Does The Stock Market Play Any Role In The Effect Of Fdi On Economic Growth In Nigeria An Empirical Investigation

Does the Stock Market Play Any Role in the Effect of FDI on Economic Growth in Nigeria? An Empirical Investigation

Oziengbe Scott AIGHEYISI

Department of Economics and Statistics

University of Benin

Nigeria

Email: [anonimizat]

Abstract

The paper seeks to investigate whether the stock market plays any role in the effect of foreign direct investment (FDI) on economic growth (using real GDP as proxy) in Nigeria. Using annual time series data that span the period from 1981 to 2014, and employing the ordinary least squares (OLS) estimation technique to estimate a multiple linear regression model specified for the investigation, the empirical evidence indicates that the effect of FDI on real GDP in Nigeria is not statistically significant, but when FDI is interacted with stock market capitalization, the effect on growth becomes positive and significant, indicating that the development of the stock market (in terms of its size) plays significant role in the effect of FDI on the growth of Nigeria’s economy. The study further finds that population (being the source of labour) is positively related to real GDP. Trade openness is observed to adversely affect real GDP. This is attributed amongst others to high rate of inflation engendered by currency depreciation, arising from high and precarious dependence on import by the country. Recommendations of the paper include easing of some listing requirements to enable more domestic firms get listed on the stock exchange and addressing issues such as political instability, infrastructural decay, etc to attract more FDI, and using legislation to ensure listing of multinational corporations through which FDI flows into the country on the stock exchange; import control to reduce import demand, etc.

Introduction

Gross investment in an economy according to Agosin and Mayer (2000) comprises domestic investment and foreign investment of which foreign direct investment constitutes a significant part. The inflow of foreign direct investment to an economy is envisaged to complement domestic investment therein all things being equal especially where there is dearth of savings (or savings gap) according to the two-gap model. Increase in investment arising from domestic capital formation and inflow of foreign direct and portfolio investments to the economy according to various growth models (neoclassical and endogenous growth models) will engender increase in economic growth rate.

Feldstein (2000) identified three benefits of FDI to host countries. The first benefit is that FDI provides a mechanism for transference of technology that cannot be achieved through financial investment or through trade in goods and services. The second is human capital development as that countries that receive FDI often gain employee training as an automatic by-product of operating the new business. Such human capital development is important for all categories of worker ranging from production workers to managers and executives. The third is the revenue accruing to the government of the host-country in the form of corporate tax revenue imposed on the profits of the multinationals through which FDI flows into the country.

Numerous studies have investigated the effect of FDI on economic growth in various countries and regions. The empirical evidence has been inconclusive. Umoh, Jacob and Chuku (2012) employ various methodologies such as error correction methodology, Granger causality test and the three stage least squares technique for simultaneous equations modeling to investigate the relationship between FDI and growth in Nigeria. The evidence shows that a feedback relationship exists between the variables that is, FDI positively and significantly affects growth, just as growth positively and significantly affects FDI inflows. Hassen and Anis (2012) also find significant positive effect of FDI on long-run growth in Tunisia using data that span the period from 1975 to 2009 and employing the time series technique of cointegration and error correction analysis. Turkcan, Duman and Yetkiner (2008) test the endogenous relationship between FDI and economic growth using a panel data set for 23 OECD countries for the period from 1975 to 2004. FDI and growth are treated as endogenous variables and a two-equation system of simultaneous equation estimated using the generalized moment of means. The study finds a two-way positive and significant relationship between FDI and economic growth. Liu (2005) employs single equation and simultaneous equations techniques to investigate the effect of FDI on economic growth using panel data set for 84 countries over the period from 1970 to 1999. The analysis finds that FDI positively and significantly affects growth, directly, and indirectly through its interactions terms as the interaction of FDI with human capital is observed to exert strong positive effect on economic growth, while the interaction of FDI with technology gap is observed to exert significant negative impact on growth.

However, applying the OLS estimation technique to analyse data that span the period from 1970 to 2007, Olokoyo (2012) finds no significant effect of FDI on economic growth in Nigeria. Similarly, using same methodology, Danja (2012) finds no evidence of significant effect of FDI on economic growth in Nigeria. The study by Louzi and Abadi (2011) on the effect of FDI on economic growth of Jordan using cointegration and error correction analysis finds no evidence of significant effect of FDI on gross domestic product in the 1990-2009 period. Alfaro (2003) employs OLS with White’s correction for heteroskedasticity and instrumental variables techniques to investigate the effect of FDI in various sectors on economic using cross country data on 47 countries for the period 1981-1999. The analysis indicates that FDI exerts ambiguous effect on growth: FDI in the primary sector negatively affects growth; FDI in the manufacturing sector positively affects growth; while the growth effect of FDI in the service sector is ambiguous. Another study by Alfaro et al (2006) finds that well developed local financial markets are important for the effect of FDI on economic growth, as financial markets act as channel for the realization of the linkage effect as well as create positive spillovers of FDI to economic growth.

