Finance, Investment and Growth Nexus
One of the principal objectives of the Nigerian government under the new democratic dispensation is the fostering of sustained economic growth. Development economies offers some insight into the determinants of growth. Over the years, the government has been on the driver’s seat in growing the economy. But lessons of experience have shown that government is not very good in the business of “business”. A paradigm lift under the National Economic Empowerment and Development Strategic (NEEDS) has underscored the need for public/private sector partnership and the need to restructure and deepen the financial system.

Some economists postulate that rising investment alone is not sufficient to bring about growth and that the role of institutions is very paramount. In particular, the view expressed that the role of finance is very critical to the success of any endeavor in that regard. It is therefore important to investigate the relationship that obtain in the case of Nigeria especially, in term of the drivers of growth in the economy in the past three decades. In addition, what is the role of finance in the growth process? What effort have been made to mobilize savings and have these been adequate? This factor is critical in view of the general belief that scarcity of long-term finance in developing countries is the major impediment to higher investment and output growth in these economies. Besides, it is importance to find out whether the capital market in Nigeria is positioned to play this critical role. In addition to investment and savings what else is necessary to achieve a desirable growth rate? For instance, what role is there for macroeconomic policy? From experience, it has been established that contraction in aggregate demand induced by adjustment measures is likely to have an adverse short run effect on investment because of its negative effect on output growth. Moreover, restrictive monetary and credit policies affect investment by raising the cost of bank credit and increasing the opportunity cost of retained earnings. (Serven and Salimano, 1992)

In this book an attempt is made to provide an overview of these issues and to understand the implications of the relationships for policy making. In other words, we hope to draw from Nigeria’s past experience to suggest how optimal mix of capital and skilled manpower could be employed more advantageously in the future.


The objective is to determine the role of finance and investment on growth in Nigeria specifically, the study will explore the empirical relationship between investment and growth. In other words, can we attribute the economic stagnation or low economic growth in Nigeria to investment gap? If investment is necessary for growth, does every investment matter? Or is there need for selective investment? Furthermore, what is peculiar about the Nigerian investment climate that precludes private investment from responding policy?

The post will also ascertain the impact of finance on investment and growth. Specifically, is finance a necessary and sufficient condition for investment and growth in Nigeria? In this regard, what is the role of finance in the growth process? If we agree that finance is important for investment and growth, then how do we fill the gap that exists? Could it be provided through domestic savings, foreign direct investment (FDI), borrowing from multilateral/bilateral institutions or through grants and aids?

Finally, the objective is to identify the factors, which constrain growth in Nigeria. In this regard, we shall examine the macroeconomic environment that exists in Nigeria as well as the various policy actions taken by successive government to foster economic growth.

The book shall adopt an eclectic approach to investment theory in order to test for the relationship between investment and growth. In this regard the book will empirically test the various growth models, using secondary time series data and econometric tools and descriptive analysis.

The analysis on data series from 1970 to 2003. The choice of the time frame work was informed by the availability of data, and desire to capture the period of structural break-control regime vis-à-vis de-regulation.


Importance of the Study and Limitations

The importance of this study lies in the fact that it will provide an insight into the relationship between investment and growth. It will further identify the reasons why Nigeria’s investment efforts have not provided the optimal result. However, the major limitation is the quality of data. While public sector investments are easily obtained from budget estimates, there is no acceptable methodology to control for waste. In the case of private sector investment, the data series in questionable as it is derived residually.


Overview of the Relationship between Finance, Investment and Growth

Finance is the process of channeling funds in the form of credit, loans or investible capital to those economic entities that need the most or can put them in the most productive use. The importance of finance in any area of human endeavor cannot be overemphasized as no reasonable investment can take place without funds.

