CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Adolph Wagner (1835–1917) was a German economist and public finance scholar. In the late nineteenth century he put forward what has become known as the law of increasing state activity, or Wagner’s law (WL), also called Wagner’s hypothesis (WH). It is often described as the first model of public expenditure in the history of public finance, and in its common form it holds that as an economy develops, public spending tends to rise relative to national income. Wagner’s ideas grew out of the historical experience of early industrialisation in Europe, and Germany in particular. Three main reasons are usually given for the expected growth of government spending. First, the administrative and protective functions of government expand as the economy develops. Second, as the economy grows, spending on culture and welfare, especially education and health, rises. Third, technological progress in industrialised countries requires government to provide certain economic services that the private sector is unwilling to supply.

Wagner’s law has been the subject of intensive and extensive investigation. Peacock and Scott (2000) observe that it has been tested with sophisticated econometric procedures, and they caution that many of these tests overlook Wagner’s own definition of state activity, which included public enterprises, and his insistence that he was not making a prediction. In its simplest testable form, the law says that government expenditure grows because the demand for public goods, and for the control of the externalities that growth creates, increases as the economy develops. It therefore implies that causality runs from national income to public expenditure, so that public spending is endogenous to the growth of national income.

The Keynesian hypothesis stands in contrast to this view. Keynes (1936) treated public spending as an exogenous factor and a policy instrument that can be used to influence economic growth, so that causality runs from public expenditure to national income. The Wagnerian and Keynesian approaches therefore represent two alternative views of the causal link between government expenditure and aggregate income. The growth of public expenditure relative to national output has attracted the attention of economists around the world, including those studying Nigeria.

Nigeria’s public expenditure has grown rapidly since the 1970s, in both relative and absolute terms, driven largely by the oil windfall that lifted government revenue. Since independence on 1 October 1960, the role of the public sector in the country’s development has changed fundamentally. Nigeria operates a mixed economy in which the public and private sectors coexist, with the balance favouring the public sector in the first two decades after independence and later tilting towards a larger role for the private sector. The rise in international oil prices transformed the macroeconomic position by greatly expanding government revenue and making government the main investor in the economy.

Government expenditure and national income have both followed a generally positive trend over the past three decades or more, and on occasion public expenditure has grown faster than national income. Against this background it is reasonable to ask whether Wagner’s law holds, that is, whether the share of government in total expenditure rises as real income per capita increases; whether the Keynesian hypothesis holds, that is, whether government expenditure is an exogenous policy instrument for achieving growth; or whether both are valid.

1.2 Statement of the Problem

Since the Second World War there has been a tendency for government expenditure to rise in both developed and developing countries, while gross national product (GNP) or gross domestic product (GDP) has also grown in most of them. The question of how the two are related, and in which direction causality runs, remains open.

In Nigeria, a central question in the economic analysis of the public sector is the size of government expenditure relative to national income or GDP. Public expenditure and national income have risen steadily since 1970, apart from a downturn in the mid-1980s when the collapse of international crude oil prices sharply reduced both government revenue and national income.

The empirical evidence for Nigeria is mixed. Some studies support Wagner’s law. Aregbeyen (2006), using Johansen cointegration and standard causality tests on data for 1970 to 2003, found causality running from national income to public expenditure. Olomola (2004) reached the same conclusion for 1970 to 2001, Ogbonna (2012) tested the law over the long period 1950 to 2008, and Nwude and Boloupremo (2018) found that government spending and national income were cointegrated and that causality ran from GDP to spending, so that only Wagner’s law and not the Keynesian hypothesis was valid for 1970 to 2014. Alimi (2013) found that the long-run evidence favoured Wagner over Keynes for 1970 to 2012, although the short-run dynamics showed two-way causality in most formulations. Dogo, Okpanachi, Muhammad, Umolu and Ajayi (2013) corroborated one version of the law, the Goffman version.

