Project Materials

THE IMPACT OF CAPITAL FORMATION VIA SAVINGS AND INVESTMENT ON GROWTH OF THE NIGERIAN ECONOMY 1980-2013.

Chapter one

INTRODUCTION

1.1 Background of the Study

The rate of growth in Nigeria’s economy cannot be properly understood without first examining the role of capital formation to Nigeria’s economic growth. This is based on the recognition that capital production is an essential component determining Nigeria’s economic growth.

According to Bakare (2011), capital formation is the share of current revenue saved and invested to increase future output and income. It is frequently the consequence of the purchase of a new plant, together with machinery, equipment, and all productive capital goods.

Capital creation is the rise in a country’s physical capital stock as a result of social and economic infrastructure investments. Continuing, he stated that gross fixed capital formation can be divided into two categories: gross private domestic investment and gross public domestic investment.

Gross public investment includes investments by the government and public enterprises, whereas gross private domestic investment is made by private enterprises. Gross domestic investment equals gross fixed capital formation + net changes in inventory.

Economic theories have demonstrated that capital development is critical in models of economic growth (Beddies 1999; Gbura and Thadjimichael 1996, Gbura 1997). This approach, known as capital fundamentalism, was confirmed by the work of Youopoulos and Nugent (1976), as cited in Bakare (2011).

Growth models, such as those proposed by Romer (1986) and Lucas (1988), imply that higher capital accumulation will result in a permanent increase in growth rate. Capital, of course, is critical to economic growth and development. It has long been viewed as a potentially growth-enhancing player.

Capital formation determines the nation’s capacity to produce, which influences economic growth. The most important impediment to long-term economic growth has been identified as a capital shortage.

Meanwhile, knowing the influence of capital formation is critical for devising a policy intervention to promote economic growth. According to Jhingan (2006), the process of capital formation consists of three interconnected conditions:

(a) the existence and growth of real savings;

(b) the existence of credit and financial institutions to mobilise and direct savings to desired channels; and

(c) the use of these savings for capital goods investment. In 1986, the Nigerian government recognised the need for improved capital formation and implemented an economic reform that shifted the emphasis to the private sector.

The public sector changes were supposed to ensure that interest rates were positive in real terms and to stimulate savings, allowing the real sector to access investment money more readily.

Aside from that, the reforms were supposed to improve labour efficiency and productivity, enhance aggregate supply, reduce unemployment, and yield a low inflation rate.

For example, in the 1980s, gross fixed capital information averaged 21.3 percent of GDP in Nigeria. This proportion rose to 23.3 percent of GDP in 1991 but fell to 14.2 percent in 1996.

It picked up and grew to 17.4 percent in 1997, with an average of 21.7 between 1997 and 2000. Gross capital creation increased from 22.3 percent of GDP in 2000 to 26.2 percent in 2002 before declining sharply to 21.3 percent in 2005 (Bakare 2011).

Economic theories have demonstrated that capital development is critical in models of economic growth (Beddies 1999; Gbura and Thadjimichael 1996, Gbura 1997). Many countries’ macroeconomic results have reflected Youopoulos and Nugent’s (1976) concept of capital fundamentalism.

It is obvious that even somewhat robust growth rates can only be sustained over lengthy periods of time if countries can keep capital formation at a significant proportion of GDP.

It has been established that any proportion less than 27% cannot support economic growth. According to Hernandez-Cata (2000), the ratio of gross capital formation to GDP in Sub-Saharan African nations that suffered low growth in the 1990s was less than 17%, compared to 28% in industrialised countries.

This pattern supports the significant relationship between capital accumulation and economic growth. To track the relationship between capital formation and growth, the gross capital formation for each year is typically scaled to the gross domestic product (GDP).

Thus, changes in capital formation are thought to have a significant impact on economic growth. However, the proportion of capital formation to GDP that can support robust economic growth must be at least 27%, and in some situations up to 37% (Gillis et al 1987).

In 1986, the Nigerian government recognised the need for improved capital formation and implemented an economic reform that transferred attention to the private sector.

The public sector changes were supposed to ensure that interest rates were positive in real terms and to stimulate savings, allowing the real sector to access investment money more readily.

Aside from that, the reforms were intended to result in increased labour efficiency and productivity, better utilisation of economic resources, increased aggregate supply, lower unemployment, and a low inflation rate. For example, in the 1980s, Nigeria’s gross fixed capital formation averaged 21.3 percent of GDP.