The Relationship Between North American Free Trade...

Q1. Examine the various types of regional economic integration. What are the differences between the North American Free Trade Agreement (NAFTA) and the European Union’s level of integration?(2 pages maximum) Regional economic integration represents agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services and factors of production between each other. Neighboring countries tend to ally because of their proximity to one another, somewhat similar regional tastes, the relative ease of establishing channels of distribution and a willingness to cooperate with one another for the greater benefit of all allied parties. Theoretically, the concept of regional economic†¦show more content†¦Customs Union - eliminates trade barriers between member countries and adopts a common external trade policy. Custom union provides for economic cooperation as in a free trade zone. The primary difference between customs union and free trade area involves members agreeing to treat trade with non-members countries in a similar manner. Most countries who enter a customs union often desire further integration in the future. For example, the Andean Pact (for agreements between Bolivia, Columbia, Ecuador, and Peru). Common Market - allows for the creation of economically integrated markets between member countries. Trade barriers are removed, as are any restrictions on the movement of labor and capital between member countries. Like customs union, there is a common trade policy for trade with non-member nations. The primary advantage of common markets is workers are no longer needing visa or work permit to work in another member country of a common market. For example, The Common Market for Eastern and Southern Africa or simply known as COMESA. Economic Union - occurs when countries enter into an economic agreement to remove barriers to trade and adopt common economic policies. European Union or simply known as the EU is an example of economic union. The European Union or simply known as the EU is often viewed as an emerging

Effect of Interest Rate on Investment Determination in Nigria free essay sample

Interest rate reform, a policy under financial sector liberalization, was to achieve efficiency in the financial sector and engendering financial deepening. In Nigeria, financial sector reforms began with the deregulation of interest rate in august 1987 (Ikhide and Alawode, 2001). Prior to this period, the financial system operated under financial regulation and interest rates were said to be repressed. According to McKinnon (1973) and Shaw (1973), financial repression arises mostly when a country imposes ceiling on deposit and lending nominal interest rates at a low level relative to inflation. The resulting low or negative interest rates discourage saving mobilization and channeling of the mobilized savings through the financial system. This has a negative impact on the quantity and quality of investment. Therefore, the expectation of interest rate reform was that it would encourage domestic savings and make loanable funds available in the banking institutions. But the criticism has been that the â€Å"tunnel-like† structure of interest rate (Ojo, 1976) in Nigeria is capable of discourage savings and retarding investment. Because of the complementarily between savings and investment, positive real interest rates will encourage savings and the increased liabilities of the banking system will oblige financial institutions to lend more resources for productive investment in a more efficient way. Therefore, the purpose of this research work concentrates on examining the effect of interest rates on investment in a theoretical frame work that mimics the financial sector prevailing in Nigeria. The study further sets out to examine empirically the pattern and direction of financial repression through controlled interest rates and the ensuing credit rationing that impedes economic growth by discouraging financial savings and fostering low, inefficient investment in Nigeria. 1. 2STATEMENT OF THE PROBLEM If the cost of capital as determined by the interest rate is not made available for investment that are capable of increasing production and productivity, the rate of the country’s expansion (growth) will be retarded. Investment enhances economic growth. The major obstacle to economic growth in developing countries such as Nigeria is the shortage of financial resources. Nigeria has the potentials to attract investment but has not been successful in attracting it despite the effort of the central bank of Nigeria (CBN) through its intensified monetary policies. Although Nigeria has embarked on interest rate policies and structural reforms, liberalized her domestic financial market and removed restrictions on capital movement, investment has been mainly in the oil sector of her economy where the country derives over 90 percent of her Gross domestic product (GDP). In terms of diversification of domestic investment to other sectors of the economy, Nigeria has not benefitted commensurate to her potentials. In the 1987 budget announcement of the then president, General Ibrahim Babangida, it was observed that the pegging of interest rate contrary to expectation, has not achieved its desire goal of stipulating new investments nor did it result in an increased capacity utilization of industry and hence the resolve for deregulation. According to Keynesian investment theory, which sees low interest rate as a component of cost administered detrimental to increased savings and hence investment demand. They argue that increase in the real interest rate would have strong positive effects on savings which can be utilized in investment because those with excess liquidity will be encouraged to save because of the high interest rate, thus banks would have excess money to lend to investors for investment purposes thereby raising the volume of product investment. Most importantly successive government in Nigeria through the central bank has devised many strategies and means to control the unhealthy rise in interest rate and improve domestic investment. Despite these measures, investment continues to be the decline. It is based on these specifics that appreciated the following research problem: (a) What is the contribution of interest rate in determining investment in Nigeria following Keynesian argument that increased real interest rate could be efficiently in investment via savings. (b) What are the causes of low investment and fluctuating interest rate in Nigeria? (c) What are the measures to control interest rate and improve investment in Nigeria? 1. 3OBJECTIVES OF THE STUDY The general objective of this research work is to present an overview of Nigeria’s level of interest rate and its desired policy objective of enhancing investment and growth in the economy using time series analysis and annual data from 1970-2008. The specific objectives of the study are: (a) To critically examine the relationship between investment and interest rate in Nigeria. (b) To empirically investigate the effect of interest rate on investment determination in Nigeria. (c) To make recommendations based on the results of the research. . 4HYPOTHESIS OF THE STUDY (a) H0: Interest rate has no effect on investment in Nigeria. (b) H0: Income has no effect on investment in Nigeria. (c) H0: Exchange rate has no effect on investment in Nigeria. 1. 5SIGNIFICANCE OF THE STUDY The main thrust of this study is to investigate the effects of interest rate on investment determination in Nigeria. This is necessitated by fact that the behavior of interest rates to a large extent determin es the investment activities and economic growth of any country. The finding would guide policy makers in designing and implementing financial policies that would enhance private and public investment friendly interest rates which are crucial to economic growth in Nigeria. The research work implies that the behavior of interest rate is important for economic growth in view of the relationship between interest rates and investment and growth. Thus, the formation and implementation of financial policies that enhance investment friendly rate of interest is necessary for promoting economic growth in Nigeria; 1. 