ABSTRACT
The study investigated the effect of fiscal policy on foreign direct investments in Nigeria using annual time series data from 1981 to 2018 sourced from the Central Bank of Nigeria Statistical Bulletin and the National Bureau of Statistics. Specifically, the study estimated the effect of tax rate, government capital expenditures, government recurrent expenditures and deficit financing on foreign direct investment inflows. The data analysis was carried out with the aid of ordinary least squares technique based on Johansen cointegration, vector error correction mechanism and Granger causality test since the variables used for the study were integrated at first difference as revealed by the unit root test. Based on the results of the analysis, it was found that a long-run relationship existed between tax rate, government capital and recurrent expenditures, and government debt. Also, it was found that increased tax rate and government debt had a negative and significant effect on FDI in the long-run, while government capital and recurrent expenditures had a positive and significant effect on FDI in the long-run. The negative and significant effect of government debt which was used to proxy deficit financing could be due to the debt burden arising from huge debt servicing. In the short-run, tax rate and government debt had a negative and significant effect on FDI, while government capital and recurrent expenditures were found to have a positive effect on FDI, but capital expenditure was not significant. The value of ECM given as -0.825584 indicated a feedback of or an adjustment of 31.16% from the previous period disequilibrium of the present level of FDI. The Granger causality test revealed that recurrent expenditures and debt Granger caused FDI, while FDI Granger caused tax rate. Based on these findings, the study concluded that fiscal policy do affect the flow of foreign direct investment into Nigeria. It was recommended, among other things, that government should establish a strong fiscal responsibility and transparency system in the country, adopt tax reforms that would be favourable and encourage increase in FDIs in Nigeria.
TABLE
OF CONTENTS
Title
Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
Table
of Contents vi
List
of Tables viii
List
of Figures ix
Abstract x
CHAPTER ONE: INTRODUCTION
1.1 Background
to the Study 1
1.2 Statement
of the Problem 4
1.3 Research
Questions 6
1.4 Objectives of the Study 7
1.5 Hypotheses 8
1.6 Significance of the Study 8
1.7 Scope of the Study 9
1.8 Limitations
of the Study 10
CHAPTER
TWO: LITERATURE REVIEW
2.1 Conceptual Framework 11
2.1.1 Meaning
of fiscal policy 13
2.1.2 Concept
of foreign direct investments (FDI) 14
2.1.3 Link
between fiscal policy and FDI inflows 17
2.1.4 Fiscal policy in Nigeria 21
2.1.5 FDI
in Nigeria 25
2.2 Theoretical
Framework 27
2.2.1 Keynesian theory 27
2.2.2 Neo-classical theory 28
2.2.3 The
real option theory 29
2.2.4 Eclectic paradigm theory 30
2.3 Empirical Framework 31
2.4 Summary of Empirical
Literature 54
2.5 Research Gap 55
CHAPTER
THREE: METHODOLOGY
3.1 Research
Design 57
3.2 Nature
and Sources of Data 57
3.3 Model
Specification 57
3.4 Classification
and Description of Model Variables 59
3.5 Techniques
of Data Analysis 60
CHAPTER FOUR: PRESENTATION OF DATA,
ANALYSIS AND DISCUSSIONS
4.1 Presentation
of Data 62
4.2 Descriptive
Statistic 68
4.3 Test
for Stationarity 69
4.4 Cointegration
and Error Correction Model 70
4.4.1 Johansen
cointegration test 70
4.4.2 Vector
error correction 72
4.4.3 Granger
causality test 74
4.4.4 Hypotheses testing 75
4.4.5 Discussion of findings 77
CHAPTER 5: SUMMARY, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary 79
5.2 Conclusion 80
5.3 Recommendations 80
5.4 Contribution
to Knowledge 81
REFERENCES
APPENDIXES
LIST OF TABLES
2.1 Summary of empirical literature 53
4.1 Annual time series data used for the
study 62
4.2 Descriptive
statistic 68
4.3 ADF unit
root test results 69
4.4 VAR lag order
selection criteria 70
4.5 Johansen
cointegration test results 71
4.6 Vector error correction model (VECM) 73
4.7 Granger causality test 75
LIST OF FIGURES
2.1 Mechanism of fiscal policy and foreign
direct investments 12
4.1 Trend of foreign direct investments 63
4.2 Trend of tax rate 64
4.3 Trend of government capital expenditures 65
4.4 Trend of government recurrent
expenditures 66
4.5 Trend of government debt 67
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
In recent times, there has been intense competition
among nations of the world due to increasing competitive activities arising
from the current waves of globalization. As a result, firms are compelled to be
more innovative, competitive and dynamic through the development of new Information
and Communication Technologies (ICT) and by entering into new markets across
the globe, but also through trade liberalization based on World Trade
Organization (WTO) provisions (Nistor and Gondor, 2012). Coupled with the need
for costs reduction and increase in competition, this process of economic
liberalization has forced companies to search out new strategies in order to
gain competitive advantages. Hence, many businesses are launching out into
other countries in search for new locations that are more attractive for
several reasons, such as cheap labor, exemption from tax payment, tax secrecy
or other taxation benefits, not forgetting geographical benefits to achieve the
desired competitive advantage through foreign direct investments (FDI). In most
cases, FDI is facilitated by Multinational Corporations (MNCs). Clearly, these
MNCs play prominent role in world trade and investment flows following the
management skills, technology, financial resources and related advantages they
demonstrate (Rafiq, 2013).
