Does public spending affect unemployment in an emerging market?

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The Nigerian economy in the last two decades up until 2013 has been growing at an average of 6% and yet unemployment was equally growing in the region of 20% within the same period. This paradoxical situation has led to a flurry of studies and postulations aimed at providing explanation and solution to the phenomenon. This study making use of a regression model with annual data from 1980 to 2013, empirically determined the impact of public sector expenditures (CEXP and REXP) together with private sector investment (PINV) on unemployment (UNEMP) in Nigeria. Capital expenditure and private sector investment both in the medium to long-run were found to serve as catalyst towards reduction of unemployment, while recurrent expenditure was not statistically strong enough to do same. The R-2 (0.84) showed that greater proportion of the total variations in UNEMP was brought about by variations in the regressors. Further tests like autocorrelation, hetroscedasticity, specification error, and multicollinearity indicated respectively that there is no presence of autocorrelation hence the model produced a parsimonious result; the variance is constant over time; the link test confirmed by Ramsey reset test suggested there was no specification error; and lastly the variance inflation factor (VIF) of the variables implies that there is no evidence of multicollinearity. The study recommends, inter alia, that the proportion of capital expenditure in Nigerian budget profile should be systematically increased while the recurrent expenditure should be reduced; and there is need to stimulate competition among investors through removal of structural and institutional rigidities and government should design clear policy incentives to private sector investment.

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Risk governance & control: financial markets & institutions / Volume 7, Issue 1, Winter 2017
DOES PUBLIC SPENDING AFFECT
UNEMPLOYMENT IN AN EMERGING MARKET?
Vincent A. Onodugo*, Kenneth Onyebuchi Obi**, Oluchukwu F. Anowor***, Nnenna
Georgina Nwonye****, Grace N.Ofoegbu*****
* Department of Management, University of Nigeria, Enugu Campus, Nigeria
** Department of Economics, Nnamdi Azikiwe University, Awka, Nigeria
*** Department of Economics, Godfrey Okoye University, Enugu, Nigeria
**** Department of Banking and Finance, University of Nigeria, Enugu Campus, Nigeria
***** Department of Accounting, University of Nigeria, Enugu Campus, Nigeria
Abstract
The Nigerian economy in the last two decades up until 2013 has been growing at an average of
6% and yet unemployment was equally growing in the region of 20% within the same period. This
paradoxical
situation
has
led
to
a
flurry of
studies
and
postulations
aimed
at
providing
explanation and solution to the phenomenon. This study making use of a regression model with
annual data from 1980 to 2013, empirically determined the impact of public sector expenditures
(CEXP and REXP) together with private sector investment (PINV) on unemployment (UNEMP) in
Nigeria. Capital expenditure and private sector investment both in the medium to long-run were
found to serve as catalyst towards reduction of unemployment, while recurrent expenditure was
not statistically strong enough to do same. The R-2 (0.84) showed that greater proportion of the
total variations in UNEMP was brought about by variations in the regressors. Further tests like
autocorrelation,
hetroscedasticity,
specification
error,
and
multicollinearity
indicated
respectively
that
there
is
no
presence
of
autocorrelation
hence
the
model
produced
a
parsimonious result; the variance is constant over time; the link test confirmed by Ramsey reset
test suggested there was no specification error; and lastly the variance inflation factor (VIF) of
the variables implies that there is no evidence of multicollinearity. The study recommends, inter
alia,
that
the
proportion
of
capital
expenditure
in
Nigerian
budget
profile
should
be
systematically increased while the recurrent expenditure should be reduced; and there is need to
stimulate competition among investors through removal of structural and institutional rigidities
and government should design clear policy incentives to private sector investment.
Keywords: Unemployment, Capital Expenditure, Recurrent Expenditure, Private Investment, Domestic
Capacity, Conducive Environment, Investment Growth
JEL Classification: G31, O16
DOI: 10.22495/rgcv7i1art4
1. BACKGROUND TO THE STUDY
infrastructure like education, health, transport,
communication, etc. This is because it is believed
The Nigerian economy has been growing in the last
two decades at an average of 6% and yet
unemployment is worsening at the same time.
