ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

ECONOMICS DEPARTMENT

SENIOR ESSAY SUBMITTED TO THE DEPARTMENT OF ECONOMICS IN

PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF
BACHELOR (BA) OF ART IN ECONOMICS

DETERMINANT OF INVESTMENT IN MANUFACTURING SECTOR IN ETHIOPIA

By
Aman Feyisa
Id. No. BER/5449/08

Advisor. Dr. Zerayehu Sime

Addis Ababa
Ethiopia
 Acknowledgement

First and for most, I would like to thanks my Almighty God that saved and helped me from lots
of dangers during my hardship, and for endowing me with the capability and endurance through
all ups and downs. I would like to express my genuine heart full gratitude to my advisor
Dr.Zerayehu Sime for his valuable advice. And I would like to thank my family who committed
their everything without reservation.

I would like to thank the employees of NBE, EIC, and CSA and MOFEC in Addis Ababa for
providing me with necessary data for this paper work. Finally, I would like to extend my
gratitude to my all friends especially my friend Dechasa Kedir who helped me in various ways
during my campus life.

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 Table of Contents
Content Page
ACKNOWLEDGEMENT..........................................................................................................................
List of Figures.............................................................................................................................................
Tables pages...............................................................................................................................................
Diagram page...........................................................................................................................................
List of Acronyms........................................................................................................................................
Abstract.......................................................................................................................................................
CHAPTER ONE.........................................................................................................................................
I. INTRODUCTION...................................................................................................................................
1.1Background of the Study.....................................................................................................................
1.2 Statement of the Problem....................................................................................................................
1.3 General Objective........................................................................................................................
1.3.1 Specific Objective........................................................................................................................
1.4. Scope of the study……………………………………………………………………………….
1.5 Significance of the Study....................................................................................................................
1.6 Organization of the Study...................................................................................................................
CHAPTER TWO.......................................................................................................................................
II. LITEATURE REVIEW...............................................................................................………………
2. Basic concept and Definition of term.....................................................................................................
2.1. Basic Theories and hypothesis of Investment......................................................................................
2.2Empirical Literature Review.................................................................................................................
2.2.1 Determinant of investment in manufacturing sector in Africa Empirical Evidence on the.............
2.2.2 Determinant of investment in manufacturing sector in Ethiopia …………………………………
2.3 conceptual frame work………………………………………………………………………………
CHAPTER THREE..................................................................................................................................
III. TERND AND STRUCTURE OF INVESTMENT IN MANUFACTURING SECTOR
3. Trends of Investments in manufacturing sector in Ethiopia..................................................................
3.1 structure of investment in manufacturing sector in Ethiopia……………………………………….
3.2 Determinant of investment in manufacturing sector in Ethiopia and their trend…………………..
CHAPTER FOUR.....................................................................................................................................
IV. METHODOLOGY OF THE STUDY AND ECONOMETRICS ANALYSIS

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4. Methodology the study...............................................................................................................................
4.1. Method of Data Analysis.........................................................................................................................
4.1.1 Descriptive Analysis...............................................................................................................................
4.1.2 Econometrics Analysis..........................................................................................................………….
4.2 Model specification……………………………………………………………………………………..
4.3 Data and data source…………………………………………………………………………………….
4.3.1 Variable, description of variable and expected sigh…………………………………………………..
4.4 Econometrics analysis of the study……………………………………………………………………..
4.5 Estimation technique…………………………………………………………………………………….
4.6. The regression………………………………………………………………………………………….
4.6.1 Econometrics result and discussion……………………………………………………………………
4.6.2Summary statistics and distribution issues…………………………………………………………….
4.6.3 Test statistics………………………………………………………………………………………….
4.7 Long run and short run estimation of the model……………………………………………………….
4.8 Interpretation of the result of both long run and short run model………………………………………
CHAPTER FIVE.........................................................................................................................................
VI. CONCLUSION, POLICY RECOMMENDATION AND LIMITATION OF THE STUDY...............
5.1 Conclusions............................................................................................................................................
5.2 policy Recommendations.......................................................................................................................
5.3 Limitation of the Study ………………………………………………………………………………..
References

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List of Figures page
Figure 3.1 The Trends of Investment in Manufacturing sector (in million birr).............................