FDI connotes investment
activities geared towards acquiring management interest in a company operating
outside the country of the investor (UNCTAD, 2000). As such, countries now
include the potential benefits from FDI inflows in their plans towards ensuring
economic advancement. This is because FDI flows consist of external resource
inflow including technology, marketing and management transfer among nations
(Thuita, 2017). However, notwithstanding the importance of FDI, efforts geared
towards attracting FDI has failed despite the cogent need for inflow of foreign
resources in developing countries, like Nigeria. One of the factors adduced to
be responsible for this is the structural characteristics of the Nigerian
economy including ineffective economic policies, lack of technical advancement,
socio-political problems, market failures, etc. (Dash, 2016). These
aforementioned structural and environmental factors are very critical because
they define the mechanisms of public policies, among other things. At the same
time, governments of most developing countries have lost fundamental strategies
traditionally used to foster domestic competitiveness towards attracting FDI.
Most countries use a variety of
incentives, through fiscal policy, to attract FDI irrespective of their developmental
stage (Effiok, Tapang and Eton, 2013). Fiscal policy entails government revenue
collection through taxation which are expended to influence economic activities
of a country. With fiscal policy, government is able to influence economic
factors such as aggregate demand, income, and economic
activity as a whole (Peters
and Kiabel, 2015; Gondor and Nistor, 2012). This
implies that market mechanism cannot solely drive economic activities in a
country; and as such there is demand for public policy to correct, guide and
supplement market forces towards correcting market imperfections and failures
(Osuala and Ebieri, 2014). The hub of fiscal policy is to influence and monitor
the economy by adjusting taxes and/or public spending by government. In
reality, there have been wastages as some public funds meant for economic
stabilization has been politicized, leading to high level of misappropriation,
mismanagement, corruption, loss of confidence in the Nigerian investment
environment. In this light, Ajisafe and Folorunsho (2002), explained that
inappropriate government expenditure, tax rates and huge deficits have been
responsible for the macroeconomic disequilibrium at varying times in Nigeria,
hence making the economy less attractive to foreign investors.
Literature
abound that fiscal activities had affected the net return on capital and
influenced capital mobility between countries. In support of this assertion,
Dash (2016), affirmed that attitude towards inward FDI should be modified
especially when most countries have liberalized their policies to attract
investment from foreign companies. This yarning became an indispensable priority
due to the expectation that investments from multinational companies (MNCs)
would create employment, increase exports and tax revenue, or that productive knowledge
of MNCs might spill over to domestic firms in the host economy. Consequent upon
this, most host governments desiring FDI inflows have provided diverse forms of
investment incentives to inspire foreign owned companies to invest within their
jurisdiction. These incentives include tax holidays, lower tax rate for MNCs,
grants as well as preferential loan extension to MNCs and other foreign
investors, alongside market preferences and even monopoly rights (Khalifa,
2016). More substantial argument in favour of public support for FDI has been
based on the grounds of knowledge spillover (Bashin, 2016). This was because technology
and skill used by foreign firms were to some extent, public goods and they have
resulted in benefits for their host countries even if the MNCs carried out
their foreign operations in wholly-owned affiliates.
As
a matter of fact, the long strive among governments to lure foreign investors
has been because foreign capital augmented the productive capacity of a
country, promoted transfer of technology and skills to the host country,
provided employment, tax revenues and hence has helped to alleviate poverty,
among other benefits (Obeng, 2014). As such, governments have used,
extensively, both non-tax and tax incentives to appease foreign investors to
locate in their economies. For instance, the non-tax incentives used to
encourage FDIs were loans, grants, rebates and investment subsidies (Anichebe,
2019). Conversely, the tax incentives could take the form of corporate income
tax reduction, elimination of import duties and tax holiday in Export
Processing Zones (EPZ). The idea was that MNCs have been profit oriented and
therefore, would be sited in locations or economies where their profits would
be maximized.
