The Link between Financial Development and Sectoral Output Growth in Ethiopia: The Case of Agriculture, Industry and Service Sectors

Abstract

This paperaimed toinvestigate the linkage between financial development and sectoral output growth with special emphasis on Agriculture, industry and service sectors in Ethiopia during the period from 1975 to 2016. The study has used Autoregressive Distributive lag(ARDL) bound testing approach viaanaugmented growth model to examine the linkage between the financial development, proxied by bank credit to sectors,and sectoral output growth.Furthermore, Vector Error Correction Model (VECM) was employed to investigates the direction of causality between financial development and sectoral output growth. The results of bound test confirmed that the long run relationship between explanatory variables and sector output growth with less cointegration of agricultural output growth and respective independent variables. The empirical results of this study showed, that in the long run financial development had aless significant positive impact on agricultural and service sector output growth but, short run relationship was found to be insignificant. However, financial development has apositive and significant impact on industrial and aggregate output growth both in the short run and long run..Furthermore, VECM granger causality tests show that there is no causality between financial development and agricultural output growth both in long run and short run. However, uni-directional causality running from (1) financial development to industrial output growth both in the long run and short run which confirmed supply leading growth hypothesis (2) financial development to service sector output growth in thelong run(supply leading) and in the short run running from service sector to financial development which supports demand leading hypothesis only in short run. At theaggregatelevel, the direction of causality is running from financial development to economic growth both in short run and long run.