The Impacts of Foreign Aid on Economic Growth of

Ethiopia

(A Time series analysis)

A Senior essay submitted in partial fulfillment of the requirements for Bachelor of Arts
Degree in Economics

By: Hiwot Tadesse

Advisor: Dagim
Gashawtena

Samara University

Faculty of Business and Economics

Department of Economics

May, 2010
Samara
Ethiopia

1
 Acknowledgements
I am highly indebted to express my heart felt gratitude to my advisor Mr. Dagim Gashawtena
Head Department of Economics of the Samara University for all his incredible efforts in encouraging me
and helping me to finish this work.

My sincerest thanks go to all my friends and families for all their help in my stay of Samara
University.

2
Acronyms and Abbreviations
ODA Official Development Assistance

IMF International Monitory Fund

CSA Central Statistical Authority

WB World Bank

OECD Organization for Economic cooperation and Development

GNI Gross National Income

MOFED Ministry of Finance and Economic Development

EDRI Ethiopian Development Research Institute

CSA Central Statistical Authority

LDCs Least Developing Countries

USA United State of America

WW2 World War the Second

GNP Gross National Product

BOP Balance of Payment

SAP Structural Adjustment Program

PFP Prepared Frame work Paper

ESDPRP Ethiopia’s Sustainable Development and Poverty Reduction Program

EC European Commission

GDP Gross Domestic Product

HDI Human Development Index

ADF Augmented Dickey Fuller

EPRDF Ethiopian Peoples Representative Democratic Front

RGDP Real Gross Domestic Product

3
 List of Tables and Figures

Figure 3.1 percentage distribution of GDP by economic activity at current prices . . . . 19

Table-3.1 Percentage of Official Development Assistance Flow to Ethiopia . . . . .. . . . 20

Table 3.2 percentage share of import and export to nominal GDP. . . . . . . . . . .. . . . . . .21

Table-3.3 Percentage Share of Government Revenue by Source . . . . . . . . .. . . . . . . . .. . . . .. . 22

Table 3.4 Indicators of debt burden 1994/95-2004/05 . . . .. . . .. . . . . . . . . .. . . . . . .. . 23.

4
 Table of Contents

Acknowledgements
Acronyms and Abbreviations
List of Tables and Figures
CHAPTER ONE
INTRODUCTION
1.1 background of the study...................................................................................................1
1.2 statement of the problem...........................................................................................2
1.3 objective of the study........................................................................................................2
1.4 significance of the study...............................................................................................2
1.5 scope of the study.............................................................................................................3
1.6 limitation of the study.................................................................................................3
1.7 data source and methodology..........................................................................................3

1.8 organization of the study...........................................................................................3

Chapter Two
Literature Review
2.1 THEORETICAL REVIEW.............................................................................................5
2.1.1 Evolution and historical role of aid.....................................................................5

2.1.2 types of aid....................................................................................................6

2.1.3 criteria for distribution of foreign aid..................................................................8
2.1.4 categories of foreign aid ....................................................................................9
2.1.5 arguments on foreign aid ...............................................................................9
2.1.6 The Breton wood institutions in the Ethiopian economic reform.....................10

2.1.7 IMF/ WB intervention and their conditionality to the Ethiopian

Economic Program...........................................................................................11

2.1.8 merits of the IMF/WB intervention and their conditionality to the

Ethiopian economic reform..............................................................................12
2.1.9 Demerits of the IMF/WB intervention and their conditionality to the
Ethiopian economic reform ...........................................................................13
2.1.10 The structure of aid in Ethiopian economy..................................................14
2.1.11 the general challenges of aid in Ethiopian economy........................................15

5
 2.2 EMPERICAL REVIEW ..........................................................................................................17
2.2.1 foreign aid in Ethiopia.........................................................................................17

CHAPTER THREE

Data Analysis and interpretation

3.1 Descriptive Analysis

3.1.1 Characteristics of Ethiopian economy .....................................................................19
3.1.2 Volume and trends of aid flow in Ethiopia..............................................................20

3.1.3 The contribution of aid to trade...............................................................................21

3.1.4 summary of external public debt ..............................................................................22

3.2 Econometric Analysis

3.2.1 the model.............................................................................................................24

3.2.2 Model specification.....................................................................................................26

3.2.3 The data...............................................................................................................27

3.2.3 Results of regression analysis.....................................................................................27

3.2.4 Hypothesis testing ......................................................................................................28

3.2.4.1 Statistical criteria ...........................................................................................28

3.2.4.2 Econometric criteria.................................................................................29

3.2.5 Interpretation of the result.........................................................................................32

Chapter Four
Conclusion and Recommendations

4.1 CONCLUSION ..................................................................................................................34

4.2 Recommendation ............................................................................................................. 35

Appendix

Bibliography

6
 CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
After four decades of independence and numerous development assistance programs, poverty in
Africa continues to be widespread, deep and severe. It s estimated to affect the lives of 60 percent of the
population in sub-Saharan Africa, and 27 percent in North African sub-region. While there are many
important factors in African poverty profile, poor economic performance is at the root of the problem. For
two decades before the mid 1990s, African economy stagnated. Since the mid- 1990s, however, the
continent has experienced a rise in many economic indicators. (Kinfe Abraham, 2001).

The contribution of Official Development Assistance to the short term economic growth cannot be
isolated, particularly on regional basis. ODA as a percentage of Gross Domestic Investment was
substantial. It was 11 percent during the period 1975-1984, 27.9 percent for the period 1985-89, and 33.5
percent for the period 1996-1999 for Sub- Saharan region. In association with the slow growth rate of the
region, the contribution of ODA could be assessed to have been low. ODA has increased steadily during
the 1980s and the early 1990s, when most economies in Africa experienced negative growth or stagnation
(ibid).

Ethiopia, as one of the poorest country in Sub- Saharan Africa the contribution of ODA in the
short run economic growth is substantial. In 2007, the Gross Domestic Product of Ethiopia reached 117.5
billion Birr. In five years (between 2000 and 2005), the economy added over 14 billion Birr. With the
optimistic population estimate of 80.7 million people in 2007, the per capital income of the country was
117 USD (IMF, 2007). Thus number is the lowest in the world in any standard. Various explanations can
be posed for the limited improvement of the economy ranging from liberalization (globalization) to
population growth.

Among with growth in the overall economy there comes increased government spending and
deficit financing. The government collected about 41701.3 million birr including taxes and grant during
2007/2008 fiscal year. Out of which, 2.6 percent (10,898.9) was in the form of grants. During the same
year, the government spent 47,747.8 million birr and hence the revenue, including grants, was short of
total expenditure by 12 percent. With out grant the deficit could have been about 16,945.7 million birr.
This makes the grant element of government’s total expenditure 26 percent. Of the 26 percent external
grant that constitute part of grants in kind and the remaining 50 percent comes in the form of cash. (CSA
2009). Also the external borrowing to finance the deficit accounts for 37 percent of the total deficit during
2004/05 fiscal year (IMF 2006). The remaining source of financing comes from domestic borrowing and
privatization revenue. This paper will help to reexamine the impacts of foreign aid to finance and enhance
economic growth in Ethiopia.

7
 1.2 Statement of the Problem
Though foreign aid has continued to play an important role in developing countries, especially
sub-Saharan Africa, it is interesting to note that after half a century of channeling resources to the Third
world, little development has takes place. In almost all the Sub-Saharan Africa there is a higher degree of
indebtedness, high unemployment, absolute poverty and poor economic performance (Lancaster 1999
James Njeru 2003). Moreover, the percentage of developed country GNI allocated to official development
assistance declined from 0.51 percent in 1960 to 0.23 percent in 2002 before improving slightly to 0.33
percent 2005 (Todaro and Smith, WB, 2009). For 2008, the OECD noted that ODA aid was at its highest
level ever in dollar terms, increasing over 10 percent from 2007 in real terms. However, this aid, as high
as it was, was still only at 0.3 percent GNI, compared to the 0.7 percent target (OECD 2008).

The Ethiopian government uses both domestic and external sources to finance the country.
Overall, the country depends on external source of finance for about 29 percent of its total government
spending, 19 percent comes in the form of budgetary support grant and the remaining 10 percent comes as
external borrowing (Bullow and Rogoff, 2005). This source of financing is something to worry about
depends on who give as the grant, for what purpose they give us, when they give us, and whether we can
count on them at all the times. If the sources are non predictable and depend on regimes it is difficult to
make progress in development with sporadic flow of money now and then. Moreover, most aid,
conventionally defined, is given primarily given to the government. And any effect of aid on economic
performance (any impact on growth and poverty reduction) will depend on the response of the
government behaviour for foreign aid inflows. The purpose of this paper, therefore, is to present a portrait
of aid flow in relation to the economic growth of the country.

1.3 Objectives of the Study

The general objective of this paper is to assess the impacts of foreign aid on economic growth of
Ethiopia. The specific objectives of the paper are

 To examine the characteristics of Ethiopian economy with share of major economic

sectors
 To identify the effect of foreign aid on government expenditure
 To assess the trade performance of the country and the contribution of foreign aid
on such area
 To examine the debt burden of the country in relation to foreign aid

1.4 Significance of the study

Studying the impact of foreign aid on economic growth helps not only to give general
information, but also have an idea to be used by concerned parties as a reference for policy making. In
addition, it is hoped to fill the gap of literature on the topic and to partially fulfill the requirements for
obtaining Bachelor degree in economics.

8
 1.5 Scope and Limitations of the Study
1.5.1 Scope of the study
This study is a general level analysis which captures the impact of foreign aid on the economic
growth of Ethiopia. In doing so a 33 years of secondary data is covered from 1974/75 up to 2007/08.

1.5.2 Limitations of the study

Although the study attempts to shed light on the trade off between foreign aid and economic growth
it suffers from certain limitations. Above all, there is a problem on the availability of some important
data and the problem of inconsistency in data as reported by different institution.

1.7 Methodology of the study

1.7.1 Data Collection
The data is collected from MOFED (Ministry of Finance and Economic Development), Central
Statistical Authority (CSA) and Ethiopian development Research Institute (EDRI). However, there were
problems with regard to the consistency of the data from these institutions.