Empirical evidence from the literature reveals that there is a strong relationship between the financial development of any country and its economic performance. There is also the common notion that the scarcity of long term finance in developing countries is the major impediment to higher investments and output growth in these economies. By implication therefore, the stimulation of sustained economic growth requires a balance between investment in physical and financial assets, human and social capital, as well as natural and environmental capital. In Nigeria, opinions are divided on whether finance is a constraint to economic growth. The ratio of money supply to GDP suggests that capital is not the problem, while the ratio of banking system credit to the private sector to GDP suggest otherwise. Empirical evidence however suggests that various factors affect the availability of investible fund in Nigeria, including: funds mobilization/aggregate savings, high bank lending rates, inflationary expectations, institutional factors (the risk premium, bank’s cost of funds), appropriate sectoral policies, paucity of external capital, public sector deposits, regulatory and monetary policies, the level of economic activities, and the structure and efficiency of the financial system. For instance, empirical evidence from Nigeria indicate that finance (measured by private sector credit), which grew by 65.4 percent in 1975, over its level in 1974, plummeted to a growth of 4.8 percent in 1984. With the introduction of the Structural Adjustment Programme (SAP) in 1986, finance (private sector credit) grew from 26.9 percent in 1986 to 46.7 percent in 1987. Also, with the recent structural reforms, which have deepened the financial system, finance has been on a steady increase from 30.9 to 43.5 percent in 2000 and 2001 respectively. This could be attributed to the renewed confidence of investors in the economy due largely to the introduction of democratic governance. The availability of finance was found to support output as some periods of growth in private sector credit also witnessed growth in output.

One other question that is often asked is, whether there is a relationship between investment and growth? In other words, does investment matter for growth? The traditional neoclassical growth model suggests that output can only grow through increased accumulation of capital and/or technical progress. All growth models have come to agree that the rate of growth of an economy is determined by the accumulation of physical and human capital, the efficiency of resources use and the ability to apply modern technology. The major source of controversy in growth theory however, pertains to the role of investment in the growth process. Movement in investment growth in Nigeria exhibit volatile trends, which peaked at 87.1 percent in 1973 and contrasted sharply with a large negative growth rate of 33.4 percent in 1984. In the 1990s, low investment growth was recorded due largely to the distress in the financial system; however, with resurging confidence in the economy, there have been increase in both local and foreign private investment. Thus in 2000, investment grew by 45.9 percent over the level in 1999. The volatility of investment flows and output growth partly explains the slow and unsustainable growth rate of output in Nigeria.

The strong positive correlation which exist between investment, saving and growth is well established in the literature. Economists are generally in agreement that a relationship exists between finance, investment and growth. The dismal growth record in most African countries, relative to other regions of the world has been of the concern to economists. This is because the growth registered in most African countries including Nigeria is often not commensurate with the level of investment. In Nigeria for instance, the economy witnessed a tremendous growth in 1970s and early 1980s a s a result of the oil boom. Following the oil boom, there was investment boom especially in the public sector. But with the collapse of the oil market in the mid 1980s, investment fell, thereby leading to a fall in economic growth. For example, during the investment boom, gross investment, as percentage of Gross Domestic Product (GDP) WAS 16.8  and 31.4 percent in 1974 and 1976 respectively, whereas it declined to 9.5 and 8.9 percent, respectively 1984 and 1985. Although the rise in oil prices during the 199-91 periods was supposed to spark off an investment boom, but that was not the case Nigeria as the accruing windfall went mostly to government and the usage depended on the regimes preference. The Nigeria’s military government for instance, was inexperienced in formulating economic policy and thus left this task to the bureaucracy, which it protected from the politicians. The result was that investment decisions which were undertaken with great haste resulted in enormous waste. To arrest this continued decline, the government adopted the Structural Adjustment Programme (SAP), in 1986 with the view to providing stable macroeconomic and investment environment. To this end, interest rates that were previously fixed and negative in real terms were replaced by an interest rate regime, which is driven more by market forces. The policy shift de-emphasized direct investment stimulation through low interest rates and encouraged savings mobilization by decontrolling interest rates.

However, the objective of enhanced investment and output growth was not realized as the county’s investment rate failed to rise to anything near the level it had reached in the 1970s. Although successive government had implemented policies and strategies for raising the level of savings and investment, these policies had been erratic as a result of frequent changes in government, induced by political instability. For instance, between 1962 and 1984, Nigeria adopted medium term national development plans. The objectives of the plans were to establish Nigeria as a united, strong and self-reliant nation; a great and a dynamic economy; a just and egalitarian society. The specific short term objectives which will bring about the realization of the national objectives were to increase per capita income; achieve a more even distribution of income; reduction in the level of unemployment; increase in the supply of high level of manpower, diversification of the economy; balanced development and indigenization of economic activity. The idea was to achieve high level growth through the adoption of appropriate policy measures which will facilitate the attainment of the specific objectives.

