Foreign Aid and Economic Growth in Ethiopia: A Cointegration Analysis

Poor countries lack sufficient domestic resources to finance investment and the foreign exchange to import capital goods and technology. The existing situation in Ethiopia is a living example of the scenario which binds economic growth. In this paper the unresolved question of aid effectiveness (usually measured by its impact on economic growth) in Ethiopia using a time series data covering the period 1970 to 2009 is addressed by employing multivariate cointegration technique. Foreign aid entered alone has a positive role in enhancing growth. However, the aid-policy interaction term has produced a significant negative effect on growth implying the deleterious impact of bad policies in constraining aid effectiveness. The overall effect of aid on economic growth over the period considered turns out to be negative due to lack of good policies. This paper indicates also that the country has no problem of capacity constraint as to the flow of foreign aid.