1.7.2 Data Analysis

In the analysis a 33 years (1974-2007) time serious data and STATA software program were
employed. In diagnosing the data, first an attempt is made to choose the appropriate functional
form. That is whether linear, natural log linear, simple log linear or other functional form is to be
used. By regress the three functions independently R 2 of the natural log linear is found to be
greater. Thus, the natural log linear model was selected as the appropriate model specification.

1.8 Organization of the paper

Chapter one provides an introduction of the study which includes background of the study,
statement of the problem , objective of the study, significance of the study, scope and limitation of the
study, and data and methodology of the study.

Chapter two reviews the literature. It has two sections one deal with theoretical literature and the
other deals with empirical literature, which is, discuss about findings from all over the world on issues
related to foreign aid.

Chapter three deals about the descriptive data analysis and presentation which discuss some concepts
that are not discuss in the econometric analysis. In addition, it deals about the result and discussion of
Econometric analysis which assess the impacts of foreign aid on economic growth helps to support the
finding in descriptive analysis.

Chapter four presents conclusion and policy implications. It summarizes and address the central
issues set out at the onset of the study and relates them to overall research findings. It further discusses
the implication of both descriptive and empirical findings at both theoretical and practical level.

9
 CHAPTER TWO
LITERATURE REVIEW

10
 2.1 Theoretical Review

2.1.1 Evolution and Historical Role of Aid

The concept of foreign aid has been explained as one that includes all official
grants as well as concessional loans, which is in the form of currency or in kind
(technical assistance) that is mainly based on the objective of transferring resources from
developed nations to less developed nations for the purpose of development. Developing
countries are the major recipients of aid , R.Cose (1994) stated that , “ nations that are
identified as LDCs, constitute 10.3 percent of developing countries population, and
receive just over 30 percent of foreign aid, where as the low income countries amount 78
percent of population and receive 69 percent of aid’’(Cassen 1994, Tilahun 2006).

Economic aid to developing countries has been traced back in general terms, to
the colonial link between Western imperial powers and their overseas territories, and in
the case of USA , to the Truman Doctrine of the late 1940s (Zelastra,1975). Whatever, its
precise origin, aid began to be an important facet of international relations in 1950s, in
the next 30 years it grew in importance both as quantity of aid flows increased and as
international attention focused more and more on the economic conditions and especially
the poverty of what became known as the developing countries. During this period, not
only did increasing number of countries became donors but colonial and post historical
links no longer provided the sole reason for giving aid, as multilateral institutions were
created or expanded their operations substantially to receive funds from the range of sources.

Whether by accident or design the attention of economists and development analysts to

the phenomenon of foreign aid coincided with the growing political acceptability of providing it
and the rapid in the quantities that different government was giving in the mid 1950s. even at this
time, however, when the theoretical justification for providing aid was emerging, there were
theories being debated in the literature which either directly or indirectly given little or no
attentions to either side as a particular form of international transfer ,or to additional resources as
a crucial factor in promoting economic development. For example, for Schumpeter the hero of
development story and the fundamental determinants of growth were neither saving nor capital
but, the entrepreneur or innovations. He would have been little sympathy for the view that
development is limited by the supply of external capital (Mckesell: 1968, Birhanu: 2006).

Many agree on the idea that the origin of development assistance is the adverse
consequence of the WW2, in other words, foreign aid is considered as a post WW2 phenomenon
that aroused form the distribution of the world economy. According to the Pal Grave dictionary,
its root is the post-war reconstruction, which was greatly facilitated by the US government to
finance the war devastated Western European countries on high concessional terms, under the
European recovery program, generally known as Marshal Plan in June 1947. This program
initially had two main objectives: to restore the economics of its member nations a rapidly as

11
possible, and to develop a viable pattern of trade that not require further concessional loans. And
in order to achieve those objectives, transfer made by the US government accounts for 2.3
percent of the total USA GNP/ ten times the current US aid level (Patan New man, et al, 1992,
Tilahun 2006).

From the beginning aid as potential to conflicting objectives: the first one is to promote
long term growth and poverty reduction in developing countries. And, the second motive was to
promote the short term political and strategic interest of the donors. Based on the second motive
aid went to regions that were politically allies of major western powers, while the underling
motivations of donors in the form objectives is a combination of there altruism and a more self
interested concern that is, the long term, there economic and political security would benefit if
poor countries are growing.

Griffin (1970) argued that a country lends to another country will not be determined by
its need, or the past economic performance, or its virtue, but by the benefit it yields in terms of
political support. in granting assistance, economic efficiency or social justice or any other
criterion is subordinate to the national interest. Therefore, he concluded that ‘foreign aid Is
merely the other instrument of foreign policy, and instrument like diplomacy, culture exchange,
technical assistance, military intervention and the war (Griffin, 1970).

2.1.2 Types of Aid

According to Howard White (1998), aid flows consist largely of three types: project aid,
programme aid (including commodity aid, which has largely been food aid) and Technical
assistance.

1. Project Aid

Project aid was of the type assumed in the two gap model: the aid was to support an
investment project and only to pay for the import component of that investment. The
traditional macroeconomic of aid assumes all aid to be project aid: Chancery and Storm
assumes aid to be fully incremental investment and imports.
2. Program Aid
A. Debt Relief
Different terms program aid: balance of payment (BOP) support and import
support –are often used interchangeably. But, properly speaking they are not
interchangeable.
In addition to BOP support, program aid also includes budget support and BOP
support also include debt relief.
All forms of program aid have a common rationale. The economy is suffering
from a constraint on current expenditure, so the existing resources are severely under
utilized: schools have neither book nor chalk, roads are crumbling and factories stand

12
 idle; under this circumstance it makes little sense to carryout further investment.
Rather, program aid should be provided for immediate imports (or free fund to the
government budget) to allow the economy to increase capacity utilization.
Another common feature of different types of program aid is that they are
conditional up on policy reform, so that a major channel for this type of aid’s
macroeconomic effect will be the reform program.

B. Import Support, Counter Part Funds, a Budget Aid

Win penny (1989), Tilahun (2006) lists the following five advantage of form
aid;
1. Disbursements are not limited by recipient absorptive capacity.
2. Funds to utilize the existing investment are more
important than funds to undertake new investments.
3. Non-project aid can be rapidly distributed
4. The aid can be ready linked to policy conditionality
5. The counter value from the sale of goods has beneficial impact on
the government’s budget.
A. Import support program Aid
Import support may take one of the two forms; administrative or market
oriented. Administrative shame allocate to the applicants according to criteria
agreed on by donors and recipient. Alternatively, the donors may allocate
import support funds for a particular (E.g. fertilizer) often with agreed
channels for distribution.

B. Counter part funds

Imports support funds are intended to be a grant to the recipient country
but not the importer. Roemer (1989) argues that any inflationary impact of
counter part funds may be further undermined if the economy is exchange
constrained. (Roemer 1989, Bruten and Hill 1990) stated that the possible
inflationary impact of the expenditure of the counter part funds was a central
part of the debate in India, and has not reemerged in African context.

Donors do not require any environmental expenditure for there

counterpart funds; rather, the funds should be set against expenditures. This
means that the funds are reducing the need for deficit funding. Hence, the
counter part funds will have a deflationary impact.

C. Budget Aid

13
 Budget aid is a general support to the government budget: that is, local
currency not tied to any specific purpose. Budget support is thus very much
like untied import support.

3. Food Aid

Food aid may generate destructives to domestic agricultural production through the
following channels (Max well and Singe 1997, Max well 1991, Tilahun 2006).

1. A price effect, as food aid pushes out the domestic supply curve, hence lowering
the domestic price of agricultural out put.
2. A policy effect, at the availability of food aid may allows a government to
postpone necessary policy reforms to stimulate domesticated agriculture, and,
3. By changing the pattern of tastes away from domestic output toward imported
funds.

4. Technical Assistance

Technical assistance covers two distinct areas: overseas training and employment of
externalities, the latter nearly always are including an on-the-job training component for counter
part staff

Chunnery and Strpouts (1966) presentation of the two gap model identified three
constraints: Saving, Foreign exchange and Capacity to investment, the last arising from a skill
gap. Foreign assistance may be required to fill gap to attain the desired level of investment.
Therefore, assistance can contribute the closure of the gap in addition to filling it.

2.1.3 Criteria for distribution of Foreign Aid

Several criteria for allocating foreign aid discussed in the literature. Some of them could
be highlighted here. First aid is usually given for political reasons. It is generally that aid will not
be given to one enemy (Little and Chilford, 1965; Thalif Deen, 2004).second aid is supported to
replenish the dearth of domestic saving in the LDCs. Generally, the difference between planned
investment and planned saving is taken as an indicator of aid necessary to attain a targeted rate of
economic growth. Third, the other criterion, which is sometimes advocated, is known as
absorptive capacity. Basically, it means a country’s ability to absorb capital and to use it in a
productive ways. Such productive use of capital is measured by positive reasonable rates of
return on total investment. Obviously, absorptive capacity would depend up on the level of
income to its growth rate supply of skill and the level of average and marginal rate of savings.
Some rough indices to measure absorptive capacity has been proposed (Rostenstein-Rodan,
1961; Thalif Deen, 2004).None of them are free of subjective bias in its construction. Such
indices are:

 The rise in the of investment in last years

14
  The measurement of increase in saving in last few years, It is particular interesting
note that the difference between marginal and average rates of savings, MRs>ARs.
Where MRs=Marginal rate of savings and ARs=Average rate of Savings.
 To examine the structure of development and administration of a country.

Next, the flow of foreign resource is sometimes guided by historical factors in the content
of their former colonies (Hayter,1971).The other criterion, which has been applied in distributing
aid, is the maintenance and promotion of the private sectors of the economy to operate freely.
The efficiency criteria have received considerable attention but not simple in practice, because
first it is necessary to contract a sound index of efficiency. Second the principle of achieving
maximum efficiency may run counter to the achievement of some other objective, and its
applications are likely to be different in different LDs. Additionally, the principle of stability,
chiefly in prices and trade balances has been regarded as the appropriate condition for allocating
aid. Because of the stability should be given high priority in rational development policy (Thalif
Deen, 2004).

