SECTORAL AND REGIONAL ANALYSIS OF THE

ETHIOPIAN INVESTMENT SCENARIO

A SENIOR ESSAY

By
KURABACHEW MENBER

Advisor: Mr. G.V. Chandra Sekhar

In Partial Fulfillment for Bachelor of Arts Degree

in Economics.

Department of Economics,
Faculty of Business and Economics,
Arba Minch University.

June, 2008
6
 Arba Minch,Ethiopia.

CERTIFICATE OF EVALUATION

This is to certify that Mr. Kurabachew Menber, student I.D. No. RBE/0828/98 has
conducted his senior essay research paper, titled “Sectoral and Regional Analysis of
Ethiopian Investment Scenario”. This work is completed with satisfactory evaluation of the
advisor and the examiners as per the requirements of the university.

Advisor: Mr. G. V. Chandra Sekhar.

Department of Economics, Faculty of Business and Economics

Arbaminch University

June,2008.

Acknowledgment
I would have been much more at ease, if only, words could explain my indebtedness
to those who extended their hands whenever I am in need of one.
7
In particular, my appreciation to my advisor Mr. Chandra Sekar is beyond any scale
of measurement. And, to my father Menber Mekonnen and all the rest of my family
deserve to be praised and credited for their unfailing and unconditioned material,
moral as well as financial support not only for this paper but for the whole completion
of Economics study. Finally, but most importantly, I would like to thank all those
friends who shared me their concerns and ideas about my achievement, on one way or
the other.

Above all I would like to thank the almighty God; it will not be possible without Him

TABLE OF CONTENTS
Chapter One
INTRODUCTION page No
1.1 Background of the
Study……………………………………………………………….
1.2 Statement of the
Problem……………………………………………………………….
8
1.3 Objectives of the
Study…………………………………………………………………
1.4Data sources and Methodology of the
Study……………………………………………
1.4.1 Data Sources and Data Type………………………………….
1.4.2 Data Analysis…………………………………………………
1.4.3 Model Specification………………………………………….
1.5 Hypothesis of the Study……………………………………………………………
1.6 Limitation of the Study…………………………………………………………..
1.7 Scope of the Study………………………………………………………………….
1.8 Significance of the
Study…………………………………………………………….
1.9 Organization of the
Paper………………………………………………………………
Chapter Two
review of litrature

2.1Theoretical Review
2.1.1 Definition of Investment ……………………………………………………..
2.1.2Growth Link to Investment……………………………………………………..

2.1.3 Investment Theories Related to Economic Growth………………………

I. The neoclassical model of investment………………………………….

II. The accelerator theory of economic development and investment…….
III. The Solow growth
model……………………………………………………..
IV. The Harod –Domar growth model
………………………………………….
V. The Lewis theory of
development…………………………………………….
VI. The Rosenstein-Rodan” big push” model …………………….
2.1.4 Relative Importance of Public versus Private Sector Investment……….
2.1.5The Linkage between Investment Sectors…………………………………………
2.1.6 An Important dilemma between Capital and Labor for Rural Development …
2.1.7 The Investment Climate and Economic Growth…………………………………
2.1.8 Capital Inflow and African economic growth and development ……………

9
2.2 Empirical Review of Literature
i. Economic growth performance of the country………………………………..
ii. Saving and investment in the country……………………………………….
iii. The investment link to growth………………………………………………..
Chapter Three
FINDING AND DISCUSSION
3.1 Relationship between Gross Private and Gross Public Investment…………
3.1.1 Trend analysis of Private vs. Public investment’………………………
3.1.2 Dose Private investment crowds ‘out’ or ‘in’ Public investment? ……
3.2 Sectoral and Regional Scene of the investment activity in the country……………..

3.2.1Analysis of the total investment scene …………………………………………..

3.2.1.1 Sectoral and ownership share of total investment projects……..

3.2.1.2 Sectoral contribution of total investment for job creation…………
3.2.1.3 Sectoral and capital share of investment projects …………….
3.2.1.4 Employment creation by type and sectors of investment
3.2.2 The analysis of the domestic investment scene………………………………

3.2.2.1 Regional distribution of amount of investment capital………………………

3.2.2.2 Regional distribution of number of domestic investment projects ……..

3.2.3 The analysis of foreign investment scene in the country……………………………….

3.2.3.1 Regional distribution of amount of investment capital……………..

3.2.3.2 Foreign investments projects ownership………………………

3.2.3.3 Regional distribution of number of foreign investment……….
3.2.3.4 Employment creation and foreign investment……………….
3.2.3.5 Sectoral distribution of foreign investment projects…………..
Chapter Four
CONCLUSIONS AND RECOMMENDATIONS
4.1Conclusion………………………………………………………………………..
4.2 Recommendations………………………………………………………………
Reference………………………………………………………………………………

10
Appendix ……………………………………………………………………………

List of Tables
Table2.1 Government policies and investment policies and investment decision-some
example
……………………………………………………………………………………
Table 2.2growth rate in real GDP…………………………………………………..
Table 2.3 GDS, GFCF, and resource gap as share of GDP………………..
Table 3.1 ……………………………………………………………………………..
Table 3.2 Number of Investment projects by type of investment and sectors …………
Table 3.3 Total investment projects by sectors and employment creation (1996_20)……….
11
Table 3.4 Net licensed investment project by sector, number and investment capital
(investment in million birr)
………………………………………………………………………………………

Table 3.5 Investment projects employment creation by type of investment and

sectors…………………………………………………………………………………..
Table 3.6 Amount of capital of domestic investment projects by sector and regional states
(in.mill.Br) ……………………………………………………………………………………

Table3.7 Number of regional domestic investment by

sector……………………………
Table3.8 Amount of capital of foreign investment projects by sector and regional
states (in millions of birr, 1994-2006)
…………………………………………………………………..
Table 3.9 Foreign investment projects by type of ownership (in millions of birr, 1994-
2007)
………………………………………………………………………………………………..

Figure 3.10 regional share of foreign investment

capital………………………………..
Table 3.11 Foreign investment employment creation by sector………………………..

Table 3.12 Number of foreign investment projects by sector………………………………

List of Figures
Figure 3.1 Trends in gross private (gpri) and gross public investment (gppi)
………………..
Figure 3.2 sectoral share of investment based on
ownership…………………………………..
Figure 3.3 percentage share of investment by ownership……………………………………

Figure 3.4 sectoral share of investment to employment

creation………………………………….
Figure 3.5 share of net licensed investment to employment by
sectors…………………………..
Figure 3.6 numbers of projects and capital allocation by
sector……………………………………
12
Figure 3.7employment creation by type of
investment……………………………………………
Figure 3.8 sectoral employment
shares………………………………………………………
Figure 3.9 regional share of domestic investment
capital………………………………………
Figure 3.10 regional share of foreign investment
capita…………………………………….
Figure 3.11 regional distributions of foreign investment projects
………………………….
Figure 3.12 numbers of foreign projects by
sector……………………………………………

Acronyms
SDPR Sustainable Development and Poverty Reduction Program
EEA Ethiopian Economic Association
MPK Marginal Productivity of capital
GNP Gross National Product
GDP Gross Domestic Product
GCF Gross Capital Formation
UN United Nation
IMF’s International Monetary Fund
(MTEF Medium-Term Expenditure Framework
MDGs, Millennium Development Goals
13
ODA Official Development Assistance
MNC Multi- National Corporation
FDI Foreign Direct Investment

Abstract

Economic growth of a country is always interlinked with the level of the countries
capacity to mobilize both domestic and foreign resources and then invest it in an
appropriate policy and regulatory framework which enables the basic essence of
investment to revive. For this end designing an appropriate sectoral and regional
distribution of investment projects and investment capital is one of the preliminary pre
requisite to be considered. Sectoral and regional analysis of the investment scene in
the country every time enables the concerned body to detect and know the problems
inherent to the investment process. At the end, at least it shows where to take a policy
measure to adjust the pitfalls encountered in the process.

Chapter 1

INTRODUCTION
1.1 Background of the Study

Investment is an essential macroeconomic variable through which economic growth

of a country is achieved. The economic growth of a country, which is a synonymous
phenomenon with development, is always attained through investment. As many
economists argue, the generation of sufficient invested capital either via the
mobilization of domestic resources and \or foreign capital flow is one of the principal
tricks for accelerated economic growth.

Most leading theories in economic development show the existence of an intrinsic

relationship between investment and economic growth. For instance the Harod-Domar
growth model states that the tricks of economic growth and hence development is a
matter of increasing national savings for higher investment with various mechanisms.

14
Lewis theory of development also states that the faster the rate of capital
accumulation, the faster the rate of new job creation and the higher growth in the
modern sector. In short it is an accepted truism in economics that future economic
growth is largely a result of current economic activity [Annual Report on the
Ethiopian economy, 1999\2000:47].

It must be noted that not only the increase in the capital stock of the country is an
engine for proper economic growth rather the sectoral ,regional , and administrative
conditions of the investment scene of a nation plays an important role in the
development process so as to achieve the desired goals of investment which is
development.

The investment trend, which prevails in Ethiopia, shows the close interdependence of
level of investment and economic growth though having insignificant level of growth
on both sides. Both investment and economic growth (measured by GDP growth) has
been decimal for many years. Besides, to its insignificant level of growth in each side,
there are some problems in the investment scene’s regional and sectoral distribution
of investment capital and projects. The investment climate of the country, which
consists of factors that shape opportunities and incentives for firms to invest, were not
in better conditions. However, nowadays the improvement in these conditions seems
to be an indicator for the slight increase in the rate of GDP growth.

The source of income\fund for investment has also played a crucial role for the
growth of the economy. Domestic savings, foreign capital inflow in the form of
foreign direct investment and debt or foreign aid are the usual sources of funds for
many developing countries. Many of the economists in development economics favor
increased investment through domestic resources mobilization for accelerated
economic growth [Barro, 1999]. Nevertheless, Ethiopia as one of the poorest
countries in the world, the lion’s share of its capital formation comes from FDI and
foreign aid as its source. Based on this context, the sectoral and regional investment
scene of the country will be given a greater emphasis.

1.2 Statement of the Problem

Economic theory assures that economic growth of a country is largely related to the
level of capital formation. Not only getting the finance is appropriate but also as a pre-

15
requisite, designing a proper financial source is important. Directing the finance into a
proper destiny is also vital for the welfare of the country. The experience of many
developed nations shows the importance of increased investment through selected
economic sectors (most of the time secondary and tertiary sectors) for accelerated
economic growth. But for agrarian countries like Ethiopia, a modernized way of
primary sector investment is given prior consideration.

Although there is a positive relationship between the rate of economic growth and
investment in the country, the level of both investment and economic growth was
decimal and to which extent they are inter linked was not exactly known. More over
the source of investment funds have also a significant impact on the desired level of
economic reform. In one or another way these all factors could attain their desired
objectives if there is an appropriate sectoral and regional investment scene in the
country. Analyzing the investment profile of the country based on economic sectors,
regional distribution patterns and type of ownership of investment projects is the basic
target of this investigation.

The assessment of the regional, sectoral and structural scene of the country’s
investment profile is the ultimate goal of this study. The analysis of the investment
climate compiled with the factors that affect its level via the insight of basic economic
development theories and international rules of investment is given a paramount place
for investigation. Astonished by the existing situation of the countries investment
level the paper asses and analyses the situation that prevails in the country with the
basis of basic economic development and growth theories in the real world.

1.3 Objectives of the Study

The analysis of the investment sectors of the country on the grounds of owner ship
and regional distributions with the base of basic economic development theories and
international investment rules is the basic objective of the investigation. Based on this
basic objective, the paper targets to attain the following two specific objectives:

 Investigate whether public investment crowds ‘out’ or ‘in’ private investment

in the country,
 Asses the existing sectoral and regional distribution framework of the
investment scene of the country
16
1.4Data Sources and Methodology of the Study

1.4.1 Data Sources and Data Type

The analysis of all the investigations depends on a time series secondary data within
the year 1980 to 2008. Basically, this data is obtained from EEA\EEPRI CD-ROM
database and the association’s library reference materials like proceedings, economic
focuses, quarterly macroeconomic bulletins, economic journals and annual reports.

