CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Capital formation refers of the proportion of present income saved and invested in order to augment future output and income. It usually results from acquisition of new factory a long with machinery, equipment and all productive capital goods. Capital formation is equivalent to an increase in physical capital stock of a nation with investment in social and economic infrastructure.
Capital formation plays an important role in economic growth and development process. It has always be seen as potential growth enhancing player. Capital formation determines the national capacity to produce, which in turns, affects economic growth. Deficiency of capital formation has become one central issues in empirical macroeconomics. One popular theory “Big Push” in 1970s, for example, suggested that countries needed to jump from one stage of development to another through a virtuous. Cycle in which large investment in infrastructure and education coupled with private investment would move the economy to a more productive stage, breaking free from economic paradigms appropriate to a lower productive stage. Growth models like the ones developed by Lucas (1988) predict that increased capital accumulation can result in a permanent increase in growth rates.
Economic theories have shown that capital formation plays a crucial role in the models of economic growth (Beddies 1999, Ghura and Hadjji – Micheal 1996, Ghura, 1997). This view called capital fundamentalism by Yoto Poulos and Nugent (1976) has been reflected in the macro-economic performances of many countries. It is clear that even mildly robust growth rates can be sustained over periods only when countries are able to maintain capital formation at a sizeable proportion of GDP. It has been discovered that any proportion less than 27 percent cannot sustain economic growth. It is estimated that the ratio of gross capital formation to GDP in the sub-Saharan African countries which has experienced poor growth in the 1990s was less than 17 percent compared to 28 percent in advanced countries (Hernandez – Cata 2000). This phenomenon justifies the strong linage between capital formation and economic growth. In order to trace the linkage between the capital formation and economic growth, the gross capital formation of each year is normally scaled to the gross domestic product (GDP). Thus fluctuations in capital formation is said to have considerable effect on economic growth. However, the proportion of capital formation to GDP that can sustain a robust economic growth must not be less than 27 percent and in some cases; it must go as high as 37 percent (Gillis et al 1987).
The relationship between capital formation of the nation and economic growth has been documented in a number of empirical investigations. The result which has been found in several analysis is that causality exists between capital accumulation and economic growth.
Nevertheless, understanding the determinants of the capital formation is a crucial prerequisite in designing a number of policy interventions towards achieving economic growth. The process of capital formation is cumulative and self-feeding. It involves three inter-related conditions.
The existence of real saving and rise in them;
The existence of credit and financial institutions to mobilize savings and to direct them to desired channels; and
To use these saving for investment in capital goods (Jhingan, 2006).
Therefore, we can understand that savings is the major determinant of capital formation. It is widely believed that an increase in the proportion of national income devoted to capital formation is only one avenue for growth. Therefore, people are encourage to save more than to consume, because a growing economic requires a constant flow of fund for investment in order to assure a supply of capital goods adequate for production of consumer goods and replacement of obsolete equipment.
In 1986, the government of Nigeria considered need for improvement in capital formation and pursued an economic reform that shifted emphasis on private sector. The sector reforms were expected to ensure that interest rates were positive in real terms and to encourage saving thereby ensuring that investment funds would be readily available to the real sector. Besides, this the reforms were expected to lead to efficiency and productivity of labour, efficient utilization of economic resources, increase aggregate supply, reduces unemployment and generate low inflation rate. Unfortunately, these reforms were unable to achieve a desired result as a result of macro-economic imbalances such as deteriorating exchange rate and corruption in public sector. The inadequacy in economic infrastructure such as poor power supply, bad road network as well as poor health facilities were equally responsible for the failure of these reforms on capital formation. Overall, the speed and the strength of economic growth in Nigeria have not been satisfactory.
1.2 STATEMENT OF PROBLEM
Capital formation is a concept used in macroeconomics, national accounts and financial economics. It can be defined in three ways:
It is a specific statistical concept used in national account statistics, econometrics and macroeconomics (Wikipedia Encyclopedias). In that sense, it refers to a measure of the net additions to the (physical) capital stock of a country (or an economic sector) in an accounting interval, or, a measure of the amount by which the total physical capital stock increased during an accounting period.
It is used also in economic theory, as a modern general term for capital accumulation, referring to the total “stock of capital” that has been formed, or the growth of this total capital stock (Wikipedia Encyclopedia).
In a much broader sense, the term capital formation has in more recent times been in financial economics to refers to savings drives setting up financial institutions, fiscal measures, publics borrowing, development of capital market, privatization of financial institutions, development of secondary financial market (Wikipedia Encyclopedia). In this case, it refers to any method for increasing the amount of capital owned or under one’s control or any method in utilizing or mobilizing capital resources for investment purposes. Thus capital could be “forms” in the sense of being brought together for investment purposes in many different ways. This broadened meaning is not related to the statistical measurement of concept nor the classical understanding of concept in economic theory.
Economics growth on the other hand, is the increase of per capital gross domestic product (GDP) or other measure of aggregated income. It is often measured as the rate of change in real GDP. Economists draw a distinction between short-term economic stabilization and long-term economic growth. Economic growth refers to the quantity of goods and services produced. The topic of economic growth is primarily concerned with the long run. The short run variation of economic growth is termed the business cycle. The long-run path of economic growth is one of the central question of economies, despite some problems of measurement, an increase in GDP of country is generally taken as an increase in the standard of living of its inhabitants (Snowdon And ZVane, 2005).
Capital has been seen as growth enhancing player. There has been a problem of vicious circle of poverty that tend to perpetuate the low level of development in less developed countries (LDCs) and it sterms from the fact that there is low level of productivity in LDCs due to deficiency of capital as one of the crucial variable in the development process. Classical economists specified that high productivity could be achieved only if more tools and machinery were made available for production. Thus, Nurke (1951), states that vicious circle of poverty in under developed countries could be broken through capital formation.
Over two decades ago, Nigeria policy makers pursed a Structural Adjustment Program (SAP) which shifted emphasis from public sectors to private sectors. The goal was to encourage private domestic savings, private domestic investment and capital formation in order to enhance economic growth. In an attempt to achieve this goal, resources were diverted from current consumption and were invested in capital formation through privatization and commercialization of state enterprises. Diversion of resource from current consumption is called saving. But unfortunately, the initial optimism expressed about public sector reforms has not been met. Although the reform program to privatization and commercialization of many state enterprises and improvement in some macroeconomic variables like the nominal interest rate, and money supply there have been disappointing performance. For example, Nigeria continues to be confronted with low rate of economic growth. Besides, the aggregate supply continues to diminish leading to demand-pull inflation. One worrisome aspect of the result of liberalization of the public sector in Nigeria is the extent of distress in the sector including high rate of unemployment.
Nevertheless, understanding the determinants of capital formation in a crucial prerequisite in designing a number of policy interventions towards achieving high capital accumulation and increased economic growth. There are many factors that determine capital formation for instance, savings, interest rate, foreign direct investment (DI), exchange rate etc. These factors captured have been examined intensively in the literature by many economists. For instances, Jhingan (2006), argues that the rate of capital formation is low in LDCs, the reason being that they lack in those factors which determine capital formation. He stressed that the issue, thus “ in fact capital formation depends upon savings, on the institution mobilizing. These savings and on the investment of these savings.
Based on the problems stated above, it becomes pertinent for these research work to be carried out. Bearing in mind that capital formation engenders economic growth, it becomes necessary to ascertain how significant capital formation has been to Nigeria’s economic growth. Also bearing in mind that there are many factors that determine capital formation, it also becomes necessary to pin down which of the specific variables among others, significantly impact on the growth rate of capital formation impact on the growth rate of capital formation so as to help in the design of a well articulated policy.
Based on the foregoing analysis, therefore this research is guided by the following questions.
1.3 RESEARCH QUESTIONS
From the analysis stated above, this research work is guided by the following questions.
What is the impact of capital formation on economic growth in Nigeria?
What is the impact of inflation on economic growth in Nigeria?
What is the impact of government deficit on economic growth in Nigeria?
What is the impact of money supply on economic growth in Nigeria?

