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FOREIGN AID AND THE BINDING CONSTRAINTS ON ECONOMIC GROWTH IN NIGERIA

REVISED PROPOSAL
BY

OPUE, JOB AGBA DEPARTMENT OF ECONOMICS UNIVERSITY OF CALABAR CALABAR-NIGERIA ngaji74@yahoo.com 07062522700

AND

LIONEL EFFIOM (PhD) UNIVERSITY OF CALABAR CALABAR-NIGERIA leoeff2002@yahoo.com 08030887565

Submitted to African Economic Research Consortium (AERC, Nairobi)

September, 2011

ABSTRACT Critics are of the opinion that given the huge misuse of foreign aid in Nigeria, she should strive not to depend on foreign aid and focus more on internal production and trade to achieve economic growth. There is need to also note that while there remain potential domestic sources of funding for growth and development, sources like taxation and savings, these channels are inadequate and substantially marginal in addressing the growthdevelopment challenges facing Nigeria or any other African country in general. Our justification for this assertion rests on several counts as depicted in our introduction. As a result, this study aims at developing an augmented three gap model to test which among savings, fiscal balance, and foreign exchange, all compounded by limitations in absorptive capacity, is the most binding constraint on economic growth in Nigeria, and then show that by maximizing the supply of foreign aids at least in the first instance, alongside other complement, these constraints could be reduced in order to boost investment and enhance growth. This study shall therefore use the VAR model to examine the relationship existing among the variables generated from the African Development Indicator (ADI) and the Statistical Bulletin of the Central Bank of Nigeria (CBN).

1. 0 INTRODUCTION Many governments around the world including Nigeria actively attempt to attract multinational corporations (MNCs) into their domestic economies for investment in order to boost productivity. One way of encouraging them is by exposing them to the available incentives such as cheap raw materials like land, labour, and other mineral resources. However, the capacity of these MNCs to invest in order to generate profit is limited by the availability of skilled man power, security network, organized institutions (political and financial), and infrastructures such as electricity supply, water supply, etc. These limitations further compound the already existing constraints of savings, fiscal position as well as foreign exchange volatility; hence, the need for foreign aids to circumvent this problem. This paper attempts to show that for a developing country like Nigeria, aid still remains relevant and significant. While there remain potential domestic sources of funding for growth and development, sources like taxation and savings, we argue that these channels are inadequate and substantially marginal in addressing the growth-development challenges facing Nigeria or any other African country in general. Our justification for this assertion rests on several counts. First, it would be a huge understatement to assert that Nigeria, nay Africa, is more than hundred years behind the developed Western world in terms of real growth and development. Our development challenges are complicated, being structural in character. With rising population growth, decrease in per capita income, rising poverty and inequality, and lower access to education, health and other poverty-reducing mechanisms, it remains an elusive dream that Africa can independently, without any semblance of foreign assistance, bridge its development gap. Over the years, numerous internal factors have impaired sustained growth and development in Nigeria. These challenges include poor and decaying infrastructure; epileptic power supply; weak fiscal and monetary policy coordination; fiscal dominance; pervasive rent seeking behaviour by private and 2

