SMALL AND MEDIUM ENTERPRISES (SMES) AS ENGINES OF ECONOMIC GROWTH AND MACROECONOMIC STABILITY IN NIGERIA: EVIDENCE FROM FMOLS

639 International Journal of Social and Educational Innovation Vol. 12, Issue 23, 2025 ISSN (print): 2392 – 6252 eISSN (online): 2393 – 0373 DOI: 10.5281/zenodo.17999529 SMALL AND MEDIUM ENTERPRISES (SMES) AS ENGINES OF ECONOMIC GROWTH AND MACROECONOMIC STABILITY IN NIGERIA: EVIDENCE FROM FMOLS Kayode David KOLAWOLE Department of Accounting Science, Walter Sisulu University, Mthatha, South Africa [email protected] 0000-0002-6704-2673 Abstract This study investigates the impact of small and medium-scale enterprises (SMEs) on economic growth in Nigeria using annual time series data spanning 2001–2022. Employing a combination of descriptive and econometric techniques, including Augmented Dickey-Fuller and Phillips-Perron unit root tests, Engle-Granger and Phillips-Ouliaris cointegration approaches, and Fully Modified Ordinary Least Squares (FMOLS) estimations, the analysis establishes a long-run relationship between economic growth and SME-related variables such as loans to SMEs, SME growth contribution, interest rates, inflation, and exchange rates. The findings reveal that loans to SMEs and SME growth significantly and positively influence economic performance, while exchange rate depreciation exerts a negative impact. Interest rates were found to be positively associated with growth when moderated by access to credit, whereas inflation had an insignificant effect in the long run. Robustness checks through sensitivity analyses confirm the stability of SME coefficients across alternative model specifications. The research paper concludes that SMEs can play a central role in the longterm economic transformation of Nigeria and suggests the policy, which can enhance the access to affordable finance, stabilise exchange rates, and integrate SMEs into innovation ecosystems and value chains. Keywords: Small and Medium Enterprises, Economic Growth, Cointegration, FMOLS, Nigeria, Macroeconomic Policy. JEL Codes: O47, E44, L26, C22 International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 640 1. Introduction SMEs play the central role in the debate on economic development, especially in emerging economies, where it plays a significant role in output, job creation, and innovation. SMEs in Nigeria are more than 80 percent of businesses and a large proportion of non-oil economic “activity, which is why they are essential to the structural diversification of Nigeria beyond reliance on resources (Aderemi et al., 2022). In spite of the perceived significance, SMEs in Nigeria still experience structural bottlenecks that comprise the lack of financing, unstable macroeconomic factors, and the lack of technological capacity that negatively affect the ability of SMEs to contribute to sustainable growth. The recent change in policies, such as the National Enterprise Development Programme introduced by the Federal Government and the SME-based credit initiatives by the Central Bank of Nigeria, highlights the resurgence of the focus on the role of SMEs as the agent of inclusive development (El-Yaqub et al., 2025). Yet with high inflationary pressures, exchange rate volatility and structural imbalances that often lead an economy away from stability, financial intermediaries may be less able to promote SME development. Macroeconomic stability is also important: If there is a lot of inflation or if exchange rates are volatile, it will make borrowing costs higher for businesses, weaken consumer demand, and reduce the ability of firms to plan; in Nigeria where even when SMEs have access to credit, they often struggle with weak infrastructure and regulatory bottlenecks that limit growth prospects, macroeconomic challenges can be a significant handicap (Nguyen et al., 2021). The initial aim of this paper is to analyze how loans to SMEs influence the economic growth of Nigeria. Credit access has been one of the most important factors that determine the survival and growth of SMEs, but access to capital through the financial system in Nigeria has traditionally been tilted toward large businesses, which have underfunded SMEs (Ajayi et al., 2021). It is empirically demonstrated that credit rationing suppresses productivity and employment