DETERMINANTS OF ECONOMIC GROWTH IN ETHIOPIA: A TIME SERIES ANALYSIS

Abstract

The purpose of this study is to investigate the major determinants of economic growth in Ethiopia from the period 1974 to 2015. Descriptive statistics and time series econometrics are used in the model to analyse the data. The study employs an Autoregressive Distributed Lag (ARDL) bound test model to co-integration in order to investigate the long run relationship and Error Correction Model (ECM) for short-run relationship between growth of real GDP and gross capital formation, human capital, export, foreign aid, external debt, inflation rate, labor force and financial sector development. The long-run empirical result using the bound test reveals that there is a stable long run relationship between growth of real GDP and its determinants. Gross capital formations (gross fixed investment), human capital (expenditures on education and health, inflation and labor force) have a positive significant impact on the growth of real GDP during the study period while external debt has a negative significant effect. However export and foreign aid have insignificant impact on the long-run with unexpected sign. The financial sector development (broad money supply (M2) as a percentage of GDP) is insignificant with expected sign. The short-run dynamic results show that gross capital formation, human capital and inflation rate have also positive impact on the growth real GDP while foreign aid has negative significant effect. Finally the coefficients of equilibrating Error Term (ECM) suggests that the speed of adjustment (feedback effects towards the long run equilibrium) takes few years for full adjustment when there is a shock in the system. In order to sustain long run growth the government or policy makers should design appropriate policies that results in the efficient use of resources contributing to economic growth and proper management of variables resulting to negative growth (external debt and foreign aid) in order to reverse their effect on output.