GOVERNMENT CONSUMPTION EXPENDITURE S AND THE CURRENT ACCOU NT [614739]

GOVERNMENT CONSUMPTION EXPENDITURE S AND THE CURRENT ACCOU NT
IN NIGERIA

Abstract

This study contributes to the body of knowledge by examining the effect of government
consumption expenditure s on the current account balance in Nigeria , covering the periods from
1970 to 2018. The study answers the question: Does government consumption expenditure s affect
the current account balance in Nigeria? Employing the Autoregressive Distributed Lag (ARDL)
bound cointegration testing approach for ev aluation, the unit root test results shows a mix level of
stationarity. The ARDL results showed that the government consumption expenditures and total
debt burden contributed significantly to the current account deficit in Nigeria . The error -correction
coefficient of the ECM( -1) term is negative as expected , indicating that the gap between long run
equilibrium value and the actual value of the dependent variable is corrected with speed of
adjustment equal to 1.06 percent annually. The study recommends redu ction in Government
borrowing in order to reduce debt servicing affecting the country’s current account.

Keywords: Government consumption, Current account, Bound cointegration, ARDL, Nigeria
Jel Classification: B22, C13, F32, H50, N47

1. Introduction

There has been an extensive research conducted without a conclusive evidence , on how changes
in government consumption expenditure s affect the current account balance of countries. The
views of the neoclass ical economists are that governm ent spending expenditures on goods and
services affects both output and investments positively , while spending based on worked hours
negatively affect the two variables (see Baxter and king, 1993). For example, Baxter (1995) asserts
that as the final consu mption expenditures increases by a 1%, it results to a 0.5% decline of the
current account balance . While evaluating the United Kingdom’s economy, Ahmed (1987) noted

a negative relationship between increases in expenditures of the government and the balanc e of
trade in the 18th and 19th centuries.
Also, Yi (1993) found that purchase of the government contributed immensely to the
decline of the economy of the United States (US) in the 1970s and 1980s. According to Abbas,
Bougha -Hagbe, Fatas, Moun & Valleso (2011) , the question most economies have asked overtime
are, to what extent through which adjustment of fiscal policy would result to resolving problems
relating to external balances. Oseni &Onakoya (2013) were of the view that issuance of bonds by
the gov ernment, raises the rate of interest, leading to higher consumption expenditure as a result
of wealth effect. High interest rate leads to currency appreciation, and as loss in competitiveness
sets in , coupled with higher marginal propensity to consume, lea ds to deterioration of the current
account (Oseni & Onakoya, 2013).
Government consumption expenditure is the values of both goods and services utilised by
various agencies, departments and institutions of g overnment s, in the provision of goods and
servic es to the population (Cavallo, 2005) . This type of goods and services which include, national
defence, administrative activities are not easily provided by private business owners. On the other
hand, current account balances of countries are the differen ces between an economy’s export and
imports of goods and services, as well as income. It also includes the differences between an
economy’s national income and domestic investments and consumption. A greater amount of local
expenditure especially the in ad vanced economies are mainly government consumption
expenditure s (Cavallo, 2005).
In Nigeria, during in 1970, expenditure of the government was estimated at a billion
dollars; this placed the country 11th in the global rankings . Also, the country’s share to the world’s
total on government consumption expenditures was 1.2%. After about a decade, in 1980 the
expenditure of the rose to 68.8 billion dollars, placing the country 8th in the global rankings . This
brings a share of the consumption expenditure of the government to 3.1 % in the world. In 1991,
consumption expenditure of the government was 4.83% of the Gross Domestic Product ( GDP ) and
in 1994, the consumption expenditure rose to 17.94 % of the GDP. The country spent a total o f 2.9
billion dollars in 1999, placing the country 68th in the world. The government final consumption
expenditure in 2003 was -23.926% , while in 2004 , it reached to 565.59% .
In 2013, the Nigeria n government spent a total of 41.6 billion dollars , thus placing the
country 38th in the global rankings, and a share to the global consumption expenditures to 0.31%.
The final consumption expenditure s in 2015 and 2016 was -11.897% and -15.116%
respectively . The final consumption expenditures as percentag e of the GDP in 2017, was 4.6%
of the GDP and 22.3 billion US dollars, in 2018, about 33.16% of the GDP (The World Bank,
2019) . The figure 1 below shows the Nigerian government consum ption expenditures from 1970
to 2018.

From the figure, it could be seen that consumption expenditure s of Nigeria was on a
constant increment from 1970 to 1980; it however decreased between 1987 and 1990. From the
figure, the consumption expenditure s of the government continued to in crease on higher scale from
2004 to 201 8.

