Government Expenditure and Economic Growth in Nigeria

Government Expenditure and Economic Growth in Nigeria

Government Expenditure – Economic growth represents the expansion of a country’s potential national output or potential real GNP; the expansion of economic power to produce (Ukwu, 2004). Without some kinds of economic growth, developing countries cannot extricate themselves from the quagmire of primordial poverty. Thus, these countries usually pursue fiscal policy to achieve accelerated economic growth. The term fiscal policy refers to the use of fiscal instruments (such as taxation and spending) to influence the working of the economic system in order to maximize economic welfare (Tanzi, 1994). The main objective of fiscal policy in less developed countries should then, be promoting long term growth of the economy.

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This is because focusing on stabilization of the economy in less developed countries would mean the perpetuation of the stationary conditions of under-developed equilibrium and would be quite incompatible with the requirements of economic dynamism.

Among the fiscal instruments, the focus of this work is on government spending. Government spending, if appropriately managed and utilized, has significant positive impact on economic growth, particularly in the developing countries, where there exist poor or meager infrastructural facilities and where private sector is not developed enough to play the expected role in the economy. Because of this observation, empirical studies on the impact of government spending on economic growth have paramount importance in formulating prudent policy measures. Reviewing relevant theoretical literature can help in building a framework for empirical analysis. Below is a review of theories of economic growth commencing from early growth theories.

  • Theories of Economic Growth

The theory of economic growth generally deals with the economy’s long run trend or potential growth path (Branson, 2002;Ukwu, 2004). It studies the factors that lead to economic growth over time and analyses the forces that allow some nation to grow rapidly, some slowly and others not at all. In this section, we are going to look at economic growth from two perspectives: factors determining economic growth; and patterns of economic growth.

2.1.1 Factors Determining Economic Growth

Beginning with early growth theories, Mercantilists emphasized surplus balance of trade while the cameralist- focused on taxation and state regulation to stimulate economic growth. Later by the end of the 18th century, physiocrats emphasized agriculture as the source of economic growth of the state and the wealth of citizens since they believe it has the capacity to create investible surplus (Lambadrive, 1996).

The classical models of Smith (1776) and Malthus (1798), describe economic growth in terms of fixed land and growing population. In the absence of technological change, increasing population ultimately exhaust the supply of free land. The resulting increase in population density triggers law of diminishing returns: fixity of land keeps output from growing proportionately to increase in labour. With less and less land to work, each new worker adds less and less extra product; the decline in labour’s marginal product means a decline in the competitively earned real wage. Malthusian equilibrium, comes when the wage has fallen to a subsistence level, below which the supply of labour will not produce itself. The classical models did not consider the reality that technological progress can keep economic growth progressing in industrial countries by continually shifting the productivity curve of labour forward (Samuelson and Nordhaus, 1985). The impact of advances in technology is to shift the production possibility curve, raising output per unit of input mix (Ukwu, 2004). The realization of the phenomenon drew attention to the role of capital – which puts machinery, equipment and technology to work in economic growth. Some economists have focused on this and develop Models of Capital accumulation to explain economic growth. Capital accumulation depends on the rate of investment; itself depends on the cost of capital and the expected rate of return on capital. When investment takes place, the economy sacrifices consumption today so that it can generate more consumption tomorrow (Ukwu, 2004).

The work of Keynes and his school of thought – is strongly associated with this perspective (Keynes, 1936). The Keynesian analysis leads to the conclusion that aggregate demand management policies can and should be used to improve economic performance. For Keynesians, demand is a prerequisite for growth. Harrod-Domar growth model is the prominent model in the Keynesian framework which gives some insight into the dynamic of growth. Harrod (1948) picks on the concept of multiplier to develop a “dynamic theory of growth” based on the relationship between consumption, investment and output. A similar approach was adopted by Domar (1957) making the Harrod-Domar model one of the central theories of growth in Economics thought.

According to the model, to determine equilibrium growth rate (g) in the economy, the balance between supply and demand for a nation’s output should be maintained. On supply side, saving is a function of the level of GDP(Y), say

S = sY.                                                       2.1

The level of capital (K) is needed to produce an output. (Y) is given by the equation

I = vY;                                                        2.2

Where: v is called capital-output ratio; I is Investment representing important component of economy as well as the increase in capital stock , if I is greater than depreciation.