Figure 3.2 Trends in Real RGDP (in million birr)………..…….....................................................

Figure 3.3 Trend of inflation rate..................................................................................................

Figure 3.4 Trends of Real Effective Exchange Rate.....................................................................

Figure 3.5 Trend of Capital Expenditure (in million birr)…………………………………………..

Figure 3.6 Trends of Real Interest Rate………………………………………………………………

List of Tables

Table page

Table 4.1 summery statistics……………………………………..…………..……………….

Table 4.2 Distributive Statistics of the Variable………………………………………………..
Table 4.3 result of ADF test for unit root test …………………………….…..……….…….

Table 4.4 co-integration …………………………………………………..……………..........

Table 4.5: Multicollinearity test………………………………………………………….………….

Table 4.5 regression result of the long run model…………...…………..………….…………

Table 4.6 regression result of the short run model...………………….…………….…………

Diagram page
Diagram 2.1 conceptual frame work…………………………………..…………………..............

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ACRONYMS

ADF ………………………………………..Augmented Dickey Fuller

ADLI……………………………………….Agricultural Development led to Industrial

EEA…………………………………………Ethiopian Employment Agency

EPRDF………………………………………Ethiopian people Republic Democratic Front

FDI………………………………………….. Foreign Direct Investment

GDP…………………………………………. Gross Demotic Product

GTP………………………………………….. Growth and Transformation Plan

IMS ………………………………………….. Investment in Manufacturing Sector

LDCs…………………………………………. Least developed Countries

MOFEC……………………………………… Minister of Finance and Economic Commotion

MPK…………………………………………. Marginal product of capital

NBE………………………………………….. National bank of Ethiopia

OLS…………………………………………...Ordinary Least Square

PASDEP…………………………………….Plan action for Sustainable Development Reduction

poverty SAP…………………………………………Structural Adjustment Program

SDPRP……………………………………......Sustainable Development and Poverty Redaction

TYPP…………………………………………Ten Year Prospective Plan

WB…………………………………..............World Bank

Abstract
This paper examines the major determinant of Investment in the manufacture sector in Ethiopia
using time serious data from the period of 1975-2017. Based on Econometric findings in which it

6
supports short run and the long run model estimation over other methods of procedure confirmed
that domestic manufacturing investment affected by different parameters: precisely,
macroeconomic factors including variations in output or real GDP, real interest rate, capital
expenditure, inflation rate and exchange rate movement in the economy are the main factors for
the variability of investments in the manufacturing sector across different times. The finding of
the study also presents pooled OLS outcomes to see the investment in the manufacture sector has
positively associated with real GDP growth, real exchange and capital expenditure. On the
contrary, the real interest rate and inflation rate, movements are unfavorable effect on the
investment in the manufacturing sector. Thus, improving macroeconomic variable through
adjusting fiscal policy and in the same way through the monetary channel control of inflation and
reduces the real interest rates believes to create stimulating and rewarding effect for investment
in manufacturing sector activities in Ethiopia.

CHAPTER ONE

I. INTRODUCTION

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1.1. Background of the Study

For economic development industrialization is the base. This is because of industrial expansion
is necessary to raise growth of income and employment and also to diversify the export and thus
extend market and avoided the excessive dependence on the few commodity for foreign
exchange and protect the economy from worsening or deficit of the term of trade. At the same
manufacturing industries has been the critical agent of structural transformation from primitive,
low productivity, low income, to the dynamics sustainable and diversified” (Lall, 1985).

