GOVERNMENT EXPENDITURE AND ECONOMIC GROWTH IN NIGERIA: A DISAGGREGATED ANALYSIS
CHAPTER TWO
REVIEW OF RELATED LITERATURE
Conceptual Review
Government spending as a fiscal instrument serves useful roles in the process of controlling inflation, unemployment, depression, balance of payment equilibrium and foreign exchange rate stability. In the period of depression and unemployment, government spending causes aggregate demand to rise and production and supply of goods and services follow the same direction. As a result, the increases in the supply of goods and services couple with a rise in the aggregate demand exalt a downward pressure on unemployment and depression.
In the case of persistent rise in price (inflation) and the depreciation in the value of money, it is expected that reduction in government expenditures discourages aggregate demand and inflation and falling in the value of exchange rate are controlled. It is worthy to note that these two tools may be adopted simultaneously in the economy.
A rise in the government expenditure has the same effects as a reduction in the tax rates on aggregate demand. Similarly, the effects of a reduction in the government expenditures are the same as increases in tax rates.
Nature of Public Expenditure: Bhatia (2008) defines Public expenditure as the expenses which a government incurs for (i) its own maintenance, (ii) the society and the economy, and (iii) helping other countries. Public expenditure refers broadly to expenditure made by local, state and national government agencies as distinct from those of private individuals. Public Expenditure also comprises of government payments for the goods and services acquired and for the works done pursuant to their respective laws, social security contributions, interest payments of domestic and foreign debts, general borrowing expenditures, payments resulting from the discounted sale of borrowing instruments, economic, financial and social transfers, donations and grants, and others.
It is conventional to classify public expenditure into various economic categories. Accounting classification has been there for centuries because it enables the State Executives to maintain an effective control and check over public expenditure and possible leakages and wastage, diversion and misappropriations (Bhatia, 2008). It may be classification base on department or heads of expenditure. Such a classification is good for auditing and safeguarding against misappropriations, etc., but it does not help in the understanding of its effects. It is therefore, difficult to formulate an appropriate expenditure policy on this basis.
Economists classify government expenditures into three main types (Gerson, 1998):
(i) Government purchases of goods and services for current use are classed as government consumption; (ii) Government purchases of goods and services intended to create future benefits, such as infrastructure investment or research spending are classed as government investment; and (iii) payments for debt services are classified as transfer payments. The classification of expenditure involves the division of government transactions into categories that would serve the purposes of government. Anyafo (1996) identifies five ways of classifying public expenditures: by levels of government, by ministries, extra-ministerial departments and parastatals, by economic life span, by object of expenditure and by sectoral economic functions. Public expenditures are functionally classified into four in Nigeria (CBN, 2008): Administration, Economic services, Social and Community services, and Transfers with capital and recurrent expenditure compositions.
Public Expenditure and Economic Growth: Public expenditure can help the economy in numerous ways in attaining higher levels of production and growth. The ways in which such effect might be brought about are obviously inter-related. The analysis of these effects can be taken up separately in the context of developed and developing economies (Bhatia, 2008). According to Dalton (1954), public expenditure tends to affect the level of production in three possible ways:
a) Effect on the Capacity to Work and Save: Public expenditure provides various kinds of social and economic facilities stimulating the capacity to work of the people. Increased capacity implies increased efficiency and greater employment. Level of income and saving tends to rise, facilitating greater investment and adding the pace of growth. Dalton opines that ‘just as taxation reduces an individual’s capacity to work, in the same way public expenditure increases the individual’s capacity to work.’
b) Desire to Work and Save: Public expenditure induces the public’s willingness to work and save. As a result, their income and standard of living rise.
c) Redistribution of Economic Resources: Public expenditure makes the economy balanced by redistributing the income resource from unproductive activities to productive ones. This results in increase in production. This effect varies between developed and developing countries.
The developed countries have enough of production capacity, but its optimum utilization does not take place as a result of low demand. Consequently, there is low level of production. By increasing public expenditure, aggregate demand can be increased. Wealth can be distributed by increasing public expenditure among those who are willing to spend. Thus increase in demand results in the increase in production. In the event of full employment already existing in the economy, increase in public expenditure will only increase prices instead of production.
Bhatia (2008) cautions that to maximize the benefits of public expenditure and to avoid possible harmful incidental effects, firstly, the various projects have long gestation period, in which case the output is delayed. Yet they need to be funded, adding to the inflationary pressures. Care must therefore be taken that inflationary pressures are put under control during the process of development.
Secondly, on account of faulty planning and execution, a lot of wastage can take place in public expenditure. This must be avoided. Thirdly, given the scarce resources, care must be taken to choose the most appropriate and most useful projects. Cost-benefits study may be needed to prioritize the projects. Fourthly, a careful decision has to be taken regarding the volume of public expenditure in various projects and on various measures expected to stimulate investment. The effects of the sources of financing the compositions of public expenditure must be considered.
