1.1. Background of the Study
Finding the best way to boost the economic activity is the subject of intense debate in most of the countries in the world. A nation’s ability to provide improving standards of living for its people depends crucially on its sustainable and long-run rate of economic growth. Hence economic growth is one of the most important issues that have received extensive attention in international political economy and one of the major goals of all countries (Mostafa, 2010). So understanding the determinants of growth is not only important from the policy perspective but also is the key component for macro management. It is determined by internal as well as external macro variables of an economy such as investment, employment, money supply, general price level, fiscal deficit, Level of export, foreign capital etc. (Biswas and Kumar, 2014).
Despite the lack of unifying theory, there are several partial theories that discuss the role of various factors in determining economic growth. Two main strands can be distinguished. The first is neo-classical based on Solow’s growth model showed that the main sources of economic growth are capital accumulation and total factor productivity. The second is the more recent theory of endogenous growth theory developed by Romer (1986) and Lucas (1988) has drawn attention on human capital and innovation capacity (Arvantids et al, 2007).
Over the last 70 years the issue of economic growth has attracted increasing attention in both theoretical and empirical research. As of World Bank (2016) world economy grew 3.1 % in 2015. Over the past 15 years, most countries in Africa experienced sustained economic growth, with growth rates often exceeding 5% per year improvements (Zamfir, 2016).
Ethiopia has passed through three politically distinct regimes with different policy reforms and various changes in economic growth since 1930: The imperial Government (1930-1974),The Derg Regime (1974-1991) and the existing government (1991-present).In the imperial regime (1930-1974) the government established three consecutive five year plans over the period 1957-1974 .The first five year plan (1957-1963) focused on industrialization and infrastructural development giving due attention to industries producing light consumer goods for domestic consumption. The second five year plan (1963-1968) was launched with the objectives of building heavy industries that produce chemicals and metals this time shows growth accompanied by increased investment, exports and employment however these two plans ignore agriculture which finally leads to failure. The other was the third five year plan (1969-1974) which favors commercial agriculture and industries. This plan did not give satisfactory result because of poor performance of agriculture and resource mobilization as well as high domestic transportation cost and natural disasters which leave the economy without transformation (Zerayehu, 2013). The GDP at constant factor cost has grown by 4.6%, 3.8% and 1.9% during 1953-59, 1960-65 and 1966-73 periods, respectively (Alemayehu, 2001).
During the Derg regime, the general growth rate of GDP was 1.6%. During the period 1974-1978 the growth rate was 0.4 due to the civil war and the instability. In 1979-83 growth rate rose to 4.2% – a period characterized by relatively stable and good weather conditions. In 1984-85 growth plummeted to -5.3%. These were periods of severe drought. This rate picked up to 7.9% in 1986-87, only to decline back to 1% and the average per capital GDP growth rate is -2.3% in 1988-89. This was because of intensive internal war that takes place in Ethiopia in order to overthrow the government and to retain power by the ruling government. However, Ethiopia experienced very high growth rate during the Derg regime between the periods of 1986-87 which was 7.9% per annum. This achievement is because of best rains season at the time (Alemayehu, 2001).
Ethiopia began to see accelerated economic progress in 1992 and it shifted to an even higher gear in 2004. Real GDP growth averaged 11.2% per annum during 2003/04 and 2008/09 period, placing Ethiopia among the top performing economies with a double digit in sub-Saharan Africa (SSA). It has experienced impressive growth performance over the last decade with average GDP growth rate of 11% which is about double of the average growth for SSA (NBE, 2013). More recently, Ethiopia has been one of the fastest growing non-oil dependent countries in Africa. It has made remarkable progress in its economic growth, with real GDP growth averaging 10.9% in 2004-2014 (WB, 2016).Notwithstanding the worst drought, Ethiopia registered 8.0% real GDP growth rate in 2015/16 which was much higher than 1.4% average for SSA. The economic growth was broad based with industry growing 20.6% service 8.7% and agriculture 2.3% (NBE, 2015/2016). However Ethiopia needs to modernize the policy framework to further strengthen the foundations of its economy and to achieve its broader goal of becoming a lower middle income country by 2025.
Generally Ethiopian economic history is characterized by ups and downs of economic performance owing to different regimes of ruling governments and their associated policies and objectives for what the government set policies. This can be the reason for the low level of living standards that the present Ethiopia is encountering. So the study of economic growth and their determinants is interesting and hot phenomena that is to be addressed to have high level of potential growth that lifts out the society from poverty.
