing of the oil price cycle. This has contributed to the observed deficit bias in the
conduct of fiscal policy. One option is to put in place a fiscal policy rule. A fiscal policy
rule makes sense in Nigeria, given the complete absence of a tradition of fiscal
discipline. Because a fiscal rule commits government to a certain level of conduct in
fiscal and budgetary management, it will help begin to build government credibility in
fiscal management and over time, promote strong fiscal discipline across all tiers of
government. A rule, based on oil prices, will also help address the issue of the
vulnerability of all tiers of government to oil price swings and reduce the pro-cyclicality
65
in the budget. This will allow savings to build up financial assets in periods with high oil
prices that can be used to finance the desired expenditure programmes when oil
prices are low (Kwakwa, 2003).
Ezeoha and Uche (2006), there is however no guarantee that rules will work in
Nigeria. Subsequent Governments have had no respect for rules, be it monetary or
fiscal policy rules. Take for instance the already mentioned regulation, which limits the
amount of credit a central bank is allowed to advance to government. A Government
that flouts one rule can easily flout another. Finding a solution to this problem is
therefore much more complex. Specifically there will be little progress towards fiscal
prudence until some powerful pro-stability stakeholders strong enough to challenge
government fiscal recklessness emerge. The people, if and when provided with a
proper democratic structure, have the potentials of constituting such an interest
group. Under such a scenario, elections could be used to get rid of pro-inflation
governments.
Financial institutions also constitute another pro-stability interest group.
Unfortunately, the indigenization exercise of the 1970s severely decimated the powers
of this group. With majority Government ownership of the main banks, it became
difficult to differentiate between the views of government and the views of the bank.
The new N25 billion bank capitalization required by the CBN, despite its flaws may well
66
turn out to have some unintended positive side. Mega banks will no doubt be in a
much stronger position to make the point that Government’s reckless fiscal policy and
its attendant macroeconomic instability is the main cause of financial instability. Until
the fiscal recklessness of the Government is checked, the use of monetary policies to
achieve macroeconomic stability will remain nothing more than an illusion (Ezeoha
and Uche, 2006).
The costs of macroeconomic volatility were significant for Nigeria”. The adverse
consequences occur via two channels: first, unsteady revenue flows tend to reduce the
quality and productivity of government expenditures; and second, private investments
tend to be reduced in a volatile environment. Both effects occurred in Nigerian’s case.
So, expenditure volatility resulted in low quality government public spending, often
with many incomplete capital projects, as well as the accrual of arrears for civil servant
salaries and government contractor payments. Macroeconomic instability also
hindered long-term planning by the private sector and resulted in a concentration of
economic activity in various short-term arbitrage opportunities (particularly in retail
trade) rather than productive long-term investments. Overall, a pro-cyclical
expenditure pattern coupled with poor management of oil earnings resulted in low
growth, and persistent fiscal deficits (Okonjo-Iweala and Osafo-Kwaako, 2007).
67
Furthermore, improvement in fiscal management has been at the centre of
recent economic reform agenda in Nigeria. These include achievement of long term
fiscal sustainability which is imperative to the enhancement of efficiency and quality of
public expenditure; improve management of oil revenue; strengthen fiscal
coordination among the three tiers of government; through implementing the fiscal
responsibility legislation and Public procurement legislation.
Despite recent successes of reform measures, Nigeria faces many challenges in
sustaining economic growth and improving its broad development indicators. An
historic opportunity exists for Nigerian policymakers to consolidate recent gains from
reform and to address outstanding areas of reform in the future. The key issues that
Nigerian policy makers must address in future administration are to: extend reforms to
the sub-national levels; strengthen domestic institutions (investment in education),
focus on non-oil growth and employment generation; improve the domestic business
climate; expand and maintain investments in infrastructure; tackle unrest in the Niger
Delta; and increase the quality of social sector spending.
2.4.5 THE CHALLENGES AHEAD
Much progress has been made, but much remains to be done, and this is that
critical juncture when maintaining the momentum is both vital and challenging. We
68
are not yet at the point where we can be confident that Nigeria's current growth
performance will be sustained over the longer term. That requires continuing
progress on lowering inflation. It also requires continuing progress towards debt
sustainability: and that means not just meeting the government's primary surplus
target but doing so in a sustainable way, through a better tax system and
expenditure management. And it requires continuing reform on a wide range of
structural issues.
The government's reform programme, of course, envisages doing just that. It
is reassuring to see the government's unwavering commitment to further reductions
in inflation; to maintaining a primary surplus sufficient to reduce Nigeria's
employment and poverty levels; to broader fiscal reform; and to reform and
consolidation of the financial sector. Credibility matters in the global economy,
perhaps today more than ever. The high-speed transmission of information that we
all take for granted, and from which we all gain, also means that markets can act
quickly. The markets can be harsh judges, as emerging market economies have
painfully discovered. It is important that economies, and economic policymakers, are
equipped to exploit the benefits that market discipline can bring. The rewards can be
69
substantial, in terms of lower interest spreads and more foreign investment, for
instance (Krueger, 2004).
Further progress is also vital because there is clear evidence that the returns
to economic reforms increase sharply as more of them are undertaken. This really is
an area where the whole is far greater than the sum of the parts. All reform is
welcome, of course: but the full benefits will not come through if reforms elsewhere
in the economy are overlooked, or postponed.
Despite the gains and heavy investments made in the past 10 years,
infrastructure, both human and physical, remains weak; also, evidence from the
decay energy situation, especially electricity generation and distribution; the poor
road conditions; the post system remains underdeveloped; and the railway has
become almost irrelevant to the Nigeria’s transportation needs. Now, most of the
government projects are substandard because government has failed to ensure that
the final output meets demand specifications for cost recovery. Therefore, capable
human capacity and effective management and organizational structures are
necessary and critical to achieving this Administration’s vision.
70
According to Krueger (2004), a reform agenda is challenging because
governments can find it difficult to press on with politically difficult reforms when
economic performance has already started to pick up. But difficult reforms are far
more painful when implemented in a downturn or, even worse, in the middle of an
economic crisis. The current upturn, both in Nigeria and in the global economy, is the
ideal opportunity for all countries—not just Nigeria—to implement the changes
needed to deliver rapid growth that is sustainable in the longer term.
2.6
CONCLUDING REMARKS
Let me not give the wrong impression. It would be wrong to view the
challenges in a negative way. The desire for reform, and the determination to deliver
it, is evident. And the benefits to be had are enormous. Let me remind us of what
could be within Nigeria's grasp if the reforms are followed through successfully.
The macroeconomic stability is worth striving for. It is the prerequisite for the
rapid sustainable growth in income and employment that raises living standards and
reduces poverty. Low inflation makes economic decision-making easier for all
citizens, and benefits the poor disproportionately. Sound fiscal policies give
governments and citizens more choice. A sustainable fiscal position makes it easier
71
for society to decide on its priorities (Krueger, 2004). Increased economic resilience
makes it easier to cope with unexpected shocks. These will always come, we just
cannot predict when or in what form: the stronger the economy, the less harm those
shocks do to a country's citizens, especially the poor. Indeed, economic reform will
be in the interests of all Nigerian citizens. Living standards will rise, poverty will be
reduced, and life will become more predictable, or at least less vulnerable to ups and
downs.
The policy-makers should know that reforms build on each other. The returns
rise more rapidly the more widespread and the more co-coordinated they are. For
any country that is ill-prepared, the modern global economy can seem harsh. For
those with sound policies, the rewards are great indeed. Perseverance is worth it.