Public expenditure can also prove helpful in accelerating the rate of economic development. In order to maintain a steady growth rate in developed economy, public expenditure can be helpful in maintaining the adequate amount of investment and consumption expenditure, so that the full employment rate of the economic development is steadily maintained. Jain et al. (2008) aver that in order to accelerate economic development in the developing economies, public expenditure plays a crucial role. Public expenditure facilitates social overheads, roads, electricity, irrigation, etc. Development of private industries and agriculture is thus assisted, markets expand and the rate of investment increases. If public expenditure is made through foreign capital, it may prove more effective. If public expenditure is unproductive, it will only result in price hike.
Buti and Van den Noord (2003) adopt a definition of neutral expenditure policy according to which primary public expenditures grow in line with potential output plus expected inflation. Fatas et al. (2003) and Hughes-Hallet et al. (2004) resort to three different definitions of ‘neutral fiscal policy’: government spending is held constant in volume terms; government expenditures grow in line with revenues; government expenditures grow in proportion with trend GDP. Moreover, Gali and Perotti (2003), among others, consider a broader concept of “non-discretionary” fiscal policy, obtained as the residual of an estimated fiscal reaction function where the primary cyclically-adjusted budget balance is regressed against its own lag, the lagged debt/GDP ratio and a measure of the output gap.
The Role of Public Expenditure:
Public expenditure is used for allocation, stabilization and distribution of resources (MUSGRAVE AND MUSGRAVE 1989). The allocation function becomes necessary so as to provide both private and in particular, social goods in appropriate mix with available resources. Due to special characteristics of goods (spillover, externalities, non- excludability/joint consumption, non rivalries) they will not be provided at all, or where they are produced the output will be inadequate and outrageously costly if left in the hands of private individuals, the government intervenes using the instrument of public expenditure and other fiscal policy tools.
According to Omoruyi (1998) stabilization function of public expenditure is that of maintaining high employment, a reasonable degree of price stability an appropriate rate of economic growth, with allowance for effect on trade and on the balance of payment. That is the stabilization function is concerned with the attainment by the national economy of full employment and capital utilization at stable price, a good balance of intervention performance and a satisfactory rate of growth in per capita income over a period of time.
Public Expenditure Policies in Nigeria:
The Second National Development plan (1970-1974) accorded a leading role to government just as it considered public enterprise as crucial to growth and self – reliance due to capital scarcity, structural defects in the private sector and perceived danger of foreign dominance of the private sector. The third National Development plan (1975-1980) advocated some shift in resources allocation in favor of rural areas, which were said to have benefited little from the economic growth of 1970’s. Thus small farmers and the rural population were expected to benefit from public expenditure.
However, against the background of the austere fiscal outlook of the government, under the Third National Plan (1981- 1985)), the role of fiscal policy was viewed mainly as the generation of revenue through increased tax effort and the control of public spending. The structural adjustment programmed (SAP) introduced in July 1986 recognized that the financial resources for public expenditure for the rest of the 1980s and beyond were likely to be less than was previously envisaged. And given the uncertainty in the oil market and substantial debt repayment falling due, there was need to curtail government expenditure, especially those involving foreign exchange.
In the main, as with other IMF and World Bank programmers, measures were to be taken to reduced government expenditure. Such measures, include reduction of the growth of government wage bill; reduction in government subsidies on fertilizer, foods petroleum and petroleum products; limiting or delaying new investments, and the
rationalization, and hence the privatization and commercialization of public enterprise, thereby efficiency of investment and expenditure control and administration. During the first National Rolling Plan (1990-1992), government aimed at effort of combat inflation hence budgetary deficit were to be avoided hence government expenditure was made more cost- effective and kept levels that were consistent with the nation’s resources, realistic growth targets and general economic stability.
An Overview of The Nigerian Economic Growth:
The Nigerian economy has had a truncated history. In the period 1960-70, the Gross Domestic Product (GDP) recorded 3.1 per cent growth annually. During the oil boom era, roughly 1970-78, QDP grew positively by 6.2 per cent annually - a remarkable growth. However, in the 1980s, GDP had negative growth rates. In the period 1988-1997 which constitutes the period of structural adjustment and economic liberalization, the GDP responded to economic adjustment policies and grew at a positive rate of 4.0. In the years after independence, industry and manufacturing sectors had positive growth rates except for the period 1980-1988 where industry and manufacturing grew negatively by - 3.2 per cent and - 2.9 per cent respectively. The growth of agriculture for the periods 1960-70 and 1970-78 was unsatisfactory. In the early 1960s, the agricultural sector suffered from low commodity prices while the oil boom contributed to the negative growth of agriculture in the 1970s. The boom in the oil sector lured labor away from the rural sector to urban centers.
The contribution of agriculture to GDP, which was 63 percent in 1960, declined to 34 per cent in 1988, not because the industrial sector increased its share but due to neglect of the agricultural sector. It was therefore not surprising that by 1975, the economy had become a net importer of basic food items. The apparent increase in industry and manufacturing from 1978 to 1988, was due to activities in the mining sub-sector, especially petroleum. Capital formation in the economy has not been satisfactory. Gross domestic investment as a percentage of GDP, which was 16.3 percent and 22.8 percent in the periods 1965-73 and 1973-80 respectively, decreased to almost 14 per cent in 1980-88 and increased to 18.2 percent in 1991 -98. Gross National Saving has been low and consists mostly of public savings especially during the period 1973-80. The current account balances before official transfers are negative for 1965- 73,1980-88 and 1991-98.