public agents, including corruption; weak institutions and regulatory deficit; policy reversals and lack of implementation; inordinate dependence on the oil sector for government revenue and expenditure; disconnect between the financial and the real sector; exchange rate instability; and, insecurity of lives and property. While it is true that most of the above mentioned constraints are internal and institutional, and can be quickly eliminated with renewed political commitment and determination, others require huge financial outlays that can only be complemented by aid inflow. In effect, the two-gap model which espouses the divergence between domestic savings and investment as well as between export revenues and the imports needed for development remains theoretically relevant in this scenario. Secondly, Nigeria is currently implementing a Transformation Agenda, a subset of the holistic vision 202020 economic blue print. Ambitious targets have been set. Achieving those targets and goals would be an economic miracle of the 21st century. Besides, Nigeria is one year into the implementation period of the blue print, and current data show that while the economy is expected to grow consistently at a growth rate of 13.8 per cent over the next 10 years leading to the year 2020, only a paltry 7.4 per cent growth rate was achieved in 2010. Thus, with the present state of affairs, this divergence between expectations and realities may increase with every passing year. Thus foreign aid may still have to play its complementary role in Nigerias development efforts. According to the Nigeria Vision 20:2020 (2009), the projected growth rate of the Nigerian economy was arrived at by using the Indonesian economy which has similar characteristics with Nigeria, and which is at the bottom five of the worlds top 20 economies. A comparison of a few macroeconomic statistics between these nations reveals the crass inadequacy of domestic sources of finance for Nigerias development efforts. For instance Nigerias gross savings as a percentage of GDP is a paltry 16.4 per cent while that of Indonesia is 26 per cent. It is therefore not surprising that Nigerias gross capital formation as a percentage of GDP is 14 per cent compared to Indonesias 25 per cent. Besides, manufacturing still contributes an absurd 4 per cent to GDP compared to Indonesias 28 per cent, while the share of manufactures to total exports for Nigeria stands at less than one per cent compared to Indonesias 45 per cent. Macroeconomic theory tells us that the macro variables of savings, consumption and investment are interdependent. Gross savings of 16.4 per cent is indicative of a high marginal propensity to consume (MPC) hence low savings and much lower aggregate investment. Consumption is high because of low incomes and productivity levels, high levels of dependents per worker coupled with unsustainable unemployment rate. In Nigeria, like any developing African country defined by cultural values of extended family bonds and relations, a single worker whether in the private or public sector, potentially caters for a long line of dependents (brothers, cousins, uncles, inlaws, etc). According to the Human Development Index (2007), 54.4 per cent of Nigerians live on less than $1 a day. Of the 6 million Nigerians graduating annually from the educational system, only about 10 per cent are often employed, thereby leaving about 4.5 million to enter into the labour market annually. The Nigerian economy is not only characterized by embarrassing unemployment figures, it also suffers from underemployment, low wage employment, and social exclusion. In the current Progressive Income Tax regime, where tax revenues are an 3

increasing function of income, government revenues are greatly constrained because of the permanent nature of unemployment, low incomes and public apathy to payment of taxes as well as weak institutional platforms of tax administration which encourage tax avoidance and evasion. These features act as constraints on the use of savings as a source of domestic funding. Fiscal balance acts as a constraint on growth because of the divergence between government expenditure and its revenue. On the other hand, there also exists a trade gap or constraint due to the discrepancy between imports and exports, a condition that manifest in the volatility and depreciation of the domestic currency. It is thus based on these prevailing premises that this study attempts to develop an augmented three gap model to test which among savings, fiscal balance, and foreign exchange, all compounded by limitations in absorptive capacity, is the most binding constraint on economic growth in Nigeria, and then to investigate whether by maximizing foreign aid these constraints could be checked.

