ANALYSIS OF TWIN DEFICIT AND MANUFACTURING SECTOR OF NIGERIAN ECONOMY(1981 - 2015)

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Department of Economics

ABSTRACT

INTRODUCTION

1.1       Background to the Study

The "Twin deficit" debate was a common policy issue during the 1980s and the early 1990s and the term was initially invented to describe the co-movement between the budget deficit and the current account deficit in the United States (Chang and Hsu, 2009). Subsequently, researchers began applying it to other countries. Ever since, it has become an area of interest for researchers to examine the causal link between the two deficits and the direction of causality. The simultaneous emergence of budget deficit and the current account deficits for most countries most especially in the United States (US) during the mid-1980s led to the characterization of this phenomenon as the "twin deficits" issue as both economic theory and empirical observation suggested a link between the two deficits (Chinn, 2005). Thus, the twin deficit hypothesis has come to be regarded as one of the important relationships among aggregate economic variables. Over the years, there has however been renewed interest in understanding the relationship between the budget and current account deficit.

According to Kim et al (2007), fiscal deficits tend to occur jointly with current account deficits. Giarcarlo et al., (2006) also argued that fiscal shocks will cause a deterioration of the government’s budget and also worsen the country’s current account balance. Thus, the main thrust of the twin deficit hypothesis, however, is that current account deficits of most countries is caused by government’s budget deficits phenomenon and the most suitable way to solve this problem and stabilize internal and external deficits is reducing the government’s budget deficit (Zamanzadeh and Mehrara, 2011).

The current account deficit, or "trade deficit" as it is sometimes called, is the measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the goods and services it exports. This is generally financed by a net capital inflow into the country from abroad. Such an imbalance is generally viewed as undesirable as consumer demand is being met increasingly by foreign goods produced by foreign workers to the detriment of the domestic workforce (Njoroge, Kosimbei and Korir, 2014).

Yanik (2006) was of the opinion that the relationship between current account deficits and budget deficits (BD) are now at the center of international macroeconomics literature. It is believed that the two deficits move together, at least in the long-run (Yanik, 2006). Having a foundation in international macroeconomics, the twin deficit hypothesis posits that changes in the budget deficit of a country can translate to a change in the current account balance of the country or could be the other way round. This relationship, however, is said to take place through the channel of real interest rate, real income and real exchange rate (Neaime, 2008).

Kim et al., (2007) observed that fiscal deficits tend to occur jointly with current account deficits. Giarcarlo et al., (2006) is of the view that fiscal shocks will cause a deterioration of the government’s budget and also worsen the country’s current account balance. Thus, the main thrust of the twin deficit hypothesis, however, is that current account deficits of most countries is caused by government’s budget deficits phenomenon and the most suitable way to solve this problem and stabilize internal and external deficits is reducing the government’s budget deficit (Zamanzadeh and Mehrara, 2011).

Ogbonna (2014) observed that a large budget deficit is a source of economic instability and in the same vein, a significant current account deficit, increases the rate of interest, reduces aggregate demand, leading to a reduction in investment and subsequent increase in unemployment, which in all, will hurt the long-term economic growth by increasing national indebtedness.

1.2       Statement of the Problem

The recent fiscal expansion due to the global financial crisis in 2008 has made it timely to revisit the twin deficit phenomenon for Nigeria and examine the impact on the manufacturing industry. Upon several government policies on the stability of Nigerian economy through manufacturing industry, there have been a lot of challenges facing the growth of Nigerian manufacturing industry as identified by researchers. These challenges include: corruption and ineffective economic policies (Gbosi, 2007); inappropriate and ineffective policies (Anyanwu, 2007); lack of integration of macroeconomic plans and the absence of harmonization and coordination of fiscal policy (Onoh, 2007); gross mismanagement/misappropriations of public funds (Okemini and Uranta, 2008); and lack of economic potential for rapid economic growth and development (Ogbole, 2010).

The apparent similar movement in both the budget and current account deficits gave rise to the idea that there might be a relationship between the two deficits (Egwaikhide et al, 2002). It has also been established in economic theory and empirical observation that there exists a link between the two deficits. For Nigeria, there have been persistent and rising budget deficits most especially from the 1970s. The country has also been having current account deficits, even though there has been a surplus in the last 12years. So, it is evident that the Nigerian economy has been experiencing the twin deficit phenomenon which has affected the manufacturing industries in Nigeria. In the same vein, Nigeria as an oil-exporting country where revenue from oil production contributes more than 95% of its foreign exchange, 40 percent of GDP and 80 percent of fiscal revenues makes the economy susceptible to fluctuations in government revenues as a result of volatility in oil revenue (Onafowokan and Owoye, 2006).

