TESTING THE APPLICABILITY OF WAGNER’S LAW IN NIGERIA’S ECONOMY

(1981-2013)

ABSTRACT

Wagner’s Law suggests that as the economic activity of a country increases, so does its
government expenditure. This study tests Wagner’s laws for Nigeria using annual time series
data between 1981 and 2013. It adopts three of the most advanced econometric methods, the
Johansen co-integration, Error correction Mechanism and the Granger causality test. From
the co-integration  results we found out that their exists a long run relationship between
government expenditure and National income in Nigeria, but on getting to the Granger
causality test we found out that causality runs from Government expenditure to National
income. The Granger causality test results show that Wagner’s law does not hold forNigeria,
over the period been tested. Rather we found empirical support in the proposition by Keynes
that public expenditure is an exogenous factor and a policy instrument for increasing national
income.

CHAPTER ONE

INTRODUCTION

1.1   Backgrounds To The Study

Adolph Wagner (1835-1917) was a German economist, politician, and public finance scholar.
He put forward his law of increasing public expenditures in 1893 known as wagner’s
hypothesis (WH) or Wagner’s law (WL). Adolph Wagner was perhaps the first to offer a
direct economic account of the increasing public expenditures. Musgrave and Musgrave
(1988) noted that he anticipated the trends to be realized fifty to hundred years later that
development of modern industrial society would give rise to increase political pressure for
social progress and a continuous increase in public sector.

Wagner’s law was derived from the historical experiences of the early stages of
industrialization inEuropeandGermanyin particular. Wagner identified three main factors for
increased government spending. First, administrative and protective role of government will
increase as a country’s economy develops. Secondly, with the expansion of economy,
government expenditures on “culture and welfare” would rise, particularly on education and
health. Finally the technological progress of the industrialized nations requires government to
undertake certain economic services for which private sector is shy (khan, 1990).

Wagner’s law since its emergence has been the subject of intensive and extensive
investigations. In particular, after the Second World War (1939-1945), when public
consumption declined in favour of the private activities development. In other words,
Wagner’s law states that government expenditure grows because there is an increasing
demand for public goods and for the control of externalities caused by growth and
development of the economy. In effect, the law also suggests that causality runs from national
income to public expenditure, indicating that public expenditure is considered endogenous to
the growth of national income.

In contrast, Keynesian hypothesis emphasizes that economic growth occurs as a result of

rising public expenditure and is considered as an independent exogenous variable to influence
the economic growth. The direction of causality runs from public expenditure to national
income (Keynes, 1963). Therefore, the Keynesian and the Wagnerian approaches represent
two alternative points of views towards the causality between government expenditure and
aggregate income.

Thus the growth of public expenditure as a proportion of Gross National product (GNP) has
received considerable attention from economists around the world,Nigeriainclusively.

The public expenditure of Nigeria has been growing tremendously since the 1970’s both in
relative and absolute terms particularly due to super abundance of “petro-naira” that boost the
economic growth of the nation. According to Aregbenyen (2006) “federal government
expenditure inNigeriaincreased at an average of 28.35 percent every 5years between 1970
and 2003.

The role of the public sector inNigeriadevelopment has undergone a fundamental

transformation since the nation achieved independence onOctober 1, 1960. It is a known fact
thatNigeriapracticed a “mixed economy where public sector and private sector coexist and
presumably cooperate. However while the balance was in favour of the public sector, during
the first two decades after independence, there has been  a tilt towards the dominance of the
private sector. However, the explosion of international oil price transformed the macro
economic situation, dramatically expanding government revenues and enabling government
to become the key investor in the economy. The public enterprise expanded to include
enterprises spinning various sub-sectors and accounting for some of government expenditure
(Ukwu: 2006). It was estimated that in the 1970’s, there were over 1500 public enterprises of
various types, of which the federal government has 600 and the states and Local government
have the rest. The economic important of public enterprises was reflected in the fact that in
1977 federal public corporations alone accounted for 17percent of modern sector
employment or 28percent of public sector employment. And in the Federal budget for 1982
named public enterprises accounted for 25percent of Federal government recurrent
expenditure, 80percent of recurrent grants and subvention and a full 50percent of the capital
programme (Ukwu: 1989).

The background of the study is that both government expenditure and National income have
averagely maintained positive trend in the last three and half decades. This is such that in
some occasion government expenditure is found to be growing at a faster rate than National
income. Against this background, we therefore expect the validity of either Wagner’s law
(that during industrialization process, as real income per capital of a nation increases, the
shares of governments in total expenditure increases), or Keynesian hypothesis (that
government expenditure is an exogenous variable and policy instrument for achieving
economic growth) or both.

1.2   Statement Of Problem

In the 20th century and especially since the end of the Second World War (1939-1945) there
has been a tendency for the size of government expenditure to increase in both developed and
developing countries. It is also confirmed that the gross national product (GNP) or the gross
domestic product (GDP) has also been increasing in most of these countries. However, what
has emerged from virtually all studies is that government expenditures tend to rise at a faster
rate than the GNP or GDP in both more Developed countries (LDCS), (Iyoha; 2004).
InNigeria, a key aspect of the economic analysis of the public sector is the study of the size of
government expenditure especially in relations to national income or GDP. Public
expenditure and national income have been increased steadily since 1970, But there was a
down turn in middle 1980’s when the collapse of international prices of crude oil severely
reduced both government revenue and national income.