2.1.4 Categories of Foreign aid

At early stage of economic development foreign capital played a significant roll by
filling the saving and the foreign exchange gap. Having this concepts, aid has two groups:

A) Foreign grants: Is genuine ‘aid’ and need not be repaid by the recipient countries, nor do
they carry any interest charges. It is usually provided too many countries to alleviate the
after effect of natural disaster such as famine, flood, earthquake etc, but, it is always string
attached. It is also provided for the promotion of economic development.
B) Foreign loans: here the foreign resources are provided on ‘soft’ terms which reflect a desire
to ‘aid’. The receiving countries where the loans are granted to the LDCs at a concessionary
rate for very long periods, which means at interest rate lower than in the market.
The inflows of foreign resource(foreign loans) takes the characteristics of genuine
aid of the net present value of foreign resource provided at a concessionary rate and to be
repaid in long period, hence would be almost the same as value of grants (Tekabe,2009).

2.1.5 Arguments on Foreign Aid

The issue of the economic effect of aid is fraught with disagreement. Economists’ debates
on both side of foreign aid argument are;

A. Pro-foreign aid arguments

Some economists argue that aid has indeed promoted growth and structural
transformations in many LDCs through supplementation to scarce domestic resource based on

15
Harrod-Domar growth model and Rostow’s theory. Aid is one of foreign resources, which fill the
dual gap for enhancing investment and earning foreign exchange. In addition, it has a key role
for structural transformation and self sustaining economic growth by eradicating domestic saving
to enhance capital formation in order to push its production and consumption curve out ward.
There are many ways of depicting the successes to which aid has contributed. Sector by sector
across economies, extend the reach of basic services, provided skill man power, and promoted
institution building. An important part of aid is the policy dialogue, which accompanies it
(Todaro & Smith, 2009).

B. Contra foreign aid argument

On the other side of critics’ aid does not promote faster growth. But it may in fact retard
it by substituting for, rather than supplementing domestic savings and investment and
exacerbating balance of payments deficits as a result of rising debt repayment obligations and the
linking of aid to donor-county exports. Rather than relieving economic bottlenecks and filling
gaps, aid not only widens the existing saving and foreign exchange gaps but create new ones
such as urban-rural (modern-traditional) sectors gap. It retards growth through reducing saving
and worsens income inequalities. To sum up;

 Foreign aid is adverse on mobilization of domestic resource

 Government may lower its tax collection effort which leads to decline in saving
 Government may change the consumption of their public expenditure-the
recurrent and capital expense or reduce their local borrowing.
 Large fraction of foreign aid provided to increase consumption rather than
investment.

 The inflow of aid in the form of loan result in massive debt and debt servicing
burden and unnatural balance of payments. Therefore, increased saving and
investment may partly be constrained by debt servicing burden.

In addition more aid recipient government responds to higher foreign aid reducing tax
and borrowing from non-concessional sources as well as local sources. Critics on the race that
foreign aid has been a failure because it has been largely appointed by corrupt bureaucrats, has
stifled initiative, and has generally engendered a welfare mentality on the part of recipient
nations.(Assefa Admase, 2000).

2.1.6 The Bretton woods institutions in the Ethiopian economic reform

16
 In the current international economic order, no developing country can alleviate its
development constraints without the support of the international community. To augment the
required financial and technical resource, to solicit foreign loan and to acquire debt relief from
previous loans developing countries are forced to appeal to bilateral and multilateral
development partners. From those partners the two sister financial institutions; International
Monitory Fund and World Bank have significant role in this area. Being part of the developing
countries and moving away from centrally planed and weak economic condition to a market
oriented system; Ethiopia remained one of those countries receiving the IMF and the World
Bank financial and technical assistances (Fantahun Belew, 2004).

In Ethiopia the period between 1974 -1999 witnessed a centralized economic system,
where the state played the dominant role in all spheres of economic activity and private sector as
well as market forces were deliberately marginalized. As a result weak institutional capacity,
market imperfections, structural rigidities, poor economic management and adverse externalities
were the overriding characteristics of the economy. The new government, which assumed power
in 1991, pursued policies towards stabilizing the economy and moving towards stabilizing the
economy and moving towards a market-oriented economic management. To that end, the then
Transitional Government began the implementation of comprehensive macro-economic and
structural reforms. The IMF, the World Bank and other multilateral and bilateral donors showed
their willingness to support the government’s development agenda (ibid).

2.1.7 IMF/World Bank Intervention and their conditionality to the Ethiopian

Economic Program
Although Ethiopia was a late comer compared to other developing countries, the
government from the out set agreed with IMF and the World Bank to conduct structural
Adjustment Program (SAP) to solicit external assistance to finance the envisaged economic
reform program and benefit from the available technical assistance. to implement the SAP the
government in collaboration with the two Bretton Woods institutions prepared policy framework
paper (PFP), which identifies the policy objectives and commitments of the government. The
PFP outline objectives, strategies and measure to be taken in macro-economic and Structural
Adjustment Policies during 1992/93-1994/95 bounded with time frame. The PFP focused on
reducing institutional rigidities and structural distortions. The principal policy requirements
include exchange rate adjustment, public expenditure reduction, trade liberalization, reduction of
the role of the state in production and distribution, controlling prices, and intervening in
exchange and product market, liberalization of the financial sector, and privatization (ibid).

17
 2.1.8 Merits of the IMF/World Bank Interventions in the Ethiopian Economic

Reform Program
The policy framework paper designed by the IMF and the World Bank with the
government from the outset based o the transitional economic policy, aiming at replacing the
previously centrally planed economy by a market oriented one. Both the government economic
policy and the PFP cautiously designed to rationalize the role of the state in the economy,
encourage private investment, mobilize external resources and draft sectoral strategies and
programmes, which have been deemed appropriate to manage the economy (ibid).

In this connection, it is worthwhile to stress that conditions attached to SAP were in

congruent with the government’s economic policy programme. In other words most of the
conditional this incorporated in SAP were components of the New Economic Policy Progrmme
of the government envisaged in advance. Hence, IMF/World Bank apart from giving their
financial and technical assistance they added momentum and give courage to the government
envisaged in advance. Hence IMF/ world Bank apart from giving their financial and technical
assistance they added momentum and give courage to the government to expedite the reform
process trough imposing conditions. Such conditional ties, however, undeniably introduced a sort
of measure tat required belt-tightening and sacrifice. It is also recognized that the IMF/World
Bank conditionality and the fund’s surveillance promote confidence to the private sectors and
facilitate there participation in the privatization processes. More importantly other bilateral and
multilateral development partners of the country were at ease to extend their support in
subsequent to the fund’s review reports. This could be justified as all development partners of the
nation quitted their assistance when the government and the fund failed to agree to continue the
ESDP program in 1996 and following the border conflict with Eritrea.

Some of the reform measures undertaken so fare are not easy to be initiated internally, as
they contained immediate negative impact on individual well-being. Te reform measures on
retrenchment and privatization might be hard, if not impossible, to implement by a new
government in the absence of forced measures imposed externally.

Experiences of other countries are very useful to seed up the reform process. Donors’
interventions in the reform program, therefore, contribute largely in advising ways and means to
tackle problems and to avoid mistakes committed by countries that have undertaken similar
reform programmes.

In this regard, the country’s tax reform studies were benefited from other countries’
experiences through a resident tax administration expert of IMF. The experts designed most of
the reforms undertaken so far and envisaged in the future. His studies proposed several reform
measures helping the government to enhance the revenue administration capacity and improve as
well as modernize the revenue collection mechanism.

18
 The task of drafting the Ethiopia’s Sustainable Development and Poverty Reduction
Programme pass through a participatory process which elicit the involvement of civil society,
other national stakeholders and elected institutions. As, a result, it is believed tat the consultation
process, which involved a broad spectrum of stakeholders, helps to foster ownership particularly
were such stakeholders included the rural and urban poor. Virtually the processes gave
opportunities to have useful insights that would otherwise have been overlooked by policy
makers.

There is a general consensus that the document has been prepared not only as a means of
securing financial support from the Fund, the bank, and other development partners, but also as a
national blueprint to guide the country’s development Endeavour. In a nutshell, Ethiopia’s
sustainable development and poverty reduction program (ESDPRP) set clear development
priorities and identifies gaps. This, in turn, gives opportunities for donors to align their assistance
strategies to the priorities for donors to align their assistance strategies to the priorities of the
country.

In order to streamline its intervention in the country’s PRSP the World Bank is preparing
its Country Assistance Strategy (CAS). The CAS is expected to base development strategies
indicated in the ESDPRP. Although its assistance has been on project base, recently it tends to
budget and balance of payment support. In this regard the Bank approved an Economic Support
Credit amounting to US$ 150 million in 2001. During the 2003 fiscal year the Bank also
extended Structural Adjustment Credit containing to $ 120 million, disbursed in a single trace
(ibid).

2.1.9 Demerits of the IMF/World Bank Interventions to the Ethiopian Economy

It is clear that the economic development agenda of developing countries requires,

different policy approaches as their economic foundation varies from country to country. But the
IMF develops similar assistance strategy for all developing countries. Therefore, its core
conditional ties sometimes fell to address the basic economic development policy problems of a
specific country, as conditional ties prescribed to all countries are more or less the same. The
IMF-World Bank support to the Ethiopia’s economic reform programme is not an exception.
As to the magnitude of conditionality, it is sometimes beyond the capacity of the implementing
country, and the time frames do not appreciate such capacity. In this regard given Ethiopia’s
limited institutional and technical expertise some conditional ties imposed at the beginning could
be burdensome (Fantahun Belew).

