The Effect of Government Expenditure on Private Investment in Ethiopia: A Time series Analysis
©2015
Textbook
107 Pages
Summary
This study attempts to investigate the effect of government expenditure on private investment in Ethiopia over the period 1980-2012. The central question of this study is weather government expenditure has a positive or crowding in effect (complementary hypothesis) or a negative or crowding out effect (the substitutability hypothesis )on private investment in Ethiopia. To achieve its objective it adopted a modified flexible accelerator model to enlighten on the economic relationship between private investment and the other variables and used the modern technique of vector auto regressive model (VAR) and vector error correction model(VECM)as its methodology. The study also used the Johansen-Juselius (1990) cointegration analysis of a multivariate system of equation to estimate the long run relationship between government expenditure and private investment to determine the order of integration of the variable and Granger-Causality test was undertaken to determine causal relationship between the variables. In addition to this the study employs the Augmented Dicky-Fuller (ADF) unit root test and phillip perron test. The statistical tests reveal that all-time series data are non-stationary in their level and they become stationary after diffrencing.i.e.they are integrated of order one I(1).The johansen-juselius cointegration test shows that the series are cointegrated and then employs the vector error correction model moreover the study applies the impulse response function (IRF)and forecast error variance decomposition (FEVD) to investigate the effect of government investment shocks on private investment. And the empirical findings support the complementary hypothesis between government capital expenditure and private investment and that tends to crowd-in private investment in Ethiopia. And the empirical finding of recurrent part of government expenditure shows a mixed effect of complementary hypothesis and substitutability hypothesis which tends to crowd-in and crowd out effect .Thus government expenditure have a positive as well as negative effect on private investment and finally the study is used CHOW test in order to know whether structural break has an effect on private investment or not and the result depict that there is a structural break that have a positive effect on private investment of Ethiopia.
Excerpt
Table Of Contents
v
CHAPTER FOUR: SUMMARY, CONCLUSION AND POLICY IMPLICATION ... 77
4.1 Summary ... 77
4.2. Conclusion ... 79
4.3 Recommendation ... 80
4.4 Policy Implications ... 81
4.5 Areas for Further Research ... 82
Reference ... 83
Appendix ... 87
vi
List of Tables
Table 1. Average growth rate of real GDP, GDP per capita and Population, (%) 1974 to 2012 ... 28
Table 2 Growth of Total Government Expenditure and GDP under the Two Regimes ... 32
Table 3.Capital and current expenditure (% of total expenditure) 1974 to 2012. ... 37
Table 4: Average share of various compositions of gov't expenditure in total expenditure, 1975 to
2012. ... 39
Table 5 Sectorial classification of government expenditure as a percentage of total expenditure,
1974/75 to 2010/11 ... 40
Table 6: Summary of budget deficit and means of financing (% of GDP), 1979 to 2012. ... 42
Table 7 Private, public and Total investment (% of GDP) ... 47
Table 8 Average gross capital formation and domestic saving (% of GDP), 1981 to 2012. ... 49
Table 9 Unit Roots Tastes Results at Level ... 52
Table 10 Unit Roots Tastes Results after differencing ... 53
Table 11: Phillips perron (pp) unit root test at Level ... 54
Table 12: Phillips perron (pp) unit root test at difference ... 55
Table 13: Johansens' Cointegration test using Maximum Eigen value& the Trace statistic ... 56
Table 14: Normalized long run beta coefficient for private investment ... 57
Table 15 Adjustment ( ) Coefficient for private investment ... 58
Table 16: Test result of weak exogenity... 60
Table 17 Result of zero restriction tests on B coefficient for private investment ... 61
Table 18 Long run relationship regression result ... 65
Table 19 Error correction Model Results ... 66
Table 20: variance decomposition of private investment ... 73
vii
List of Figures
Figure 1 Average growth rate of real GDP, GDP per capita and Population, (% of GDP) 1974 to 2012 ... 29
Figure 2 Trends in nominal GDP and Total government spending ... 31
