AN EMPIRICAL ANALYSIS OF THE EFFECTS OF FISCAL CENTRALISATION ON ECONOMIC GROWTH IN NIGERIA

AN EMPIRICAL ANALYSIS OF THE EFFECTS OF FISCAL CENTRALISATION ON
ECONOMIC GROWTH IN NIGERIA

 

TABLE OF CONTENTS
CHAPTER ONE: GENERAL INTRODUCTION
1.1 Background to the Study
1.2 Problem Statement
1.3 Aims and Objectives of the Study
1.4 Research Questions
1.5 The Thesis
1.6 Justification for the Study
1.7 The Organization of the Study
CHAPTER TWO: THE EVOLUTION OF NIGERIA’S FISCAL SYSTEM
2.1 Evolution of Nigeria’s Fiscal System in the Colonial Period – 1914-1960
2.2 Evolution of Nigeria’s Fiscal System in the Post-Colonial Period-1960-2009
2.2.1 The 1960-1966: Period of Fiscal decentralization
2.2.2 The 1966-2009: Period of Fiscal Centralization and Fiscal Fragmentation in Nigeria
2.3 Contestation
2.4 The Trend of Revenue, Expenditure and Growth Performance in Nigeria
2.5 Sectoral Contributions to Economic Growth
CHAPTER THREE: LITERATURE REVIEW
3.1 Concept and Measurement Issues
3.1.1 Fiscal Centralization
3.1.2 Fiscal decentralization
3.1.3 Fiscal Fragmentation
3.2 Theories of Fiscal Systems
3.3. Fiscal Centralisation and Economic Growth
3.3.1. External Effects and Economies of Scale
3.3.2 Quality of Governance and Corruption
3.4 Fiscal Decentralization and Economic Growth
3.4.1. Heterogeneous Preferences
3.4.2. Inter-jurisdictional Competition
3.4.3. Leviathan Model
3.5 Impact of Alternative Federal Fiscal Systems
3.6.1 Alternative methodologies
3.6.2 Findings
3.7 Empirical Review
3.8. The Gap in Literature
CHAPTER FOUR: METHODOLOGY
4.1 Conceptual Framework
4.2 Empirical Framework
4.3 Econometrics Analysis
4.3.1 Macro-Econometric Model
4.3.2. Model Discussion and Specification
4.3.3 The Stochastic Equations
4.3.4 Estimation Method, Simulation Experiments and Data Source
CHAPTER FIVE: PRESENTATION AND ANALYSIS OF RESULTS
5.1 The Estimation of Costs of Fiscal Centralization
5.2 The Estimation and Simulation Results of Macro Econometrics Model
5.2.1 The Estimated Results
5.2.2 Baseline Simulations
CHAPTER SIX: SUMMARY, CONCLUSION AND RECOMMENDATIONS
6.1 Summary
6.2 Conclusion
6.3 Recommendations
References
Appendix
Data Set

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Abstract
Fiscal centralization in Nigeria has generated regional, vertical and horizontal contestations over
resource control issues. These contestations have led to militancy and open rebellion that have
resulted in oil production shut- in, rising costs of operations in the oil industry, risks and
uncertainties for investments and a rise in the costs of maintaining security in Nigeria. The
literature on fiscal centralization has been dominated by the measurements of the impact of fiscal
centralization on economic growth and the results have been mixed. This study however,
measures the economic cost of fiscal centralization and assesses its sustainability in the light of
the consequences of the militancy and rebellion that have been associated with it. Impacts such
as production shut-in, rise in operational costs and uncertainties as well as growth in cost of
maintaining security have led to some economic effects that need to be measured and analyzed.
The study develops a framework to measure the costs of fiscal centralization and a macroeconometrics
model was built to analyze the impact and sustainability of fiscal centralization in
Nigeria. The macro-econometric model comprises of five sectors, namely, aggregate demand,
aggregate production, Nigeria’s fiscal system, financial sector and external sector. The model
was estimated using Two Stages Least Squares techniques and solved to derive baseline
equilibrium values of the endogenous variables. The model was found to effectively track the
key turning points of the endogenous variables and was then used to conduct simulation
experiments under three scenarios. (a) The impact of the loss of oil revenue by oil related cost as
a result of militancy; (b) the impact of excess expenditure on defence and internal security if
invested in the agricultural sector; and (c) a one percent increase in gross fixed capita formation.