6DELIMITATIONS OF THE STUDY This study aims at discussing the various factors (macro-economic variables) that determines investment in the Nigeria economy and only few variable will be considered because of unavailability of data and also to avoid the violation of the ordinary least square (OLS) technique that would be used in analyzing the data. The study would also aim at analyzing the data collected from the CBN statistical bulletin and would be limited to cover the period of 1970-2008. Interest rate as used in this research refers to lending rate of banks, and income is being proxied by GDP. Efforts will be made to ensure that despite all the impediments mentioned above, this research work will be relevant in serving the objectives for which it is intended. 1. 7 DEFINITION OF TERMS (a) INTEREST RATE: It is seen as the reward for parting with liquidity for a specified period. It is the price which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash i. e. the price of credit. It could also be seen as the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time. b) INVESTMENT: It refers to capital expenditures on consumer durables, residential construction (buildings) and plants and machinery. Thus, investment refers to the purchase of real tangible assets such as machines, factories or stocks of inventories which are used in the production of goods services for future use as oppose to present consumption. Investment can also be vie wed as the sacrifice of certain present values of consumption for future value of consumption. It is the commitment of money in order to earn a financial return of the purchase of inancial assets such as stocks or bonds with future end date in mind. (c) EXCHANGE RATE: it refers to the price of one currency (domestic currency) in terms of another (foreign currency). It plays a key role in international economic transactions. The importance of exchange rate derives from the fact that it connects the price system of two different currencies, making it possible for international trade to make direct comparison of prices of traded goods. CHAPTER TWO LITERATURE REVIEW 2. 1 THEORETICAL LITERATURE Interest rate affects decisions about how to save and invest. Investors differ in their willingness to hold risky assets such as bonds and stocks. When the returns to holding stocks and bonds are highly volatile, investors who rely on these assets to provide their consumption face a relatively large chance of having low consumption at any given time. For example, before retirement, people receive a steady stream of income that helps to buffer the change in wealth associated with changes in the returns and their investment portfolios. This steady return from working helps them maintain a relatively steady level of consumption. After retirement, people no longer have the steady stream of income from working hence a less volatile investment portfolios is called for investment returns allow retirees to maintain a relatively even of consumption overtime. Interest rate policy in Nigeria is perhaps one of the most controversial of all finance policies. The reason this may not be farfetched because interest rate policy has direct bearing on many other economic variable such as investment decision. Interest rate play a crucial role in the efficient allocation of resources aimed at facilitating growth and development of an economy and as a demand management technique for achieving both internal and external balance. Nigeria experienced severe macroeconomic problems towards the end of 1970s through the first half of the 1980s when output declined substantially. The real GDP growth rate averaged only 1. 5% per annum during the period 1973-1980 (registering negative growth rate in 6years during the period) (CBN, 1990). In response to this deteriorating economic situation, the Nigeria authorities launched policy progammes contained in the structural adjustment programme (SAP). Several forms corrective measures were undertaken including financial sector reform policies. Prior to 1986 in Nigeria, a common practice has been the support of certain economic projects considered to be essential part of development strategy. Government adopted policies aimed at accomplishing specified objectives such as interest rate ceilings and selective sectoral policies. These policies were introduced with the intension of directing credit to priority sectors and securing inexpensive funding for their own activities. The ceiling on interest rates and quantity restrictions on loanable funds for certain sectors ensure that a large share of funds is made available for favored sectors. Such a practice hinders financial intermediation since the financial market will only be accommodating the credit demand of the government plan and ignoring risks. The practice has been disfavourd as a growth policy by the repressionist school led by McKinnon (1973) and Shaw (1973). According to McKinnon (1973) and Shaw (1973) financial regression paradigm, government’s efforts to promote economic growth by such indiscriminate measures have repressed financial system. This discourages financial intermediation. Thus, the repressionist school calls for financial liberalization, the removal o ceiling on interest rates among others as a growth (investment) promoting policy. According to them, the removal of interest rate ceiling will raise savings rates because the interest elasticity of private savings is positive which in turn would increase investment. To date, Nigeria has pursued tow-interest rate regime. The 1960s to mid-1980s with the administration of low interest rates which was intended to encourage investment. However, the advent of the structural adjustment programme (SAP) in the third quarter of 1986 ushered in an era when fixed and low interest rates were gradually replaced by a dynamic interest rate regime, where rates were more influenced by market forces. Hence, the pursuit of the two interest rate regime in Nigeria provided a case study of the Keynesian interest rate-investment relationship and the McKinnon (1973) and Shaw (1973) interest and investment hypothesis. The gradual deregulation of the Nigeria economy between 1986 and 1992 affected these key economic variables: interest rate and investment. In the Nigerian context, interest rates were extensively regulated prior to the adoption of SAP in 1986. But the economic rationale behind this control of interest rates and other elements of financial markets has been motivated by a variety of factors including the desire to influence the flow of credit to preferred sectors of the economy and the concern that market determined interest rate could result in serious imperfection in the market. Moreover, the upsurge in real interest rates observed worldwide in the early 1980s has raised widespread concern about their possible detrimental economic effects. Therefore, in response to these concerns, numerous studies were carried out to measure the effect of high interest rate on the key macroeconomic variables. Nevertheless, the concurrent increase in interest rates resulting from the deregulation seems to lay credence to McKinnon (1993) and Shaw (1993) interest rate and investment hypotheses. In consonance with the Fleming-Mundell model, in an open economy with perfect capital mobility and flexible exchange rate, an increase in government expenditure (income), leads to an increase in interest rate which would in turn lead to increase in capital inflow (investment) from abroad leading to exchange rate appreciation. On the other hand, capital outflow (investment) from the domestic economy would be instigated by a depreciating exchange rate whereby foreigners would purchase imported goods because they are relatively cheap. According to uchendu (1993), interest rate policy is among the emerging issues in current economic policy in Nigeria in view of the role it is expected to play in the deregulated economy in inducing savings which can be channeled to investment and thereby increasing employment, output and efficient financial resources utilization. Also, interest rates can have a