As it has been argued in empirical literature that large budget deficits can have negative implications for the stability of the current account, countries that run budget deficits are believed to most likely have a current account deficit. According to Harshemzadeh and Wilson (2006), growing budget deficits are reflected in growing current account deficits. This makes it important to know to what extent fiscal balances can be used to achieve adjustment in the current account balance. Despite the detrimental economic and social effects of large budget deficits on an economy, it is believed that running a budget deficit over a period of time is not necessarily bad for an economy, likewise a current account deficit, in as much as the deficit is used to finance developmental project for the country to bring about growth. According to Fleegler (2006), governments often incur fiscal deficits to grow their economies and provide certain services to the population. So, at some points, an economy incurs deficit in its budget balance.

Thus, the issue is not whether the country is running a budget deficit or current account deficits in as much as the deficits is being incurred for developmental purposes, the problem lies in a country running the two deficits simultaneously known as having a twin deficit. This have important implications for the economy as it can affect the country’s external rating in the global economy and foreign direct investment into the country. The importance of the policy implication is that if the basic reason for rising current account deficits is the escalating budget deficits, then policy makers may have to focus on curtailing the budget deficits to resolve the current account deficits. On the other hand, if the reverse is the case, then the reductions in the budget deficits will not resolve the current account problem (Onafowokan and Owoye, 2006). This will also help make fiscal policy more prudent especially in the case when an unbalanced budget causes predicted changes in current account.

As it is believed in open economy macroeconomics that budget deficit leads to deterioration of the current account balance (Jayaraman et al, 2008), it therefore becomes imperative to find out if the resulting current account balance experienced by the Nigerian economy is as a result of the substantial increase in its budget deficit over the years has been argued by the twin deficit hypothesis or it is the other way round. In other words, this study investigates the direction of causality between the two deficits. Also, as it has been advocated in empirical literature that domestic fiscal consolidation can be used as a necessary measure to correct current account deficits, it becomes important to ascertain the direction of causality as the causality may flow from current account deficit to budget deficit for an oil-based economy like Nigeria. On the above notes, this study intends to investigate the causal relationship between budget deficit and current account imbalance in Nigeria from 1980 - 2015.

1.3       Research Questions

The following research questions will guide this study

        i.            What is the effect of twin deficit on Nigerian manufacturing output?

      ii.            What is the impact of fiscal deficit on Nigerian economic growth?

1.4       Objectives of the study

The main objective of this study is to examine the analysis of twin deficit and manufacturing sector of Nigerian economy. Specifically, the study intends:

        i.            To examine the effect of twin deficit on Nigerian manufacturing output

      ii.            To determine the impact of fiscal deficit on Nigerian economic growth

1.5       Research Hypotheses

The study intends to test the following research hypothesis;

H01: Twin deficit does not have significant effect on Nigerian manufacturing output

H02: There is no significant relationship between fiscal deficit and Nigerian economic growth

1.6 Significance of the Study

The study will contribute immensely in aiding the young entrepreneurs, government bodies, policy makers, economic planners, researchers and the academia generally. This study will provide an insight and understanding to the government on how to be prudent in spending public funds that would bring about economic growth and development. It is also of immense help in providing an insight and knowledge to the general public, policy makers and economic planners on the analysis of twin deficit and manufacturing sector of Nigerian economy.

To the academia, the findings of the study will contribute to the available literature on twin deficit hypothesis and in Nigerian economy.

Finally, this work will be of immense benefit to the policy makers and economic planners in terms of using its findings in formulating and implementing appropriate policy measures towards accelerating economic growth through the manufacturing sector.

1.7       Scope of Study

This study examines the analysis of twin deficit and manufacturing sector in Nigeria by applying theoretical considerations of the twin deficit hypothesis using annual data covering the period 1981 through to 2015, which is a period of 34years. The data for this study will be sourced from the Central Bank of Nigeria (CBN) Statistical Bulletin (2016 edition) and the World Bank Development Indicators (WDI) Database for 2016.