Since the study conducted by Cavallo (2005) on the effect of government consumption
expenditure s for the US economy, fewer studies had focused on this area of research. As studies
on the effect of fiscal policy on current account balance continued to attract debates among
researchers without conclusive evidence, theoretical debates on current account balances
explaining variations in fiscal measur es, had centered on macroeconomic models. Among the
models include, the Mundell –Fleming and Ricardian Equivalent models. In the Mundell –Fleming
approach, fiscal deficit causes current account deficit , while the Ricardian equivalent hypothesis
posit it that deficit financing, either through reduced taxes , or by issuing bonds does not change
the present value wealth of individual households, since both temporarily reduced taxes and
issuance of bonds represent future tax liabilities (Kim,1995 ; Oseni & Onakoya,2013). Following
the twin -deficit hypothesis, it is expected that recorded fiscal deficit is accompanied by huge current
account deficit (Kim & Roubini, 2004).
On the other hand, the Keynesian principle s uggest that increase s in fiscal de ficit as a result
of expenditure increment, households will be compelled to utilize s additional income to boost
consumption, thereby causing national saving, both public and private to decline (Ekundayo,
2011). The impl ication of this, is that the country would resort to borrowing, unless the local investment
activities decreases enough to offset the short fall in the saving rate. Nonetheless, the Keynesian approach
centred on the fact that, there is a positive interacti on effect between fiscal deficits and private consumption,
implying that higher deficit results to a higher private consumption expenditures. This view point however
may not be realistic according to Briotti (2005), based on the literature of expansionary effect of fiscal
consolidation
It therefore becomes crucial to understand the current account dynamics especially in the Sub –
Saharan African economies, as the performance of the economies of the region in the recent past has been
discouraging. For instan ce, since Nigerian government embarked on the Structural Adjustment Programme
(SAP), geared towards liberalization of the economy, it has in practice led to a decline of the economy, and
further worsened the current account imbalances. Thus understanding c urrent account dynamics, might lead
to a mitigation of these effects; though it is still unclear what the current account determinants are, and also,
not yet if the imbalances are sustainable. Equally, the burden of debt service repayments , has also
contri buted to the huge c urrent account deficits of the country . As an import dependent economy,
consumption expenditure s which constituted greater part of the total expenditures , and a greater
share of the total output, has resulted to a huge trade deficit for the country.
The questions this study tends to answer is therefore stated as follows: Does government
consumption expenditure s affect the current account balance in Nigeria? What are the other
variables that affect current account balance in Nigeria? Th e overall objective of this research is
therefore to evaluate the effect of government consumption expenditure s on the current account
balance in Nigeria

2. Literature Review
In the literature, it is argued that that there are opposite effects of the consumption expenditures
on goods and hourly worked on a key macroeconomic variables which include, private investment
and the total output. These variables are the key determinants of current account (Cavallo, 2005).
The model of the Neo-Classical model e conomy posits that there is positive effect between
expenditures on goods, output and investment; and a negative effect between hourly worked and
the variables (Baxter & king, 1993 ; Finn, 1998 ). However, Baxter (1995) noted that expenditures
on hourly wor ked, are smaller in magnitude than the goods expenditures on current account.
According to the author, a 1% increases in the hourly worked expenditure, decreases the current
account to 0.5% of the GDP.

Equally, increases in government spending on goods is accompanied by an increases in
imports, while an increases in hourly worked is accompanied by an increase in domestic supply of
labour. Increases in the rate of import leads to trade decline and current account deficit, while
increases in the domestic lab our supply have little impact on services, income and net exports
(Baxter, 1995). Since hourly worked is a non -traded goods, an increase in hourly worked have no
direct impact on local expenditures goods, and therefore does not impact directly on current b ut
rather, an indirect effect. Thus, it is important to firstly evaluate consumption expenditure changes
while assessing its effect on current account (Cavallo, 2005).

