FOREIGN DIRECT INVESTMENT AND THE MANUFACTURING SECTOR IN NIGERIA

ABSTRACT

The importance of the manufacturing sector in the economic growth cannot be overemphasized. This has led to interests in the determinants of its performance over the years. This study therefore, investigated the impact of foreign direct investment (FDI) on the performance of the manufacturing sector in  Nigeria as  well  as  the  causal relationship between foreign direct investment and manufacturing capacity utilisation (MCU) from 1970-2012 under the framework of VAR. The result of co-integration revealed that there is no long-run relationship among the variables. In addition to this, findings show that FDI is significant at 5% and positively related to MCU. On the other hand, other variables are not significant and both EXR and INT exhibit wrong apriori signs. For causal relationship, the results show that there is a unidirectional causality running from MCU to DOP. There is also a unidirectional causality running from MCU to EXR. Also, causality flows from EXR to DOP without a feedback. It runs from INT to DOP as well as from INT to EXR, while it flows from FDI to MCU and from FDI to DOP. The results of the variance decomposition and that of the impulse response function further reveal the link between FDI and MCU. On grounds of these results, we recommend that policies that seek to achieve a realistic exchange rate of the country’s currency should be put in place. Our argument is that exchange rate policy in the country should not be restrictive in order not to hamper manufacturers’ quest to obtain raw materials for their production. We also recommend that the external sector be liberalized so that manufacturers in the country can easily import some of their inputs without some hiccups and that the authorities should make the cost of doing business in Nigeria to be cheap.  Finally, we pointed out that every effort should be devoted to attract foreign investment in the country.

CHAPTER ONE

INTRODUCTION

Economists are quick to support the free flow of capital across national borders because it allows capital to seek out the highest rate of return since international ventures seek higher profit as per the capital arbitrage theory propounded by Samuelson (1948). Nigeria is believed to be a high-risk market for investment although blessed with abundance human resources. The co-existence of vast wealth in natural resources and pervasive poverty referred to as the “resource curse” or ‘Dutch disease’ (Auty,

1993) appears to bedevil the country. In 2011 the country ranked 170 out of 213 countries with respect to the Gross National Income Per Capita; the country had US$1,200 (World Bank, 2011). Many analysts and experts have suggested the use of foreign direct investment (FDI) as a variable injection to kick- start the Nigerian economy. This is because; FDI is not only the transfer of ownership from domestic to foreign companies, but also a device for improved corporate governance and attendant transparency  in  business  practice.  International  investment  also  provides  opportunities  for  global transfer of technology and human capacity development, in addition to the promotion of competition in the domestic input market. Despite the contributions to corporate tax revenues to the host country from profits generated from FDI, the highly capital intensive technology engendered can exacerbate the unemployment situations in labour surplus host countries. In addition, the creation of monopolies in areas where the entry barriers have been raised in some cases may crowd out domestic operators. The importance of FDI in the growth dynamics of countries has created much interest amongst scholars and lots of researches have been focused on the impact of FDI on the economy.

The manufacturing sector plays a catalytic role in a modern economy, and has many dynamic benefits that are crucial for economic transformation. That is, the manufacturing sector serves as a catalyst for economic growth and development as well as the bedrock of every economy. In advanced economy the manufacturing sector is a leading sector in many respects. It is an avenue for increasing productivity in relation to import substitution and export expansion, creating foreign exchange earning capacity, raising employment and per capita income, which widen the scope of consumption in dynamic patterns. Furthermore, it promotes the growth of investment at a faster rate than any other sector as well as wider and more efficient linkage among different sectors (Ukoha, 2000). That is why most countries including Nigeria, strive to attract foreign direct investment in the manufacturing sector because, of its acknowledged advantage as a tool of economic development. The growth of industries in Nigeria may

be investigated through the study of such vital indices of growth, of value added, employment in modern establishment and capital formation in the sector, capacity utilisation and changes in trade structure. A cursory look at some concentrations of industrial development in Nigeria, may lead to a misleading picture of a high rate of industrialisation in Nigeria. For a country with the size and potential of Nigeria, manufacturing is essential if the country is to achieve rapid economic and social development. This recognition of the importance of the manufacturing industries, in the growth process is linked with the choice of an appropriate strategy of industrial development such as the attraction of FDI. The choice of this study period covering 1970-2012, forms about 80 per cent of the existence of Nigeria as an independence nation since 1960, provides an opportunity for a comprehensive assessment of the role of FDI on the manufacturing sector in Nigeria.

