Foreign aid and economic growth in Ethiopia

Abstract The study has examined the impact of foreign aid on investment and economic growth in Ethiopia over the period 1970 to 2009 using multivariate cointegration analysis. The empirical result from the investment equation shows that aid has a significant positive impact on investment in the long run. On the other hand, volatility of aid by creating uncertainty in the flow of aid has a negative influence on domestic capital formation activity. Foreign aid is effective in enhancing growth. However, the aid-policy interaction term has produced a significant negative effect on growth implying that bad policies can constrain aid effectiveness. The growth equation further revealed that rainfall variability has a significant negative impact on economic growth as the economy. This study indicated also that the country has no problem of capacity constraint as to the flow of foreign aid.