The short-run target for the economy must be able to consolidate economic
reforms through continued pursuance of sound macroeconomic management and
fiscal prudence. In the medium-term, government should empower micro units of
productive activities to utilise the benefits from the macroeconomic reforms. In the
long-run, government must strive to attain the growth objectives as set out in our
NEEDS 2 in order to reduce poverty by at least 30% by 2011, and attain annual GDP
72
growth rate of at least 13% so as to make Nigeria one of the 20 largest economies in
2020.
Finally, Nigeria needs to ensure better value for money, manage the recurrent
spending of the government, seek better participation of the private sector, especially
in the provision of infrastructure, strengthen monitoring, auditing and reporting
processes and strengthen fiscal co-ordination amongst the 3 tiers of government.
73
CHAPTER THREE
THEORETICAL FRAMEWORK AND METHODOLOGY
3.1
THEORETICAL FRAMEWORK
In an economy in which fluctuations are partly due to the combination of
aggregate demand effects and nominal rigidities, fiscal policy has the potential to
reduce fluctuations in aggregate demand and thus increase welfare. This has long been
a theme of Keynesian macroeconomics. Whereas for monetary policy the major tradeoff is between price and output stability, the trade-off for fiscal policy is between
output stabilization and the distortions from tax and spending policies (Blanchard and
Fisher, 1989).
In order to examine the effect of fiscal policy upon the level of aggregate demand,
Musgrave and Musgrave (2004) begin with a situation of substantial unemployment,
where changes in overall expenditure are reflected in changes in real output rather
than in prices. Concern with the budget as an active ingredient of stabilization policy, it
began in the great depression of the thirties, when Keynes’ (1936) General Theory and
its message of fiscal expansion burst onto the scene. To be sure, little was done during
the thirties to apply this approach. Roosevelt’s New Deal started out on a platform of
budget balance, and such modest recovery as emerged during the thirties was largely
private-sector based (Brown, 1956). However, the massive fiscal expansion generated
74
by World War II demonstrated the potential force of such a policy. In the course of the
war, the budget rose from 10 to 45 percent of GNP, with half thereof deficit-financed
and a supporting monetary policy which held interest rates at 3 percent. Real output
rose by 50 percent and unemployment disappeared. While inflationary effects were
delayed by price control, even the resulting postwar inflation was moderate by recent
standards (Musgrave and Musgrave, 2004).
In order to stimulate growth and maintain a healthy external balance, which is
what is generally referred to as macroeconomic stability, Busari et al, (2006) concluded
that monetary policy stabilizes the economy better under a flexible exchange rate
regime may look like an over statement. It is observed that monetary policy stimulates
growth better under a flexible rate regime but it is accompanied by severe
depreciation, which could destabilize the economy. In other words, monetary policy
would better stabilize the economy if it is used to target inflation directly than be used
to directly stimulate growth. Other policy measures and instruments are therefore
required to complement monetary policy in macroeconomic stabilization. Much of the
literature on monetary policy in open economies has been based on the premise that
the internal and external balance of an economy is instantaneously affected by
movement in exchange rates (Svensson, 2000 and Ball, 1998).
75
Buchanan and Wagner (1977) argued that the pre-Keynesian presumption that
the budget should at all times be balanced was replaced by Keynes with an
agnosticism that permitted deficits to become arbitrarily large – which with a
remarkable long lags, they duly become in the 1980s in the United State. In fact
Keynesians and others (e.g., Friedman 1948) have argued for a cyclically balance
budget, with deficits in recessions offset by surpluses in booms.
Romer (1988) has used the model of perpetual youth to assess the social
welfare costs of protracted deficits when the economy is below the modified golden
rule capital stock. The argument has been made that the tax cuts of the early 1980s in
the United State were in part implemented to force reductions in spending, through
the political pressure resulting from large deficits. One may ask what the welfare cost
of these deficits may be if these reductions do not lead to decreased spending but
have to be financed by higher taxes later (Blanchard and Fisher, 1989).
Okonjo-Iweala and Osafo-Kwaako (2007) posited that “The costs of
macroeconomic volatility were significant for Nigeria”. There is considerable
theoretical and empirical evidence on the adverse effects of volatility for growth (Fatas
and Mihov, 2003; Servén, 2003; Bleaney and Greenaway, 2001). These adverse
consequences may occur via two channels: first, unsteady revenue flows tend to
reduce the quality and productivity of government expenditures; and second, private
76
investments tend to be reduced in a volatile environment. Both effects appear to have
occurred in the case of Nigeria. First, expenditure volatility resulted in low quality
government public spending, often with many incomplete capital projects, as well as
the accrual of arrears for civil servant salaries and government contractor payments.
Indeed, by 2003, accumulated arrears to domestic contractors alone amounted to
about N150 billion (US$1.17 billion). Second, macroeconomic instability also hindered
long-term planning by the private sector and resulted in a concentration of economic
activity in various short-term arbitrage opportunities (particularly in retail trade) rather
than productive long-term investments. Overall, a pro-cyclical expenditure pattern
coupled with poor management of oil earnings resulted in low growth, persistent fiscal
deficits, and the accumulation of debts (Okonjo-Iweala and Osafo-Kwaako, 2007).
For this study, the theoretical framework is based on Barro Endogenous
Growth Model in a simplified form. The model assumes that growth is influenced by
policy variables other than the technical relationship between capital and labour
(Barro, 1990). Such policy variables include public spending and taxation which are
proxies for fiscal policy in this study.
The model is based on the following basic assumptions:
(i)
There are two sectors in the economy: Private (P) and Public (G);
(ii)
The output of these sectors depend on Labour (L) and Capital (K); and
77
(iii)
The output of G has some externalities effects on the output in P.
The constant functions of the two sectors therefore appear thus:
P = p (Lp, Kp, G)
--------------------------------------------------------- (3.1)
G = g (Lq, Kq)
--------------------------------------------------------- (3.2)
The total input functions would therefore appear thus:
Lt = Lp + Lq
--------------------------------------------------------- (3.3)
Kt = Kp + Kq
--------------------------------------------------------- (3.4)
The total output (Y) will then be the sum of equations (3.1) and (3.2) or (3.3) and (3.4):
Y=P+G
--------------------------------------------------------- (3.5)
Or
Y = p (Lp, Kp, G) + g (Lq, Kq)
Or
Y = L t + Kt + G
-------------------------------------- (3.6)
----------------------------------------------- (3.7)
Since G is government policy, it can be fiscal policy and monetary policy, thus,
the introduction of money supply as concurrent policy variable. Among the reasons for
this is that government often prints money to finance some of its developmental
programmes and in financing fiscal deficits.
Following this trend and coupled with what Anderson and Carlson (1972)
discussed on the central role of expectations in the Saint Louis Model. The model could
be used for policy analysis, specifically for studying the effect of fiscal and monetary
policy on inflation, output and interest rate. The St. Louis Model specified that any
78
macroeconomic variable is a function of fiscal policy and monetary variables. Here,
each of the fiscal policy variables would be treated separately to avoid the problem of
serial correlation and to evaluate their impact on macroeconomic variables. Therefore,
the structural form of Barro Endogenous Growth Model states that macroeconomic
variables (output, inflation rate, for the purpose of this study) depends on fiscal policy
instruments (government revenue and expenditure) and monetary policy variable
proxy by money supply. To many researchers and policy makers, this discussion
represents both an opportunity and a constraint on optimal fiscal and monetary policy
measures. Although various schools of thought exist on the subject, the opinions
expressed are logically consistent.
3.2
METHODOLOGY
This study adopts E-Views 4.1 version for the single equation models using
ordinary least square (OLS) estimation techniques to investigate the impacts of fiscal
policy (expenditure policy) measures on economic growth (proxy by GDP growth) and
inflation rates in Nigeria. Therefore, with the use of time series data, the research
work employs the methodology which tests for stationarity and cointegration as well
as error correction mechanism (ECM).
