Concept Note Title: The impact of FDI on economic growth of Ethiopia

Background of the Study

Now a day almost all the peoples of developing countries and governments have the highest aspiration to achieve economic development in different ways; like getting food security, adoption of new technology, transition from agriculture based to industry-based economy, access to education and health care, and the general improvement in living standards. But, economic development cannot simply achieved by a mare wish. In place, it requires practical actions mainly in saving and investment. The saving requirement can be fulfilled either by domestic saving or foreign resources in an open economy. But, most of developing countries are neither in a position to generate adequate resources from domestic saving nor able to borrow money for their investment in international capital market at ongoing market interest rate. Thus, FDI is one of the tools for bridging the gap between saving and investment.

Statement of the Problem

Economists have shown that capital accumulation is the building block of development process of one country as the ultimate goal of any country is to achieve sustainable economic development. Their straight forward view is that economic growth is driven by the capital formation regardless of its sources. But the LDCs in general and African countries in particular are characterized by the savinginvestment, trade and fiscal gaps that makes difficult to achieve what is known as sustainable economic growth and development.

Ethiopia, being one of the LDCs is characterized by the low saving performances and investment activities that in turn affect its economic growth adversely. According to Abeba (2002) lack of capital is one of the main problem for the sluggish growth of the countrys economy. Possibly capital is supposed to be the key scarce factor in developing countries including Ethiopia. Thus, capital formation in LDCs economy has vital role in increasing production and productivity. In essence, capital formation is determined by the saving rate but developing economies are characterized by low level of income and which lowers level of saving rate. Therefore, minimal amount of saving rate and the required rise in demand for capital stock (or investment) create a resource gap. To fill the gap and achieve sustainable growth and development LDCs have searched for the inflows of resources. One way for resource inflow is through foreign direct investment from developed countries.

Research Questions
As growth theories suggested, an increase in capital flow would lead to a higher economic growth by filling the resource gaps. For instance, if FDI is used to fill the saving gap then saving rate increases and lead to higher capital accumulation (investment) in the country. This higher rate of investment would in turn leads to a faster economic growth. In line with this growth theory hypothesis, some of the research questions that need explanations on the impacts of FDI on economic growth of Ethiopia are:
Does FDI contribute to avoid the bottlenecks of economic growth in Ethiopia? Is there a long run and short run relationship between FDIand economic growth?

Is the effectiveness of FDI policy dependent?

Objective of the Study

The prime objective of this study is to analyze the impact of FDI on the economic growth of Ethiopia. In doing so, the study incorporates the following specific objectives;
a) Empirically investigate the long run and short run impacts FDI on economic growth. b)

Show whether the effectiveness FDI is policy dependent or not. c) Draw concluding remarks and appropriate policy implementations for sustainable development of the country based on the empirical findings of the study. Model specification and methodology

For this paper I will use the secondary data that I would going to collect from MoFED, national bank of Ethiopia and Ethiopian central statistics agency. The dependent variable is the real gdp and the explanatory variables are labor force, FDI, domestic investment (gross capital formation) and openness-trade as percentage of GDP. Yt =f(AtLtKt) Where Yt is the production of the economy which is real GDP at time t; At, Kt, Lt are the total factor productivity, the stock of capital, the stock of labor. The impact of FDI and other relevant variables can be captured through at component of the APF (Aggregate production function). Since I am interested to know the impact of FDI on economic growth I will include FDI as one of explanatory variable. Again I will use openness which is measured by trade as a percentage of GDP. Thus, Yt = K t 1 Lt 2 FDI t 3 OPEN t 4 E t where B1,B2, B3 ,B4 are constant elasticity coefficients of output with respect to K,L,FDI and OPEN-trade as a percentage of GDP and Et exogenous components of growth. From the equation above after taking log in both sides the equation now will become lnYt= 0 + 1 ln K t + 2 ln Lt + 3 ln FDI t + 4 ln OPEN t + t where t is the white noise error term. After reviewing many literatures I will add some explanatory variables which affect economic growth as needed when I start doing the paper. All the required tests such as unit root, cointegration etc will be conducted for the proposed model.