substantial influence on the rate and pattern of economic growth by influencing the volume and disposition of savings as well as the volume and productivity of investment (Leahy, 1993). Nwankwo (1989), however, believes that interest rate deregulations will definitely lead to more efficient allocation of financial market resources because interest rate will now reflect scarcity and relative efficiency in different use. That is, only efficient investors will have access to scare financial resources. Abiodun (1988), on the other hand believed that deregulation of interest rate is like a double-edged sword, which will stimulated the economy or mar it He asserted that the deregulation of interest rate will lead to an increase in interest rate, which will have a positive effect on savings as savings will be increased. However, he stated that high interest rate might not bring about cost-push inflation because borrower will pass high cost of borrowing to the customers by including it in their cost of production. He further stressed that high cost of borrowing will slow down investment, as borrowing will be greatly reduced. Hence investment in new business will reduce while existing ones may not be able to compete favourably for scarce finance due to high cost of borrowing. He opined that free market should serve as checks and balance and that some measure of control of interest will be beneficial if only to deliberately channel investment into the sectors. Interest rate policy in Nigeria is discussed along the dividing period of pre-reform (1970-1986) and post reform (1987-2006) periods. In order to compare the structure of interest rates between the sub-periods, deposit rate, lending rate and minimum rediscount rates are being combined as the interest rate reform process sets in. The pre-reform period (1970-1986) is considered as a period of financial repression and was characterized by a highly regulated monetary policy environment in which policies of directed credits, interest rate ceiling and restrictive. Monetary expansion were the rule rather than the exception (Sajibo and Olayiwola, 2000). Although, the interest rate policy instruments remained fixed, there were marginal increases. For instance, the deposit rate was increased from 3% in 1975 to 9. 5% in 1986, while the lending rate rose from 9 to 12% within the same period. For the reform period (1987-2006), deposit and lending rates were allowed to be determined by market forces and the interest rates actually increased as envisaged. For instance, the nominal deposit and lending rates rose from 9. 5% and 12% in 1986, to 14% and 19. % respectively in 1987, as a result of the interest rate reform in Nigeria. By 1990, the deposit and lending rates have risen to 18. 8% and 27. 7% respectively. The government intervened in 1991 and pegged the deposit and lending rates at 14% and 21% respectively. Unfortunately, between 1997 and 2006, the lending rate did not show a significant trend in reduction with an average of 22% The implications of the â€Å"tunnel-like† structure of interest rates and the low deposit rates are that savings will likely be discouraged and this will negatively affect funds mobilization by the banks. This will in turn affect the amount of funds available for investment with retarded influence on economic growth. On the other hand, the high lending rate is detrimental to productive investment and hence economic growth. As Soyibo and Olayiwola (2000) observe, borrowers with worthwhile investment may be discourage from seeking loans and the quality of the mix of applicants could change adversely. Again, high lending interest rates could create moral hazard where loan seekers borrowed to escape bankruptcy rather than invest or finance working capital. Generally, the behavior of the interest rate structure is such that there is a wide spread margin between deposit and lending rates which may encourage speculative financial transactions. As a result of the interest of the interest rate structure in Nigeria, the real GDP growth rate which was 5. 7% in 1970 increased to 11% in 1974, but became mostly negative during the pre-reform period until 1985, when a positive real GDP growth rate of 9. 4% was achieved. With a real GDP growth rate of 4. % in 2006, Nigeria requires an average annual GDP growth rate of 7% in order to meet the united nations Millennium Development Goals (MDGS) of reducing poverty by 2015 (AIAE, 2005). Keynes (1936) emphasized the need for careful financial management to ensure the smooth running of economic activity. Keynes introduced the concept of a â€Å"liquidity trap† that sets a ceiling to the nominal interest rate. When a trap is binding, the real interest rate exceeds the equilibrium level consistent with full employment and planned savings exceed planned investments. A decrease in income would therefore reflect a drop in savings to equal investments. Shaw (1973) stressed that a well functioning financial market needed to facilitate intermediation between creditors and debtors. He argued that higher interest rates would create higher savings and a more effective functioning of the financial sector thereby ensuring a real return to creditors and the real cost to borrowers. The development of the financial market thus increases; incentive to save raises the volume and efficiency of investment and accelerates economic growth. Post-Keynesians placed substantial emphasis on both effective demand and the demand for bank credit, arguing that investment decisions determines savings. They claim that the higher interest rates following liberalization increase the cost of capital and stifle investment especially if the economy is near full capacity. Dutt (1991), who suggested that higher deposit rate will increase not only the volume of deposit and the supply of bank credit but also the marginal propensity to save as well as reducing aggregate demand. If the reduction in aggregate demand outweighs the expansion in bank credit, there will be no incentive to invest. Reduction of interest rates was one of the key recommendations of the G-20 (group of 20 leading economics) at its meeting on the global financial crisis in Washington DC in 20008. Even without the prompting, various countries had set interest rates ion the decline to revitalize declining economics. For example, the Bank of England recently cut interest rates to the lowest level in its 315 year history. The half percentage point reduction brought interest rates to 1. 5 percent the first time it would be below two percent since the bank was founded in 1694. In the United States, the Federal Reserve slashed interest rate to 0. 25% the lowest level in the nation’s 232 year history. The bleak outlook for jobs, investment justified cutting interest from 4% in some developing economics like Kenya, Egypt and South African, interest rates range between 9 and 15 percent. In Nigeria, the official lending rate is 17 percent, but real rates at banking halls could be as high as between 25 to 30 percent. And there is growing concern in various sectors of the economy about the strangulating effects of such rates. Also worrisome is the fact that the rising rates of interest, as other macro-economic indicators that used to enjoy some relative stability, signify a downturn on investment. The reality of the current situation is that not only are interest rates headed for the ceiling, but many bank have stopped lending out of the fear of the unknown. Some of the banks complain about high rate of default in the repayment of facilities already given out. A potential danger to this situation is that high interest rates and a general scarcity of money and credit so severely restrict borrowing for consumer spending, construction and business investment as to cause, or worsen, a bad economy. Ani (1988) opined that, the Central Bank is too eager in its objective to accelerate the attainment of the objectives of the on-going structure adjustment which among other recommended the deregulation of the economy. He believes that the central bank is trying to deregulate the interest rate aim at strangulating a lot of industries particularly the small and medium scale industries because interest rate deregulation will lead to a very high lending rate which in his own opinion, the medium scale industries could not afford because of their limited capital and production base. The Central Bank in its policy increase its lending rates from 11 to 15% in situation where Naira is under valued. In view of these increase, the commercial banks increased their own lending rate to between 17 to 22%. Also, the liquidity ratio was to be increased from 25% and their credit expansion reduced from 8 to 7. 