Figure 3. Total government expenditure (% of GDP) and real GDP annual growth 1974 to 2012 ... 33
Figure 4. Total government expenditure (% of GDP), 1974 2012 ... 34
Figure 5.Real GDP Growth rate, 1974 to 2012 ... 36
Figure 6 Revenue, Expenditure and Deficit share of GDP from 1979-2012 ... 44
Figure 7 Trends in Investment (In Levels) in million birr ... 47
Figure 8 Trends in Investment (% of GDP) ... 48
Figure 9 shows the effect of a one standard deviation shock on recurrent government expenditure on
private investment ... 70
Figure 10 shows the effect of a one standard deviation shock on budget deficit on private investment71
Figure 11: shows the effect of a one standard deviation shock of Domestic credit to private sector on
private investment ... 72
viii
Acronyms
ADF- Augmented Dickey Fuller
CBE -Commercial Bank of Ethiopia
CSA- Central Statics Authority
CUSUM- Cumulative sum
CUSUMSQ -cumulative sum squares
ECM- Error Correction Method
EEA -Ethiopian Economic Association
GDP- Gross domestic product
GE -Government expenditure
GLS- Generalized Least square
GNP- Gross National Product
GS- Government spending
GTP -Growth and Transformation Plan
HO- Null hypothesis (HO)
IMF- International Monetary Fund
IRF -The impulse response function
LDCs- Less Developing Countries
MoFED- Ministry of Finance and Economic Development
OECD Organization for Economic Cooperation & Development
OLS -Ordinary least Square
PI -Private investment
SSA -Sub-Sahara Africa
VAR- Vector Auto Regression
ix
VDC -Variance decomposition coefficients
VECM -Vector error correction Model
RGNP-Real Gross National Product
EPRDF- Ethiopian People's Revolutionary Democratic Front
ODA- Official Development Assistance
GCF Gross capital formation
MDGs- Millennium development goals
FDI - Foreign Direct investment
PP -Phillip Perrons Units root test
SAP Structural adjustment program
x
List of tables in the Appendix
Appendix A1: Result of granger causality test------------------------------------------------89
Appendix A2: VAR diagnostic tests -----------------------------------------------------------90
Appendix A3: VAR estimation result----------------------------------------------------------93
xi
Abstract
This study attempts to investigate the effect of government expenditure on private investment
in Ethiopia over the period 1980-2012. The central question of this study is weather
government expenditure has a positive or crowding in effect (complementary hypothesis) or a
negative or crowding out effect (the substitutability hypothesis )on private investment in
Ethiopia. To achieve its objective it adopted a modified flexible accelerator model to enlighten
on the economic relationship between private investment and the other variables and used the
modern technique of vector auto regressive model (VAR) and vector error correction
model(VECM)as its methodology. The study also used the Johansen-Juselius (1990)
cointegration analysis of a multivariate system of equation to estimate the long run
relationship between government expenditure and private investment to determine the order of
integration of the variable and Granger-Causality test was undertaken to determine causal
relationship between the variables. In addition to this the study employs the Augmented Dicky-
Fuller (ADF) unit root test and phillip perron test. The statistical tests reveal that all-time
series data are non-stationary in their level and they become stationary after
diffrencing.i.e.they are integrated of order one I(1).The johansen-juselius cointegration test
shows that the series are cointegrated and then employs the vector error correction model
moreover the study applies the impulse response function (IRF)and forecast error variance
decomposition (FEVD) to investigate the effect of government investment shocks on private
investment. And the empirical findings support the complementary hypothesis between
government capital expenditure and private investment and that tends to crowd-in private
investment in Ethiopia. And the empirical finding of recurrent part of government expenditure
shows a mixed effect of complementary hypothesis and substitutability hypothesis which
tends to crowd-in and crowd out effect .Thus government expenditure have a positive as well
as negative effect on private investment and finally the study is used CHOW test in order to
know whether structural break has an effect on private investment or not and the result depict
that there is a structural break that have a positive effect on private investment of Ethiopia.
