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FINANCIAL LIBERALIZATION, CAPITAL FLIGHT AND ECONOMIC GROWTH IN NIGERIA

 Format: MS WORD   Chapters: 1-5

 Pages: 145   Attributes: COMPREHENSIVE RESEARCH

 Amount: 3,000

 May 01, 2020 |  01:09 pm |  1184

ABSTRACT

This study is specifically designed to analyse the trend and pattern of financial liberalization capital flight, and economic growth, and to examine both the short run and the long run impact of capital flight and financial liberalization on economic growth in Nigeria between the period of 1970 and 2017 (48 years period). To achieve the specific objectives of the study, two mulitvariate linear regression models were employed. The first empirical model specified real GDP growth as a function of capital flight and its determinants, while second model specifies real GDP growth as a function of financial liberalization variables using the Autoregressive Distributed Lag Model (ARDL) framework. The data collected on the macroeconomic variables used in the study were purely secondary time-series, obtained from various sources.  Based on the results of the various empirical analysis carried out in the study, it was found that while capital flight has a significant negative effect on real GDP, financial liberalization variables on the overall have a significant positive effect on real GDP both in the short run and in the long run. This led to the conclusion that capital flight is on the increase in Nigeria and its existence is inimical to economic growth of the country and the implementation of financial policies has contributed positively to the economic growth in Nigeria over the period under study. The study therefore recommends among others, that policies that will curtail the excessive outflow of capital, retain high level capital stock in the economy and at the same time position the economy for sufficient inflow of foreign capital, must be put in place by the government to drive economic growth and that adequate policies should also be put in place to improve on the quality of governance and the depth of the financial sector.


CHAPTER ONE 

INTRODUCTION

1.1 Background to the Study

The Financial sector is a sector that performs the responsibility of coordinating funds between surplus spending units and deficit spending units and as such serves as the nervous system of the economy. Kenton(2019)posits that financial sector is a section of the economy made up of firms and institutions that provides financial services to commercial and retail customers. This sector comprises of a broad range of industries including banks, investment companies, insurance companies, and real estate firms.  The organisation of the financial system is crucial to economic development in the sense that the financial system can both dynamically help to promote growth and or help to stifle it in the case that it is particularly poorly developed. This observation is based on the fact that the “financial system” is one of the sectors that play important role in the allocation and distribution of financial resources and risk sharing of future cash flows in any given economy.

During the period before financial liberalization, the government of developing countries practiced financial repression. Financial repression is a revolving set of policies where the government insidiously takes wealth from the private sector, and more specifically makes it easier for government to finance its debt (Thornton, 2015).Theories of financial repression associated especially with Mckinnon and Shaw postulated that administrative control of financial markets by the government distorts interest rate thereby lowering it. As a result of this savings is discouraged, consumption is encouraged and the quantity of investment is crippled. Hence, the restrictive financial policies are known to have contributed to the retardation of the economic development process in many of these developing countries (Okwuchukwu & Ariwa, 2017).

Another remarkable feature of the pre-liberalization era is the problem of capital flight which to a large extent can be associated with financial repression. Capital flight entails the outflows of resident capital which is motivated by economic and political uncertainties in the home country. Capital flight also means lost resources to the domestic economy and therefore lost opportunities. According to Saheed, Zakaree & Ayodeji (2012), capital flight is seen as a movement of local saving from less developed economies away from financing local real investment for a foreign financial investment in advanced economies of the world leaving the economic growth and development of the less developed economies at base.

The coexistence of financial repression and capital flight in most developing economies especially in Nigeria during those periods constitutes double challenges; it implies that there are some disturbances in the allocation of financial resources in the domestic economy and at the same time there are outflows of scarce foreign exchange. This led to many of these countries, including several in Africa, to reform their domestic financial markets in an attempt to improve the functioning of their domestic financial systems and to increase the efficiency of resource allocation—that is, to enhance financial development (Fowowe, 2013).

These reforms were triggered by both domestic and international developments. On the one hand, government policies focusing on controlling financial markets were increasingly criticized, because they were seen as causing the inefficient functioning and development of domestic financial institutions (McKinnon, 1973 & Shaw, 1973). On the other hand, globalization of financial markets put pressure on governments to reduce financial market and capital account controls. The general belief was that lifting these controls and integrating with the world economy would enhance effective mobilization of financial resources and ultimately contribute to enhanced economic growth. For this reason, financial reforms have been strongly promoted by, among others, the International Monetary Fund (IMF) and the World Bank(Hermes & Lensink, 2014).

