Impact of Trade istortions on EconomicGrowth: The Case of Nigeria

By

Adeoye, Babatunde W. (08037267836)&

Ajuwon, Oluseye (08053066892)

(Lecturers)

Department of EconomicsUniversity of Lago , Akoka, Lagos

e-mail: bwadeo·\e0.vahoo.com

e-mail: aj_seye(Cllyahoo.com

A paper presented at the si« Annuli! Conference of the NigerianEconomic Society (NES) ill Abu]a between zr' and is" September,2010.

Abstract

Necemly, economists and policy-makers hare rekindled an interest in the links between trade policy and growth.In particular. there has emerged a large literal lire that revisits the empirical and theoretical linkages betweenthe degree of an economy's openness to international trade and its real growth rate, 1/'hile no real consensushas emerged in 11'/'/11\' of theorv or empirical regularities. the debate has targelyfocused (In the linkages betweenmeasures oftrade protection or other more domestic distortions and the rate of lac lor aCClIIIIIII{Jfiun

This paper examines the possible impact of trade distortions captured by the nominal exchange rate on thegrowth ofthe Nigeria economy, The paper applies a simple ordinarv least square (OUi) method 10 explore thelinks between trade distortions and economic growrh in Nigeria. The result shows that one ofthe majordistortions preventing the free .11011' of goods and services from the Xigerian economv is the vagaries in thebehaviour ofthe exchange role, The instability Ih(/I has been associated with the ,\'igeriunnuim compared withother trading partners currencies has made the ,\'igerian economy 10 be uncompetitive in the internationalmarket. This 110,1 in turn affected the level of economic growth. Therefore, this papa supports the earlierhypothesis that trade libearlization in Nigeria has some negative effects on the growth of the economy. ThisI){[per reiterates that until the distortions 10 trade are removed the economy cannot adequately benefitfrom theongoing reforms in/he real sector. This calls for u need for the government to speed lip the process ofclontesti;reforms. Government must accelerate reforms 1/1 trade and industrial policies ulong with macroecononucpolicies that provide a favourable environment 1'01' enterprises competing in the global market, as well usauractingforeign investors.

l. Introduction

The role of trade in promoting industrialization and econormc development cannot be

overemphasized, This is because foreign trade provides impetus for industrial development

b) making inputs available for domestic production, particularly in developing economies

especially Nigeria where production activities heavily depend on imported inputs, Also,

foreign trade enlarges market frontiers for domestic industrial output (exports), thus leading

to increased investment, employment. output and income, Foreign trade expands production

possibility frontiers and broadens the consumption baskets of the people in the participating

countries and thereby improves their welfare (Adewuyi and Adeoye. 2008), However. thc

extent to which a country benefits from foreign trade is a function 01' a number of factors.

Among these factors is the trade policy regime operating in an economy, This could be

protective or liberalized, Nigeria as a country has experimented with a mix of the two trade

policy regrmes.

After independence, Nigeria em barked upon im port substitution ind ustrial izat ion (I SI)

strategy as a means of promoting industrial transformation, The implementation of the ISI

necessitated imposition of high rate of tariff and non-tariff barriers to trade (Oyejide. 1977:

Adewuyi and Adeoye, 2008), Trade policy in the post-independence period was largely

import licensing and haphazard application of tariff via annual budget. This engendered a

serious anti-export bias which seemed to hinder gro\~ th and development or the igenan

2

economy (Oycjide, 2001). Since 1986 however. trade policies have aimed at liberalization or

the economy as well as achievement of greater op nness and greater integration \\ ith the

world economy. The policies thus ranged from abolition of' marketing board. to introduction

of the second tier foreign exchange market (SFEM). various export expansion incentive

schemes. establishment of the igeria Export- Import Bank etc. Liberalization or track

regime began with a partial dismantling or quantitative re trictions in 1986, which gave room

for interim measures that led to a reduction of the number of items in the import prohibition

Iist from 72 to 17 products categories ( Adew uyi and Adeoye. 2008).

rhus. this implies selecti e import prohibitions and elimination of import licensing. Coupled

\\ ith this was a tariff reform which was instituted via the Cu toms. Excise and Tariff

Consolidation Decree 1988. This Decree featured a new classification based on the

l larmonised System of Tariff classification (H Chapters). which permitted direct

international comparison of the country's tariff lines and levels. It also featured a seven-year

tariff regime .,0 as to usher in stability and predictability. This reform was continued \\ ith

Decree 0.4 of 1995. which specified tariff for another seven-year tariff regime

spann ing 1995 to 200 I.