54%. Ani (1988) thus maintained that the central bank of Nigeria measures would reduced the lending capacity of the banks and with a reduction in quantity of money in circulation there would be no money to save. Ani (1988) was also of the view that money which would have been saved are already in the vault of the central bank in the form of draw back money awaiting remittance to the second tier foreign exchange market, profit and petroleum subsidies. He thus, concluded that, fixing of interest rates at such a high level does not give Nigerian businesses any chance of competition with their foreign counterpart, particularly those from countries where interest rates are low compared to our own. Ojo (1988) share a similar view with Ani. He also believes that since domestic financial markets are to some extent structurally oligopolistic, if interest rate is left uncontrolled, it mighty led to a sharp increase in lending rate leading to increase in cost capital and discouraging investment. . 2 EMPIRICAL LITERATURE The results of investigation on the relationship existing between interest rate and investment hold divergent views: Rame (1990) investigated the theoretical and empirical determinant of private investment in developing countries and identified macroeconomic and institutional factors such as financial repression, foreign exchange shortage, lack of infrastructure and economic instability as important variable that explained p rivate investment. Chetty (2004) showed that the investment demand curve is always a backward-bending function of the interest rate in a model with non-convex adjustment costs. At low interest rate, an increase in the rate of return raises the cost of learning and increases aggregate investment by enlarging the set of firms for whom the interest rate exceeds the rate of return to delay. An increase in interest rate in more likely to stimulate investment when the potential to earn is larger in the short run rather than the long run. Akintoye and Olowolaju (2008) examined optimizing macroeconomic investment decision in Nigeria. The study employed both the ordinary least square and vector Auto-regression frameworks to stimulate and project inter temporally private investment response to its principal shocks namely public investment, domestic credit and output shocks. The study found low interest rate to have constrained investment growth. The study then resolved that only government policies produce sustainable output, steady public investment and encourage domestic credit to the private sector which would promote private investment. Obamuyi (2009) studied the relationship between interest rate and economic growth in Nigeria. The study employed co integration and error correction modeling techniques and revealed that lending rate has significant effect on economic growth. The study then postulated that investment friendly interest rate policies necessary for promoting economic growth needs to be formulated and properly implemented. Albu (2006) studied trends in the interest rate, investment, GDP growth relationship. The study used two partial model to examine the impact of investment on GDP growth and the relationship between interest rate and investment in the case of the Romanian economy. The study found that the behavior of the national economy system and interest rate-investment relationship tend to converge to those demonstrated in the normal marked economy. Ologu (1992) in a study of the impact of CBN monetary policy on Aggregate Investment behavior found that contrary to expectation and to Chenery’s stock adjustment hypothesis, the existing stock of capital goods was not a major determinant of investment behavior of firms in Nigeria and that interest rate was significant in influencing investment decisions noting that this is not surprising since in a situation of limited residual funds as in Nigeria , the cost of capital should exert significant influence on both the frequency and volume of demand for investible funds by investors. Evans (1998) estimated that net investment in the US would rise by anything between 5% and 10% for a25% fall in interest rate. These percentage changes were calculated to occur over a two year period after a one year lag. Iyoha (2004) postulated based on the combination of all the theories of investment ranging from the classical to Keynesian and a study on sub-Sahara African countries, identified macroeconomic factor such as income, interest rate, exchange rate and debt overhang provide by bebt-income ratio variable as his investment determination model. De Gregori and Guidotti (1995) cited Oostergaan et al (2000) studied the effect of a rising real interest rate on growth and claimed that growth is maximized when the real rate of interest lies within the normal range of -5 to +15% Green and Villanueva (1991) find a negative relationship between real interest rates and investment. World bank report cited in Ooterbaan et al (2000) show a positive and significant cross section relationship between average investmen and real interest rates over the period1965 to 1985 the empirical works by Mackinnon (1994) and Fry (1995) have shown evidence to support the hypothesis that interest rate determine investment. Thus, there are two transmission channels through which interest rate affects investment. They relate to investment as cost of capital. They also opined that interest rates encourages loans (external finance). May studies have investigated these transmission mechanisms, which tallies with interest rate policy regimes articulated in Nigeria prior to and after the 1986 deregulation. Khat and Bathia (1993) used non-parametric method in his study of the relationship between interest rates and other macro-economic variable, including savings and investment. In his study he grouped (64) Sixty-Four developing countries including Nigeria into three bases on the level of their real interest rate. He then computed economic rate among which were gross savings, income and investment for countries applying mann-Whitny test, he found that the impact of real interest was not significant for the three groups. However, his method of study was criticized by Balassa (1989) that a relationship has been established by the use of regression analysis. Agu (1988) reviewed the determinants and structure of real inetrest rates in Nigeria between 1970-1985. He demonstrated the negative effect of low real interest rate on savings and investment using the usual Mackinnon financial repression diagram. His main conclusion was that the relationship between real interest rate savings and investment is inconclusive. CHAPTER THREE RESEARCH METHODOLOGY 3. 1INTRODUCTION Several factor determine the flow of investment in Nigeria. These factors could be economical, political and social in nature. For the purpose of this study we adopt the Econometric method, owing to the fat that it would facilitate parameter estimation, method specification, the conduct of the appropriate statistical and Econometric tests that will aid and contribute to policy formulations. This research would employ the ordinary least square (OLS) estimation method for the econometric analysis. The choice of this techniques is justified by the need to test economic theory and explanatory ability of the independent variable chosen. Other reasons that warranted the adopted of OLS method in this research work are that it has a very high forecasting ability, its parameter estimates are stable, its mechanisms are simple to comprehend and parameters estimated by OLS have same optimal properties. They are Best Linear Unbiased Estimates (BLUE). Koutsotyiannis (1997) states that despite the improvement of computational equipment and statistical information which facilitated the use of more elaborate econometric techniques, OLS is still one of the most commonly used methods in estimating relationship in econometric models. Studdenmund (1998) stipulated that OLS method is best suited for testing specific hypothesis about the nature of economic relationship. 