BACKGROUND OF THE STUDY

Developing countries are characterized by resource starved economies, specifically capital-related. Capital to boost economic growth and welfare is largely inadequate domestically, which consequently warrants the need for external capital. The only external capital readily available to support development undertakings have to come from foreign aid.

The existence of foreign assistance has been on the global scene as it has been in existence since the creation of national states and republics. The developed or rich countries have always assisted the developing orpoor countries to achieve similar achievements to provide livelihoods for their citizens. There have beendifferent views in terms of the effects of foreign aid on the recipient country. The history of foreign aid canbe traced back to the 1940s following the destruction that was caused during the Second World War. Someof the post Second World War challenges were the collapse of the international economic systemscharacterized by shortage of capital required for infrastructure reconstruction. In the past four decades,however, there has been an increase in foreign aid towards developing countries. The concept of foreignassistance is a voluntary action which is dependent on the recipient country from a donating country,governments, private organizations, individuals, which are for providing support to the recipients’ economicgrowth.  (Ouattara, 2006).

Rostow (1990) opines that foreign aid is the imposition of the developed countries on the less developed countries as a prerequisite for economic development. On the contrary, Hayter (1971) views foreign aid as a form of modern imperialism and may not lead to the anticipated economic benefits. Tadesse(2011) argues that foreign capital inflows are popular due to their potential to finance investments and the perception of their ability to enhance economic development in the recipient country. The growing departure in reduction and asset rates, import-export gap (foreign exchange constraints to import capital goods) and budget deficits in lessdeveloped countries make them to depend highly on inflow of foreign capital. The large deficit betweendeveloping and developed nations has led to the sustenance of the foreign assistance initiatives (Andrews, 2009). This status quo has led to the frequent inflow of capital from developed countries to developing countries in an attempt to reduce the gap while overcoming their problems. According to Andrews (2009), there is evidence to suggest that although African countries have been receiving aid for several decades there has been no significant change to their destinies. Most of these countries continue to exhibit slow development rates.

Although there has been extensive flow of foreign aid to developing nations and extensive empirical work for decades on the aid-growth link, the aid effectiveness literature remains controversial. An important objective of foreign aid to less developed countries is to enhance their economic development and welfare, this is more often measured by the impact that it has on economic growth. Despite decades of transfer offoreign capital to the developing countries, there is evidence from numerous studies that seeks to unmask the relationship between aid and economic development, that there has been less evidence of achieving these objectives (Durbarryet al., 1998).

Girmaet al. (2005) study on 25 sub-Saharan Africa countries, from 1970 to 1997 showed that the aid appears to be ineffective. Their study found that in terms of receiving aid these countries only saw 0.6 percent development in their GDP per year following this period. Tarp (2009) agrees that aid is still an important tool for enhancing the growth outlook of poor countries.  This includes the access to such services as health and education and food security which are significant determinants of the human capital, which participates in the economic growth of the country. Clemes and Gani (2003) study found that there was an effect of aid on human development, which was found in health and education and also showed a significant correlation in terms of human development among the lower-middle countries. The Gross Domestic Capital is mostly associated with economic growth and ignores several issues of development such as standard of living, levels ofeducation and health.