The study is motivated by the observation that though numerous multinational corporations operate in Nigeria’s economy, only a small fraction of these are listed on the country’s stock market. Several studies have shown that stock market development positively affects growth (Olweny and Kimani, 2011; Ovat, 2012; Ogboi and Oladipo, 2012; Ahmad, Khan and Tariq, 2012). A major determinant of the extent of the development of the stock market is the number of firms listed thereon. This enhances market capitalization and market liquidity which are key indicators of stock market development. Listing of multinationals on the stock exchange will no doubt enhance the market size and liquidity (Aigheyisi and Edore, 2013), just as foreign portfolio investment enhances the growth of the capital market (Eniekezimene, 2013). Thus the inflow of FDI to the economy (through the multinational companies), if interacted with stock market development indicators is hypothesized in this study to enhance the impact of FDI on economic growth. The objective of this paper therefore is to investigate whether the stock market plays any significant role in the effect of FDI on the growth of Nigeria’s economy. Though numerous studies have been conducted to investigate the effect of FDI on Nigeria’s economic growth, none to our knowledge have yet investigated the role the stock market plays in this effect. The current study intends to fill this gap as well developed stock market could enhance the effectiveness of FDI in promoting the growth of an economy.

Brief Review of the FDI-Financial Markets-Economic Growth Literature: Theory and Empirical Evidence

It was hinted earlier that for countries, especially the LDCs where there is a dearth of investment as a result of low savings rate, FDI inflow is required to raise the level of investment therein to accelerate the growth of such economies. This is actually a major focus of the two-gap model which has been described as an extension of the Harrod-Domar model (which shows that the rate of growth of an economy is jointly determined by the national savings rate, that is the national savings-income ratio, and the national capital-output ratio, suggesting that the more a country can save and invest, the faster it can grow) identifies two gaps which necessitate foreign finance and aid (or foreign exchange) inflows, namely the savings-gap arising from low level of savings, and the foreign exchange gap arising from low level of export (and high level of imports). The savings-gap can be closed with foreign direct investment, while the foreign exchange gap can be bridged with foreign aid (Akande and Oluyomi, 2010). The two-gap model therefore provides an explanation of how capital inflows affect economic growth by increasing the level of investment in the economy. However, the empirical evidence on the effect of FDI on economic growth has been mixed, and yet remains inconclusive. Though, evidence on the effect of FDI on growth has been previously discussed in the introductory section of this paper while laying the background of the study for the sake of clarity and coherence, we present below further empirical evidence on the FDI-financial market-economic growth relationship.

Nunnenkamp and Spatz (2004) examine the relevance of host-economy characteristics (such as real GDP per capita, level of schooling, institutional development and openness/closeness of the economy) and industry characteristics (such as technology intensity, factor requirements, linkages to local and foreign markets, and the degree of foreign vertical integration of foreign affiliates) in the effect of FDI on economic growth in developing economies. Evidence from the cross-country analysis indicates that higher FDI stock in a particular period tend to be associated with lower growth in subsequent period in economies with unfavourable characteristics, suggesting that FDI crowds out domestic investment in those economies. The picture is however brighter for economies with favourable characteristics. Specifically, it is found that availability of complimentary human capital in host countries is important for FDI to stimulate economic growth. It is also found that sound institutions are a prerequisite for attracting and benefiting from the market-seeking and efficiency-seeking FDI. Openness to trade is also found to be a sine quanon to successfully participate in the widely perceived trend towards efficiency seeking FDI.

Alfaro et al (2003) examine the role financial financial markets play in the relationship between FDI and economic development using cross0country analysis of data on seventy countries. The empirical analysis provides ample evidence that the levelof development of the financial markets is crucial for FDI to positively affect economic gdevelopment. Specifically, the evidence shows that well developed financial markets allow significant gains from trade, while the effect of FDI alone on economic development is ambiguous.

Esfandyari (2015) investigates the role of financial market development in the foreign direct investment effect on economic growth in the Developing 8 (D8) countries (Bangladesh, Egypt, Indonesia, Iran, Malaysia, Nigeria, Pakistan, and Turkey), with emphasis on Iran, using data for the period from 2004 to 2013. The empirical evidence shows that FDI alone has no significant effect on economic growth in the countries, but when interacted with a threshold level of financial development (3.39), FDI positively and significantly affects growth, suggesting that the D8 countries should channel efforts towards developing their domestic financial markets before absorbing FDI.