Available data shows that unemployment has
maintained a rising trend over the years from 4.1%
in 1981 to 5.3% in 1983; from 7.0% in 1987 to 13.1%
in year 2000; from 13.6% in 2001 to 14.9% in 2008;
from 19.7% in 2009 to 24.7% in 2013. Surprisingly,
Nigeria’s GDP has been increasing, as can be
observed from Central Bank of Nigeria (CBN) annual
publications, with an average growth of 6.4 percent
between 2000 and 2014.
This socio-economic anomie has provoked
several, policy initiatives, studies and debates aimed
at providing explanations and even solutions to this
phenomenon. As with macroeconomics, an increase
in the rate of unemployment reduces aggregate
output and consequently retards growth. On the
social side, it provides idle minds and hands for
indulging in criminal activities. Meanwhile,
reduction in unemployment rate unarguably justifies
public expenditure on social and economic
that this reduction has the potential of contributing
positively to the performance of the economy and
promoting higher productivity. Public expenditure as
observed by Bhatia (2008) has an active role to play,
especially in a developing country, in reducing
regional disparities, developing social overheads,
creation of infrastructure for economic growth in
the form of transport and communication facilities,
education and training, growth of capital goods
industries, basic and key industries, research and
development and many others.
Economic growth, as Mrinal (1999) opined,
more often comes from technological progress,
which is essentially the ability of an economic
organization to utilize its productive resources,
especially manpower, more effectively over time.
The underlying reason for government intervention
in the economy is based on the recognition that the
market mechanism, which is supposed to guide
private economic agents, has several inadequacies
(Ojo and Okunronmu, 1992). Gerson (1998) further
stressed that without market failure there is no
32
Risk governance & control: financial markets & institutions / Volume 7, Issue 1, Winter 2017
reason to assume
investments would
that additional public sector
be more productive than the
2. REVIEW OF RELATED LITERATURE
private investments. Expectedly, one of the major
intended purposes of public sector investments is to
Theoretical Framework
guarantee an economic climate in which the labour
needed to produce goods and services will be fully
employed in various sectors of the economy.
Obviously, there seems to be a consensus in the
literature on the definition of unemployment as
what occurs when people who are willing and able to
work at prevailing wage rate could not be able to
find any pay-rewarding job. It is worrisome that
about 25 million Nigerians out of estimated 95
million persons in the labour force are unemployed (
World Development Indicator, 2014). This
unemployment figure is somehow so callous given
the fact that, with 2015 World Bank estimate, it is
like a combined population of New Zealand = 4.5
million; Belgium = 10.6 million; Costa Rica = 4.9
million and Denmark = 5.4 million. And is also
equivalent to the total population of Mozambique =
24.9 million. The problems of chronic
unemployment are very evident in Nigeria as
observed by Okafor (2011), and also corroborated in
the works of Adepegba (2011); Ibrahim (2011);
Lartey (2011); and Olatunji & Abioye, (2011). Every
year thousands of graduates are turned out from
various tertiary institutions of learning, for whom
there are no jobs. Nigerian streets are littered with
hawkers who ordinarily would have been gainfully
employed in some enterprise. These growing army
of unemployed are further disillusioned as most of
them possess little skills and startup capital to be
self-employed.
The successive Nigerian governments have
reacted differently to this malaise. Some of them
created institutions charged with the responsibilities
for building capacities of the unemployed to either
get a job or create one. Of a particular note in this
category is the National Directorate of Employment
(NDE) programme. NDE was introduced in 1986 and
designed to provide training opportunities as well as
support services to graduates and small scale
entrepreneurs. Its major targets were to undertake
youth employment and vocational skills
development programmes; special public works;
small scale industries and graduate employment and
agricultural development programmes.
Unfortunately, factors which include, but not limited
to inadequate and late release of funds, impaired the
effectiveness of the NDE programmes (Njoku and
Ihugba, 2011).
Another more common response is for
government to use the annual budget and other
instruments of fiscal policies to stem the tide of
unemployment and inflation. To shore up
employment rate, government usually embarks on
expansionary fiscal policies and deficit budget
financing. A typical example is the 2016 budget
where government is undertaking a deficit budget
of about 30% and commit to spending half a trillion
Naira monthly handout of N5,000 to each
unemployed as a palliative to their plight. Similar
fiscal measures have been going on for years with
minimal success.