In a bid to expand her market access. Nigeria ha signed bilateral. regional and trade

preferential agreements \\ ith different countries. For instance. igeria is one or the rounding

members of Economic Community or West African tates and or the World Tracie

Organization and a signatory of the Lorrie Convention (Ogunkola and 0) ej ide. 200 I) despite

these efforts trade in igeria has dwindled in the period of' great liberalization.

Similarly. along side with trade liberalization is financial liberali at ion policies whicl. were

imp lemented to foster com petition among the domestic firms and between the domes: ic

import competing firms and foreign firms \\ ith a view to promoting efficiency. ndcr trade

libcralisation policy. the levels of both tariff and non-tariff barriers were reduced and the

commodity marketing boards were scrapped. Despite these poi icy mea ures, the performance

01' the economy ill terms of growth has been dismal (Table 1.1). For instance. the grO\\ th

performance of Nigeria's manufacturing sector ha been influenced mainly b) domestic

demand. import substitution policies and availability of foreign exchange to procure imported

inputs ( dew uyi. 2004). Consequently. the sector heavily depended on import of rav,

3

material and capital good. protection from foreign competition. preferential treatment in

foreign exchange allocation and persua ion of people to patroni e and demand locally

manufactured goods for its survival. This therefore r suited in lack of competitiveness or

trad especially non-oil exports.

Table 1.1: Macroeconomic Data in Nigeria

2001 2002 2003 I 2004 200S I 2()06 I 2()()7 2()()8I Economic Indicators I 1990 I 2000:

G!)P growth 8.2 5.-+ -+.6 3.5I

9.6 6.6 I 5.8 5.3 5.7 I 6._1

Oil sector ":" __ --'-_8-_..66-~14-1.-_I.I---r-:.292 I -_I5.)~ I 2:~9I on-oi I sector growth lCll,

3.3 I -1.7 -3.7 -:.9 -_1.8

_. - .- .- .-I

Budget deficit GDP -:2.9 -2.3 _1.3 -5.5 -2.8 -2.6 -0.2 0.3 0.7 1.-1

-- - I f- 2_1~ ~6 - +- ,L::-d. reserves na na a Na 7.7 I 1.4 . I.J·) _12.6 53

I I

External debt (iDP 106.5 64.9 7.3 72.1 61.1 84.5 69.2 7.-1 -I 2--+- - --

Domestic debt GDP 31.3 32.2 6.6 26.1 28.6 25.3 20.8 18.6 19.2 9.7

: Sav ings-invest GDP 9.9 16.4 _1.4 6.4 1.5 -0.9 15.09 36.97 22.66 23.1 J- --

0\ erall BOP liDP I -2.1 I 6.9 0.5 -10.3 -2.3 5.2 10.5 12.7 1.-1 O.SI -Ilnllation rate 7.5 6.9 18.9 12.9 22.2 I 14.7 16.2 I 13.6 5.9 11.6

- I ILending rate 27.7 21.6 ~ 1.3 22.5 22.9 I 20.7 19.2 I 18.6 18.7 I 21.2

I - -M I growth 30.7 28.7 28.1 15.9 13.8 I 8.6 I 9.3 I 20._1 0.6 55.9

I --- - ~ -- - )

78 8 _I 9 ') 01

r

_1_1.9 48.1 h27

A \ erage 0 ff. I. ,-c-h-r-at-e-I-7-. 9- 101.7 I 11.91 12 I.. I I _........L..I __ .....L ~ ~ __

Source: CBI c..,tati.tical Bulletin. various issues.

21.6 16.9 6.) 18.0 29.1 II )7.8

127.8 132.8 132.9 128.5 127._1 120.8

Despite all reform , trade was severely constrained by a et of factors that have led to high

transaction costs and general cost of doing business leading to em ion of compctitiv nex-.

