Nexus Between Foreign Direct Investment and Domestic Investment in Ethiopia: Crowding-in/out Effects

Abstract

Ethiopia has devoted itself to entice foreign direct investment across time. The experiences of many countries have shown that FDI has either supplementary or substitution effects. This paper is geared based on the FDI contribution and intends to reveal the path of influence on domestic investment. To reach at a conclusion, the research used a time series data between 1975-2014 periods and Vector Error Correction Model (VECM) approach. Accordingly, the result shows that FDI crowds out private domestic investment despite it is being crowd out by domestic investment through private domestic investment. FDI has no effect on domestic investment in the long run and short run dynamics. The result also found public investment has a crowding in effect for both private domestic investments and FDI in both short run and long run dynamics. This shows that FDI might not be increased in the expense of private domestic investment. By the same token, private domestic investment has a supplementary effect on public investment which is supported by a theory where a booming of investment nurtured the income of the government in the form of tax and other revenues. Therefore, to increase foreign investor participation, government should pursue privatization and liberalization policies in the remaining sectors along with building up in a house investment by creating a forward and backward linkage investment policy in domestic-foreign investment. Moreover, the inefficient private investment should have to merge to increase their potential to compete foreign counterparts together with empowering themselves with technology.

Keywords: Multinational Corporations, VECM, FDI, GDP, Crowding-in/out, bi-directional