1.4.2 Data Analysis

As a crucial instrument for proper investigation, the analysis is based on statistical,

econometric and descriptive methods. In the case of statistical and econometric
analysis, EVIEWS soft ware package is in use for a linear regression model
assessment. The descriptive analysis is based on those issues related to behavioral and
non-regressed aspects.

1.4.3 Model Specification

The model to be estimated is formulated on some reasonable assumptions so as to the
empirical analysis of the objectives mentioned be reliable. The model is based on who
undertakes investment activities.
The basic essence of this model is to examine through the public investment crowding out
whether there is any private investment crowding in. The model is,

Ipr=βo+β1Ipp+ε,
At the initial case but the parameters estimated are biased. To be appropriate it should
include at least import and interest rate. Therefore the model becomes

Ipr =βo+β1Ipp+β2M+β3r+ε
Where, Ipr is gross private investment

Ipp is gross public investment

M country’s import

r lending interest rate

β’s refers to coefficients. Ipp, M and Ipr are taken as percentage of GDP.

17
Where autocorrelation, stationary and cointegration test will be conducted as far as in
time series data is concerned with Eviews econometric package.

1.5 Hypothesis of the Study

Based on the review of deferent literature the paper hypothesizes:

 Public investment has a stimulant effect on private investment in the country.

 There exist structural, sectoral and regional inappropriateness in the
investment scene of the country.
1.6 Limitation of the Study
The researcher has been encountered by many problems which could have hindered
the successful completion of the investigation. To mention some of these problems,
the first one is the lack of adequate time series data on the share of investment in the
three sectors of the economy which makes impossible to show the sectoral relevance
and significance with an econometric model. Being member of low income family,
financial constraints also have greatly affected the researcher in the process of
fulfilling his input requirements for the investigation. Lack of sufficient computer
centers for the writing, editing process and the econometric tests of the model
specified was some of the problems to be mentioned.
1.7 Scope of the Study
Analyzing investment scene of the country by its nature is very broad. But here the
scope of the investigation for the researcher is to asses the major investment activities
of the country based on major economic sectors, that is, investment in the primary,
secondary and tertiary sectors of the economy. It also analyses the investment
situation on major economic activities based on owner ship of investment projects.
The relationship between public and private investment, sectoral shares of
employment creation, number and amount of investment capital allocation based on
regional distributions are the basic delimitation of the investigation under the review
period 1981 to 2007.
1.8 Significance of the Study
As it is a joiner’s research, this paper will have a significance of indicating the
situation of the country’s sectoral and regional investment scene. Then it is helpful for
any interested senior researcher to conduct a deeper investigation and to initiate the
concerned authorities to take an appropriate policy measures for the good running of

18
the country’s investment activities so as to attain their ultimate objectives, which is
economic growth. Up to this researcher, the significance of the paper is indicating the
sectoral and regional scene of the investment activity in the country, giving possible
recommendations for some pitfalls found, and creating an area of investigation for
any interested senior researcher to be used as a foot step for further detailed analysis
are the vital once.
1.9 Organization of the Paper
The paper has four chapters. The first chapter tries to incorporate things like
background, objective, scope, significance and hypotheses of the study. Chapter two
discusses on the review of related literature that includes both empirical and
theoretical conceptual framework evidence on global and national level. Chapter 3
gives the data analysis and discussion part of the paper. The last chapter provides the
conclusion and policy implication generated from the study.

Chapter Two
REVIEW OF LITRATURE

2.1THEORETICAL REVIEW

2.1.1 Definition of Investment

The common definition of investment -gross capital formation- is the expenditure or

payouts which consist of outlay on addition to the fixed assets of the economy, net
changes in the level of inventories and net acquisition of valuables. Fixed assets
include land improvements(includes fences, ditches , drains);plant ,machineries and
equipment purchase; and construction of road, railways and the like including schools
offices , hospitals private residential dwellings and stocks of goods held by firms to
meet temporary or unexpected fluctuations in productions and work in progress. For
consistency these can be grouped as business fixed investment-equipments and
structures purchase by businesses for production, residential investment-buying of
new houses for living or rent out, and inventory investment-refers to all goods in
storage[David Romer, 1996].

19
The above definition is based on the functional values to which the capital is allocated
in the mean time of investment activity. Investment can be classified as private or a
public based on the ownership of the capital allocated and the activities managed. The
former is mainly refers to investment by domestic individuals, firms or companies and
foreigners in the form of foreign direct investment; and the latter refers to all
investment activities which is run by the government. Moreover, it could be primary,
secondary or tertiary sector investment based on the economic activity where the
investment is under taken. Primary economic activities are classified as those, which
produce the raw materials for industry. Examples include mining, quarrying, farming,
fishing and forestry, all of which produce raw materials that can be processed into a
finished product. Investment in these sectors is described as primary sector
investment. Secondary economic activities are activities in the manufacturing and
assembly industries. They take raw materials and manufacture finished products from
them. Examples include steel manufacture, bread making and food processing.
Investment in these sectors is described as secondary sector investment. Tertiary
economic activities are activities in the service industries, and are the area of most
growth in the in most developed countries. Examples include doctors, teachers,
lawyers, estate agents, travel agents, accountants and police officers. Investment in
these sectors is described as tertiary sector investment. Quaternary economic
activities are the newest, most hi-tech sector. They are the research and development
industries. Examples include the development of new computer components and
research into GM crops. Investment in these sectors is described as the quaternary
sector investment. However, investment in this last sector is not well developed or
hardly exists in Ethiopia. It is common to developed countries [Ibid].

Primary investment in Ethiopia includes those investment activities engaged in

food crops farming, cash crops farming, mixed food and cash crops farming, livestock
farming, integrated crops and livestock farming ,agricultural services, forestry,
fishing, mining and quarrying. Secondary investment includes investment in food
products, beverages, and textiles except garment, garment and related articles,
tanneries, footwear, wood products except furniture. It also includes Paper: paper
products and printing, chemical products, pharmaceutical products, plastic/rubber
products except footwear, non-metallic mineral products, metal products including
machinery & equipment, electrical machinery and apparatus, Radio TV and
20
communication equipments, motor vehicles and other transport equipments, furniture
and other manufacturing activities. Tertiary sector investment also incorporates those
investment activities in electricity generation, construction, construction machinery
leasing, real estate development, distributive trade & maintenance service, hotel and
tourism, transport and storage service, education service, health service and other
businesses[Adopted from EEA database list].

2.1.2Growth Link to Investment

Over the past centuries, most countries in the world have enjoyed substantial
economic growth. Real income has risen from generation to generation; their higher
incomes have allowed people to consume greater quantities of goods and services;
and higher levels of consumption enabled them to have a higher standard of living.
However, the reverse was true in Ethiopia until recently [S.Patterson, 2000]. Patterson
states that the economic growth of these countries is due to the growth of inputs, such
as labor and capital, and to improvements in technology. The engine of growth for
these countries was mainly the increase in capital accumulation through savings and
investment. They could exhibit sustainable growth through their ability to accumulate
greater capital for investment.

Many countries followed different modalities to achieve economic growth through

capital formation. Early capital accumulation assisted by colonization helped England
to achieve industrialization parallel with invention. Capital formation through an
effective usage of banking system has helped Germany greatly. Russia in the
nineteenth century trusted the taxation power of the government to launch
industrialization. Latina America countries make use of financial institutions to
mobilize resources while sub Saharan African countries relay on government budget.
In china, rural industries make spare parts using foundries. South East Asian countries
make use of their human resources; and their effective use of an interventionist state
to launch industrialization [Gills, et-al; 19:23] as quoted [World Development Report,
2006]. Gills also states that “…although capital accumulation is viewed as a panacea
for poor countries, it is nevertheless clear that even mildly robust growth rate in
income can be sustained over long periods. This happens only when society are able

21
to maintain investment at a sizable proportion of GDP. This proportion can rarely be
mach less than 15%and in some case, it must be as high as 25%, depending on the
environment in which capital accumulation takes place; and on what rate of income
growth is deemed essential to allow progress towards basic societal goals. ...”

According to students of investment process there are three important stagers in the
investment process of capital formation that need to be successfully completed if
countries hope to a chive the desired level of investment and its fruits. These are the
stage of saving – a stage where resources which might be used for consumption are
put aside; the stage of canalization or resource mobilization- a stage where savings
that secured in the first stage are assembled and be ready for investors; and the
investment itself which is the final stage. This is the stage where resources that are
mobilized are utilized for the production of capital goods [Missr and Puri, 1991:226-
8, as quoted from Dawit Shegu, 2005]

An economy can have problems of mobilizing and using investment resources

because of failure in any one of these stages. Accordingly, the usual recommended
level of investment ranges from 12% to 15% and even as high as 25%. However, the
level of saving and hence investment is very low in developing countries associated
with little growth rate. Even worse; the quality of capital so accumulated is not
dependable in the sense that these resources might not be used efficiently. More over
with out finding away to mobilize resources to such a high level effectively and utilize
this savings thus mobilized, countries such as Ethiopia cannot hope to achieve
successful rapid economic growth and sustainability over social and economic
development [Annual Report on the Ethiopian economy, 2004\2005].

P.Todaro [2006] also assures that the mobilization of domestic and foreign saving to
generate sufficient investment to accelerate economic growth is one of the principal
tricks of development necessary for any take off.

As has been seen, sub Saharan African has made important progress in the buildup of
human capital. However, this is to the extent that this capital formation has been only
imperfectly accounted for the unconventional measures, Africa’s investment and
savings have been seriously under estimated. It will be important to preserve and
utilize this capital and of course to continue to build it in any future strategy for long
22
term African development [F.Stewart, S.Lall and S.Wangewe, 1992]. This shows that
even in the contemporary situation where “capital fundamentalism” is criticized it is
still accepted that capital accumulation explains a significant part of economic
growth.

2.1.3 Investment Theories Related to Economic Growth

Investment theory has remained one of the unsettled issues in economics. Keynes
[1996], for example under scored that investment depends on the future marginal
return to capital relative to the cost of invested funds. The human instinct in
investment decision making nowadays is an important determinant in such a world of
uncertainty. Besides, of the existence of many under mined variables that affect
investment decisions the following are some theories about investment.

I. The neoclassical model of investment ,

The neoclassical model of investment, which is the standard model of business fixed
investment, shows how the level of investment- the additions to the stock of capital-is
related to the marginal productivity of capital (MPK) the interest rate and the tax rule
affecting the investors or firms. According to this model, the firms’ decision,
regarding its capital stock – to add to it or not – depends on profitability of adding the
capital stock. The change in the capital stock, which is called net investment, depends
on the difference between the MPK and the cost of capital. If MPK exceeds the cost
of capital, firms find it profitable to add to their capital stock. If the MPK fall short of
cost of capital, their existing capital shrink and they will not have an incentive to
invest.

II. The accelerator theory of economic development and investment

This theory postulated that there is a linear relationship between investment and
output. The theory assures that the investment requirement for certain target desired
level of output growth is computed from a given incremental capital output ratio. But
the theory does not give consideration with regard to the importance of expectation,
profitability and the cost of capital for investment decision [G.Mankew, 2005].
23
 III. The Solow growth model

The Solow growth model shows the significance of saving rate as a key determinant
for a steady state capital stock. If the saving rate is very high, there will be large
capital stock and hence greater output. This model assumes that all savings are
converted to investment and investment is equal to saving. Over time a higher
investment causes the capital stock to rise. As the capital accumulates, output
consumption, and investment gradually increases, eventually approaching the new
steady state levels [Dornbush, 1983]

The Solow model is based on three variables- capital accumulation, population

growth and technological progress. The model with each of the variables considered,
asserts the importance of investment via saving for faster economic growth. The
Solow model with capital accumulation will have an important significance for
Ethiopia since the latter two are not in one or another way depend on it or even may
not be a problem. For example, technological progress is the out come of a higher
investment in the economy. Labor force is abundant in the country whose quality can
be improved via increased investment on education and training.

In spite of simplifying many aspects of the world and omitting many other
considerations, the Solow model shows that sustained growth arises from
technological progress which intern is a result of good saving habit, and hence greater
investment in the economy.

IV. The Harod –Domar growth model

The Harod- Domar model ascertains that every economy must save a certain
proportion of its national income, if only to replace worn-out or expired capital goods.
However, in order to grow, new investment representing net additions to the capital
stock are necessary. The model is represented by:

∆y/y=s/k

Where, “s” is the proportion of saving to national income, “k” is capital output ratio
and “y” is national income.

