Impact of Foreign Direct Investment on Economic Growth in Ethiopia
| Autor | Abdillahi Nedif Muse/Saidatulakmal Mohd |
| Cargo | Universiti Sains Malaysia/Universiti Sains Malaysia |
| Páginas | 56-77 |
Latin American Journal of Trade Policy 10 (2021) – ISSN 079-9668 – Universid ad de Chile
56
Impact of Foreign Direct Investment on Economic Growth in Ethiopia:
Empirical evidence
Saidatulakmal Mohd *
Abdillahi Nedif Muse **
Abstract
This article analyses the impact of foreign direct investment (FDI) on Ethiopia’s economic growth.
For this purpose, it uses Vector Autoregressions (VARs) model for the period comprised by years
1981-2017. It finds that FDI had a significant positive impact on Ethiopia’s economic growth for
both the short and long-run periods. Adequate human capital and stable macroeconomic
envirornment have catalysed the contribution of FDI to economic growth. Gross fixed capital
formation and government consumption exerted a negative and significant effects on economic
growth during the period of interest. Moreover, the study reveals that there is no causal relationship
between FDI and economic development. Ethiopia needs to open up the economy and restructure
the financial sector to attract foreign multinational companies (MNC), especially in the manufacturing
and agro-industry sectors. Human capital investment should be strength to absorb more foreign
direct investment and transform the agricultural-based economy to a modern one. Effective
budgeting system and prioritisation of government consumption will support a more rapidly growing
economy.
Keyword:
Economic growth, Foreign Direct Investment, VECM, Ethiopia
JEL Classification:
O41 - F23 - O55
Resumen
Este artículo analiza el impacto de la inversión extranjera directa (IED) en el crecimiento económico
de Etiopía. Para ello, utiliza el modelo de autorregresiones vectoriales (VARs) para el período
comprendido por los años 1981-2017. El estudio encuentra que la IED tuvo un impacto positivo y
significativo en el crecimiento económico de Etiopía tanto a corto como a largo plazo. Un capital
humano adecuado y un entorno macroeconómico estable han catalizado la contribución de la IED
al crecimiento económico. La formación bruta de capital fijo y el consumo público tuvieron efectos
negativos y significativos sobre el crecimiento económico durante el período de interés. Además, el
estudio revela que no existe una relación causal entre la IED y el desarrollo económico. Etiopía
necesita abrir la economía y reestructurar el sector financiero para atraer empresas multinacionales
extranjeras, especialmente en los sectores de manufactura y agroindustria. La inversión en capital
humano debería ser la fuerza para absorber más inversión extranjera directa y transformar la
economía basada en la agricultura en una moderna. Un sistema presupuestario eficaz y la priorización
del consumo gubernamental respaldarán una economía de crecimiento más rápido.
Palabras clave: Crecimiento económico, Inversión extranejra directa, vectores autoregresivos,
Etiopía
* Centre for Global sustainability Studies and School of Social Sciences, University Sains Malaysia & Jigjiga University,
Ethiopia. Email: eieydda@usm.my. Received: 6th may 2021. Accepted: 25th August 2021.
** School of Social science, Universiti Sains Malaysia. Email: nadiif_98@hotmail.com.
Latin American Journal of Trade Policy 10 (2021) – Universidad de Chile
57
Introduction
Foreign direct investment (FDI) has been one of the salient features of the literature in economic
growth and development in the past decades. Many studies have been conducted both in developing
and developed countries to examine the several channels affecting economic growth (Akinlo, 2004).
The fast growth of FDI over the last decade has intrigued prominent economists and policymakers
to examine FDI’s impact on economic growth. Empirical findings for the effect of FDI on economic
growth show a positive result for most recipient countries. The main benefits include spillover
knowledge such as packages of capital, technical skills, managerial and organisational know-how
(Astatike & Assefa, 2005). FDI is a crucial component to developing countries and provides access
to resources and technology that otherwise would not be available.
FDI contributes to economic development and poverty reduction while creating jobs, new supply,
and a better business competitive environment. As a result, it will eventually improve the economic
growth of the recipient country. FDI is an amalgamation of a bundle of capital stock and technology
that can enrich the existing knowledge in the host economy (Xiaoming, 2003). Economists assumed
the decisive role of FDI on economic growth in developing countries due to increasing employment
opportunities, technical know-how in the domestic market, and enabling environment for business
competition to enhance productivity and export (Ghatak & Halicioglu, 2007). Another critical feature
for today’s globalisation is to consider FDI’s as an engine for their economic growth. Therefore,
facilitating technological advancement for a country to achieve higher sustainable economic growth
becomes the critical economic priority to attract FDI as an essential economic development source
(Akinlo, 2004; Ayanwale, 2007).
In Africa, attracting FDI is one of the government’s main priorities for economic growth,
predominantly in Sub-Saharan Africa. FDI attraction in Africa was limited due to the inadequate
infrastructure, political instability, oscillating of the exchange rate, and unpredictable inflation
(Ayanwale, 2007). African record in FDI is smaller than other regions, and multinational companies’
presence was minimal, until the recent China’s involvement in the continent, with 2.9% of the world
FDI. A continent with a significant market and sizeable young population attracting this minimal
share of FDI is a puzzle, in which it becomes relevant to look for the root of the shortage of FDI.
Ethiopia is not an exceptional country from the rest of the continent, although it is one of the top
FDI recipients in this decade. Likewise, FDI is crucial for Ethiopia’s economic growth as an essential
source of capital and knowledge split over, so it is vital to finance growth and development (Astatike
& Assefa, 2005).
Therefore, examining the effect of FDI on economic growth in Ethiopia has its importance. FDI has
played an essential role in Ethiopian economic growth and attracted multinational companies.
Studies about the contribution of FDI inflows and their relationship to economic growth are not well
explored in Ethiopia. Therefore, this study assumes to fill this gap and better understand the
relationship between FDI and Ethiopia’s economic growth.
The paper is organised as follows. After this introduction, the following section reviews the relevant
literature, both theoretical and empirical. After this review, the methodological framework is
presented. A series of test are show to assess the sensibility of the model. The discussion of the results
is presented. Finally, some conclusing remarks are shown.
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