Nigeria is a resource-rich country, with over thirty different minerals, including gold, iron ore, coal and limestone. After a robust economic growth in the average of 7.5 per cent growth experienced over the past decade, theNigerian economy slowed down in 2012. Despite the robust economic growth, unemployment rate in the countryyet increased from 21 per cent in 2010 to 24 per cent in 2011. Also, poverty remains widespread, with a headcount that declined marginally from 48 per cent in 2004 to 46 per cent in 2010. In addition, during the first, second and third quarters of 2012, Nigeria’s exports increased while its imports decreased, resulting in a 59 per cent improvement in its trade balance and foreign direct investment (FDI) of 24 per cent relative to 2011. Official Development Assistance (ODA) decreased from USD 2.0 billion in 2010 to USD 1.8 billion in 2011. Total FDI in 2011 was USD 8.9 billion, representing 20 per cent of the total FDI to Africa in 2011. However, these investments are mostly in the oil and gas sector. Essentially, Nigeria’s problem of underdevelopment has, for a long time, been connected to the lack of infrastructural facilities, wrong policy frameworks, hostile environment, backwardness in technology, problem of unemployment and over-dependence on imported products amongst other constraints. Interestingly, National Economic Empowerment and Development Strategy (NEEDS) targeted minimum annual GDP growth rates of 5 per cent in 2004 but achieved 4.2 per cent, while 6 per cent growth rate was targeted in 2005 and 2006 but realized 4.5 per cent and 6.1 per cent growth rates respectively. Also, 7 per cent growth rate was targeted in 2007 but realized 7.4 per cent. On the whole, the remarkable growth narrative is evident in an average annual real growth rate of GDP of over 6 per cent between 2004 and 2012. These statistics actually depict an improvement in the economic output, but the question begging for an answer is to what extent does this statistics translate to better living standard for the people of Nigeria? Though much attention had been focused on domestic savings and export earnings from crude oil, the potency of these variables to affect economic growth in the country is far from reality. It is along this expectation that the 2-Gap growth model draws that foreign aid should be channeled to those countries that have a balance of payments constraint while foreign direct investment should be directed to augment the domestic savings. Foreign aid and foreign direct investment will therefore be reviewed to palliate the short comings of export earnings and domestic savings respectively.

Thus, despite the various economic growth models that have been adopted, the country desires a growth model that would mobilize domestic savings in order to reduce (if not eliminate) excessive foreign borrowing.

OBJECTIVES

The broad objective of the study is to investigate the impact of foreign assistance on economic development in Nigeria from1980  to 2015 using Error correction model.

Specific Objectives

1 To determine the magnitude and direction of impact of foreign aid on economic development.

2 To find out whether the impact of foreign aid on economic development of Nigeria depends on macroeconomic policy environment or not.

3 To identify the types and forms of foreign aid in Nigeria

To identify the costs and benefits of foreign aid to Nigeria

To establish the factors affecting foreign aid effectiveness in Nigeria

METHODOLOGY AND DATA

Specification of Model

The study focused on the impact of foreign aid on the growth of Nigerian economy. Time series secondary datafor the study on will be collected on foreign aid and all other relevant variables over the 1980–2015(35 years)period . The secondary data will be obtained from such publications as World Bank Digest of Statistics, Central Bank of Nigeria statistical bulletin and International Financial Statistics. Data were also to be obtained from website, Journals and Newspapers. The data on foreign aid are to be obtained from the Organization for Economic Corporation and Development (OECD), OECD. State online database and from the United Nations Conference on Trade and Development (UNCTAD), Handbook of Statistics 2008 database.

Since the study will makes use of time series secondary data, unit root tests will be conducted to determine the stationarity of the variables.

The models specified are to be estimated using panel least squares estimation method.Error correction mechanism will be used to determine the existence of a long-term relationship among the variables.The model is derived, in conventional manner, from a production function in which foreign aid is introduced as an input in addition to labor and domestic capital. In the usual notation theproduction function can be written as follows:

Y =f (L, K, A)——(1)

where Y is gross domestic product (GDP) in real terms, L is labor input, K is domestic capital stock, and A is stock of foreign aid.