24
The economic logic of this equation is interpreted as, in order to grow, the economy
must save and invest a certain proportion of its GNP. The more it can save and invest
the faster it can grow. However, the actual rate at which it can grow for any level of
saving and investment –how much additional output can be had from an additional
unit of investment – can be measured by the inverse of capital out pout ratio because
this inverse 1/k is simply the output capital or the output investment ratio. It follows
that multiplying the ratio of investment, s=I/y by its productivity, 1/k, will give the
rate by which national income or GNP grows.

Unfortunately the mechanism of development embodied in the theory of stages of

growth did not always work. This is because of the fact that not more saving and
investment is a necessary condition for accelerated rate of economic growth – it is-
rather not a sufficient condition. to be functional the economy should posses the
necessary structural, institutional and attitudinal conditions ( for example well
integrated commodity, and money market , highly developed transport facilities , a
well trained and educated workforce , the motivation to succeed, an efficient
government bureaucracy)to convert new capital effectively into higher level of output
[Debaj Ray,1998].

V. The Lewis theory of development

The Lewis theory of development focuses on the structural transformation of a

primarily subsistence economy to the modern capitalist one. In the Lewis model the
under developed economy consists of two sectors a traditional over populated rural
subsistence sector characterized by zero marginal productivity of labor and a high
modern urban industrial sector in which labor is labor from the subsistence sector is
gradually transferred the focus is on increment of out put and employment in the
modern sector . Both labor transfer and modern sector employment growth are
brought about by output expansion in the sector. The speed with which this expansion
occurs is determined by the rate industrial investment and capital accumulation in the
modern sector. Such investment is made possible by the excess of the modern sector
profit over wage on the assumption that capitalists reinvest all their profit. Though
there are critics on labor saving type of investment, non existence of constant wage
vacancy in urban areas, it is essential that greater investment and capital accumulation
is helpful for development [P.Toodaro and C. Smith, 2006]

25
 VI. The Rosenstein-Rodan ” big push” model

It is the most famous coordination failure model in development literature. It is a

model of how the presence of market failure can lead to a need for a concentrated
economic wide and probably a public policy- lead effort to get the long process of
economic development underway or to accelerate it. The model’s recent appeal is due
in part to its perceived value in explaining the success of east Asian miracle
economies ,notably that of south Korea. One value of using formal model is to get a
clear sense of when the need for coordination is more likely to present serious
problems. Big push represents great deal of investment.

In this context, the investment sector is categorized based on two scenarios, one is
based on weather the activity is under taken by government or any other firms or
individuals. Based on this principle investment sectors are defined as private and
public investment. But based on the economic areas where the capital is invested it
could be primary, secondary or tertiary sector investment. The primary sector
investment mainly focuses on investment in agriculture, forestry, fishing; the
secondary sector mostly of manufacturing and the tertiary sector consist of investment
in commerce, finance, transport and service [the Author]. On the private investment
side it could be further categorized as private domestic investment or foreign direct
investment on the basis of investor’s origin.

2.1.4Relative importance of public versus private sector investment

In 2002, Ethiopia drew up a Sustainable Development and Poverty Reduction

Program (SDPRP) that targets economic growth averaging 7 percent a year in order to
halve income poverty by 2015. The strategy is premised on a transformation of
agriculture from mostly subsistence to commercial production, which would act as a
catalyst for the development of industry and exports, and the generation of off-farm
employment and income. Specifically, the government aims to increase agricultural
value-added growth from an annual 2.2 percent historically to 7.5 percent a year, and
nonagricultural growth from 5.8 percent to 6.6 percent. In the agricultural sector, this
strong improvement in real output is premised on productivity growth rising from an
annual 0.4 percent historically during 1991–2003 to an average of 9.0 percent a year
over the medium term. The reason for such a big impact on agriculture where

26
agriculture still sustains around 80 percent of the population, according to an IMF
study, is that it would require major increases in public and private sector investment
and productivity. Public investment as a ratio of GDP would have to rise to an
average of 15.8 percent over the next 15 years compared with 7.7 percent during
1991–2003. Private investment is expected to be stimulated by the government’s
reform program. In our analysis, we assumed that private investment would rise
broadly in line with public investment, increasing from an average of just over 9
percent in 1991–2003 to almost 16 percent during 2004–15[David Andrews,
Lodewyk Erasmus, and Robert Powell, 2005].

In developing countries even though their relative importance is a function of

historical and political circumstance, the degree of ownership in the private sector is
an important variable when differentiating among LDCs.

Large foreign owned private sector usually creates economic and political
opportunities as well as problems not found in countries where foreign investors are
less important. Foreign investment argument fill the gap between domestic available
supply of savings, foreign exchange and government relevance and management
skills which is necessary to achieve growth and development. Generally, foreign
investment fills the resource gap between desired level of investment and mobilized
savings. It also fill the gap between foreign exchange requirement, net export earnings
and net public foreign aid, and to fill the gap between targeted government tax and
locally raised tax and also the gap in management, entrepreneurship, technology and
skill may be filled by local operations of private foreign owned firms. Nevertheless,
they may also create the following problems:

 aggravate inequalities
 production of inappropriate products and socially undesirable projects
 direct government policy which is un favorable to development
 Crowd out local investors
 Powerful MNCs have a considerable influence on political decisions at all
levels.

The results also suggest that public investment on infrastructure projects has a
positive externality on private investment. This implies the complementarily nature of

27
private investment and the availability of infrastructure, at least in the long run. Thus,
the government can stimulate private investment by investing on infrastructure
projects [Daniel Zerfu, 2005].

Most developing countries have mixed economy system, featuring both private and
public ownership use of resources. The deviation between the two and their relative
importance is mostly a function of historical, political and economic circumstances.
Thus, in general Latin America and South East Asian nations have large private
sectors than South East Asian and African nations. The degree of foreign ownership
in the private sector is another important variable to consider when differentiating
among LDCs.

Often in countries like those of in Africa with sever shortage of skilled human
resource have tend to put greater emphasis on public sector activities and state run
enterprises on the assumption that limited skilled man power can be best used by
coordinating rather than fragmenting administrative and entrepreneurial activities.
The wide spread economic failure and financial difficulties of many of these concerns
in countries such as Ghana, Senegal , Kenya, Tanzania rise equations , however about
the validity of this assumption. As a result of these, most African nations have moved
in recent years towards less public and more private enterprises. The most dramatic
examples are found in the 15 countries of former Soviet Union and other once
centrally planned economies which have privatized a majority of there once mostly
state owned economies [Ibid].

Economic policies such as those designed to promote more employment will

naturally deferent for countries with large public sector and one’s with sizable private
sector. In economies dominated by the public sector direct government investment
projects and large real work programs will take precedence, where as in private
oriented economies, special tax allowance designed to induce private business to
employ more works might be more common. Finally not that the degree of corruption
differ s widely across developing countries and may influence both the size of public
sector and the design of the privatization program[P.Todaro and C. Smith, 2006].

2.1.5The linkage between investment sectors

28
The linkage approach targets investment in a key linkage as a start to overcome
coordination failure on generating positive feedbacks. Such a policy would select
industries with a large number of links with to other industries and the greater strength
of those links. In choosing among industries with several strong links and cost
benefits, one policy would generally select sectors that have a similar likely hood of
private sector investment, because that is where the most intransigent bottlenecks are
most likely to be found. If an investment is a profitable, it is more likely that an
entrepreneur will come along to fill the niche. This observation [provides a reason to
interpret with some caution studies that shows government enterprise to be less
efficient than private once. If government system actively enters vital but less
profitable industries because of their beneficial effects on development, it is
unreasonable to hold these enterprises to the same profit standards as those of private
sectors. This is certainly not to say that state owned enterprises are generally as
efficient as privately owned once. In fact, there is much evidence to the contrary.
Some one can however that a blanket of problems/ statements such as; has often been
made in publication from agencies such as the world bank, the government should be
in the business of production, even temporarily in any sector is sometimes
unreasonable in the light of linkage and other strategic complementarities that a
developing country needs to address.

Baro (1994) also says that an explanatory economic policy characterized by large
public investment, support of small agriculture units, and incentives for private
industrial investment played an important role in the early stage of growth. 7% GDP
growth in the first decade after independence along with the oil price shock, a lack of
domestic adequate saving and investment slowed the growth of the economy of
Nigeria. Various economic policies designed to promote industrial growth lead to
neglect of agriculture and consequent decline in farm price, farm production and farm
incomes.

Early.H.Fray also states that in a golden age of international investment the MNCs
will continue to be the main initiator of direct investment.

According to Agosin and Mayer [2000], FDI in non-extractive sectors in developing

countries tends to crowd domestic investment in rather than out.

29
On the other hand, there is no doubt that aid can stimulate growth, investment and job
creation. If it is used appropriately, flows of capital in the form aid can finance
resource gaps and results in higher level of investment and ultimately, increase
economic growth. Aid flow can potentially stimulate job creation through increased
investment (private and public) and accelerated economic growth. But to be
appropriate the aid flow must be allocated to public investment since it is
complementary with private investment for rapid economic growth [World Bank,
2001].

2.1.6 An important dilemma between capital and labor for rural development

This is a legacy inherited by the days of development economists from there

predecessors in the developed countries who considered capital to be the key
instrument of development. The Harod-Domar model represents a typical example of
this dogma. In this model , the rate of growth is expressed as the product of the saving
rate and the output-capital ratio under the assumption that capital and labor cannot
cannot be substituted for each other , and that labor is in surplus supply, capital
becomes the overriding constraint on economy growth. This dogma receives a further
flip from those techno economists who held that all new technology is embodied in
capital.

Capital fundamentalism has been accepted by development economists and planners

in the developing countries. This has led to the promulgation of a number of policies
in these countries, all aimed at increasing savings, redistributing income from the
workers to the capitalists. It also focuses on granting monopoly rights to national and
multinational corporations, transferring resources from the private to the public sector,
increasing dependency on foreign aid and loans and under pricing capital, particularly
foreign exchange for capital goods. This has resulted in a number of adverse effects
on the economies of these nations. For example, under pricing exchange from capital
goods has killed the incentive to develop labor intensive technologies adapted to
domestic needs and circumstances and has led to premature and excessive machinery
in a number of sectors resulting in unemployment of labor and under utilization of
domestic resources [Blomstram, Magnus, Robert E.Lipsey, and Mario zejan, 1996]

Capital fundamentalism has extended to cover human capital formation as well.

Higher education is highly subsidized in most developing countries , with the result
30
that millions of college and university graduates are add up annually to the pool of the
unemployed white collar preliterate[Griffin, Keith, 1973]

2.1.7 The investment climate and economic growth

The investment climate is the key to growth. It reflects the mainly location-specific
factors that shape the opportunities and incentives for firms or investors to invest
productively, to create jobs and to expand. A good investment climate is not just
about generating profit for firms- if that were the goal the focus could be limited to
minimizing costs and risk, rather it must improve outcomes for society as a whole. It
fosters productive private investment with the engine for growth and poverty
reduction through creating various opportunities and jobs for society. It expands the
Varity of goods and services available and reduces their cost to the benefit of
consumers. It supports a sustainable source of tax revenues to fund other important
social goals. In addition, many features of a good investment climate such as efficient
capital (infrastructures), courts, and financial markets improve the lives of people
weather they work or engage in entrepreneurial activities directly or indirectly. With a
rising population growth, economic growth is the only sustainable mechanism for
increasing a society’s standard of living. Economic growth is not just a result of
higher incomes but better indicators’ of human development. This intern is attended
through the establishment of proper and equitable distribution of investment activities
and other margins to the society as a whole.

Many factors shape the cost, risk and barriers to competition in a particular location,
which are the basic factors that influence investment. Among these factors some like
geography are difficult to influence. Government have more decisive impact over
many aspects of the investment climate such as the security of property rights ,
approach to taxation and regulation the adequacy of infrastructures and the
functioning of finance and labor market e.t.c.

