Determinants of Foreign Direct Investment in Ethiopia: The ARDL Bounds Testing Approach
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Date
2020-02
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A.A.U
Abstract
Many capital-starved countries compete with each other to attract Foreign Direct Investment (FDI) by liberalizing their policy regimes and offering various incentive packages, such as tax holidays, trade liberalizations, an establishment of industrial parks, and other incentives. Despite these, only a few succeed in attracting the much-needed capital through inward FDI. Hence, one could ask what factors determine the inflow of FDI into a host country. In line with this question, this paper aimed at analyzing the key determinants of FDI inflow into Ethiopia by using- an ARDL Bounds Testing method for the period 1996-2018. The variables considered were FDI inflow as dependent variables and the independent variables considered in the study include; GDP growth, Trade openness, Inflation, voice, and accountability, government effectiveness, political stability and the rule of the law. The data for the later governance variables were collected from the World Governance Index of the world bank. These variables were given an index value of +2.5 to -2.5 indicating strong and weak governance structures respectively. To evaluate the long-run cointegration of the dependent and the independent variables, the ARDL bounds test was conducted. The result revealed a long-run relationship between the regressors and FDI inflow. Accordingly, from the long-run estimation output, inflation, voice, and accountability, and government effectiveness were found affecting FDI inflow negatively and significantly at a 5% critical value. The rule of law, however, shows a positive long-run impact on the dependent variable. GDP growth, Political stability, and trade openness were found not to affect FDI inflow in the long-run. The short-run equation, on the other hand, revealed that trade openness, political stability, and rule of law having a positive and significant impact on FDI inflow into Ethiopia. The relationship of the voice and accountability and government effectiveness with the dependent variables remained the same as the long-run relations. Eventually, the researcher recommended the enhancement of institutional capacity to improve the competitiveness of the nation’s economy to attract FDI inflows. More on, prudent and strategic management of inflation rate in light of dynamics in the macroeconomic environment and overall social and environmental changes is critical to have sustained competitive economic landscape and improve foreign direct investment inflow.
Description
A Thesis Submitted in Partial Fulfillment of the Requirement of Masters Degree in Accounting and Finance
Keywords
Ethiopia, ARDL Model, Foreign Direct Investment, Governance