In accordance with the globalization trend, Nigeria embraced the Structural Adjustment Programme (SAP) in 1986 as a corrective measure to the deteriorating economic situation. The SAP was proposed as an economic package to rapidly and effectively transform the Nigerian economy. The basic thrust of the economic reforms embodied in SAP is deregulation, particularly financial deregulation (Okpara, 2010). The financial liberalization process in Nigeria progressed gradually in a phase-like manner with various policy measures implemented in different years. Financial liberalization measures that were adopted included deregulation of interest rates; elimination or reduction of direct credit control; allowing free entry in the banking sector as well as giving autonomy to commercial banks; allowing private ownership of banks; and liberalizing international capital flows (Odhiambo, 2009).

These measures were expected to enhance economic performance via improved level of competitiveness with a robust efficiency posture within financial markets and with accrued benefits indirectly flowing to the coffers of non-financial sectors of the Nigerian economy. However, since the application of the prescribed financial liberation, the Nigerian economy has not been able to experience impressive performances in terms of growth and has not been able to attract sustainable foreign investment or to checkmate capital flight.

Whereas, as the problem of capital flight in Nigeria persists, it does not only aggravate the scarcity of resources for development, it obliquely leads to a decline in domestic investment as well as a reduction in potential tax receipts of the governments.

In theory, there are two ways in which financial liberalization can affect capital flight. On the one hand, conventional analysis proposes that capital flight should be greater in a closed economy due to residents turning to illegal channels for moving capital abroad. Thus, by freeing up capital flows, financial liberalization policies are expected to cause a decline in the magnitude of capital flight. On the other hand, capital flight can still exist in a liberalized regime because financial openness may also bring about certain risks such as uncertainties and vulnerabilities to financial crises (Demirgtic-Kunt & Detragiache 1998). Park (1996) supports this view, and discusses how capital flight can be greater under a free capital account. Groombridge (2001) argues that liberalization can lead to capital flight if the country does not undertake the necessary reforms before opening up its capital account. It is necessary that the effect of financial liberalization on capital flight be thoroughly examined as this outcome may significantly indicate the causes of capital flight and its effect on economic growth in Nigeria.

1.2    Statement of the problem

The rate at which capital flight has increase in the past four to five decades has been one of the unanswered, disturbing and continual macroeconomic problems in Africa in general, and Nigeria in particular. The volume of capital flight in developing countries especially Nigeria, as it seems to be a household name due to its frequent occurrence and dominance in the economy, is assuming a serious dimension and posing huge threat to sustainable economic growth and development. It is believed that capital flight particularly from Nigeria has been substantial and is more severe” than it is elsewhere in other Sub-Saharan African countries.

During the periods before financial liberalization in Nigeria, capital flight has been mainly attributed to financial repression which constrained the financial sector to effectively carry out its role in the coordination and mobilization of funds among economic units within the domestic economy as well as international flow of funds. This attracted a number of significant changes in the rules and regulations governing financial operations and these include; relaxation of controls on interest rates and also on conditions of granting banking license, abolition of credit ceilings and guidelines and complete deregulation of money and capital markets.

However, the subject of financial liberalization has remained controversial especially for developing countries. With the introduction of structural adjustment programme in 1986, Market based reforms were proposed to ensure that the cost of capital would be achieved in Nigeria. The aim of domestic financial liberalization is to improve economic performance through increased competitive efficiency within financial markets thereby indirectly benefiting the non-financial sector of the economy as well as in order to attract foreign capital inflows that can help finance not only investment but also the rising debt stock (Yalta & Yalta, 2012). However, various studies have shown that despite the widely held view on the advantages of financial liberalization much progress has not been made especially given the fact that with the liberalization of the capital accounts, capital flows can take place in the opposite direction resulting in capital flight.

This present study is related to three different strands of literature. The first concerns the measurement and determinants of capital flight and its effect on economic growth. The second focuses on the relationship between financial liberalization and economic growth, while third concentrate on the relationship between financial liberalization and capital flight. This study focused on the nexus between financial liberalization and capital flight and its implication on economic growth.

Several authors have examined the causes of capital flight and its adverse effect on investment and growth. One of the two strands of empirical literature on capital flight has focused on the measures and causes of capital flight. Lensink (2012); (Adaramola & Obalade, 2013).

Uguru(2016), suggested that the key drive behind capital flight is the fear that the flow of financial assets resulting from the holder’s perception is that capital is subjected to inordinate level of risk due to devaluation, hyperinflation, political turmoil, or expropriation if retained at home in domestic currencies. On the other strand, recent empirical studies have focused on the effect of capital flight on economic grwoth and development. (Otene & Richard 2012; Onodugo, Kalu, Anowor & Ukweni, 2014; Obidike, Uma, & Odionye, 2015 and Lawal, Kazi, Adeoti, Osuma, Akinmulegun & Ilo, 2017).