1.2. Statement of the Problem
Nowadays the diverse economic growth patterns are very common in the world. The process of economic growth and the source of differences in economic performance across nations are some of the most interesting, important and challenging areas in modern social science. So the sources of economic growth is a question of great importance concern for many economists, politicians and policy makers who are interested to know and search for factors enabling some countries to grow and develop while others are suffering from abject poverty (Tewodros, 2015).
The Ethiopian economic growth is characterized by mixed, erratic and averagely poor performance exhibiting positive and negative real GDP growth rates. For example it shows a negative growth rates seven times between 1981 and 2010 (WB 2011). This shows it has been moving back and forth owing to different factors. On the other hand official report on growth poverty and inequality show that Ethiopia has registered a two digit rate of economic growth in the last decade and has made immense progress in poverty reduction. Many suspect that the current unprecedented high growth rate is attributed to a combination of pro poor growth policy (since 2003 on wards) and state led development program (since 2005 on wards) Zerayehu, 2013). However, there is no consensus among scholars’ academicians and policy makers (politicians) on the causes of this mixed, erratic, volatile and low performance of the economy for long periods and the fast growth rates registered in the last decade
Added to the lowest living standard this stochastic growth is the main problem in Ethiopia. Otherwise solved, Ethiopia have no any guarantee not to encounter the problems that she have faced in the last three regimes as far as the growth of the economy is concerned. This premise is evidenced by the growth patterns that she comes across in the last four decades. So research is mandatory on what affects the Ethiopian economic performance over the past periods and what is injected to the promising that, the Ethiopian economy is performing well in the last decade as compared to the past. However some argue that even this growth rate is not enough for small country like Ethiopia to achieve the intended objectives of joining middle income countries and above all lifting the society out of poverty.
There are a number of studies which have examined the determinants of economic growth in many countries around the world. For instance, Barro, (2003) for panel countries, Ndambira et al, (2012) for SSA, Hui et al,(2015) for Singapore, Adhiambo & Were, (2015) for East African Community, Permani ,(2008) for East Asia, Loayza et al,(2004) for Latin America and the Caribbean, Mostafa ,(2010) for Egypt, Pitia,(2015) for Sudan,Mbulawa,(2015) for Zimbabwe, Patrick Enu et al. (2013) for Gahana, Biswas & Kumar ,(2014) for India, Mamoundou (2011) for Japan etc. through different methods of analysis at different time by using different determinants of economic growth.
With regard to Ethiopia several studies have been undertaken on economic growth. But these researches are done mostly on impact of one or two variables on economic growth in different time periods rather than using potential determinants or source of economic growth as general. However, Tadesse (2011) used an aggregate Cobb-Douglas production function and OLS regression analysis to compute the growth contributions of capital, labor and technical progress for Ethiopian economic growth. He found capital labor ratio had positive effect on economic growth in short run as well as long run in Ethiopian during 1981-2009.
Tewodros, (2015) in his research modelfrom 1974 to 2013, found that physical capital and human capital had a significant positive relationship with economic growth while external debt had a significant negative effect on it. He also found export of goods and service, foreign aid and inflation had insignificant effect on economic growth in the long run. However in his study he did not include some determinants which are area of recent interests in Ethiopian economic growth like labour force and financial development. Therefore, the inclusion of such pertinent variables on the model will contribute to the theory. In addition to that much is not done on the determinants of economic growth in Ethiopia as compared to other world. So it is difficult to generalize the findings of other world economies to Ethiopian economy since Ethiopian has different social, political economic and institutional setup that distinguishes her from other world. This shows that there is mixed evidence on the driving forces of economic growth on one hand and lack of exhaustiveness in at least the main determinants on the other hand. So the researcher is going to analyse the main macroeconomic determinants of economic growth by being exhaustive as much as possible and including the basic factors believed to affect growth like labour force and financial development by mixing with the variables used in the past research. A continuous and multi-disciplinary rigorous study is also required to take the policy implications seriously as relevant to Ethiopia. Therefore this study tried to provide a comprehensive more recent evidence to identify the main macroeconomic determinants of economic growth in Ethiopian during period of 1974-2015 to disprove theories related to the issue or to conform it.