1.1      Background to the Study

The classical economists are of the view that most developing countries are endowed with numerous natural resources which when refined could serve as engine of growth and development. They argued that, because of the low income base and the high propensity to consume their levels of savings are low, which further translate to low capital formation and low productivity hence, the existence of high rate of poverty. These groups of thinkers, therefore, suggested that to break this vicious circle of poverty, FDI  must  be  encouraged to  complement  domestic  investment  so  as to  provide these  developing countries with their desired growth and development.

One of the remarkable trends in the world economy over the past three decades has been increasing global economic integration. This is significantly symbolized by the rising wave of foreign private investment, since the days of the “Washington Consensus”, which titled the stock of development literature in favour of globalisation. As structural thinking on development gave way to neo-liberal resurgence, conventional wisdom shifted towards the  view that  foreign investment  was good  for development. Consequently, developing countries had to depend less on dwindling official resource flows to assist the process of economic development. Thus, many developing countries had to turn to foreign private resources in order to fill the resource gap in their quest for economic development. (Adejumo, 2013).

With respect to economic development, the lessons of experience offered by the British and later industrial  revolutions,  have  made  industrialisation  a  chief  strategy.  The  relationship  between

industrialisation and development is surprisingly diverse and many reasons have been put forward why developing economies are so committed to it. However, the international economic system shaped and directed by orthodox economic doctrine of market determinism, strongly influences the  industrial progress of developing countries in direct and indirect ways. In the light of this relationship, it  is pertinent to note that the international environment represents both constraints on and opportunities for the expansion of third world industrial production (Rajnesh Chandra, 1992) The effect of international economic environment on third world industrialisation reached its peak, when the global economic order stipulated non-negotiable tripod set of conditions, among others, that qualify developing economies for global integration, and for partaking in the development benefit this is deem to offer. Codified in John Williamson’s well known Washington consensus, stabilisation, privatisation, and liberalisation became the arrow-head of economic policy agenda for industrial development, in mush of the periphery of the world economic system. This inspired a wave of economic reforms in Latin America and Sub-Sahara Africa and fundamentally reshaped the policy landscape in those developing regions.

Recent experiences with opening capital accounts in emerging and developing economies however, have proved to be a mixed blessing, as it is becoming increasing clear that not all types of capital imports are equally desirable. It is therefore frequently advised that such countries should primarily try to attract foreign direct investment (FDI), and be very careful about accepting other sources of finance (Prasad, 2003).  Empirical researches however, suggest that while the evidence of negative effect from FDI is inconclusively, evidence of its positive effect is overwhelming (Graham, 1995).

In Nigeria, manufacturing sector grew slowly over the years; for instance, the share of manufacturing sector in GDP has been declining over the decades, from 7-11 per cent in 1970s and 1980s. Between

1990 and 1996, manufacturing sector recorded a negative annual growth rate of 1.6 per cent. Consequently, the  contribution of the  sector to  GDP  fell  to  only 3  per  cent.  Rapid growth was experienced in the late 70s, which corresponds to the “oil boom” years in Nigeria. As at 1980, the sector was at its peak of about 11 per cent. With the fall in the price of crude oil and high debt profile, the sector contribution to GDP fell drastically to 2.4 per cent as at 2010. Manufacturing capacity utilisation in the late 1970s was as high as 78.70 per cent, and nosedived to as low as 43.80 per cent in the 1980s, between 2000 and 2005, it oscillated around 34.60 per cent and 58.78 per cent.

The Nigeria manufacturing value added fell in 1985 from 5,954.697 million to 1,357.907 million in

1989, which adversely affected industrial output to fall from 12,448.317 million to 2,999.709 million. During this period there was no incentive for industrial development. Manufacturing value added also declined by 40.8 per cent and overall investments expenditures of manufacturing enterprises declined by 0.8 per cent in 1997. In addition, the manufacturing sector was characterised by increasing cost of production, emanating from high tariff, increased cost of energy input, reliance on poor and inadequate public sector infrastructures, rising cost of import and sharp depreciation of exchange rate.