Other studies are less supportive. Owolabi-Merus (2015), using data for 1980 to 2011, found a long-run relationship between government expenditure and GDP but no causal relationship in either direction, and he concluded that neither Wagner’s law nor the Keynesian hypothesis was supported. Anoke, Odo, Chukwu and Agbi (2016) found two-way causality between national income and government expenditure for 1980 to 2015 and concluded that the law was not applicable in that form. Edeme, Okolo, Idenyi and Okolomike (2018) also found two-way causality for 1981 to 2015 but interpreted it as evidence that Wagner’s law holds. Raifu and Aminu (2020), using linear and nonlinear ARDL methods on data for 1981 to 2016, found that the symmetric form of the hypothesis held in only two of five versions tested. International evidence is also divided. For example, Halicioglu (2003) found no empirical support for the law in Turkey for 1960 to 2000.

These different results reflect differences in time period, model version and estimation method. The controversy over the validity of Wagner’s law in the Nigerian economy is therefore unresolved. This study aims to re-estimate and re-evaluate Wagner’s hypothesis for Nigeria, using the period 1981 to 2013 and a robust time-series estimation procedure, so as to add to the evidence on which of the competing views better describes the relationship between national income and public expenditure.

1.3 Research Questions

The study seeks answers to the following questions:

1. Is there any significant effect of national income aggregates (such as GDP) on public expenditure?
2. Is there a long-run relationship between national income and public expenditure in Nigeria?
3. Is the causality between the two variables bidirectional?

1.4 Objectives of the Study

The broad aim of the study is to verify and discuss empirically the validity of Wagner’s law, which is the tendency for government activities to expand as the economy progresses, in the Nigerian economy.

The specific objectives are to:

1. investigate whether national income aggregates (that is, GDP) have a significant effect on public expenditure;
2. ascertain whether there is a long-run relationship between national income and public expenditure in Nigeria; and
3. investigate whether there is bidirectional causality between the two variables.

There are at least two reasons for re-estimating Wagner’s law for Nigeria. First, the study attempts to gain insights that can support better theories of public expenditure growth in the Nigerian case. Second, it seeks to overcome the methodological shortcomings of earlier studies, which, as the review above shows, differ in the versions of the law they test and in the techniques they use (Peacock & Scott, 2000; Babatunde, 2011; Raifu & Aminu, 2020).

1.5 Significance of the Study

The study is significant in the following ways:

1. Its findings will be relevant to policy makers, since they will deepen understanding of the factors behind the growth of public expenditure in Nigeria and so support better theories of public spending.
2. The findings will be useful to government in planning, because they will show the direction of causality between national income and government expenditure, and therefore whether spending should be treated as a result of growth or as an instrument for promoting it.
3. The study will serve as a reference for further research on public expenditure and economic growth in Nigeria.

1.6 Research Hypotheses

The following hypotheses will guide the research:

H₀₁: β₁ = 0. There is no significant effect of national income aggregates on public expenditure.

H₁₁: β₁ ≠ 0. There is a significant effect of national income aggregates on public expenditure.

H₀₂: There is no long-run relationship between national income aggregates and public expenditure.

H₁₂: There is a long-run relationship between national income aggregates and public expenditure.

H₀₃: There is no bidirectional causality between national income aggregates and public expenditure.

H₁₃: There is bidirectional causality between national income aggregates and public expenditure.

1.7 Scope and Limitations of the Study

The study covers the relationship between national income, measured by GDP, and public expenditure in Nigeria for the period 1981 to 2013. It was constrained by the following factors.

Finance. Funds are limited, and financial constraints were one of the difficulties encountered in the course of the study.

Time. The period allowed for the study was too short, since the complete work was to be submitted within one semester, which is not enough for a full-scale research project.

Data. Poor data and information hampered the research, as some of the data needed were incomplete or inconsistent.

1.8 Operational Definition of Terms

To make the work clearer, the key economic terms used in the study are defined below.

Wagner’s law: An economic proposition advanced by Adolph Wagner, which states that in the course of economic growth, government expenditure tends to expand faster than national income (Peacock & Scott, 2000).

Government expenditure: The part of total spending in a country over a given period that is financed by government. It measures the extent to which government is involved in economic activity and the size of the government.

Economic growth: The quantitative and qualitative increase in the output of an economy and the improvement in its productive capacity over a given period.

