Chapter One

Introduction

1.1 Background of the study[1]

This thesis investigates the impact of economic liberalisation on the development and performance of manufacturing Small and Medium Sized Enterprises (SMEs) in Nigeria; in this specific context, the effects of trade and financial market liberalisation on the development, performance and survival of manufacturing SMEs. The Nigerian government has, since independence in 1960, implemented various economic policies, such as the Import Substitution Industrialisation (ISI) Strategy, the Structural Adjustment Programme (SAP) trade and financial market liberalisation (Adenikinju and Chete, 2002; Mesike, Giroh and Owie, 2008). All these policies were implemented by the Nigerian government in an attempt to develop the country and make it economically and politically self-sufficient (Agboli and Ukaegbu, 2006).

The ISI policy was meant to develop the industrial potentials of Nigeria, but some analysts believed that the programme achieved very minimal success. It was believed that the ISI policy was plagued with problems ranging from policy inconsistencies and lack of commitment on the part of the government and its agencies, to initiate and conclusively implement economic programmes (Ikpeze, Soludo and Elekwa, 2004; Agboli and Ukaegbu, 2006; Ayadi, Adegbite and Ayadi, 2008). The lack of commitment and inconsistencies were linked to the inability of the government to prudently and judiciously manage the revenue proceeds from the sale of primary products with public governance immediately after independence towards sustainable economic development of the country (AkyüzandGore, 2001).

Nigeria’s gross domestic product (GDP) per capita was put at $300 per annum in 1998 and in 2007, was estimated at $1,169. The country is classified among less developed countries (LDC) of Sub Saharan Africa (SSA) under the tariff order of 2005 (IMF, 1999; UNSD, 2009). According to the World development report of 1997, LDCs are countries that their level of economic and social developments are lower than that of the advanced capitalist West due to their low industrial base and dependence on primary product export.

Nigeria is a major exporter of crude oil and producer of primary products such as cocoa, rubber, cotton, and groundnut. It relies heavily on revenue from the sale of crude oil and the primary products (Mesike, Giroh and Owie, 2008).In the late 1970s and early 1980s, the Nigerian economy faced a serious balance of payment crisis, following the fall in the international market price for primary products, including crude oil (Mosley, 1992; Akinlo, 1996). The subsequent fall in revenue, due to the drop in demand for primary products in the international market, resulted in balance of payment problems. This prompted the Nigerian government to embark on a fundamental economic reform process called SAP based on the recommendation of International Monetary Fund (IMF) and the World Bank (WB) (Okome, 1999).

The SAP prepared the ground for the complete liberalisation of the Nigerian economy, with the aim of creating a competitive business environment for manufacturing SMEs and Multinational Corporations (MNCs) (Onyeonoru, 2003). It was envisaged that economic liberalisation would give SMEs the chance to exploit the domestic market and also explore international market opportunities occasioned by the liberalised business environment (Dawson, 1994; Vachani, 1994). In so doing, SMEs would then have an unhindered opportunity to contribute meaningfully to the economic development of Nigeria and help reduce the reliance on primary products (Agboli and Ukaegbu, 2006; Obokoh, 2008c).

It has been argued that SMEs are an effective instrument for economic growth and development in Developed and Less Developed Countries (Beyene, 2002; Nitani, 2005). This is because SMEs contribute significantly to the Gross Domestic Product (GDP) and produce substantial amounts of locally consumed products (ECA, 2000; Wattanapruttipaisan, 2003; Tagoe, Nyarko and Anuwa-Amarh, 2005; Saleh and Ndubisi, 2006). According to Mojmir (2000), SMEs play an important role in the economic growth of any country including industrialised countries because they account for more than half of a country’s output and employment (Hussain, Matlay and Scott, 2008). In the same vein, Udechukwu (2003) asserts that the development of SMEs is an essential element in the growth strategy of most economies, which holds particular significance for developing countries like Nigeria. SMEs are a vital part of any market economy because they are represented in all major branches of manufacturing and service sectors (Obokoh, 2008c). This is in addition to their role in job creation for the unemployed, provision of goods and services within and across national boundaries of countries (Saleh and Ndubisi 2006; Woldie, Leighton and Adesua, 2008).