The  UNCTAD  world  investment  report  2006  shows  that  FDI  inflow  to  West  Africa  is  mainly dominated by Nigeria, who received 70 per cent of the sub-regional total and 11 per cent of Africa total. Out of this, Nigeria’s oil sector alone receives 70 per cent of the inflow. On the average, the stock of FDI in the manufacturing sector over the period of analysis compare favourably with the mining and the quarrying sector with an average value of 32 per cent, while FDI in the mining and the quarrying sector has been diminishing, from about 51 per cent in 1970-1974 to 30 per cent in 2000-2001. The stock of FDI in trading and business sector rose from 16.9 per cent in 1970-1974 to 32.6 per cent in 1985-1989, before nose-diving to 8.3 per cent in 1990-1994. However, it subsequently rose to 25.8 per cent in

2000-20001.  Agriculture,  transport,  communication,  building  and  construction remained  the  least attractive hosts in Nigeria. However, the transport and communication sector, seem to have succeeded in  attracting  the  interest  of  foreign  investors, especially  the  telecommunication sector,  while  the banking sector is highly regulated with re-occurring limits placed on foreign participation, make it less desirable for foreign investors. The privatisation of the power sector has just begun; foreign investors are expected to invest in the near future.

In terms of growth rate, FDI inflow dropped from 95.6 per cent in 1971 to -31.21 per cent and -17.23 per cent in 1976 and 1984. Although the growth of FDI increased by 182.68 per cent in 1986, the value soon fell by 24.76 per cent in 1989 and further to -89.87 per cent in 1996. Since the year 2000, the growth of FDI has remained positive, except in 20001 when the value was -70.00 per cent. The recent surge in FDI inflow to the country is attributable to the reduction in the nation’s debt profile and renewed confidence of foreign investors in the Nigeria economy (CBN, 2006).

In 1960s and 1970s when imperialism and dependency hypothesis flourished, FDI was viewed as a vehicle  for  continued  political and  economic  domination of Nigeria.  Hence, the  policy thrust  of

government was to limit  foreign direct  investment in the country through the Nigerian enterprise promotion degree (NEPD) promulgated in 1972 and as amended in 1977. NEPD, otherwise known as the indigenization decree, regulated FDI flows in Nigeria, only a maximum of 60 per cent foreign private participation was allowed. This resulted in a decline in foreign investment and slowed down the pace of economic activities in all sectors of the economies (Ndebbio and Ekpo, 1994).

In an attempt to create a suitable climate for investment and growth within the economy and stimulate her economy recovery from prolonged and severe recession, the Nigerian government introduced the Structural Adjustment Programme (SAP) in July 1986. But as we know, SAP was a colossal failure and this impacted negatively on macro-economic indicator including FDI.

The immediate post-sap era, was characterized by intense political conflicts that paralysed every sphere of the Nigerian nation. The development  limited the achievement of the reform under SAP. The inauguration of a democratic government in May 1999, the country then began a gradual progression towards creating a political and social environment supportive of corporate social responsibility (CSR) and ultimately sustainable development.

Policies that  were put  in place to  attract  FDI are: The establishment of the Nigerian Investment Promotion  Commission  (NIPC)  in  1990s,  Nigerian  Enterprises  Promotion  Act  No.  54,  Foreign Exchange Monitoring and Miscellaneous Provision Act  1995 (it  was enacted to liberalise foreign exchange transactions and thereby command a freer flow of FDI), Investment and Security Act 1999, and Nigeria Export Processing Zone Authority (NEPZA) etc.

The figure given below shows FDI inflows over the years. We can notice that FDI flows in Nigeria since 1970s have maintained a downward trend with less than $200.00 million between 1970 and 1980, it oscillated between about $100 million to $2300 million between 1980 and 2000, since then it has been on the increase. In 2005, inflow reached its peak of 108%, from about $5 billion to $ 13 billion. This astronomical increase in FDI inflow can be linked to the dramatic rise in FDI flows from emerging countries in Asia such as China, India and Malaysia. Another reason is the rapid increase in the price of crude oil prices, which increased investment in the petroleum extractive industries. Nigeria is deemed to have been reaping the benefit of its return to democracy, as the country seems to be achieving strong economic growth in recent times. FDI flows in Nigeria are quite concentrated in the oil sector, as the

vast reserves of oil and gas attracted MNCs into the extractive industries and not to the manufacturing sub-sector. However, a combination of events and policies are likely to lead to a significant decline in the FDI flows to Nigeria. The first is the global economic crisis which affected MNCs across the globe.

