The Impact of Foreign Aid, Trade Balance, and Remittance on Economic Growth in Ethiopia: Application of Autoregressive Distributed Lag Model
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Background: Economic growth is profoundly affected by inflow of foreign capital (foreign aid, foreign investment, and personal remittances). Ethiopia’s economy has declined from time to time due to the variations in foreign aid, trade balance, remittances, etc. Therefore, it is necessary to elucidate the impact of capital inflow on economic growth of the country to handle the variation and mitigate its negative effect on development.
Objective: The objective of the study was to examine the impact of foreign aid, trade balance, and remittance on economic growth in Ethiopia in the short-run and long-run.
Materials and Methods: This study adopted yearly time series data from 1981 to 2021 to estimate Autoregressive Distributed Lag (ARDL) model. To estimate the model, a Dickey Fuller test was applied using generalized least squares. The bound tests for co-integration were used to scrutinize the long-run relationships between the variables.
Results: The results of the study revealed that unexpected shocks in foreign aid, trade balance, remittance and trade openness have had a negative impact on economic growth while unexpected shocks in government expenditure will have significant positive effects on economic growth in the long-run. The lagged error-correction term indicated the system corrects its previous period disequilibrium at the adjustment speed of 52.21% yearly in the long-run.
Conclusion and Implications: The short run changes in remittances have strong and significant impacts on economic growth in the long run. Foreign aid affects economic growth negatively and positively in the long run and short run respectively. This implies that 1% increase in foreign aid causes a 0.017% decline in economic growth of the country in the long run and 1% increase in foreign aid of the country contributes a 0.025% increase to economic growth of the country in the short run. The short run changes in trade balance will have strong and significant impacts on economic growth in the long run. This implies that the government should formulate various systems and raise consciousness on both remittances receivers and senders regarding the use of money to raise savings and businesses to increase fixed investment in the long run. Moreover, the government should focus on the production of domestic commodities to reduce remittances and foreign aid from other countries and increase the yield of export commodities to raise the export performances of the country.
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