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

Wuhib Seyoum

doi:10.7176/ejbm/12-35-02

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

Highlights

Nowadays it is observable that countries all over the world have interdependence in economic, political, and other social aspects
One way to fill this shortage in capital accumulation and technology could be through foreign direct investment
The results indicate the absence of any instability of the coefficients because the plot of the cumulative sum of recursive residuals (CUSUM) statistic and the CUSUM of square (CUSUMSQ) fall inside the critical bounds of the 5% confidence interval of parameter stability

Summary

Introduction

Nowadays it is observable that countries all over the world have interdependence in economic, political, and other social aspects. Foreign direct investment is an investment which an investor from one nation invests his/her capital to another nation This shows that the citizens of a given nation can participate in economic activities out of their nation boundary and contributing their capital for mutual benefit plus strengthening the economic relation. It is deep-rooted in economic growth theory that investment in capital is crucial to growth. In LDCS, domestic resources are found to be inadequate to meet the financial requirements of economic development They have too low level of capital formulation and any substantial increase in saving is not possible due to low level of income. To overcome the retarding forces of rapid growth, the meager domestic savings are to be supplemented by imported capital (OECD, 2005)

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Conclusion