Some of IMF and World bank core conditions, such as deregulation of fertilizer prices,
privatization and devaluation, have had adverse effect on the welfare of the poor. Moreover,
higher input prices, lifting subsidy on fertilizer and declining agricultural export prices
automatically affect the livelihood of the farmers that accounts about 85 % of the population.
Apparently, fertilizer prices both DAP and UREA has skyrocketed from Birr 107.1 and Birr 95.3

19
per quintal in 1992 to birr 262 and Birr 237 respectively. The devaluation of the country’s
currency accounted for an exorbitant price increase (MOFED, 1999). Furthermore, in recognition
of the agreement reached with the BWIs the government has removed fertilizer price subsidy at
the end of 1996. At the time of removing fertilizer subsidy; there was Birr50 price subsidy per
quintal. It is apparent that the removal of price subsidy and market liberalization on such
strategic commodity highly reflected in the deterioration of income of rural households, which in
turn affects the rest of the economy (Tadele, 2002).

The commitment pledge by the government to pursue a more vigorous divestiture to full
fill conditionality will be accompanied by job losses. In addition, lifting subsidy across sectors
indeed, again impose hardship to such victims. The IMF and the World Bank insisted to conduct
complete financial liberalization with out the presence of prudent fanatical management and
competent expertise. In theory this is expected to facilitate investment capital to flow in.
unfortunately, the real situation in a country were the necessary preconditions do note fulfill the
outcomes will be massive outflows.

Another aspect related to the domestic investment and growth is a tied prescription on
rapid custom duty reduction, which exposed the domestic industry to foreign competition.
Currently, our infant industries are thrown in a playing filed open to foreign goods. As they are
found in unequal footing, massive imported goods seriously damage products of domestic
investment. Yet, the Fund and the Bank forced the government to reduce further the maximum rate, tariff
bands, and average tariff rate. (Fantahun Belew, 2004).

2.1.10 the Structure of Aid in Ethiopian Economy

Foreign aid has played a major role in Ethiopia’s development effort since the end of
World War II. It has been instrumental in bridging the country’s savings-investment and foreign
exchange gaps. Its importance as a source of financing for the development of capacity building
(human capital, administrative capacity, institutional building, and policy reforms) is also
unquestionable. Thus, increasing efforts were made to mobilize foreign aid in the last two
regimes. Following the change in political regime in 1991 and the adoption of the structural
adjustment program in 1992/93 in particular, the country has enjoyed a significant amount of aid.
A large and growing inflow of concessionary loans and grants has occurred since 2001,
following the issuance of the first poverty reduction strategy paper (known as the Sustainable
Development Poverty Reduction Program) from 14 multilateral sources—mainly EC, the Global
Fund, and the African Development Fund and more than 30 bilateral sources—mainly the USA,
UK, Italy, Canada, Germany, Ireland, Japan, Netherlands, Norway, and Sweden. (Hussen 2009).

Ethiopia has been one of the major recipients of international aid in recent times.
According to OECD-DAC statistics, net ODA to Ethiopia amounted to US$1.94 billion in 2006,
making it the 7th largest recipient among 169 aid receiving developing countries. In absolute
terms, the amount of ODA has risen sharply from an average of $881 million per annum in the
second half of the 1990s to over $1574 million per annum for the first half of the 2000s. Over the

20
last seven years (2000-2006), ODA has averaged at $1683 million per year. The average
contribution of bilateral donors to ODA over the eight year period was $322.4 million per year,
accounting for 31 percent of ODA. In the 1990s, some 49 percent of the total net ODA was in
the form of multilateral aid. This was slightly reduced to 46 percent for 2000-2006, reflecting the
increased importance of non-multilateral sources

The flow of net ODA actually declined from 1992 to 2000 and sharply increased in 2001
with a modest increase onwards. The main driving force for donors to resume their assistance
was the issuance of the Sustainable Development Poverty Reduction Program in 2001/02. Of
these significant net ODA flows, the contribution of the World Bank’s support through the soft
windows of IDA was tremendous. In 2001 alone it was 38.7 percent of the total net ODA. Since
1993, the Bank has committed a total of $3.1 billion to Ethiopia. Ethiopia receives about $8.0 per
capita from IDA. This makes Ethiopia the largest IDA borrower in Africa and the fifth largest in
the world. In addition, the Bank has coordinated a percent of the gross national savings, 40
percent of gross domestic investments, 58.5 percent of overall government expenditure, and 10
percent of consortium of donors to support the economic reform program. ODA flows account
for about 48 the GNI of the country. Although there was an increasing ODA inflow, the savings-
investment gap was as high as 20 percent of GDP, leaving a huge gap to be bridged by non-ODA
inflows (Hussen Mohamed, 2010).

2.1.11 the General challenges of Aid in Ethiopian Economy

The link of aid to donor countries and their export may not relieve economic bottlenecks
and filling economic gap in developing countries like Ethiopia. Rather it retards the economic
growth in the following cases.

 Ethiopia does/may not prioritize the goods and services offered by donors
 Some type of aid focused on recipients’ country import tax, tariffs, etc to made
exception for donor export. This action reduces and replaces government
revenue and the level of saving and investment is diminished. On the other
hand, national plane based on revenue distorted by temporarily aid donations.
 The trends of aid dependency have led the country under the control of donors
particularly; economically, and socially. It develops insecure national policy
and performance by the enforcement of foreign pressures.
 Donors’ especially bilateral donors have many different motives; political,
economical, humanitarian, etc. as a result poverty eradication can not be
addressed as the government became busy and un able for fuelling all there
interest and project designs.
 Loss of comparative advantage line provision of aid. This creates inefficiency
that hidden its effective utilization and reduce the real value of resources.

Like most sub-Saharan African countries, Ethiopia has been accepting a large share of aid
form both bilateral and multilateral sources. The country has aid dependent economic

21
performance, and not yet such ‘self reliant’. Therefore, Ethiopia’s long term involvement with
foreign aid dose not yielded a satisfactory result (Tekabe, 2001)

2.2 EMPERICAL REVIEW

Much of the literature on foreign aid and its impact on development in the recipient
countries focuses on the relationship between aid and economic growth and uses international
cross-section statistical investigations rather than individual country case studies (Riddel, 1987:
Mosley et al 1987: James Nejeru.2003). The results of cross-sectional studies depend on the
countries and periods of study chosen. Such studies face numerous problems of measurement
and interpretation and often ignore the stylized structural features of individual countries.

The aid-saving debate has been the central focus of discussion of the fiscal response to
foreign capital inflow to the recipient countries. The debate relies on the initial work by Griffin
(1970), which suggested sub different avenues through which aid may lead to a decline in
saving. This is mainly through its effect on government expenditure patterns and revenue
generation. The debate further benefited from Heller’s (1975) utility maximization model and the
later extension by Mosley et al. (1987). Heller concluded that foreign loans do not fully increase
total expenditure, but reduce borrowing and taxation while increasing consumption and
decreasing investment.

Fiscal analysts, including the donor community, are convinced that the aid process is undermined
by the ability of the recipient governments to alter their spending patterns to subvert the sectoral
distribution of expenditure for designated projects. Empirical literature on the impact of foreign
aid is inconclusive. A few studies (Heller 1975; Jkhilyi and Zampelli 1991, 1994; Pack 1993)
have supported the theoretical proposition that developing countries have been rendering foreign
aid fungible by transferring resources from the donor- aided sectors to non donor aided sectors (Jame
Njeru, 2003).

According to the World Bank’s 1998 report, assessing aid, countries is good monitory,
physical and trade policies (I e. good policy environment) registered high positive effects of aid.
Such good policy environments depend on the donor or recipient country, however of great
importance is whether recipient countries spend donor funds on intended purposes. Studies
using time series data in individual countries (Levy, 9178: Mc Guire, 1987: Gang and Khan,
1990: Pack, 1990: Nathi and Sobhee: 1999) found no significant diversion and all agree that
countries spend foreign aid founds on the designated purposes. These results are interesting.
Pack in his analysis of Indonesia, for example rejected the idea of fungibility, but in 1993 on the
basis of data from the Dominican Republic Confirmed that foreign aid among countries. Further,
donors give foreign aid to different countries for different reasons; economic, social, cultural,
commercial and political. These reasons influence the impact of aid on the recipient expenditure
pattern.

22
 A study by Feyzioglu et al (1998) using cross country data from 14 developing countries
found that aid is not fungible at aggregate levels in smaller samples, but that increasing the
number of countries makes aid fungible. At sectoral levels, the study founds that aid is fungible
on earmarked on concessional loans for agriculture, education and energy, but not for transport
and communication sector. Aid money increased government expenditures on a roughly one to
one basis for the smaller samples. Increasing the sample to 37 countries changed the results: a
dollar’s worth of aid lead to significantly less than a dollar’s worth of government expenditure (a
weaker fly paper effect).this results contrast with those of Cashel-Carodo and Graig(1990) and
Pillai(1982) who found that categorical grants (bilateral loans) are list fungible with fly paper
effects. On the other hand, pack (1990, 1993) concur with Feyzioglu et al, (in the case of
Indonesia and Sri Lanca) that strong fly paper effect do occur on concessional loans (but results
differ with data on Dominica republic).the evidence that aid money increases government
expenditure means that the recipient governments do use the increased resources as they chose-to
increase spending, cut taxes or reduce fiscal deficits.

Deverajan et al (1998), in the study ‘what does aid to Africa finance?’, found that most
aid (90%) boosted government expenditure with no significant evidence that tax relief. About
half the aid was used to finance external debt service payments: one quarter financed investment
and the other quarter offset current account deficits. At sectoral level, aid was highly fungible in
health, industry, and agriculture.aid to the energy, transport, and communication sectors was
partially fungible, while that to education was the least fungible. On the other hand, Swaroop et
al (2000),focusing in the effects of foreign aid on non development activities. This implies that
government expenditure choices are unaffected by external source of finance.aid merely softens
the government’s budget constraints. (James Njeru, 2003).