However, the recovery in 2010 is likely to overturn the decline as a result of the recession.

Source CBN Statistical Bulletin (2010)

Despite the aforementioned measures at attracting FDI in Nigeria, the Nigerian manufacturing sector has stagnated, weak and small in terms of its contribution to GDP. As a result of high cost of production that results from inadequate infrastructure, the manufacturing capacity utilisation remains on the down side. As a result, most Multinational Corporation in 2013 are already putting spanners into works to move their business to Ghana.

1.2       Statement of the Problem

Nigeria is one of the highest recipients of FDI but most of these FDI flows are to the extractive industry,  most  especially  the  oil  sub  sector.  Due  to  high  cost  of production that  emanate  from inadequate infrastructure, depreciation in exchange, inadequate energy input etc. the manufacturing capacity utilisation, manufacturing value added and manufacturing output level remains low. Foreign investors are thereby compelled to invest either in the oil sector, where the cost of investing is relatively

low. These have negatively impacted on the inflow of FDI in the manufacturing sector in Nigeria. (Oyinlola, 1995; Akinlo, 2004).

Furthermore, good infrastructure facilitates production, reduces operating cost and thereby promotes FDI. Infrastructure increases the productivity of investment and thereby enhances economic growth. Some of the measures of infrastructure include: power supply, the works of Siyan and Ekhator (2001) gave  an insight  into the gross inefficiency that  characterise most  public enterprises like National Electric Power Authority (NEPA). The study reveals that, some of the plants which were available in1980s were no longer available by 1990. In 1980 there were a total of 76 installed units with a total capacity of 6000MW, but by 2001, only 22 units were available with a total capacity of 2716.6MW and actual capacity generated being 221.8MW. There was 333.8MW of generation loss from available capacity. Poor road network, poor railway and lack of raw materials, pose a great treat. FDI in the manufacturing sector had  not  fared better largely,  due  to  lack  of infrastructure and  high cost of production. Also kidnapping, killings, and corruption seem to be the political cum economic trinity bedevilling Nigeria today. The current state of insecurity and bombings especially in the northern part of Nigeria has posed serious challenges to the peace and stability of Nigeria macro-economic environment. The nation has not only suffered colossal loss in terms of infrastructure, properties and viable human lives, but also economic sabotage which leads to the displacement of foreign direct investment. These have made FDI in the manufacturing unattractive. Hence for a country like Nigeria, characterised by significant inefficiency, corruption, and uncertainty, an insight into the relationship between FDI and manufacturing sector is very necessary.

Exchange rate is important to inflow of FDI; an overvalued exchange rate will discourage export and negatively affect FDI. On the other hand a real depreciation, raises cost of imported capital goods and since large chunk of investment goods in developing countries is imported, domestic investment would be expected to fall on account of significant depreciation (Adegbite and Ayadi, 2010). The instability of the foreign exchange market in Nigeria is a problem, in technical terms there is the occurrence of “inelasticities” of the relevant supply and demand curves, all resulting from “wrong” attitude of citizens to consumption of import and production for export. In the specific Nigeria case, it has been established by empirical analysis and simulation as far  back as 1985 that  an initial devaluation of the naira exchange rate far from moving the market towards equilibrium, rather moves it away from equilibrium. This is why each successive devaluation has necessitated further devaluation, in the belief that such

policy action moves the system to market clearing solutions (Osagie, 2007). In Nigeria, maintaining a realistic exchange rate for the naira is very crucial, given the structure of the economy and the need to minimize distortions in production and consumption, increase the inflow of non-oil export receipts and attract foreign direct investment.

