ABSTRACT
This study probes the effectiveness of fiscal spending in the context of crowding out/in hypothesis for Sub-Saharan Africa, using annual panel data for the period 2000 – 2011 obtained from the World Bank online data bank for forty six countries in the region. The data set were included in the model based on review of past studies and taken mainly as a ratio to GDP to minimize the problem of heteroscedasticity. The fixed effects model was applied based on the specification tests. The panel output indicates that private investment is positively responsive to fiscal policy measures- though minimally, hence increases in government spending are found to crowd in private investment in all the countries selected both individually and on the average. Variables like real exchange rate and value of total debt servicing as a ratio of GDP have positive significant effect on private investment in the region. While the value of total external debt as ratios of GDP and real interest rate have significant negative effect on private investment. The study also finds that real per capita income growth has positive significant effect on private investment with random effects model only, whereas domestic credit to the private sector appeared insignificant and negative. Other macro variables such as inflation, real per capita GDP and real per capita income growth, are statistically insignificant in affecting the behaviour of private investment in the region. The study therefore recommends, among other things, a strengthened proactive regional fiscal policy agenda – with no room for half measures- aimed at stimulating private investment as well as ensuring a stable, predictable and healthy macroeconomic environment. Also, efficient and effective public-private strategies will reduce information asymmetries between both sectors on investment related policies and pave the way, all other things being equal, for the much desired economic transformation of the sub-region.
1.1 Background of the Study
CHAPTER ONE INTRODUCTION
The economic problems of third world countries are not, in their totality, uniform. But their basic characteristics transcend the boundaries of individual countries (Ray, 1983). These problems according to Jhingan (2005) are the problems of a fundamental disequilibrium of the economy, with the attendant features of stilted economic growth, an adverse balance of payment, low capital formation, unequal distribution of income, price level instability, severe unemployment among others. The African continent is worst hit by underdevelopment, while Sub-Saharan Africa is generally described as the poorest region of the world; one that is getting poorer in the face of sustained growth and significant improvement of living standards in the rest of the world (Todaro and Smith, 2006; Bayraktar and Fofack, 2007). Virtually all countries in the region have been confronted with deep-rooted developmental constraints: rapid population growth, low physical and human capital development, and inadequate infrastructure. These and other similar economic problems have constituted major impediments to private sector development and to their economies in general. In addition, ethnic conflicts, political instability, and adverse security conditions have aggravated the economic performance of several countries in the region. These all have been putting huge obstacles to the capital formation in the subcontinent- one of the very crucial factors of production for the progress of economies (Chhibber and Dailami, 1990; Sima
2007)
Private investment is essential for ensuring economic growth, sustainable development and poverty reduction. It increases the productive capacity of an economy, drives job creation, brings innovation and new technologies, and boosts growth. Private investment plays an important role in developing nations for the same reason that it does in industrial countries: investment determines the rate of accumulations of physical capital and is thus an important factor in the growth of productive capacity (Agenor and Montiel ,1996). However, the amount of physical capital in general and private investment in particular falls short of development needs in these countries especially African nations. Several studies, such as Mlambo & Oshikoya (2001), Anyanwu (2006),Bayraktar & Fofack (2007), Douglas and Quentin (2007) and Bakare (2011) show that the contributions to growth of physical capital and total factor productivity in Sub- Saharan Africa (SSA) have been low and have declined over time.
In economic growth literature, neoclassical growth models such as Solow (1956) and Swan (1956) postulate that economic policies do not affect steady state economic growth, although they can affect the level of output or its growth rate when the economy is in transition from one steady state to another; while in endogenous growth models some fiscal policy instruments are harmful for growth while others are not (Barro, 1990; Lucas 1990). However, these days it is believed that macroeconomic policies may affect economic growth either directly through their effect on the accumulation of factors of production, namely capital, or indirectly through their impact on the efficiency with which factors of production are used. Macroeconomic stability (reflected in low and stable inflation, sustainable budget deficits, and appropriate exchange rates) sends important signals to the private sector about the direction of economic policies and the credibility of the authorities regarding their commitment to manage the economy efficiently. Such stability, by facilitating long-term planning and investment decisions, encourages savings and private capital accumulation (Ghura & Hadjimichael, 1995).
Specifically, endogenous growth models have shown that fiscal policy can have significant effects on economic growth in the long run. For example, in a model that assumes constant returns to scale with respect to government inputs and private capital combined but diminishing returns with respect to private capital alone, Barro (1989 and 1990) has shown that high levels of government taxation distort savings decisions, which in turn lower economic growth in the steady state. Fiscal policy can foster growth and human development through a number of different channels. These channels include the macroeconomic (for example, through the influence of the public investment, as a catalyst, on private investment) as well as the microeconomic (through its influence on the efficiency of resource use) channels.