2.2.1 Foreign Aid in Ethiopia

The research findings conducted by Osman Ali (2004), on foreign aid and the Ethiopian
economy, reveals that foreign assistance helped the government to implement its short and
medium term programs in various sectors like education, health, road, power, etc and to increase
the revenue generation capacity of the government with a view of a maintain macroeconomic
stability at large and also to implement the policy directed towards the introduction of market
oriented economy from the command economy. According to Osman Ali, although such
improvements have been observed over the years, foreign aid is still used in efficiently.
Utilization lags behind commitments: projects lack sustainability; resources are not always
focused on priority programs; and local ownership of aid –financed projects are not strong.

Some findings on the other hand, revealed that foreign assistance has little impact on the
development of Ethiopia. According to Merarto Abera (2005), aid can assist the proper
allocation of resources of a country, but its impact is very insignificant. Not only does aid is less
correlated with the development of the country, it appears to offer a long term crisis of external
debt and dependency syndrome to the country a well.

23
 According to Rigbe Hagos (1999), foreign grants, which is one of the components of
foreign aid has very small coefficient when it is compared with the real per capital income.
Foreign loan also has significant contribution to the domestic savings. This might be due to high
debt and debt servicing of the country. (Rigbe Hagos 1999; ZeraYasin 2003).

With respect to aid and investment, Mered Haile (2004), concluded that foreign aid does not
accelerate the economic growth of Ethiopia. Because, for one thing the pattern of aid utilization
in Ethiopia is that, it has been directed to a place where their multiplier effect generates
maximum growth. This is to say, also the development aid had financed a very large share of
capital expenditure, investment pattern by it self had been poor. He supported his argument by
giving instance as: out of the external assistances, the significant portion has been utilized in
sectors which are unproductive or in directly productive, by neglecting the directly productive
once and hence; this is to show the situation where the return from foreign assistance is not even
sufficient to meet the debt obligation of the country.

The study also provided other constraint in the effective use of aid in the recipient side
which has limited absorptive capacity. The sources for this are mainly weak structural and
institutional arrangement in the economy as well as undemocratic political system and practice.
Such problem may lead the aid-financed project or programs to be largely donor-driven. More
over, lack of coordination within the recipient country due to the implement of many institutions
in specific projects in particular and in the over all aid flows in general, can be a hindrance to the
effective use of aid. (Meried Haile 2002; Zera Yasin 2003).

CHAPTER THREE
DATA ANALYSIS AND INTERPRETATION
3.1 Descriptive Analysis

24
 3.1.1Characteristics of Ethiopian economy
The structure of Ethiopian economy is dominated by agriculture. Agriculture being the
back bone of the economy accounts about 60 and 50.5 percents of the GDP in 1974 and 2007
respectively. According to the central statistical authority report in 2004, 85 percent of the
population is engaged in this activity for livelihood, and the country heavily depends on this
sector for its foreign exchange earning. The figure below presents the percentage share of main
economic sectors of the country in 2007/08.

Figure 3.1 percentage distribution of GDP by economic activity at current prices

(Source: Computed from MOFED, National Account)

The figure presents the contribution of the industrial sector to the national income is very
low, as it only accounts for about 4 percent of the GDP of the country in 2007. This result may
be attributed to the operation of the industries mainly on consumer goods. The share of service
sector (distribution of other service) has been growing steadily over time. It was 39 percent in the
early 2000s and grows to 45 percent in 2008. The above figure also present the share of service

25
sector holding about 45.5 percent of the GDP in 2007, which is highly greater than the
manufacturing sector.

3.1.2 Volume and Trends of Aid Flow in Ethiopia

Developing countries like Ethiopia have major options to finance the deficit in their
economy and also to achieve their objective in their socio economic development programs. The
first alternative will be using domestic resources of financing and adopting foreign sources is
another option. Foreign sources including development assistance, which is again consists of
foreign resource transfers from government, non-government organization and private
institutions of the developed countries to the developing countries officially.

Ethiopia has been receiving development assistance for a long period of time from both
bilateral and multilateral. The country receives about $ 270 million from bilateral and $586
million from multilateral donors on average between 1991/92 to 2008/09.

Table-3.1 Percentage of Official Development Assistance Flow to Ethiopia (in million USD)

Fiscal Year Bilateral Multilateral

1991/92 43.4 56.4
1992/93 43.3 56.7
1993/94 23.3 76.7
1994/95 30.4 69.6
1995/96 32 68
1996/97 27.3 72.7
1997/98 44.3 55.7
1998/99 28.2 71.8
1999/00 27.4 72.6
2000/01 23.4 76.6
2001/02 14.8 85.2
2002/03 14.7 85.3
2003/04 27.3 72.7
2004/05 29 71
2005/06 45.3 54.7
2006/07 37.4 62.6
2007/08 34.3 62.6
2008/09 24.2 75.8
(Source: Computed from MOFED)

From the above table one can observe that both the flows of bilateral and multilateral
financing showed a fluctuation over the years. It can be explained with respect to political
changes, natural hazards and the fulfillment of some conditional ties required by both sources. In

26
this period the government is very reluctant to accept changes and able to exploit multilateral
finance by accepting many of the policy changes as forwarded by IMF and WB. The table shows
that, especially after 2000/01 not only multilateral aid, but also bilateral aid showed an upward
trend attributed to the same reason for sound policy as the donors call it whether it is conducive
or not for the country they donate.

3.1.3 The contribution of foreign aid to trade

According to World Bank report in 2006, 23 percent of the population of Ethiopia
survives on less than $ 1 a day and 77.8 percent live on less than $ 2 a day. Its purchasing power
parity PPP adjusted GNP is ranked 200th out of 206 countries. And the HDI ranked Ethiopia the
91st out of 94 developing countries.

The trade balance of Ethiopia has been in deficit through out all the years that this study
covers (i.e. 1974 up to 2007). The following table shows the average percentage share of the
countries’ import and export to GDP.

Table 3.2 percentage share of import and export to nominal GDP

Year Import Export Trade Balance

1979/80-82/83 16.9 10.15 -6.75
1983/84-86/87 17.15 9 -8.15
1987/88-90/91 13.8 7.57 -6.23
1991/92-94/95 18.15 9.68 -8.47
1995/96-98/99 15.68 14.8 -0.88
1999/00-02/03 32.3 15.6 -16.7
(Source: MOFED and own computation)

As it is shown in the table, the volume of import and export rose over time. This is due to
economic expansion as a result of free market economy and the appreciation of private sectors
especially after the 1990s. Besides, an increase in imports is a common and standard
phenomenon under the IMF/ World Bank inspired Structural Adjustment Program (SAP)
because of the reduction of import barriers including the removal of quotas and cut in tariff rate.
However, at a given expansion Ethiopia does not exhibit a positive trade balance under the stated
time period. This is due to the import of expensive manufacturing products relative to the export
of cheaper and price inelastic agricultural products. It is also observed a fast decline in both
import and export between 1987-1990/91. The reason behind this doctrine was the intensification
of the civil war which is the major determinant of economic activities.

This gap in import and export and other phenomenon indicates the vulnerability of the
country to indebtedness or the demand for aid. The dependence on external resource is quite
apparent in financing of such deficit and government capital expenditure. The table below shows
government revenue by source.

27
 Table-3.3 Percentage Share of Government Revenue by Source (in million Birr)

YEAR
2005/06 2006/07 2007/08
REVENUE
A Ordinary revenue 66.8 59 61
Direct tax 23 24 22.8
Indirect tax 16.2 18.6 16.5
Foreign trade tax 34.3 38.2 38.0
Non tax revenue 26.3 19.2 22.7
B Capital receipt 1.3 0.7 -
C External assistance 16.2 23.1 21.6
D borrowings 15.7 17.2 17.4
internal 33.5 68 68.2
external 66.5 32 31.8
total 100 10 100

(Source: Central Statistical Authority and own computation)

As it is shown in the table the share f external assistance to the total government revenue is
not simple. It accounts about 16.2%, 23.1%, 21.6% of government revenue In 2005/06, 2006/07,
2007/08 respectively. While external borrowing accounts 66.5%, 32%, 31.8% in the same year
with a decreasing trend. Therefore, we can say that foreign aid in the form of long term
concessional loan and grants play a great role in the short term economic growth of the country
in financing deficits.

3.1.4 Summary of External Public Debt

Watching the recent data about the external public debt of Ethiopia, the country can be
listed among those having high debt ratio.

Table 3.4 Indicators of debt burden 1994/95-2004/05

28
 year Debt servicing Debt Ratio of external Percentage share
service debt to GDP % of export to GDP
ratio

Principal Interest

1994/95 71.5 25.5 30.20 58.31 14.5

1995/96 69.3 30.7 34.99 50.73 13.1

1996/97 85.3 14.7 49.82 47.87 16.2

1997/98 56.8 43.2 15.04 52.52 15.9

1998/99 71.9 28.1 18.17 55.13 14.1

1999/00 78.4 21.6 25.24 69.84 15.1

2000/01 69.2 30.8 22.18 70.44 14.7

2001/02 63.7 36.3 15.41 84.57 15.5

2002/03 67 33 22.32 85.53 17.1

2003/04 66.5 33.5 17.04 71.13 18.3

2004/05 71.7 28.9 11.49 53.89 19.6

(Source: MOFED and own computation)

From the above table we can observe that Ethiopians debt has gone beyond its export
income. This indicates one of the shortcomings of foreign aid in the long run economy of the
country as a result of what is known as concessional loan. Arrears of both principal and interest
show fluctuation from one to the other year. However, it records a large amount which has
revealed the incapability of repaying the debt obligation. The debt has already beyond 2.75 times
of the percentage share of export earnings in 2004/05. Generally, it is becoming clear that the
country’s debt is beyond its capacity to service it.

3.2 Econometric Analysis

29
 In the previous section attempt was made to show the trend and relationship between
foreign aid, trade balance (import and export) and the genera economic performance of the
country. However, the relationship between foreign aid and economic growth can not be
captured using only simple descriptive data analysis. Thus econometric diagnosis will be used to
explain the relationship between foreign aid and economic growth.

The present analysis has been carried out at the aggregate level using the Ethiopian data
for the period 1974/75-2007/08. As the first step in analyzing time series data is checking the
order of integration (stationarity) of variables under consideration Augmented Dickey-Fuller
(ADF) test has been employed.