31
Table2.1 Government policies and investment policies and investment decision-some
example

Factors that shape opportunities and incentives for firms to invest

Government has strong Government has less

influence influence
Costs Corruption Market determined price
Tax of inputs
Regulatory burdens ,red Distance to input and
tape output market
Infrastructure and finance Economies of scale and
cost technology
Labor market regulation
Risks Policy predictability and Consumers and
credibility competitors response
Right to property External shock
Contract enforcement Natural disaster
Expropriation Supplier reliability
Macro economic stability
Barriers to competition Regulatory barriers to Market size and distance to
entry and exit input and output market
Competition low and Economies of scale and
policy scope
Functioning financial
markets
infrastructures
Source: world development report, 2005

2.1.8 Capital inflow and African economic growth and development

The ultimate goal of increased capital flow is to enhance development. Among the
various channels through which capital flow affects economic performance, one
possible canal is through the linkage between deferent capital inflows foreign direct
investment and foreign aid .FDI can stimulate domestic investment activity through
upstream or downstream linkage. For instance, MNCs may sources raw materials
from domestic suppliers or it may out source particular activities to firms in the host
country. However, in many African countries the bulk of FDI has flowed in to the
natural resource sector, which has little linkage and therefore, the indirect effect of
FDI on domestic investment is likely to be marginal in such economies. It can also
have adverse effect on financial markets in the host country. MNCs borrowing in the
domestic financial market can push up interest rate which subsequently crowds out
borrowing by domestic companies. More over if the capital flow coming into the
country is are relatively large, this may lead to an appreciation of the exchange rate
32
and reduce export competitiveness and incentives for domestic investment [Befekadu
Degfe, 1998]

Further more the preferential treatment of foreign investors in terms of tax breaks,
cash grants, duty exemption and subsidies is another mechanism for crowding out
effect of FDI.

Nevertheless in most of the cases FDI has a higher potential for stimulating domestic
investment than other forms of capital inflow [Mody and Marsshid, 2005; Bosworth
and Collins, 1999]. According to Agosin and Mayer [2000], FDI in the extractive
sector in developing countries tends to crowd domestic investment ‘in’ rather than
‘out’. On the other hand, there is no doubt that aid can stimulate growth, investment
and job creation if it is used appropriately. Flows of capital in the form of capital aid
can finance resource gaps, and results in higher levels of investment and ultimately,
increase economic growth. However to be important aid flow must be allocated to the
public sector by the government since it is complimentary with the private sector so as
to achieve rapid economic growth[Danial Assefa, 2004].

According to David Andrews, Lodewyk Erasmus, and Robert Powell [2005], donor
countries have targeted Ethiopia for extra assistance because of its size and potential
for growth. Symbolically, the United Nations has selected Koraro in Ethiopia as one
of its test villages, singled out by economist Jeffrey Sachs in an experiment to monitor
the scaling up of aid at the local level. On current trends, Ethiopia will not meet any
of its UN Millennium Development Goals (MDGs) except for the target on primary
school enrollment. Considerably faster economic growth, supported by a strong policy
package and higher inflows of net official development assistance (ODA) are
therefore needed. After all, there is still considerable controversy surrounding the
record of aid in many countries. Against this background, and in view of the possible
lessons for other African countries, we undertook a study to assess the potential
macroeconomic implications of scaling up assistance to achieve the MDGs. We
looked at the potential impact of higher aid flows on the tradable goods sector and
reviewed priorities for improving fiscal management and financial sector
development. Our findings suggest that Ethiopia faces enormous challenges in
boosting growth and meeting the MDGs, even with far higher levels of aid—in part
because of the need to ensure that this aid is absorbed and used effectively.

33
As their analysis indicates IMF as part of its regular consultations with Ethiopia, it
developed a preliminary framework to assess the potential macroeconomic
implications of scaling up assistance. Their analysis was built around the IMF’s
financial programming framework, supplemented by a growth accounting analysis to
assess the feasibility of a pickup in growth to halve income poverty by 2015, and a
medium-term expenditure framework (MTEF) to assess trends in public recurrent and
capital expenditure needed to reach other MDGs. The growth accounting framework
models real GDP growth as a function of the weighted rates of growth in the capital
stock and human capital, and a residual contribution that is interpreted as the growth
in total factor productivity. These elements were combined with additional analysis
and judgments informed by recent experience to arrive at an overall assessment of the
macroeconomic implications of scaling up external assistance. The scaling-up
scenario is conditioned on both a sustained increase in the flow of external aid over
the medium term and implementation of accompanying economic policies that would
allow the assumed aid flows to be effectively used and absorbed without destabilizing
the economy[Ibid].

2.2 Empirical Review of Literature

Ethiopia, among the poorest countries in Africa, presents one of the biggest
development challenges in a region beset by frequent drought and food shortages and
hobbled by inadequate roads and communications. A landlocked country of about 70
million people, sandwiched between Sudan and Somalia in the Horn of Africa,
Ethiopia has suffered bloody upheavals and famine over the past two decades and is
still recovering from a bitter border war with neighboring Eritrea. It ranks in the
bottom 10 of the UN’s Human Development Index, a composite measure of per capita
income, health, and education (in 2004, it was listed as 170th out of 177) [Brihanu
Nega and Seid Nur, 2004].

Until recently, Ethiopia is one of the poorest nations in the world. In terms of per
capita income, the country ranks 210[world development report, 1999; p.274] when
purchasing power parity (ppp) is used to measure per capital income, Ethiopia is
ranking to 208(Ethiopian public expenditure review, 1997). An agrarian economy
characterized by labor-intensive production, and low productivity is prevalent in the

34
country. More than 65 millions of people eke out there living in this sector. The sector
accounts 50%of the GDP and about 90% of the export earning. More than 50% of the
people live under poverty line [Quarterly Report on the Macroeconomic Performance
of the Ethiopian Economy, 2005].

The reason for this level of poverty line is something like low productivity. Low
productivity is the result of many factors in Ethiopia. It includes low real wage, poor
health, poor energy level, scarcity of capital (such as machinery, and financial capital)
inadequate accessibility to education and so on. Low productivity also leads to low
level of income earning and, and low rate of savings which intern results to low level
of investment. Investment is an increase in the national stock. With more capital,
workers produce more up to a point. The countries gross domestic product is prone to
vicissitudes for many years. For instance the annual average percentage growth of
GDP was2.6 in 1990, 2.7 in 2002 and. However, it was 4.2 for the year 2005.the gross
capital formation to GDP was 12, 21, 20 and 26% respectively for the period s under
review [Annual report on the Ethiopian economy, 2007]

The country is now showing an increase in its economy. Empirical findings by

Thirwall, Pensmazogu and Madison have come up with a result that 30% to50%of the
growth of more than 20 countries is the share of capital formation in 1970s [Thirwall,
1974: 6]. This indicates that there is no doubt that the rise in GCF is the case for
economic growth of these days [United Nations Human Development Report (2005)].

i. Economic growth performance of the country

In terms of macro-economic performance, the Ethiopian economy recorded an

average growth of 4.5 percent, in real terms, during the period FY00 to FY04.
Between FY04 and FY05 the economy registered an average growth of about 10
percent in real terms ranging from 11.6 percent in FY04 to about 8.9 percent in FY05.
In spite of significant improvements in economic performance over recent years, the
country remains amongst the poorest countries in the world. According to the United
Nations Human Development Report (2005) Ethiopia, ranked 170th out of 177
countries and is at the bottom in terms nearly of all economic and social indicators
including life expectancy (42 years and declining due to the prevalence of HIV/AIDS
pandemic), adult literacy (about 40 percent), etc. Ethiopia has continued as

35
backwardness and poverty remains a concern to the Government. In order to face the
challenges of backwardness and poverty, the Government adopted a long-term
development strategy in the 1990s supported by sector-specific policies and strategies,
and more recently, a medium-term program aimed at sustainable development and
poverty eradication[ICT-policy, et.al].

Reforms aimed at transforming Ethiopia from a centrally planned economy to a

market-oriented one were launched in 1991 after the overthrow of the former pro-
Soviet Derg regime, boosting the overall GDP growth rate to an annual 4.0 percent in
1991–2003 from 2.8 percent during the Derg rule (1974–91). The structure of the
economy also changed, with the contribution of agriculture to real GDP falling from
57 percent in 1991 to 42 percent in 2003, while that of services rose from 34 percent
to 47 percent. However, the contributions of industry and the private services sector
remained essentially unchanged, and Ethiopia’s growth potential remained largely
untapped [David Andrews, Lodewyk Erasmus, and Robert Powell, sep.2005].

The over all performance of the macro economy, as measured by the GDP growth
was more than satisfactory for many years. More specifically, according to revised
national data, GDP growth nowadays more significantly. The GDP growth for the
previous three years was about 10.28%. This shows that the countries economic
growth is now improving. The following table shows real GDP growth trend.

Table 2.2growth rate in real GDP

Period Real GDP growth

1960/61_2004/05 2.7

1960/61_73/74 3.7

1974/75_90/91 2

1991/92_2004/05 4.7

1997/98_2004/05 4.5

1997/98_2006/07 5.65

2002/03-2004/05 5.5

2001/02 1.6

2002/03 -3.9
36
2003/04 11.6

2004/05 10.59

2005/06 9.51

2006/07 10.37

EEA database
ii. Saving and investment in the country

Gross domestic saving as a ratio of GDP has been very low in Ethiopia both from a
historical perspective and relative to similar economies. The average gross domestic
saving to GDP over the last fifteen years has been 4.1%and the average of the last
three years has been about 2.66%. This is due to the subsistence nature of the
economy in which total consumption constitutes a significant share of GDP. For
instance, during the above period total consumption averaged 96%, exhausting almost
the entire GDP and leaving very little or a small fraction for capital formation or
future economic growth. This low domestic saving further reflected by the presence
of negative resource gap in the country. The gap between investment and saving
results in dependency of the economy on foreign resource (capital inflow) to fill the
gap [Dawit Shegu, 2005].

The following table shows the gap between investment and saving, which results in
dependency of the economy on foreign resource. It clearly shows the inadequacy of
domestic source in financing investment activities and the degree of dependency of
the economy on foreign resources.

Table 2.3 GDS, GFCF, and resource gap as share of GDP

Year GDS GCF Resource Share of

gap GFCF

1993/94 5.03 15.16 -10.1 66.6

1994/95 7.43 16.14 -9.01 54.8

1995/96 6.99 16.88 -9.89 58.6

1996/97 7.71 17 -9.29 54.6

1997/98 7.73 17.15 -9.42 54.9

37
1998/99 2.14 16.94 -14.8 87.4

1999/00 0.9 15.85 -15 94.6

2000/01 2.65 17.79 -15.2 85.4

2001/02 1.8 20.4 -18.6 91.2

2002/03 2.3 20.5 -18.2 88.8

2003/04 2.8 22.6 -19.8 87.6

2004/05 2.6 20.5 -18.4 87.4

2005/06 NA NA NA NA

2006/07 NA NA NA NA

Av(1993/94_2006/07 NA NA NA NA

Source: MoFED, NBA staff compilation

iii. The investment link to growth

As the theoretical review part of the investigation shows, the Harrod-Domar growth
model can be used to predict the role of foreign inflow on growth. According to this
model, if Ethiopia desires an ambitious growth rate of 10% the required level of
investment is 35% of the out put given the equation g=I/k assume k~3 which is
constant [Annual Report on the Ethiopian Economy, 2006]]

A considerable amount of work has been done on the determinants of investment in

general and particularly private investment. In the context of countries in the
developing world the relationship between private and public investment (in terms of
‘crowding in’ and ‘crowding out’) has been a major focus of analysis. Beyond the
relationship between private and public investment, the concern for private
investment has been in terms of its impact on growth. Among the authors who have
contributed to investment analysis in Africa are Oshikoya (1994), Mlambo and
Oshikoya (1999), Devarajan et al. (1999), Mataya and Veeman (1996), Khan and
Reinhart (1990), and Gunning and Mengistae (1999) [quoted from Harry A. Sackey,
et.al, 2006].

Writing on the macroeconomic determinants of domestic private investment in Africa,

Oshikoya (1994) found a positive relationship between public investment and private
investment. The study spanned 1970 to 1988 and covered seven African countries,
38
namely, Cameroon, Mauritius, Morocco, Tunisia, Kenya, Malawi and Tanzania.
Though public investment ratios had fallen in some of the countries, particularly in
Mauritius and Morocco, a strong positive impact of public investment on private
investment was observed. The results suggested that: “the productivity of these types
of investment may be as important as their magnitude in influencing private
investment” (Oshikoya, 1994, p. 589). Along the same theme, Mlambo and Oshikoya
(1999) using a sample of 18 African countries for the period 1970 to 1996 found that
fiscal, financial and monetary policy, macroeconomic uncertainty and trade variables
were significant determinants of private investment in Africa. The study also found
political stability to be a major factor in the determination of private investment rates
on the continent [Harry A. Sackey, et.al, 2006].
The results from the trend analysis of Harry A. Sackey show that private investment
rates have increased modestly in recent times. At the same time per capita income
growth has moved from negative to positive. The empirical growth and structural
transformation models suggest private investment exerts a positive and statistically
significance impact on per capita income growth, and the industry-to-agricultural
output ratio.

