The Impact of fiscal deficit on the economic performance in developing countries: A study on Nigeria

The Impact of fiscal deficit on the economic performance in developing countries: A case study on Nigeria

ABSTRACT

This study examines the effects of fiscal deficits on economic growth of the Nigerian economy. The study explore the trend of fiscal deficits over the three decades and showcase its  implications on output growth and other macroeconomic indicators. While the issue of fiscal balance remain a prime macroeconomic objective of the Nigerian economy, fiscal deficit has serious implications on the economic and social welfare of a given economy. The study adopts the VAR technique and Johansen cointegration test to determine the possible existence of long- run relationship and other impacts among the variables. Estimated result from the Johansen cointegration test indicates two cointegrating relations between the variables as revealed by both the trace statistics and the maximum eigen value, while the error term is found to be negative and significant indicating a moderate convergence to the long-run equilibrium. It is established by the trend analysis that fiscal deficit adversely affects output growth rates and this situation has been prominent in the domestic economy from the last three decades. Other empirical results show evidence in favour of the negative effect of deficits on economic growth within the sample period. This result is consistent with the epistemological approach of neo-classical theory which established that deficit has growth-retarding effects on the economy. There is need for appropriate accountability in the public sector such that all spending are justified, and government activities are directed in accordance with the principles of equity and efficiency.

CHAPTER ONE/INTRODUCTION

Background to the study

One of the most debated concepts in macroeconomics is the effects of fiscal deficit on economic growth. The aim of attaining sustainable growth and achieving macroeconomic stability have been the prime target of every economies whether developed or developing nations. The aggregate economic performance of developing countries in the recent period has brought the issue of fiscal deficit into the pole position. Different approaches are used in the economic literature to conceptualise the fiscal deficit, hence it is deduced as the differences between total expenditure and total revenue of the public sector. In other words, it is the excess of public expenditure including loans net recovery over revenue receipts and non-debt capital receipts. This deficit occurs either due to shortfall in revenue or rapid increase in expenditure beyond the spending capacity of the government. In some cases, high deficit can negatively affects the economic growth and other essential macroeconomic indicators in a given economy. A large fiscal deficit could be due to accumulation of government debt and debt servicing which may compel the government to cut down expenditures on essential sectors like education, infrastructure, and health services. This will certainly decrease output in human capital development, hence, an important element for realising sustainable growth and development.

In the last three decades among many of these developing economies, there is evidence of dramatic shift in expenditure and tax policies to the extent that budgetary balance have virtually remains unattainable while deficit financing by the public sector becomes realistic. This situation has resulted into several debt crises which are usually noticeable in developing countries including those within the Sub-Saharan region; Nigeria is inclusive, due to poor development of private sector. As a result, it causes increased government participation in economic activities and increased fiscal dominance such that the highest share of aggregate demand is allocated to government spending and investment. While the revenue generation mechanism is weak and underdeveloped, thus, there is lack of adequate revenue to shield the corresponding expenditures. The overall outcome of this tendency is the rising and growing trend of fiscal deficit which is eminent since the early 1980’s. This fiscal deficit can be financed through selling the  government bonds. However, the main practice of deficit financing in Nigeria is through the financial institutions mostly the Central Bank of Nigeria. This alternative has resulted to countless instabilities including limitations for private sector credits, higher rate of interest, and decline in economic activities within the domestic economy. This decline in productivity causes high increase in price for the limited goods, hence inflation and business cycle’s fluctuation  arise. Therefore, there is growing need for government to reduce the size of budget deficit with the view to avoiding its instabilities and other spill over effects in the economy.

Since Nigeria is experiencing a rapid increase in budget deficit within the recent period, the need for adopting a reliable fiscal measures becomes necessary since the fiscal policy has the potentials to regulate the tempo of aggregate economic performance in the Nigeria (Idris & Bakar, 2017). The significant effects of this measure will certainly improve the aggregate output and halt the continuity of fiscal deficit that the Nigerian economy is experiencing. The reason behind the increase in deficit may be due to the over dependency of the economy on oil revenue and external loans (Idris & Ahmad, 2017). Furthermore, in lieu of the general criticisms and allegations of corruption in addition to the mismanagement of public funds which have been listed against the government, the needs for evaluating the impact of deficit becomes paramount. The situation appeared more evident since the previous military government are accused of high level of corruption and maintenance of deficit as a means of enriching the military leadership, despite the negative effects of such scenario on the Nigerian economy (Edame & Okoi, 2015). Now, the question that may interest the reader is whether this increasing level of deficit hinder sustainable economic growth in the Nigerian economy, how those the trend of fiscal deficit impacted on the economic growth of Nigeria during the last three decades? This, and other fascinating issues are discussed in this study.

A good number of literature exists on the impact of fiscal deficit in Nigeria, however, they are not based on critical review that shows the trend of fiscal deficit using a longitudinal dataset. These observed shortcomings has warrant for the need to challenge this traditional approach by examining this scenario using a recent data for developing countries with particular reference to the Nigerian economy. In view of that, this study aimed at examining the effects of fiscal deficits on economic growth in Nigeria using empirical analysis