Due to their small size, SMEs are flexible and are more able to adapt to changes within the market environment than large firms (Mazzarol, 2000; Udechukwu, 2003; Aryeetey, 2005). However, the small size of SMEs and their small capital base also constitutes an obstacle to their access to funds for their operations (Obokoh, 2008d). It is expected that SMEs, with ready and willing entrepreneurs, can succeed in an increasingly competitive world, especially if there are enabling and supportive government policies (Biggs, 2007). In this vein, Berry (2002) asserts that the flexibility of SMEs operations persuades business analysts to believe in their strategic role towards future industrial growth of developing nations. Despite this flexibility, SMEs are also exposed to external environmental risks such as government policies and competition from MNCs (Watson and Everett, 1999; Abonyi, 2003). Some of these environmental factors often hinder SMEs from gaining the necessary international exposure for achieving large scale production for the efficient utilisation of resources (Mambula, 2004).

Given favourable policy environment and support, it is believed that SMEs can achieve an efficient production process that would enable them to compete successfully in the global market (Briggs, 2007). Therefore, government policies should be directed towards improving the economic environment in which SMEs operate (Fredland and Morris, 1976; Everett and Watson, 1998). There is now a re-newed emphasis on the development of SMEs especially in LDCs (ECA 2001). This is in view of LDCs governments’ formulation of policies that would create the enabling environment for the establishment and the operation of SMEs (Agboli and Ukaegbu, 2006).

The re-newed emphasis by various Governments in LDCs on SMEs development can be linked to the current global trend of economic liberalisation and the need to bridge the development gap, that hitherto existed between LDCs and industrialised countries through private sector participation (Akinlo, 1996). The realisation of the need to encourage private sector (SMEs) participation in economic activities was borne from the balance of payment crisis of the 1980s. This is because the private sector that would have provided the needed substitutes for domestic consumption was not well developed owing to defaults in earlier policies.

1.2Statement of Research Problems

Prior to the liberalisation process in Nigeria, manufacturing SMEs were characterised by small capital base which constituted an obstacle to access to funds for their operations and expansion. This resulted in low productivity value-added to economic growth and Gross Domestic Product (GDP) (Dawson, 1994; Ekpenyong, 2002; Mambula, 2002).

The effect of SMEs low productivity, absence of a strong private sector (SMEs) and the dismal performance of the manufacturing sector to sustained economic growth in Nigeria became evident in the early 1980s, following the fall in the international market price for crude oil. The revenue from crude oil sales accruing to the government dropped drastically, which led to a balance of payment deficit and the government’s inability to meet up with import bills (Adenikiju and Chete, 2002). The recognition of the vital role of the private sector and manufacturing SMEs necessitated the need for economic reform that culminated in the liberalisation of trade and financial market by the Nigerian government (Mosley, 1992; Adenikinju and Chete, 2002).

The liberalisation of the financial market was aimed at creating avenues for easy and cheap access to finance for SMEs. It was widely believed that the Nigerian financial market was highly repressed by the government’s regulation of the interest rates through the Central Bank of Nigeria (Akinlo and Odusola, 2003). In order to make the liberalisation of the financial market effective, the government removed the restriction on exchange rate movement to allow free flow of investible funds into and out of the country and also make market forces determine the Naira exchange rate (Obadan, 2006a). The liberalisation of the financial market that resulted in the deregulation of interest rates and exchange rates had two basic purposes. The first was to maintain a positive real interest rate in order to encourage savings which would make funds available and accessible to SMEs. The second purpose was to devalue the Naira exchange rate to make the import of finished goods more expensive and less attractive to Nigerians (Ikhide and Yinusa, 1998). It was also envisaged that this would provide the needed opportunity for SMEs development through the utilisation of local raw material and intermediate inputs for production (Dawson, 1994).