Raheem and Oyinlola (2013) examines the relationship between FDI and economic growth in 15 African countries, putting the role of the level of financial sector development into consideration. The two-stage least squares instrumental variable technique is used to estimate the model specified for the investigation. The results suggest that financial sector development is a precursor for positive effect of FDI on economic growth, suggesting that policies directed towards attracting FDI should go along with policies aimed at financial sector development, and not precede it.

Hsu and Wu (2006) investigate the role of financial intermediary in the effect of FDI on economic growth using cross country data for the period from 1975 to 2005. The least squares, limited information maximum likelihood (LIML) and the Fuller methods are used to estimate the model specified, while the heteroskedasticity robust limited information maximum likelihood (HLIM) and the heteroskedasticity robust Fuller (HFUL) estimators are used to control for heteroskedasticity. Contrary to previous works, the empirical evidence shows that economies with well developed financial markets do not necessarily benefit more from FDI to accelerate their economic growth as the interaction term for FDI and financial market variable is observed to be negative and significant.

Theoretical Model and Methodology

The Solow growth model is adopted as the theoretical basis for this study. The model relates output to capital, labour and total factor productivity. Mathematically, the basic Solow growth model is expressed as:

Yt = f(Kt, Lt) (1)

Where Y represents real output, K represents capital (proxy by gross fixed capital formation) and L represents labour (or population since everyone is assumed to work). Gross fixed capital formation is composed of domestic and foreign investment (Agosin and Meyer, 2000). In this study, we utilize only the FDI component of gross fixed capital formation, population is used to proxy labour. The New Growth theory recognizes the role of trade in the growth process (Roe and Mohtadi, 1999). Thus, trade openness shall be included as a growth determinant in our model. Furthermore, we incorporate two stock market indicators, market capitalization (to proxy the size of the stock market) and value of securities traded (to proxy stock market liquidity). This shall be interacted with FDI to create two interaction terms (also to be incorporated in the model as explanatory variables), viz, interaction between market size and FDI and interaction between market liquidity and FDI to examine how they affect the growth of Nigeria’s economy and to determine whether their effects on growth differ significantly from the effect of only FDI on growth.

Thus we augment the basic Solow model (Equation 1), and specify our model in functional form as:

RGDP = f (NFDI, TOPEN, POP, MCAP, VT, NFDI*MCAP, NFDI*VT (2)

Where:

RGDP = Real gross domestic product

NFDI = Net inflow of foreign direct investment

TOPEN = Trade openness (defined as ratio of total trade (export plus import) to the GDP

POP = Population size, included in the model to proxy labour, since it is the source of labour

MCAP = Market capitalization, measured as the market value of all the outstanding shares of corporations listed on the stock exchange. This variable is included in the model to capture the size of the stock market.

VT = Value of transactions on the floor of the stock exchange. The variable reflects the total value of trades or transactions (on the floor of the stock exchange. It is included in the model to proxy stock market liquidity and activity

NFDI*MCAP = interaction term capturing interaction between net inflow of foreign direct investment and market capitalization. This will enable us determine whether the market capitalization is a significant determinant of the effect of FDI on real GDP.

NFDI*VT = Interaction term capturing the interaction between net inflow of foreign direct investment and value of transactions on the Nigerian bourse. This will enable us determine whether effect of FDI on economic growth in Nigeria depends on the value transactions of the stock exchange.

Equation 2 is specified in econometric form as a multiple linear regression (MLR) model as:

RGDPt = α1NFDIt + α2TOPENt + α3POPt + α4MCAPt + α5VTt + α6NFDIt*MCAPt + α7NFDIt*VTt + ϵt

(3)

ϵt is a white noise error term. The a priori expectations are: (α1, α2, α3, α4, α5, α6, α7) > 0.

All the explanatory variables of the model are hypothesized to positively affect economic growth. Net foreign direct investment inflow is expected to supplement domestic investment to close the savings-gap, thus accelerating the growth of the economy according to the two-gap model. The New Growth Theory posits that the long-run growth path of an economy can possibly be influenced by international trade (Roe and Mohtadi, 1999). Trade openness has also been identified as a source of economic growth as it guarantees access to acquisition of leading technologies of developed countries (Barro and Lee,1994). Thus, openness to trade enhances economic growth. Population is the source of labour and labour as seen in the basic Solow model is a determinant of growth. In fact in the basic Solow model, population is equated to growth as everyone is assumed to work. Since the theory predicts positive effect of labour on economic growth, population is therefore expected to also have positive effect on economic growth, all things being equal. The stock market has been hypothesized to positively affect economic growth as it constitutes the market for long-term, development finance (Aigheyisi and Edore, 2013). Thus we expect the stock market indicators, viz: market capitalization and value of transaction to be positively related to growth.

