Macroeconomic, Political, and Institutional Determinants of FDI Inflows to Ethiopia: An ARDL Approach

Abstract

Based on the lines of the eclectic theoretical framework of Foreign direct investment (FDI) flows, this study investigates the macroeconomic, political, and institutional determinants of FDI inflowsFDI inflowsto Ethiopia for the period 1970–2013. Using the ARDLAutoregressive distributed lagmodeling approach, it finds that political and institutional factorsInstitutional factorsare crucial both in the long run and the short run in FDI inflows to the country. On the macroeconomic side, the market size of the country, availability of natural resourcesNatural resources, openness to trade, and deprecation in the nominal exchange rateExchange rate trade zonesare found to positively affect FDI inflows to the country. On the other hand, macroeconomic instability is found to effect FDI inflows negatively. In addition, better political stabilityPolitical stability, government effectivenessGovernment effectivenessand regulatory qualityRegulatory quality, and better performance of the rule of lawRule of laware found to positively affect FDI inflowsFDI inflowsto the country. A careful liberalization of the foreign exchange market and that of external trade, sustaining the current growth momentum of the economy, improving institutional qualityInstitutional quality, and strengthening the political stabilityPolitical stabilityof the country, among others, are fundamental areas that the government could work on to strengthen Ethiopia’s position in FDI inflows on the continent.