The degree or openness (measured by the ratio of total trade in the GDP) increased gradually

from about a third in 1970 to close to two-third in 1990 before it declined to about two-fifths

in 199-+. Although. it rose up sharply in 1995. there was a continuous decline from 1996 to

2000(Table 2). However, the expected improved efficiency in resource use. international

competitiveness as well as trade-induced growth usually accompanying increased trading and

trade liberali/ation are yct to materialize due to distortions in the economy. Rather. the

country has become vulnerable in the international market. While the share or imports in the

(jDP has been stable to orne extent. hox ering between 15 per cent and 18 per cent between4

1970 and 199-J. (except for 1985 when it was about 10 per cent), the development in the

export-Gfrl' ratio has been less stable. TI1 share of exports in GDP ranged between 17 per

cent and 48 per cent for the same period Crable 1.2).

Table 1.2: Trends of share of trade variables in GDP in Nigeria

Yell/, ~mp/gdp Oilexp/gdp Non-oilexp/gdp Total exp/gdp Total trade/gap

1970 14.5 9.7 7.2 17.0 31.5

1975 17.7 21.7 1.7 23.5 41.2

1980 18.3 27.4 1.1 28.5 -J.6.9

1985 9.8 15.7 0.6 16.4 26.3

1990 17.7 41.3 1.2 42.6 60.3

1991 27.1 36.4 1.4 37.9 65.1

1992 26.8 37.3 0.7 38.0 64.8

1993 24.0 30.9 0.7 31.6 55.6

199-J. 17.8 22.0 0.5 22.6 -J.O.-J.

1995 38.5 47.3 1.1 48.4 86.9

1996 20.5 46.9 0.8 47.7 68.3

1997 29.8 42.7 1.0 43.8 73.6

1998 30.7 26.3 1.2 27.6 58.3

1999 26.5 35.9 0.5 36.5 63.1

2000 19.8 39.6 0.5 40.1 60.0

2001 23.0 38.0 0.5 38.5 61.6

2002 19.7 20.6 0.2 21.8 -J.0.8

2003 20.5 29.5 0.1 30.5 51.0

2004 17.0 38.5 1.0 39.4 56.5

2005 16.6 ,42.1 0.7 42.8 59.-J.

2006 13.9 30.8 0.7 31.6 -J.5.-J.

2007 21.18415 38.49 0.85 60.52 60.52

5

12008 12I . 18834 14_0_.6_0__ ---'-14_.0_4 1-165_._83 --'-16_5_.8_3 _

Source: Computed from Underlying Data obtained from CBN Annual Reports and Statcment ofAccounts Various lssucs

From the foregoing. the main problems that have featured in the igerian economy include

high import dependency. low level of product competitiveness and low level or output. This

could be traced to distortions in the economy. Based on this feature it is imperative to

examine the impact of trade policy distortions on economic growth In igeria. This is the

major issue addres ed in this paper.

It is important to note that there are divergent views on the impact or trade to economic

grow tho While some authors measure the effects of export as a trade variable on economic

gro« th, others traced the impact of trade liberalization on economic growth in Nigeria \\ ith

little or no attention to the effects of distortions. It is important to note that a number or

empirical studies which. have investigated the export-led-growth hypothesis. have found that

exports have been instrumental to igerias growth performance suggesting that in Nigeria

export-led-growth hypothesis holds (Fajana, 1979; Langley, 1968; Olomola, 1998: Ekpo and

Egw aikhide.1994). The introduction of the index of openness. revealed a negative

relationship between output growth and openness (Oladipo, 1998: Olomola. (1998: Ogunkola

and Oyejide, 2001). in their study of market access for Nigerian exports in the European

L'nion (E ) lound that the impact 01" commodity specific and the generalized trade

liberalization on the economy have remained minimal. Therefore. studies relating trade

distortion and economic growth are abound in the literature, but with divergent views. This

paper is to lend credence to the existing literature. Using a simple ordinary least square (OLS)

method the paper explores the effects of nominal exchange rate (which is a measure of trade

distortion), trade flows on economic grov th in Nigeria.

The next section which is section 11details the theoretical and empirical issues relating to

trade distortions and economic growth. Section III outlines the analytical framework and the

model. Section IV presents the empirical results and discussions. while section V contains

summary. policy suggestions and conclusions.

6

11. Theoretical and Em pirical Issues

lhe fact that trade is an engine of gro\\ th is evidenced by the tremendous world econorn ic

gro« th that followed the d ismantl ing of trade barriers among the industria Iized countries in

the 1950 and 1960s. Growth was also ev ident among developing countries that adopted

out \\ ard look ing trade pol icy as a strategy for structural econorn ic re form in the 1970' and

1980 .