The manufacturing sector is one of the most dynamics and essential component of the good
producing sector of an economy. The development and the expansion of manufacturing
industrial sector is important to increasing agricultural productivity through providing
agricultural input and by creating the agricultural output demand . the expansion of manufacture
input is play significant role by stimulating other economic sector such as trade constriction and
other service sector and also important to reducing the number of unemployment rate
(Sintayehu, 2013)

In Ethiopia modern manufacturing had begun in the early 20th century, mainly following the
construction of the Ethio-Djibouti railways. Growing demand for manufactured imported goods
on the one hand and rising cost of transportation for the imported goods on the other were
believed to have necessitated domestic manufacturing. The expansion of manufacturing in
Ethiopia is believed to have benefited from the entrepreneurial skills of foreigners (from
Armenia, Italy, Greece and India) who had begun settling in the country at the time (Befekadu et.
al., 2000).

During the Imperial regime private ownership was dominant (the majority of the firms being
owned by foreigners either fully or partially as joint ventures) in the manufacturing sector. The
role of the government was limited at the time as it owns (either fully or as a shareholder) a small
proportion of the manufacturing firms (Befekadu et. al., 2000). During the Derge regime, the
manufacturing sector became under full control of the government as a result of the socialist
ideology the government chose to pursue. Consequently, the government nationalized all
privately owned large and medium scale manufacturing industries, prohibited ownership of

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private firms in some sectors (particularly in large scale manufacturing), imposed a ceiling on
capital investment on others, and instituted various rules and regulations that discouraged private
investment in the manufacturing sector (MEDaC, 1999). These had greatly constrained the
development of the manufacturing sector during that period.

The current government after it came to power in 1991, adapted and implement under structural
adjustment program during transition period. And thus followed agriculture development led
industrialization (ADLI) and lifted the restrictions (probably not all) imposed by its predecessor
and took various reform measures as well, such as privatization of selected public industries and
public enterprises reform program, which limit public ownership, encourage expansion of the
private sector, and enhance efficiency and competitiveness (ICC, 2004). As a result, the number
of large and medium (L&M) scale manufacturing industries has considerably increased in the
country as revealed by a series of census surveys conducted by the Central Statistical Authority
of Ethiopia (CSA). The Industry development strategy of the country has put in place the
principle of that primarily focus on the promotion of agriculture led industrialization, export led
development and expansion of labor intensive industries.

However in Ethiopian economy the contribution of industry especially in manufacturing sector to

over all GDP of the country is lower and stagnant. For example, from contribution of industrial
sector 13% of GDP, the share of manufacturing was only 5% in 2006, in2010/11 the output of
industrial contribution to total GDP which was 13.4%. But the share of manufacturing sector was
5%.whichmeans the same to 2006(computed from MOFED report 2010/11).

In this regard in Ethiopia the manufacture industry growth has virtually stagnant and lower per
capital level of the manufacturing value added relative to population growth. And the industrial
sector of Ethiopia depends not only on imported inputs; but also on imported industrial
technology, about 98% of machineries and equipments of new establishment and 80% of spare
parts required for existing industries are imported from abroad. Hence has not developed
significant technological base to its own development of other economic sector. This is partly
because very little or no attention was given to the local technological capability. In addition to
financial performance of sector has also remained poor (cannot finance itself).These is the

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problems in the economy which were affecting the development of the manufacturing sector in
Ethiopia. The main constraints of manufacturing sector are technology related, market related,
finance related, policy related, input related, human resource related and sociopolitical factors
(EEA, 2009/2010).

The current government also committed for the development of industrial sector through new
development of growth and transformation plan (GTP) which enables the manufacture sector to
play considerable role in economic development by promoting export oriented industrial
development and import substituted based on free market (World Bank, 2010).

Despite the government plans to broader industrial base through establishment of basic industry
and expansion of existing industry to warren the basic industrial in non metallic mineral, though
this sector is dominated by the cement production. On the other hand the chemical sector
continues to orient to warren the production of final good.

Therefore key area of this paper is to investigate the determinant of investment in manufacturing
sector and focused on the role, trend and the main obstacle of investment on manufacturing
sector in Ethiopia becomes the basic themes of this study.