in SMEs, hence reducing their role in aggregate growth (Nguyen et al., 2021). This study contributes to ongoing debates by quantifying how lending to SMEs translates into long-term growth effects, using econometric methods that account for endogeneity and longrun relationships. The second objective is to evaluate the impact of SME growth, proxied by the contribution of SMEs to gross domestic product, on the broader Nigerian economy. SMEs are increasingly recognized as vehicles for structural transformation, capable of generating backward and International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 641 forward linkages within domestic industries (Gherghina et al., 2020). Their role in innovation diffusion, labor market dynamism, and inclusive growth aligns with the endogenous growth theory, which emphasizes firm-level activities as engines of long-run expansion (Acs et al., 2021). This study thus explores whether SME growth has a statistically significant and stable impact on overall economic growth, particularly in the Nigerian context where informality and volatility present unique challenges. The third objective focuses on the effect of macroeconomic factors on the SME–growth nexus. Although a moderate interest rate aligned with credit facilitation support SMEs’ business expansion, a high interest rates can limit SME borrowing (Ambam et al., 2024). Inflation, if uncontrolled, erodes purchasing power and raises input costs, but mild inflation may stimulate production by signaling growing demand (Ojeka et al., 2024). Exchange rate fluctuations, meanwhile, directly affect SME competitiveness in both domestic and international markets. Given Nigeria’s recurrent currency volatility, it becomes imperative to assess whether such dynamics reinforce or weaken the growth effects of SMEs. The fourth objective is to establish the existence of a long-run equilibrium relationship among the studied variables. While short-term dynamics are subject to fluctuations, identifying cointegration helps determine whether SME activities and macroeconomic indicators are jointly sustainable drivers of growth. Earlier studies in developing countries often ignored long-run dynamics, leading to inconclusive results (Onyeiwu et al., 2020; Afolabi, 2013). This study addresses that gap by employing cointegration techniques and Fully Modified Ordinary Least Squares (FMOLS) to capture both the direction and magnitude of the long-run effects. This study aims to conduct sensitivity, and robustness checks to ensure the stability of results and to provide policy-relevant insights. By systematically testing alternative model specifications, the study enhances the reliability of its findings and informs policymakers on which SME-focused strategies are robust to macroeconomic uncertainties. This aligns with the growing scholarly emphasis on evidence-based policymaking in Africa’s development context (Asongu et al., 2023). In doing so, the study contributes to the empirical literature on SMEs and growth by presenting an updated and rigorous analysis based on recent Nigerian data, while offering insights applicable to other resource-dependent developing economies. International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 642 2. Empirical Literature The literature on access to finance and SME-driven growth is extensive and largely consistent in identifying credit constraints as a binding limitation on SME expansion and their aggregate contribution to growth. Cross-country and firm-level studies using World Bank Enterprise Survey data show that formal credit access is associated with higher investment, employment and productivity among small firms (Chowdhury et al., 2022; Amadasun, 2022). Panel studies that exploit microdata and quasi-experimental variation report that increases in lending to SMEs causally raise firm output and employment (Nguyen, Trinh & Nguyen, 2021; Brixiová et al., 2020). Country-specific time-series analyses for Nigeria and comparable economies similarly find that expansions in SME credit correlate with higher GDP or sectoral output (Musa et al., 2024; Akanyonge et al., 2023). These empirical regularities underline the theoretical prediction that alleviating financial constraints enhances SME investment and their capacity to