1.3. Research Questions
The study critically investigates the following questions regarding to the determinants of economic growth.
v What are the main determinants of economic growth in Ethiopia?
v Is there a long run and short run relationship between real GDP and its determinants?
v What is the impact/influence of these determinants on economic growth?
v Which macroeconomic variable or variables is/are major driver/s or more potent for economic growth?
1.4. Objective of the Study
1.4.1. General Objective of the Study
The main objective of this study is to provide a comprehensive study and critical overview of the macroeconomic determinates of economic growth in Ethiopian between the periods 1974 to 2015.
1.4.2. Specific Objectives of the Study
The specific objectives of this study are:
Ø to examine the major macroeconomic determinants of economic growth in Ethiopia
Ø to analyse the long run and short run relationship between real GDP and its determinants.
1.5. Research Hypothesis
The study hypothesized the following:
H0: All physical capital, human capital, export,foreign aid, external debt, inflation rate, labor force andfinancial development do not simultaneously determine the growth of real gross domestic product.
H1:All physical capital, human capital, export, foreign aid, external debt, inflation rate, labor force and financial development do simultaneously determine the growth of real gross domestic product.
1.6. Significance of the Study
The study gives a modest contribution to the body of empirical knowledge by identifying the potential macroeconomic determinants of real economic growth in Ethiopia. It provides important contribution for different stake holders like researchers, Policy makers, government, professionals, scholars or academicians, etc. as an input for the purpose they intended to use. In doing so it serves as a good base for the researchers, scholars or academicians who want to do further research on this area in Ethiopia or elsewhere. By developing a conceptual framework regarding the relationship between growth of real GDP and explanatory variables, this research contributes to the current literature in Ethiopia. The research also use as policy recommendation for policy makers if believed to be important for their purpose to formulate effective policy. It is believed to provide relevant information for policy makers in considering areas of intervention to promote economic growth. Knowing the direct relationship between growth and its determinants is not sufficient by itself, however if proper policy is to be formulated the information is going to play a vital role for designing proper policy and fill the knowledge gap. Moreover, the study may benefit government, Professionals and other economic agents by providing relevant information regarding the main areas that will be focused to accelerate the current economic practices and drawing lessons.
1.7. Scope and Limitation of the Study
1.7.1. Scope of the Study
The geographical scope of the study is delimited to the political boundary of Ethiopia. It considers only the main macroeconomic factors that affect economic growth in Ethiopia. Therefore, areas and countries other than this boundary are not the subject of this study. The duration covered under this study will be delimited to the time period from 1974 to 2015 by using time series data from different sources. The variables used in this study include one dependent and eight independent variables. The dependent variable representing growth of real GDP and the eight explanatory variables namely physical capital, human capital, export, foreign aid, external debt, inflation rate, labour force, and finical development .
1.7.2. Limitation of the Study
The study only covers from the period 1974-2015 (Derg regime and EPRDF regime) which covered forty two years of time-series data on macroeconomic variable that can affect economic growth in Ethiopian because of the limitation of data before 1974. In the process of conducting this research, the researcher has encountered some problems which have anadverse effect on the output, quality and efficiency of this research. The first greater challenge of this study is the one associated with data availability. There is ashortage of data on some variables like foreign direct investment in which the researcher will hope to add it but it is not included the model. The second challenge while doing this study is the inconsistency of data from different organizations. So as to avoid such inconsistency attempts made to stick to the same source of data as much as possible. Even the data that are found in the same source is not consistent over time. Thirdly,the main aim of this study is to analyse the macroeconomic determinates of economic growth. However there are also non-economic factors that affecting growth like political stability institutional factors, rules of economic regulations (monitoring and fiscal policy) and rules of law (property right) and even economic factors like public service and infrastructural development is not addressed in this study. The other problem is shortage of time in order to undertake the research. However, the researcher tries to fix the problems as much as possible inorder complete the research on time.
1.8. Organization of the Thesis
The paper consists five chapters with different sections and sub sections. The rest of the paper is organized as follows: the second chapter presents the theoretical and empirical literature reviews related to economic growth. Chapter three gives insight on the methodological aspect of the study which includes source and type of the data used, model specification, estimation procedure and definition of the variables. Chapter four consists both descriptive and econometric results. It discusses the regression results, main findings and interpretation. Finally, chapter five provides the conclusion and policy implications based on the main findings