The Interactions of Foreign Direct Investment, Economic Growth and Export promotion in Ethiopia

Abstract

The flow of Foreign Direct Investment (FDI) has been increasing rapidly all over the world, and liberalization policies followed by most countries in the world are among the main factors behind the surge. Ethiopia is among these countries to follow such policy shifts. Nowadays, the country is also among the fastest growing economies in Africa, even though the country is suffering from serious macroeconomic problems. These problems include a large trade deficit, despite improved performance in the export sector. This paper tried to examine the interaction of FDI with economic growth and export performance in Ethiopia using both descriptive and empirical analysis. The study also tried to test the possible conditionality of the growth impact of FDI from Ethiopia’s trading regime (Bhagwati Hypothesis). Our empirical estimation provided positive and significant growth effects of FDI, though with a two year lag, implying that foreign investment flows to the country take time to bring meaningful impact on the economy. This could be due to poor infrastructure or limited human capital at the time of investment that needs to be upgraded before any meaningful production takes place. At the same time, our empirical test confirms the Bhagwati hypothesis, implying that the growth impact of FDI to be stronger in an open trading regime. However, the positive backing of FDI in with Ethiopian exports remains weak or insignificant, which is in line with our descriptive analysis. Descriptive explanations for the FDI-growth interaction are misleading and difficult to match with the empirics.