contribute to aggregate demand and capital accumulation (Beck, 2006; Ayyagari et al., 2017). A closely related strand investigates the transmission from finance to productivity and innovation within SMEs. Firm-level evidence demonstrates that access to external finance increases the probability of adopting productivity-enhancing technologies and undertaking R&D or process innovation (Garrido-Prada, 2024; Surya et al., 2021). Microeconometric analyses exploiting panel structures and matching methods find that better-financed SMEs exhibit higher labor and total factor productivity, conditional on managerial capabilities and firm age (Chowdhury et al., 2022; Garrido-Prada, 2024). Research emphasises complementarities: finance must be joined by managerial skills, digital adoption and market access for SMEs to translate credit into persistent productivity gains (Acs et al., 2021; Akanyonge et al., 2023). Empirical studies also document a strong role for digitalisation and non-bank finance in mitigating traditional financing gaps. Recent cross-country work shows that fintech, mobile money, and alternative lenders improve small firm liquidity and sales, particularly in contexts where formal banking is shallow (McKinsey MGI, 2024; Amadasun, 2022). Randomised controlled trials (RCTs) and field experiments in lower-income countries indicate that credit combined with digital training or market linkages yields larger impacts than credit alone (Bédécarrats et al., 2020; Bloom et al., 2022). These findings imply that policymakers should consider integrated interventions when seeking to scale SME impact on growth. International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 643 Another large body of work investigates how macroeconomic conditions condition SME performance. Empirical panels and vector autoregression (VAR) studies for emerging markets show that high real interest rates and persistent inflation reduce SME investment and survival rates (Ambam et al., 2024; Ojeka et al., 2024). Exchange rate volatility is consistently associated with reduced export orientation and profitability among SMEs that rely on imported inputs (Balcilar, Gupta & Majumdar, 2022). Time-series evidence for many developing countries suggests that macroeconomic instability not only lowers the effectiveness of SME credit programs but can reverse gains by increasing working-capital costs and input price uncertainty (Grandes & Yeo, 2023; Hashi & Krasniqi, 2008). The literature emphasises firm heterogeneity and institutional context as decisive mediators of SME impacts. Cross-sectional and panel estimates reveal that SME contributions to growth are concentrated among firms with stronger governance, better access to markets, and higher managerial capabilities (Acs et al., 2021; Brixiová et al., 2020). Studies in sub-Saharan Africa find that firm size, formality, sector, and gender of ownership generate systematically different outcomes from finance and policy interventions (Pinto et al., 2025; Brixiová et al., 2020). Empirical work using interaction terms and subgroup analyses indicates that credit programs yield larger returns for medium-sized formal firms than for microenterprises in the informal sector, unless complementary measures reduce costs of formalisation (Nguyen et al., 2021; Asongu et al., 2023). Shocks and resilience have inspired a wealth of recent empirical research on SME survival and recovery. Cross-country surveys and panel analyses show that SMEs faced steep revenue losses during the pandemic, with access to finance, digital readiness, and pre-existing liquidity buffers explaining cross-firm recovery heterogeneity (McKinsey MGI, 2024; Pinto et al., 2025). Empirical evaluations of policy instruments show mixed effects: emergency credit preserved liquidity but often reached better connected firms, while subsidies protected employment in formal SMEs when quickly implemented (World Bank policy evaluations; Bloom et al., 2021). These studies underline that crisis-responsive SME policy must be timely, well-targeted, and coupled with digital delivery systems to avoid capture and leakage. Researchers increasingly combine microdata with quasi-experimental methods (difference-indifferences, instrumental variables, propensity score matching) and structural models