Chapter 3
FINDING AND DISCUSSION
39
This part of the paper thoroughly investigates what has happened to the country’s
sectoral and regional investment scene on the period between 1985 and 2007 based on
the basic models specified earlier and based on thoughtful descriptive analysis of the
sectoral and investment data in the country. The first part of this chapter examines the
relationship between private and public investment in the country. Weather public
investment is crowding ‘out’ or ‘in’ private investment in the country will be assed
here. The second part of the chapter investigates sectoral and regional scene of the
investment activity with brief descriptive analysis in the country. The final part clearly shows
the tests of the hypotheses estimated in the beginning.

3.1 Relationship between gross private and gross public investment

3.1.1Trened analysis

There have been controversies over the issue that that public investment has
controversies over the relationship between public and private investment. In some
countries increased public investment discourages private investment, where as in
other countries more investment in the public sector kills private sectors incentive for
increased investment. This is because of the divergence in the motives for production.
Public sector investment is always concerned with welfare maximization of the
society, where as private sector investors ultimate objective is to earn profit.

The relationship between gross private investment and gross public investment has
been positive in the country. As a share of GDP, gross private investment always
outweighs gross public investment.

Figure 3.1 Trends in gross private (gpri) and gross public investment (gppi)

40
 20

15
gppi & gpri

gpri
10
gpbi
5

0
87 9 89 9 91 9 93 9 95 9 97 9 99 0 01 0 03 0 05 0 07
19 1 1 1 1 1 1 2 2 2 2
year

It is an accepted truism that investment in the private and public sectors of an

economy to go hand in hand so that a better economic wellbeing to occur in the
country. As the figure above shows, even if there is insignificancy in amount, there
has been almost similar trend of growth for the period under reviewed. The dispersion
between the two are always in consistence with some government policies ,such as
privatization , taxation and changes in the rate of lending and other factors which will
affect the private investors return from investment. There for to keep the relationship
between the two in harmony, the government should invest more in selected social
over headings like infrastructures to boost the economic growth of the country.

3.1.2 Dose private investment crowds ‘out’ or ‘in’ public investment?

The relationship between public and private investment can be best explained by the
crowding ‘out’ or ‘in’ model specified in the first chapter. The initial equation of the
model,

Ipr=βo+β1Ipp+ε
is not an appropriate estimation model. The R-squared value and F-statistic shows the
problem of the overall fitness of the model. Durbin-Watson stat also shows the
probability of having the problem of serial correlation (table AP1, APPENDEX). The
introduction of the two variables, M and r, improves the overall fitness of the model.
But the presence of high R-squared and insignificant Durbin-Watson stat shows the
presence of the problem of serial correlation (autocorrelation) (table AP2). Moreover,
the Breusch-Godfrey Serial Correlation LM Test with low level of probability

41
ascertains the existence of the problem (table AP3). But the comparison between the
two makes introducing AR(1) error specification term in the model more appropriate
(compare table AP4 and AP5). The model with high adjusted R-square, and high level
of   Akaike info criterion and Schwarz criterion is the best mode [Eviews user’s
guide].

Therefore introducing the lagged value of the explanatory variables or AR(1) error
specification term in the model makes the estimation of the model correct.

The estimated model becomes:

Ipr = C(1)* Ipp + C(2)*r + C(3)*M + C(4) + [AR(1) =C(5)]

Or from the previous model specified,

Ipr =βo+β1Ipp+β2M+β3r +et

et =r et-1+mt

Then Substituted Coefficients becomes:

Ipr = -8.240164737+1.660794714*Ipp + 0.2032666715*r +

4.128066609*M + [AR(1)=0.6072938326]

The Breusch-Godfrey Serial Correlation LM Test for serial correlation labeled by

Obs*R-squared against the null hypothesis, there is no autocorrelation, indicated by

high probability value of (0.7438) shows the less likelyhood of the problem of
autocorrelation table (table AP6).

The interpretation of the model is therefore based on the estimated coefficients of the
model with error specification term.

Table 3.1
Dependent Variable: GPRI
42
 Variable Coefficient Std. Error t-Statistic Prob.  

Ipp 1.660795 0.300782 5.521586 0.0001

r 0.203267 0.192530 1.055768 0.3078
M 4.128067 0.472831 8.730525 0.0000
C -8.240165 3.279503 -2.512626 0.0239
AR(1) 0.607294 0.313746 1.935625 0.0720

Durbin-Watson stat 1.919453

R-squared 0.850063
Adjusted R-squared 0.810080

The table above shows that two of the coefficients of the explanatory variables, Ipp
and M are significant at significant level of 5% given the AR(1) error specification
term in the model where as ‘r’ is insignificant. But the concern of the investigation
here is that to assess whether there exist a crowding ‘out’ or ‘in’ effect between the
private and public investment. The estimation of the model shows that a unit increase
in public investment as percentage of GDP will rise private investment as percentage
of GDP by 1.661. The implication is that public investment has a crowding ‘in’ effect
on private investment. There is a positive relationship between the two. The increase
in public sector investment encourages and stimulates more private investment in the
country. The goodness of fit test of the model is shown by the Adjusted R-squared
which is equal to 0.810080. It is a satisfactory model since 81% of the given variables
are responsible for explaining the dependent variable.

Moreover, the import capacity of the country also has a significant impact on the level
of private investment in the country. This is due the fact that more of the private
investment in the country is on the secondary sector economic activity which requires
a large amount of foreign inputs for operation. As it will be seen in the next
descriptive analysis of the countries investment scene, the greater proportion of the
amount of investment income is allocated for the secondary economic sector
investment activities. The investment activate in this sector is always capital intensive
requiring an immense import of foreign capital; and hence the greater the crowding
‘in’ effect of import on private investment in the country.

There is also a positive link between private investment and interest rate in the country. Based
on the rules of international flow of investment foreigners invest there assets in areas where

43
there is high level of interest rate than where there is low interest rate so as to earn the gain
from interest deferential. According to the above estimation, interest rate has no that much
significant impact on private investment activity.

3.2 Sectoral and regional scene of the investment activity in the country

3.2.1Analysis of the total investment scene

Total investment in this context includes domestic investment (private and public),
and foreign investment (which might be wholly foreign or joint with domestic) based
on type of ownership. On the other hand, it could be also categorized as primary
sector investment, secondary sector investment and tertiary sector investment based
on the where about the investment activity is conducted in the economy.

In Ethiopia the primary sector investment sector incorporates those investment

activities in food crops farming, cash crops farming, mixed food and cash crops
farming, livestock farming, integrated crops and livestock farming ,agricultural
service, forestry, fishing, mining and quarrying.

The secondary sector investment sector includes investment in the manufacturing

process. These are investment in food products, beverages, and textiles except
garment, garment and related articles, tanneries, footwear, wood products except
furniture. It also includes Paper: paper products and printing, chemical products,
pharmaceutical products, plastic/rubber products except footwear, non-metallic
mineral products, metal products including machinery & equipment, electrical
machinery and apparatus, Radio TV and communication equipments motor vehicles
and other transport equipments, furniture and other manufacturing activities.

Tertiary sector investment includes investment activities in electricity generation,

construction, construction machinery leasing, real estate development, distributive
trade & maintenance service, hotel and tourism, transport and storage service,
education service, health service and other businesses.

Based on the above consideration, this part of the investigation tries to analyze the
sectoral, regional, and ownership analysis of investment in terms of amount of capital
investment (capital intensity), number of investment projects and amount of
employment creation in the country.

3.2.1.1 Sectoral and ownership share of total investment projects

44
Total investment broadly consists of, domestic investment, foreign investment and
public investment based on the owners who run the investment activity. Table 3.2
shows that domestic investors own 98.58% of the country’s domestic projects, where
as foreign investors own 4.23% wholly and 2.54%jointly with domestic investors and
the government, that is, public investment has a share of 0.65%. this is clearly shown
by the table and the figure drown below.

Figure 3.2 sectoral share of investment based on ownership

60

50
primary sector% from
percentage share

40 total
secondary sector%
30
from total
20 tertiarysector % from
total
10

0
domestic wholly joint with public
foreign domestic
ownership

The domestic and public type of investment mainly focuses on the tertiary sector
investment which is the investment activities in social infrastructures. On the other
hands, particularly, joint ones own the largest share of secondary sector investment
activities (52.67% of the total projects in the respective category). Surprisingly wholly
foreign investors own the largest share of primary sector investment projects
(17.85%of there total) more than any other investors.

Table 3.2 Number of Investment projects by type of investment and sectors

    Type of investment    
    Foreign      

45
 joint
wholly
sectors domestic with public total
foreign
domestic
Primary
Sector 1,618 78 36 2 1,734
% from total 16.94 17.85 13.74 2.99 16.80
Secondary
Sector 3,759 170 138 28 4,095
% from total 39.35 38.90 52.67 41.79 39.68
Tertiary
Sector 4,176 189 88 37 4,490
% from total 43.71 43.25 33.59 55.22 43.51
Grand Total 9,553 437 262 67 10,319
% from
total 92.58 4.23 2.54 0.65 100.00
Source: Ethiopian Investment Commission; compiled by EEA

The implication is that there seems to be a more emphasis towards the secondary and
tertiary sector investment in the form of all type of investors. There is a lack of
consideration towards the primary sector, which is the engine of growth for a
developing country like Ethiopia. The table also shows that only the share of the
private sector is satisfactory. The share of the government as well as the foreigners is
very small in terms of investment projects. This is clearly shown by the following
Figure.

Figure 3.3 percentage share of investment by ownership

100
90
80
70 domestic
60
% from total

wholly foreign
50
joint with domestic
40
30 public
20
10
0
% from total

sectors

3.2.1.2 Sectoral contribution of total investment for job creation

46
During the period under review, there were about 550,385 permanent and 775,169
temporary employment creation opportunities from totally licensed projects. But from
this a number of projects which could have 131,028 temporary and 29,862 permanent
employment creation opportunities are canceled. Because of the investment 520,523
permanent and 644,141 temporary employments has been created from net licensed
investment projects.

The Sectoral analysis form net licensed projects to employment creation shows that
the primary sector has taken more than half the total(51.67%) followed by the
tertiary(25.72%) and the secondary(22.62%) sectors which have more or less similar
shares as shown in the following figure.

Figure 3.4 sectoral share of investment to employment creation

25.72
primary sector % from
total
secondary sector %
51.67 from total
tertiary sector % from
total
22.62

The cancellation of investment projects greatly affects employment in the primary

sector. From the total loss of employment due to cancellation of projects, the primary
sector constitutes 56.66%permannt and 99.28%temporary employment loss.

In terms of permanent job creation the tertiary sector have a share of 41.29%;
followed by secondary sector (38.94%) and primary sector, which have a share of
19.77% from net licensed projects.

Table 3.3 Total investment projects by sectors and employment creation (1996_20)

Total Total
sectors licensed   Canceled   Net licensed Employment %
  Employment Creation Employment Creation Employment Creation from total net
47
 Perm. Temp. Perm. Temp. Perm. Temp.

Primary 119,83 628,89 498,8 5

Sector 2 7 16,920 130,084 102,912 13 1.67
21.7 77.4
% from total 7 81.13 56.66 99.28 19.77 4  
Secondary 209,04 61,27 60,7 2
Sector 1 8 6,344 569 202,697 09 2.62
37.9 9.4
% from total 8 7.91 21.24 0.43 38.94 2 -
Tertiary 221,51 84,99 84,6 2
Sector 2 4 6,598 375 214,914 19 5.72

% from total 40.25 10.96 22.09 0.29 41.29 13.14 -

550,38 775,16 644,1
Grand Total 5 9 29,862 131,028 520,523 41 100
Source: Ethiopian Investment Commission; compiled by EEA

The implication is that a greater investment in the primary sector leads to more
temporary employment creation, where as more investment in the tertiary and
secondary sector of the economy leads to greater creation in permanent employment
(as it is seen from their own share). However, the larger proportion of total
employment creation is accounted for the primary sector. In short, the primary sector
is the dominant sector in terms of employment creation, though the largest proportion
of it is temporary one. The following figure clarifies this situation clearly.