The ordinary least squares estimation technique shall be used to estimate the model. This method involves minimizing the sum of squared residuals to obtain estimates that are BLU (best, linear, unbiased) (Koutsoyiannis, 1973). The estimations shall be performed with the aid of Eviews 9.5 statistical and econometric software.

Data used for the analysis are annual time series data spanning the period from 1981 to 2014. They were sourced from the Central Bank of Nigeria’s Statistical Bulletin (2014) and World Bank’s World Development Indicators (2014). Specifically, data on real GDP, trade openness, stock market capitalization and value of transaction were sourced from the CBN Statistical Bulletin, while data on net FDI inflow and population were sourced from the WDI.

Results and Discussion

The result of estimation of the specified model (equation 3) is presented in Table 1.

Table 1. Estimation Results

The result shows that the effect of net foreign direct investment on economic growth in Nigeria is not statistically significant. This is in sync with the findings of Olokoyo (2012) and Danja (2012), indicating that net inflows of FDI to Nigeria’s economy has not been a significant determinant of the growth of the nation’s economy. The result also shows that none of the stock market indicators (market capitalization and value of transactions) have had significant effect on the growth of the economy. The effect of interaction of net FDI inflows with market liquidity (that is, value of transactions) on real GDP is also not statistically significant. This suggests that market liquidity does not influence the effect of FDI on Nigeria’s real GDP. However, the interaction of net FDI inflows with market capitalization positively and significantly affects real GDP (at the 10% significance level). This indicates that development of the stock market in terms of its size measured as market capitalisation, enhances the effect of FDI on economic growth. In other words, the larger or more developed the market, the greater will be the effect of FDI on economic growth of Nigeria. Furthermore, trade openness is observed to have had negative and significant effect on the real GDP. The effect is highly significant even at the 1% level. This could be attributed to the highly import dependence nature of the economy which engenders depreciation of the local currency, which in turn raises the rate of inflation therein, adversely affecting real output.

The effect of population growth on real GDP is observed to be positive and statistically significant even at the 1% level. However the coefficient which is very low suggests that the percentage of the population contributing to real output is quite low. This is an indication of low level of employment.

An examination of the diagnostics reveals that the model has very high goodness of fit as indicated by the coefficient of determination (R-squared) which shows that over 89% of the systematic variation in the dependent variable is explained by the regressors. The F-statistic value of 27.67 which is highly significant even at the 1% level indicates the the explanatory variables are jointly significant in explaining changes in the real GDP. The Durbin-Watson statistic of 1.83 indicates absence of problem of autocorrelation in the model.

Conclusion and Recommendations

In this paper we empirically investigated the role of the stock market in the effect of FDI on economic growth (using real GDP as proxy) in Nigeria in the period from 1981 to 2014. The ordinary least squares estimation technique was used to estimate a multiple linear regression model specified for the investigation. The empirical evidence indicates that the effect of net inflow of FDI on economic growth was not statistically significant, but when interacted with market capitalization, the effect was positive and statistically significant, indicating that the size of the stock market as indicated by market capitalization plays significant role in the effect of FDI on economic growth in Nigeria. The study also finds that value of transactions, standing alone or, interacted with FDI has no significant effect on Nigeria’s economic growth. Further evidence was that trade openness adversely affected economic growth and that population (being the source of labour) is positively related to economic growth.

In view of the empirical evidence, we proffer, as recommendation for policy considerations, efforts by the government through the regulators of the capital market, to expand the size of the stock market by ensuring that more firms are listed thereon to broaden its size. This could be achieved by easing the listing requirements for firms (especially local firms) which intend to get listed on the stock market and the use of legislation to ensure more foreign firms operating in the country are listed on the country’s bourse. The observation that trade openness adversely affects Nigeria’s real GDP calls for import control as this is attributed to excessive and precarious dependence on imports, owing mainly to low level of domestic output or production. To boost the level of domestic output, there is need to articulate and implement programmes and policies that are germane to boosting domestic investment and lowering the cost of doing business in the country (such as lowering of domestic lending interest rate, favourable tax regimes, infrastructural development) and attracting foreign direct investment using policies that ensure internal security, political stability, less control on capital flow, etc. (with the precondition of a well developed stock market). These will no doubt boost real GDP and employment, thus leading to the realization of the macroeconomic goal of economic growth.

We believe that implementation of the recommendations of this paper will undoubtedly enhance the effect of FDI inflows on economic growth, not only in Nigeria, but also in other countries whose economies are at the same state or level of development as that of Nigeria.

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Bio-note

Oziengbe Scott Aigheyisi is an economist. His main research interests and areas of specialisation are International Trade and Finance, Monetary Economics, Development Economics, Financial Analysis and Applied Econometrics.