79
3.2.1 Description of the Macro Models
Following from the theoretical framework, the empirical models for this
research study are explicitly formulated and described as:
LnGDPt = α0 + α1LnGEt + α2LnMts + ε1t ,
α 1, α 2 > 0
------------------- (3.8)
LnGDPt = β0 + β1LnGRt + β2LnMts + ε2t ,
β1, β2 > 0
------------------- (3.9)
INFt = η0 + η1LnGEt + η2LnMts + ε3t ,
η1 < 0, η2 > 0
------------------- (3.10)
INFt = τ0 + τ1LnGRt + τ2LnMts + ε4t ,
τ1 < 0, τ2 > 0
------------------- (3.11)
Where: GDP is the gross domestic product which is used as a proxy for
economic growth; GE is the government expenditure; MS is the broad money supply
(M2) which is our proxy for the monetary policy; GR is the Government Revenue; INF is
the inflation rate which is our proxy for composite consumer price index; Ln is the
natural logarithms of the variables; ε is the random term independently and identically
normally distributed with mean zero and constant variance which also control other
variables that influenced economic growth; the parameters (α0, α1, α2, β0, β1, β2, η0, η1,
η2, τ0, τ1, and τ2) represent the magnitude and size of the coefficients that are
necessary to measure the nature and extent of the variables in use and t is the time
subscript.
80
However, it is expected that an increase in GE, MS, and GR will cause GDP to
rise by the values of the coefficients (α1, α2, β1, and β2 > 0). Also, a positive effect is
expected through MS on Inflation rates (η2, τ2 > 0), while an inverse relationship is
anticipated through GE and GR on Inflation rates (η1, τ1 < 0).
3.2.2
Estimation Techniques
In this analysis, we explore the long-run properties of the time series data. The
stationarity test of the series was examined using Augmented Dickey-Fuller (ADF) test
statistics to investigate the presence of unit root under the alternative hypothesis that
the series is stationary around a deterministic or fixed trend. The ADF test is carried
out using OLS technique to estimate the equation below:
∆Xt = δ0 + δ1t + δ2Xt-1 + øi ∑ni=1 ∆Xt-i + εt
-------------------------------------- (3.12)
Where ∆ is the first-difference operator, Xt is nonstationary but its first
difference is stationary, ∆Xt = (Xt-Xt-1) is the first difference of Xt, ∆Xt-1= (Xt-1-Xt-2), ∆Xt-2 =
(Xt-2 - Xt-3) etc., are the lagged difference terms, δ is a drift parameter, and ε is a pure
white noise error term. Note that the null hypothesis of non-stationarity is rejected if
δ2 is less than zero (0) and statistically significant.
81
The analysis is based on standard technique provided by Engel and Granger
(1987). Since some variables are not stationary, then cointegration tests were carried
out using Augmented Engel and Granger (AEG) test. In event some variables are I(0)
and some I(1). We basically solve for the lagged residual in the long-run equation and
substitute into the error-correction model. This suggests that the F-statistic test for
joint significance of the lagged level variables were carried out. If they are found to be
jointly significant, it means there is a single level relationship between the dependent
variable and the independent variables (i.e., they adjust jointly towards fullequilibrium). Also, using Cointegrating Regression Durbin-Watson (CRDW) test, we
applied Durbin-Watson d obtained from the cointegrating regression such as the null
hypothesis is that d=0 rather than the standard d=2. If the computed d value is above
the critical value suggesting that the variables are cointegrated.
Once cointegration is established, the long run effects of independent
variables on the dependent variables are inferred by the size and significance of the
coefficients. An error correction mechanism (ECM) was estimated for the models in
order to restrict the long-run (static) behaviour of the endogenous variables to
converge to their cointegrating relationships while allowing for short-run adjustment
dynamics. The ECM was first used by Sargan (1984) and later popularized by Engel and
Granger (1987) corrects for disequilibrium known as Granger representation theorem.
82
Error Correction Term (ECT) is the one-period lagged value of the residual from the
static model.
3.2.3 Data types and Sources
The study made use of secondary data. Time series data on macroeconomic
variables of interest for the study spanning from 1970 to 2007 were collected. Data
were obtained from the Central Bank of Nigeria Statistical Bulletin, Bullion, Economics
and Financial Reviews and Annual Reports and Statement of Accounts for various
years. Data on public expenditure, revenue, output and inflation were obtained from
the Central Bank of Nigeria publications mentioned earlier. Also other relevant
publications from the Federal Office of Statistics (FOS), World Bank, the International
Monetary Fund (IMF), and e-library, books, periodical journals and articles were used
as sources for data.
83
CHAPTER FOUR
EMPIRICAL ANALYSIS
4.1
INTRODUCTION
In order to effectively analyze the impact of fiscal policy measures (fiscal
spending) on the macroeconomic stability indices (GDP growth and inflation rates),
there is a need for models specification which was dealt with in the previous chapter.
In this chapter, therefore, we deal with the estimation procedures and issues of the
empirical models specified, the analysis of results generated, trends analysis and
transmission mechanisms of fiscal operations as well as policy implications of results
thereof.
4.2
ESTIMATION PROCEDURES
As a preliminary step to estimating the model, stationarity test was performed
since spurious regression and the attendant misleading inferences are inevitable when
nonstationary variables are used for estimation. Hence, Augmented Dickey-Fuller
(ADF) unit root tests were employed for the study. The relationships among the key
fiscal policy and macroeconomic stability variables were examined. The long-run
relationships among the variables were studied by analyzing the existence of
cointegration which governs their long-run, or equilibrium association. Relatively
short-run dynamics were also investigated using error correction mechanism (ECM) to
84
reconcile the short-run behaviour of the economic variables with its long-run
behaviour.
4.2.1 UNIT ROOT TESTS
The tests for stationarity were carried out using ADF unit root tests on the
residuals obtained from the estimated models (3.8, 3.9, 3.10 and 3.11). The time series
behaviour of each series in the models is represented in the tables below:
Table 4.1: Stationarity Test for model (3.8)
Stationarity Test
t-statistic for (levels) at 5% critical value (-2.9434)
Variables
ADF test statistics
Log(GDP)
0.2604
Log(GE)
-0.7204
Log(Ms)
0.4008
Source: Researcher’s Computation, 2009.
From the table 4.1, the ADF test statistic values for the variables (Log GDP, Log GE and Log
Ms), in absolute terms, are less than the critical value (-2.9434) at 5% level, so, we reject the null
hypotheses that the variables are nonstationary. Therefore, the results indicate that the series are
integrated of order zero, i.e., I(0). (See Figure 4.1 and Appendix 1 for detail).
85
Table 4.2: Stationarity Test for model (3.9)
Stationarity Test
t-statistic for (levels) at 5% critical value
Variables
ADF test statistics
Log(GDP)
0.2604
Log(GR)
-0.6687
Log(Ms)
0.4008
Source: Researcher’s Computation, 2009.
From the table 4.2, the ADF test statistic values for the variables (Log GDP, Log GR and Log
Ms), in absolute terms, are less than the critical value (-2.9434) at 5% level, so, we reject the null
hypotheses that the variables are nonstationary. Therefore, they are stationary or integrated of order one,
i.e., I(0). (See Figure 4.1 and Appendix 1 for detail).
Table 4.3: Stationarity Test for model (3.10)
t-statistic for (levels) at 5% critical value
t-statistic for (1st Difference) 5% critical
(-2.9434)
value (-2.9604)
Variables
ADF test statistics
ADF test statistics
INF
-3.0530
-2.7785
Log(GE)
-0.7204
-
Log(Ms)
0.4008
-
Stationarity Test
Source: Researcher’s Computation, 2009.