National income: The total income of the residents of a country, measured at factor cost after deducting capital consumption. In this study, GDP is used as the measure of national income in Nigeria.

Keynesian hypothesis: The view that government expenditure is an exogenous variable and a policy instrument that can be used to promote economic growth, so that causality runs from public expenditure to national income (Keynes, 1936).

1.9 Organisation of the Study

The study is organised into five chapters. Chapter one is the introduction, which comprises the background to the study, the statement of the problem, the research questions, the objectives, the significance of the study, the hypotheses, the scope and limitations, the definition of terms and the organisation of the study. Chapter two is the literature review, which covers the theoretical and empirical literature on Wagner’s law. Chapter three is the methodology, which presents the research design, the model specification, the method of estimation, the method of testing the hypotheses, and the data and their sources. Chapter four presents and analyses the results, evaluates the parameters, tests the hypotheses and discusses the findings. Chapter five contains the summary of findings, the recommendations and the conclusion, followed by the references and appendix.

References

Alimi, R. S. (2013). Testing augmented Wagner’s law for Nigeria based on cointegration and error-correction modelling techniques (MPRA Paper No. 52319). University Library of Munich. https://mpra.ub.uni-muenchen.de/52319/

Anoke, C. I., Odo, S. I., Chukwu, B. C., & Agbi, P. E. (2016). Testing the applicability of Wagner’s law in Nigeria. Journal of Research in Business and Management, 4(6), 33–45.

Aregbeyen, O. (2006). Cointegration, causality and Wagner’s law: A test for Nigeria, 1970–2003. Central Bank of Nigeria Economic and Financial Review, 44(2), 1–22. https://dc.cbn.gov.ng/efr/vol44/iss2/1

Babatunde, M. A. (2011). A bounds testing analysis of Wagner’s law in Nigeria: 1970–2006. Applied Economics, 43(21), 2843–2850. https://doi.org/10.1080/00036840903425012

Dogo, M. Y., Okpanachi, U. M., Muhammad, A. A., Umolu, C. V., & Ajayi, K. J. (2013). Government size and economic growth in Nigeria: A test of Wagner’s hypothesis. Central Bank of Nigeria Economic and Financial Review, 51(3), 57–85. https://dc.cbn.gov.ng/efr/vol51/iss3/4

Edeme, R. K., Okolo, C. V., Idenyi, C. J.-F., & Okolomike, C. F. (2018). Rising public expenditure and economic growth, was Wagner right? Evidence from Nigeria. Jurnal Perspektif Pembiayaan dan Pembangunan Daerah, 6(1), 43–50. https://doi.org/10.22437/ppd.v6i1.5150

Halicioglu, F. (2003). Testing Wagner’s law for Turkey, 1960–2000. Review of Middle East Economics and Finance, 1(2), 129–140. https://doi.org/10.1080/1475368032000139279

Keynes, J. M. (1936). The general theory of employment, interest and money. Macmillan.

Nwude, E. C., & Boloupremo, T. (2018). Public expenditure and national income: Time series evidence from Nigeria. International Journal of Economics and Financial Issues, 8(1), 71–76.

Ogbonna, B. C. (2012). Does Wagner’s law hold for Nigeria? 1950–2008. JORIND, 10(2), 290–299.

Olomola, P. A. (2004). Cointegration analysis-causality testing and Wagner’s law: The case of Nigeria, 1970–2001. Journal of Social and Economic Development, 6(1), 76–90.

Owolabi-Merus, O. (2015). Re-examining the Wagner’s law versus Keynesian hypothesis: Evidence from Nigeria. International Letters of Social and Humanistic Sciences, 57, 142–146. https://doi.org/10.18052/www.scipress.com/ILSHS.57.142

Peacock, A., & Scott, A. (2000). The curious attraction of Wagner’s law. Public Choice, 102(1–2), 1–17. https://doi.org/10.1023/A:1005032817804

Raifu, I. A., & Aminu, A. (2020). A reconsideration of Wagner’s hypothesis for Nigeria using linear and nonlinear ARDL methods. International Journal of Sustainable Economy, 12(4).