The argument lor free trade i couched on the 1(\\\ of absolute advantage developed b) Adam

Smith and later fine-tuned by David Ricardo (in the 18th century) into the lav, or comparative

advantage. According to Adam Smith each country should specialize in those goods or

service in which it has absolute advantage. David Ricardo further argue that even when one

country ha absolute advantage in the product of two goods and against another country. it

ma) still be more beneficial to both countries ifeach ofthem specialize in the production of

onl) one or the goods. With this. both countries can enjoy the benefits of comparative

adx antage and enhance the process or exchange between the two. Thus the underlining tenets

ofthe cia ical theory is that a country \\ ill tend to export the commodity whose comparative

cost (the opposite of comparatives advantage) is lower in autarky and import the goods or

\\ hich the comparative cost i higher in pre-trade isolation (Iyoha. 1995: Okoh. :WO-+). [he

classical theory assumes can tant costs. only one factor or production. perfect competition ill

both factor and product market. These assumptions are said to be unrealistic.

The neoclassical theory of external trade was developed out of the need to rnodify some of

the assumptions of the classical theory to provide realistic information 1'01' the existence or

differences in comparative costs between countries. introduce capital as a second factor or

prod uet ion, and allow ed for international d i Iferences in the pattern 0 I' demand. Th is theor- 0 I'

trade. also known as the modern theory ofexternal trade was developed b) Eli l leckschar and

Bcrtil Ohlin. The theory postulates that trade arises from differences in comparative cost that

in turn arises from inter-country differences in relative factor endow merit or relatix e factor

(abundance). 10 them. differences in relati e factor endow ment are most important single

cause or international difference in price structures (lyoha. 1995). According to Agicbencbo.

t 1995) the policy conclu ion of the modern theory of trade is exactly the same a. that of

classical trade theory To him free trade internationally and in the domestic economy \\ ill

7

maximize national and world production efficiency, output. consumption and hence. welfare.

The distortions to free trade uch as tariffs, quotas. or sub ides \\ ill lower world and national

output and keep the nations of the world on lower indifference cur es.

In contemporary times a number of theories have been propounded to modify aspect of the

modern theory of trade. These may include the Linder theory of external trade, the size and

distance theory of external trade postulated b) Linnemann and Tinbergen. (lyoha. 1995:

Okoh. 200'+). and the vent- for-surplus theory (first formulated b) Adam Smith but it was

modified and applied to third world nations by Hla yint). The import of all the e theories is

that free movement of goods across national frontiers is beneficial and leads to grov, th and

dcx clopment of the trading nations.

The relationship between trade liberalization and growth is a highly debated topic in the

growth and development literature. Yet. this issue is far from being resolved. Theoretical

grov, th studies suggest at best a very complex and ambiguous relationship between trade

restrictions and grow tho The endogenous growth literature has been diverse enough to

prox ide a different array of models in \\ hich trade restrictions can decrease or increase the

worldwide rate of growth (see Romer. 1990: Grossman and Helpman. 1990: Rivera-Batiz and

Romer. 1991a.b: Matsuyarna. 1992). lore that if trading partners ar asymmetric countries in

the sense that the) have considerably different technologie and endow mcnts. even if

economic integration raises the world. ide growth rate. it may adversely affect individual

countries (see Grossman and Helpman, 199Ia.b: Lucas. 1988: Rivcra-Batiz and Xic. 1993:

Young 1991).

In the world today tariff and other trade barriers are been reduced or eliminated through

global and regional trade negotiations. customs modernization becomes more and more

important to each country's interest in attracting foreign direct investment. As tari IT barricr-.

fall. multinational and other companies look increasingly to the existence of bu. iness friendlv

policies in deciding where to invest. Countries that fail to keep pace \\ ith \\ orld class

standards lor customs administration will find that investors simply cannot afford the high

logistics costs imposed by customs inefficiencies. Customs inefficiency imposes a significant

tax. hidden but very real, on consumers and traders - taxes whose "revenues" are not realized

b) the government. but rather comprise a dead weight to the economy.

