Crowding-Out and Crowding-In Effects of Public Borrowing on Private Domestic Investment in Nigeria

International Journal of Research and Innovation in Social Science (IJRISS) | Volume V, Issue XI, November 2021 | ISSN 2454–6186

Crowding-Out and Crowding-In Effects of Public Borrowing on Private Domestic Investment in Nigeria

Mathias A. Chuba
Department of Economics, Achievers University Owo,
Km 1, Idasen-Ute Road, P. M. B. 1030, Ondo State, Nigeria

Abstract: Monetarists believe that public domestic borrowing crowds-out private domestic investment (PDI) and Keynesians believe that it does not crowd-out PDI. Most previous studies focused on the crowding-out effect of public spending on PDI but the point of contention between monetarists and Keynesians is the effect of increased public domestic borrowing on PDI. The results of the previous investigation that public domestic borrowing crowded-in and public external borrowing crowded-out private domestic investment in Nigeria are questionable. In view of the above stated problems, this paper determined the effect of public borrowing on PDI in Nigeria from 1986 to 2019 using a vector error correction model. The results of the investigation showed that public domestic borrowing drove-up interest rate. PDI was found to be negatively related to interest rate. Domestic credit provided by banks is positively related to interest rate. Public domestic borrowing crowded-out and public external borrowing crowded-in PDI. This paper suggests that instead of borrowing money from internal sources, the government should borrow money from external sources to finance the federal budget deficits in order to increase PDI in Nigeria.
Keywords: Private Domestic Investment, Public Borrowing, Vector Error Correction Model, Nigeria

JEL Classification: E52, E62, H62

I. INTRODUCTION

When there is a federal budget deficit, government borrows money from the credit market to finance the deficit. Government borrows money to finance the deficit from both domestic and external sources. In literature, there are two different views regarding crowding-out effect of public domestic borrowing on private domestic investment. They are monetarist and Keynesian views. In monetarist view, an increase in public domestic borrowing drives up interest rate and crowds-out private domestic investment. In Keynesian view, an increase in public domestic borrowing does not drive up interest rate and crowds-out private domestic investment (Amacher and Ulbrich, 1986). The public external borrowing crowds-in private domestic investment based on the dual gap theory. The dual gap theory states that the governments in developing countries borrow money from external sources in order to fill the domestic savings and the foreign exchange gaps. The domestic savings gap exists when the domestic savings capacity falls below that necessary to permit the level of investment required to achieve a particular rate of growth of gross domestic product (GDP) while available imports are adequate. In this situation, foreign financial resources cover this gap or make up the deficits and

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