Analysis of Foreign Aid Effectiveness on Economic Growth in Ethiopia
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Date
2023-06
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Addis Ababa University
Abstract
Developing countries like Ethiopia need effective transformations if they are to experience rapid economic growth and raise the standard of living for their people. On the other hand, the saving-investment gap and foreign exchange constraint makes economic growth difficult. Consequently, to bridge the resource gap, the nation looks for aid from developed nations abroad. But the impact of foreign aid on economic growth has been hotly contested. Thus, the objective of the study is to analyze the effectiveness of foreign aid on economic growth in Ethiopia. The study used 30 years of secondary time series data over the period of 1991 to 2021. To analyze the data, the study employed multivariate cointegration method of analysis. The key variables examined are real GDP growth, aid as a percentage of GDP, investment (non-aid financed), labour force, and policy index variable (a composite of budget deficit, inflation, and trade openness). The Johansen cointegration test outcome showed the presence of cointegrating vector among the target variables. The study also employed a vector error correction model (VECM) to find out the relationship between these variables in the short and long-run. According to the result from the estimated model, the impact of foreign aid on real GDP growth is statistically significant and positive in the long-run. Ceteris paribus, on average a one percent increment in foreign aid brings about 3.56 percent increase in real GDP growth. Moreover, the outcome of the study calls for better strategies to mobilize domestic saving, creating favorable macroeconomic environment so that aid can be employed to bridge the saving-investment and foreign exchange gaps and boost economic growth