Since 1980s, extensive efforts have been directed at generating economic recovery in Africa through the Structural Adjustment Program (SAP) and other similar programmes. However, little (or only recently) attention has been given to the need to promote private investment, although investment is essential in any country for a number of economic reasons (Arin, 2004). Policy makers have not tended to give much practical attention to the link between private investment and socio-economic progress (Atukeren, 2010). The Structural Adjustment Programme of the World Bank (WB) and the International Monetary Fund (IMF), aiming to address the problem of poverty and declining private investment, emphasize the need to reduce government budget deficits; Hermes and Lensink, (2001) stressed that these bodies assume that reducing fiscal
deficits is beneficial for the long-run growth process, no matter how such a reduction is achieved.
Fig 1.1 Sub-Saharan Africa Government Final Consumption Expenditure Annual % Growth
The investigation on the effectiveness of fiscal spending in Africa is essential in the decision making process. This is because government spending has been on the increase since the turn of the millennium, especially during the peak of the global economic crisis which witnessed the region increase expenditure from 5.47% in 2008 to 23.29% in 2010 while the developed world were battling with public spending cuts (see fig 1.1) and most governments in the continent have been running a budget deficit for more than a decade (Motlaleng, Nangula and Moffat, 2011). According to the WB and the IMF, reducing the role of the government would reduce barriers to the economic endeavours and ginger private initiative and intervention. Despite these efforts, the continent’s poor economic performance has been persistent due to, among others things, the low levels of private investment as the share of GDP in the subcontinent (Alfredo, 2006; Udah,
2010). This opens a door for suspicion of those policies formulated by these two organizations. However, there is a need to emphasize that the aim of this study is not to attest whether the public policies designed by the WB and/ or the IMF, particularly for the developing world, such as the SSA region, are correct or not. Rather, the study will focus on investigating the effectiveness of fiscal policy measures in enhancing the performance of private investment in the region.
The association between public investment spending and private investment is a controversy in the realms of macroeconomics and public policy making that has strong implications for determining the government policy to promote economic growth (Kollamparambil and Nicolaou,
2011). On the one hand, increased government involvement in the economy (mainly through expenditure activities) might distort the economic and political environment of business and discourage or crowd-out private sector investment. On the other hand, government protective and productive investments in physical, legal, and human capital infrastructure might crowd-in
private sector investments (Atukeren, 2010). It is thus vital to establish whether efforts being made by the governments of African nations, with regard to their investment contributions, are thwarting or fostering the private sector’s incentive to invest. Ascertaining such a relationship between these two key elements is imperative for economic growth-oriented public policy in the region.
1.2 Statement of the Problem
Private investment is a powerful catalyst for innovation, economic growth and poverty reduction (Todaro and Smith, 2006). Chhibber and Dailami (1990), Oshikoya (1994), Ndikumana (2005) and Bakare (2011) particularly stress that the importance of private domestic investment to the growth and development strategy of developing countries is emerging with particular clarity from the convergence of two strands of empirical concerns. One is the evidence that in almost all these countries, domestic investment has borne the brunt of the aggregate demand contraction associated with the process of external adjustment. The second, which derives partly from the first, is the growing agreement on the desirability of increasing private sector’s share in total capital formation through increased reliance on market forces and incentives.
In addition to its documented contribution to growth, private investment in the case of Africa deserves serious attention for three additional reasons. First, sustained increase in private investment serves as a visible proof of the private sector’s confidence in public policy both in the sense that policy is heading in the right direction and that policy reforms are deemed sustainable in the long run (Ndikumana, 2005) Achieving the growth rates needed to alleviate poverty and raise employment will require active participation of private investors. Second, sustained increase in private investment is a sign of efficiency of public investment especially in reducing the costs of private investment, thus raising profitability (Motlaleng, Nangula and Moffat, 2011). Third, sustained improvement in private investment serves as a medium for attracting foreign direct investment as it is an indicator of high returns to investment and declining risk of investment in the country (Caballero and Krishnamurthy, 2004).
However, attention given to promote domestic investment in Africa is rather below par relative to other regions of the world (United Nations Economic Commission for Africa 1995; IMF,
2009). The rate of return on both capital and labour and the overall productivity of the Sub- Saharan African economies remain low because of a variety of distortions and institutional deficiencies (Sima, 2007). The problems according to Udah (2010) and Jecheche (2011) include obstacles to international trade, overvalued exchange rate, poor infrastructure, bad governance &
corruption, insufficient competition & monopolistic structures in many of the sectors. It has always been argued, in one way or another, that all of these problems are related to the policies formulated in these countries.
