The Nexus between Financial Development, Foreign Direct Investment and Economic Growth in Ethiopia
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Date
2021-02
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Addis Ababa University
Abstract
Foreign direct investment (FDI) has been recognized as a growth-enhancing factor in various economies more especially in less developed countries. It is among the most vibrant foreign inflows that promote economic growth. Foreign direct investment (FDI) improves economic growth; however, the FDI that contributes to the growth is dependent on the recipient countries circumstances. The aim of this study is to empirically investigate the relationship between financial development, foreign direct investment (FDI) and economic growth, and to examine the effect of the interaction variable on economic growth in Ethiopia. The study used the co-integration and Autoregressive Distributed Lags Approach (ARDL) approach, using time series data which covers from 1981-2019. Also the study employed Granger causality test to see the direction of causality. From the result of the bound test there is a long-run relationship among the variables. The obtained results shows that FDI and private sector credit has a positive and significant impact on economic growth, while, the interaction variable has a significant negative relationship with economic growth in the short run. The result also revealed that in the long run private sector credit and the interaction variable has a positive and significant impact on economic growth. However, the FDI to have a positive effect on economic growth of Ethiopia in the long run if the threshold level of financial development should be attained. Moreover the Granger causality test result shows bidirectional causality from foreign direct investment (FDI) to GDP per Capita, private sector credit to GDP per capita and a unidirectional causality from FDI to private sector credit. The result suggest that there is a need to reform the domestic financial sectors to make it more attractive for any foreign firms to invest in, although, this can be considered as a pre-condition for the positive impact of FDI on growth. Thus, the reform of the domestic financial sector should precede policies that would attract FDI inflow into the Country.
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Keywords
Economic growth, foreign direct investment, financial development, ARDL, Ethiopia