Keyword: Government expenditure, private investment, VAR, crowding-In, crowding out,
Ethiopia
1
CHAPTER ONE: INTRODUCTION
1.1. Back ground of the Study
The interest of economists in the relationship between government spending and private
investment is motivated mainly by the controversy over the crowding out or crowding in effect
of government spending on private investment. With the renewed interest in the role of the
private sector as an engine of economic growth, the examination of this relationship is given
further impetus. The idea of a private sector led economic growth in Ethiopia is therefore
traceable to the observed success of the major industrialized countries; which attributed to the
resilience of their organized private sector (Nasir & Muhammad, 2009).
As a result of the poor performance of the economy over the period in which government
played the leading role in the economy, there was a change in the expected role of the
government. To this end, market oriented structural reform programs such as privatization and
deregulation were adopted to ensure a reduction in the role of government in the economy.
The guiding principle in this redefined role of government was that government should
concentrate its resources in areas that compliments rather than crowd-out private sector
investment, thereby creating an enabling environment for the private sector investment (Nasir
& Muhammad, 2009).
Some economists have argued that increase in government spending can be an effective tool to
stimulate aggregate demand for a stagnant economy and to bring about crowed-in effects on
private sector. According to Keynesian view, government could reverse economic downturns
by borrowing money from the private sector and then returning the money to the private sector
through various spending programs. High levels of government consumption are likely to
increase employment, profitability and investment via multiplier effects on aggregate demand.
Thus, government expenditure, even a recurrent nature, can contribute particularly to private
investment and economic growth. On the other hand, endogenous growth models like Barro
predict that only those productive government expenditures will positively affect the long run
growth rate (Barro, 1990).
2
In the neoclassical growth model of Solow productive government expenditure may affect the
incentive to invest in human or physical capital, but in the long-run this affects only the
equilibrium factor ratios, not the growth rate, although in general there will be transitional
growth effects. Others have argued that increase in government expenditures may not have its
intended salutary effect in developing countries, given their high and often unstable levels of
public debt. Thus government consumption crowds out private investment, dampens economic
stimulus in short run and reduces capital accumulation in the long run (Solow, 1956).
Further Vedder and Gallaway argued that as government expenditures grow incessantly, the
law of diminishing returns begins operating and beyond some point further increase in
government expenditures contributes to economic decline and stagnation (Gallaway &
Vedder, 1998).
The Ethiopian economy is a mixed system in which the government and the private sector co-
exist. The two could play complimentary roles to enhance economic growth. Thus, it is in line
with this that the use of government expenditure to enhance private investment is being
advocated.
To address the inefficiencies in public expenditure management in Ethiopia, the federal
government introduced wide range of policies and institutional reforms, geared towards
privatizing the economy, particularly since 1992 when the structural adjustment program
(SAP) was implemented. The Transitional Government of Ethiopia, which was established
after the downfall of the military regime in May 1991, initiated a new market-driven economic
policy followed by a comprehensive structural and economic reform program. One of the
major objectives of the reform program was to rectify the fiscal ills & attain a consolidated
government budget. This objective called for rationalizing the state's role in the economy,
implying reorientation of government expenditure, and at the same time enhancing revenue
performance with the support of International Monetary Fund and the World Bank as well as
other multilateral and bilateral donors (MoFED, 2010).
