Explaining Nigeria’s Economic Growth: Balance of Payments Constrained Growth Approach With External and Internal Imbalances

• Author: Hüseyin Ozdeser,Yohanna Panshak,Irfan Civcir
• DOI: http://doi.org/10.1111/saje.12216
• Published date: 01 September 2019
• Date: 01 September 2019

© 2019 Economic Society of Sout h Africa.

South African Journal of Economics Vol. 87:3 September 2019

doi : 10.1111/ saje .12216

376

EXPLAINING NIGERIA’S ECONOMIC GROWTH: BALANCE

OF PAYMENTS CONSTR AINED GROWTH APPROACH WITH

EXTERNAL AND INTERNAL IMBALANCES

YOHANNA PANSHAK†, IRFAN CIVCIR ‡,* AND HÜSEY IN OZDESER†

Abstract

This study employs a system estimator to examine the validity of balance of payment constrained

growth model in the case of Nigeria. We modified a version of Thirlwall’s model developed by

Soukiazis et al. (2014) to incorporate the role of foreign contents in growth process. The new

version of the model improves significantly explaining the growth in Nigeria. The outcome of this

study shows that imported intermediate and capital goods significantly contribute to manufacturing

export and domestic investment growth. However, high reliance on the imports of intermediate

goods constrains economic growth. World real income exerts significant effect on aggregate

exports, similar arguments could not be established when the manufacturing export sector is

considered in isolation. Our results reveal that economic growth in Nigeria is constrained by

internal and external imbalances. The study recommends among others increasing the

manufactured export share, efficient use of oil rents as well as containing budget deficit within

acceptable threshold to position the economy on a viable growth path.

JEL Classification: C32, E12, H11, O1

Keywords: balance of pa yments constraint, relative prices, fore ign content in the aggregate demand

components, Nigeria

1. INTRODUCTION

The recent reappearance of massive def icits in the external accounts of many countries

across the globe is attracting significant interest in the economic literature. This re-

echoes the long-standing dispute concerning balance of payments (BoP) adjustments as

well as the concepts of external sustainability between the mainstream and heterodox

economists. It has reached the point that these concepts (external account deficits and

BoP adjustments) are perceived to mirror the resourceful intertemporal consumption de-

cisions of economic agents in the quest to maximise utility. Hence, a temporary current

account deficit is often regarded a s an important driver of growth. Nevertheless, this c an

only be achieved when a country has the financial capacity to fund increasing imbal-

ances; a constantly growing deficit would inevitably create an unsustainable BoP crisis.

Ultimately, this would cause a reduction in aggregate demand and long-run growth

(Nell, 2003; Lanzafame, 2014).

* Corresponding author: Facu lty of Political Science s, Department of Economics, Anka ra

University, Ankara 06590, Turkey. Tel: +903125951287. E-mail: civcir@pol itics.an kara.edu.tr

† Department of Economics, FE AS, Near East University

‡ Department of Economics, Facu lty of Political Science, Ankara Universit y

South African Journal

of Economics

377South African Journal of Economics Vol. 87:3 September 2019

© 2019 Economic Society of Sout h Africa.

The Mainstream economic theory maintains that differences in the growth rates of

countries can be explained by the disparities in the growth rates of supply factors as well

as productivity levels. Accordingly, under perfect capital mobility and flexible exchange,

BoP is transient. On the contrary, the heterodox argue that because of sticky wages and

prices, the nominal exchange rate depreciation may not be sufficient for BoP adjust-

ments. Similarly, import and export price elasticities may be too low and the Marshall–

Lerner conditions may hardly (or not) be achieved. In this context, the exchange rate

movement may be limited in enhancing BoP adjustment. Therefore, BoP may possibly

act as an important restriction on long-run growth. Therefore, whenever supply adjusts

to demand, in line with the standa rd Keynesian framework, growth disparities among

countries ought to be attributed to disparities in the rates of growth of aggregate de-

mand. This, in tur n, originates from the exi stence of long-run restrictions on the growth

of demand, imposed by the condition that external account ought to be in equilibrium

in the long run (Bagnai, 2010).

Based on the above-mentioned conditions, Thirlwall formally proposed a simple

demand-led “law” that def ines long-run growth as the ratio of export growth to income

elasticity of demand for imports assuming that relative prices are constant. This “law”

has survived refutation for approximately 40 years and has shown to be relevant for

many countries (See, McCombie and Thirlwall, 1994, Thirlwall, 2011 for history and

survey of literature). Several studies have sought to extend the “law” to incorporate:

the effects of capital f lows (Thirlwall a nd Hussain, 1982), sustainable debt (Moreno-

Brid, 1998-99, Barbaso-Filho, 2001), interest repayment on debts (Moreno-Brid, 2003),

multi-sectoral income elasticities among other factors(Araujo and Lima, 2007; Romero

and McCombie, 2016). However, a minimal number of studies have examined the sit-

uation where simultaneous distortions on internal and externa l accounts of countries

alongside relative prices restrict long-run growth in a ba lance of payment-constrained

growth (BOPCG) framework.