Findings from the study revealed that the oil related cost, expenditure allocation cost and
social/human cost of maintaining fiscal centralization in the country are very high and rising.
From the macro-econometrics model, it was found that fiscal centralization impact negatively on
aggregate demand by reducing private consumption expenditure, government consumption
expenditure as well as investment by 9.5%, 6.2% and 1.5% respectively. Again, while money
supply reduced by 5.4%, the outputs from agriculture and manufacturing sub-sectors declined,
by 2.5% and 2.1% respectively. It is clear that while the oil related cost is reducing the oil
revenue component of federally collected revenue, the deterioration in the real sector is reducing
the non-oil revenue component. Based on these results and the forecast values of oil related cost
and expenditure allocation cost, it was established that the present fiscal centralization is not
sustainable. We therefore recommend a negotiated decentralization or economic and political
actions that will reduce militancy and its associated economic costs.

CHAPTER ONE
GENERAL INTRODUCTION
1.1 Background to the study
Attempts by countries in the world to strengthen the relevance and efficiency of governments have led to the adoption of fiscal
federalism. Until recently, fiscal federalism received little attention from economists, political analysts and policy makers. From 1980 however, it
has not only become a vital focus of serious academic discourse but it is equally a topical issue in discussions for national development (Taiwo,
1999). Fiscal federalism, according to Anyanwu (1999) entails a series of legal and administrative relationships that exist among units of
governments possessing varying degrees of real authority and jurisdiction autonomy. Fiscal federalism recognizes that modern governments are
stratified and fiscal structures could be centralized or decentralized. The degree of centralization or decentralization depends on the individual
decision making process by various arms of governments in the provision of both public and economic goods.
By fiscal centralization, it means a situation where fiscal powers are centered more at the central level of government in a federation.
It is a state of affairs where the federal government in a country assumes more responsibility for most of the economic activities of the public
sector, while the lower levels of governments have less responsibility for economic activities (Omola, 1999). Fiscal decentralization on the other
hand means endowing lower levels of governments with financial resources- either own- resource revenue or transfers, sufficient to carry out
their functions (Raffaele and Emmanuela, 2004).
The theoretical justification for either fiscal centralization or fiscal decentralization is clear in literature. The case for fiscal
decentralization rests on the assumption of heterogeneity of regional preferences and the benefits of competition. When communities have
heterogeneous tastes, the government closest to the citizens can deliver a bundle of services that reflects community preferences (Elliot and
Thornton, 2007). Similarly, Tiebout model (1956) posits that, with capital and labour mobile, local governments are motivated by competition
with other lower levels of governments to provide public goods efficiently. For fiscal centralization, it is believed to work better when
externalities are present, particularly with reference to central provision of public goods, where average cost can be reduced with increasing
output (Markus, 2004). Samekal (2001) however argues that, for the decreasing costs reason, fiscal centralization recommendation is not tenable
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because the information costs for the local citizens, the control costs for the central level and lack of accommodativeness would rather increase
the overall costs.
Relating fiscal centralization and decentralization to economic growth and development, the body of empirical studies supports both.
In studying fiscal centralization and decentralization in China and Russia, Elliot and Thornton (2007) examined the evolution of fiscal systems in
the two countries. Applying Ordinary Least Square method, 2 Stage Least Square and the Generalized Method of Moment (GMM), findings in
the two countries were approximately the same. In china, during the period of fiscal centralization (1994-2004), economic growth of the nation
was enhanced. Also in Russia, the study revealed that recentralization has been associated with expansion of state ownership of enterprises and
productivity. In United States, Zou and Davoodi (1999) studied the 50 states covering 1948-1994. Using growth regressions based on annual data
and applying Ordinary Least Square method, the result indicated that spending shares of states and local levels of government are irrelevant to
growth. On the contrary, Akai and Sakata (2004), in their study of 50 states in United State, found that fiscal decentralization is conducive for
providing a stable economic growth. In a cross-country study (40 countries), Oates (1995) found a significant and robust positive correlation
between fiscal decentralization and per capita economic growth. In China, Lin (2000) found that fiscal decentralization in the country raised the
over all growth rate by improving the efficiency of resource allocation. In India, Zhang (2001), in studying 29 provinces from 1987 to 1993,
obtained a significant and robust negative impact of fiscal decentralization on provincial economic growth while the study of 16 states of India by
Zhang (2001) found a positive relationship between fiscal decentralization and states’ economic growth. Based on the above empirical findings
therefore, the link between fiscal centralization and decentralization with economic growth depends on the nature of the economy, the policy
instruments in place and the time of the study.