Also, the relationship between financial liberalization and economic growth has received considerable attention in recent theoretical and empirical studies. Some of the studies ( Fowowe, 2013;  Okpara, 2010; Maimbika & Mumangeni, 2016) found financial liberalization to have a positive effect on economic growth thus, corroborating the financial liberalization hypothesis. Whereas, others are of the view that financial liberalization does not contribute to economic growth. For instance studies such as Mamoon (2017), found the impact of financial liberalization on growth to be negative.

Surprisingly, the literature on the relationship between financial liberalization and capital flight is very scanty. Some of the few recent studies that have examined the relationship between financial liberalization and capital flight were carried out by Yalta and Yalta (2012) and Hermes & Lensink (2014). Meanwhile to the best of my knowledge, there has not been any known study yet on the consequence of financial liberalization on capital flight in Nigeria.

Despite the enormous contribution of these previous studies in establishing the relationship between financial liberalization and economic growth and capital flight and economic growth, there is shortage of studies which examined the tripartite relationship that exists between financial liberalization, capital flight and economic growth particularly in Nigeria. The author argues that the failure of the past studies to account for the effect of the financial liberalization on capital flight-growth nexus is a gross omission given the fact that policy environment in which the financial sector operates can have a major influence on the nature and magnitude of capital flight as well as its effect on economic growth. Moreover, the relationship between financial liberalization and capital flight in Nigeria is equally important to examine in order to understand the implication of the relationship between the two variables on economic growth. This study therefore intends to the fill these gaps by examining the dynamic interaction among financial liberalization, capital flight and economic growth in Nigeria.

1.3    Research Questions

In light of the foregoing, the study shall be guided by the following research questions

     i.        What are the trends of financial liberalization, capital flight and economic growth in Nigeria?

   ii.        What influence does the co-existence of financial liberalization and capital flight have on economic growth in Nigeria?

  iii.        Are there any long run relationship that exists among financial liberalization, capital flight and economic growth in Nigeria?

1.4    Objectives of the Study

The broad objective of this study is to analyze the dynamic relationships among financial liberalization, capital flight and economic growth in Nigeria. The specific objectives are to:

     i.        examine the trend of financial liberalization variables, capital flight and economic growth in Nigeria within the period under study.

   ii.        analyse the effect of financial liberalization and capital flight on economic growth in Nigeria.

  iii.        determine the long run relationship among financial liberalization, capital flight and economic growth in Nigeria.

1.5    Significance of the Study

The prevalence of capital flight in Nigeria requires the deliberate efforts of the policy makers to checkmate it. Most especially now that it has been observed to have adversely impacted on scarce capital which leads to the deficiency of resources for sustainable economic growth and development. The sustainable development of Nigeria may not be actualized, if enough resources is not mobilized and retained domestically. These resources are needed to fund the provision of necessary services such as health, infrastructure, education and the investments needed to meet Millennium Development Goals (MDGs). Capital flight weakens sustainable development by increasing dependence on external resources such that are needed to replace the gap left by the fleeing of domestic capital. In addition, where resources stay within the country, they can be invested to promote economic growth and development. Hence, there is the need for urgent policy action in Nigeria to reverse this capital flight trend from her economy.

This study is therefore significant since it will contribute to the body of literature on dynamic relationships among financial liberalization, capital flight and economic growth in Nigeria. The motivation for the study is to establish empirically whether financial liberalization has any adverse effect on capital flight and the implication of this on economic growth and also to determine whether financial liberalization contributes to the dynamics of the relationship between capital flight and economic growth in Nigeria. A research of this kind is very crucial bearing in mind that the problem of capital flight is still prevalent, and in view of the financial liberalization policies undertaken by most developing countries, the possibility that capital flight reduces with financial liberalization is an appealing and imperative question that requires empirically study.

Moreover, the findings of the study will provide insightful information about the subject matter which is necessary to have proper understanding of the nature of the possible nexus between financial liberalization and capital flight which has important policy implications. If financial liberalization shows a significant positive impact on capital flight, then these policies can be useful to prevent it. However, if “financial liberalization” does not have any effect or have a positive effect, then such policies may not be the solution for reducing capital flight, showing the need for more efficient policy measures.

1.6    Scope of the study

This study limits its scope to the period between 1970 and 2017 (48 years). This period is chosen for two main reasons. First is to capture the periods of pre-liberalization and post-liberalization in the Nigerian economy. During the pre-liberalization periods the financial market was majorly regulated by the government and prices of many products were fixed by executive fiat and were driven by related policies. For instance, the interest rate and exchange rate regime in place was driven by the fixed interest rate and exchange rate policies. The financial liberalization era started in 1986 driven by the Structural Adjustment Programme (SAP), which marked the beginning of a market determined interest rate and exchange rate. The second is to generate adequate data for our empirical analysis and to provide up to date information based on data availability. Time series data will be used for the 48 years period of this study. The data will be sourced from the Central Bank of Nigeria (CBN) Statistical Bulletin (various issues) and World Development Indicators (WDI, 2017)

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