3
Notwithstanding the developments stated above, total expenditure during the period 1991/92
to 1997/98 increased at an annual average rate of 16.7 percent per annum. Though both
recurrent & capital expenditure have been rising, capital spending accounted for a larger part
of the increase in total spending. Similarly recurrent expenditure as a ratio to GDP has
declined during the post-reform period while that of capital expenditure increased from their
pre-reform levels. Much of the increased in capital expenditure was accounted for by spending
on roads, energy, education and health sectors. On the recurrent side, wages and operating
expenses and debt servicing took the lion's share during the period under review (MEDaC,
1999)
Recent developments also indicate a trend of increasing government expenditure, especially
expenditure on priority sectors of education, health and roads. Total government expenditure
as share of GDP has increased to 33.5 percent annual average in 2001/02-2004/05 from 28.8
percent during 1991/92-1995/96 periods. And it also emphasized on the evolution of a private
sector led market oriented economy with competition as a driving force. The key elements of
this strategy include privatization, deregulation, and reducing the influence and involvement
of government in the economy.
During the Derg Regime (1974-1991), Ethiopia's private sector hardly existed. The socialist
regime provided little rooms for the private sector to flourish until the period it vanished in
1991. Following the fall of the Derg regime in 1991, a shift in policy from command economy
to free market economy was introduced in the country. This shift has opened opportunities for
the private sector to have an active role in various sectors of the country's economy. Since
then, a lot of efforts have been exerted and various forms of incentive packages have been
provided by the government to encourage domestic private investment in the country. Despite
the incentives taken by the government, the sector's contribution towards the economy of the
country has remained very poor by international standards, even when compared with Sub-
Saharan countries (World Bank., 2010)
Similarly the trend of domestic private investment as a percentage of GDP is a good evidence
of how low the sector's contribution to the economy is. For instance, from 1992-2000 and
2001-2010 domestic private investment as a percentage of GDP were 2.6 and 1.2 respectively.
4
Particularly, in the last five years domestic investment has been reduced though the country's
economy was growing continuously. For instance, from 2006-2010 the average domestic
investment as percentage of GDP was only 0.5% while average economic growth for the same
period was about 11%. Similarly while the country's domestic private investment to GDP is
low, the resource gap between savings and domestic investment is very high. For instance, the
resource gap between savings and investment in 2009/10 was 19.4 % which is very high in
comparison to the international standard (MoFED, 2010).
Understanding this problem, the government has prepared a strategy document namely
Growth and Transformation Plan (GTP) in 2010 that addresses many issues of the country
including domestic investment and its constraints as one agenda (FDRE, 2010). Low per
capita income of citizens, limited saving behavior, poor and limited financial institutions and
lack of infrastructure are some of the factors identified by the government in its GTP as
bottlenecks to the country's domestic private investment (MoFED, 2010).
However, as Ascharer (1989) noted, the precise effect of government expenditure on private
investment depends on the type of government expenditure being considered. To the best of
the knowledge of the researcher, there is paucity of literature conducted particularly on
Ethiopia. Certain categories of government expenditure crowd out private investment while
others complement or crowd-in private investment. Amidst the prevailing contradicting view;
it is unquestionable to conduct an empirical study to understand the effects of government
expenditures on private investment (Aschauer, 1989).
1.2. Statement of the Problem
Undertaking macroeconomic policy, various development strategies and economic policies
introduced by the government so as to increase private investment did not bring a desired
result. As it is well established in the literatures the failure of the government to achieve
rapid and sustained private investment in Ethiopia spurred the debate on whether the
government or the private sector should spearhead the nation's economic growth process.
To reconcile this issue, in the last five years the government dominated the economic
activities of the country by changing the expenditure level. For example; growth in
5
recurrent expenditure registered an average of 13.8 percent per annum over the past seven
years (2003/04-2009/10) while the growth rate in capital expenditure averaged 30 percent
per annum during the same period (MoFED, 2011).
