Factors Affecting Foreign Direct Investment in Ethiopia: ARDL Approach to Co-integration

Abstract

Different studies show that FDI has important roles to the economic development of a given country and it is determined by several factors. This study tried to investigate what critical factors are determining the amount of FDI inflow into Ethiopia. To accomplish the objective of the study a time series data ranging from 1981 up to 2016 is employed. The results of the Augmented Dickey Fuller (ADF) test indicate that the variables under consideration are a mixture of integrated of order zero and order one, that is, I(0) and I(1). Moreover, the result of bounds testing confirms the existence of stable long run relationship between FDI and its determinants. Accordingly, Autoregressive Distributed Lag (ARDL) model or bounds testing approach to co-integration and Error Correction Model (ECM) are applied to investigate the long run and short run relationship between FDI and its determinants respectively. The results of the study revealed that trade openness and real GDP positively influence the inflow of FDI while real effective exchange rate and government fiscal deficit have an adverse effect on FDI inflow. As a policy implication, it is recommended to dismantle restrictions on the free flow of capital, promote poverty alleviation strategies to enlarge the domestic market, strive to reduce budget deficit and avoid frequent changes in exchange rate. Keywords: ARDL, Bounds testing, ECM, Ethiopia, FDI DOI: 10.7176/EJBM/12-35-02 Publication date: December 31 st 2020