Therefore, the result of the ADF test shows all the selected variables except foreign aid,
gross capital formation, and adult illiteracy are stationary with the inclusion of drift even though,
Adult illiteracy become stationary at its’ second lag value. Foreign aid and gross capital are not
stationary up to their 5 lagged values. However, standing from their great influence on the
economic growth of a certain country in reality, the study uses them even if they are failed to
pass their ADF test.

3.2.1 THE MODEL

DEFINITION OF VARIABLES

Climate; according to world Encyclopedia climate is the average condition of the atmosphere
near the earth’s surface over a long period of time, taking in to account temperature and
precipitation. Agriculture remains the main engine for economic growth for most sub-Saharan
(SSA) countries, contributing around 40 percent to their gross domestic product and employing
more than half of the total labor force (Barros and et al 2004). The important factor that should
be emphasized is the high dependence of agriculture on rainfall. The empirical studies by Barros
et al (2004) suggests that climate, measured as change in country-wide rainfall and temperature,
has been a major determinant of agricultural production in sub Saharan African economies
(Barros and et al 2004).

Particularly in countries like Ethiopia, where the irrigation system is underdeveloped,

agricultural GDP growth and there by the overall GDP growths are expected to be sensitive to
the amount of rain fall. Climate changes in Ethiopia made labor and capital inefficient. Droughts
also make capital less productive because animals (ox, horse, etc) are the main agricultural
capital stocks which are vulnerable to the recurrent drought. Farmers’ capital acquisition depends
on the frequency of drought. A drought in particular year forces agricultural house holds to sell
their capital stock, including their oxen to bridge there consumption gap. This leaves them with
meager or no capital to work after recovery from famine. These lead to lower output for the
following years (Berhanu Nega and Seid Nur 2004). Therefore, rainfall is taken as a proxy
variable for climate and it is expected a positive sign relationship between rainfall and economic
growth.

30
Human capital; according to Paul A David, human capital is the collection of acquired
individual abilities that are substantially durable, and persistent and over some significant
portion of the life of the possessor. Kim and lee (2001) argued tat “the higher stock of the width
of human capital relative to the level of the depth leads one country to the high growth path
(and) depending on the initial structure of human capital and the uncertainty about the nature of
new technologies, an economy can have multiple paths. Many theoretical models of economics
such as Lucas (1992) stress the role of human capital in the form of educational attainment.
Education is not of minor importance in sustaining growth as discoveries of new ideas and
transferring technologies are functions of quality education. According to Solow (1975), 87.5
percent of the growth of the US economy for the period 1909-1949 is attributed to technical
change (Berhanu Nega and Seid Nur 2004).

In Ethiopia, the possibility of sustaining per capital income growth through the augmentation of
human capital seems to be missed, as enrollment level is low. Empirical studies of growth in a
cross country and individual country setting have been hampered by in adequate data. Different
studies have used different proxies for human capital. In this study adult illiteracy rate (percent
of people aged 15 and above) is taken as a proxy variable for human capital. Therefore, it is
expected a negative relationship between human capital and adult illiteracy rate.

Population Growth; different empirical studies tells that population growth correlated with
economic growth differently in different countries. There is also a debate about how population
change affects economic and social development in social sciences. On one the one hand, there
has been the Malthusian view that emphasizes the negative effects of population growth. This t
strand of thought as been remarkably strong and it has gained additional support during the extra
ordinary rapid world population growth after ww2. Oh the other hand, there has been a small
group, sometimes labeled “population optimists” who have argued that population growth is an
important positive factor in economic growth. To this group belongs Simon Kuznets, together
with the influential Danish economist Ester Bserup, who conventionally argued that the
introduction of new technology is closely linked to the size of the resident population (Bo
Malmberg 2004). According to him, the cyclical drought, and widespread starvation in Ethiopia
during the past three decades is population growth. Since the 1970s, the population has doubled,
bringing the country to rank the third in Africa in 2003.Therefore, as an increase in population
number especially dominated by children have Malthusian effects on the subsistence situation of
Ethiopia. In this study it is expected a negative relationship between economic growth and
population growth.

Grosse Capital Formation; the other determinants of economic growth is gross capital formation.
If the investment climate is conducive then the expansion of domestic capital investment will

31
bring high level of growth and development. Therefore, the expected sign for gross capital
formation is positive for the fact that an increase in investment leads to employment creation and
export expansion which intern raises the living standard of the population, which consequently
brings about economic growth and development.

Foreign Aid; foreign aid is conventionally measured and defined on the basis of the organization
for Economic Cooperation and Development (OECD’s) official development assistance (ODA).
ODA is defined as loans and grants made on concessional term from official sources with the
objective of promoting economic development and welfare (Robert 1987). However with the
issue of the economic effect of aid, especially public aid is fraught with disagreements. On one
side are the economic traditionalists, who argue that aid has indeed promoted growth and
structural transformation in many LDCs. On the other side critics who argue that aid do not
promote faster growth but may in fact retard it by substituting for, rather than supplementing
domestic savings and investment, and by exacerbating LDCs balance of payments deficit as a
result of rising debt repayment obligations and the linking of aid to donor-country export
(Todaro and Smith 2009, 9th edition).

In the case of Ethiopia where there is inconsistent political stability, recurrent drought, and the
prevalence of oppressive donors policy it is difficult to think foreign aid will bring sustainable
economic development. Therefore in this study, it is expected a negative relationship between
foreign aid and economic growth.

3.2.2 MODEL SPECIFICATION

Limitations for the study of the relationship between economic growth and foreign aid did
not allow the inclusion of many variables in the model. Unfortunately there is no any
conventionally accepted theory on the determinants of economic growth and therefore, there is
no generally accepted set of variables to include in the study

Thus, the model is specified in the following form

(-) (+) (-) (+) (+)

Where,

ln = natural logarithm

RGDP= Real Gross Domestic Product

(Proxy of economic growth)

FA= Foreign Aid

(Based on annual monetary value of aid inflow)

32
 POP= Population
(Measured on the number of total population)

AI= Adult Illiteracy Rate

(Proxy of human capital)

GCF= Gross Capital Formation

= Rain Fall
(A one year lagged value of rain fall a proxy for climate)

Ui= the error term incorporating other implicit and explicit determinants which are not

included in the model due to various reasons (lack of adequate data, immeasurability

of data, etc). From those excluded variables Trade Liberalization, Political Stability,

and Foreign exchange rate, government expenditure and fiscal Policies are some of

the examples.

= the basic value of RGDP

= Coefficients of explanatory variables each representing the marginal impact of

these variables on RGDP

(+-) = Expected sign effect

3.2.2 THE DATA

(See appendix 1)

3.2.3 THE RESULT OF REGRESSION ANALYSIS

33
 . regress rgdp pop adultity gcf aid rfall

Source SS df MS Number of obs = 33

F( 5, 27) = 82.60
Model 3.22542831 5 .645085662 Prob > F = 0.0000
Residual .210869879 27 .007809996 R-squared = 0.9386
Adj R-squared = 0.9273
Total 3.43629819 32 .107384318 Root MSE = .08837

rgdp Coef. Std. Err. t P>|t| [95% Conf. Interval]

pop .6035568 .4264633 1.42 0.168 -.2714736 1.478587

adultity -.8169236 .6484245 -1.26 0.219 -2.147381 .5135337
gcf .0344377 .15561 0.22 0.827 -.2848476 .3537231
aid -.096284 .0471907 -2.04 0.051 -.1931113 .0005433
rfall .0729184 .1833373 0.40 0.694 -.3032586 .4490954
_cons 2.355821 6.563998 0.36 0.722 -11.11239 15.82403

. summarize rgdp pop adultity gcf aid rfall

Variable Obs Mean Std. Dev. Min Max

Thus, rgdp
the results of the 34
econometric analysis .3300236
10.75831 is put in the following
10.36682 form
11.55403
pop 34 17.71274 .2887189 17.28983 18.18047
adultity 34 1.471703 .0590717 1.335001 1.617406
LnRGDP = 2.35 +gcf
0.6LnPOP – 0.82LnAI
34 + 0.034LnGCF
9.821854 – O.O9LnAID
.8427626 8.531298 + 0.07LnRF
11.28036
aid 34 20.18388 .9058074 18.56123 21.60806

SE (6.56)rfall(0.42) (0.64)
33 (0.15)
7.05276 (0.04) 6.861712
.0935815 (0.18)7.198333

T (0.36) (1.42) (-1.26) (0.22) (-2.04) (0.40)

2 2
R = 0.93 Adjusted R =0.92

N=33 Df = 32

3.2.4 HYPOTHESIS TESTING

It simply helps us to test the statistical validity and theoretical meaningfulness of the
estimation and it is done on the ground of statistical and econometric criteria.

3.2.4.1 STATISTICAL CRITERIA

Standard Error Test

Null hypothesis: Ho: all the parameters are zero

Alternative hypothesis: H1: all the parameters are different from zero.

34
In this analysis, that is coefficient of foreign aid is found to be statistically significant.

Therefore, we have to reject the null hypothesis and accept the alternative hypothesis for the
variable.

T-test
Null hypothesis: HO: all the parameters are zero

Alternative hypothesis: H1: all the parameters are different from zero

The study used a 5 percent level of significance and the critical T value is taken based on two
tail test at 32 degree of freedom. Therefore, based on the above competitions, foreign aid is
found to be statistically significant and hence we should reject the null hypothesis and accept the
alternative hypothesis for this variable. The calculation of standard error and t-test is found in the
appendix.

F-test
This test helps us to have a filtered idea on the overall significance of the estimated
parameter when they taken together.

Thus,

Null hypothesis: HO : all variables are zero jointly and simultaneously

Alternative hypothesis: H1: all variables are different from zero jointly and
simultaneously

From the STATA output we have F*= 82.60 which is by for greater than the critical
F0.05, 5, 27 (=2.72) value at 5% level of significance, thus, the null hypothesis should be rejected
and the alternative hypothesis should be accepted. That is, when all the variables are taken
together simultaneously, they are found to be significant.

