Foreign Direct Investment, Environmental Quality and Economic Growth in Ethiopia: An Empirical Study Using ARDL Model Analysis

Abstract

This study examines the relationship between foreign direct investment, environmental quality and economic growth in Ethiopia over a period of 1981 to 2019 by using Autogressive Distributed Lag approach (ARDL) and vector error correction model (VECM). The result of bounds cointegration test approach shows the presence of long run equilibrium relationship between the variables under consideration. Based on economic growth equation, gross capital formation, labor force and inflation have statistically significant positive impact whereas financial development and trade openness have statistically significant negative impact at 1% significance level on economic growth in the long run. On the other hand, only gross capital formation, CO2 emissions, human capital; trade openness and inflation have statistically significant impact on economic growth in the short run. In environmental quality equation, the estimated coefficients revealed that gross domestic product per capita has statistically significant and negative impact on CO2 emissions in the long run. But the square of gross domestic product has statistically significant and positive impact on CO2 emissions. This indicates that the EKC hypothesis is not valid in Ethiopia for the study period since EKC to hold the sign for GDP per capita and GDP per capita square anticipated to positive and negative respectively. Foreign direct investment has also negative and statistically significant impact on CO2 emissions. But, in the short run, only foreign direct investment has statistically significant impact on carbon-dioxide emissions. Speed of adjustment, -0.492832 for economic growth equation and-0.798364 for environmental quality equation is showing that around 49.3% and 79.8% shocks happened in short run is restored (converge) to long run equilibrium per year respectively. The study underlined that the government should adopt CO2 emissions reduction policy in Ethiopia should focus on environmental friendly growth, encouraging technology innovation and adopt new technologies that may lead to energy efficiency and advance low carbon economic growth. The government should be guided by policy prescriptions like Supporting High-Quality and In-Depth Cooperation with FDIInvested Enterprises and Projects as well as Strengthening Environmental Standards and Enhance Environmental Supervision of Foreign-Invested Enterprise.