(Thus ∆K = V∆Y = I).                                2.3

Therefore, the equilibrium rate of growth (g) is given by

g = ∆Y/Y = s/v.                                          2.4

Thus tells us how the economy can grow such that the growth in the capacity of the economy to produce is matched by the demand for economy’s output. The analysis presented above describes the movement of output along the warranted growth path. Once the economy reaches the path, it will continue moving along it. According to the model, temporal divergence from the warranted growth path would not be self–correcting because of the lack of self–correcting forces. In the Harrod-Domar model, the growth path is said to be characterized by “Knife-edge instability” (Ketema, 2006). The policy implication of this instability is that, market-regulated growth is unstable as it seems to be in the 1930s; and then perhaps, there is need for a planned or command economy.

The weaknesses of the Harrod–Domar model are the assumption of the fixed coefficients production function (it does not allow for factor substitution) and that the saving ratio is fixed. It is also not relevant to developing economy as it assumes full employment and easy availability of capital (Ketema, 2006).

Nurske (1955) theorized about the problem of capital accumulation in a poor a country. In his famous doctrine of the “vicious circle of poverty”, he said that poor societies remain poor because with low per capita income, they could not supply enough savings to increase their stock of reproducible capital.

Rosenstein–Rodan (1943) analyzed the demand side of capital accumulation according to him, the structure of backward economies was such that there are not enough incentives for investors to choose the right pace or pattern of capital accumulation. He said that in the poor economy, the size of the market for industrial products was small and people need to spend most of their incomes on necessities, he argued that the production process in modern industries were subjected to great indivisibilities and economies of scale. He particularly identified one category of physical capital for special attention: social overhead capital like transport, communication, power, urban infrastructure etc. These activities had to be in place before private entrepreneurs could decide to install direct productive capital (MrinalDatta-Chaudhure, 1990).

The neoclassical growth model of Solow (1956) and Swan (1956) relaxes the assumption of the fixed coefficient of production made by the Harrod-Domar model. Their model is known as Solow-Swan model or simply Solow model. According to the Solow model, other things been equal, saving/investment and population growth rates are important determinants of economic growth. Higher saving and investment rates lead to accumulation of more capital per worker and higher saving/investment rates, hence more output per worker. On the other hand, high population growth has a negative effect on economic growth simply, because, a higher fraction of saving in economies with high population growth has to go to keep the capital – labor ratio, constant. In the absence of technological progress and innovation, an increase in capital per worker would not be matched by a proportional increase in output per worker because of diminishing returns. Hence capital deepening would lower the rate of return on capital.

The conclusion of Solow model is that that accumulation of physical capital cannot account for either the vast growth overtime in output per person on the vast geographic differences in output per person. The model predicted technological progress typically assumed to grow at a constant “stead state” is what determines most output growth; but the technology parameter is determined outside the model independent of preferences. The other prediction of the model is that economies may experience growth before steady state and as they approach the steady state, growth slows down and eventually ceases. This implies that poor countries with lower value of capital and output grow faster than rich ones and consequently the former tend to catch up with the latter. This second prediction of the model is one of the weaknesses of the neo-classical model of growth, because of the fact that long run data for many countries indicate that positive rates of per capita growth can persist over a century or more and that these growth rates have no clear tendency to decline (Ketema, 2006; Barro and Sala-i-Martin, 2004).

In the Solow neo-classical model, if an expansionary fiscal policy is maintained, then the long run consequences may be a lower level of steady state GDP. This is because the government – via a budget deficit derives a wedge between private saving and investment. The reason is that government absorbs part of the private saving to finance the deficit. If this results in less saving being available for private investment, the consequence will be a lower capital stock and lower steady state GDP. However, to extent that government runs a deficit in order to finance public investment on roads, schools, public health etc, the negative effect on steady state income could be reduced or eliminated (Leach, 2002).

On the other hand, even if the incentives to save or to invest in new capital are affected by fiscal policy, this alters the equilibrium capital output ratio and therefore the level of output in the economy, but not its slope (with transitional effects on the economy moves on to the new path). That is, these policies raise the growth rate temporarily as the economy grows to a higher level, but in the long run the growth rate returns to its initial level. In other words, policy changes are temporary shock which can affect growth only temporarily just until a new steady state level is reached.

Thus, the Solow model gives no room to the role of changing economic policies and institutions in explaining rises in long-run growth rates.

This article was extracted from a Project Research Work Topic


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