3.2.4.2 ECONOMETRIC CRITERIA

To deal with this, we will consider measures of Multicollinearity, autocorrelation and

Heteroscedasticity which are regarded as the theoretical (or econometrical) check point for the
violation of basic classical regression assumptions.

35
 Multicollinearity Test

This test helps as to check the degree of correlation between the explanatory variables.

Null hypothesis: Ho: no Multicollinearity

Alternative hypothesis: H1: there is Multicollinearity

There are a number of tests to measure the degree of Multicollinearity such as, condition
number, condition index, degree of tolerance, Variance Inflation Factor (VIF) and auxiliary
regression. Inference using the first four is done based on the rule of thumb where an auxiliary
regression applies series of vivid computational inference. Thus, for the sake of conducting
reasonable analysis, auxiliary regression, which is based on the regression of each independent
variable on the remaining explanatory variables, is chosen, to go thorough auxiliary regression.

Calculating R2xi of each variable, the calculated F* is greater than the critical value F
(F0.05, 4, 28) amounts 5.76 at 5 percent level of significance. Thus, we should reject the null
Hypotheses and accept the alternative (i.e. there is Multicollinearity) supported by the auxiliary
regression.

However, Multicollinearity is a question of degree and not of kind. The meaningful

distinction is not between the presence and the absence of Multicollinearity, but between its
various degrees. Again, since Multicollinearity refers to the condition of the explanatory
variables that are assumed to be no stochastic, it is the feature of the sample and not of the
population (Gujarati 2003: Dagim 2008). Thus it is of normal circumstance to expect some
correlation between the explanatory variables since every thing on earth is interrelated.

In reality the only remedial measure to deal with Multicollinearity is to reduce its
degree. It s degree can be reduced through: transformation of the functional form of the model
and specification bias, addition of new variables, removal of highly correlated variables, pooling
the data (i.e. combining both time series and cross sectional data), and widening the sample size
can be the remedies.

Heteroscedasticity Test

This test helps us to detect the Homoscedasticity of the error variance. To do so, Park
test, Glejser test, Spearman rank correlation coefficient, Goldfeld-Quandt, breusch-pagan and
other formal and informal methods can be applied. However in this study breusch-pagan/Cook-
Weisberg test is employed.

Null hypothesis: Ho: constant variance

Alternative hypothesis H1: different variance

36
 From the STATA out put we have chi2 (1) = 2.00 less than the critical value of 3.841.
Therefore we reject the null hypothesis and accept the alternative hypothesis meaning there is
Heteroscedasticity in the error variance. However, we should not much bother about
Heteroscedasticity (i.e. whether it prevails or not. since it does not destroy the unbiasedness and
consistency properties of OLS estimators, but they are not longer efficient not even
asymptotically (i.e. large sample size) (D.N Gujarati, 2003).

Autocorrelation Test

This test helps us to detect the existence of relationship between successive values
of the same variable (usually, the error term) .to deal with this, the usual Durbin Watson (d-
statistics) test can be applied.

According to this test when d=2, there is no autocorrelation and when d 2, there is
autocorrelation, thus we can hypostasize as:

Null hypothesis: H0: no autocorrelation

Alternative hypothesis H1: there is autocorrelation

=
From the STATA out put we have d*=0.7083552 which is less than the stated
1.061 in the d- statistics distribution so that we reject the null hypothesis of no
autocorrelation in favor of the alternative hypothesis implying existence of
autocorrelation.

Model Specification error test

The Ramsey’s specification error test (RESET), on the other hand, shows absence
of functional problem. Te computed value of F is sufficiently high. That is, the computed F-value
=13.69 is higher than the critical value =5.52 at 5 percent level of significance, indicating the
absence of functional problem.

Chow Test

Chow test is important for testing the equality of two regressions in a time series data. It
is also applied for testing the stability of regression coefficients when increasing the size of the
sample. If calculated F* greater than the critical F value we reject the null hypothesis, i.e. we
accept that the structural coefficients are unstable, their value changing in expanded sample
periods. We also accept the hypothesis that there is a difference in the coefficient obtained from
the two samples regressed.

In these analysis two samples one starting from 1974-1990 and the other from 1991-2007
are regressed separately. This is to compare the economic relationship between the previously

37
stated explanatory variables and the dependent variable, and to test their statistical significance
under the Derg and EPRDF regime. Appendix 6 show the regression output from STATA
software in the two regimes. The out from the chow test shows that the calculated F*=42.9 is
greater than the critical F= 3.35. Therefore, we accept that the two regressions differ
significantly, or the two samples give different relationship and the structural coefficients are
unstable.

3.2.5 INTERPRETATION O F THE RESULT

The Constant Term

Basically, the constant term has not such explanations in economic theory. It simply
exhibits the value of LnRGDP which is amounted to 2.35 in the absence of all the explanatory
variables. Moreover, it is found to be insignificant as it is seen from the p value.

The Explanatory Variables

 Population; it is found to be inconsistent with the priory criterion and technically it

reflects a one percent increase in population number leads to a 0.6 percent increase in
economic growth. It is found insignificant at 5% level of significance as the
calculated t value 1.42 less than the critical t value 2.03. This might be due to data
gathering problem or may be as ‘population optimist’ suggests technological changes
rater than population affects the economy. The positive correlation between RGDP
and population might be because of the increase on school enrolment level and
expansion of labor intensive investments. Moreover it might be due to the expansion
of new policy instruments like microfinance services which reduce the capital
constraints of working labor force and the implementation of BPR (Business Process
Re-engineering) program to effectively allocate the labor force.

 Adult Illiteracy Rate; it is found consistent with the priory criterion. However, it is
insignificant as it is seen from its t value 1.26 less than the critical t value of 2.03.
This might be due to the aforementioned problem of the data and the model from
economic point of view, but from reality point of view it supports the economist’s
widespread perception that the economic development of illiterate society is at the tail
of any development. Econometrically it explained as, a unit percent decline in AI
leads to a 0.81 Percent increase in RGDP. Thus human capital has a positive
influence on RGDP.

 Gross Capital Formation; is found consistent with the priory criterion. But
insignificant at 5 percent confidence interval as its’ calculated t value is less than
the actual t value (0.22<2.03).this may happen as a result of the suspected limitation
of the model and the very slow change of the recorded data for the successive 33

38
 years. That is the slow development of gross capital formation all over the given
years. Econometrically, a one percent increase in the level of gross capital formation
leads to a 0.03 percent increase in RGDP.

 Foreign Aid; is found consistent with the priory criterion. It is also significant at 5
percent confidence interval that is the calculated t value 2.04 is greater than the
critical value 2.03. Econometrically, a one percent decline in foreign aid will led to a
0.12 percent increase in RGDP. This is might be due to the linkage of aid to donor-
countries individual interest, the transferring of debt burden of the past to the next
generation in the long run and, poor utilization of aid in the home country.

 Rainfall; is found consistent with the priory criterion but insignificant at 5 percent
level of significance as its’ calculated t value 0.4 less than the critical t value 2.03,
this is also associated with the problems aforementioned. And also due to the rising
environmental degradation as a result of population explosion and the vulnerability
of the countries topography (mountainous feature) for massive soil erosion at the
time of raining. Econometrically, a unit percent increase in RF leads to a 0.07
percent increase in RGDP. This result shows rain fall has a little impact in Ethiopia’
economy even if the country nurtured agriculture as a dominant economic base.

In general, the inconsistency, insignificancy of some variables is attributed to smallness in

sample size for assessing long run relationships, problems on selection of best fit and other latent
limitations of the model.

THE R2

As the result indicates, the R 2 is found to be large amounted to 93.8 percent. It is

interpreted as: 93.8 percent of the variation in the level of RGDP is explained by the
explanatory variables. To call a remark, adjusted R 2; degree of freedom adjusted version of
the R2 amounted to 92.7 percent. However, this largeness of the R 2 might not exhibit the
higher goodness of the fit.

39
 CHAPTER FOUR
CONCLUSION AND RECOMMENDATIONS

4.1 Conclusion
As it has seen from the previous discussion, Ethiopian economy is characterized by a
very large traditional (subsistence) sector consisting mainly of peasant agriculture and, under
developed industrial and service sector. The country seeks rapid and equitable growth by
focusing on rural development and improvement in physical and human capital. The country also
needs to ensure food security and poverty reduction program. To achieve this and related
development objectives, external development assistance is necessary in the short run. The
overall macroeconomic performance of Ethiopia between 1991/92-2008/09 revels that there is
high dependency on external assistance to attain economic stability, financing government
capital expenditure and trade deficit, etc. In achieving this, the country receives both bilateral
and multilateral assistance with a fluctuating rate. However, this kind of inconsistency will create
uncertainty for policy design and sustainable economic development.

The econometric result in the previous section reveled that foreign aid in Ethiopia does
not have a positive contribution for the growth of the economy in the long run. This may be
attributed to natural calamities, political instability, and poor aid project managements. This is to
mean that even if aid play a vital role in filing gaps in the short run, domestic investment (capital
expenditure is little on utilization of aid. The other reason can be the lack of appropriate policy
and strategy design by donors like that of IMFs which is similar assistance strategy for all
developing countries. Moreover, the country is highly indebted as a result of foreign aid and it is
beyond her capacity to service it only by using her income. These reflect the poor allocation of
resources.

4.2 Recommendations

40
 The main challenge for Ethiopian government both for the Derg regime and EPRDF is to
make foreign aid more effective for bringing development and to have a potential and policy
instruments to be self sufficient. Generally aid flows and utilization can be improved if the
Ethiopian government and donors adopt the following.