Consequently, the share of capital expenditure to total expenditure increased from 40
percent in the fiscal year 2003/04 to 55 percent in 2009/10. While the share of recurrent
expenditure to total expenditure declined from 58 percent in 2003/04 to 45 percent
in2009/10. Even if the government undertakes such tremendous increases and decrease in
its expenditure components its contribution to increase private investment has been
remained in significant. Thus private investment has been persistently low in Ethiopia; For
instance, from 1992-2000 and 2001-2010 private investment as a percentage of GDP were
recording 2.6 and 1.2 respectively. It was identified that this low performance of private
investment is a factor responsible for the lowest share of private investment as a
percentage of GDP. For instance, from 2006-2010 the average share of private investment
as percentage of GDP was only 0.5% while average economic growth for the same period
was about 11% (MoFED, 2011)
Standing with the above juncture, private sector operators argued that the factors which
militate against their contributions to the economy include high cost of doing business,
unstable macroeconomic policies, infrastructural bottlenecks, faltering consumer spending,
and lack of capital investment and stifling effect of multiplicity of taxes. Hence low
productivity/un competitiveness of the private sector is therefore as a result of the hostile
business environment (Nasir & Muhammad, 2009).
Further more political instability and social unrest can also be taken as potential sources of
uncertainty and may even be highly damaging factors of the private investment
environment. According to Seyoum (2002), there are two important mechanisms through
which socio-political factors could influence private investment in developing countries.
The first relates to extreme cases of instability that lead to changes in the rules of the game
and threatens investors of possible confiscations. The other and perhaps the most common
one relates to the unpredictability of the political environment say due to repeated changes
of government or officials of key government institutions which undermines the
responsiveness of private investors to economic incentives or reform measures. The basic
6
idea is that investors may not regard government policy under political instability as
credible, hence creating a value for waiting. This indirectly weakens the effectiveness of
fiscal policy measures taken by government bodies to improve the share of private
investment in the economy.
As to the researcher knowledge, researches conducted on the effects of government
expenditures on private investment didn't exist in Ethiopia. But there are other limited related
researches. For example the research that was undertaken by Zerfu. (2001) assesses the
Macroeconomic determinants of private investment in Ethiopia using time series data for the
period 1965-1999. The result from this study indicated that GDP, public investment on
infrastructure and foreign exchange availability all have positive effects on private investment.
On the contrary, inflation rate and external debt to GDP ratio showed a negative effect on
private investment. Another research which was conducted by Getnet (1992) on the
determinants of private investment in Ethiopia using annual data for the period 1970-1989
identified a negative relationship between public investment and private investment. This
result demonstrated a crowding out of public investment on private sector activities. However,
on estimating a reduced form of the investment equation, public investment turned out to be
insignificant while real Gross National Product (RGNP) growth was seen to have a negative
effect on private investment. This result may not seem plausible, as it is inconsistence with the
theoretical economic a priori.
In addition Mitiku (1996) carried out a study using survey and time series data for the period
1975- 1994, was also another attempt to investigate the determinants and constraints of private
investment in Ethiopia, The results based on the time series data indicated that private
investment in Ethiopia is determined by the availability of finance, the real exchange rate,
investment policy (private investment policy), debt-service payment and debt-overhang. On
the contrary, real interest rate, growth of GDP per capita, public investment and changes in
terms of trade did not affect private investment during the period of study.
7
Without prejudicing the importance attached to the mobilization of resources, current
circumstances obliged the proper allocation and efficient utilization of government
expenditure as the reward is greater. Likewise, the penalty for bad policy in this respect is
greater than ever before in the realm of globalization. In a nutshell, government expenditure
could adversely affect domestic private investment if its allocation and utilization is not
properly addressed. However, there is also lack of unanimity in the empirical findings as to the
crowding-in/ crowding-out effects of Government expenditure on private investment.
Research outputs often conflict with one another on the issue. For instance, while some have
identified positive effects of government investment spending on private investment (Greene
& Villanueva, 1991 and Ghura & Goodwin 2000), others such as Balassa (1988) cited in
Bashier Al-Abdulrazag (2009),
have found the other way round (Bashier, 2009).
