Abstract:
This paper investigates the causal linkage between foreign aid and economic growth in Ethiopia
based on time series annual data for the period 1981 to 2020. The Autoregressive Distributed
Lag approach to Co-integration and Error Correction Model was applied to investigate the
long-run and short-run relationship between economic growth and its determinants. Therefore,
the results of the bound test confirmed that the long-run relationship between explanatory
variables and economic growth. The empirical results implied evidence of a long-run and short run negative impact of foreign aid on economic growth in Ethiopia. Concerning other control
variables except for squared foreign aid and political instability, all variables significantly
influence economic growth in the long run. While in the short-run, gross capital formation, total
export, external debt, inflation rate, and drought have a significant impact on economic growth
but human capital, and political instability is insignificant. Furthermore, Vector error correction
model Granger causality tests show that the direction of causality is running from economic
growth to foreign aid in the long run, and no short-run causality exists between foreign aid and
economic growth. The study also found that economic growth during EPRDF relatively strong in
growth compared to the military regime, and foreign aid as a percentage of GDP declining
during the study period under consideration. Therefore, based on the finding, the government
should minimize the dependence on foreign aid, and work to bridge gaps in the financial source
by setting policies to increase domestic saving which is believed as a backbone of economic
growth.