3. 2 MODEL SPECIFICATION In specifying econometric model, it has to be based on economic theory and on the available information relating to the phenomenon being studied Koutsoyiannis (1973:12). Specification of a model involves expressing the relationship between variables in a mathematical form which will be sued in exploring the economic phenomenon empirically. The adoption of this approach of model building in this research is justified by the following: (a) There is need to find out the effect of interest rate on investment determination based on economic theory. This is as seen from the subject matter of the research. (b) The effect of the independent variable may not be automatic or direct on the dependent variable. According to Koutsoyiannis (1997), the first and most important step a researcher has to take in attempting the study of any relationship between variables is to express this relationship in mathematical form. The foregoing discussion of the determinants of investment results in the following. INVMT = F(INT, GDP, EXCHR)- (1) The choice of the variable used in model (1) is justified by the subject matter of the research and the knowledge of apriori expectations and other literatures reviewed on the subject matter. The mathematical equation of model (1) is given as: INVMT =B0 + B1 INT + B2 GDP + B3 EXCH - (2) Econometric form of model (2) can be written as: INVMT =B0 + B1 INT + B2 GDP + B3 EXCHR +  µ Where: Bo =intercept B1 – B3=Regression coefficient (slope) INVMT =Investment INT=Interest rate RY =Real income proxied by GDP EXCHR =Exchange Rate  µ=Stochastic Error term 3. 2. 1 DEFINITION OF MODEL VARIABLES 1. Investment (INVMT): It is the commitment of money in order to earn a financial return of the purchase of financial assets such as stocks or bonds with future end date in mind. It also refers to capital expenditures on consumer durables, residential construction and plants and machinery. 2. INTEREST RATE (INT): This is the cost of borrowing capital in the financial market. It is also the amount paid on capital that is used on production. 3. EXCHANGE RATE (EXCHR): Exchange rates play a key role in international economic transactions. It refers to the price of country’s currency (foreign currency) of the world. 4. REAL INCOME (RY): Real income is being peroxide by Real Gross Domestic Product (RGDP) in this research. This is the monetary value of goods and services produced in an economy in a year after accounting for inflation. 3. 2. 2 ESTIMATION PROCEDURE The estimation period is from 1970-2008. The ordinary least square (OLS) technique will be used in estimating the parameters because of its simplicity in economic modeling and also to determine whether the variable are statistically significant or not. Therefore, the signs and sizes of the parameter estimates will be compared to their apriori economic expectation. Also, the statistical test of parameter estimates is carried out using the estimates of their standard error, t-test, f-Test, R2 and Durbin Watson (DW) test, in order to enhance the robustness of the empirical analysis. 3. 3. TECHNIQUES OF EVALUATION 3. 3. 1ECONOMIC TESTS (EVALUATION OF APRIORI SIGN) Parameters | Explanation | Apriori sign | | Intercept The Higher the interest rate, the lower the level of investment. Hence, interest rate is expected to be negative in relation to investment. With regards to the investment function, the quantity of investment depends on the real interest rate because the interest rate is the cost of borrowing. The investment function slopes downward when the interest rate rises because fewer investment project are profitable. | | ? | Increase in income, leads to an increase in investment. With regards to the Keynesian cross, an increase in government expenditure increases its purchase of goods and services, the economy’s planned expenditure rises, the increase in planned expenditure stimulate investment which causes total income to rise. | ? | Increase in exchange rate (depreciation) of the Naira in relation to the Us dollar, leads to capital outflow which in turn results to chapter exports (current account surplus) leading to lower investment. On the other hand, decrease in exchange rate (appreciation of the naira in relation to the US dollar, result in capital inflow (higher investment) exports becomes expensive and there is a ca pital account surplus and current account deficit. | | 3. 3. 2 ECONOMIC CRITERIA It involves examining economic meaningfulness of the equation with regards to meeting the apriori or expected signs of parameters to ensure that the model conforms to empirical expectation. Investment being the dependent variable has no sign interest rate and exchange rate are expected to be negative while real income proxied by Real GDP is expected to be positive. 3. 3. 3STATISTICAL (FIRST ORDER) TESTS (a) R2: Adjusted to the degrees of freedom, this statistic will be used to measure the goodness of fit of the estimated regression models. b)Student t-test: This will be used to test the significance of the individual parameters estimate of the regression model. (c)The F-test: This will be used to test the overall significance of all the parameters in the regression model. 3. 3. 4 ECONOMIC (SECOND ORDER) TESTS (a) Test for Muticollinearity: This is used in testing for linear collinearity among the explanatory variables and the values of the R2 and the F-test would be employed in this test i. e pair wise correlation coefficient matrix. b)Test for Sationarity: This is used to test whether the means value, variance and co-variance of the stochastic process are constant overtime. The augmented dickey-fuller (ADF) test would be adopted for this test (c)Test for Autocorrelation: This is applied to test whether the errors corresponding to the different observations are uncorrelated. This means testing for the randomness of the error term. The Durbin Watson (d-Statistic) will be used to test the randomness of the residuals involved. d) Test for co integration: This is used to find out whether there is a long run relationship among variables in the model using Augmented Dickey-Fuller (ADF) test. (e)Test for Heteroscodosticity: This is used to find out if the error term of the explanatory variables of the estimated model has equal variance. White Heteroscedasticity test will be carried out for this test. 3. 4 BATTERY TEST This is a test being carried out before the model is being estimated. The essence of this test is to determine if the variables being estimated in the model are stationary either in its level form, order I or 2 using Augmented Dickey-Fuller (ADF) test. Likewise, we test of there exists long run relationship among the variable being estimated. Thus, we carry out unit root and co integration test before estimating our model to determine for stationarity and long run relationship in the variables being estimated. STATIONARITY TEST VARIABLES | LEVEL FORM | FIRST DIFFERENCE | ORDER INTEGRATION | INVMT| 1. 054138| -3. 750202| I (I) | INTEREST | -1. 699283| -6. 516255| I (I)| GDP| -1. 736970| -3. 630594| I (I)| EXCHR| -0. 144931| -3. 725515| I (I)| From the stationarity result obtained above, it could be deduced that the variables being estimated in the model were not stationary (in absolute term) in its level form but turned out stationary when estimated in its First difference form (Order 1) COINTEGRATION TEST ADF TEST statistic | Critical value10% | Critical value5% | Critical value 1%| -2. 679841| -2. 6092| -2. 9422| -3. 6171| The co integration result obtained above signifies that there exists no long run relationship among the variable estimated in the model. This is because the absolute value of the ADF test statistic (-2. 679841) is less than the critical value at 5% level of significance (-2. 9422). 3. 