1.4 OBJECTIVE OF THE STUDY
The broad object of the study is to find out the impact of capital formation on economic growth in Nigeria. The specific objectives are as follow.
To ascertain the impact of capital formation on economic growth in Nigeria.
To ascertain the impact of inflation on economic growth in Nigeria.
To ascertain the impact of government deficit on economic growth in Nigeria.
To ascertain the impact of money supply on economic growth in Nigeria.
1.5 STATEMENT OF HYPOTHESES
The hypotheses to be tested in this research work are stated below:
Capital formation has no impact on economic growth in Nigeria.
Inflation has no impact on economic growth in Nigeria
Government deficit has no impact on economic growth in Nigeria
Money supply has no impact on economic growth in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
It is obvious that the importance of capital formation on economic growth cannot be ignored. Understanding the relationship between capital formation and economic growth would have significant implications to the study of Nigeria economy. To this end, the major significance of the study are as follow.
It would provide an econometric assessment of the contribution of capital formation on economic growth in Nigeria.
It would identify factor responsible for poor performance of capital formation in Nigeria over the years.
It would show how money supply has gone so far to affect Nigerian economic growth.

1.7 SCOPE OF THE STUDY
The study covers thirty years of observation (1980 – 2010). There are many variables that are affecting Nigeria economic growth but this research work will only covers the following variables. Gross Fixed capital, Inflation, Government deficit and many supply. However, other variables will be captured be the error terms.
1.8 LIMITATION OF THE STUDY
This work is principally limited to the analysis of the Nigeria economy. However, it is limited to the use of secondary data. The study uses annual time series data. Quarterly time series data would have been a better alternatives that is not chosen because most of the data are presented on annual basis
Owning to this, the researcher acknowledge any inadequacy or anomaly that may be encounter here in.

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