As argument noticeably asserted in the above paragraph and the literatures of different
researches undertaken in other countries on this area forwards an implication as understanding
the underlying relationship between government expenditures and private investment is
essential for devising and implementing policies. Coincident with the above fact, the distinct
feature of this study is that it tried to investigate effects of government expenditures on private
investment in Ethiopia; which is expected to bridge the existing gap in the area of the study.
1.3
. Research Questions
This study sought to address the following research questions, that is, investigate the effects of
government expenditures on private investment.
9 What is the trend of government expenditure and private investment looks like over the
study period? Does liberalization policy boosts private investment?
9 What are the variables affecting private investment?
9 What is the relationship between categories of government expenditure and private
investment? Does components of government expenditure crowd in or crowd out
private investment in Ethiopia?
9 Which type of government expenditure complement private investment and which has
crowding out effects?
8
1.4. Objective of the Study
The general objective of the study is to determine the effect of government expenditures on
private investment in Ethiopia.
The specific objectives of the study are`
:
9 To investigate the causal relationship between disaggregate government expenditure
and other variables on private investment in Ethiopia.
9 Analyze the relative effects of various components of government expenditures on
private investment in Ethiopia (crowding in and crowding out)
9 Analyze the Effect of Budget Deficit on Private Investment in Ethiopia.
9 Determine the effects of government domestic credit to the private investment in Ethiopia.
9 To review and analyze the trend of government expenditure and private investment in
Ethiopia under the two regimes (The Derg and The post Derg)
This study put tentatively the following hypothesis in line with the objectives stated above.
Hypothesis 1: The recurrent government expenditure and private investment will have a
negative relationship.
Hypothesis 2: There will be positive relationship between capital government expenditure and
private investment.
Hypothesis 3: There will be a negative effect of inflation on private investment.
Hypothesis 4: There will be a positive relationship between economic growth and private
investment.
Hypothesis 5: There will be a negative relationship between budget deficit and private
investment.
Hypothesis 6: Structural break before reform program is expected to have negative
relationship with private investment while the after reform program will be expected to have
positive relationship with private investment.
9
1.5. Significance of the study
Albeit it's significance for policy makers and to the best of my knowledge there is no research
that was undertaken on the effect of government expenditure on private investment in
Ethiopia. In this respect, existing literatures done in different countries have different result
and conclusion for the effect of government expenditure on private investment. Hence, such
work can usually be conducted in the context of country specific to capture the effects of
government expenditure on private investment.
One more advantage of this study is that it incorporates the most recent data and employs
quantitative analysis and a more advanced econometric technique (Johansen approach to
cointegration) to study the effect of government expenditure on private investment. Thus, the
immediate outcome of this study will be to provide pertinent result and policy implication to
policy makers by bridging the aforementioned gap. Besides, the researcher believe that the
study will provoke and pave a way for further study in the area as it reveals the difficulty in
resolving the empirical question of the effect of government spending on private investment.
1.6. Limitation and Scope of the Study
One limitation of this study arises from lack of clear agreement on which categories of
government expenditure can affect domestic private investment (or how to measure its
constituents). Economists are not yet certain about the relative importance of each component
which clearly or perhaps not so clearly influences private investment. Without such
knowledge the area of disturbing doubt is uncomfortably large. Besides, the definition of
particular expenditure as productive or unproductive is open to debate.
The other limitation of the study was that it does not explicitly consider the quality of
government spending, which was probably the most important factor. The caliber of the civil
service and the military and the conditions in which they function have impact on creative and
efficient use of public expenditures. Unproductive public spending can take various forms,
including spending on wages and salaries of unproductive or ghost workers. Public spending is
also unproductive when government expenditures do not reach designated spending
objectives. This happens, for example, when government officials are corrupt and seek bribes
10
for preferentially selecting beneficiaries of government programs, for authorizing private
investment projects, for allowing participation of government enterprises in joint ventures with
private investors, or for allowing access to inputs provided through state enterprises.
