Determinants of Private Investment in Ethiopia: A Time Series Study

Abstract

In the growth literature, investment has been regarded as one of the primary engines of growth. Growth theories emphasise the importance of investment in determining the level of income (neoclassical) and the pace of economic growth (endogenous growth model). However, the Ethiopian private investment performance has been weak for long time. It had been stagnantly low until the end of the socialist regime. In spite of little improvement in the post‐socialist era, the share of private investment in GDP has never been above 6 percent even until 2003. Yet, the reasons behind the weak performance have not been well studied. Hence, investigating the performance trend and maim constraints of private investment in Ethiopia becomes the core theme of this study. Targeting at addressing a question of what measures should be taken to promote investment in the country, the research proceeds to test empirically whether demand augmenting and trade liberalization policies, improved infrastructural facilities, macroeconomic and political stabilities improve the private investment performance of Ethiopia. Motivated by the modified version of the Flexible Accelerator Model of investment behaviour, the empirical investigation employs a multivariate single equation ECM estimation methodology on integrated of order one, I(1), variables using annual time‐series data sets for 1950‐2003 and two sub‐periods. According to the estimation results, private investment in Ethiopia is influenced positively by domestic market, return to capital, trade openness and liberalization measures, infrastructural facilities and FDI; but, negatively by government activities, macroeconomic uncertainty and political instability. Hence, enhancing demand augmenting and trade liberalization policies, improving infrastructural facilities and maintaining macroeconomic and political stabilities should be among the main ingredients of a policy package designed to promote private investment in Ethiopia. Furthermore, the operations of the public sector and other institutions will need new thinking. Keywords: Investment, Determinants, Time‐Series, ECM, Ethiopia