Impact of Capital Flow on Economic Growth: Empirical evidence from Ethiopia (1980-2010) using ARDL Approach

Abstract

Evidence abound that some transitioning and developing countries are attracting large inflows of foreign capital that could engender economic growth or have destabilizing effects on their economies if not well managed. This has undoubtedly aroused anxiety over its potential effects on economic growth, the competitiveness of the export and external sectors viability. The study examines the impact of capital flow on economic growth in Ethiopia as well as the causal shortrun and long-run relationship among the variables, using time series data from 1980 – 2010. Using the Autoregressive Distributed Lag (ARDL) approach, the result reveals that all the variables are statistically significant; which implies that the capital flow has an impact on economic growth in both short- and long-run dynamic equilibrium models. Additionally, Vector Autoregressive (VAR) and Innovative Accounting Techniques approach to Granger causality analysis shows that there exists bidirectional causality between gross capital flow, and economic growth. Consequently, these findings suggest that policy makers should critically understand, the nature, what drives the capital flows, and the impact of its sudden surge or reversal on economy. Moreover, it is also recommended that government should continue to pursue trade and foreign exchange policies that would ensure competitiveness of the export sector viability and economic growth.