Asiedu (2002) noted that the impact of openness on FDI depends on the type of investment. Market – seeking and non-market – seeking, FDI are expected to respond differently to openness of a host economy. Asiedu, (2002) explains that when investment uses market-seeking, trade restriction (and therefore less openness can have a positive impact on FDI). The reason stems from “tariff jumping hypothesis”, which argues that foreign firms that seek to create local market may decide to set up subsidiaries in the host country, if it is difficult to import their products to the country. In contrast, export-oriented FDI and therefore non-market-seeking may prefer to locate in a more open economy, but these are motivated by the characteristics of host country. For non-market-seeking FDI, the aim is to sell the goods produced in the host economy on markets abroad. Therefore, this type of investment will be beneficial to the host country through the trade nexus-in other words, how easy it is to export the products and how competitive the products are in the global market? Essentially, FDI will boost economic growth through increase in productivity of capital. Therefore, providing policy makers with measures that can make FDI led manufacturing export open to international trade in Nigeria is of utmost important.

Changes in the interest rate differential will affect the exchange rate. The impact of the changes in interest rate on foreign exchange rate has been found to be very powerful. High interest rate attracts foreign investment in developed economies such as the United State of America and this help to keep their real exchange rate high. The source of output and interest rate volatility in driving activities (Cavallari and Stefano, 2012) find that, output and interest rate volatility mainly act as push factor that is, they are more effective in determining rather than encourage FDI. A rise in host country volatility does reduce the amount of FDI outflow in the recipient country. Source country volatility on the contrary does not have a symmetric effect on FDI inflow in booms than in recession while, the opposite is true for output volatility in the host country. It is certain that in developing countries such as Nigeria, investors want a lower interest rate in order to invest. Therefore, an underdeveloped economy whose interest rate is high as in the case of Nigeria reduces FDI, because investors would most likely be discouraged. When bank lend money to manufacturer, they use depositor’s money. The interest rate

charged, which currently is about 25 per cent of the principal is made of two components, 5 per cent to depositors and 20 per cent to cover bank overhead and profit. If this interest is too high as is the case in Nigeria,  production cost  will  also  increase  and  impact  negatively on  capacity  utilisation.  Again, deregulation of interest  rate is  like  a double-edge sword, which will either stimulate or  mar the economy.  The  deregulation  of  interest  rate  will  lead  to  an  increase  in  interest  rate,  which  will discourage FDI. There is therefore, the need for a comprehensive evaluation of the role of interest rate (deregulation) in promoting FDI in Nigeria.

Most studies found that FDI inflows led to higher per-capita GDP, increase economic growth rate and higher productivity growth. As noted by De mello (1999), two channels have been advanced to explain the positive impact of FDI on the manufacturing sector. First, through capital accumulation in the recipient country, FDI is expected to be growth-enhancing by encouraging the incorporation of new inputs and foreign technologies in the production function of the recipient economy. Second, through technological transfer, FDI is expected to increase the existing stock of knowledge in the recipient economy through labour training and skill acquisition (Borensztien, 1998), on one hand and through the introduction of alternative management practices and organization arrangements, on the other. Essentially, the extent to which FDI is growth- enhancing depends on the economic and technological conditions of the host country: Political regime, real income per capital, rate of inflation, world interest rate, credit rating, debt servicing and the level of skill, were the key factors explaining the variability of FDI in the manufacturing sector in Nigeria (Ekpo, 1995). Although, there is a negative relationship between FDI and the manufacturing sector in Nigeria, there is the need for the government to know if FDI causes the growth of the manufacturing sector, especially with respect to Greenfield investments or the growth of the manufacturing sector cause FDI inflow with respect to Brownfield investments. This is to enable policy makers; develop strategies that could encourage domestic investors and a favourable macroeconomic environment first, before going after foreign investors.

Further, the problem of the Nigeria manufacturing sector started in 1970s which corresponded with sharp  increase  in  international oil  price.  The  government  responded with  the  import  substitution strategy aimed at increasing domestic production. Like in most countries in Africa, the import substitution strategy failed to generate income and employment growth. (Soderbon and Teal, 2002). Following the fall in oil prices in late 1970s and early 1980s, the economy went into rapid decline, resulting to a fall in capacity utilisation. The stock of FDI in manufacturing sector export has not been

impressive over the years; and this is a very serious problem militating against the performance of the manufacturing sector in Nigeria.