1.2. Statement of the Problem

Economic development of the countries and society welfare depends up on the development of
industrial sector. Industrialization is pre-request for economic development as the history of
developed countries show. Industrialization is necessary in order to provide employment to the
underemployed and unemployed in agriculture sector. Further the share of industrial sector is
better than the share of agricultural sector because of industrialization is important for generating
of employments opportunity, better utilization of all type of resource than agriculture. The
agricultural production is limited to availability of land but industry is not limited in land scope
as result industrialization is capable of removing regional disparities. Industrialization is essential
for LDCs because it bring increase the return and economic scale , free themselves from adverse
effect of fluctuation in primary product, and distortion in term of trade ,people enjoy the fruit of
modernization in the form of variety of good and service available of in urban
area(Netssanet,2011).

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So industrialization is important for bring social transformation, social equity, equitable
distribution of income and balance of regional development in the process of economic
development and also economic prosperity is brining from by increasing manufacture quality.
“A critical development of challenge for African economy is increasing the contribution of
manufacturing to GDP and world export of manufacture product” (Shiferaw, 2007).

There was rapid economic growth, but Africa industry remains small and underemployed. If this
trend is not reserved, Africa is likely to remain mainly dependent on agriculture and extraction
natural resource in the foreseeable future (Mans Soderblom, 2011).

The same to Africa, Ethiopia critical development challenge is increasing the contribution of
manufacturing sector to GDP and increase of export of manufacture goods. The Ethiopian
manufacturing sector is stagnant for long period of time, for example: the contribution of
industrial sector in 2006 is 13% of GDP but the share of manufacturing sector is only 5% and
also in 2010/11 the total contribution of industrial sector is 13.4% but the share of manufacturing
sector is also the same to 2006 period that means 5%, the same to 2006 (computed from MOFEC
report).

Between 2004 and 2014 manufacturing has been grown at 11% and manufacturing export
increased more than even told this was largely because of the increasing export earnings of the
foot wear and apparel industries. However the share of manufacturing at the gross GDP remains
5% well below the Africa average of 10%. Manufacturing value added (%of GDP) in Ethiopia
was reported at 4.34% in 2016 (World Bank, 2016).

Many papers have attempted to study the determinant of investment in manufacturing sector.
Bezawork Hailu (2007) undertake the study on the determinant of investment on manufacturing
sector in Ethiopia in this study, the data used from 1974-200 as she found a gross saving, and
current government policy have positive impact on investment in manufacturing but interest rate,
inflation rate, and war are have negative impact on investment in manufacturing sector, both in
short run and long run but this paper lacks description of all variables included in the model. For
example, budget deficit and capital expenditure.

SintayehuNigussie (2013) he found out that the higher expected inflation rate would induce
increases the real investment rate and the real interest rate fluctuations from time to time was not

11
unable to affect investment activity. Mohammed (2006) he found also the real interest rate did
not affect the real investment activity. Siyoum (2007) he suggest that tolerable domestic inflation
stimulate investment in the short run.

Therefore for the aim of this study is to further investigate the determinant of investment in
manufacturing sector for the period of 1975- 2017, to solve the contradictions that existing
literature has regarding the effect of the determinant investment in manufacturing sector. And to
identify the main obstacle to the growth of investment in manufacturing sector in Ethiopia and in
addition the study will close the time gap of existing literature and analysis the performance of
the sector in the country and identify their any reminds to improve their problem

1.3. Objective of the Study

The general objectives of the study are to investigate the major determinants of investment in
manufacturing sector of Ethiopia.

1.3.1. Specific Objectives

 To analyze the performance of investment in manufacturing sector in Ethiopia

 Show the major determinants of investment in manufacturing sector in Ethiopia

1.4. Scope of the Study

The main focus of this paper is to identify the factor that affecting the investment through
directly or indirectly in the manufacturing sector in the period from 1975 to 2017. Due to
different time and cost constraint the study has limited to investigate the factor that affecting
investment in manufacturing sector and investigation was based on secondary data.