Figure 3.5 share of net licensed investment to employment by sectors

90
77.44
80
70
60
50 41.29 permanent employment
38.94
40 temporary employment
30 19.77
20 13.14
9.42
10
0
primary sector secondary tertiary sector
% from total sector % from % from total
total

This analysis, in one or another way, indicates the importance of giving considerable
emphasis for the primary sector for the creation of and boosting up of domestic
employment.

48
3.2.1.3 Sectoral and capital share of investment projects

The following table shows the Sectoral distribution of net licensed investment
activities in terms of number of projects and investment capital. From 10,319 projects
43.51%is in the tertiary sector, 39.68% is in the secondary sector and 16.80% is in the
primary sector. In the same sequence, investment capital is 56.61%, 32.93% and
10.46% in the three sectors of the economy.

Table 3.4 Net licensed investment project by sector, number and investment capital
(investment in million birr)

Inv.cap/projec % from total net

Net licensed
t licensed
Investment
No of Investmen No of
sectors capital
Projects t capital Projects
Primary 11,559.1 6.66 10.4
Sector 1734 2 16.80 6
% from 16.8
total 0 10.46    
Secondary 36,408.9 8.90 32.9
Sector 4095 2 39.68 3
% from 39.6
total 8 32.93 - -
Tertiary 62,582.3 13.94 56.6
Sector 4490 0 43.51 1
% from 43.5
total 1 56.61 - -
Grand 110,550.3 10
Total 10319 5 100 0
Source: Ethiopian Investment Commission; compiled by EEA

Unlike level of employment creation the primary sector has the least share in terms of
number of capital projects and investment capital allocated in the country under the
period reviewed. The following figure illustrates this situation.

Figure 3.6 numbers of projects and capital allocation by sector.

49
 60

50
Primary sector% from
40 Total
Secondary sector %
30
From total
20 Tertiary sector % from
Total
10

0
No of Projects Investment capital

This is partially because of the fact that the secondary and tertiary sector needs a
greater amount of investment capital than employees or labor in the operation of
there activity. However, the primary sector investment activities need less of capital
and more of employees. It is a labor intensive activity. The investment capital per
project column reveals the situation clearly. The primary sector has lesser investment
capital per project (6.66) than the secondary (8.90%) and tertiary sectors (13.94%).

This indicates that primary sector projects in the country require lesser amount of
capital per project than the other two sectors. The primary sectors need of less amount
of capital per project on the one hand, and its contribution for high employment
creation on the other hand makes investment in this sector more crucial for under
developed country like Ethiopia, which has immense labor and scarce capital
resource.

3.2.1.4 Employment creation by type and sectors of investment

Employment generation is one of the significant contributions of investment activities

for economic growth. To this end, the domestic investors takes a paramount share of
the total permanent (81.63%) and temporary (91.81%) employment creation for the
period under review, then followed by foreign and public investors respectively. The
public sector here has the least share, that is, 1.38%of permanent and 0.40% of the
total employment creation. This happens because there is a small share of investment
projects in this category as shown in the following figure. The first bar represents
temporary employment share from total where as the second bar represents permanent
employment share from total in each type of investment.

50
Figure 3.7employment creation by type of investment

employment

100 91.81
90 81.63
80
70
60
50 employment
40
30
20 12
5.56 4.99 2.24
10 1.38 0.4
0
Employment

Employment

Employment

Employment
Creation

Creation
Creation

Creation

domestic wholly joint with public

foreign domestic

Sectoraly, still the largest share of temporary job creation comes from the primary
sector (77.44%) followed by the tertiary and secondary sector (13.14% and 9.42%
respectively. However, the largest share of permanent job creation share comes from
the service sector (41.29%), followed by the tertiary and primary sector investment
(38.94%and (19.77%) respectively as shown below in the figure.

Figure 3.8 sectoral employment share

120
100
80
% share

temporary employment
60
permanent employment
40
20
0
secondary
from total

from total
sector %

sector %
from total
primary

tertiary
sector%

sectors

Foreign owned investment projects (wholly owned) have a larger share of permanent
and temporary job creation in the primary sector (49.6% and 64.14%from their own

51
 share). Unlikely to this; the public sector contributes 49.25% and 55.25% of
temporary and permanent employment from its own total share in the tertiary sector.

In short, the table illustrates that Permanent employment always take the largest share
of employment in the secondary and tertiary sector where there is stability in
production process. However, the seasonality nature of the primary sector economic
activates makes temporary employment higher in this sector. The prevalence of such a
situation in this sector necessitates the importance of using improved technological
inputs to overcome seasonality in production and make employment stable

Table 3.5 Investment projects employment creation by type of investment and sectors

    type of investment            
  foreign            
joint with
Sector domestic   wholly foreign domestic public   total  
Employment Employment Employment Employment Employment
Creation Creation Creation Creation Creation
Perm. Temp. Perm. Temp. Perm. Temp. Perm. Temp. Perm. Temp.
Primary
Sector 68,267 468,818 29,320 22,983 4,425 5,994 900 1,018 102,912 498,813
% from
total 16.07 79.28 46.96 64.14 17.03 41.62 12.50 39.98 19.77 77.44
Secondary
Sector 169,145 51,808 15,776 5,412 15,450 3,215 2,326 274 202,697 60,709
% from
total 39.81 8.76 25.27 15.10 59.47 22.32 32.30 10.76 38.94 9.42
Tertiary
Sector 187,491 70,735 17,345 7,436 6,103 5,194 3,975 1,254 214,914 84,619
% from
total 44.13 11.96 27.78 20.75 23.49 36.06 55.20 49.25 41.29 13.14
Grand
Total 424,903 591,361 62,441 35,831 25,978 14,403 7,201 2,546 520,523 644,141
% from
total 81.63 91.81 12.00 5.56 4.99 2.24 1.38 0.40 100.00 100.00
Source: Ethiopian Investment Commission; compiled by EEA

3.2.2 The analysis of the domestic investment scene

3.2.2.1 Regional distribution of amount of investment capital

52
The following table shows the sectoral distribution of domestic investment projects
among regions in terms of investment capital. As the table indicates in the ‘% share
from total investment’ column, over half of the projects capital is concentrated in the
capital Addis Ababa(57.5%).Oromia and Amhara takes the second third lead with a
share of 14.87% and 4.94%respeeectively. The rest of the regions constitute nearly
23%, which have insignificant share separately. For example, Gambela regional state
has a share of 0.04% from total investment, which is the least.

Table 3.6 Amount of capital of domestic investment projects by sector and regional states
(in.mill.Br)

    Sectors      
   
  % share from rank of as
  Primary Secondary Tertiary Total total share of
Region         investment investment

530.1
Tigray 5 2,966.80 1,875.34
5,372.29 7.47 3
Afar 940.38 36.55 365.41
1,352.05 1.88 7
Amhara 478.8 1,111.34 1,958.99
3,550.13 4.94 5
Oromia 2,736.33 4,439.94 3,510.10
10,685.39 14.87 2
SNNP 850.66 1,173.55 2,359.27
4,273.49 5.95 4
Benishangule 694.85 40.56 15.47 750.88 1.04 8
Gambela 25.25 2.42 0.37 28.04 0.04 12
Dari dawa 107.84 2,104.33 794.01
3,006.18 4.18 6
Addis Ababa 669.66 13,599.01 27,162.01
41,330.68 57.5 1
Harari 29.72 203.2 300.29 533.2 0.74 10
Somali 162.33 288 172.85 623.18 0.87 9
Multi-regional 0 366.77 8.17 374.93 0.52 11
71,88
Total 7,234.99 26,222.16 38,423.28 0 100  
Source: Ethiopian Investment Commission; compiled by EEA

In short, the above table and the following table show the existence of great disparity
for capital invested by residents among regions.

Figure 3.9 regional share of domestic investment capital

53
 70 Tigray
Afar
60
Amhara
50 Oromia
SNNP
40
Benishangule
30 Gambela
20 Dari dawa
Addis Ababa
10
Harari
0 Somali
Region Multi-regional

This might be because of the existence of some unique features which makes
investment to be favorable in on region and less profitable in the other. For instance,
Oromia regional state could have such a great deal of investment share because of
greater enrichments with extensive and fertile land for agricultural projects as well as
presence of factor inputs for the operation of the secondary sector investment projects.
In one or another way the table shows the existence of regional imbalance in the share
of domestic capital investment.

3.2.2.2 Regional distribution of number of domestic investment projects

The proper distribution and implementation of an equitable investment projects is a

vital instrument for boosting under developed economy like Ethiopia. The following
table reveals the distribution of number of investment projects among regions.

From a total of 9553 projects in the country, capital city Addis took the largest
proportion (53%), followed by Oromia region and SNNPR with a total share of 16
and 10. The rest of the regions constitute the remaining share. This shows that there
is a prevalence of regional imbalance in the regional distribution of investment
projects.

Table3.7 Number of regional domestic investment by sector

54
  Sector          
Regional state primary secondary tertiary total % from total rank
Tigray 271 170 112 563 5 5
Afar 106 6 14 126 1 8
Amhara 144 167 161 572 6 4
Oromia 578 635 297 1510 16 2
Benishangule 59 15 5 67 1 9
Somali 13 3 31 59 1 10
SNNPR 201 503 246 950 10 3
Gambela 8 3 1 12 0 11
Harari 23 86 141 250 3 7
Addis Ababa 150 205 2835 5036 53 1
Dire Dawa 65 118 222 405 4 6
Multi-Regional 0 2 1 3 0 12
Grand total 1618 3759 4176 9553
% from total 16.94 39.34 43.72 100 100  
Source: Ethiopian Investment Commission; compiled by EEA

3.2.3The analysis of foreign investment scene in the country

3.2.3.1 Regional distribution of amount of investment capital

The following table shows the sectoral distribution of foreign investment projects
among regions in terms of investment capital in millions of birr. The table clearly
shows the percentage share of total foreign investment in terms of capital invested.
Accordingly, Addis Ababa takes the lion’s share (47.22%) followed by Oromia
(28.56%) as is in the case of domestic investment. Multi-Regional investment activity
and SNNPR takes 7.61%, 5.05% respectively next to Addis and Oromia region. The
remaining seven regions constitute a share of 11.07%, which is insignificant as
compared to the above regions.

Figure 3.10 regional share of foreign investment capital

% share

60 47.72
50
40 28.56
30 % share
20
1.36 3.49 3.72 5.05 7.61
10 1.04 0.11 1.27 0.08
0
i i l
ay r ra ia al la a ba ar P
R
na
gr Af
a
ha ro
m m be a w ba ar N io
Ti Am O So am d A H SN
re
g
G ire s ti-
D d di ul
A M

55
Despite there exist favorable or unfavorable factors which makes a region to be
unique for foreign investment, the table below shows the existence of imbalances in
share of foreign investment among regions. By the same or any other additional
reasons of the disparity in regional capital allocation on investment projects, here is
also an imbalance in the regional distribution of number of investment projects.

Table3.8 Amount of capital of foreign investment projects by sector and regional states (in
millions of birr, 1994-2006)

      Sectors      
  Primary Secondary Tertiary Total    
% from total rank in
Regional states         investment. investment share
Tigray 6.18 270.20 40.91 317.29 1.36 7
Afar 775.01 42.39 0 817.40 3.49 6
Amhara 274.6 502.19 94.97 871.77 3.72 5
Oromia 2,507.57 1,951.93 2,226.87 6,686.37 28.56 2
Somali 0 242.40 0.00 242.40 1.04 9
Gambela 24.9 0 0 24.9 0.11 10
Dire dawa 3.9 257.15 35.67 296.71 1.27 8
Addis Ababa 456.05 4,461.52 6,255.61 11,173.18 47.72 1
Harari 0 0 18.45 18.45 0.08 11
SNNPR 132.94 625.93 424.7 1183.57 5.05 4
Multi-regional 136.7 32.24 1613.07 1782.01 7.61 3
Total 4,317.87 8,385.94 10,710.24 23,414 100  
Source: Ethiopian Investment Commission; compiled
by EEA3.2.3.2 Foreign investments projects ownership

As stated in the second chapter of the paper, foreign investment projects are two in
terms of ownership, namely ‘wholly foreign’ owned and joint ownership with
domestic residents. As clearly shown in the table, 62.52% of the projects are ‘wholly
foreign’ and the remaining 37.48% are jointly owned with domestic investment
projects, which have an investment capital share of 70% and 30% respectively.
Wholly foreign owned investment projects are more capital intensive than the joint
sector. It is about 37.5 and 26.82 million birr per project on average respectively.