1.1 STATEMENT OF THE PROBLEM AND RESEARCH QUESTIONS There seems to be a resurgence of inquiry into the effectiveness of foreign aid on economic growth of recipient nations, like Nigeria. Empirical results are mixed, with some affirming the positive aid-growth nexus while others decry continuous aid to developing nations as useless and a waste of resources. While there are institutional bottlenecks in the absorption and utilization of aids, bottlenecks which have a net negative cumulative impact on aids effectiveness, the utilitarian relevance of aids cannot be discounted as far as the long term growth paradigms and process of Nigeria are concerned. It sounds rather extremely paradoxical that while the leading OECD countries (e.g. the US, Greece, Ireland, Italy, etc) on both sides of the Atlantic are craving for aids to salvage their ailing economies, empirical studies that mostly stand on faulty assumptions and which suffer from methodological deficit are advocating for a seizure of aids to nations who are yet to economically stand on their feet. The micro-macro paradox result of aids should teach us that with greater policy articulation, consistency, and transparency in public sector mechanisms of aid management, the paradox can be narrowed or bridged. This means that the salutary results of aids noticed at the micro level can as well be translated to the macro. Outright stoppage of aids would amount to throwing away the baby with the bath water. We have argued above, that the domestic resources of recipient nations, abundant as it may seem, do not constitute enough threshold to guarantee that developing nations can go it all alone; foreign aid into sectors that require huge capital and technological investments are urgently needed. After all, at the incipient stage of growth of the developed West, they indeed were aided by the surplus value created by African labour. We are not here tacitly advocating for reparation; but the reasoning remains valid that the West, in spite of their abundant knowledge structure which is the basis of their technological prowess, still needed help from outside. With specific reference to Nigeria, it is our intention in this paper to demonstrate that Nigerias long term ambitious goal of becoming one of the 20 largest economies in the world come year 2020 would not be achieved in the absence of aid. We inquire: from whence does the government hope to finance its anticipated huge investment 4

in energy, road and rail infrastructure, health, education, agriculture etc. over the next ten years? Is it from oil? From the services sector? With increasing public expenditure on recurrent items, domestic sources of funding are unsustainable. It is within this context that the study attempts to empirically aver that aids is still relevant in the Nigerian scenario. We show that there exist three major binding constraints on our growth process, namely, savings, fiscal balance and foreign exchange constraints; and that by systematic consistent inflow of aids, these constraints would be relaxed and smoothened for the growth process to take its full course. The underlying assumption however is that the institutional and political mechanisms currently underway in the economy would be strengthened to ensure that future foreign assistance would not go the way others went. Democratic and legal institutions would be nurtured to maturity in order to pave way for proper inflow of investment for the benefits of the beneficiary and benefactor. Consequently, four research questions are developed to investigate the issue of the propriety or otherwise of continuous aid flow to Nigeria:
(1.) Is there a significant two way relationship between economic growth and foreign aid in Nigeria (i.e., does

the Nigerian economy need foreign aid to grow)?


(2.) Is there a significant two way relationship between foreign aid and savings constraints, foreign aid and

fiscal constraints, and then foreign aid and foreign exchange constraints in Nigeria?
(3.) Which among savings constraints, fiscal constraints, and foreign exchange constraints is the most binding

constraint (or impacts more) on economic growth in Nigeria?


(4.) Can the various constraints on economic growth in Nigeria be reduced by maximizing the supply of foreign

aid, especially in the first instance (i.e., short run)?

2.0 RESEARCH OBJECTIVES The broad objective is to investigate what is the binding constraint on economic growth in Nigeria and then show that by maximizing the supply of foreign aid, these constraints could be reduced to enhance growth. The specific objectives are: (1.) To analyze the two way linkage of economic growth and foreign aid in Nigeria. (2.) To analyze the two way linkage of foreign aid and savings constraints, foreign aid and fiscal constraints, and then foreign aid and foreign exchange constraints in Nigeria. (3.) To examine the impact of savings constraints, fiscal constraints, and foreign exchange constraints on economic growth in Nigeria. (4.) To investigate if the various constraints on economic growth in Nigeria could be reduced by maximizing the supply of foreign aid, at least in the first instance.