to identify causal effects (Nguyen et al., 2021; Garrido-Prada, 2024). At the macro level, longrun cointegration techniques are common for assessing the aggregate SME–growth relationship (Onyeiwu et al., 2020; Musa et al., 2024). Meta-analyses and systematic reviews International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 644 find generally positive average effects of SME finance and development on growth and welfare, albeit with substantial heterogeneity that depends on country institutions and policy design (Surya et al., 2021; Fajarika, 2024). Finally, policy-oriented empirical work converges on several actionable lessons. First, expanding SME access to affordable finance matters, but credit programs must be complemented by capacity building and market integration to secure sustainable productivity gains (Nguyen et al., 2021; Akanyonge et al., 2023). Second, macroeconomic stability, particularly exchange rate and inflation management, enhances the returns to SME investments and reduces downside risks (Balcilar et al., 2022; Ojeka et al., 2024). Third, digital finance and non-bank channels can materially shrink financing gaps if regulatory frameworks foster competition and protect consumers (McKinsey MGI, 2024; Amadasun, 2022). 3. Methodology 3.1. Theoretical Framework The study on small and medium-sized businesses effects on economy development is based on the theoretical foundations such as Schumpeterian theory, Keynesian demand-side growth model, and Solow neoclassical model of economic growth. Taken together, these views shed light into how SMEs contribute to output expansion (GDP), capital deepening (capitalization) and structural transformation (structural adjustment) in developing economies including Nigeria. The relationship here can be defined as a connection between the economic growth (EGR) and the innovative capacity of the SMEs (INN) using the innovation-driven production function.: 𝐸𝐺𝑅𝑡= 𝛼 + 𝛽 𝐼𝑁𝑁𝑡+ 𝜇𝑡 (1) where 𝐸𝐺𝑅𝑡 denotes economic growth at time 𝑡, 𝐼𝑁𝑁𝑡 represents innovation and productivity spillovers from SMEs, 𝛼 is the constant term, 𝛽 is the elasticity of growth with respect to innovation, and 𝜇𝑡 is the error term. A positive 𝛽 validates Schumpeter’s view that SMEdriven innovation enhances long-term growth. From a Keynesian perspective, SMEs contribute to aggregate demand through employment creation and investment spending. Keynesian models argue that output (Y) depends on aggregate demand (AD), which in turn is influenced by household consumption (C), investment (I), government expenditure (G), and net exports (NX) (Keynes, 1936). SMEs significantly affect the investment component. This can be represented as: International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 645 𝑌 𝑡= 𝐶𝑡+ 𝐼𝑡 𝑆𝑀𝐸 + 𝐺𝑡+ 𝑁𝑋𝑡 (2) where 𝐼𝑡 𝑆𝑀𝐸 represents investment attributable to SMEs. An increase in SME activity raises 𝐼𝑡 𝑆𝑀𝐸, which in turn raises 𝑌 𝑡. Thus, SME-led expansion stimulates short-run and mediumterm growth through demand-side effects (Man et al., 2002). The Solow growth model, in contrast, situates SMEs within the broader context of capital accumulation, labor, and technological progress. Economic growth is determined by a neoclassical production function: 𝑌 𝑡= 𝐴𝑡𝐾𝑡 𝛼𝐿𝑡 1−𝛼 (3) Yt is the output, Kt is the capital stock, Lt is the input of labor, and At is the level of technology at time t. Under this framework, SMEs will provide a contribution to both Kt and Lt, as they will increase the access to capital, using the credit, and mobilize labor to smallscale production. As time passes by, SMEs also improve At through the diffusion of knowledge and modern technology adoption, which creates continuous productivity growth (Zhu et al., 2019). Combining these two models, the theoretical framework postulates that SMEs generate growth in three key ways (i) innovation and productivity spillovers that promote long-term competitiveness; (ii) demand-side growth through investment and job creation; and (iii) factor accumulation and technological diffusion as discussed in Solow model. The interaction between the SMEs and the economic growth in Nigeria can be usefully understood in an integrative functional way: 𝐸𝐺𝑅𝑡= 𝑓(𝐿𝑆𝑀𝐸𝑡, 𝐺𝑆𝑀𝐸𝑡,𝐼𝑁𝑇𝑡,𝐼𝑁𝐹𝑡,𝐸𝑋𝑅𝑡) (4) where 𝐿𝑆𝑀𝐸𝑡 represents loans and advances to SMEs, 𝐺𝑆𝑀𝐸𝑡 is the growth of SME contribution to GDP, 𝐼𝑁𝑇𝑡 denotes interest rate, 𝐼𝑁𝐹𝑡 is inflation rate, and 𝐸𝑋𝑅𝑡 represents exchange rate. This equation captures both the supply-side and demand-side roles of SMEs within the broader growth dynamics of Nigeria. 