8

Because customs administration can be an important barrier to trade. countries \\ ith

inefficient customs administrations are breaking faith with their partners who have made

tari ff concess ions. Absent a un iforrnly high standard of customs effie iency. the bene fits 0 f

market opening are unfairly denied to those countries that have efficient customs

administrations and trade with neighbours whose inefficient customs administrations act as

non-tariff barriers. Trade ministers in countries V\ ith forward looking customs administrations

must insist on the modernization of the customs administrations of their trading partners if

they are to realize the benefit of the bargains they strike with their neighbours (Adewuy i and

!\deoye.2008).

The accelerating trend toward trade liberalization, both globally and regionally. puts customs

modernization at the heart of a mutually beneficial "race to the top" in a form of virtuous

c irc Ie in four steps: Increasing levels 0 f trade Iibera Iization become a world« ide rea Iit)

through WTO and regional negotiations. Trade liberalization eases the need to invest behind

tariff barriers. and investors are freer to seek business-friendly environments. rather than

bei ng forced to invest beh ind high tari If barriers in each country where the) hope to do

business (ICe 1999).

"I he initial condition for realization of the virtuous circle is a trend toward trade liberalization.

and it is clear that the condition holds in today's world. Trade liberalization at the multilateral

and regional levels is progressing at an accelerated pace. The Uruguay round and creation of

the WTO have resulted in substantial, continuing tariff reductions, and ongoing work in the

\VTO \,viII further market liberal ization on many fronts. Regional arrangements. such as the

orth American Free Trade Agreement ( AFTA), the Association or South East Asian

Nations Free Trade Area (AFTA). the Asia Pacific Economic Cooperation (APJ::C). the

European Union (EU) and its association agreements, numerous Latin American trade

arrangements. and the negotiation of the Free Trade Area of the Americas also contribute to

the downward pressure on trade barriers. And the spirit of liberalization has taken firm root:

in the face or the 'Asian financial crisis. members of the Association of South Last Asian

Nations did not abandon. but rather accelerated duty reduction schedules under AFTA (ICe.

1999).

9

A t the ame time. econorn ic turbulence has the potent ia I to arouse protection ist sent iments

that are self-defeating and lead to a vicious circle that can trigger worldwide trade wars and

economic depression, Customs frequently is a favoured tool of protectionists. Countries must

guard against employing their customs administrations as barriers to trade to eliminate all

form of trade barrier. Some researchers are of the view that there is little or no e\ idence to

support the view that open foreign trade policies boost economic growth. For instance. Busari

and Ornoke (2006) study presented an empirical assessment of the impact or trade policy

practice and its credibility on private investment using firm level data over the period 1980 to

2003. They came to conclusion that trade policy practice in Nigeria has deterred investment

b) making cost of importing high which invariably affected firms with high import intensity.

The study argued. among other things, that there is the need to drastically reduce the cost or

importing capital goods,

Adew u) i and Adeoye (2008) did a stud) on expectation on the implementation or common

external tariff and argued that trade policy reform usually generate gainers and losers, This

explained why the concerned stakeholders particularly the gainers oA:en lobby for the

retention of a ne» or existing policy in their favour, while the losers usually canvass for the

removal of an; policy seen as being biased to them.

Kingsley et al (2004) pose this question in their research work title 'Is "Trade" Openness

Valid for Nigeria's Long-Run Growth: A Cointegration Approach?' should Nigeria liberalize

to all countries on all products or opt for a discriminatory approach through unilateral trade

agreements? Where do we think Nigeria should be open. and on what issues should the) be

closed? What should Nigeria's trade policy be in the face of globalization's negative effects

and increasing protectionism of developed countries? The paper reviews key issues regarding

an appropriate design of trade policy reforms in igeria and its validity for igerias long-run

growth using the cointegration approach. The results show that there is no significant

relationship between openness and economic growth, and that unbridled openness could have

deleterious implications for growth of local industries. the real sector and gP\ crnmcni

revenue.

Young (1995) in his work title 'The Tyranny of Numbers: Confronting the Statistical

Realities of the East Asian Growth Experience' report decades or unbalanced gro« th 1'01'

10

developing countries. In other work, Vamvakidi (1998) has tried to estimate the effect on

growth of the size and openness of neighbouring countries, and finds that countries which

have neighbours with large open economies experience raster growth. Openness matters more

than size. Being near a developed country also has a positive spill-over effect. In both

respects. sub-Saharan Africa is at a disadvantage, consisting as it does of mainly small and

highly protected economies, relatively remote from the industrialised economies or Europe

and North America.