Table 3.9 Foreign investment projects by type of ownership (in millions of birr, 1994-
2007)

type of no, of %from total investment % from investment per

ownership projects capital total project
wholly foreign 437 62.52 16386.22 70 37.5
joint with 37.48 30
domestic 262 7027.83 26.82
Total 699 100 23414.05 100 33.5
Source: Ethiopian Investment Commission; compiled by EEA

56
 3.2.3.3 Regional distribution of number of foreign investment projects

The following figure indicates the regional imbalance of the number of investment
projects among regional states in the country. From the 699 investment projects in the
country, Addis Ababa’s share is 437 projects, which is 62.52% from the total.

Figure 3.11 regional distributions of foreign investment projects

70 62.52
60
50
% SHARE

40
26.32 % from total
30
20
10 1.29 0.85 3 0.14 3 0.14 0.14 1.43 1.14
0
y r a a
ra Afa har mi ma
li
P R e la rar i b a wa nal
g N mb Ha a a io
Ti ro So Ab e D eg
Am O SN Ga s r R
di Di lti-
Ad M
u

REGIONS

Oromia regional state has a share of 26.32% with 184 projects. The remaining states
constitute 11.16%of the total share, which is insignificant separately.

The table below also indicates that great deal of investment projects are in the
secondary sector and the tertiary sector, that is, 308 and 277 projects respectively. The
primary sector, which is the engine of the economy, has a little share of investment
projects. However, Oromia, SNNPR and Afar regional states have a large share of
investment projects in the primary sector. On contrary to this, Addis Ababa and other
remaining regional states investment projects share is greater in the secondary sector

Table 3.10 Regional distribution of foreign investment on each sector

Primar % from
Region y Secondary Tertiary Total total rank

Tigray 2 5 2 9 1.29 6

Afar 5 1 0 6 0.85 8

Amhara 4 13 4 21 3 3
Oromia 78 23 184 26.32 2

57
 83
Somali   1   1 0.14 9

SNNPR 8 7 6 21 3 3

Gambela 1     1 0.14 9
Harari     1 1 0.14 9
Addis
Ababa 8 196 233 437 62.52 1

Dire Dawa 1 5 4 10 1.43 5

Multi-
Regional 2 2 4 8 1.14 7
1
Grand total 14 308 277 699 100  
Source: Ethiopian Investment Commission; compiled by EEA

The table also indicates that great deal of investment projects are in the secondary
sector and the tertiary sector, that is, 308 and 277 projects respectively. The primary
sector, which is the engine of the economy, has a little share of investment projects.
However, Oromia, SNNPR and Afar regional states have a large share of investment
projects in the primary sector. On contrary to this, Addis Ababa and other remaining
regional states investment projects share is greater in the secondary sector.

The table in short indicates the regional and sectoral imbalances in the distribution of
number of investment projects.

3.2.3.4Employment creation and foreign investment

The table below shows the sectoral share of foreign investment projects in the
creation of domestic permanent and temporary employment creation. These projects
have created 88,419 permanent and 50.234 temporary domestic employment
opportunities. As the table indicates, the largest share of both temporary and
permanent employment creation goes to the primary sector that is 38.6% and 57.68%
from the total. The wholly foreign owned projects are more likely contribute to
primary sector employment where as the joint once contribute more to the secondary
sector employment creation. For instance, 58.23%temporary and 49.58%permanent
jobs (from their own) have been created from the wholly foreign new investment
projects. Likewise, 83.85% of temporary employment from the expansion investments
is the share of the primary sector. On the other hand out of the total permanent and

58
temporary employments created by the joint expansion projects the share of the
secondary sector is 90.01% and 93.32% from its own.

Table 3.11 Foreign investment employment creation by sector

joint
wholly with
    foreign       domestic        
sector new expansion new expansion total
  Perm Temp Perm Temp Perm Temp Perm Temp Perm Temp
Primary Sector 27,663 16,047 1,657 6,936 4,425 5,994 - - 33,745 28,977
% from total 49.58 58.23 24.94 83.85 18.09 42.73 - - 38.16 57.68
Secondary
Sector 15,129 5,267 647 145 14,089 2,866 1,361.00 349 31,226 8,627
% from total 27.11 19.11 9.74 1.75 57.59 20.43 90.01 93.32 35.32 17.17
Tertiary Sector 13,004 6,245 4,341 1,191 5,952 5,169 151 25 23,448 12,630
% from total 23.31 22.66 65.33 14.4 24.33 36.85 9.99 6.68 26.52 25.14
Grand Total 55,796 27,559 6,645 8,272 24,466 14,029 1,512 374 88,419 50,234
Source: Ethiopian Investment Commission; compiled by EEA

The implication of this analysis is that wholly foreign owned investment projects are
more prevalent in the primary sector which is the engine of the countries economic
growth. Increases in the investment activities of these groups in this sector stabilize
the problem of seasonal fluctuations in production and, hence seasonal unemployment
in the economy.

3.2.3.5 Sectoral distribution of foreign investment projects

The foreign investment projects are more likely to happen in the secondary sector, and
then followed by the primary and tertiary sectors. These are 44.06%, 39.63% and
16.31% from the 699 projects for the period under review. The situation is also the
same in terms of categories. For instance, 50.42% and 77.27% (from its own) of the
total jointly owned new and expansion projects are in the secondary sector. The same
thing happens in the foreign owned projects with a share of 38.66% and 44.44% from
its own share.

Table 3.12 Number of foreign investment projects by sector

  wholly foreign joint with domestic  

59
    

Sector new expansion new expansion total

No of No of No of No of No of
  Project Project Project Project Project

Primary Sector 78 5 36 - 114

% from total 17.42 27.78 15.00 - 16.31

Secondary Sector 162 8 121 17.00 308

% from total 38.66 44.44 50.42 77.27 44.06

Tertiary Sector 184 5 83 5 277

% from total 43.91 27.78 34.58 22.73 39.63

Grand Total 419 18 240 22 699

Source: Ethiopian Investment Commission; compiled by EEA

The implication is that foreign investment projects are more in the secondary sectors
other than the two sectors. This is essential for the country, which enables the country
to adopt the technologies that foreigners have in their country. The figure given below
clarifies the former analysis.

Figure 3.12 numbers of foreign projects by sector

100%

80% tertiary sector % from

total
secondary sector% from
60%
total
primary sector% from
40%
total
sector
20%

0%
wholly joint with
foreign domestic

3.3 Hypothesis Testing

The analysis shows that the two hypotheses, the researcher has formulated to test in this
research are acceptable. The crowding in effect of the public investment on private
investment is shown by the econometric model estimated in the first part of this
chapter. The implication of the estimation is that a unit increase in percentage of gross
public investment stimulates gross private investment to increase by more than a unit.

60
The existence of structural, sectoral and regional inappropriateness in the investment
scene of the country is clearly shown by the descriptive part of this chapter. There is
sectoral and regional imbalances on the investment capital allocated, employment
opportunities created and number of investment projects net licensed

Chapter 4

61
 CONCLUSIONS AND RECOMMENDATIONS
4.1Conclusion

The experiences of most developed countries and theories of economic development

ascertain the importance of increased capital formation for economic growth. But to
attain its desired objectives a nation needs a well designed regional and sectoral
investment is crucial.

There has been a dilemma whether public investment stimulates private investment in
the economy in many countries. The findings from the country in the previous 20
years show that public investment has a crowding in effect on private investment.
Increasing the level of public investment in selected areas that is social over headings
plays an important role so as to stimulate more of private investments in the country.

The sectoral and regional analysis of the investment scene in the country shows the
existence of disparity in the investment projects based on the number of investment
projects net licensed, employment creation and amount of investment capital allocated
among regional states and sectors.

The sectoral analysis shows that though there is low level of investment both in terms
of number of projects and investment capital allocated in the primary sector, it
constitutes the largest share of employment created as a result of investment during
the period under review. The primary sector investment projects require less amount
of investment capital per project as compared to the other two sectors. The scenario
makes investment in this sector important for developing countries with limited
supply of capital and huge amount of labor force. This needs a policy consideration
for the growth of the country.

The ownership structure of the country’s investment scene also shows that domestic
investors are under taking the highest proportion of the country’s investment activity,
and then followed by foreigners and the government respectively. The separate
analysis of each category in terms of employment creation, investment capital
allocation and number of investment projects net licensed shows the existence of
disparities between the three sectors of the economy. There is a high level of
investment in the secondary sector of the economy, and then followed by the tertiary

62
sector of the economy. In terms of employment creation, the foreign owned projects
are providing a larger proportion of permanent employment than temporary
employment from its own share. But, the domestic investors and the government
create more of temporary employment than permanent employment from their own
share in the primary sector. This is because of the fact that there is seasonality nature
of operations influenced by various natural calamities which can overcome via the
application of modern technologies and hence possible to create more of permanent
employment. This is what is seen in the foreign investor’s side of the economy, where
there is a larger proportion of permanent employment as a result of the use of modern
technologies.

In general the analysis shows the existence of a sectoral, structural and regional
imbalance in the investment activity of the economy.

4.2 Recommendations

Having investigated the existence of some favorable and other unfavorable patterns in
the country’s investment scene, the following recommendations are assumed to be
very influential for the future well being of the countries investment profile:

 Public investment has a crowding in effect on private investment. But, the

level of public investment in the country is short of private investment.
Therefore increasing the level of public investment, like in social over
headings is required for further stimulation of the private sector investment
and hence economic growth.

 The largest proportion of investment activities are in the hands of domestic

investors. Both the public and foreign sector investment share is almost
insignificant. This situation necessitates the importance of raising the share
of government investment in social over head capitals. Improving the way
to boost the share of foreign investors as joint ventures with the domestic
residents via policy and strategic measures should also be given a greater
emphasis for the well being of the economy. This is because of the
spreading effect of new technology through the adoption mechanism.

63
  There is a regional, sectoral and structural disparity in the investment
scene of the country. But a well functioning economy requires an equitable
sectoral, regional and structural distribution of investment projects in terms
of number and amount of capital invested. The implication here is that the
concerned body should design a mechanism by which there is an equitable
investment activities among regions and sectors based on the opportunities
for greater economic growth.

 More of the investment activity is concentrated on the tertiary and

secondary sector, and the primary sector which is the engine of the
country’s economic growth has been given lesser attention. This is
explained by the small number of projects as well as lesser amount of
investment capital allocated in the sector on the period under review. As a
result giving more emphasis for the development of the investment
activities in the economy plays an important role for economic growth.
This is because of the fact that investing more in this sector creates more
employment in one hand and increases the growth of the economy on the
other hand. Introducing a high-tech factor of production which results
from increased investment stabilizes the production process and hence the
employment condition in this sector of the economy.

In general, an appropriate equitable sectoral and regional investment projects

distribution mechanism from the concerned body should be given a paramount place.