5 NATURE AND SOURCE OF DATA The data derived for this research work are basically secondary data. They are being sourced from recognized publications of the Central Bank of Nigeria (CBN) annual report and statistical bulletins of 2008. CHAPTER FOUR PRESENTATION AND ANALYSIS DATA 4. 1 PRESENTATION AND ANALYSIS OF RESULTS The purpose of this chapter is presentation and analysis of the estimated models. The parameter estimates are subjected to various economic, statistical and econometric tests and as a result, the hypothesis to be tested will be evaluated based on this analysis. 4. 1 MODELING INVMT By OLS, is presented in the table below Table 4. 1 Variable | Coefficient | Std. Error | t. Statistic | Prob| CONSTANT | 83449. 70| 73626. 25| 1. 133423| 0. 2647| INTEREST | -1174. 030| 3677. 818| -0. 319219| 0. 7515| GDP| -0. 469400| 0. 085127| -5. 514081| 0. 0000| EXCHR| 23245. 43| 4205. 570| 5. 527296| 0. 0000| Dependent Variable: INVMT R2=0. 780977 R-2 =0. 762203 F-Statistic =41. 60011 (0. 00000) DW=1. 858878 Where R2=Coefficient of Multiple determination R-2 =Adjust Coefficient of Multiple determination DW=Durbin Watson Statistic 4. 1. 1INTERPRETATION OF RESULTS The table above has shown the coefficients of the various regressors. The value of the intercept which is 83449. 70 shows that investment growth in Nigeria would increase by 83449. 70 when all other variables are kept constant. Also, the positive value of investment shows that commercial bank’s lending rate in Nigeria is low which in turn encourages investment in the Nigeria economy. The regressors coefficient i. e 1174. 030 (interest), 0. 469400 (GDP), 23245. 3 ( EXCHR) shows that a unit change in interest rate would bring about 1174. 030 increase in investment, a unit change in GDP and Exchange rate (EXCHR) would result to 0. 469400 and 23245. 43 increase respectively in investment holding other variables constant. 4. 1. 2EVALUATION OF REGRESSION ESTIMATE Table 4. 1. 2 ‘A priori† Criteria Expectation Variable | Sign expected | Estimated sign | Interpretation | INTEREST | blt;0| blt;0| Conform to apriori expectation | GDP| blt;0| blt;0| Did not conform to apriori expectation | EXCHR| blt;0| blt;0| Did not conform to apriori expectation| 4. 2EVALUATION BASED ON ECONOMIC (CRITERIA) Apriori Expectation On the apriori ground, the signs of all parameter estimates are specified above. We observed that some of the variable did not conform to its apriori expectation (i. e GDP and EXCHR), while interest rate (INTEREST) did conform to it’s apriori expectation. GDP did not conform to it’s aprior expectation. This implies that there exists a negative relationship between GDP (income) and investment, although it was statistically significant. The negative GDP also implies that there is a decrease in government expenditure which in turn reduces planned expenditure and investment respectively. The coefficient of exchange rate was expected to be negative. This support the idea of Fleming and Mundel, 1963) which states that exchange rate increase (depreciation) result to capital outflow that results to cheap domestic export that encourage domestic investment (current account surplus) and reduces capital account. Interest rate conformed to its apriori expectation. The negative interest rate shows its inverse relationship with investment although it is statistically from the estimation model. 4. 3EVALUATION BASED ON STATISTICAL (FIRST ORDER) CRITERIA The utilized statistical tests are the coefficient of multiple determination t-test and F-test of the estimates. (a) The co-efficient of multiple determinations (R2). This statistic will be used to measure the goodness of fit of the estimated regression models. The model results are evaluated on the basis of the following statistical tools from the result presented above. It could be observed that the R2 value of 0. 780977 shows that that the induced variables account for about 78% of the causes of variation in investment. (b) Evaluation of working hypothesis using the relevant economic criteria i. T-Test and F-Test H0:There is no significant effect of the explanatory variables on investment. H1:There is significant effect of the explanatory variables on investment. Thus tested as: H0: ? 1 = 0 H1: ? 1 ? 0 At 5% level of degree of freedom The Student T-Test It is used to test the significance of the individual parameter estimate ? =0. 05. The hypothesis is thus stated as: H0: ? 1 = 0 H1: ? 1 ? 0 Where: ? 1 is the coefficient of the parameter estimate Decision rule: Reject Ho, if t * gt; t ? /2, otherwise accept i. e if t* lt; t ? /2 Where t* = Computed or calculated ? /2 = tabulated value of t n = number of observation k = number of parameter estimates degree of freedom (df): n – k = 40 – 3 = 37. From the t-distribution table, for a two tailed test at 5% level of significance with 37 degrees of freedom, the tabulated t37(0. 025) =  ±2. 021 Illustration of the concept of the acceptance and rejection Region i. e criteria region by Koutsoyannis (1997:89) is as follows: TABLE 4. 2 T-TEST TABLE Variable | t-computed | t-prob| t-tabulated | Decision | Constant| 1. 133423| 0. 2647| 2. 021| Insignificant | INTEREST| -0. 319212| 0. 7515| 2. 21| Insignificant | GDP| -5. 514081| 0. 0000| 2. 021| Significant | EXCHR| 5. 527296| 0. 0000| 2. 021| Significant | Conclusion: This means that Variable GDP and EXCHR are statistically with INTEREST being statisticall y insignificant. THE F-TEST The F-statistic is applied to measure the joint influence of the explanatory variables on the dependent variable i. e the overall significance of the model. In testing the overall significance of the regression result, the null hypothesis is specified as Ho: ? 1 = ? 2 = ? 3 = 0 against the alternative hypothesis: H1: ? 1 ? ?2 ? ?3 ? Decision rule: Reject Ho if the F-value computed is greater than the F-value tabulated at 5 percent level of significance with (V1 /V2) degree of freedom where V1 = K – 1 and V2 = n –k. we accept H1 if otherwise. The test is applied with the following results obtained from the regression result (Table 4. 1). The F* cal = 41. 60011. The F* value tabulated = 2. 84 where V1 = 3-1 = 2 and V2 = 40-3 = 37. F0. 05 (2, 37) = 2. 84 Since F* cal = 41. 60011 gt; F0. 05 (2, 37) = 2. 84, we reject Ho and conclude that the explanatory variables have joint explanatory power over the dependent variable. Therefore the model has good fit and is statistically significant. This means that there exist a relationship between the dependent variable and the explanatory variables. 4. 4EVALUATION BASED ON ECONOMIC CRITERIA (SECOND –ORDER TEST) (a) MULTICOLLINEARITY TEST Below is the table which shows the collinearity between the variables used in the model being estimated. TABLE 4. 3 RESULTS ON CORRELATION TEST CORRELATION MATRIX VARIABLES | INTEREST| GDP| EXCHR| INTEREST| 1. 000000| 0. 435068| 0. 400028| GDP| 0. 435068| 1. 0000000| 0. 693575| EXCHR| 0. 400028| 0. 693575| 1. 000000| TABLE 4. 4. SUMMARY OF CORRELATION MATRIX VARIABLES | CORRELATION MATRIX| CONCLUSION| INTEREST and GDP| 0. 435068| No muticollinearity| INTEREST and EXCHR| 0. 400028| No muticollinearity | GDP and EXCHR | 0. 693575| No muticollinearity| None of the cross partial is in excess of 0. 8. This implies that there is no problem of multicollinearity among the independent variables in the model also implying that the model is significant. (b) STATIONARITY TEST The unit root test was used for used for testing stationarity using Augmented Dickey Fuller (ADF) test with the assumption that: Ho: ? 1 =0 (Non-Stationarity) or (unit root problem) H1: ? 1 ? 0 (stationarity exists) Decision rule: reject the mull hypothesis (Ho) if the calculated ADF statistic (in absolute term) is greater that the critical value (in absolute term) at 5% and 10% i. e. If /tcab/gt;/ ttab) using the 5% and 10% level of significance, and accept the alternative hypothesis if otherwise. Table 4. 5 RESULTS ON STATIONARITY TEST VARIABLES | ADF TEST STATISTIC| CRITICAL VALUE 5%| CRITICAL VALUE 10%| CRITICAL VALUE 1%| INVMT (-1)| -3. 750202| -2. 9446| -2. 6105| -3. 6228| INTEREST (-1)| -6. 516255| -2. 9446| -2. 6105| -3. 6228| GDP (-1)| -3. 630594| -2. 9446 | -2. 6105| -3. 6228| EXCHR (-1)| -3. 725515| -2. 9446| -2. 6105| -3. 