3.0 LITERATURE REVIEW 3.1 Theoretical Literature 5

Theory behind Harrod-Domar and the gap models: Empirical studies of the aid-growth relationship carried out until the mid-nineties were influenced by the early growth theories, which asserted that the growth process depends on the ability to surpass the constraints regarding the accumulation of physical capital. Investment was perceived as the key to economic growth. Traditionally, the lack of savings crucial to investment was regarded as the most important limitation to the economic growth of developing countries. Indeed, one characteristic of developing countries is their limited capacity to generate savings, due to their low per capita income. The original Harrod-Domar model was expanded in the sixties in the Chenery and Strout (1966, 1979) two-gap model. The foreign exchange shortage was introduced as another possible growth constraint. Typically, developing countries need to import goods and services, vital to investment and production; but import requirements usually exceed export earnings. Investment can be constrained either by a shortage of domestic savings (the savings gap) or by a shortage of exports earnings (the trade gap). Therefore, foreign aid inflows in particular, and foreign capital inflows in general, are needed to fill the prevailing gap, so that countries can grow more rapidly than their internal resources would otherwise allow. If these inflows do not exist, the country will experience slower growth and inefficient employment of internal resources (labour and natural resources). The desirable outcome is self-sustaining growth. Investment is financed by savings, and in an open economy total savings equal the sum of domestic and foreign savings. A savings gap is said to arise if domestic savings alone are insufficient to finance the investment required to attain a target rate of growth (e.g. Rosenstein-Rodan, 1961 and Fei and Paauw, 1965). The traditional two-gap model sees imports as aiding capital accumulation, whereas more recent statements of the three-gap model reflect the fact that output may be constrained by low capacity utilization due to lack of spares and intermediate goods rather than lack of investments (e.g. Nalo, 1993; Ndulu, 1991; Shaaeldin, 1988 and Taylor, 1993). Following the crippling debt crisis of the 1980s, Bacha (1990) and other neostructuralist authors, like Lance Taylor, introduced a third fiscal gap between government revenue and expenditures. The three-gap model predicts that government budget limitations rather than foreign exchange constraints or an overall savings restriction, may be binding. Evidence is available suggesting that government expenditure in the sub-Saharan African region has been curtailed by foreign debt service (Fielding, 1997; Gallagher, 1994 and Sahn, 1992, 1990). The closing of this fiscal gap could thus be facilitated by external resources directed to the government budget. If foreign aid supplements government revenue, then it will be perceived as promoting economic growth. In sum, the gap models predict a positive role for foreign aid whereby it supplements domestic savings, export earnings and government revenue, hence increasing, investment, imports and government expenditure, and thereby growth. However, the empirical record of aid seems rather more mixed, and a number of macroeconomic complications have been advanced in the literature to explain why there is no one-for-one relationship between aid and economic performance.

3.2 Empirical Literature There is a plethora of literature on the macro economic effects of foreign aid on growth. To say the least, these studies are yet to be definitively conclusive or affirmative on aids impact on recipient economy. Some empirical studies found evidence of a positive association between aid and recipient country growth (Papanek, 1973; Dowling and Hiemenz, 1982; Gupta and Islam, 1983; Levy, 1987, 1988). Others either failed to find any association or if they did, found that it was negative (Rahman, 1968; Griffin, 1970; Gupta, 1970; Weisskopf, 1972; Voivodas, 1973; Mosley, 1980; Mosley et al., 1987 and Boone, 1996). Early influential scholars on the subject were more critical, cynical and pessimistic of aids role in positively impacting on the economies of recipient nations. Amongst them are Friedman (1970); Hayter (1971); Hensman (1971); Bauer (1981, 1991) and Hancock (1989), and many more. It was Mosley (1986) who coined the term micro-macro paradox in the aid-growth literature as an attempt to analyse the lack of consensus amongst researchers on the country-level impact of aid. He came to the conclusion that while aid had positive marginal effects at the micro level, its impact on the macro level was ambiguous and unidentifiable. This paradox gained prominence and was even consolidated by further studies with similar outcomes with policy implications averse to pro-aid regimes. But the tide changed. Burnside and Dollar (1997) came up with a significant study with optimistic results which showed that growth would be slower and lower in the absence of aid. Thereafter subsequent studies emerged supporting the position. These include those of Hansen and Tarp (2000); Morrissey (2001); Beynon (2002); McGillivray (2003); Clemens, Radelet and Bhavnani (2004); Addison, Mavrotas and McGillivray (2005) and McGillivray et al. (2006). Thus the pattern and outcomes of empirical research looked wavelike and unstable, with a group of studies affirming foreign aids salutary effects on economic growth only to be upturned by much influential and persuasive studies underlining its adverse consequence on growth. Thus there seems to be no end to these spiraling, unstable outcomes of studies. More recently, studies by Rajan and Subramanian (2009) and Arndt et al (2010) seem to revive the old micro-macro paradox of aid which, for a while, was thought to have been resolved with the studies mentioned above. While Rajan submits evidence of an adverse impact of aid on manufacturing exports, Arndt counteracts these findings by reaffirming the positive impact of aid on growth. Bakare (2011) in his study examined the extent of the impact of foreign aid on economic growth in Nigeria. The paper employed standard statistical method, Vector Autoregressive Model, (VAR) to determine the sources of shock to growth in Nigeria and treated foreign aid as an endogenous variable. The study found a negative relationship between foreign aid and output growth, which imply that foreign aid tend to worsen output growth in Nigeria rather than improving it. The findings of the study support his earlier discovery on aid fungibility, which argue that foreign aid did not promote growth in Sub-Sahara Africa. According to him, the findings have important implications for policy. Since huge estimates of foreign aid suggest a huge potential for economic growth, the government should make efforts towards the implementation and effective utilization of foreign aid. An appropriate policy measures that would monitor the maximum and effective utilization of foreign aid is however required. 7