3.2. Methodology The reported study uses a 22-year time-series of data (20012022) to examine the role of SMEs in Nigeria economic growth. Sources of data were the Central Bank of Nigeria (CBN) Statistical Bulletin (2023) and the official publications of the National Bureau of Statistics (NBS) supplementary to ensure accuracy and credibility. The variables are the economic growth (EGR), which is proxied by the growth rate of gross domestic product (GDP); loans International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 646 and advances to SMEs (LSM); growth of SMEs (GSM) in terms of the contribution of SMEs to GDP; interest rate (INT); inflation rate (INF); and the exchange rate (EXR). This dataset was selected because it provides most of the macroeconomic indicators that reflect on the financial assistance that SMEs receive and the macroeconomic condition that they can operate under. This is guaranteed by the use of secondary data to be comparable to previous empirical results (Onyeiwu et al., 2020; Afolabi, 2013) and allows one to rely on the more complex econometric estimation methods that could be used in the long run. The empirical specification is based on SME-growth literature frameworks (Afolabi, 2013). The formal representation is that of: 𝐸𝐺𝑅𝑡= 𝑓(𝐿𝑆𝑀𝑡, 𝐺𝑆𝑀𝑡,𝐼𝑁𝑇𝑡,𝐼𝑁𝐹𝑡,𝐸𝑋𝑅𝑡) (5) This is further represented in its econometric form as: 𝐸𝐺𝑅𝑡= 𝛽0+ 𝜋 𝑇𝑟𝑒𝑛𝑑 + 𝛽1𝐿𝑆𝑀𝑡+ 𝛽2𝐺𝑆𝑀𝑡+ 𝛽3𝐼𝑁𝑇𝑡+ 𝛽4𝐼𝑁𝐹𝑡+ 𝛽5𝐸𝑋𝑅𝑡+ 𝜇𝑡 (6) where 𝐸𝐺𝑅𝑡 denotes economic growth at time 𝑡; 𝐿𝑆𝑀𝑡 represents loans and advances to SMEs; 𝐺𝑆𝑀𝑡 is the growth rate of SMEs’ contribution to GDP; 𝐼𝑁𝑇𝑡 is the prevailing interest rate; 𝐼𝑁𝐹𝑡 is the inflation rate; 𝐸𝑋𝑅𝑡 is the naira-dollar exchange rate; and 𝜇𝑡 is the error term. The coefficients 𝛽1 and 𝛽2 are expected to be positive, reflecting the hypothesis that increased financing and growth of SMEs enhance overall economic performance. Conversely, 𝛽3, 𝛽4, and 𝛽5 are anticipated to be negative, given that higher interest rates, inflation, and exchange rate” volatility often constrain SME activities and economic growth (Beck et al., 2005). Table 1: Variable Definitions and Sources Variable Abbrev. Definition Measurement/Proxy Source Economic Growth EGR Growth rate of Gross Domestic Product Annual % change in GDP CBN Statistical Bulletin (2023) Loans to SMEs LSM Aggregate loans and advances to SMEs ₦ billion (constant terms) CBN Statistical Bulletin (2023) Growth of SMEs GSM Contribution of SMEs to GDP % of GDP NBS; CBN (2023) Interest Rate INT Commercial bank lending rate Annual % CBN (2023) Inflation Rate INF General price level changes Consumer Price Index (annual %) NBS (2023) Exchange Rate EXR Naira/US dollar rate Annual average CBN (2023) Source: Author (2025) International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 647 Given the time-series nature of the data, econometric procedures were undertaken to ensure valid inference. Stationarity was first tested using the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) unit root tests. Results confirmed that all variables became stationary after first differencing, which means integration of order one, I(1). As a result, the existence of a long-run equilibrium relationship between the variables was investigated with the help of the Engle-Granger and Phillips-Ouliaris residual based cointegration tests (Engle and Granger, 1987). After determining the cointegration, the research made use of the Fully Modified Ordinary Least Squares (FMOLS) estimator in order to derive consistent long-run parameters. FMOLS is used to correct the endogeneity and serial correlation in Cointegrated regressions and hence the efficiency of FMOLS is better than Ordinary Least Squares (Phillips and Hansen, 1990). The FMOLS definition of the Equation (6) is stated as: 𝐸𝐺𝑅𝑡= 𝛽 󰆹0+ 𝛽 󰆹1𝐿𝑆𝑀𝑡+ 𝛽 󰆹2𝐺𝑆𝑀𝑡+ 𝛽 󰆹3𝐼𝑁𝑇𝑡+ 𝛽 󰆹4𝐼𝑁𝐹𝑡+ 𝛽 󰆹5𝐸𝑋𝑅𝑡+ 𝜈𝑡 (7) where 𝛽 󰆹𝑖 are long-run consistent estimators of the true parameters. To validate robustness, an alternative specification is employed, excluding the trend variable to control for spurious correlation: 𝐸𝐺𝑅𝑡= 𝛼0+ 𝛼1𝐿𝑆𝑀𝑡+ 𝛼2𝐺𝑆𝑀𝑡+ 𝛼3𝐼𝑁𝑇𝑡+ 𝛼4𝐼𝑁𝐹𝑡+ 𝛼5𝐸𝑋𝑅𝑡+ 𝜖𝑡 (8) This auxiliary model allows for sensitivity analysis by testing whether the observed relationships persist under alternative specifications. The adjusted coefficient of determination (𝑅2) was used to evaluate the explanatory power of the model, while Durbin–Watson statistics were employed to check for autocorrelation. These methodological choices are consistent with established practices in empirical SME– growth studies (Afolabi, 2013; Beck et al., 2005). 