REFERENCE

64
Barro, Robert and Jong-Wha Lee “Loser and Winner in Economic Growth,” in
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Blomstram, Magnus, Robert E.Lipsey and Mario zejan “is Fixed Investment the Key
for Economic Growth?” Quarterly Journals of Economics, (February 1996),
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Brihanu Nega and Seid Nur “Determinants of Low Growth in Ethiopia,” in
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International Conference on the Ethiopian Economy, Volume 3, 2004
Dawit Shegu. “Casual Relationship between Economic Growth and Gross Domestic
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David Romer. “Advanced Macro Economics,” second edition, 1996
Debaj Ray. “Development Economics”, 1998
De Long, J.Bradford and Lawerence Summers “Equipment Investment and Economic
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Economic Focus, “Ethiopia’s Export Sector,” Volume2, No.2, 1999
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Itana Ayana. “Credit Policy in Financial Institutions and Private Investment in
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Mekonnen Bekele. “Contribution of FDI to the Economic Growth of Sub Saharan
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the Ethiopian Economy, Volume 3, 2005
Michael Todarro. “Development Economics,” 1956, pp. 79-125

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Quarterly Report on the Macroeconomic Performance of the Ethiopian Economy,
“Employment Contribution of Pectoral Investment,” Volume3, No.1, 2005
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Sewasew Pawlos. “The Relationship between Import and GDP in Ethiopia,” in

Proceedings of the Second International Conference on the Ethiopian
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the Second International Conference on the Ethiopian Economy, Volume 1,
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Shibeshi Gebre. “Determinants of Investment: A review,” in Proceedings of the Third
Annual Conference on the Ethiopian Economy, 1992
Tigabu Deggu. Determinants of Economic Growth in Ethiopia, Working paper in
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Tsegaye Teklu. “Investment promotions and incentives in Ethiopia,” in Proceedings
of the First Annual Conference on the Ethiopian Economy, 1991
Winrock International “African Development Lessons from Asia,” 1991
World Bank Africa Data Base, 2006(CD-ROM)
World Bank Africa Data Base, 2000 (CD_ROM)
World Development Report, 1999/2000
World Development Report, 2005
World Development Report, 2006
F.Stewart, S.Lall and S.Wangewe, alternative development strategies in sub Saharan
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Dornbush, 1983
Annual Report on the Ethiopian economy, 2004\2005

P.Todaro and C.Smith, 2006

G.Mankew, 2005

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David Andrews, Lodewyk Erasmus, and Robert Powell, scaling up of the Ethiopian
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Daniel Zerfu, determinants of private investment in Ethiopia Addis Ababa University,
FBE, 2005 et. al
Early.H.Fray, the politics of international investment, 1983
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Griffin, Keith, 1973
Annual report on the Ethiopian economy, 2006\2007
ICT-policy, et.al
Harry A. Sackey, et.al, 2006

APPENDEX
67
 ECNOMETRIC TESTS

AUTOCORRELATION TESTS

Table AP1the Durbin-Watson stat shows the existence of autocorrelation

Dependent Variable: GPRI

Method: Least Squares
Date: 06/11/08 Time: 07:20
Sample: 1987 2007
Included observations: 21

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI 0.368009 0.270959 1.358172 0.1903

C 9.900656 1.772256 5.586470 0.0000

R-squared 0.088494     Mean dependent var 12.16343

Adjusted R-squared 0.040520     S.D. dependent var 2.827134
S.E. of regression 2.769263     Akaike info criterion 4.965433
Sum squared resid 145.7076     Schwarz criterion 5.064911
Log likelihood -50.13704     F-statistic 1.844631
Durbin-Watson stat 1.529332     Prob(F-statistic) 0.190319

Table AP2 here also the same case

Dependent Variable: GPRI

Method: Least Squares
Date: 06/11/08 Time: 07:22
Sample: 1987 2007
Included observations: 21

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI 1.791869 0.255869 7.003070 0.0000

R 0.133595 0.104459 1.278917 0.2181
M 4.632951 0.619405 7.479685 0.0000
C -9.623077 2.986870 -3.221793 0.0050

R-squared 0.788606     Mean dependent var 12.16343

Adjusted R-squared 0.751301     S.D. dependent var 2.827134
S.E. of regression 1.409885     Akaike info criterion 3.694537
Sum squared resid 33.79219     Schwarz criterion 3.893493
Log likelihood -34.79264     F-statistic 21.13946
Durbin-Watson stat 1.031137     Prob(F-statistic) 0.000006

Table AP3 the following test also shows the existence of autocorrelation with low Obs*R-
squared

Breusch-Godfrey Serial Correlation LM Test:

F-statistic 6.181483     Probability 0.024337

68
Obs*R-squared 5.852230     Probability 0.015557

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Date: 06/11/08 Time: 07:29
Presample missing value lagged residuals set to zero.

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI -0.045887 0.224758 -0.204163 0.8408

R 0.111709 0.101890 1.096369 0.2891
M -0.388952 0.564371 -0.689178 0.5006
C 0.617085 2.626596 0.234937 0.8172
RESID(-1) 0.679900 0.273463 2.486259 0.0243

R-squared 0.278678     Mean dependent var 2.45E-15

Adjusted R-squared 0.098347     S.D. dependent var 1.299850
S.E. of regression 1.234278     Akaike info criterion 3.463106
Sum squared resid 24.37507     Schwarz criterion 3.711802
Log likelihood -31.36261     F-statistic 1.545371
Durbin-Watson stat 2.078945     Prob(F-statistic) 0.236679

Table AP4

Dependent Variable: GPRI

Method: Least Squares
Date: 06/11/08 Time: 07:34
Sample (adjusted): 1988 2007
Included observations: 20 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI 1.625296 0.324407 5.010047 0.0003

R 0.160798 0.273523 0.587878 0.5675
M 4.393255 0.602394 7.292997 0.0000
C -8.354446 5.740095 -1.455454 0.1712
GPRI(-1) 0.538211 0.401954 1.338987 0.2054
GPPI(-1) -0.520448 0.798960 -0.651407 0.5271
R(-1) 0.061090 0.247891 0.246440 0.8095
M(-1) -1.581546 2.038820 -0.775716 0.4529

R-squared 0.876837     Mean dependent var 12.18876

Adjusted R-squared 0.804993     S.D. dependent var 2.898134
S.E. of regression 1.279806     Akaike info criterion 3.620468
Sum squared resid 19.65483     Schwarz criterion 4.018761
Log likelihood -28.20468     F-statistic 12.20460
Durbin-Watson stat 2.467635     Prob(F-statistic) 0.000132

AP5
Dependent Variable: GPRI
69
Method: Least Squares
Date: 06/11/08 Time: 07:42
Sample (adjusted): 1988 2007
Included observations: 20 after adjustments
Convergence achieved after 16 iterations

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI 1.660795 0.300782 5.521586 0.0001

R 0.203267 0.192530 1.055768 0.3078
M 4.128067 0.472831 8.730525 0.0000
C -8.240165 3.279503 -2.512626 0.0239
AR(1) 0.607294 0.313746 1.935625 0.0720

R-squared 0.850063     Mean dependent var 12.18876

Adjusted R-squared 0.810080     S.D. dependent var 2.898134
S.E. of regression 1.263001     Akaike info criterion 3.517176
Sum squared resid 23.92756     Schwarz criterion 3.766109
Log likelihood -30.17176     F-statistic 21.26056
Durbin-Watson stat 1.919453     Prob(F-statistic) 0.000005

Inverted AR Roots       .61

Table AP6 the autocorrelation test for the above estimation =no autocorrelation with high
Obs*R-squared probability value
:
Breusch-Godfrey Serial Correlation LM Test:

F-statistic 0.075172     Probability 0.787954

Obs*R-squared 0.106815     Probability 0.743800

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Date: 06/11/08 Time: 13:33
Presample missing value lagged residuals set to zero.

Variable Coefficient Std. Error t-Statistic Prob.  

GPPI 0.019635 0.318587 0.061633 0.9517

R 0.002224 0.198920 0.011182 0.9912
M 0.005651 0.488527 0.011568 0.9909
C -0.197159 3.460288 -0.056977 0.9554
AR(1) 0.081421 0.439348 0.185323 0.8556
RESID(-1) -0.129575 0.472599 -0.274175 0.7880

R-squared 0.005341     Mean dependent var -1.94E-05

70
Adjusted R-squared -0.349895     S.D. dependent var 1.122205
S.E. of regression 1.303834     Akaike info criterion 3.611821
Sum squared resid 23.79977     Schwarz criterion 3.910540
Log likelihood -30.11821     F-statistic 0.015034
Durbin-Watson stat 1.832796     Prob(F-statistic) 0.999898

Table AP7

F-statistic 0.139105     Probability 0.713782

Obs*R-squared 0.154209     Probability 0.694545

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 06/11/08 Time: 17:10
Sample (adjusted): 1989 2007
Included observations: 19 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.  

C 1.290172 0.633534 2.036469 0.0576

RESID^2(-1) -0.090897 0.243712 -0.372968 0.7138

R-squared 0.008116     Mean dependent var 1.187859

Adjusted R-squared -0.050230     S.D. dependent var 2.428948
S.E. of regression 2.489204     Akaike info criterion 4.761104
Sum squared resid 105.3343     Schwarz criterion 4.860518
Log likelihood -43.23048     F-statistic 0.139105
Durbin-Watson stat 2.011044     Prob(F-statistic) 0.713782

Table AP8 UNIT ROOT TEST

Null Hypothesis: GPRI has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic based on SIC, MAXLAG=3)

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -2.903531  0.0626

Test critical values: 1% level -3.808546
5% level -3.020686
10% level -2.650413

*MacKinnon (1996) one-sided p-values. it shows non existence

of non stationary

71
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(GPRI)
Method: Least Squares
Date: 06/11/08 Time: 17:31
Sample (adjusted): 1988 2007
Included observations: 20 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.  

GPRI(-1) -0.637181 0.219450 -2.903531 0.0095

C 7.772668 2.742158 2.834507 0.0110

R-squared 0.318968     Mean dependent var 0.017150

Adjusted R-squared 0.281133     S.D. dependent var 3.272168
S.E. of regression 2.774341     Akaike info criterion 4.973343
Sum squared resid 138.5454     Schwarz criterion 5.072916
Log likelihood -47.73343     F-statistic 8.430492
Durbin-Watson stat 1.785604     Prob(F-statistic) 0.009473

Coefficient test
Redundant variable tests for r r is redundant

F-statistic 3.793778     Probability 0.070410

Log likelihood ratio 0.450954     Probability 0.337070

Redundant Variables: GPPI not redundant

F-statistic 7.021761     Probability 0.018196

Log likelihood ratio 7.679618     Probability 0.005585

Redundant Variables: GPPI not redundant

F-statistic 7.021761     Probability 0.018196

Log likelihood ratio 7.679618     Probability 0.005585

Model specification
The former model is specified based on the Harrod-Domar growth model with the
assumption of constant incremental capital-output ratio, and with the existence of law
rate of local domestic saving. By using this model as afoot step, some moderate
modifications are made so that the model to become logically reliable and statistically
reasonable.
From the Harrod-Domar growth model:
g = [1/k] [I/Y]

72
Where, g is growth rate of GDP, k incremental capital-output ratio, I investment and
Y is GDP.
According to the two-gap model, capital is the key constraint for growth. In the
context of such discussion equation one can be written as
Yt+1_Yt= [1/k] [It]
Since, Yt+1_Yt=gYt
Then, [1/k] [It] =g [Yt]
This implies, g= [1/k] [It/Yt]
However, the investment activity can be categorized in to three sectors based on the
economic activity under taken, that is, primary sector, secondary sector, and tertiary
sector investment.

It=Ipt+Ist+Itt

Therefore

g= [1/k][Ipt/Yt+Ist/Yt+Itt/Yt]

Or,

g= [1/k] [ipt+ist+itt]

Where

i=I/Y

Then the linear regression model becomes,

g=ßo+ß1ipt+ß2ist +ß3itt+

, Where autocloration, stationary and co integration test will be conducted as far as in

time series data it is concerned with Eviews econometric package

This is a model failed to be estimated because of lack of sufficient time series data.

Value of estimated variables

GPRI GPPI M R year

11.657 4.477 16.2 6.00 1987

18.826 4.5577 16.0 6.00 1988

7.7858 5.759 14.6 6.00 1989

8.9048 4.0305 12.2 6.00 1990

7.9959 3.0725 12.5 6.00 1991

73
8.4308 2.2828 10.7 8.00 1992

8.4308 3.5762 16.9 14.00 1993

11.297 5.0823 21.5 14.33 1994

12.649 5.3094 23.5 15.08 1995

12.27 5.3373 23.0 13.92 1996

13.159 6.2121 25.5 10.50 1997

14.821 6.2403 25.3 10.50 1998

14.075 6.8827 28.9 10.58 1999

16.18 4.3077 30.0 10.89 2000

13.974 7.0135 29.9 10.87 2001

14.058 9.5012 34.1 8.66 2002

13.978 8.7703 35.3 7.00 2003

12.14 9.1103 36.6 7.00 2004

11.4 9.1 37.4 7.00 2005

11.4 8.4 41.5 6.50 2006

12 10.1 39.6 6.78 2007

74