2.1. Fiscal policy effects on current account balance
Studies on fiscal policy effects on current account balance according to Abbas et.al. (2011),
includes effect on consumption, tradable goods demand and investment. Large part of the local
demand for goods are always accounted for the government, thus depending on propensity of
impo rt, a change in the demand for import by the government leads to a movement in the balance
of trade. Also, changes in the rate of exchange affects current account by altering the relative prices
of non -tradable goods ( Abbas et.al. 2011) . An increased gover nment spending on non -tradable
goods like real estate sectors or services, can lead to exchange rate appreciation , thereby tilting
forward private consumption and production away from tradable goods. Other channel through
which fiscal policy affects curren t account include, country’s risk premia and rate of interest
(Abbas et.al, 2011

2.2. Government expenditures as a measure of size of government
In the literature, there exist several ways through which the size of government is
measured. According to Alesina, Glaeser & Sacerdote (2001), these measures are typically based
on, either total expenditure of the g overnment , or general consumption expenditure s. The authors
were of the view that the relative measure of the government size is the expenditure ratio of
government and that depicts how the government utilizes local resources. However, Leonard
(1986) argued that budget might not actually state clearly, the true size of since it may not account
for the government ‘quiet size’ activities. Government role in an economy therefore goes beyond
collection of revenues and spending (Leonard, 1986).
2.3. A cross country studies on government consumption expenditure
Cross country studies on government consumption expenditure shows that in 2013, the
Nigerian government spent a total sum of 41.6 billion dollars on consumption expenditure s. This
amount bring s the country on par with other countries like Greece 41.6 bill ion dollars , the Czech
Republic 41 billion dollars , Ireland 40.6 billion dollars , Algeria 39.7 billion dollars , Malaysia 42.3
billion dollars and Portugal 43.1 billion dollars respectively. Also, the country’s consumption
expenditures far exceeded that of the neighbouring countries . For instance, consumption
expenditures for counties like Camero un in the same year 2013, was 3.4 billion dollars , Chad 2.6
billion dollars, Republic of Niger, 1 billion dollars, and the Republic of Benin 0.93 billion dollars
respectively. As a percentage of the GDP, t he Nigeria’s consumption expenditures in 2015 and
2017 was 5.94% and 4.6% respectively. The consumption expenditures as a percentage of the
GDP in 2017 for Ghana was 8.8%, Niger 15.8%, and Cameroun 11.5% respectively (The World
Bank , 2019).

2.4. Empirical literature
Bhavesh & Prabheesh (2017) investigate macroeconomic and external factors that affect
current account balance in India from 1997 to 2012. The study show that twin deficit hypothesis
that fiscal deficit reduction ameliorate the current account deficit applies. Ișık, Yılmaz & Kılınç.
(2017) evaluate the relationship between current account balance and credit to firms in 26
Organization of Economic Cooperation and Development (OECD) countries from 2005 to 2015.
The study results indicate that credit to households and firms have negative effect on current
account balance in the short run while credit to firms and government have positive effect in the
long run .
Klemm & Iakova(2013) investigate growth following investment and consumption driven
current account crises for industrialized countries. The results show that a deficit reversal that
follows investment boom are identified with better growth than those following consumption
booms. The st udy find that large current account deficits are as a result of consumption or non –
productive investment booms. Also, Oseni & Onakoya (2013) examine fiscal policy effect on
current account balance in Nigeria from 1980 to 2010. The study employ Structural V ector Auto
Regression (VAR) model approach. The result show that expansionary fiscal policy has a positive
effect on the output and exchange rate and negatively impact on the current account balance
Nurudeen & Usman (2010) evaluate the effect of government expenditure and the growth
of the Nigerian economy from 1970 to 2008 using cointegration and error correction model
techniques. The study results show that government capital expenditure, recurrent and educat ion
expenditures indicate a negative effect on economic growth. Nickel and Vansteenkiste (2008)
investigate the relationship between fiscal policy variables and current account balance of 22
advanced economies. The panel data results show that countries wi th debt to GDP ratio of 90%
indicate a positive relation between fiscal policy variables and current account balance. The result
also indicate that for 11 largest Euro area economies, a statistically insignificant result exists
between fiscal policy vari ables and current account balance.

3. Methodology of Research
3.1. Data analysis method
The study adopts an Auto Regressive Distributive Lag (ARDL ) model approach for evaluation.
The current account is the dependent variable, while government final consu mption expenditure s,
total debt, exchange rate, interest rate and trade openness, are the independent variables. The model
for the effect of government consumption expenditure s on current account in Nigeria is therefore
specified as follows:
  F , , , , CAB CEXP TDEBT EXCH INTR OPEN
……………………………… …….(1)
where
CAB = The current account balance
CEXP = The Government consumption expenditure
TDEBT = Total government debt
EXCH = Exchange Rate
INTR = Interest rate
OPEN= Trade openness

In order to establish a linear relationship between the dependent variable and the
independent variables , an econometrics model is therefore specified as follows:
0 1 2 3 4 5 t = + + + + + + CAB CEXP TDEBT EXCH INTR OPEN      
…………….……(2)
where
t
= Error term
0
= the constant term