The first plan was between 1962 and 1968, the second between 1981 and 1985. The main plank of the post-colonial national development plan was on the use of resources to enhance production and economic growth. The first national development plan envisaged a capital expenditure of N2.2 billion but its failure was predicate on the fact that social and regional development received only 24.4 percent while the economic sector got 67.8 percent.

The second national development plan was launched soon after the civil war and therefore focused on reconstruction and rehabilitation of war torn infrastructure. The plan like the previous one has its objectives, creating a just and egalitarian society by reducing inequality in the distribution of income. Out of N3.2 billion ensivaged capital expenditure, 53.1 percent was allocated to the economic sector with 26.6 percent going for social and regional development. The administration then made some modest impact on the economy but lacked the foresight to industrialize the country during the oil boom era.

The third plan was more ambitious and grand in concept and scope because it made serious effort to use revenue from oil export to achieve radical economic transformation in the areas of health care delivery, water supply, rural electrification and community development. The plan however, failed because it did not encourage private investment and it neglected the grassroots. The result was that the expected GDP growth rate 9 percent crashed to 5 percent because revenue earnings from oil exports dropped. Also the level of agricultural and industrial productivity dropped significantly, as a result of over-dependence on government contracts and political patronage.

The fourth development plan (1981-1985) was not much different from the third. The failure of these plans to meet the aspirations of the people could be traced to several factors including, frequent revision in projected expenditure, overemphasis on public investment, distortion in plan implementation, official corruption, poor coordination, inconsistences and overdependence on oil. The decline in investment in the late 1980s and the low investment ratio, which persist into the 1990s, no doubt, partly explains the slow output growth rate during the period. The growth rate averaged 2.3 percent over the period (1986-2000) compared with the target annual growth rate of 5 percent and the 3.2 percent averaged growth rate for developing countries. The growth rate also failed to level up with the population growth rate, which stood at an average of 2.9 percent during the period thereby worsening the level of poverty. During this period, the country earned approximately US$340 billion from the sale of crude oil alone. One question that is yawning for an answer is: what is the impact of finance and investment on growth? It has been argued that savings affect investment, which in turn influences growth in output. The transformation of initial growth into sustained output expansion requires in turn sets in motion a self-reinforcing process by which the anticipated growth encourages investment, which supports growth, as well as the level of investment, (public and private) no meaningful growth in output would be achieved. Indeed if private investment remains at the current low level, it will slow down potential growth and reduce long run level of per capita consumption and income thereby leading to slow savings and investment.

Analyzing the relationship between investment and growth; and what need to be taken into consideration to increase investment will provide the necessary knowledge as to the direction of causation between investment and growth. This is necessary if economic growth and development is to be stimulated. The experience if East Asian countries suggests that an investment ratio f between 20 and 25 percent could engender a growth rate of between of between 7 and 8 percent. Statistical evidence reveal that output represented by the real GDP in Nigeria showed a positive growth soon after the civil war, following the oil boom of the 1970s such that growth rate stood at 21.3 percent in 1971.

As the oil glut of the 1980s, hit the world economy, output growth in Nigeria contracted such that GDP had negative growth rate of 26.8 percent in 1981 to 5.3 percent in1984. However with the structural adjustment in the mid-1980s, it grew positively at 9.3 percent in 1985 before hitting a high of 10.9 percent in 1990. That was the highest growth rate recorded ever after. The economy has since then been growing at positively rate steady growths due mainly to the renewed confidence I the economy, as a result of the democratic rule, which started in 1999.

An analysis of Nigeria data using correlation technique to establish the relationship between investment and growth showed a weak relationship between capital formation and economic growth. For instance, between 1971 and 1980, the average correlation co-efficient between investment and economic growth was 0.11 which indicated that though a positive relationship exist between the variable, this relationship is weak. Indeed during the period 1981 and 1986, investment and growth moved in opposite directions with negative co-efficient of 0.22. Data for SAP and post SAP period indicated that the relationship between investment and economic growth was positive with a correlation co-efficient of 0.30.  The general picture revealed a positive relationship but a very low average correlation coefficient.

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