The economy never experienced double-digit inflation during the 1960s. By 1976, however, the inflation rate stood at 23 percent. It decreased to 11.8 percent in 1979 and jumped to 41 percent and 72.8 percent in 1989 and 1995, respectively. By 1998, the inflation rate had, however, reduced to 9.5 percent from 29.0 percent in 1996.
Unemployment rates averaged almost 5 per cent for the period 1976-1998. However, the statistics especially on unemployment, must be interpreted with caution. Most job seekers do not use the labour exchanges, apart from the inherent distortions in the country's labour market. Based on some basic indicators, it appears that the economy performed well during the years immediately after independence and into the oil boom years. However, in the 1980s the economy was in a recession. The on-going economic reform programme is an attempt to put the economy on a recovery path with minimal inflation. The analysis that follows tries to discuss the developments in the economy for different periods.
Theoretical Literature
Theories of Public Expenditure and Economic Growth
Economic theory has shown how government spending may either be beneficial or detrimental to economic growth. This section highlights same basic theories that have been used to support the effects of government expenditure on economic growth. Such theories amongst others are:
Musgrave Theory of Public Expenditure Growth
This theory was propounded by Musgrave as he found changes in the income elasticity of demand for public services in three ranges of per capita income. He posits that at low levels of per capita income, demand for public services tends to be very low, this is so because according to him such income is devoted to satisfying primary needs and that when per capita income starts to rise above these levels of low income, the demand for services supplied by the public sector such as health, education and transport starts to rise, thereby forcing government to increase expenditure on them. He observes that at the high levels of per capita income, typical of developed economics, the rate of public sector growth tends to fall as the more basic wants are being satisfied.
The Keynesian Theory: Of all economists who discussed the relation between public expenditures and economic growth, Keynes was among the most noted with his apparently contrasting viewpoint on this relation. Keynes regards public expenditures as an exogenous factor which can be utilized as a policy instruments promote economic growth.
From the Keynesian thought, public expenditure can contribute positively to economic growth. Hence, an increase in the government consumption is likely to lead to an increase in employment, profitability and investment through multiplier effects on aggregate demand. As a result, government expenditure augments the aggregate demand, which provokes an increased output depending on expenditure multipliers.
Further more in Keynesian macroeconomics, many kinds of public expenditures, can contribute positively to economic growth through multiplier effects on aggregate demand. On the other hand, government consumption may crowd out private investment, dampen economic stimulus in the short run and reduce capital accumulation in the long run. Studies based on endogenous growth models distinguish between distortionary or non-distortionary taxation and productive or unproductive expenditures. Expenditures are categorized as productive if they are included as arguments in private production functions and unproductive if they are not (Barro and Sala-I-Martin,1992).
Empirical Literature
Much empirical researches have been conducted to investigate the impact of government expenditure on economic growth in various countries. The results however have been mixed. While some observe that public expenditure favours growth, others argue that excessive government expenditure could be detrimental to growth. Many Nigerian authors have attempted to examine government-economic growth relationship. Fajingbesin and Odusola (1999) empirically investigated the relationship between government expenditure and economic growth in Nigeria. Their econometric results indicated that real government capital expenditure has a significant positive influences on real output.
However, the results showed that real government recurrent expenditure affects growth only by little. Odedokun (1997) and Shioji (2001) obtain a similar result as they find that infrastructural public investment promotes economic growth. Odedokun concentrated on a sample of 48 developing countries during period 1970-1990, while the latter study focused on 48 states in United States over the period 1963-1967 and on 46 Japan’s prefectures during the 1955-1999 periods some researcher however believe the government spending has no or negative effects on economic growth.
The work of Abu and Abdullahi (2010) in their short-run analysis of recurrent and capital expenditures, as well as government spending on agriculture, education, transportation, health and transport communication sectors of the Nigerian economy obtained results that revealed that government total capital expenditure, total recurrent expenditure, and government expenditure have negative effects on economic growth. On the contrary, the rising government expenditure on transport, communication, and health results to an increase in economic growth. Also Maku (2009) examined the link between government spending and economic growth in Nigeria over the last three decades using time series data to analyze the Ram (1986) model and regression real GDP on private investment, human capital investment. He tested for the presence of stationary in the variables using the Augmented Dicker Fuller (ADF) unit root test, and used the co- integration test to establish the long-run relationship among variable, the Error Correction Model (ECM) was used. Empirical results showed that public and private had insignificant effects economic growth during the review period.
Abu and Abdullahi (2010) in their paper observes that rising government expenditure has not translated to meaningful development as Nigeria still ranks among world’s poorest countries. In an attempt to investigate the effect of government expenditure on economic growth, we employed a disaggregated analysis. The results reveal that government total capital expenditure (TCAP), total recurrent expenditures (TREC), and government expenditure on education (EDU) have negative effect on economic growth. On the contrary, rising government expenditure on transport and communication (TRACO), and health (HEA) results to an increase in economic growth.