’s = the parameters to be estimated

3.2. Method of result evaluation
This study utilizes the Augmented Dickey Fuller (ADF) test for stationari ty test. This is
because, the Auto Regressive Distributed Lag (ARDL) bound test procedure is conducted based
on the assumption that , the variables under consideration are either integrated of order zero or
order one. Hence an order of integration was determined applying the ADF test procedures. The
null hypothesis that guided the test is stated as follows: H 0: β=0 (β has a unit root); H1: β<0 (for
alternative hypothesis). According to Pesaran, Shin & Smith (2001), the variables under
consideration cannot be integrated of order two to avoid a spurious regression . In conducting an
ARDL model procedure, a choice for an appropriate lag leng th is provided. Pesaran & Shin (1999 )
were of the view that Akaike info criterion (AIC) and Schwarz criterion (SC) are appropriate in a
small sample, though SC is superior to AIC : The ARDL model is written as follow:
n n n n n n
t 0 1 t-1 2i 1t-1 3i 2t-1 4i 3t-1 5i 4t-1 6i 5t-1
i=1 i=0 i=0 i=0 i=0 i=0
n
7i t-1 8 t-1 9 t-1 10 t-1 11
i=0CAB = + CAB CEXP + TDEBT + EXCH + INTR + OPEN
+ CAB + CEXP TDEBT EXC Hi
INT      
           
       
 t-1 12 t-1 OPENt R
…… (3)
where
Δ = Difference operator
𝜀𝑡 = Stochastic term
Conducting ARDL bound test, an Ordinary Least Square (OLS) is estimated firstly in order
to establish if there exists a long run relationship between the variable under consideration. The
test is based on an F-Statistic for the joint statistically signif icance of the lagged variables.
The null hypothesis of no cointegration (
0 7 8 9 10 11 12:0H           ) is
evaluated using Pesaran et.al. (2001) procedure. The underlining assumption is therefore stated as
follows: if the F -statistic is > upper critical bound, H 0 is rejected and concludes that the variables
under consideration are cointegrated, otherwise it is not accepted. However, if F -statistic ≥ lower
critical bound ≤ upper critical bound, then decision becomes inclusive. If the null hypothesis of no
cointegration is rejected, a vector error -correction model (VECM) is therefore estimated (Narayan
& Narayan, 2006). The VECM model is therefore specified as follows:
n n n n
t 0 1 t-1 2i 1t-1 3i 2t-1 4i 3t-1
i=1 i=0 i=0 i=0
nn
5i 4t-1 6i 5t-1 t
i=0 i=0CAB = + CAB CEXP + TDEBT + EXCH +
+ + ECM( -1)+i
INTR OPEN    
       
   

.(4)
where:
ECM( -1) = The error correction term
𝜆 = the error coefficient

4. Presentation and Analysis
The trend of the current account balance in Nigeria from 19 70 to 2018 is therefore
presented in the figure 2 below:
Figure 2: The trend of the current account balance (CAB) in Nigeria from 1970 – 2018
A look at the figure of the c ountry’s current account showed a record low in 1978 as the
figures are close to negative. There was an upward spike from 1981 to 1996, with a surplus for
Nigeria in 1990 s. The figure showed current account balance to be fluctuating in the period from
2000 to 2010; also, the country recorded a deficit in 2015 and a surplus in 2016 and 2018
respectively .
4.1. Descriptive statistics
The descriptive statistics for the variabl es under consideration are therefore presented in table 1
below:
From the table above , the descriptive statistics indicated that from 1970 to 2018, all the
variables under study showed an averaged positive mean values with 49 observations. The
standard dev iation indicated that the highest standard deviation is recorded by the variable CAB,
while the least standard deviation is recorded by variable INTR. The Jarque -Bera (JB) test of
normality for the variables under consideration revealed that five of the va riables are significant at
5% level.
4.2. Unit root test
The results of the Augmented Dickey Fuller (ADF) unit root test obtained are presented in
table 2 below as follows:
From the table above, the results showed that two of the variables, CAB and CEXP are
stationary at level at 5% significant level s. The other variables, TDEBT, EXCH, INTR and OPEN
are stationary at first difference I (1) at 5% significant levels in the ADF test procedure respectively.
Therefore, s ince there exist a mix order of stationarity among the variables, an ARDL model
Procedure is therefore conducted . Oteng -Abaiye & Frimpong (2006) stated that instead of utilising
Johanson cointegration approach which requires that all variables are integrated o f order one I(1),
an ARDL that incorporates variables that are I(0) and I(1) are therefore utilised.
4.3. Lag Length selection
To determine the lag order of the estimated model, we evaluated several order sele ction
criteria. From estimated lag length criteria results (see table 4 below), the Akaike Information
Criterion (AIC), the Schwarz Criterion (SC) and Hannan -Quinn information criterion (HQ)
indicated 4 lag. Therefore we utilized the AIC and SC test result s and estimate d the ARDL model
with a (4) lags.
The study tries to establish whether there exist a long run relationship among the variables
under study by conducting bound cointegration test procedure. An F -statistic to test the long -run
relationship is t herefore computed. A maximum lag length of 4 is adopted. The result of ARDL
bound cointegration test is presented in table 4 below:
The ARDL bound test result from the table 4 above indicated that the F – Statistic value is
greater than the critical value bounds at both 1%, 5% and 10% significant levels respectively. We
can see that the value of 6.081641 is higher than 2.62 and 3.79 critical values at 5% significant
levels. The hypothesis of no long run relationship is therefore rejected. Thus it showed th at ARDL
model estimate d, is proven to determine the long -run slope -estimated coefficients and the short –
run dynamic -estimated coefficients. Hence there exists a long run relationship between CAB,
CEXP, TDEBT, EXCH, INTR and OPEN

