IMPACT OF FOREIGN DIRECT INVESTMENT ON ETHIOPIAN ECONOMIC PERFORMANCE: A VECTOR ERROR CORRECTION MODEL

Abstract

There is a general consensus that Foreign Direct Investment (FDI) will do more good than bad to the economic performance of a host country. However, the net effect of the inflows of foreign capital in the form of FDI depends on the specific characterstics of the host country as well as on the state of economic development that prevails in the host country. The main purpose of this study is to analyze the impact of FDI on the economic performance of Ethiopia by using time series data for the period ranging from 1971 to 2015 using aggregate national data. The research employed Vector Error Correction Model (VECM). The result showed that all the variables are non stationary at level but they become stationary after first differencing indicating that all the variables are integrated of the same order and also that the results of cointegration test indicates as there is cointegartion among the variable meaning that they do have tendency to move together in the long-run. The result of the study also shows that FDI inflows will have negative adverse effect on the performance of the Ethiopian economy in the long run but it has positive contribution in the short run. Therefore every policy actions with respect to FDI has to take into consideration the long run issues as well. More specifically the size of local content in the final products of foreign investors should be identified and included in terms of investment. Moreover the incentive packages provided for foreign investors should be certian so that the benefits from provissions exceeds the social costs incurred for the purpose.