1.5. Significant of the Study

The main purpose of this paper can be seen from two perspectives that is, policy perspective and
academic perspective and other goal is to increase share of manufacturing sector in sustainable
basis as one of the central objectives of the study. The study will attempt prove on empirical
evolution on the impact of government investment policy because the good policy make draw
input from many source and research is one of such input in addition to these paper will add the

12
empirical verified idea to the stock of knowledge hence the student can also use it as a reference
of in the future research work.

The industrial policy should be designing in such way that they will alleviate the constraint in the
sector. In these regard, there for these study is relevant in indicating the current status of
Ethiopians manufacturing industries and the most serious problem encountered its activity with
their possible solution.

1.6. Organization of the study

This paper organized in such way this is chapter one contain introduction to the topic, chapter
two of the study deals with the review of literature, chapter three contain descriptive analysis of
the study, chapter four study about the econometric analysis of the study and the last chapter are
contain conclusion, policy recommendation limitation of the study.

CHAPTER TWO

II. LITRERATURE REVIEW

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2. Basic Concept and Definition Term

Usually and the most definition of investment as all resource spent for acquisition of capital
stock, for enhancement of technology and work method improving entrepreneur management
skill (Hashim, 2003).

According to economics, investment is the utilization of resources in order to increase income or

production output in the future or the purchase of goods that are not consumed today but are used
in the future to create wealth. In finance, an investment is a monetary asset purchased with the
idea that the asset will provide income in the future or appreciate and be sold a higher price
(Investopedia, 2014).

In addition mankiw defining Investment as spending on the factor of production like capital,
spending on goods bought for future use and divided it in to three sub- categories. The first
category is the business fixed investment which including the purchasing of new plant and
equipment by firm, Second is the residential investment which is about purchase of new housing
by household, and, third is inventory investment which is about the increasing firm inventories of
good (Mankiw, 2007).

2.1. Basic Theories and Hypothesis of Investment

There are different theories of investment and there exists a considerable variation among
Economists as to what determines investment behavior. Therefore, in this section the study
review some of widely discussed theories of investment.

A. Classical theory

The fundamental principle of the classical theory is that the economy is self –regulating through
the market system this theory is based on two firmly held beliefs. The first is says law and the
second is belief that price, wage and interest rate are flexible to create perfect competitive
market. The says law “supply create its own demand” state that when an economy invests and
produces a certain level of real GDP. In other word, the economy is always the power of
demanding the entire output that is workers and firms choose to produce. Hence the economy is
capable to achieve the natural level real GDP.

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But the achievement of the natural level of real GDP is not as a simple as says law would seems
to suggest. It is true that the income is obtained from production of certain level of real GDP.
Must be sufficient to purchase that the level of real GDP. But there is no grant that all these will
be spent. Some of this income will be saved. Income is that is saved is not used to purchase
consumption good and serves implying supply.

If aggregate demand is fall below aggregate supply due to saving, investor will cut back their
investment and cause the real GDP to fall below the natural level. As result, the economy may
not achieve the natural level of GDP if there is aggregate saving. The classical economist
response that is that the fund from aggregate saving are eventually borrowed and turned in to
investment expenditure which are component of real GDP. Hence aggregate saving is not leads
to reduction in the investment rather make it to rise along with these increase in the level of
investment the economy will expand.

B. Keynesians theory of investments

J.M Keynes (1936) who was the pioneer to analyses systematically and questions the then
exciting ideas a bought investment is the most volatile macroeconomic component due to the
uncertainty that attached with the return from it. Firm makes the choice of investment only after
comparing the marginal efficient of capital with the interest rate, which is opportunity cost of
invested capital. He realized that this choices of investment could be revised either by increase
the marginal efficient of capital or by reducing the interest rate.

In his general theory, investment played a key role in that it was present as the most important
factor governing the level of spending in an economy, despite that the fact that it was only small
fraction of the total spending. This paradox can be understand in term of “multiplier” concept the
multiplier is the amount by which a change in investment word be multiplying in achieving its
final effect on income or expenditure.