Apart from these, the econometric model does not consider the incidence of revenue structure
and financing issues. It is believed that when government expenditure is not covered by own
revenue, the nature of expenditure financing has a bearing on economic growth. Moreover, the
nature of own revenue itself (whether it is distortionary or not) has a role in explaining the
effect of government expenditure on domestic private investment.
The scope of this study is limited to an empirical analysis of the effects of government
expenditure on private investment between 1980 and 2012. The major focus is on the effects
of government expenditure on private investment. The choice of this study period is based on
the availability of data.
11
CHAPTER TWO: RESEARCH METHODOLOGY
2.1. Research Design
This study aimed at analyzing the effect of government expenditure and other variables on
private investment in Ethiopia. Quantitative data was used in the study to answer the research
questions. The study used the time series data of 33 years for the period 1980 to 2012 the
collected data were analyzed using Vector auto-regressive (VAR) modeling technique and the
error-correction model was generated after undergoing time series properties tests.
2.2. Data Type and Source
This study purely depends on secondary data. Different data sets were collected from various
sources such as Central Bank of Ethiopia (CBE); Ministry of Finance and Economic
Development (MoFED); Ethiopian Economic Association (EEA).These three agencies served
as the main sources of data for federal government capital and recurrent expenditures and their
various sub-components. Private investment data and other explanatory variables data were
sourced from World Bank (WB) development indicators.
2.3. Method of data analysis
2.3.1. Descriptive Analysis
In this study, to analyze the effect of government expenditure on private investment
descriptive analysis was employed as starting point of analysis part. Here the theoretical
relationships and empirical analysis of the variables and private investment were dicussed.In
order to analyze the effect of government expenditure on private investment and to look at
their trend different tools like tabulations, percentage and graphs were employed to make an
inference.
12
2.3.2. Econometrics Analysis
In addition to descriptive analysis, econometric analysis was used for analyzing data. These
help to capture the degree of influence and significant effects of government expenditure and
other variables on private investment. In doing so the government expenditure and other
macroeconomic variables that are supposed to affect private investment are used as
independent variable and private investment as dependent variable. The collected data were
analyzed using Vector auto-regressive (VAR) modeling technique and the error-correction
model was generated after undergoing different time series properties tests.
2. 4. Definition and Measurement of Variables
Private investment (PI)
: (i.e. Gross domestic investment) is the total change in the value
of fixed assets plus change in stocks. Gross capital formation is used as proxy to private
investment. The researcher used domestic private investment as dependent variable and other
explanatory variables. The explanatory variables that may affect the decision making of
domestic private investment in the literatures are very wide and only variables having sound
theoretical explanations and complete data will be selected. In this section the researcher
attempt to describe the theoretical explanations and empirical evidences of the explanatory
variables selected for this study.
Government capital Expenditure (GCE): It is the government expenditure on capital overheads.
It was measured by the total government expenditure less recurrent expenditure.
Government recurrent Expenditure (GRE):
It is the current expenditure for purchase of
goods and services at all levels of government. It encompasses purchases of materials, office
supplies, fuel and lighting, salaries and wages, travel services and payment of rent. It was
measured by recurrent expenditure on labour costs and other goods and services.
Inflation rate (INF):
inflation results from the macroeconomic effect of government
spending and is the fourth variable that the researcher was used in the study as a proxy to
measure macroeconomic stability of the country. There is no uniformity on the theoretical
explanation of the variable and its effect on domestic private investment. Some models such as
13
the cash-in-advance models (e.g. Stockman, 1981) forwarded that inflation raises the cost of
acquiring capital which then lowers capital accumulation. This model further states that the
existence of high inflation may make it difficult and costly for economic agents to extort the
right relative price which could then lead to misallocation and inefficient resources. However,
other models like the Tobin-Mundell model argues that higher anticipated inflation lowers the
real interest rate which then causes to be made portfolio adjustments away from real money
balances to real capital which then expected higher inflation to raise real investment (Ghura
Goodwin, 2000) Empirical studies such as (Bakare A. , 2011) and (Léonce, 2000) reported
that inflation has a negative effect to private investment.