In the study of Clemens and Wi II iam son (2002) they said that wh i Ie theory ma, be

ambiguous. late 20th century evidence certainly is not. This evidence can be found in lour

kinds of studies. First, the authors of a large National Bureau of Economic Research project

assessed trade and exchange-control regimes in the 1960s and 1970s by making classic

partial-equilibrium calculations of deadweight losses (Bhagwati and Krueger 1973-1976).

They concluded that the barriers imposed significant costs in all but one case. l lowcvcr, these

standard welfare calculations have been criticized by those who have pointed out that

protection in such studies is not allowed a chance to lower long-run cost curve. as in the

traditional infant-industry case, or to foster industrialization and thus growth. as in those

modern grow th models where industry is the carrier 01° technological change and capital

deepening. Thus. economists have had to look for late 20th century proof to support the

openness- fosters-growth hypothesis.

Second, analysts have contrasted the growth performance or relatively open \\ ith relatively

closed economies. The World Bank has conducted such studies for 41 countries going back

before the first oil shock. The correlation between trade openness and growth is abundanti)

clear in these studies (Lindert and Williamson 2001). but the analysis is vulnerable to two

criticisms. Assigning countries to trade policy categories is always trick). since it is hard [0

measure overall openness (Anderson and Neary 199-L Sachs and Warncr 19(5). More

importantly. it is difficult to isolate the effect of trade policies alone. since other policies

usually change at the same time. Liberalism typically comes as a package. Thus. countries

that liberalized their trade also liberalized their domestic factor markets. liberalized their

domestic commodity markets. and set up better property -rights enforcement. The appearance

ofthese dome-tic policies may deserve more credit for raising income while the simultaneous

appearance of more liberal trade policies may deserve less.

11

Th ird. there are country event stud ies. where the focus is on periods \\ hen trade pol ic)

regimes change dramatically enough to see their effect on grow tho 1'01' example. Anne

Krueger (1983, 1984) looked at trade opening moments in South Korea around 1960, Brazil

and Colombia around 1965, and Tunisia around 1970. Growth improved after liberalization

in all four cases. More recently, David Dollar and Aart Kraay (2000) examined the reforms

and trade liberalizations of 16 countries in the 1980s and 1990s. finding, once again. the

positive correlation between freer trade and faster growth. Of course. these reform episodes

may have changed more than just global participation. so that an independent trade effect

may not have been isolated,

Fourth. macro-econometric analysis has been used in an attempt to resolx e the doubts left b)

simpler historical correlations revealed by the other three kinds or' studies. This macro-

econometric literature shows that free trade policies have had a positive effect on growth in

the late 20th century, especially with many other relevant influences held constant. The most

famous of these is by Jeffrey Sachs and Andrew Warner (1995), but many others have also

confirmed the openness-fosters-growth hypothesis for the late 20th century (e.g. Dollar 1992:

Edw ards 1993: Harrison 1996; Bloom and Williamson 1998; Dollar and Kraay :2000:

Greenaway. Morgan and Wright 2002).

In a major study of trade orientation. distortions and growth in developing countries. Edwards

(1992) develops a model which assumes that more open economies are more efficient at

absorbing exogenously generated technology. Using nine indicators of trade orientation

constructed b) Leamer (1988). he shows for a sample of 30 developing countries over the

period 1970-82, that more open economies tend to grow faster. To test the hypothesis, a

conventional growth equation is used relating the growth of per capita income or countries to

their investment ratio; their initial level of per capita income as a proxy for technological

backwardness. and a measure of trade distortion. All but one of the trade distortion measures

produce a significant negative coefficient, and the findings are robust with respect to the

sample taken. the time period taken and the method of estimation. The findings are also

robust to some of the alternative indicators of trade liberalization and distortion mentioned at

the beginning. In Edward's model, however, the only channel through which trade

12

liberalisation enhances growth is through the absorption of foreign technology. This IS

undou bted Iy i 111portant, but there are other irn portant mechan isms.

