Determinants of foreign direct investment in Ethiopia; time series evidence from 1991-2013

The hub of this study is investigating the forces behind the foreign direct investment inflow to Ethiopian economy in the long run as well as in the short run. To this end, the researcher has reviewed theoretical explanations relating to the determinants of foreign direct investment. The investigator has also reviewed relevant empirical literature pertaining to the determinants of foreign direct investment in the context of developing and developed countries and Ethiopia in particular. The review of the literature and the context analysis has culminated with a fundamental question what are the major determinants of foreign direct investment inflows in Ethiopia in both the long run and the short run? Methodologically, the researcher adopted empirical and quantitative analysis. To this end, a time series model was developed based on the critical synthesis of theoretical and empirical literature on foreign direct investment. The model is estimated using error correction model(ECM) formulation for the period 1991 to 2013 using annual data from World Bank world development indicators report after co-integrating relationship is proved with the Dickey Fuller residual based unit root tests. The tests for stationarity before the model developed was estimated proved that the variables in the model suffer from mixed order of co-integration at levels and hence the variables were differenced so as to alleviate that problem of mixed order co-integration. The result revealed that the determinants of foreign direct investment inflow are found to be consistent in the short and long run models. The most important forces behind foreign direct investment are found to be the GDP per capital, GDP growth rate, real interest rates, inflation rate, gross capital formation, adult literacy rate, Labor force growth rate, telephone lines per 1000 people and official exchange rate. In both models, Export of goods and services, and energy consumption per capita in transport sector are found to have insignificant impact on foreign direct investment inflow to Ethiopia. The policy implication of the result is that policy makers need to put in place policies congenial to pursue economic growth, macro-economic stability, human capital formation and fixed capital formation for attraction of foreign direct investment.