86
From the table 4.3, the ADF tests show that the null hypothesis of
nonstationarity would not be rejected for the variable (INF) at 5% level, while it was
rejected for both Log(GE) and Log(Ms) at levels. However, differencing the
nonstationarity INF series once, led to the rejection of the null hypothesis. Hence, the
results in the table indicates that the variable (INF) is integrated of order one, i.e., I(1).
Whereas the variables (GE and MS) are integrated of order zero, i.e. I(0). (See Figure 4.1
and Appendix 1 for detailed results).
Table 4.4: Stationarity Test for model (3.11)
t-statistic for (levels) at 5% critical value
t-statistic for (1st Difference) 5% critical
(-2.9434)
value (-2.9604)
Variables
ADF test statistics
ADF test statistics
INF
-3.0530
-2.7785
Log(GR)
-0.6687
-
Log(Ms)
0.4008
-
Stationarity Test
Source: Researcher’s Computation, 2009.
87
From the table 4.4, the ADF tests show that the null hypothesis of
nonstationarity would not be rejected for the series INF at 5% level, while it was
rejected for both Log(GR) and Log(Ms) at levels. However, differencing the
nonstationarity INF series once, led to the rejection of the null hypothesis. Hence, the
results in the table indicates that the variable (INF) is integrated of order one, i.e., I(1).
Whereas the variables (GR and MS) are integrated of order zero, i.e. I(0). (See Figure 4.1
and Appendix 1 for detailed results).
4.2.2 COINTEGRATION TESTS
The results from the unit root tests conducted revealed that at levels, the
variables (GE, GR and MS) did not show any tendency towards reverting to their mean
values while the variable (INF) did. The variables that are not stationary have some
linear combinations of them that are stationary, thus, they are said to be cointegrated.
This implies that there is a long-run or equilibrium relationship among the variables,
so, we conduct cointegration tests. Here, we used the Johansen’s procedure which
utilizes vector autoregression (VAR) approach to test the models for cointegrating in
the following tables:
88
Table 4.5: Cointegration result for model 3.10
Data: 08/27/09 Time: 16:10
Sample(adjusted): 1972 2007
Included observations: 36 after adjusting endpoints
Trend assumption: No deterministic trend (restricted constant)
Series: INF LOG(GE) LOG(MS)
Lags interval (in first differences): 1 to 1
Unrestricted Cointegration Rank Test
Hypothesized
Non of CE(s)
None**
At most 1
At most 2
Trace
Eigenvalue
Statistic
5 Percent
Critical
Value
0.507285 41.7258
0.288213 16.24410
0.105283 4.00493
34.91
19.69
9.24
1 Percent
Critical
Value
41.07
24.60
12.97
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Trace test indicates 1 cointegrating equation(s) at both 5% and 1% levels
Source: Researcher’s Computation, 2009.
From the Table 4.5, the trace statistic test suggests the existence of one
cointegrating equation at both 5% and 1% critical levels for model 3.10. Since there is
at least one cointegrating relation, we assert that the time series variables are
cointegrated. Although the time series variables individually exhibit random walks,
there is a stable long-run relationship among them; they will not wander away from
each other, which is evident from Figure 4.1.
89
Table 4.6: Cointegration result for model 3.11
Data: 08/27/09 Time: 16:13
Sample(adjusted): 1972 2007
Included observations: 36 after adjusting endpoints
Trend assumption: Linear deterministic trend
Series: INF LOG(GR) LOG(MS)
Lags interval (in first differences): 1 to 1
Unrestricted Cointegration Rank Test
Hypothesized
Trace
Non of CE(s)
Eigenvalue
Statistic
5 Percent
Critical
Value
None*
At most 1
At most 2
0.444104
0.267156
2.50E-05
32.32877
11.19050
0.000901
29.68
15.41
3.76
1 Percent
Critical
Value
35.65
20.04
6.65
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Trace test indicates 1 cointegrating equation(s) at both 5% level
Trace test indicates no cointegration at 1% level
Source: Researcher’s Computation, 2009.
From the Table 4.6, the trace statistic test suggests the existence of one
cointegrating equation at 5% critical level and no cointegration at 1% critical level for
model 3.11. Since there is at least one cointegrating relation, we assert that the time
series variables are cointegrated. So, there is a stable long-run relationship among
them; they will not wander away from each other, which is evident from Figure 4.1.
Thus, they are modeled in what follows.
90
4.3
ESTIMATION ISSUES
4.3.1 LONG-RUN MODELS (STATIC MODELS)
Having
checked
for
cointegration
among
the
contemporaneous
macroeconomic variables in levels, we then obtained the long-run results of the
impact of fiscal policy measures (fiscal spending) on the macroeconomic stability
indices (GDP growth and inflation) by estimating the general models (3.8, 3.9, 3.10,
and 3.11). All these are presented in the tables below:
Table 4.7: Long-Run Model 3.8
Dependent Variable: LOG(GDP)
Method: Least Squares
Date: 08/27/09 Time: 12:19
Sample: 1970 2007
Included observations: 38
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GE)
LOG(MS)
1.488297
0.684824
0.330585
0.191290
0.136498
0.128129
7.780335
5.017092
2.580091
0.0000
0.0000
0.0142
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
0.991208
0.990706
0.241033
2.033398
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
12.59725
2.500219
0.067894
0.197177
Log likelihood
1.710016
F-statistic
1973.052
Durbin-Watson stat
1.043927
Prob(F-statistic)
0.000000
Source: Researcher’s Computation, 2009.
91
Results Interpretation:
The results of the estimated equation 3.8 in the table 4.7 above shows that the
explanatory variables (GE and MS) are significant in explaining observed variations in
the GDP growth. The analysis reveals that the explanatory variables in the model
accounted for 99.1% variations in the GDP growth. The explanatory variables depict
the right signs (i.e., positively related to GDP growth) as anticipated from the a priori
expectation. The Durbin-Watson d-statistic value (1.0439) confirms the absence of
autocorrelation or serial correlation among the variables. Overall, the high value
(1973.05) of F-statistic in the model indicates the joint significance of the explanatory
variables.
Therefore, the long-run model shows that the explanatory variables
(government expenditure and money supply) are quite able to explain the variations in
GDP growth. Thus, this implies that fiscal and monetary policy measures impact
positively on economic growth in Nigeria.
92
Table 4.8: Long-Run Model 3.9
Dependent Variable: LOG(GDP)
Method: Least Squares
Date: 08/27/09 Time: 13:36
Sample: 1970 2007
Included observations: 38
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GR)
LOG(MS)
2.127782
0.663234
0.276204
0.143533
0.085308
0.089917
14.82437
7.774568
3.071763
0.0000
0.0000
0.0041
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.994458
0.994141
0.191380
1.281926
10.47557
0.797204
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
12.59725
2.500219
-0.393451
-0.264168
3139.924
0.000000
Source: Researcher’s Computation, 2009.
Results Interpretation:
The results of the estimated equation 3.9 in the table 4.8 above shows that the
explanatory variables (GR and MS) are significant in explaining observed variations in
the GDP growth. The analysis reveals that the explanatory variables in the model
accounted for 99.4% variations in the GDP growth. The explanatory variables depict
the right signs (i.e., positively related to GDP growth) as anticipated a priori
expectation. The Durbin-Watson d-statistic value (0.7972) confirms the absence of
serial correlation among the variables. Overall, the high value (3139.92) of F-statistic in
the model indicates the joint significance of the explanatory variables. Therefore, the
93
result implies that fiscal and monetary policy measures have positive effect on
economic growth in Nigeria.
