The Effect of Foreign Aid on Public Spending in Ethiopia

Abstract

The motivation behind this study is to investigate the effect of foreign aid on public spending in Ethiopia secondary time series data from MOFED and world bank official website is used and from 1981-2018 was used. The Johansen co-integration analysis, VECM was conducted in addition to that impulse response and variance decomposition was conducted. Based on VECM result the response of public spending for the change positive change of foreign aid is negative and the result of short run for VECM shows that the percentage change in forging aid associated with 0.6 present decline in public spending and it is significant. According to the impose response result the response of public spending for the positive change of foreign aid is negative it shows continues negative response from the beginning up to the last forecasting period in the other hand the variance decomposition result shows that the greater variance in the public spending came from the foreign aid next to its own change. In the short run the 89 present variation in public spending came from its own change and 5.7 present of variation is sourced by the foreign aid. Based on the result the researcher recommended that the country should not be depend on different source of foreign aid because the foreign aid affect negatively the public spending and the decrease of foreign aid negatively affect the economic growth of the country. This is caused by most of the foreign aid are directly used in the consumption such as military purpose and projects which has not any significant effect for the long run economic growth of the country Rather than the government depend on foreign aid it should be used some alternative domestic source in order to increase public spending like increasing the revenue from tax in addition to this the government should check the check how to use the foreign aid because in most developing countries foreign aid related to different corruption issue.