Nigeria,
like other developing countries across the globe had prospect for favourable
investment inflows at the time of independence. FDI inflows into the region
have been marred by gross economic mismanagement and inefficient fiscal
policies. Comparing Nigeria with other developing countries in Southeast Asian
countries, it was glaring that foreign investment inflows into Nigeria has been
paltry (Peters and Kiabel, 2015). In recent years, most Southeast Asian
countries had far higher inflows and income levels, while the Nigerian economy
had been plagued with several challenges (Olaleye, Riro and Memba, 2016). In
spite of diverse, and frequent changing of fiscal policy, Nigeria is yet to tap
her economic potentials for increased FDI inflows. Notably, fiscal policy has been
central to the health of any economy, as government has power to raise revenue
(tax) and expend revenue to ensure economic stability and increased inflows of
foreign investments. Based on this premise, the study analyzed effect of fiscal
policy on FDI in Nigeria.
1.2 STATEMENT OF THE PROBLEM
A
major idea in literature concerning the effectiveness of fiscal policy in
fostering FDI is that the host country’s government support for knowledge spillover,
research and development (R&D), productive investments, the maintenance of
law and order as well as the provision of other public goods could stimulate
investments in both the short-run and the long-run (Okoh, Onyekwelu and Iyidiobi,
2016; Ogbole, Amadi and Essi, 2011). This, notwithstanding, the extent to which
fiscal policy engender FDI inflows has continued to attract empirical debate
especially in developing countries. For instance, globalization and the
resulting increase in capital mobility have created opportunities for tax
competition among countries eager to attract FDI. In the process, tax
incentives have assumed new and increasing importance. Use of fiscal incentives
like tax holidays and tax reduction to attract FDIs is usually justified by the
expected additional beneficial effects of the foreign investment on the host
economy. It needs to be noted, however, that while tax incentives (like, tax
holidays and tax reduction) might lead to incremental foreign investment, such
incentives might also lead to weakening of public finances through decreased
tax revenues. As shown by prior literature, numerous studies such as, Gondor
and Nistor (2012); Effiok, Tapang and Eton (2013); Peters and Kiabel, (2015);
Thuita (2017) had focused on the influences of taxation on foreign direct
investments.
Fundamental
to the problem statement is the representation of fiscal policy. Theoretically,
four standard fiscal policy measures; government expenditure, tax rate, tax
revenue and deficit financing exist. Out of these four variables, literature
did not single out any as the most representative of fiscal policy. While
scholars such as (Okorie, Sylvester and Simon-Peter, 2017; Rafiq, 2013; Engen
and Skiner, 1996), have made use of tax rates as a proxy for fiscal policy
others such as Edame and Okoi (2015); Umaru and Gattawa (2014); Maji and
Achegbulu (2012), had used deficit financing to measure fiscal policy in their
studies. Yet, scholars including Ogbole, Amadi and Essi (2011), used government
expenditure to indicate the stance of fiscal policy. When government
expenditure was considered as a fiscal policy measure certain studies such as,
Osuala and Ebieri (2014), had considered total government expenditure as one variable,
while others, such as, Gondor and Nistor (2013), holds the view that the
variable should be categorized as recurrent and capital expenditure. This is what the present study has done.
The
effectiveness of taxation (a dimension of fiscal policy) in FDI attraction has
been documented in diverse literature. The second perspective of fiscal policy
which is government spending (expenditure) have not received adequate attention
regarding its influence on FDI. While tax incentives (revenue side of the
fiscal policy) might be used to improve inbound FDI, the expenditure of
government on production of public expenditures which might be of productive
use to both foreign and domestic investors that could also play a significant
role in attracting foreign investors. Countries competing for FDI might want to
offer a better tax environment, improve investments in infrastructure, enhance human
capital formation, and promote economic stability of the country (Effiok,
Tapang and Eton, 2013). This, in turn, could be achieved if the expenditure
policy of the government is welfare-oriented. Such policies could be a successful
way of attracting FDI as well as promoting economic development since such
measures result in benefits that accrue to domestic producers as well (Osuala
and Ebieri, 2014).