Table 4.9: Long-Run Model 3.10
Dependent Variable: INF
Method: Least Squares
Date: 08/27/09 Time: 16:24
Sample: 1970 2007
Included observations: 38
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GE)
LOG(MS)
15.70025
-2.293906
2.635216
13.5724
9.684836
9.091024
1.156778
-0.236855
0.28987
0.2552
0.8141
0.7736
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.007422
-0.049297
17.10182
10236.53
-160.2462
0.852399
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
19.94474
16.69526
8.591904
8.721187
0.130849
0.877777
Source: Researcher’s Computation, 2009.
Results Interpretation:
From the table 4.9 above, the estimated model (3.10) result suggests that the
independent variables are quite unable to explain the variations in the levels of
inflation. This is evident by the insignificance and low value of adjusted R2 for the
model which stood at -4.9%. Also, the low value of F-statistic (0.1308) for the model
indicates that the explanatory variables are jointly insignificance.
94
Table 4.10: Long-Run Model 3.11
Dependent Variable: INF
Method: Least Squares
Date: 08/27/09 Time: 17:30
Sample: 1970 2007
Included observations: 38
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GR)
LOG(MS)
12.73054
-4.326632
5.015346
12.7773
7.594138
8.004431
0.996341
-0.569733
0.626571
0.3259
0.5725
0.5350
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.014966
-0.041322
17.03671
10158.73
-160.1012
0.86059
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
19.94474
16.69526
8.584274
8.713557
0.265884
0.768062
Source: Researcher’s Computation, 2009.
Results Interpretation:
From the table 4.10 above, the estimated model (3.11) result suggests that the
variables are quite unable to explain the variations in the levels of inflation. This is
evident by the insignificance and low value of adjusted R2 for the model which stood at
-4.1%. Also, the low value of F-statistic (0.2659) for the model indicates that the
explanatory variables are jointly insignificance.
4.3.2 SHORT-RUN MODELS (Error Correction Models)
Based on the cointegration results, it is evident that there is a long-term or
equilibrium relationship among the variables of the models (3.10 and 3.11) estimated.
95
In using these results, we employed ECM to reconcile the short-run behaviour of the
variables with its long-run phenomenon. As a result, we present dynamic models here
starting with the over-parameterised models that we tested down until we arrived at
our preferred parsimonious models. These are reported in the following tables:
Table 4.11: Over-Parameterised Short-Run Result for Model 3.10
Dependent Variable: D(INF)
Method: Least Squares
Date: 08/31/09 Time: 12:03
Sample(adjusted): 1973 2006
Included observations: 34 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GE)
LOG(MS)
LOG(GE(-1))
LOG(GE(+1))
LOG(GE(-2))
LOG(MS(-1))
LOG(MS(+1))
LOG(MS(-2))
D(INF(-1))
D(INF(-2))
D(INF(+1))
ECTINF(-1)
-4.486049
-18.32584
48.71729
-14.43987
0.253678
1.936923
24.30692
11.97529
-56.84959
-0.170423
-0.107035
-0.302879
-0.435287
11.96403
10.48454
26.6053
10.9837
9.764183
10.07795
32.02973
20.86522
19.61136
0.181448
0.164312
0.175587
0.181745
-0.374961
-1.747892
1.831112
-1.314663
0.02598
0.192194
0.758886
0.573935
-2.898809
-0.939239
-0.65141
-1.724949
-2.395042
0.7114
0.0951
0.0813
0.2028
0.9795
0.8494
0.4564
0.5721
0.0086
0.3583
0.5218
0.0992
0.0260
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.679897
0.496981
11.49634
2775.481
-123.0816
1.480554
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
Source: Researcher’s Computation, 2009.
96
0.147059
16.20941
8.004802
8.588410
3.716989
0.004181
Results Interpretation:
From the tables 4.11, the dynamic over-parameterised model for the estimated
equation 3.10 depicts that the exogenous variables explained 49.7% of the variations
in the inflation rates. The p-values of all the variables were not significance except
money supply at lagged 2 and the error correction term [ECTINF(-1)]. As a result, we
then tested down until we arrived at our preferred parsimonious model. The
parsimonious interation involves dropping those insignificant variables from the shortrun over-parameterised macro model. So, the numbers of the exogenous variables in
the model was reduced by imposing zero coefficients on the insignificant ones.
Through simplification, the parsimonious model is shown in the
Table 4.12 below:
97
Table 4.12: Parsimonious Short-Run Model 3.10
Dependent Variable: D(INF)
Method: Least Squares
Date: 08/31/09 Time: 12:17
Sample(adjusted): 1972 2006
Included observations: 35 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GE)
LOG(MS)
LOG(GE(-1))
LOG(MS(-2))
D(INF(-1))
D(INF(+1))
ECTINF(-1)
-3.612884
-15.30506
67.75057
-11.30805
-43.26115
-0.098736
-0.336305
-0.522088
9.68976
7.747215
13.34397
8.599571
8.722092
0.144593
0.131032
0.131981
-0.372856
-1.975557
5.077241
-1.314955
-4.959951
-0.682858
-2.566586
-3.955776
0.7122
0.0585
0.0000
0.1996
0.0000
0.5005
0.0161
0.0005
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.662242
0.574676
10.512
2983.555
-127.4595
1.443869
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
Source: Researcher’s Computation, 2009.
98
-0.222857
16.11851
7.740543
8.096051
7.562713
0.000046
Results Interpretation:
Judging from the table 4.12, the dynamic parsimonious result reveals that the
independent variables accounted for 57.5% variations in the level of inflation. The
value of the feedback effect for parsimonious short-run model (3.10) is 0.5221. This
means that 52.21% of the discrepancy in the macro variables in the previous period
will be eliminated in this period. This suggests that if the INF rate was higher more
than expected a priori in the last period, this period it will be reduced by 52.21% points
to restore the long-run relationship among the variables. Besides, the short-run
changes in the explanatory variables are quickly reflected in the dependent variable, as
the slope coefficients of the variables are shown.
Statistically, the absolute value of [ECTINF(-1)] i.e. 0.5221 decides how quickly
the equilibrium is restored. The equilibrium error term is zero, indicating that INF rate
adjusts to change in exogenous variables (GE and MS) in the same time period. As a
result, the short-run changes in the M2 money supply have a positive impact on the
short-run changes in the inflation rates, while the government expenditure has a
negative effect.
99
Table 4.13: Over-Parameterised Short-Run Result for Model 3.11
Dependent Variable: D(INF)
Method: Least Squares
Date: 08/31/09 Time: 12:37
Sample(adjusted): 1973 2006
Included observations: 34 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GR)
LOG(MS)
LOG(GR(-1))
LOG(MS(-1))
LOG(GR(-2))
LOG(MS(-2))
LOG(GR(+1))
LOG(MS(+1))
D(INF(-1))
D(INF(-2))
D(INF(+1))
ECTIN(-1)
-41.25582
-15.29972
41.81469
-11.66617
16.73405
-5.308451
-53.08436
3.316608
24.54017
-0.072455
0.014144
-0.385737
-0.597331
16.69007
9.016266
26.56715
8.944992
31.1863
8.11882
18.25683
6.590271
22.50072
0.160396
0.157087
0.173132
0.167113
-2.471877
-1.696902
1.573924
-1.304212
0.536583
-0.653845
-2.907644
0.503258
1.090639
-0.451724
0.09004
-2.227997
-3.574417
0.0221
0.1045
0.1305
0.2063
0.5972
0.5203
0.0084
0.6200
0.2878
0.6561
0.9291
0.0369
0.0018
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.694330
0.519662
11.23417
2650.336
-122.2973
1.350816
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
0.147059
16.20941
7.958664
8.542273
3.975132
0.002820
Source: Researcher’s Computation, 2009.