Anyone concerned about SSA’s dismal growth performance over the past three decades cannot help noticing that private investment, too, was significantly lower as well; such that Africa invested 9.6% of GDP while the ratio of other regions was above 15.6% (Devarajan, Easterly and Pack, 2001). During the late 1970s and 1980s, many African countries experienced a profound slowdown in economic growth. Oshikoya (1994) adduced that a widely recognised reason was that gross private investment fell substantially in Africa during the period and remained severely depressed for the rest of the decade across the region. He further stated that the proportion of total private investment to GDP fell from 20.8% per year during 1973 – 80 to
16.1% per year during 1980 – 89. In some African countries, private investment has fallen to less than 10% of GDP – a level that is insufficient even to replace depreciated capital (OECD, 2006). Much more investment is needed in the continent in order to achieve significant success in meeting the millennium development goals, the minimum private investment needed to attain this is estimated at between 25% – 30% of GDP (IMF, 2009; Atukeren, 2010).
The impact of government spending on private spending constitutes one of the central issues in empirical and policy debates (which Africa is not left out). Empirical evidence reveals that investments of the public sector exert mixed effects on the private sector, such that the relationship between the two types of investments is either complementary or substitutive. Literature from previous studies offer inconsistent conclusions on the impact of public investment on private investment in developing economies, with some studies suggesting that public investment stimulates private investment (Jecheche (2011), Atukeren (2010), Kollamparambil and Nicolaou (2010), Hermes and Lensink (2001), Ndikumana (2005), Bogunjoko (1998), Ghura and Godwin (2000), Alfredo (2005) and Motlaleng, Nangula and Moffat (2011)) and others suggesting that public investment crowds out private investment (for example Martin and Wasom (1992), Anyanwu (1997), Badawi (2000), Muyambiri et al (2010), Fan and Saurkar (2007), Everhart and Mariusz (2001), Devarajan, Easterly and Pack (2001), and Ogbole, Amadi and Essi (2011)). The literature on the impact of public investment in developing economies thus gives conflicting results on whether it complements or crowds out private investment.
In addition, most studies mentioned are country specific, covering individual countries in Africa ((Jecheche (2011), Kollamparambil and Nicolaou (2010), Ndikumana (2005), Bogunjoko (1998), Motlaleng, Nangula and Moffat (2011), Martin and Wasom (1992), Anyanwu (1997), Badawi (2000), Muyambiri et al (2010)). While others conducted inter-regional studies of developing countries collectively (for instance; Chhibber and Dailami (1990), Fan and Saurkar (2007), Everhart and Mariusz (2001), Ghura and Godwin (2000), Alfredo (2005), Hermes and Lensink (2001) and Atukeren (2010). This gives room for new research contribution that studies the case of Sub-Saharan Africa strictly as it available studies looked at Africa as whole (see; Oshikoya, (1994) Devarajan, Easterly and Pack (2001) and Fosu, Getachew and Ziesemer (2012)).
Obviously, empirically studies on public – private investment nexus devoted to Sub-Saharan Africa is still scanty. The methodologies adopted in the aforementioned works are either cross- section or time-series in nature, with the exception of Bousrih and harrabi (2006), Ghura and Godwin (2000), Everhart and Mariusz (2001) and Fan and Saurkar (2007). However, cross- section studies cannot satisfactorily control for country-specific effects and time series studies does not satisfactorily control for time-specific effects. Apart from this, several studies were concerned with either investigating the relationship between public expenditure and growth with investment playing a secondary role.
This work will attempt to fill the above identified gaps by focusing on the Sub-Saharan Africa region and give attention to the heterogeneity of the countries in the sub- continent. It will aspire to contribute to empirical literature on the effect of fiscal policy, proxied by public investment, on the performance of private investment in the region using panel data. In so doing, it will incorporate other previously identified factors of interest in order to indicate the relative importance of the fiscal policy variable in explaining the behaviour of private investment in SSA. Moreover, the mixed results of previous studies on private investment behaviour in developing countries in general and the dearth of research output that captures the entire SSA as a unit in particular, provides a rationale for new research contributions. This study will try to show how private investment responds to public policies, among other things, particularly to fiscal policy changes in the sub-continent.