Source CBN Statistical Bulletin (2010)

The figure above shows the fluctuations in manufacturing capacity utilisation “between”, 1970-2010. Manufacturing capacity utilization declined from impressive value of about 75% in the 70s to about

50% between 2000 and 2009. There was remarkable slump from about 73% in 1981 to about 38% in

1985, due to a fall in the price of crude oil in the early 80s, and further fell to 10% in 1995 and raised to about 33% in 1996, it fell again to 30% in 1998.  However, a sign of gradual increase as from 2000 to about 58% in 2003; it fell to about 52% in 2006 and remained constant to 2010. This literary implies that manufacturing industry has been operating at half of its capacity. This is related to the fact that high cost of production and tough environment result in both domestic and foreign plant producing below capacity.

Many theories explicitly connect investment in human capital development to education and the role of human capital in economic development, productivity growth and innovation as a justification for government  subsidies  for  education  and  job  skills  training.  This  tends  to  attract  foreign  direct investment. But human capital development in Nigeria is low (Ayanwale, 2007), and this is also a serious problem to FDI inflow in Nigeria.

This study will include some macroeconomic indicators (e.g. FDI, manufacturing sector and trade openness) while examining the relationship between FDI and the manufacturing sector in Nigeria.

1.3  Research questions

However, the questions that shall be addressed here are:

  What is the impact of foreign direct investment on the performance of the manufacturing sector in Nigeria?

  What is the causal relationship between foreign direct investment and the performance of the manufacturing sector in Nigeria?

  What are the structural responses of foreign direct investment to changes in the performance of the manufacturing sector in Nigeria?

1.4 Objectives of the Study

The broad objective of the study is to analyse the relationship between foreign direct investment and the manufacturing sector in Nigeria. The specific objectives include the following:

  To estimate the impact of foreign direct investment on the performance of the manufacturing sector.

  To examine the causal relationship between foreign direct investment and the manufacturing sector.

  To  examine  the  structural  responses  of  foreign  direct  investment  to  changes  in  the performance of the manufacturing sector in Nigeria.

1.5 Hypotheses of the study

To shape the research work, the following hypotheses are given below:

  The impact of foreign direct investment on the manufacturing sector in Nigeria is not significant.

  There  is  no   significant  causal  relationship  between  foreign  direct   investment  and  the manufacturing sector in Nigeria.

  There are no structural responses of foreign direct investment to changes in the performance of the manufacturing sector in Nigeria.

1.6 Significance of the study

A major economic challenge for Nigeria is to ‘fight’ its way out of stagnation and move towards long- term sustainable economic development through rapid industrial development. To arrive at the long- term perspective for industrial development, the work will undertake a thorough analysis of the various problems and impediments associated with attracting FDI into the manufacturing sector in Nigeria. It has discovered that multiplicity of solutions proffered and incentive towards FDI is not sufficient condition to attract them and make them work toward the industrial development aspiration of the economy, since there exist internal factors affecting FDI and the manufacturing sector in Nigeria.  For Nigeria to fully exploit  its potentials in the global economic system; it  should try to explore the possibility of making FDI in the manufacturing sector to be export oriented. A desire to identify the potential roles of FDI on the manufacturing sector is the driving force behind this work.

.

The position of the work therefore, is that since there exist powerful, technical, economic and political forces likely to render the world economy even more globalised tomorrow than today. Attracting FDI into the manufacturing sector must be accompanied with appropriate negotiation and a study of their operational modalities because the global economy never gives what one deserves, except by negotiation. The work will be highly useful for policy makers and planners in Nigeria and in other developing countries, that deserve foreign investment in the increasingly volatile world where Multinational Corporations (MNCs) are concerned about milking the global economy among themselves, yet developing countries are not only desirous but compelled to attracting FDI. It will equally satisfy the demands of academic in area of international economic relations under the current globalization that is managed by the global economic governance institutions.

.

1.7 Scope of the Study

This work shall use secondary data, time series spanning 43 years (1970 – 2012). The choice of this study period is because of the availability of data. The study also limits its scope to the variables of interest in the study that is; foreign direct investment, manufacturing sector (manufacturing capacity utilization), interest rate, exchange rate and degree of openness. The justification for including degree of openness is to involve the external sector in the study since manufacturing activities involve the importation of raw materials, the export of finished products, the level of restriction of host country to repatriation of income, capital and dividend; compare and contrast the inflow of FDI in the 70s when Nigeria was hostile to foreign investment and when the economy became open to FDI in the 90s.

₦5,000.00 – DOWNLOAD FULL PROJECT DOWNLOAD FULL PROJECT Added to cart

---

---

---

---

Related Project Topics :