 The government should design a better policy for developing human

resource visualizing future economic development, and for becoming self
sufficient.
 The government should improve aid policy coordination and allocation
behavior with in the country, ensure most cost effective utilization of
assistances especially technical assistance, improve the monitoring process
in state bureaus, design proper pricing policy to protect domestic
producers who are/will be affected by aid in kind.
 The government should give due emphasis for joining regional and inter-
regional trade and economic cooperation’s for increasing export share and
reducing costs in an attempt to penetrate in developed countries market.
 The country should work hard in socially productive safety net program
by using public Medias, traditional associations, and cultural practices to
aware the people. This is for reducing dependency on foreign aid at the
time of manmade or natural disaster, and to initiate and develop the
working habit of the victims. Additionally, to bring sustainable
environmental and economic development the adoption of safety net
program will be vital.
 The Ethiopian government in combination with other highly indebted
countries should have to bargain for effective and sufficient debt
cancelation programs. Moreover, African Union as it is a group of many
poor African countries should have to facilitate inter regional economic
and political cooperation, and it should have to bargain for policy changes
and improvement by major donors like that of IMF and World Bank.
 Moreover, the government should have to give priority for cash base
donation since, it is flexible and easy for domestic allocation. The
government should also have to implement and strength BPR (Business
process Re-engineering) for reducing state bureaucracy and effective
allocation of aid.
 Donors should design appropriate policy instruments for different
countries differently, providing timelier grant and shift from loan to grant
financing that will assist in reducing external debt burden, and hence
reduce the need for additional aid.
 Above all, donors should base their motive on humanitarian and
development motive than only for maintaining their individual interest.

41
 Bibliography

 Adugha Lemi (2004). “Anatomy of Foreign Aid to Ethiopia”. Boston.

42
  Central Statistical Authority (1986-2008). “Annual Statistical summary”.

 Ethiopian Economic Association (2004). “Proceedings of the first International Conference on

the Ethiopian Economy”, volume 1 and 2. Addis Ababa.

 Fassil.G. Kiristos (2005). “Enough with famine in Ethiopia”. Addis Ababa. Ethiopia

 Gujarati (2004). “Basic Econometrics”, Forth Edition. The McGraw-Hill Companies.

 James Njeru (2005). “The Impact of foreign aid on public expenditure”. The case of Kenya.
African Economic Research Consortium (AERC). Nairobi.

 Knife Abraham (2001). Ethiopia: “The Dynamics of Economic Reforms”. Ethiopian

international institute for peace and development, Addis Ababa, Ethiopia

 Koutsoyiannis (1992). Theory of Econometrics, University of Ottawa, Ontario.

 Mc. Jhingan (2004). “The Economics of Development and Planning”. 37 th edition, Washington.

 Michael.P and Todaro Stephene.C.Smith (2009). “Economic Development”, England.

 Tilhun and Zera (2004). “Foreign aid reconsidered”, Addis Ababa.

 World Bank (2007). “Millennium development goal: global monitoring report”. Washington.

APPENDEX

Appendix 1

43
Table-1 The Data

YEAR RGDP GROSS CAPITAL FOREIN AID POPULATION ADULT ILLITRACY RAIN FALLt-1
FORMATION

1974 10.36682 8.531298 18.57683 17.28983 1.617406

1975 10.37804 8.591401 18.69793 17.31034 1.61343 7.115582

1976 10.38479 8.75592 18.75537 17.3262 1.609438 7.182048

1977 10.39496 8.817606 18.56122 17.33858 1.501853 7.117368

1978 10.3893 8.817606 18.75228 17.35002 1.499623 7.046212

1979 10.43614 8.977201 19.06558 17.36389 1.495149 6.934494

1980 10.48349 8.972905 19.16784 17.38247 1.492904 7.008053

1981 10.49597 9.03299 19.31616 17.40632 1.4884 7.078679

1982 10.49498 9.122365 19.11047 17.43446 1.48614 7.049602

1983 10.59096 9.122365 19.639 17.46558 1.483875 7.047691

1984 10.52593 9.274369 19.69997 17.49793 1.481605 7.100357

1985 10.42398 9.236106 20.39255 17.53029 1.479329 6.996224

1986 10.51839 9.308926 20.26299 17.56236 1.474763 6.951102

1987 10.64976 9.249185 20.25051 17.59446 1.479329 7.008776

1988 10.64923 9.330879 20.68809 17.62673 1.479329 7.039748

1989 10.65263 9.41395 20.4055 17.65947 1.481605 7.081288

1990 10.6925 9.640118 20.73247 17.69279 1.4884 6.905553

1991 10.65558 9.801399 20.81116 17.72664 1.4884 6.873371

1992 10.61798 10.01496 20.87385 17.76069 1.48614 7.086989

1993 10.73131 10.07523 20.80177 17.79436 1.477049 7.046734

1994 10.74816 10.21635 20.7841 17.82702 1.472472 7.000608

1995 10.80053 10.3432 20.59142 17.85826 1.465568 7.102993

1996 10.90145 10.42655 20.5199 17.88803 1.453953 7.176178

1997 10.94709 10.42655 20.17562 17.91653 1.437463 7.108326

1998 10.93256 10.56183 20.30801 17.94408 1.446919 6.861712

44
 1999 10.98255 10.59767 20.28178 17.97107 1.449269 7.159059

2000 11.03971 10.64291 20.34659 17.99778 1.442202 7.166961

2001 11.11126 10.58155 20.81468 18.02426 1.430311 6.923629

2002 11.12747 10.65019 20.98767 18.05047 1.420696 6.962811

2003 11.10626 10.8627 21.19298 18.07651 1.408545 7.198333

2004 11.21717 10.98003 21.316 18.10249 1.396245 7.190601

2005 11.33624 11.09458 21.37366 18.12847 1.388791 7.164514

2006 11.44544 11.19178 21.38997 18.15447 1.386294 6.997789

2007 11.55403 11.28036 21.60806 18.19046 1.335001 7.057697

Source: MOFED and CSA

Appendix 2

Unit root test

45
 Before estimation of the model stationarity of the data is checked using Augmented Dickey Fuller
test. The results are summarized I the following table.

Table-2 Unit Root Test for variables RGDP, Population, Adult Illiteracy, Gross Capital

Formation, Foreign Aid, Rainfall

statistics Variable sample observation With Drift

ADF RGDP 1974/75-2007/08 33 2.053 (-1.696)

ADF POP = 33 2.053 (-1.696)

ADF FA = 33 0.490 (-1.696)

ADF AI = 33 -1.272 (-1.696)

ADF GCF = 33 0.426 (-1.696)

ADF RF = 33 -4.624 (-1.697)

95% Critical values in brackets.

Appendix 3

T – Test

46
 Null hypothesis H0 all the parameters are zero

Alternative hypothesis H1 all the parameters are different from zero

The study used a 5% level of significance and the critical t value is taken based on the two tail test at 32
degree of freedom.

T0.025, 32 > 2.039 > 0.358900322

T0.025, 32 > 2.039 >1.415260821

T0.025, 32 > 2.039 > 1.259859243

T0.025, 32 > 2.039 > 0.221307756

T0.025, 32 > 2.039 < 2.040317266

T0.025, 32 > 2.039 > 0.397728121

47
Appendex-4

Standard error test

Null hypothesis H0 all the parameters are zero

Alterative hypothesis H1 all the parameters are different from zero

> 6.563998 > 1.1779105

48
 > 0.4264633 > 0.3017784

> 0.6484245 > 0.4084618

> 0.15561 > 0.01721885

> 0.0471907 < 0.048142

> 0.1833373 > 0.0364592

APPENDEX 5

Multicollinearity Test

This test helps us to check the degree of correlation between the explanatory variables.

Null hypothesis H0 no Multicollinearity

Alternative hypothesis H1 there is Multicollinearity

49
 FI= R2 ( Xi . X2 X3 X4 . . . . Xk)/ (K-2)

(1-R2 Xi.X2 X3 X4 . . . . Xk)/ (n-k+1)

Where, k ~ no of parameter

N ~ no of observations

GCF F1 = 0.9853/4 = 469

(1-0.9853)/28

AID F2 = 0.8597/4 = 42.89

(1-0.9853)/28

POP F3 = 0.9835/4 = 417.23

(1-0.9853)/28

AI F4= 0.8007/4 = 28.122919

(1-0.9853)/28

RF F5 = 0.1703/4 = 14.26

(1-0.9853)/28

Where, F , (K-2), (n-k+1) = P0.05, 4, 28 = 5.76

50
Appendix 6

STATA Regression out put of two samples in the chow test:

. regress RGDP GCF AID POP AI RF

Source SS df MS Number of obs = 16

F( 5, 10) = 8.24
Model .140268547 5 .028053709 Prob > F = 0.0026
Residual .034050802 10 .00340508 R-squared = 0.8047
Adj R-squared = 0.7070
Total .174319349 15 .01162129 Root MSE = .05835

RGDP Coef. Std. Err. t P>|t| [95% Conf. Interval]

GCF -.0283263 .2797542 -0.10 0.921 -.6516574 .5950048

AID -.0235007 .0634407 -0.37 0.719 -.1648554 .1178541
POP .7934291 .5010935 1.58 0.144 -.3230767 1.909935
AI -.0754167 .5970412 -0.13 0.902 -1.405707 1.254874
RF .0696336 .2925663 0.24 0.817 -.5822448 .721512
_cons -2.982899 5.573709 -0.54 0.604 -15.4019 9.436099

Regression out put from 1974-1990

51
. regress RGDP GCF AID POP AI RF

Source SS df MS Number of obs = 17

F( 5, 11) = 139.76
Model 1.14261183 5 .228522367 Prob > F = 0.0000
Residual .01798632 11 .00163512 R-squared = 0.9845
Adj R-squared = 0.9775
Total 1.16059815 16 .072537385 Root MSE = .04044

RGDP Coef. Std. Err. t P>|t| [95% Conf. Interval]

GCF .0598946 .1639483 0.37 0.722 -.3009531 .4207423

AID .092074 .0556308 1.66 0.126 -.0303685 .2145165
POP 1.507111 .662777 2.27 0.044 .0483491 2.965874
AI -2.473702 .8888452 -2.78 0.018 -4.430037 -.5173667
RF -.1472189 .1071888 -1.37 0.197 -.3831398 .088702
_cons -13.90448 12.34174 -1.13 0.284 -41.06846 13.25951

Regression out put from 1992- 2007

52