Il l. Analytical Framework and the Model

3.1. Trade Variables Relationship

Following the model developed by Nabine (2009) in his work titled "The Impact of Chinese

Investment and Trade on igeria Economic Growth" trade openness is interpreted to include

import and export taxes. as well as explicit non-tariff distortions of trade or in varying

degrees of broadness to cover such matters as exchange-rate policies. domestic taxes and

subsid ies. com petition and other regulator) pol icies, education pol icies. the natu re 0 I' the

legal system. the form of government. and the general nature of institution and culture. Most

empirical studies define openness of an economy as the ratio of trade to GDP. Trade (exports

and imports) as a proportion of GDP does not capture the dynamic effect of trade to gr(l\\ th

(Such analysis from the supply side neglects the manifest balance of payments di ITiculties

experienced by many countries. But balance of payments constraints as well as internal

saving and budget constraints are central variables for the understanding of trade and growth

nexus.). "In order to capture the dynamic effects of trade from demand and supply side.

growth rate or exports related to marginal propensity to import is clcarl, more appropriate.

Exports are an important demand side variable" (Nabine. 2009).

3.2. Model specification

Following from the above ana Iytical framework, we develop the est ima ting cq uat ion uSing

the augmented production function approach in investigating the interaction between trade

policy distortions and economic growth in Nigeria during the period 1980- 2007.

This paper adopts the popular analytical framework provided by abine (2009). According to

Nabine (200lJ), let a country's production be represented by the following aggregate

production function:

l'=f(L.K.rI} (I)

13

Where,

Y is output (gross domestic production (CiDI1));

L is employment:

I( is capital stock.

A captures the total factor productivitx (TFP) of growth 111 output not accounting for

increasing in factor inputs (K and L).

According to the new (endogenous) grow th theory. A is endogenously determined b)

economic factors. We start with the assumption that the methods of estimating trade and its

effect on economic growth operating through 'A' have been consistent over the years. It is

noteworthy that the effect of trade on A also depends on the trade policy regime. Hence. a

proxy variable for the openness of trade policy regime (TP) needs to be incorporated in the

equation.

,--/= G(X, M, EXR * T) (2)

Where,

A captures the total factor productivity (TFP) of growth 111 output not accounting for

increasing in factor inputs (K and L)

G is the grow th rate

X is export

M is import

EXR is ominal Effective Exchange Rate (NEER), and

T stands tor the trade policy

orninal effective exchange rate (NEER) provides a measure of competitiveness of an

economy. A falling value of NEER implies a depreciation of local currency vis-a-vi~

international currency which indeed measures the trade policy regime in an economy.

Substituting (2) in (I)

}' = f(L. K.X.M.EXR* T) (3 )

14

In vie« of the fact that a reliable data series on capital stock is not available for Nigeria. this

study employ ~ the gross domestic capital formation to represent K: this proxy variable has

been used in numerous previous studies (e.g. Barre, 1999: Balasubramanay an et al, 1996).

The estimating equation used in the empirical analysis is

(4)

Where Y = gross domestic product, GDP (in log form)

L = number of labour force (in log form)

K = GCF= the gross capital formation (in log form)

FDI = Foreign Direct Investment (in log form)

EXR = Nominal Effective Exchange Rate

t = time subscript.

£ = stochastic error term

The coefficient signs are as follows: ~ I > 0: ~2 > 0; ~3 >< 0; ~4 > 0; ~5< 0

J\ positive sign is expected from the coefficients of the number of labor force. capital. exports

ancl index of openness, a negative sign is expected from the coefficient of imports while the

coefficient sign on exchange rate is expected to be negative. The outcomes are based on a

priori expectation

The coefficienrf I. ~2. ~3. and ~4 are the output elasticity with respect to L. GCF and FDI.

The impact of exchange rate on growth is given by ~5. The sign of ~3 is ambiguous: it can be

positive or negative depending on the nature of the trade policy bias over the entire sample

period whereas ~5 aims to capture the impact of trade policy regime operating thorough

foreign exchange rate on growth.

IV. Empirical Results and Discussions

The regression results are presented in Table 4.1. The regression analysis is based on the data

from 1970 to 2008, using the ordinary least square (OLS). The result obtained conforms to

the J priori . pectation and ~111the variahl s are statistically sign ificant. 'j he Durbi n- \\' arson

Statistics shows that the model estimates is free from the problem of autocorrelation.

15

However. going by the value of the co-efficient of each variable, it shows that a one percent

increase in nominal exchange rate will bring about 0.3 percent reduction in economic growth.