4. Results and Discussions 4.1 Results Table 2: Descriptive Statistics Statistic EGR LSME GSME INF INT EXR Mean 10.112 40,279,639 23.131 66.428 20.059 215.733 Median 15.354 41,680,550 18.064 54.929 19.509 183.272 Maximum 27.935 90,176,500 55.208 151.466 31.650 411.502 Minimum -42.651 12,550,300 8.278 7.256 15.480 102.542 Std. Dev. 18.620 21,881,832 14.602 42.652 3.708 95.422 Skewness -1.543 0.719 0.966 0.471 1.776 0.825 Kurtosis 4.776 3.105 2.716 2.142 6.396 2.581 International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 654 targeting job-rich industries including agribusiness, renewable energy and digital services. In such a way, governments have a chance to support inclusive growth and increase economic resilience to global shocks (Asongu et al., 2023). 5. Conclusion In this paper we attempt to explore this mutual dependence between SMEs and economic growth considering large-scale or fast-growing firms as well, which would be more relevant for incorporating important measures like interest rates, inflation, and exchange rates. These results provide strong evidence that the SME is a major source of long-run economic growth with positive coefficients showing relatively high consistency across model specifications, as well as through robustness tests (Acs et al., 2021), thereby supporting the theoretical claim from endogenous growth theory which states that entrepreneurial activity at firm level drives sustainable growth. This also suggests evidence that SMEs have sticky impacts on growth in all alternative specifications used here to transform the economy. The study further found that an appropriate form of interest rates could complement SME-led growth by enhancing access to credit markets, meaning that financial sector policies should be designed for a conducive environment where these small firms can thrive and align with developmental banking initiatives (Nguyen et al., 2021). The negative effect between depreciation exchange rate on the one hand and growth on the other reflects how vulnerable SMEs are from foreign shocks or macroeconomic instability; hence, exchange rates management is an important policy instrument to support competitiveness of these small firms and maintain economic momentum. While inflation did not appear significant in the primary regression, its potential for distorting cost structures as well as weakening purchasing power justifies closer scrutiny when it comes to other stabilization policies (Ojeka et al., 2024). In policy terms, this evidence suggests that efforts at SME development need not be a shortterm strategy for job creation but must become part of an overall long-run growth agenda that entails multifaceted solutions involving financial inclusion programs, infrastructural support and technological modernization. The combination of digital platform investments with innovation ecosystems and value chain integration may further enhance the potential to boost productivity growth as well as structural change (Gherghina et al., 2020). Furthermore, integrating SME promotion in sustainable development policies allows for addressing goals related to inclusiveness, resilience and industrial diversification (Asongu et al. 2023). International Journal of Social and Educational Innovation (IJSEIro) Volume 12/ Issue 23/ 2025 655 On the basis of these findings, the research suggests a number of measures. To begin with, policymakers need to increase accessibility to low-cost finance by SMEs by providing credit guarantees, special subsidies, and SME banking departments. Second, the exchange rate stabilization policies such as hedging facilities and macroprudential management must be enhanced in order to cushion the SMEs against international market volatility. 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