Accordingly, Soukiazis et al . (2013, 2014) developed a simultaneous model to explain

the growth experiences of certain European countries faced w ith mounting budget defi-

cits to show that growth could be constra ined by internal and external deficits. Given the

above understanding, the recent fiscal developments in Nigeria, where the Deficit-to-

GDP ratio rose to 4.46% in 2015 coupled with the dramatic decrease in public revenue

due to instability in commodity prices, require urgent investigation. To compound the

problem, interest repayments on loans currently account for approximately 30% of fed-

eral government revenue. Comparatively, this ratio is higher than that for Kenya

(12.34%), South Africa (10.23%), India (25.65%) and even the whole of sub-Saharan

Africa (3.30%), South Asia (11.24%), East Asia (6.29%) and the Latin America &

Caribbea n region (10.45%).1

This raises concerns about the sustainability of the fiscal

position of the economy in the medium and long term.

Similarly, the lack of access to foreign intermediate capital goods is often perceived to

be one of the most important constraints on long-term growth for the Periphery-South.

The significant roles these factor inputs play in supporting domestic income growth is

irrefutable. Contributing to the above, this research seeks to explain Nigeria’s growth

1 This is so, when we consider debt serv ice as % government revenue only, not debt-GDP or

debt stock-GDP ratio.

378 South African Journal of Economics Vol. 87:3 September 2019

© 2019 Economic Society of Sout h Africa.

path using the modif ied simultaneous model (SCA-BOPCG) developed by Soukiazis

et al. (2014). This version of Thirlwall ’s model incorporates both external and internal

deficits and includes relative prices as well as intermediate capital imports as additional

determinants of long-run growth. The adoption of the model is informed by the massive

importation of machinery and equipment, intermediate and raw material goods, which

has accounted for approximately 60% of total imports since 1982 in Nigeria. Hence, this

represents an exciting context of enquiry. However, the present study departs from the

existing SCA-BOPCG versions of Thirlwall’s model on three major fronts. Firstly, it in-

corporates the role of foreign contents used in manufactured export growth and domes-

tic investments within the BOPCG framework. Imported intermediate and capital

goods, particularly those with substantial technological content, are fundamental in the

long-run growth process because they exert positive effects on performance and produc-

tivity. The modification is, therefore, meant to capture the structural needs of the econ-

omy. Thus, the study contends that for a correct and comprehensive determination of the

long-run growth path of a small open economy, the role of imported intermediate and

capital goods as important restrictions on growth ought to be included. While the prin-

cipal restriction on long-run growth in the Centre-North is foreign demand, as estab-

lished by the traditional Thirlwa ll model, this may not be the same for a country in the

Periphery-South as a result of severe capital shortages.2

Secondly, even if the hypothesis

holds for the aggregate economy, it may differ across export sectors. It should be noted

that the SCA-BOPCG version focuses on the aggregate export function only, whereas

this study focuses on the manufacturing export sector. This disaggregation is necessar y

to identify the most binding constraints limiting the progress of the sector, which could

enable efficient and accurate policy formulation. Thirdly, as indicated in the literature,

while substantial empirical evidence abounds regarding Thirlwall (1979), only a few

studies have examined the situation in which an economy is constrained simultaneously

in terms of its external and interna l accounts. Moreover, no study has been conducted on

this particular issue regarding any developing country to the best of the authors’

understa nding.

Our main finding suggests that the variables have significant implications for domes-

tic income growth. Imported intermediate and capital goods significantly contribute to

manufacturing export growth and domestic investment. The results clearly reveal that

when they are not included in the estimation, the domestic income growth rate could

be biased upwards. Interestingly, it is revealed that even though the original and mod-

ified versions of the BoP-constrained growth models are appropriate for determining

the growth of domestic income for Nigeria, which is a feasible proposition but does not

2 In the Periphery-South, the creation of embodied tec hnological knowledge nece ssitates ad-

vanced skil ls and advanced machinery, which are largely unobtainable. Therefore, in the fac e of

huge technological def icits, it is rationally satisfactory for a Periphery-South country to import

the appropriate embodied technologica l knowledge than to produce it because of t he high cost of

creating it in the loca l environment. This would have substantia l positive implications for growth

especially when a su itable industrial policy framework is e stablished to direct capital invest ments

in areas and product ion sectors where the economy has c omparative adva ntage. The nece ssity of

such industrial policy is aimed at ensuring t hat the correct and releva nt infrastructural base is

established to enha nce the absorption of foreign technologies (See, Eaton and Kortum, 2001;

Habiyaremye, 1939).