228| From the above table 4. 5, INVMT (investment) was not stationary at ordinary level, but it became stationary both at 5% and 10% critical value at its first difference, i. e, /-3. 750202/ gt; / -29446/ and / -3. 750202/ gt;/ -2. 6105. For interest rate (INEREST), it was not stationary at its ordinary level, but became stationary when differenced once at both 5% and 10% cricital levels, i. e \-6. 516255/ gt;/-2. 9446/ and /-6. 516255/gt;-3. 6171/. Hence, from the above result, all the variables are stationary at 5% and 10% level of significance with the absolute values greater that the tabulated values at 5% and 10%. TABLE 4. 6. COINTEGRATION TEST RESULT ADF TEST Statistic| Critical value 10%| Critical value 5%| Critical value 1%| -2. 679841 | -2. 6092| -2. 9422| -3. 6171| Since absolute value of ADF Test statistic /1-2679841/ is less that its critical value /1-2. 9422/ at 5% level of significance at order 1, we conclude that the variables are not co integrated at order 1, i. e They have no long run relationship existing among them at order 1. (c) AUTOCORRELATION TEST The test is based on the use of Durbin-Watson (d-statistics) to test the randomness of residuals. Based on this, we state our hypothesis thus: Ho: Po = o (no positive first order autocorrelation) H1: Po ? o (positive first order autocorrelation) At ? = 0. 05. Table 4. 7 SUMMARY OF DURBIN WATSON TEST NULL HYPOTHESIS| DECISION| IF| No positive | Reject | O lt; d lt; d| Autocorrelation | | | No Positive Autocorrelation | No Decision | dL ? d ? du | No Negative Autocorrelation | Reject | 4-dL lt; d lt; 4| No Negative Autocorrelation | No Decision | 4-du ? d ? 4-dL| No Autocorrelation (positive or Negative) | Do no Reject | du lt; d lt; 4-du | Where d = d calculated or computed u = upper limit of Durbin- Watson for the corresponding values. dL = lower limit of Durbin- Watson for the corresponding values From the regression result, we can see that the Durbin Watson Statistic (d) = 1. 858878. With n = 40 and k = 3, where n = number of observation. K = number of estimated independent variable. From the Durbin Watson table dL = 1. 338 while du = 1. 659. Thus we have du lt; dlt; 4 – du Where 4 – du = 2. 341 Therefore, 1. 659 lt; 1. 858878 lt; 2. 341 From the result above, we can see that 1. 659 lt; 1. 858878 lt; 2. 341, therefore, we conclude that we do not reject i. No autocorrelation (Positive or Negative). (d) HETEROSCEDASTICITY TEST The hypothesis tested were: Ho: ? 1 = ? 2 = ? 3 = ? 4 = 0 (Homescedasticty) H1: ? 1 ? ?2 ? ?3 ? ?3 ? 0 (Heteroscedatcity) at 5% level of . significance. This test was carried out using white heteroscedasticity test. We further test this to find out if the error term exhibited constant variance. It follows F* cal or X2 cal distribution. DECISION RULE: Accept null hypothesis (Ho) if F* cal lt; F tab or if X2 cal lt; X2 tab, otherwise reject Ho and conclude that the variance of the error term is heteroscedastic. The error term equation is stated as follows: Ut = ? + ? 1 (INTEREST) + ? 2 (GDP) + ? 3 (EXCHR) + ? 4 (INTEREST)2 + ? 5 (GDP)2 + ? 7 (INTEREST, GDP) + ? 8 (INTEREST) (INTEREST, EXCHR) + ? 9 (GDP, EXCHR) + Vt From our result analysis, F cal = 2. 139441. Deriving our F tab is as follows: V1 = k – 1 = 9 – 1 = 8 V2n – k 40 – 9 31 Where n = 40 k= 9 Therefore F tab 0. 05 (8, 31) = 2. 27 Conclusion: Since F cal = (2. 139441) lt; F tab = (2. 27), we accept Ho and conclude that the variance of the error term is homesedastic, that is error term is constant. (e) Test for specification errors The Ramsey’s rest test was conducted for specification errors. This test is assumed to follow an F-distribution. Hypothesis Test: Ho:  µ = o (the model is well specified) Hi:  µ ? o (the model is not well specified i. e. there is misspecification of the model). At a = 5% and 1% with degree of freedom (k-1, n-k) df, where the first k excludes intercept while the second k includes it. Decision rule: Reject Ho: if F cal (F*) gt; F tab and if otherwise accept Ho. The F calculated (F*) = 23. 19901. F tab 0. 05 = (3-1, 40-4) F tab 0. 05 (2, 36) = 3. 23 and 5. 18 at 1% level of significance. Therefore since F cal = (23. 19901) lt; F tab = (3. 23), and at 1% F cal = (23. 9901) lt; F tab (5. 18), we accept the null hypothesis of correct specification of the model and conclude that there is no specification error in the model. CHAPTER FIVE SUMMARY, POLICY RECOMMENDATION AND CONCLUSION 5. 1SUMMARY OF FINDINGS In this research, attempt is made to investigate the effect of interest rate on investment determination in Nigeria. The investigation covered th e period 1970-2008 and the OLS technique of estimated. A theoretical analysis was undertaken to explain the relationship between changes in interest rate and investment determination with other explanatory variables, income proxied by GDP and exchange rate affecting investment followed by an empirical analysis that discussed estimation results. The study revealed that interest rate played a negative role and was highly insignificant in investment decision in the economy as opposed to the expectation of interest rate being significant decisions. In other words interest rate has a negative impact on investment decisions both in the short run and long run investment decisions. The other determinant being GDP also played a negative role and is highly significant in the sort run and long run on investment determination. Also, it was inferred from the study that exchange rate played a positive and significant role in investment determination in the short and long run. 5. 2POLICY RECOMMENDATIONS: In order to achieve sustainable economic growth and development in Nigeria, there is need to improve the economic, political and social environment of the country. Empirical evidence by Guseh and Oritsejafor (2007) shows that investment has negative impact on economic growth in Nigeria indicating that investment has not promoted economic growth. Further, Guseh and Oritsejafor (2007) supported their findings with the following arguments: (1) Most public sector infrastructure investments are not worthwhile. (2) Political and military elites implemented public project that proved to be money draining projects. (3) Government contracts were awarded at inflated prices by as much as three or four times their worth and development project were shoddily executed or completely abandoned after mobilization fees had been paid. (4) There was looting of public funds necessary for savings and investment. 5) Declining government savings. (6) Frequent regime changes concomitant with policy uncertainties, leading to lower long run investment. I therefore postulate an interest rate reform that should be a component of the broad package aimed at facilitating financial intermediation and monetary management as well as enhancing investment determination and economic growth in Nigeria. However, in high inflation countries like Nigeria, a strong a nd credible stabilization programme and an equally strong set of prudential interest rate guidelines are generally the best initial policy measures. Furthermore, there is need to review on a continuous basis interest rate developments even after liberalizing with a view to ensuring that level and structure of interest rates are adequate and consistent with policy objectives and that the unfolding scenario is suited to the circumstances of the country in which the reform is taking place. However, the deregulation of interest rates in Nigeria may not optimality achieve its goals if those other factors which negatively affects investment in the country as suggested by Guseh and Oritsejafor (2007) are not tackled. This implies that the link between interest rate, investment and economic growth in Nigeria may not allow for optimal benefits from interest rate reforms in the country. 5. 