In Nigeria, the country has over the years, experienced both fiscal decentralization and fiscal centralization. From 1946 to 1951, there
was strong central control of fiscal matters, 1952 to 1966 was the era of fiscal decentralization and from 1966 to date, fiscal variables are highly
centralized at the federal level. Empirical studies of fiscal decentralization by Chete (1998) and Aigbokhan (1999) confirm that fiscal
decentralization and fiscal centralization are contested issues theatrically and empirically. The Nigerian Economy Society (1999), the agitations
for resource control and the 2006 Nigerian Political Reform Conference (NPRC) all show that fiscal centralization/decentralization is a truly
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contested political economy issue in Nigeria. The inability to arrive at theoretical, empirical and political economy consensus suggest that fiscal
centralization and fiscal decentralization deserve to attract intellectual discourse and more so, where the consequences may be significant for the
continuing survival of a polity.
The basic questions to ask at this point are; (i) why did the country shift from a fiscally decentralized state to a fiscally centralized one? (ii) Is the
present fiscal centralization the best option for the nation’s economic growth and development? To examine the two basic questions, reference to
Mbanefoh (1993) suggestion becomes vital. He suggested that a good fiscal arrangement should:
(i) be conducive for rational and equitable allocation of the country’s resources among the tiers of government and groups.
(ii) minimize intergovernmental and inter-group tension and
(iii) promote national unity. In addition,
(iv) such fiscal arrangements should enhance accelerated growth of the economy.
Considering the political and economic situations before 1966, the above conditions were not satisfied. Politically, the era was characterized by
struggle for power and ethnic rivalry. The disagreement among the regions over the sharing of revenue resulted to about four committees and
commissions mandated to evolve acceptable rates and principles for revenue. The political, economic and social ills that period ‘necessitated’ the
military take over in 1966. General Yakobu Gowon, the then Military Head of state immediately embarked on measures to centralize fiscal
matters. The answer to question two however, needs an empirical investigation, hence the need for this study.
1.2 Problem Statement
The present fiscal structure in Nigeria consists of 36 states, the Federal capital Territory (FCT) and 774 local government areas and the
fiscal matters are centralized. The fiscal centralization of the Nigerian state is established from the institutional framework for fiscal federalism in
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Nigeria. The constitutional provisions on the assignment of responsibilities among the three tiers of government clearly show a deliberate
concentration of powers in the central government. In the 1979 constitution for instance, there were 66 items on the Exclusive List of the Federal
Government, many others on the Concurrent List (Parts I and II section 4 of the second schedule)
1
and 11 minor others reserved for the local
governments (Fourth Schedule). In the 1999 Constitution however, all these were restructured and expanded to greatly favour the Federal
Government. The intergovernmental fiscal relations in Nigeria also exhibit fiscal centralization in tax assignment and revenue sharing
arrangements. Regarding tax assignment, the major revenue heads in the country, including custom duties, mining rents and royalties, petroleum
profit tax and company income tax, all of which account for over 80 per cent of total national recurrent revenues, fall under the legislative and
administrative jurisdiction of the federal government, while the less productive and less buoyant sources are devolved to the fiscal jurisdiction of
states and local governments.
The rates and principles used for vertical and horizontal revenue sharing are usually from the recommendations of ad hoc committees
or commissions formed at particular instances. The rates and principles were often amended by the use of Decrees and annual budget
pronouncements by the governments in power. All the revenue sharing rates used, from Philipson Commission in 1946 through to the present,
favour the federal government more than lower levels of governments. The principles for horizontal revenue sharing among the states too tend to
favour some states more than others.
The present fiscal centralized system has therefore generated severe contestations in Nigeria. The key players in the agitations and conflicts, who
also have varied interests, are;
i) The Federal Government, the 36 States of the Federation and the Federal Capital Territory (FCT) and the 774 Local
Government Areas.
ii) The Federal Government, the oil producing states (Niger Delta region) and the non-oil producing states.