Eregha and Irughe (2009) in their study examine the impact of foreign aid inflow on domestic savings in Nigeria. This study is necessitated by the fact that most studies examine this issue with either panel data analysis or cross-country analysis framework, which do not really show specific country characteristics and moreover, there is no time series analysis on the impact of foreign aid on domestic savings in Nigeria. The study employed Ordinary Least Square method of estimation with an autoregressive model to examine the short run and long run elasticity coefficients of this impact. Data for the study were mainly secondary source extracted from the World Development Indicator, 2007. The study revealed that both at the short run and steady state, foreign aid inflow to Nigeria has positive effect on domestic savings. However, total debt service payment has negative impact on domestic savings. The study then recommends that policies aim at reducing the dependency and proper use of foreign aid should be implemented. Thus another literature is relevant, that on absorptive capacity. According to a review by Clemens and Radelet (2003), a number of studies have attempted to measure absorptive capacity for aid via inclusion of linear and quadratic aid terms in growth regressions (Hadjimichael et al., 1995; Durbarry, Gemmell, and Greenaway, 1998; Hansen and Tarp, 2000, 2001; Hansen, 2001; Lensink and White, 2001; Collier and Dollar, 2002; Dalgaard, Hansen, and Tarp, 2002; Clemens, Radelet, and Bhavnan,i 2004). Clemens and Radelet report that the implied turning points in the marginal impact of aid range from 15% to 45% of recipient GDP. Many pathways have been suggested that would cause the marginal productivity of aid to fall and even go negative as aid increases. These can be organized along the sequence of aid flow from donor to recipient central government to field implementation.

3.3 Summary of the Literature Review and gap to be filled The literatures reviewed actually examine the impact of foreign aid on most developing economies as well as in Nigeria. None of these literatures critically investigated what the binding constraint on economic growth in Nigeria is, and none investigated whether by maximizing the supply of foreign aid in the first instance, and not subsequently, these constraints could be reduced, and investment improved in order to enhance growth. This study therefore fills this gap.