3CONCLUSION Although, the empirical findings show that investment has an indirect relationship with interest rate, other variables such as debt burden, economic stability, foreign exchange, shortage and lack of infrastructure affect domestic investment. Improvement in these key macro-economic variables is a necessary condition towards facilitating investment in Nigeria. Also, government should provide sound macro-economic environment by ensuring a non-distorting but competitive tax system, low inflation rate through prudential fiscal and monetary policies as well as a stable but non-misaligned interest rate. Nothing can hurt investment more than an uncertain or highly volatile macro-economic environment. Perhaps, of great importance for the profitability of investment are the issue of efficient infrastructures and the availability of skilled labour. The financial sector should also be developed to encourage more loan availability. Moreover, strict guidelines should be made to ensure that loans are utilized for the purpose for which they are meant for. BIOGRAPHY Agu, C. C. (1988). Interest rate policy in Nigeria an attendant distortion. New York: Prentice Hall Inc. African Institute of Applied Economics (AIAE) (2005). Sustainability of Economic Growth in Nigeria: The Role of the Renewable Natural Resource: Enugu, Nigeria: Summary of Research Findings and Policy Implications. Akintoye, I. R. and Olowolaju, P. S. (2008). Optimizing Macroeconomic investment decision lesson. Nigeria: Macmillan Publisher. Akiri, E. S and Adofu, L. (2007). Interest rate deregulation and investment . India: Dehli Publishing. Albu, L. (2006). Trends in the interest rate? Investment? GDP Growth relationship. Romanian J. Econ. Forecast. , 3:5-13. Anyanwu, J. C. and Oaikhenon, H. E. (1995). Modern macroeconomic: Theory and Application in Nigeria. Onitsha: Joanee Educational publishers Ltd. , Nigeria, Pp: 29-38. Burkett, P. and Dutt, A. K. (1991). Interest Rate Policy, Effective Demand, and Growth in LDCs. International Review of Applied Economics. Germany: Longman. CBN, 1990. Annual report and Statement of account for the year ended. Central Bank of Nigeria, 31st December, Pp. 26. Iyoha, M. A. , (2004). Applied Econometrics. Benin: Mindex Publishing. Pp. 37-43. Keith, S. (1993). The cyclical volatility of Interest Rat. Philadelphia: Federal Reserve Bank of Philadelphia. Pp. 15-29. Mckinnon, R. I. (1973). Money and capital in Economic Development. 1st Edition. USA: Brookings Institution. Nwankwo, G. O. (1989). Nigerian Financial System. London: Macmillan Publishers Ltd. Ojo Jat (1976). The Nigerian Financial System. Ireland: University of Wales Press Cardiff. Ologu, E. D. (1992) The Impact of CBN Monetary policy on Aggregate Investment Behaviour. Benin: University of Benin Press. Shaw, E. (1993). Financial Deepening in Economic Development. New York, USA: Oxford University Press. Soyibo, A. , Olayiwola, K. (2000). Interest Rate policy and the Promotion of saving investment and resource Mobilization in Nigeria. Ibadan: Development policy centre.

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PGP Individual Use or Organizational Use an Example by

PGP: Individual Use or Organizational Use In order to answer the question of Is using an encrypted system like PGP a good idea of individuals and organizations? I need to first explain what PGP is. I would also like to present information pertaining to why PGP has been created, its purpose and another encryption system named S/MIME, which is PGPs current rival. Need essay sample on "PGP: Individual Use or Organizational Use" topic? We will write a custom essay sample specifically for you Proceed PGP or Pretty Good Privacy is a public-key encryption program. It uses three known algorithms to encrypt, sign, decrypt, and authenticate messages. It converts the digitally encoded message or signature into a format suitable for text transmission by use of `Radix-64. Because PGP operates with the use of asymmetric encryption `keys', only the intended recipient of the message may decrypt it. To use PGP, you must generate a pair of keys. One key is the public key; the other is the private key. The private key allows you to decrypt a message sent to you by some other user. To allow other users to encrypt a message intended only for you, you must provide them with a copy of your public key. A public key will not allow decryption of an encoded message. A special command issued to the PGP program begins a process of creating your own personalized pair of keys. You respond to the requests of PGP (to questions it asks) to generate those special keys for you. It will ask you for a pass phras e to allow the newly created private key to remain unusable by anyone but you. Additionally, PGP can be used to authenticate that a message was sent by the key holder of the message. By generating an electronic signature, the sender cannot deny that he sent the message. An example of this would be someone sending an email request for work to be performed and then later denying that he made the request. Certainly this could be a troubling situation for anyone who is in the business world. Most persons and companies like to get paid for their work. Upon receipt of the request, the sender's identity can be verified by using the sender's public key to confirm that the message was indeed sent by the party it appears to have come from. This feature certainly has some major benefits for the business world, which we will discuss in further into this paper. This is to be contrasted with S/MIME, which was developed by the IETF using classical Standards Organization processes, similar to PGP (Secure Multipurpose Internet Email Extensions). A new version of the MIME protocol that supports encryption of messages. S/MIME is based on RSA's public-key encryption technology. Specifies formatting non-ASCII messages so that they can be sent over the Internet. Many email clients now support MIME, which enables them to send and receive graphics, audio, and video files via the Internet mail system. There are many predefined MIME types, such as GIF graphics files and PostScript files. It is also possible to define your own MIME types. In addition to e-mail applications, Web browsers also support various MIME types. This enables the browser to display or output files that are not in HTML format. Now that I have explained what PGP is and how it works, let us identify the advantages and disadvantages it may have for either individual use or organizational use. PGP combines two encryption methods, the convenience of public-key encryption with the speed of conventional encryption. Its conventional encryption is about 100 to 1,000 times faster than public-key encryption, which solves the problem of slow encryption with symmetric algorithms. Public-key encryption provides a solution to key distribution and data transmission issues when using symmetric encryption. When used together, performance and key distribution are improved without any sacrifice in security. PGP is good hybrid solution; it ties together the advantages of public key and symmetric cryptography, while also providing a feasible solution to the disadvantages of both. PGP also has its disadvantages. Using PGP can be a complex process and its concept is often difficult for some people to grasp. In order to resolve this, people will require more training. Both parties must be able to use PGP, meaning it is impossible to use PGP unless people at both ends of the connection are capable of using some version of PGP. Though I read that PGP has resolved this by implementing a self-decrypting archive (SDA), which creates an executable file that uses conventional, symmetric encryption. Key management is a challenge at first within the program and can be a little awkward for users to learn. Again, providing users with more training will help resolve this issue. So now that I have informed you about the advantages and disadvantages PGP brings to the table, let us determine if the individual or the organization would best utilize this encryption method. From what we have learned, PGP is completely compatible with modern day email exchange. The individual user today already uses PGP, since it is the most common encryption standard. For organizations, PGP is definitely an option to consider, but today you will find the use of the above mentioned S/MIME encryption, due to its comparative maturity, support for centralized key management via x.509 certificate servers and widespread technical support. Works citied: http://www.zdnet.com/blog/ou/?p=89