Keynes was not only introducing but also analyses broad the interdependence of relationship
between incomes, consumption and saving. In this analysis he defined the proportion of any
additional income that budget for consumption of marginal propensity to save (MPS) and there
was also an empirical relationship consumption saving and investment (Fridric, 2010).

15
Keynesians economics further argues that the government expenditure in infrastructure
technology, educations and even in some productive activities will discourage privet investment
i.e. it crowd out. An increasing government borrowing (a kind of expansions of fiscal policy),
reduce investment spending in the other word; the increased Borrowed crowds our privet
investment.

Original crowing out was related to an increasing interest rate from the borrowing, but latter
broadened to include many factor such as decreasing in tax revenue which leads to a deficient for
government that is financed by increasing borrowing. Generally economist used the term of
“crowding out” to refer to the government spending using up financial and other resource that
would otherwise be used by privet enterprise.

Finally, Keynes argument which states that investment is depend up on the prospective marginal
efficiency of capital relative to some interest rate i.e. the opportunity of invested fund faced
critical challenge in 1950s and early 1960s. Other economist formulate model that gave rise to
the accelerator theory of investment.

C. The accelerator theory

The accelerator theory was developed early in the 20 th century by Tomas Nixon afflation among
other. In the 1950 and 1960, the accelerator theory of investment postulated a linear relationship
between investment and output. According to this theory the investment requirement for a certain
desired target of output growth is computed from a given incremental capital output ration.
However this model disregarded the importance of expectation, profitability and cost of capital,
in stark contrast to the forward looking nature of investment (Shibeshi, 1994).

This theory is based on the following simplistic assumptions.

1. There is a constant ration of desired capital stock to output
2. There is sufficient investment to keep actual capital stock to desired level (Akpalu,1997)
D. The neo- classical theory

Jargeson (1967) and Hall and Jargeson (1971) formulated the neo-classical approach which
criticized the accelerator model on its static assumption. In this approach, the desired or optimal
capital stock is proportional output and the user cost of capital (which intern depend up on the

16
price of capital good, the real rate of interest, the rate of deprecation and the tax structure )
which has an impact on the privet investment behavior (BrasonH,1989)

Even though the neoclassical theory of business fixed investment seems to be more
comprehensive in its approach. It has criticized because of its assumption of perfect competition,
exogenously give output, which are inconsistence with the real world. Moreover, the assumption
of static expectation regarding policies, interest rate and output failed to pass the test of time due
to the fact that economic agent have rational expectation about the future.

E. The Tobin’s q theory

The Tobin’s theory also called general equilibrium theory or q theory was proposed by the US
Nobel laureate economist James Tobin. Economic theory or investment behavior where q
represent the ratio of the market value of a firm existing share (share capital) to the replacement
cost of the firm physical asset (thus, replacement cost of the share of capital) which is given by

marketvalueofinstalledcapital
q=
replacemntofinstlledcapital

It is states that if q (replacement equilibrium) is greater than one (q>1), additional investments in
the firm would make sense, because the profits generated would be exceed the cost of assets.
Firm can be buy new plant which expand the volumes of investment and hence the GDP on the
other hand if q is less than one (q<1), firm do not have the ability to buy new plant rather they
buy used ones which could not bring any change on the GDP. The advantage of Tobin’s q as
measure of incentive to invest it reflects the expected future profitability of the capital as well as
the current profitability (Investopedia, 2014)

F. the Neo-Liberal Theory

The followers of this approach are McKinnon and Shaw (1930), the center of their argument
resets on the claim that developing countries suffer from financial repression. According to this
school of thought, government and central bank regulations distorted financial markets resulting
in adverse effect on saving and investment decision (Asante,2000).financial repression reduce
the quantity and quality of increasing investment in an economy by promoting economic
dualism(co-existence of both modern and traditional production techniques) in developing

17
countries hence they recommend financial liberalization as means of increasing investment and
productivity which in effect enhance economic growth.