1.3 Research Questions
To be able to accomplish the task at hand, the study will address the following questions:
i. Does public spending crowd-out private investment in SSA?
ii. What is the extent to which macroeconomic variables like inflation, interest rate, exchange rate, external debt and GDP growth rate affect private investment in the region?
1.4 Objectives of the study
The broad objective of this work is to examine the fiscal policy effects on private investment in Sub- Saharan African countries. In doing so, it aspires to contribute to empirical literature on the effect of fiscal policy, proxied by public spending, on the performance of private investment in the region.
In particular, the study seeks to:
I. Ascertain if public investment crowds-out private investment in SSA.
II. Assess the extent to which macroeconomic variables like inflation, interest rate, exchange rate, external debt and GDP growth rate affect private investment in the region.
1.5 Research Hypothesis
Based on the objectives of the study, the following null hypotheses are proposed: Ho1: Public investment crowds-out private investment in SSA.
Ho2: Macroeconomic variables like inflation, interest rate, exchange rate, external debt and
GDP growth rate do not significantly affect private investment in the region.
1.6 Policy Relevance of the Study
The work will be helpful in showing how country specific factors are significantly important in fiscal policy formulation to enhance private investment and hence economic progress in the sub- continent. The results to be obtained from this analysis will therefore contribute to the literature on the effects of public investments on private investment by shedding light on the dynamics between the public – private sector interactions, understanding this relationship would enable governments in the region to formulate policies most suited to improve private investment and much desired economic transformation. Also, since private investment decisions are influenced by a couple of factors – including government spending- the work will serve as a resource material to the private sector and aid understanding of government fiscal actions, which in turn will determine their response to policy reforms.
Moreover, the study will also contribute to the existing literature by extending the works of others on fiscal policy devices- for enhancing private investment in SSA by applying panel econometric models. This would give policy makers in developing countries a clue for better policy formulation, because identifying the most significant determinants of private investment
and indicating those that fall within the domain of the public policy choices will help improve effectiveness of reform measures taken by government bodies.
The work will also shed light on the relative importance of fiscal policy measures in enhancing private investment by explicitly modelling the effects of public investment and some other macro variables on private investment. This shows the alternative measures that the government bodies may take in order to accelerate the performance of private investment in the region.
1.7 Scope of the Study
The study is a macro level analysis which will involve both cross-sectional and time elements, thus the econometric analysis of private investment is to be based on a panel of 46 Sub-Saharan African countries (out of 48 countries in the region) for the period 2000 – 2011 based on the available dataset. The choice of Sub-Saharan Africa is informed by the fact that it is considered the most backward economic region of the world. The countries include
| S/N | COUNTRY |
| 1 | Angola |
| 2 | Benin |
| 3 | Botswana |
| 4 | Burkina Faso |
| 5 | Burundi |
| 6 | Cameroon |
| 7 | Cape Verde |
| 8 | Central African Republic |
| 9 | Chad |
| 10 | Comoros |
| 11 | Congo, Dem. Rep. |
| 12 | Congo, Rep. |
| 13 | Cote d’Ivoire |
| 14 | Equatorial Guinea |
| 15 | Eritrea |
| 16 | Ethiopia |
| 17 | Gabon |
| 18 | Gambia, The |
| 19 | Ghana |
| 20 | Guinea |
| 21 | Guinea-Bissau |
| 22 | Kenya |
| 23 | Lesotho |
| 24 | Liberia |
| 25 | Madagascar |
| 26 | Malawi |
| 27 | Mali |
| 28 | Mauritania |
| 29 | Mauritius |
| 30 | Mozambique |
| 31 | Namibia |
| 32 | Niger |
| 33 | Nigeria |
| 34 | Rwanda |
| 35 | Sao Tome and Principe |
| 36 | Senegal |
| 37 | Seychelles |
| 38 | Sierra Leone |
| 39 | South Africa |
| 40 | Sudan |
| 41 | Swaziland |
| 42 | Tanzania |
| 43 | Togo |
| 44 | Uganda |
| 45 | Zambia |
| 46 | Zimbabwe |
This material content is developed to serve as a GUIDE for students to conduct academic research
FISCAL POLICY AND PRIVATE INVESTMENT IN AFRICA: A TEST OF THE CROWDING-OUT HYPOTHESIS
Project 4Topics Support Team Are Always (24/7) Online To Help You With Your Project
Chat Us on WhatsApp » 09132600555
DO YOU NEED CLARIFICATION? CALL OUR HELP DESK:
09132600555 (Country Code: +234)
YOU CAN REACH OUR SUPPORT TEAM VIA MAIL: [email protected]
09132600555 (Country Code: +234)