Extensive empirical analysis of Wagner’s law has produced mixed results inNigeriaas in
other countries of the world. Some studies supports Wagner’s law i.e Aregbeyen (2006) using
Johansen co-integration and standard causality tests, supported that Wagner’s law holds in
Nigeria, another supporter of this is Aigbokham (1996), while other studies such as ; Essien
(1997) found that the variable (public spending and real income) were not co integrated and
hence could not establish a long run relationship, Babatunde (2008) also did not find any
evidence in support of the law in Nigeria.

As a result of the controversies over the validity of Wagner’s law in the Nigerian economy.
This research work is aimed at re-estimating and re-evaluating the Wagner’s hypothesis
forNigeria, using a more robust estimation method. While researching on this topic,
researchers have made use of different scope; Bigben Chukwuma Ogbonna made use of the
period (1950-2008), M. Adetunji babatunde made use of the period (1970-2006). This study
fills the gap by making use of a more recent scope (1981-2013).

1.3 Research  Questions

 Ø Is there any significant effect of national income aggregates (such as GDP) on

public expenditure?
 Ø Is there a long run relationship between national income and public expenditure
inNigeria?
 Ø Is the causality between the two variables bidirectional?

1.4   Objectives Of The Study

This study is aimed at verifying and discussing empirically the validity of Wagner’s law (the
tendency for government activities to expand in relations to economic progress) in the
Nigerian economy.

The specific objectives of this study include;

 Ø To investigate if there is any significant effect of national income aggregates (i.e

GDP) on public expenditure.
 Ø To ascertain if there is a long run relationship between National income and public
expenditure inNigeria.
 Ø To investigate if there exists a bidirectional causality between the two variables.
       Generally, there are at least two reasons for re-estimating Wagner’s law forNigeria. First,
we attempt to reach some insights in order to develop better theories of public expenditure
growth in the case ofNigeria. Second, so that we can eliminate earlier studies methodological
shortcomings in terms of Wagner’s law.

1.5   Significance Of The Study

This research work is considered significant in the following ways:

 Ø The finding of this study will be relevant to policy makers as it is going to enrich
their insights in order to develop better theories of public expenditure growth
forNigeria.
 Ø The findings of this study will also be useful to the governments in developing
planning, as it will reveal the direction of causal arrow between national income and
government expenditure.
 Ø Finally, this study will serve as a reference material (point) for further researches or
studies.

 1.6  Research Hypothesis

     The following hypothesis will guide this research work; 

 Ø Ho: B1=0;There is no significant effect of national income aggregates on public

expenditure.
 Ø Ho: B10;There is a significant effect of national income aggregates on public
expenditure.
 Ø Ho: B1=0; There is no long-run relationship between national income aggregates
and public expenditures.
 Ø Ho: B10; There is a long-run relationship between national income aggregates and
public expenditures.
 Ø Ho: B1=0; There is no bidirectional causality between the two variables.
 Ø Ho: B10; There is a bidirectional causality between the two variables.

1.7   Scope and Limitations  of the Study

The following posed a constroint to this study:

 Ø Finance: money as we know is a scarce commodity. Consequently, financial

limitation is one of the problems encountered in the course of this study.
 Ø Time constraint: The time set for this study is too short as it is expected that the
complete work should be submitted within a semester which is too short to carry out a
normal research work.
 Ø Poor data: poor data and information of this country hampered the smooth outcome
of this research, as some data needed for this research were either incomplete or
inconsistent.

1.8   Operational Definition of Terms

       To make this work more understandable and clear, the key economic terminologies that
feature in this study are defined below.
Wagner’s Law: Wagner’s law is an economic proposition advanced by Adolph Wagner in
1983, which states. “In the course of economic growth, government expenditures expand a
even faster than national income”.

Government Expenditure: Government expenditure is the part of total spending in a

country over a given period that is financed by the government. It is used to measure the
extent to which a government involves in economic activities as well as the size of a given
government.

Economic Growth: Economic growth is the quantitative and qualitative increase in output

and improvement in the productive capacity of an economy, over a given period of time.

National Income: National income is the total income of the residents of a country measured
at factor cost after deducting capital consumption (GDP) this equals gross national product
(GNP). In the study, we follow Halicioglu (2003) in using GDP as measure of National
income inNigeria.

1.9   Organization of the Study

This study is harmonized into five (5) chapters. Chapter one is the introduction which include
the background of the study, statement of problems, significance of the study, objectives of
the study, hypothesis of the study, limitation and scope of the study, definition of terms,
organization of the study and chapter references. Chapter two is the literature review which
encompasses theoretical literature and empirical literature on Wagner’s law and chapter
references. Chapter three is the methodology which consists of research design, model
specification, and method of estimation, method of verification of hypothesis, required data
and sources as well as chapter references. Chapter four contains the presentation and analysis
of results, evaluation of parameter, verification of hypothesis, discussion, as well as chapter
references. While the last chapter five incorporates the summary of finding,
recommendations and conclusion as well as references and appendix