1 The functions of the states are specified on the Concurrent Legislative list. They include, among others, the
provision of public services whose consumption could be confined to the areas within their jurisdiction, secondary
education, health, industry and agriculture.
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iii) The Federal Government, oil producing states, communities in Niger Delta region and the Multinational oil companies.
The central issue of concern that generates the contestations is the quest for ‘resource control’. Among the levels of governments, the
disagreement is over the rates of revenue allocation, and among the states, the contentions are over the principles used in sharing the states
allocations. For the third category, the agitation revolves around issues of oil rents, compensation and provision of infrastructure, claims to
ownership of oil fields, environmental degradation and profit maximization. With oil being strategic as the anchor for Nigeria’s fiscal system and
as the main source of foreign exchange inflow, contestations that impact negatively on oil revenue will have systematic effect on the Nigerian
economy.
Particularly from 1999, the contestations linked to fiscal centralization degenerated to militancy and rebellion. The militancy and
rebellion have involved;
(a) Damage to oil facilities leading to production shut-in;
(b) Kidnapping and loss of lives that have increased uncertainties and risks for investment in Oil and Gas;
(c) Rising cost of operations; and
(d) Growing costs of maintaining security in the Niger Delta which may crowd-out spending on agriculture, education, health and
economic infrastructure.
These developments suggest two propositions:
(a) The net economic cost of fiscal centralization is positive and increasing;
(b) Fiscal centralization is unsustainable.
The analysis of the propositions is necessary to provide credible information required for effective decisions to arrive at the right fiscal system to
drive the development of the Nigerian economy.
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1.3 Aims and Objectives of the Study
The major objective of the study is to generate credible information required for solving the contestation over fiscal centralization in
Nigeria. The specific objectives are
(i) To analyze the costs of maintaining fiscal centralization in the Nigerian economy.
(ii) To analyze the sustainability of fiscal centralization in Nigeria.
1.4 Research Questions
The following research questions are derived from the two propositions of the study
(i) What is the cost of maintaining fiscal centralization in Nigeria?
(ii) Is fiscal centralization sustainable?
These two questions are the focus of this study.
1.5 The Thesis
Based on the objectives and the research questions of the study, the thesis of the study is that the cost of maintaining fiscal centralization in
Nigeria is positive and increasing; therefore, fiscal centralization is not sustainable in Nigeria if nothing is done to reduce the cost.
1.6 Justification of the Study
The issues arising from the fiscal relations of the levels of governments in nations operating federal systems of governments are so
critical to the individual nations in particular and the globe at large. This is because such fiscal relations determine the economic stability of the
countries and the subsequent impact on their growth.
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In Nigeria, the country’s fiscal system has been the subject of much research
2
. Yet the fiscal problems appear to have worsened after
1999. The vertical and horizontal fiscal problems have resulted to high tension among the levels of governments and groups. They have also
aggravated agitations and tension among the states and local governments. In addition, the militancy and open rebellion in the Niger Delta Region
took a more dangerous dimension and became a threat to the peace and stability of the nation after 1999. Given the possibility that the effects
may be systematic, it is important to measure and analyze the cost of fiscal centralization to provide the needed information for reforming the
fiscal system.
The present study is expected to measure the cost of maintaining the present fiscal centralization in Nigeria and analyze the
sustainability of the fiscal system. It is likely that the cost will be so enormous that maintaining fiscal centralization will be detrimental to
economic growth of the country. The recommendations from the study shall present to policy makers the opportunity to choose the best options
in solving the perennial problems caused by the present fiscal centralization in the country.
1.7 The Organization of the Study
The work is organized into six chapters. Chapter one is the introduction which contains the background to the study, problem
statement, aims and objectives, and the justification of the study. Chapter two presents an overview of the evolution of fiscal system in Nigeria.
The evolution is presented in two parts, the colonial period and the post- colonial period. Chapter three is the literature review, where the
conceptual and measurement issues are clarified. Theories of fiscal systems, the political economy of oil and gas, and empirical literature are
presented. While chapter four discusses the methodology, chapter five presents and discusses the results. Chapter six contains the summary,
conclusion and recommendations.
2 See The Nigerian Economic Society’s Annual Conference, (1999), Ogbogu, (1982), Mbanefoh, (1993), Chete
(1998) Aigbokhan, (2006)

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