Labour force -tand out has the most influencing factor on economic growth in this model

\\ ith 627.2 percent increase in economic growth to just one percent increase in labour force.

Cross fixed capital formation also shows positive pressure on economic growth to the tune or

'+7.S percent increase in economic growth ofjust one percent increase in gross fixed capital

accum ulation.

The Table shows that the key determinants of growth in ligeria are the nominal effective

exc hange rate (EX R) wh ich measures the com petitiveness of the igerian econorn; (prox ing

trade distortions). foreign direct investment (FDI), labour force (LF) and gross capital

formation (GFC). It is important to note that the variable of interest the nominal effective

exchange rate (EXR) provides a measure or competitiveness. Besides, it has been argued in

the literature that nominal effective exchange rate presents the measure of trade distortions

since it measures the competitiveness of an economy. n economy facing distortions in her

trade flows \\ i II not be competitive in her exports vis - a - vis other countries of the \\ orld.

The coefficient of EXR which measures the impact of trade distortions on economic growth

had the a priori sign and appears to be statistically significant. This suggests that movement

in nominal exchange rate vis-a-vis other countries currencies have negative effects on the

growth of the economy. It also suggests that the economy is not competitive enough to allo«

free flow of goods to other countries which could have earned the economy foreign earnings

and promote growth in the economy. This finding is in line with findings from Adeoyc and

Chete (200S).

Table 4.1: Regression Results oflmpact of trade distortions on Economic Growth

Dependent Variable: LNGDP

Method: Least Squares

Date: 08/07/10 Time: 17:43

Sample: 19802007

Included observations: 28

Variable Coefficien Std. Error t-Statistic Prob.

16

c -101.0043 I 1.99920 -8.417592 0.0000

L IFDI 0.066436 0.032986 2.014087 0.0558

EXR -0.003584 0.001621 -2.211018 0.0373

L LF 6.272042 0.740725 8.467433 0.0000

LNGFC 0.477970 0.082168 5.816957 0.0000

R-squared 0.995620 Mean dependent var 13.58414

Adjusted R-squared 0.994859 S.D. dependent var 2.111984

S.E. of regression 0.151435 Akaike info criterion -0.776889

Sum squared resid 0.527449 Schw arz criterion -0.538995

Log likelihood 15.87644 F-staristic 1307.154

Durbin-Watson stat 1.933597 Prob( F-statistic) 0.000000

Source: Authors' Computation

V. Summary, Policy Suggestions and Conclusion

This paper has examined the possible impact of trade distortions captured by the nominal

exchange rate on the growth of the Nigeria economy. It is important [0 note that the result or

[he paper is highly revealing. The result shows that one of [he major distortions preventing

[he free flow of goods and services from the Nigerian economy is [he vagaries in the

behaviour of the exchange rate. The instability that has been associated with the Nigerian

naira compared with other trading partners' currencies has made the ligerian economy to be

uncompetitive in the international market. This has in [urn affected the level or economic

gro« tho Therefore. this study support the earlier hypothesis that trade libearlization in Nigeria

has some negative effects on the growth of the economy. It is instructive to note that until the

distortions to trade are removed the economy cannot adequately benefit from the ongoing

reforms in the real sector.

The result also shows that there are a plethora of factors beside tariffs in Nigeria that

constrain the supply response of the .igerian manufacturing outputs and gro« th of the

economy. These include instability in the exchange rate. poor absorptive capacity in terms or

labour and poor flow of investments.

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Based on this findings however, there is a need for the government to speed up the process or

domestic reforms. Reforms must focus 011 policies that favour the flow of capital to the more

competitive sectors in the economy, lower the existing high transaction costs associated \\ ith

domestic production activities in the country. In other words. government must accelerate

reforms in trade and industrial policies along with macroeconomic policies that provide a

fav curable em ironment for enterprises competing in the global market, as well as attracting

foreign investors. Most economies integrating domestic policies \\ ith global standards not

only to attract foreign investment. but to re-direct the outflow of capital from the country. a

predictable tariff regime. efficient custom services. and transparent rule or laws is a good

strategy that helps to address injury as a result of unfair trade practices. It is an important

strategy in warding off lobbyists and rent seekers. In particular, it is an efficient strategy to

address effects of rampant policy reversals and make government policies more predictable.

18

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