Results Interpretation:
From the tables 4.13, the dynamic over-parameterised model for the estimated
equation 3.11 depicts that the exogenous variables explained 51.96% of the variations
in the inflation rates. The p-value of the error correction term [ECTINF(-1)] was
100
significance. From this result, we then tested down until we arrived at our preferred
parsimonious model. The parsimonious interation involves dropping those insignificant
variables from the short-run over-parameterised macro model. So, the numbers of the
exogenous variables in the model was reduced by imposing zero coefficients on the
insignificant ones. Through simplification, the parsimonious model is shown in the
table 4.14 below:
Table 4.14: Parsimonious Short-Run Model 3.11
Dependent Variable: D(INF)
Method: Least Squares
Date: 08/31/09 Time: 12:43
Sample(adjusted): 1972 2006
Included observations: 35 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(GR)
LOG(MS)
LOG(GR(-1))
LOG(GR(-2))
LOG(MS(-2))
LOG(MS(+1))
D(INF(+1))
ECTIN(-1)
-35.46818
-12.30545
48.31468
-10.35144
-4.274631
-42.5677
21.99635
-0.40144
-0.611916
12.65577
7.222141
17.04809
7.588577
6.862557
8.098289
17.35298
0.136751
0.119236
-2.802531
-1.703851
2.834023
-1.364082
-0.622892
-5.256383
1.267584
-2.935558
-5.131962
0.0095
0.1003
0.0088
0.1842
0.5388
0.0000
0.2162
0.0069
0.0000
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.687067
0.590779
10.31107
2764.273
-126.1236
1.379323
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
Source: Researcher’s Computaion, 2009.
101
-0.222857
16.11851
7.721348
8.121294
7.135596
0.000055
Results Interpretation:
Inferring from the table 4.14, the dynamic parsimonious result reveals that the
independent variables accounted for 59.08% variations in the level of inflation. The
value of the feedback effect for parsimonious short-run model (3.11) is 0.6119. This
indicates that 61.19% of the discrepancy in the macro variables in the previous period
will be eliminated in this period. That is, if the INF rate is higher more than expected a
priori in the last period, this period it will be reduced by 61.19% points to restore the
long-run relationship among the variables. Besides, the short-run changes in the
explanatory variables are quickly reflected in the dependent variable, as the slope
coefficients of the variables are shown.
Statistically, the absolute value of [ECTINF(-1)] i.e. 0.6119 decides how quickly
the equilibrium is restored. The equilibrium error term is zero, indicating that INF rate
adjusts to change in exogenous variables (GR and MS) in the same time period. As a
result, the short-run changes in the M2 money supply have a positive impact on the
short-run changes in the inflation rates, while the government revenue has a negative
effect.
102
4.4
TRENDS IN FISCAL OPERATIONS AND MACROECONOMIC STABILITY INDICES IN
NIGERIA 1970-2007
The fiscal operations in the last three decades (1970-1999) resulted in overall
fiscal deficits which were evident in each of the period under review except in six years
(1971, 1973, 1974, 1979, 1995 and 1996) when surpluses were recorded. So, these
trends of the imbalances continue from year 2000 to 2007 the periods of these
reviews.
The immediate effect of oil-price volatile increase in the Nigerian economy was
an expansion in government revenue over the years. This was evident by the 1978 oil
price shock that accounted for the raised in total revenue from 14.99% of GDP to
26.18% in 1980. In 1981, the oil revenue declined to 64.4% from 81.1% in 1980 of the
total oil revenue due to the oil glut in the international market. However, oil revenue
resumed an upward trend in 1982 when it contributed 68.3% of the total revenue to
73.5% in 1984. The total revenue grew at an average of 28.7% of GDP between 1990
and 2001. And this trend continued till 2007 (see appendix table 4.15 and figure 4.1)
The pattern of public expenditure during the period under review was largely
influenced by expected performance of the oil sector. The high oil earnings enhanced
government to raise expenditure to unsustainable levels. The onset of recession in
103
1981 led to the decline in total expenditure to 22.6% of GDP from 30.2% in 1980. The
downward trend continued until 1985 when it resumed an upward movement. By
1993, expenditure had risen to 27.6% over the preceding year’s level and by 1999 the
total expenditure increased to 29.4% of GDP. The upward trend was maintained and
by 2001 a new threshold was reached when the level of expenditure peaked
representing 18.6% of GDP (see appendix table 4.15 and figure 4.1).
Therefore, from the foregoing, as a result of the higher growth in the public
expenditure compared to the raise in government revenue, the fiscal operations
resulted in overall deficits continuously from 1980 to 1995 while overall surpluses
were recorded in 1996 and the deficits later increased from 1997 to 2001. The overall
deficit as a percentage of GDP average 8.25% between 1980 and 1994 and 4.1%
between 1997 and 2002 (see appendix table 4.15 and figure 4.1).
104
Figure 4.1 Trends in Fiscal Operations and Macroeconomic Stability indices in Nigeria:
1970-2007
80
70
60
50
Gov.Exp/GDP(%)
Gov.Rev/GDP(%)
40
MS/GDP (%)
30
GDP Growth (%)
INF Rate (%)
20
10
0
-10
From figure 4.1, after pursuing formal tests, we plot the time series under
study for the data given in the table 4.15. This gives a clue about the nature of the time
series. The GDP time series shown that over the period of study it has been increasing,
that is, showing an upward trend, suggesting that the mean of the GDP has been
changing. This indicates that the GDP series is not stationary. This is also more or less
true of the other Nigeria economic time series shown in the figure. Hence, this
intuitive feeling is the starting point of the more formal tests of the stationarity and
cointegration tests conducted in the subsection 4.3 above.
105
Figure 4.2 Selected Macroeconomic Indicators (1970-2007)
45
40
35
30
GE/GDP (%)
25
GR/GDP (%)
20
MS/GDP (%)
CPI Inflation (%)
15
GDP Growth (%)
10
5
0
1970
1980
1990
2000
2005
2006
2007
As is evident from the illustration of this subsection, there are many ways in
which the functioning of the public sector bears on economic growth and may do so in
both a helpful and a harmful way (see appendix table 4.16 and figure 4.2). The general
view of the challenge is provided in figure 4.2 above, which relates public sector share
in GDP to the rate of economic activity and growth. Including a sample of M2 money
supply, inflation rates, fiscal spending and revenue as well as covering the decades of
1977-2007, we find little or no evidence of a systematic relationship. This is perhaps is
as may be expected since so much depends on the context of public expenditures, and
106
many other factors, unrelated to the budget, enter as well. Nevertheless, it is
important to note that no ready judgment, pointing one way or the other can be
made. But a closely look at the empirical analyses in the previous subsections (4.2 and
4.3) will shed more light and provide appropriate policy measures on the issues in
relation to fiscal and monetary policies effect on the macroeconomic stability in
Nigeria.
4.5
THE TRANSMISSION MECHANISMS OF FISCAL POLICY
The channels through which fiscal policy measures affects economic growth
and development in Nigeria are reflected in macroeconomic stability that yields
numerous benefits including; higher rates of return on investment, infrastructural
development,
technological
advancement
and
human
capital
development
(educational attainment) which are better achieved in an environment of low inflation.
In the period under review, Nigeria experiences high rates of inflation with little or no
growth in economic activities. This resulted in poor standard of living and poverty at
every level. As a result, there is serious macroeconomic instability in the economy
which is damaging to the populace (the poor) since their earnings are not indexed to
inflation; and inability to invest in assets that provide a hedge against inflation.