Assuming (1) to be linear in logs, taking logs and differencing, the following expression describing the determinants of the growth rate of real GDP is obtained:

y =α+β1+δk+Φa(2)

where lower case letters denote the rate of growth of individual variables. Following the precedent set in numerous previous studies, the rate of growth of the capital stock is approximated by the share of investment in GDP. Error correction term is introduced to establish a long-term relationship among the variables

The rate of change in labor input is also replaced by the growth rate of population. Following Karras (2006) and others, several other variables that are often believed to have a favorable effect on growth are also included. As pointed out by Feeny and McGillivray (2008), a reasonably robust finding of recent studies is that there is an inverted U shaped relationship between aid and growth. This finding indicates that there are diminishing returns to aid due to recipient countries having absorptive capacity constraints. Absorptive capacity relates to an aid recipient’s ability to utilize foreign aid inflows effectively. In order to take into account this relationship, a square term is added to the following model. These changes yield the following growth equation:

GGDPt=βo+β1GPOPt+β2[INV/GDP]t+β3[AID/GDP]t+β4[AID/GDP]2t+β5ln[GDPo]+β6

INFt+ECMt-1+℮t —————(3)

Where GGDPtis the growth rate of real GDP per capitain year t ,GPOPtis the growth rate of populationin year t , INV is the investmentin year t , AID is the foreign aidin year t ,GDP is the initial level of GDP , and INFtis the inflation rate year t . The growth rate of population is a proxy for the growth rate of labor force, and the investment/GDP ratio represents the growth rate of capital stock ECM is the error correction term.This is the modified version of the model adopted from the work ofTanbi(1999.)

EXPECTED EMPIRICAL RESULTS

The main concern is to test whether the marginal impact of foreign aid on growth, is positive or negative and statistically significant. The expected signs of the coefficients β1 and β2 are positive and that of β3 either positive or negative, β4 is negative, and that of β5 andβ6are negative ECM is negatively signed.

REFERENCES

Andrews, N. (2009). Foreign aid and development in Africa: What the literature says and what the reality is?. Journal of African Studies and Development, 1(1): 008-015.

Clemes, M. and Gani, A. (2003).Aid Type and Its Relationship with Human Well Being.International Journal of Social Economics.Vol. 30-6.

Durbarry, R., N. Gemmell, and D. Greenaway (1998), “New Evidence on the Impact of Foreign Aid and Economic Growth,” Centre for Research in Economic Development and International Trade Research Paper No. 98/8.

Hansen, H., and F. Tarp (2000), “Aid Effectiveness Disputed,” in Foreign Aid and Development: Lessons Learnt and Directions for the Future, eds. by F. Tarp, and P. Hjertholm, London: Routledge, 103-128. Also published in Journal of International Development, 12, 375-398.

McGillivray, M., Feeny, S., Hermes, N. and R. Lensink (2006), “Controversies over the impactof development aid: it works; it doesn’t; it can, but that depends,” Journal of

International Development, vol. 18, no.7, p.1031–1050.

Hansen, H. and F. Tarp (2001), “Aid and growth regressions,” Journal of Development

Economics, vol.64, p.547–570.

Girma, S., Gomanee, K., and Morrissey, O. (2005), Aid and Growth: Accounting for Transmission Mechanism in Sub-Saharan Africa, UNU-WIDER, Research Working Paper No.2005/60.

Hayter, T. (1971).Aid as Imperialism. Penguin Books Inc., Britain.

Jensen, P. S., M. Paldam (2003), “Can the New Aid-Growth Models Be Replicated?,” WorkingPaper No.2003–17, Institute for Economics: Aarhus.

Karras, G. (2006), “Foreign aid and long-run economic growth: empirical evidence for a panel ofdeveloping countries,” Journal of International Development, vol.18, no.7, p.15–28.

Ouattara, B. (2006), “Foreign aid and government fiscal behavior in developing countries: Paneldata evidence,” Economic Modeling, vol.23, p.506-514.

Rostow, W. W. (1990). The Stages of Economic Growth: A Non-Communist Manifesto, Cambridge Press, Cambridge.

Tadesse, T. (2011). Foreign Aid and Economic Growth in Ethiopia: A Cointegration Analysis. Economic Research Guardian, Weissberg Publishing, 1(2): 88-108, December.

Tambi N.E.(1998) co-integration and error correction modeling. Journal of agricultural economics 20 (1999) 57-67

Tarp, F. (2009).Aid Effectiveness, UNU-WIDER, Working paper 2009/05.