Consequent on the above, this study sets out to
assess the extent government expenditures affect
unemployment and the implications of this for
national development.
The role of government in the economy has always
been a subject of debate over a long period of time.
Some economists argue against large governments
while others believe that without government taking
a more active and participatory role to steer the
economy, countries could move from unstable
growth to prolonged recessions and massive rates of
unemployment. As a result, there is a growing
debate about the effects of government expenditure
on unemployment. As a result various scholars have
come up with conflicting postulations and
perspectives regarding this economic phenomenon.
In an attempt to explain the concept of
employment and unemployment, the classical
economists based the weight of their argument on
the Walrasian general equilibrium model (Sodipo and
Ogunrinola, 2011). The two broad features of
classical theory of employment are: the assumption
of full employment of labour and other productive
resources; and the flexibility of prices and wages to
bring about the full employment (Islam, 2002) in the
event of any deviations from the original intensions.
Full employment of labour: The classical
economists see labour and the other resources as
always fully employed. Consequently, it is believed
that the over-production and general unemployment
are presumed to be impossible. However, if there is
any unemployment, it is assumed to be temporary
or abnormal and believed that it will not persist for
long as there are economic factors that inherently
work towards returning it to equilibrium (Islam,
2002). Following this assumption the classicists
adduced that the major reasons for unemployment
are: intervention by the government or private
monopoly, wrong calculation by entrepreneurs and
inaccurate decisions and artificial resistance
(Walterskirchen, 1999). Regardless of the reason(s)
for unemployment, there is the general belief that
the economy is self-adjusting and would work its
way back to full employment equilibrium in a
perfectly competitive economy where the relative
values of goods and services are determined by the
general relations of demand and supply. The pricing
system therefore serves as the planning mechanism.
Flexibility of prices and wages: the second
assumption of full employment theory is the
flexibility of prices and wages. The classical
economists believe in the flexibility of prices and
wages which automatically brings about full
employment. Consequently, if there is general over-
production resulting in low demand and
unemployment, prices would fall as a result of which
demand would increase, prices would rise and
productive activity will be stimulated and
unemployment would tend to disappear (Islam,
2002). Classical economists believe that
unemployment could be cured by cutting down
wages which would increase the demand for labour
and would stimulate economic activity and
employment. Thus, in the classical labour market,
shortages or surplus of labour is dealt with by wage
movement. The inherent flexible wages would fall
below the equilibrium to mop up excess labour
supply, and rise above the equilibrium when there
are shortages (Sodipo and Ogunrinola, 2011).
33
Risk governance & control: financial markets & institutions / Volume 7, Issue 1, Winter 2017
Therefore, if the prices and wages are allowed to
economic policies therefore have a fundamentally
move freely, unemployment would disappear and
collectivist
approach
which
monetarists,
as
the
full
employment
level
would
be
restored.
The
followers of Freidman are called, abhors. Centralized
classical economists believe that by so doing, the
planning
is
fraught
with
inefficiencies
of
capital
incidence of involuntary unemployment is removed
allocation
and
prone
to
economic
volatility.
The
from the classical labour market.
Monetarists
conclude
that
Keynes'
study
of
the
The Keynesian School of thought on other hand
aggregate relations in an economy is misleading, as
rejected the classical view of wage flexibility and in-
recessions are caused by micro-economic factors.
built
power
of
the
invisible
hands
to
restore
They
also
submit
that
in
reality,
temporary
employment
level
and
output
whenever
the
governmental
interventions
usually
become
otherwise is the case. This stance was strengthened
permanent and expanded programmes which end up
by the inability of the market forces to normalize
suppressing
the
private
sector
and
civil
society.
employment and output level during the period of
Therefore, Keynes’ approach might work best in a
Great
Depressions
of
the
1930’s
(Sodipo
and
totalitarian state.
Ogunrinola, 2011). Following this flawed position of
Battaglini and Coates (2011) emphasize that
the classicists by the Keynesian School, the latter
despite
doubts
on
the
relationship
between
therefore proposed that government should, where
government
expenditure
and
employment,
policy
necessary,
intervene
in
the
management
of
the
makers tend to be optimistic about the efficacy of
economy
using
appropriate
policies.