107
Thus, it is evident that the fiscal system plays multifaceted roles in the process
of economic growth and development. Firstly, the distributions of tax burdens play a
large role in enhancing equitable distribution of economic resources. For instance, the
structure and the level of taxation affect the level of public and private savings as well
as the volume of resources available for capital formation. Also, the tax treatment of
investment from abroad affects the volume of capital inflow and the rate of
reinvestment of earnings there from as well as the pattern of taxation on exports and
imports relative to that of domestic products will affect foreign trade balance.
Therefore, a good system of tax incentives and penalties must be designed to
influence the efficiency of resource utilization.
The role of expenditure policy in macroeconomic stability has been explored
more extensively than that of tax policy in this study due to difficulty in obtaining
comparative data. We obtained some evidence regarding the role of GDP in economic
growth as well. The low-income earners direct a higher share of expenditures to
education and health services and lower share to transfers. The higher share for
education to some degree reflects the higher cost of educational services in this
nation. The higher share of transfers in high-income earners reflects the more
developed social security systems they achieve. The particular importance of this form
108
of capital formation, it is essential that the educational inputs be designed to meet the
country’s need for specific labour skill.
Moreover, the rent-seeking incentives by the government reduce growth by
diverting higher human capital away from productive activities with adverse impact on
productivity and resulted in lower economic performance. However, prudent fiscal
policy can help enhance factors productivities. The endogenous growth theory
suggests that fiscal policy can either promote or retard economic growth through its
impact on decisions regarding investment in physical and human capital; increased
fiscal spending on education, health, infrastructure, research and development will
boost long-term growth; while government expenditure on infrastructure and private
sector productivity complementary public inputs.
The strategic role of public investment in economic growth and development is
based in part on the underdeveloped state of private capital markets and in part on
local scarcity of entrepreneurial talent; it is also based on the fact that the type of
investment needed at the earlier stages of development frequently includes very large
outlays on infrastructure investment which call for public provision. Therefore, huge
public investment is needed to provide for the infrastructure types of investment.
109
Hence, the distribution of expenditure benefits plays a large part in promoting
equitable distribution of the fruits of economic development.
Finally, ineffective fiscal policy harms the growth process through dead-weight
loss from taxes that finance public expenditure and the associated adverse factorsupply effects as well as the inefficiently and inequitably used of public resources.
Therefore, Growth is important for poverty reduction, whereas poverty reduction
constitutes an essential ingredient to achieving high quality growth. But entrenched
poverty and inequality can themselves be impediments to growth. So, from the
foregoing, redistribution policies are relevant in eradicating poverty or at least
alleviating some of its most adverse effects, particularly when income inequality is
severe.
4.6
POLICY IMPLICATIONS
The results obtained from the analysis reveals that fiscal spending, revenue and
money supply positively related with the growth in national output. This implies that
both fiscal and monetary policy measures will impact positively on economic growth.
As such, fiscal and monetary policies that are not properly targeted to the happenings
110
within the macroeconomy will have adverse effects on economic growth as well as
raises inflationary effects.
Finally, the research study finds out that adequate and prudent expenditure
policy together with healthy monetary policy raises economic growth in a good policy
environment. Thereby, public resources would be used efficiently and equitable in
order to sustain the economy. Therefore, fiscal prudent as reflected in appropriate
fiscal sustainability tend to reduce the risk of economic crises and prevents interest
expenditure from squeeze out critical social spending. Hence, proper funding of
education and health directly impact on socio-economic outcomes which are
important for poverty eradication that will enhance economic growth and sustainable
development. It is not just the level of spending that matters, but also the efficiency of
the outlays and how well they are targeted to the poor in the society.
111
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION
5.1
SUMMARY/CONCLUDING REMARKS
This study attempted to assess the impact of fiscal policy (fiscal spending)
measures on macroeconomic stability indices (GDP growth and inflation rates) in
Nigeria. This was meant to determine whether the level and dynamic behaviour of
expenditure policy measures coupled with monetary policy during the period under
review have effectively and efficiently led to economic growth and reduced
inflationary pressure. Thus, the discussion in this chapter summaries the entire study
in what follows:
Chapter one of the studies dealt with the historical background, problem
statement, research objectives, justification, scope, methodology and the plan of the
study.
In chapter two, we reviewed the related literature under which the followings
where considered: the theoretical and empirical literatures on fiscal policy and
macroeconomic stability as well as monetary policy practices; implementation of
economic reforms; appraisal of economic policy measures; the challenges ahead and
concluding remarks.
112
The third chapter presented the basic theoretical framework for fiscal relations
and the methodological issues such as the macro models description, estimation
techniques, data types and sources.
However, chapter four examined the estimation procedures and issues of
empirical analyses (including the long-run and short-run models), the trends in fiscal
operations, transmission mechanisms and the policy implications of results. Thus, the
discussion in this subsession summaries the findings as follows; we evaluated critically
both trend and regression analyses. The trend result indicated that: The pattern of
public expenditure was largely influenced by the revenue generated during the period
under review. High oil revenue earnings encouraged government to raise expenditure
to unsustainable levels, thus the fiscal operations resulted in overall fiscal deficits
continuously from 1980 to 1994 while surplus was recorded in 1996 and it later
increases from 1997 to 2007.
Also, the relationships among the variables were examined by analyzing their
long-run properties and short-run dynamics. The macroeconometric results from the
long-run models showed that the explanatory variables are significant in explaining the
observed variations in the GDP growth. This implies that the fiscal and monetary policy
measures impact positively on economic growth in Nigeria. But surprisingly, the
113
explanatory variables were quite unable to explain the variations in the levels of
inflation.
Similarly, the macroeconometric results from dynamic short-run (error
correction models) revealed that the independent variables accounted for the
variations in the level of inflation. This suggests that INF rate adjusts to change in
exogenous variables (GE, GR and MS) in the same time period. As a result, the shortrun changes in the money supply have a positive impact on the short-run changes in
the inflation rates, while the other variables have negative effects.
Finally, this last chapter of the research works centre on summary of findings,
conclusions and recommendations. Lessons for public policy from the analysis and
suggestion for further studies are presented.
5.2
CONCLUSIONS
The improvement in fiscal management has been at the centre of recent
economic reform agenda. To achieve a long term fiscal sustainability, it is imperative to
enhance efficiency and quality of public expenditure, strengthen fiscal coordination
among the three tiers of government, through Implementing the fiscal responsibility
legislation, Public procurement legislation and Improve management of oil revenue.
Growth, wealth creation and poverty reduction are all undermined when public
114
financial management and taxation are weak. Fiscal policy’s full potential will not be
realized until good and accountable expenditure and taxation systems are put in place.
The policy-makers should understand that the goal of macroeconomic policies
has broadened to the full recognition that macroeconomic stability involves multiple
dimensions, including not only price stability and sound fiscal policies, but also a wellfunctioning real economy. A well-functioning real economy requires, in turn, smoother
business cycles, moderate long-term interest rates and competitive exchange rates, all
of which may be considered intermediate goals of the ultimate Keynesian objective:
full employment. Such a broad view of macroeconomic stability should recognize, in
any case, that there is no simple correlation between its various dimensions and, thus,
that multiple objectives and significant trade-offs are intrinsic to the design of “sound”
macroeconomic frameworks. This view would lead to the recognition of the role
played by two sets of policy packages, whose relative importance will vary depending
on the structural characteristics, the macroeconomic policy tradition and the
institutional capacity of the country.
