The impact of foreign aid on economic growth of Ethiopia

Abstract

Poor countries including Ethiopia need successful transformations that lead them to targeted economic growth which in turn improves the living standard of their people. But under the scenario of visible resource gap notably low domestic saving that does not satisfy the increase in investment demand the targeted growth cannot be simply achieved. Thus, to fill the resource gap the problem calls for the country to lookup for and depend on external assistance from developed countries. However, there has been a great debate on the contribution offoreign aidfor economic growth since the long years channeling of resources to this country. Therefore, the main nidus of this study is to examine the impact offoreign aid on economic growth of Ethiopia using multivariate co integration analysis over the period of 1969/70 to 2010/11. The result of co integration test, using Johansen cointegration approach, indicates the existence of long run relationship among the variables entered the specified growth model. The estimated short run model comments that the current and past level of aid inflow entered alone has a negative impact on economic growth. Similarly, current level of aid interacted with policy has also negative effect on economic growth. However, in the long run foreign aid inflow entered alone has a negative and significant impact on economic growth. Whereas, aid interacted with policy appears to have a positive contribution to economic growth of Ethiopia in the long run. Thus, the results of the study calls for better focus on internal factors specifically investment on human capital (labor force) and domestic investment arising from domestic saving to foster economic growth than external one which can be uncertain even when donor countries face long recession. In addition, the study also found that aid remains as a key tool of enhancing the economic growth of Ethiopia if and only if assisted by favorable macroeconomic environments (i.e., good monetary, fiscal and trade policies). viii