4.5. The estimated short r un ARDL Regression model
The ARDL (1, 4) is selected based on Akaike info criterion.
From the result table 5 above, the coefficient of the variables, CAB ( -1) is positively signed
and significant statistically. It indicates that the lag value of the dependent variable contributes
positively to the growth of th e current account balance in Nigerian . The coefficient of the variables
CEXP and TDEBT, indicate negative signs and are significant statistically. The negat ive
coefficient of the variable CEXP implied that the consumption expenditure contributed
significantly to the decrease in the current account balance of Nigeria in the short run . The finding
conform to the study by Cavallo (2005) that consumption expenditures of the governments
overestimates its role while accounting for current account movement. Also, t he result of TDEBT
conforms to the findings of Ramanan (2017) that current account deficit leads to fall in demand,
lower output and income and this translates into huge government deficit and i n turn affect the
public debt.
The coefficient of the variable INTR indicate a positive signs and is significant statistically
at 5% significant level. A rise in interest rate as the Central bank buys domestic currency , leads to
a liquidity squeeze , there by contributing to high interest rate. The result conform to the findings
by Spiro (1997) , that testing fiscal policy and interest rate in Canada have been unsuccessful as
the interaction between fiscal policy and current account seems to be indirect and thus are
influenced by monetary policy. The coefficient of EXCH shows a positive sign and i nsignificant
statistically. Heera (2014) noted that once there is a breech in exchange rate comfort level, the
apex bank intervenes by selling foreign exchange in order to curb local currency depreciation.
However, Pettinger (2017) stated that the Marshall Lerner condition asserts that exchange
rate depreciation leads to current account improvement. It also leads to an increase cost of import
purchase, thus leadi ng to low demand fo r imported goods and services, thereby reducing current
account deficit. Also, the coefficient of the variable OPEN indicates a positive sign and significant
statistically at 5% level. The result shows that the level of trade openness o f the economy leads to
a current account balance improvement. The result conforms to the finding of Khan, Jaffri &
Abbas (2017) that tariff reduction improves balance of trade in the short run while non -tariff
barriers leads to deterioration of balance of trade in the long run.
The error -correction term, ECM( -1) from the ARDL model estimate is negative as
expected with a value of -1.063659 and is statistically significant. This implies that there is a
possibility for cointegration and therefore the existe nce of a long run relationship among the
variables. We can therefore conclude that the gap between long run equilibrium value and the
actual value of the dependent variable CAB is corrected with speed of adjustment equal to -1.06
percent annually. It also showed that there exists a backward move towards equilibrium.
The coefficient of determination
2R indicates a value of 0.798349 and the adjusted
2R with
a value of 0.533018. This shows that 53% of variatio ns in the dependent variable (C AB) are
explained by independent variables . The F -statistics results indicate that the overall model is
significant with a value of Prob(F -statistic) = 0.008291; while the Durbin -Watson (DW) statistics
value of 2.034288 indicat es absence of serial correlation in the model under consideration.
The long run model for the relationship between consumption expenditure and current
account balance is therefore presented as follows:
From the results, it showed that the estimated coef ficient s of the long -run relationship are
significant for TDEBT, EXCH and INTR , and insignificant for CEXP and OPEN. The estimated
coefficients are positive for TDEBT, and OPEN, and negative for CEXP, EXCH and INTR. This
implies that the country’s debt and degree of openness of the economy positively affected the

current account balance , while consumption expenditure, exchange rate and interest rate indicate
a negative relationship with the current account in the long run during the period under review.

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