The first policy package involves a mix of counter-cyclical fiscal and monetary
policies with appropriate exchange rate regimes. The second includes a set of capital
management techniques designed to reduce the unsustainable accumulation of public
and private sector risks in the face of pro-cyclical access to international capital
115
markets. To encourage economic growth, such interventions through the business
cycle would lead to sound fiscal systems that provide the necessary resources for the
public sector to do its job, a competitive exchange rate and moderate long-term real
interest rates. These conditions, together with deep financial markets that provide
suitably priced investment finance in the domestic currency with sufficiently long
maturities, are the best contribution that macroeconomics can make to growth.
In the context of the overall objective of accelerated economic development,
monetary policy has had to grapple with the major challenges, thus: the maintenance
of a healthy balance of payments and relative price stability. The relative success or
lack of it, in the attainment of such demand management objectives should not be
arrogated to or blamed on the monetary policy because other policies and factors
simultaneously influence the macroeconomic goals of income, employment, prices and
balance of payments equilibrium. However, the monetary authority should look back
into its short history of monetary management with the satisfaction that it has so far
skillfully made a selective use of the available and applicable techniques to suit the
dynamic economic and financial conditions of the emerging modern economy of
Nigeria.
116
Overall, fiscal policy reveals more about the political priorities underpinning our
country’s development strategy than any other area of policy making. The major
problem with our government and leaders is that they have concentrated more on
how to share poverty than how to create wealth. The intensity of the government
struggle has been so fierce, divisive and selfish that they have succeeded in improving
themselves.
5.3
RECOMMENDATION
Given the foregoing situation, to turn the scales, the government must invest
and fund education; increased productivity in agricultural sector; investments in
infrastructure to support the growth of the private sector and create jobs as well as
ensuring that the state and local governments live up to the challenge of ensuring
transparent accountable and responsible governance in order to broaden and deepen
the reforms, therefore delivering the benefits of the reforms to the Nigerian populace,
especially the poor and underprivileged.
The policy-makers in Nigeria need to implement Pareto-improving revenue
allocation policy. This is necessary because the Pareto-optimal for the revenue
allocation formula would provide incentives for the three tiers of government that
117
want to exert more tax effort to generate more revenues in their specific areas of
jurisdiction rather than being a free-rider as is currently the case.
The revenue sharing problem should be reformulated as a classic principalagent paradigm under moral hazard conditions
to overhaul Nigeria’s fractious
revenue sharing arrangement in order to minimize the anomalies identified in the
system.
More importantly, our leaders should properly design an inter-governmental
transfer system that compensates federating units for tax effort sine qua non for both
long-term political and economic stability. The bearing of such an approach to fiscal
transfer on fiscal prudence, sustainability and political stability of the federation and
social harmony would be evident. Enough of opportunistic fiscal behaviour otherwise
the ultimate economic and social outcomes may be against the long-term of the
federation.
Therefore, governments are expected to address resource distribution inequity
and the associated fiscal imbalances in the environment. Also, they should use
transfers to induce some sub-national units (local and state governments) to
internalize social and economic externalities through the adoption of a certain socioenvironmental quality, and infrastructure.
118
Adopting performance-based budgeting, that will link envisaged outcomes to
budgetary allocation, promoting citizens participation in public budgeting, and
expenditure monitoring and rigorous application of the provisions of the Fiscal order
to: review taxes to make them fewer in number, more broad-based and higherrevenue yielding; shift the focus of tax system from direct taxation to indirect taxation;
and avoid multiple taxation by various tiers of government on income, property,
imports, production and turnover.
For the future, there are obvious indications that the CBN would continue to
face a complex financial situation featuring, among other things, a destabilizing
monetary expansion from factors largely outside its direct control. This been the case,
there is a critical need to employ monetary policy more flexibly to counteract the
destabilizing effects of exogenous factors and steer the economy along the desired
path of socio-economic progress. The persisting practice of annual frequency of
monetary policy formation as if it was a mere component of the government
budgetary exercise, is not only peculiar but also represents an inadvertent
compounding of the problem of action lag in policy formation. This is clearly
unsatisfactory in a dynamic and rapidly changing society such as Nigeria.
Although the Nigerian financial and economic conditions do not as yet admit of
such frequency of monetary regulation as their counterpart advanced countries, there
119
is obviously a convincing case for taking an immediate monetary policy action as soon
as the need is recognized rather than wait for the beginning of every fiscal year before
formulating monetary policy. Furthermore, as financial adviser to the government, the
CBN should not relent its efforts in emphasizing the need for a more integrated
approach to macroeconomic management in order to minimize the pursuit of
conflicting objectives by the various organs of governmental machinery responsible for
policy formation and implementation.
Also, government should recognize that the great responsibility of the CBN is to
safeguard the national money which requires that it must keep itself liquid at all times
and hold only first class assets. Therefore, its management must be above sectional
politics, that is, the need to insulate the CBN from partisan politics. Thus, CBN should
be kept absolutely free to give impartial advice to government on the use of monetary
policy instruments based solely upon the good of the economy and never upon
political experiences.
The policy-makers should know that reforms build on each other. The returns
rise more rapidly the more widespread and the more co-coordinated they are. For
any country that is ill-prepared, the modern global economy can seem harsh. For
those with sound policies, the rewards are great indeed. Perseverance is worth it.
120
The short-run target for the economy must be able to consolidate economic reforms
through continued pursuance of sound macroeconomic management and fiscal
prudence. In the medium-term, government should empower micro units of
productive activities to utilise the benefits from the macroeconomic reforms. In the
long-run, government must strive to attain the growth objectives as set out in our
NEEDS 2 in order to reduce poverty by at least 30% by 2011, and attain annual GDP
growth rate of at least 13% so as to make Nigeria one of the 20 largest economies in
2020. On a final note, Nigeria needs to ensure better value for money, manage the
recurrent spending of the government, seek better participation of the private sector,
especially in the provision of infrastructure, strengthen monitoring, auditing and
reporting processes and strengthen fiscal co-ordination amongst the 3 tiers of
government.
5.4 SUGGESTION FOR FURTHER RESEARCH
On one side, there is the vast array of fiscal institutions such as tax system,
expenditure programmes, budget procedures, stabilization instruments, debt issues
etc., and there is an endless stream of issues arising in the operation of these
institutions. Further issues in fiscal and stabilization policies which need to be explored
extensively and demand the attention of the researchers are: tax-structure policy and
incentives; shares of education and transfers; spatial aspect of stabilization; federal
121
grant and equalization; fiscal solvency and debt issues; earnings indexation and
inflation; term structure of rate theory; and coordination of income, expenditure and
stabilization.
The forgoing non-exhaustive issues make rising further conceptual and policy
researchable questions, thus: What taxes are to be chosen and who really bears their
burden? How the fiscal functions should be divided among levels of government? How
big a share of GDP should be included in the public sector and how should the choice
of public expenditures be determined? How can a high level of employment be
reconciled with stable prices? How does inflation enter into the rate structure? To
what extend can earnings of populace be indexed to inflation? And does debt finance
burden future generation? Pursuit of these issues will lead from one end of economic
analysis to the other.
In conclusion, therefore, the application of economic theories, principles, and
policies to an imperfect world such as Nigeria is not only challenging but also
stimulating analytically and policy-wise. What this study has done is to apply modern
macroeconomic theory to an important issue in fiscal sustainability of expenditure
policy in Nigeria. However, there are several areas of research in Nigeria Sub-Saharan
Africa that would benefit immensely from this application of public finance. The
122
pervasiveness of macroeconomic instability in the region reveals that wide range and
fruitful research can be undertaken in all areas of economics from microeconomics to
public sector economics, development, international, monetary, industry, financial,
environmental, petroleum and energy, econometrics, political economy, information
economics and macroeconomics.
123
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