Effect of Foreign Aid on Economic Growth and Investment in Ethiopia

Abstract: This study examined the effect of foreign aid on both economy and investment of Ethiopia from time 1974 to 2014. The empirical analysis has been done using multivariate cointegration analysis of both vector autoregressive model (VAR) and (Vector Error Correction Model (VECM). Both models enable to capture of short-run dynamics. VECM model is constructed by restricting the long-run behaviour of endogenous variables for allowing for short-run adjustment dynamics. The cointegrating vector which is a deviation from the long-run equilibrium corrected through a series of partial short-run dynamics, which is known as the error correction term The main findings of the study show foreign aid has a significant positive effect on economic progress in both lengthy run and squat run. On other hand, aid has an irrelevant and optimistic effect on gross domestic investment in both extensive time and short run. Further, the findings discovered that there is unidirectional causality between foreign aid to economic growth and foreign aid to gross domestic investment. Based on the findings the study recommends aid should be used to support the shortage of resource gap; also, aid should be focused on growth-enhancing sectors as well as poverty reduction policies, then it will rise savings in societies’