4.0 METHODOLOGY 4.1 Analytical framework Here, we intend to maximize the rate of growth via investment, It subject to the limitations or constraints in savings, fiscal balance, and foreign exchange. Absorptive capacity will exist side by side as the interacting variable. To project GDP, as well as the existing gaps or constraints, we introduce the Harrod-Dormar equation as follows: ( ) Where, = Growth rate 8 ( ) ..(1)

K= incremental capital-output ratio (ICOR) Investment to GDP ratio Equation (1) may be reduced to (2) Since, ( Then, ( )(4) According to Economic Commission for Africa (2005), if the target rate of growth is specified as investment (It*) required for achieving a desired growth rate will be given by, ( )(5) However, where absorptive capacity for additional investment in any period is limited by the supply of complementary inputs such as land, labor, infrastructures, ports facilities, technology, institutions, etc, which can be increased as a result the development process (Chenery and Strout, 2006), or by the supply of aid we have that, ( Where, ) ( .(6) ) .(7) the level of ) ..(3)

= Absorptive capacity limit,

Where IG is the result of the limitation in absorptive capacity on investment growth. If absorptive capacity is maximized, i.e, <0, then the supply of complementary inputs will be adequate to stimulate additional investment, thus, investment would not be constrained by the limitation in absorptive capacity. But where absorptive capacity is minimized, i.e., investment. Therefore, where ( ) , equation (5) and (7) becomes, .(8) , then the supply of complementary inputs will not be adequate to stimulate additional

Normalizing, we obtain, .(9) the constraint on investment which impacts on growth. From our macroeconomic identity, we have, (10) Yt = Total income (GDP); Ct = Total consumption; It = Total investment; Gt = Government expenditure; Xt = Total export; Mt = Total import. Where, ..(11) and 9

.(12) Introducing equations (11) and (12) in (10) we obtain, ( Where, Yd = Disposable income; St = Savings; Tt = Government revenue; Tt-Gt = Budget surplus/deficit; Mt-Xt = Trade balance. From equation (13), Savings function for private, public and foreign sector indicates that private savings, S p is a function of disposable income, Yt, public savings, Sg are expected to rise with increasing capacity utilization, CU, because increases in tax revenues are operational profit of public enterprises. Foreign savings is a function of import, Mt and export, Xt. Therefore, total savings is a function of the following: ( Where and ) ..(14) are captured by the random term , then, (15) Here, equation (15) is the savings constraint on investment. However, normalizing equation (15) and multiplying through with the reciprocal of ICOR, we obtain the savings constraint on growth. That is, ( ).(16) ..(17) . If investment growth is constrained by savings and the limitation in absorptive capacity given that the current account balance is constant, then government may resort to borrowing to sustain the economy. Therefore, the fiscal and monetary accounts are linked by assuming that any government deficit (T-G) can be financed only by borrowing from the banking system ( DCG) or from abroad ( FIG). (Mallik, 1997). That is, * + ( ) (18) ( )..(19) ) ( ). (13)

Therefore, equation (13) becomes,

Where investment growth (I*) is constrained by fiscal deficit; where savings and current account balance are captured by the random term 2, we obtain the fiscal constraint equation from equation (19) as follows, ( ) ..(20)

Normalizing equation (20) and multiplying through by the reciprocal of ICOR we obtain our fiscal constraint on growth. * ( . 10 ( ) ) +(21)

.(22)

Where import (M) exceeds export (X) we experience a balance of payment deficit. However, where saving and budget deficit are captured by the random term 3 then we obtain the foreign exchange constraint on investment as follows: ( ) (23)

Normalizing (23) by Yt and multiplying through by the reciprocal of ICOR, we obtain our foreign exchange constraint on growth i.e, * ( . Therefore, given that in equations (15) , (20) and (23) we have the savings constraint, fiscal constraint , and foreign exchange constraint on investment growth, by introducing these in equation (13) we obtain our national identity reflecting the various constraints on investment (I) as, ( ) (26) ( ) ) +...(24)

...(25)

By normalizing equation (26) and multiplying through by the reciprocal ICOR, we obtain our augmented three gap model revealing the various constraints on growth (g), * *
( ( ) )

+.(27)

+..(28)

Where K = ICOR; k = GCF = Gross Fixed Capital Formation; g = GDP per capita growth.