Keynesian
fiscal
policy
in
solving
unemployment
problems.
School’s weight of analysis rests on the influence
This belief is manifested in the variety of fiscal
government policy can have in influencing the level
strategies deployed by countries facing economic
of
aggregate
demand
in
the
economy.
Full
downturns in a bid to solve the problem (Monacelli,
employment
will
only
be
restored
through
an
Perotti and Trigari (2010); Ramey (2012).
increase in aggregate demand and not through the
Gbosi
(2005)
posits
that
by
changing
its
classical prescription of falling money wages. Keynes
taxation and spending (fiscal policy), government
recommended
fiscal
policy
measures
in
form
of
can change the amount of cash in the hands of
increased government expenditure on public works,
consumers
and
by
extension,
the
direction
of
rather than relying on wage flexibility. This has the
aggregate
demand
for
goods
and
services.
He
potentials
of
increasing
aggregate
demand
and
believes that tax increases and reduced government
hence,
removing
the
incidence
of
involuntary
spending will lead to a decline in aggregate demand.
unemployment.
Accordingly,
taxation
should
be
While on the other hand, tax cuts and increased
devised to promote and sustain consumption and
government
spending
will
stimulate
aggregate
investment; the budget should be in deficit-spending
demand. Further, he explains that one of the major
to
raise
the
level
of
effective
demand
and
to
reasons
for
regulating
aggregate
demand
is
to
overcome depression. Public expenditure therefore,
balance
production
of
goods
and
services
with
should be planned in such a way as to finance public
consumption.
work
programs
and
provide
social
security
In
contemporary
theory
of
unemployment,
measures;
direct
taxes
should
be
lowered
to
Shimer
(1999,
2001)
uncovers
much
more
encourage savings and investment to further create
remarkable evidence of a nexus between rates of
more
employment
opportunities;
and
productive
births in
preceding
decades
and
current
rate
of
borrowings should be on a large scale to finance
unemployment. He observes that unemployment has
productive public expenditure (Somashekar, 2003).
a
significant
component
forecasted
by
births
in
To Keynesian School, once full employment level is
earlier
decades.
His
study
findings
were
that
reached
it
has
to
be
constantly
maintained
by
countries with high fraction of young workers enjoy
adopting appropriate fiscal measures from time to
lower unemployment than in other countries with
time.
low fractions of young workers.
Friedman (1969) criticizes the Keynesian theory
Battaglini and Coates (2011) however observe
of unemployment by bringing in the influence of the
that willingness to use government expenditure to
money supply on spending which was somewhat
aggressively
fight
unemployment
is
tempered
by
absence
in
Keynes
analysis.
To
him
government
high levels of resultant indebtedness. They present a
fiscal policy alone cannot affect aggregate demand if
theory showing the interaction between fiscal policy
the money supply is so low that it is unable to
and unemployment. The starting point of the theory
encourage private spending through high interest
is a model in which unemployment can be mitigated
rate. The postulation is that problems caused by the
by tax cuts and public spending increases. Such
use of fiscal policy to control the economy may be
policies they point out are fiscally costly, but can be
alleviated
through
the
use
of
monetary
policy.
financed
by
issuing
debt.
Battaglini
and
Coates
Accordingly, he is of the opinion that the best thing
(2011)
believe
that
in
the
presence
of
for the economy is to keep an eye on the money
unemployment,
reducing
taxes
increases
private
supply and let the market take care of itself. This
sector
hiring,
while
increasing
public
production
implies
that
markets
(without
government
creates
public
sector
jobs.
Thus,
tax
cuts
and
interference through fiscal policy) are more efficient
increases
in
public
production
reduce
at dealing with unemployment. Friedman argues that
unemployment. However, both actions are costly for
Keynesian Theory of unemployment is also short in
the government. They believe that the way in which
advocating for a centrally planned economy. If the
the government achieves this is by accumulating
government is expected to spend funds to reverse
bond holdings and long term indebtedness which
depressions, it impliedly means that it knows what
complicates
the
economic
health
of
the
nation
is
best
for
the
economy
as
a
whole.
Keynesian
overtime.
34

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