On the other hand, trade liberalisation resulted in the abolition of import license, tariffs, and removal of import and export restrictions. The liberalised trade was intended to create competition in the domestic goods market for the production and distribution of consumables, especially with the free import of finished goods. In addition, it was envisaged that the competition brought about by liberalised trade would help reduce the rent seeking ability of large manufacturing firms and eliminate the inefficient ones(Söderbom and Teal, 2002; Akinlo, 2006). The liberalised trade was also meant to promote the development and utilisation of indigenous technology; generate employment and encourage the export of manufactured goods by SMEs.

However, the SAP policy that prompted the reform process anchored on the neoliberal policy of the Washington Consensus precluded the government from direct participation in economic activities. This then confined the government to a supervisory role in order to allow market forces to determine the allocation of scarce resources. The SAP policy also required the government to cut down on public expenditure and the removal of subsidies on petroleum and other items (Mosley, 1992). The reduction in public expenditure then resulted in serious cases of non-performance of public infrastructure owing to poor budgetary outlays towards their expansion and rehabilitation (Lee and Anas, 1992; Agboli and Ukaegbu, 2006). The bottom line of the economic reform in Nigeria was to create a conducive and competitive business environment for the development of private sector, especially manufacturing SMEs.

Financial market liberalization enabled the government to pursue positive real interest rates, as a means of inducing local savings and attracting foreign funds from abroad (Ikhide and Alawode, 2002, Obokoh, 2009). On the other hand, the devaluation of the Naira was aimed at discouraging the import of finished goods. While the deregulation of the foreign exchange market, allowed the Naira to float against other major currencies. It was envisaged that this would facilitate easy access to foreign exchange for the importation of needed raw material and intermediate goods. Despite the perceived advantages of these actions, the outcome created obstacles to SMEs competitive performance in Nigeria. These policies have put SMEs in a position where they have to struggle for survival and have even led to the failure of some SMEs against the expectation of exporting their finished products, as was promised by the liberalization policy. In addition, the absence of functioning public infrastructure and the low level of technological development in Nigeria constituted a serious obstacle to SMEs competitiveness.

In this thesis it is argued that these problems militate against the performance and development of SMEs. It also gave an insight as to why government programmes designed for the development of manufacturing SMEs have failed to achieve their desired objectives (Mambula, 2002) under an economic liberalisation policy in Nigeria.

1.3Research question

In view of the perceived benefits of economic liberalisation by the Nigerian government and the opinions of the proponents of liberalisation, the main research question of this thesis is; what is the impact of economic liberalisation on manufacturing SMEs in Nigeria? The answer to this question would enable this study to assess the desirability, or otherwise, of economic (trade and financial market) liberalisation that commenced in 1987. The following sub questions would assist in answering the main research question and also help in assessing the impact of economic liberalisation policy on the development, performance and survival of SMEs in Nigeria:

(i)What is the effect of interest rate liberalisation on SMEs performance and is there any link with the shut down decision of SMEs?

(ii)What is the effect of exchange rate deregulation on SMEs performance and does it have any link with the failures of SMEs in Nigeria?

(iii)To what extent has the liberalisation of the financial market solved the problems of access to finance for SMEs?

(iv)To what extent has trade liberalisation facilitated the export of manufactured goods by SMEs?

(v)To what extent has the state of infrastructure in Nigeria hindered the performance and competitiveness of SMEs in the liberalised economy?

(vi)What are the constraints of SMEs after economic liberalisation and how have these constraints hindered their performance?

(vii)To what extent has the government development programmes designed to boost SMEs performance achieved their desired goals under a liberalised economic environment?

1.4Objectives of the study

This study sets out to examine empirically the impact of economic liberalisation on manufacturing SMEs in Nigeria and how it has affected their profits, turnover and cost of operation. The specific objectives of this study therefore are to:

(i)Examine the effects of interest rate deregulation on the performance of manufacturing SMEs and to establish if there is link with the shut down decision of SMEs.

