Possible Synergies between Foreign Aid and Foreign Direct Investment in Promoting Economic Growth in Ethiopia

Abstract

Although the literature on both foreign aid and foreign direct investment is abundant, no unanimity about their effect on economic growth has yet taken place. Furthermore, the effect of foreign aid on the Ethiopian economy through complementing FDI‟s effect on growth has not yet been explored. This paper empirically investigates the impact of foreign aid and FDI on the Ethiopian economy as well as possible synergies between the two capital flows in promoting economic growth in Ethiopia. Employing time series data for Ethiopia from the period 1992/93 – 2014/15 and utilizing OLS estimation techniques, this study found the individual effect of both foreign aid and FDI on growth to be positive. However, this study did not find synergies between aid and FDI in promoting growth of the Ethiopian economy. According to the findings, when the country receives aid, FDI affects growth negatively. Therefore, the country needs to spend aid money on factors such as education, infrastructure and better institutions that increase its absorptive capacity to FDI as well as formulate aid policies that will further attract FDI from the donor country including a transparency regime as a precondition for such policies.