If the various constraints are further compounded by the limitations in absorptive capacity (ABC), with the limitation in absorptive capacity as the interacting factor, then we obtain, ( ) * ( )+ {
( )

}.........(29)

In this circumstance, by comparing eqn. (28) and (29), we hope to deduce what should be the binding constraint on growth. Is it savings, is it fiscal deficit, or is it foreign exchange (or trade imbalance)? However, aid is needed to service the existing gaps compounded by the limitations in absorptive capacity which is inherently the interacting factor in equation (29). Therefore, in order to maximize growth, we maximize aid; hence, reducing the limitations in absorptive capacity and the other constraints on growth. ( ) ( ) *( )( )( ( ) )+...(30)

4.2 Model specification 4.2.1 The Vector Autoregressive Model: In order to test the relationships in the current study, multivariate Granger causality tests will be conducted to examine possible causal relationships among the variables which comprise of economic growth ( ), foreign aid 11

( (

), savings constraint (

), fiscal constraints (

) and foreign exchange contstraints ((

) ), all expressed in natural logs. These tests are based on the following vector autoregressive (VAR) model

as shown below; all variables are systematically and endogenously considered at first. The specified model for objective (1) is as follows: + (32)

On a priori, as aid increases, we expect an increase in growth.

The specified model for objective (2) is as follows: ( ( [( ( ) ) ))] ( ( [( ( ) ) )) ( ( ] [( ( ) ) ))

(33) ]

On a priori, as foreign aid increases, we expect a decrease in savings constraint, fiscal constraint as well as in foreign exchange constraint.

The specified model for objective (3) is as follows: [ ( ( ( ( ) ) ] )) [ ( ( ( ( ) ) )) ] [ ( ( ( ( ) ) )) ] ..(34)

The specified model for objective (4) is as follows; given that foreign aid is used to finance the limitation in absorptive capacity. If ABC in eqn. (34) is replaced by Aid then we have, [ ( ( ( ( ) ) ] )) [ ( ( ( ( ) ) )) ] [ ( ( ( ( ) ) )) ] ..(35)

By maximizing foreign aid, we also analyze eqn. (36) below, ( ( [( ( ) ) ))] ( ( [( ( ) ) )) ( ( ] [( ( ) ) ))

..(36) ]

A0=vector of constant terms, are all matrices of parameters (i=1, 2, , s), and t ~ IN (0, 1). On a priori, by maximizing aid to finance absorptive capacity, we expect an increase in growth.

Expectation of our equation (34): Collectively, these views cover the overriding parameter estimates for equations (34). They are as follows: 12

(1.) One characteristic of developing countries is their limited capacity to generate savings, due to their low per
capita income. The original Harrod-Domar model was expanded in the sixties in the Chenery and Strout (1966, 1979) two-gap model. The foreign exchange shortage was introduced as another possible growth constraint. As a result, a unit increase in savings constraint as well as in foreign exchange constraint will result in a fall in economic growth (see a priori information in eqns. (17) and (25)).

(2.) Following the crippling debt crisis of the 1980s, Bacha (1990) and other neostructuralist authors, like
Lance Taylor, introduced a third fiscal gap between government revenue and expenditures. The three-gap model predicts that government budget limitations rather than foreign exchange constraints or an overall savings restriction, may be binding. Evidence is available suggesting that government expenditure in the sub-Saharan African region has been curtailed by foreign debt service (Fielding, 1997; Gallagher, 1994 and Sahn, 1992, 1990). As a result, a unit increase in fiscal constraint will result in a fall in economic growth (see a priori information in eqn. (22)).

However, in order to analyze the causal linkages it is necessary to check whether the variables are stationary. According to Granger (1969), standard tests for causality are valid only if there exists cointegration. Therefore, a necessary precondition to causality testing is to check the cointegrating properties of the variables under consideration. The cointegration and error-correction methodology will be conducted. As the case may be, the impulse response and variance decomposition will also be done.

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