In
view of the aforementioned potential gains from a well-conceived fiscal policy,
it becomes necessary to gauge influence of the fiscal policy on inflows of FDI
into Nigeria. There is very sparse literature examining influence of fiscal
policy on FDI inflows with respect to Nigeria. The present study attempted to
bridge the gap in literature through incorporating both revenue and expenditure
sides in its model to examine effects of fiscal policy on FDI inflows into the
Nigerian economy. By
the time it is completed, the researcher would be in a position to propose
recommendations that would facilitate the free flow of FDIs into Nigeria in the
years ahead.
1.3 OBJECTIVES OF THE STUDY
The major objective of this study is
to empirically analyze effects of fiscal policy on FDI in Nigeria. The specific
objectives are to:
1.
Evaluate effect of tax
rate (proxied by total tax revenue to GDP ratio) on foreign direct investments
in Nigeria.
2.
Analyze effect of
government capital expenditure on foreign direct investments in Nigeria.
3.
Ascertain effect of government
recurrent expenditure on foreign direct investments in Nigeria.
4.
Investigate effect of
deficit financing (measured by public debt) on foreign direct investments in
Nigeria.
5.
Examine causal
relationship between fiscal policy variables and foreign direct investments in
Nigeria.
1.4 RESEARCH
QUESTIONS
The
following questions emanated from the research problem:
1.
To what extent does tax
rate (proxied by total tax revenue to GDP ratio) affect foreign direct
investments in Nigeria?
2.
In what ways do government
capital expenditure affect foreign direct investments in Nigeria?
3.
What is the nature and
magnitude of effects of government recurrent expenditures on foreign direct
investments in Nigeria?
4.
How does deficit
financing (measured by public debt) affect foreign direct investments in
Nigeria?
5.
What is the direction of
causality between fiscal policy variables and foreign direct investments in
Nigeria?
1.5 HYPOTHESES
The
following hypotheses have been formulated and tested during the conduct of this
study to include the followings:
Ho1: Tax rate (proxied
by total tax revenue to GDP ratio) does not have significant effect on foreign
direct investments in Nigeria.
Ho2: Government capital expenditure does not
have any significant effect on foreign direct investments
in Nigeria.
Ho3: Government recurrent expenditure does
not have any significant effect on foreign direct
investments in Nigeria.
Ho4: Deficit financing (measured
by public debt) does
not have any significant effect on foreign direct
investments in Nigeria.
Ho5: There is no significant causal
relationship between fiscal policy variables and foreign
direct investments in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
The
empirical findings of this study would be of immense significance to the
following:
1)
Government
of Nigeria:
The Nigerian government
is grappling seriously with the bureaucratic management of fiscal policy
especially in the aspect of taxes which may have the incentive of negating
peoples’ attitude towards working and paying higher taxes while affecting both
foreign and domestic investments within the economy. This study will therefore
assist the government of Nigeria in ensuring proper management of fiscal policy
measures to encourage both foreign and domestic investors. This will certainly led
to favourable investment climate that would attract FDIs to Nigeria.
2)
Investors:
A
well-managed fiscal process attracts foreign investments. This investment could
be local as well foreign. An effective management of fiscal policies can spur the
informal sector activities which include economic activities that are done
outside the purview of government surveillance. Informal activities in
agriculture, mining, small scale production of goods and services, retail
trade, transport, financial intermediation, personal services etc. gets a boost
when fiscal policies are effectively managed. Therefore, outcomes of this study
will assist policy makers in fashioning out policies that will crowd-in
investment in the informal sectors which will result in more FDI.
3)
Academic:
This study will contribute
significantly to the volume of literature available in the area of impact of
fiscal policy on FDI flows. In academics, debates are unending and studies will
continue to support or disprove theories. Therefore, the outcome of this study
will contribute immensely in determining impact of fiscal policy variables on
FDI from a structural perspective.
1.7 SCOPE
OF THE STUDY
The
focus of this study is to determine effects of fiscal policy on FDI in Nigeria.
Fiscal policy variables such as government tax rate, government capital and
recurrent expenditures, and deficit financing (debt) was considered to ascertain
if they have an effect on FDI in Nigeria.
The study covered the period from 1981 to 2018 for two reasons. First,
the period covered the era of regulated (1981-1985) and deregulated (186-2018)
financial system. Also, it covers years of military rule and democratic
government which is seen to have affected fiscal policy mechanism in Nigeria.
Above all, time series data were available for the period of time.
1.8 LIMITATIONS
OF THE STUDY
The constraints that was encountered
during the course of this study were time factor and lack of funds. These two
factors are economic resources and it is a clear fact that economic resources
are limited and scarce. However, the researcher applied the principle of
opportunity cost, scale of preference and prudent utilization of available
resources to accomplish the study.
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