Economic growth (GDP)
: The gross domestic product GDP is used as proxy for
economic growth. This indicates the level of output in the economy. Its rate of growth is
therefore an indication of the rate of growth of the economy and it is one of the most
commonly variable used as explanatory variable to measure its effect on domestic private
investment. Some literatures such as Fielding, (1997), Greene and Villanueva (1991)
explained that private investment is positively related with real GDP growth of one country.
This is because countries with higher income level inclined to allocate more of their wealth to
domestic savings which could be then used to help in financing private investment. Empirical
results such as Ajide and Lawanson (2012) from Nigeria, Outtara (2004) from Senegal and
Asante (2000) from Gahana have evidenced that real GDP growth rate helps domestic private
investment. Ghura and Goodwin (2000) on their part revealed that real GDP growth has
stimulating effect on private investment in Asia and Latin America though its effect in Sub_
Sahara Africa was found insignificant. But (Ndikumana Sher, 2008) found the positive and
significant relationship in Sub-Sahara Africa (SSA) which contradicts the findings of (Ghura
Goodwin, 2000).
Domestic Credit to the Private Sector(DCPS) ;Domestic credit to the private sector refers to
financial resources provided to the private sector, such as through loans, purchases of non-
equity securities and trade credits and other accounts receivable, that establish a claim for
repayment.
14
Domestic credit thus represents the investible resources devoted to productive activities in the
economy. Credit provision to the private sector is a critical determinant of the quantity as well
as the quality of private investments that are undertaken. In a situation where policies are
implemented that facilitate increased private sector participation such as increased financial
sector liberalization, these should have a positive effect on domestic credit to the private
sector, leading in turn to greater investment and in turn economic growth. Domestic credit is
widely used in the literature including by Badawi., (2003), (Boopen Khadarro., 2007)
Public Investment(PUI): It comprises all additions to the stocks of fixed assets (including
purchases and own-account capital formation), land improvements fences, ditches, drains etc.-
plant, machinery and equipment purchases (including imports), construction of roads,
railways, schools, hospitals, office buildings, less any sales of second-hand and scrapped fixed
assets, by government units and non-financial public enterprises. Outlays by government on
military equipment are excluded. Fixed Investment by the public sector is expected to have a
positive effect on real output. In Neo classical growth theory, increases in the level of public
capital stock (public investment) are argued to lead to increases in the capital stock and this in
turn should lead to increases in real output. This effect however only occurs if the public
investment is coupled with increased private investment or if the reductions in real output due
to any reductions in private investment are offset by the increase in output due to an increase
in public investment. Public sector gross fixed capital formation is used in the literature as a
measure of public investment by among others (Badawi., 2003),
Public Consumption (PUC); It comprises government purchases of goods and services,
including office supplies and maintenance charges, wages and salaries of employees and
expenditures on national defense. Public consumption leads to an increase in real output in the
economy. This is particularly the case when it is used to encourage private investment to meet
the additional demand, by way of supply of goods and services purchased by the government.
However if public consumption is financed by borrowing from the domestic economy it can
reduce private investment. Similarly, if say for political economy reasons, public consumption
is encouraged at the expense of public investment, it can have potentially deleterious effects
on real output. Public consumption has been used in the literature by (Nazima Adiqa, 2011).
Details
- Pages
- Type of Edition
- Erstausgabe
- Publication Year
- 2015
- ISBN (eBook)
- 9783954898541
- ISBN (Softcover)
- 9783954893546
- File size
- 489 KB
- Language
- English
- Publication date
- 2015 (January)
- Keywords
- effect government expenditure private investment ethiopia time analysis