(ii)Analyse the effects of exchange rate deregulation on manufacturing SMEs and if it has any link with the failures of SMEs.

(iii)Investigate the impact of financial market liberalisation on the problem of access to finance for manufacturing SMEs and if it has solved the problem of access to finance for SMEs.

(iv)Examine whether the removal of trade restrictions improved manufacturing SMEs opportunities in the international market or facilitated the export of their finished goods.

(v)Examine the effects of the state of infrastructure on the performance and competitiveness of SMEs in a liberalised economy of Nigeria.

(vi)Highlight the constraints of SMEs after economic (trade and financial liberalisation) and how these constraints impact on their performance in Nigeria.

(vii)Investigate the reasons why programmes designed by the government to boost manufacturing SMEs performance are yet to fully achieve their desired objectives.

The performance of SMEs in this study would be measured in terms of cost of operations (production cost), sales/ turnover and profits.

1.5Hypothesis of the study

The following null and their alternate hypothesis were formulated based on the literature that high interest rates affect working capital and output of firms which invariably also affect profits (Wijnbergen, 1985). It has also been argued that SMEs are more sensitive to interest rates shocks compared to big businesses because of their small resources (Vickery, 2008). This is on the backdrop of inadequate infrastructure in Nigeria which earlier research indicates affect the performance of SMEs due to their resorting to self provision of the needed infrastructure (Lee and Anas, 1992). These three hypotheses would be tested to find out whether they hold true for SMEs operating in Nigeria:

(i)(Ho) There is no significant relationship between high interest rates and operational cost of SMEs after financial market liberalization.

(Hi) There is significant relationship between high interest rates and operational cost of SMEs after financial market liberalization.

(ii)(Ho)There is no significant relationship between high interest rates and SMEs profit levels.

(Hi) There is significant relationship between high interest rates and SMEs profit levels.

(iii)(Ho)There is no significant relationship between the state of infrastructure and the operational costs of SMEs.

(Hi) There is significant relationship between the state of infrastructure and the operational costs of SMEs.

1.6Motivation and Justification for the study

This study is motivated by the fact thatall the studies on economic globalization and liberalization in developing countries, including Nigeria, have dwelt on narrow issues of the effects of either financial market liberalisation or trade liberalisation. Issues discussed in those studies revolved around theproblems of access to finance by SMEs and the positive effects of market determined interest rates. On the other hand, studies on trade liberalisation dwelt on problems of raw materials constraints affecting SMEs and the need for the removal of all trade restriction that encourages competition among manufacturing firms in Nigeria (see for example Mambula, 1997; Adenikinju and Chete, 2002; Ekpenyong, 2002; Mambula, 2002; Iyanda, 2003; Onyeonoru, 2003; Udechukwu, 2003; Aryeetey, 2005; Tagoe et al, 2005). None of these studies have so far investigated how the performance of manufacturing SMEs in Nigeria has been affected by the combined effects of trade and financial market liberalisation in view of the poor state of infrastructure in Nigeria. That is, how the high interest rates, the depreciation of the Naira and the removal of trade restrictions as a result of economic liberalisation policy have affected SMEs in view of the poor state of infrastructure. This study attempts to bridge the gap in literature with respect to these economic variables which it believes has led to the failures of most manufacturing SMEs in Nigeria.

It has been suggested that a private sector-SMEs led economy would contribute positively towards the realisation of the United Nations millennium development goal of the global partnership for economic development, through the eradication of poverty, hunger and job creation in Nigeria and other SSA countries (Nwankwo and Richards, 2004). Based on the recognition of the importance of manufacturing SMEs’ abilities to diversify the Nigerian economy and their potentialsto contribute towards the attainment of the millennium development goalsfurther justify the need to study how the economic liberalisation policy has affected the performance and survival of SMEs in Nigeria.