The McKinnon and Shaw hypothesis further emphasized that very low and negative real interest
rate resulting from financial disintermediation and hence reduce growth through lower level of
investment (Fry, 1996).

2.2. Empirical Literature Review

Different researchers have conducted research on the determinants of investment in

manufacturing sector looking at the firm level and at the aggregate level analysis. Most of the
study focused on testing several hypostases advanced to explain the variation in investment
especially in investment in manufacturing sector in the countries. The result indicates that the
feature that influenced investment directions are varied among the nation. Given that the purpose
of this section is to investigate the determinant of investment in general and investment in
manufacturing sector in particular in empirical context on some in other developing countries,
and in Ethiopia.

2.2.1. Determinants of Investment in the Manufacturing Sector in Africa

There are few studies on the determinants of investment in the manufacturing sector. Most of
them mainly focus on the role of manufacturing sector to the GDP, while others focus on policy
issues. It is clear that, to study the whole Africa at a glance is difficult. However, it is possible to
draw some macroeconomic conclusion about Africa investment in manufacturing. In Africa
poor growth performance is partly the result of inadequate privet investment and stagnant in
public investment.

The Africa growth process characterized by widening gap between saving and investment in the
year between 1974-1980 saving investment gaps was 0.6% but in 1995 the gap was increases to
2.9% so this widening saving investment gap has been covered by increasing the role of aid flow
in the total investment in Africa. However increase in dependence on aid has negative impact on
the economic growth of Africa.

Kamarudeen and Soderbom 2013 they studied the manufacturing sector of Rwanda with its
constraints and opportunities. They define small scale manufacturing enterprise (SME) those

18
enterprises employing 10 to 100 person and large firms employing more than 100 people. As
their result shows large firms are more productive than SME and they have close to four times as
much capital stock per worker. It is also indicated that owned by foreigner are more productive
than firms owned by Rwandan people. This is because; foreigners come with higher skill and
knowledge about the market which give them advantage over the domestic firms.

The study also describe that firms located in Kigali (the capital city) and around are more
productive than others, which is the result of access to skilled employed, infrastructure and
information. They use the Cobb-Douglass production function for their analysis The finding of
the paper also suggests that younger firms have higher probability of investing than older firms,
because; young firms often need to invest in their early stage. Credit does not play high role in
investment decision in Rwanda. This is the result of the fact that most firms finance their
investment and operation capital using enterprise funds.

As indicated earlier firms owned by foreigner are more productive than firms owned by
domestic investors. The paper does not show the long run effect of social and cultural change
that come through foreigners. This change may lead to change in society's way of life either
positively or negatively. On the other hand, if the difference is high between domestically owned
firms and foreign owned firms competitions for domestic firms become difficult. The other
result is firms located in and around the city more productive than others. If this is the case, more
firms need to be located in and around the city so that; the development of social infrastructure,
communication and others will be affected adversely. This is because; it is through
industrialization that the social and economic development can come, where the life of the
society improves, market condition become competitive and everyone in the economy
participate to the maximum possible.

Mbugua, (2000) carried out the study on the micro and macroeconomics determinant of
investment in manufacturing sector in Kenya. His study identified expenditure on infrastructure,
public expenditure on education ,public debit, real interest rate and real GDP lagged on the
current and the past once as the main determinant of privet investment in manufacturing sector of
Kenya. His model was the privet investment equation by using OLS method and the period
covered from 1964-1998 the result indicates the real interest rate, public expenditure on
infrastructure, lagged credited to privet sector, real GDP lagged once and public expenditure on

19
education lagged twice all have positive relation with the privet investment on manufacturing
sector in Kenya, but public debit are negative impact on privet investment on the manufacturing
sector in Kenya.

Elhiraika,(2008) the main objective of the paper was to investigate the role of structural
dynamics and transformation, specifically in increasing the share of manufacturing in aggregate
output, in accelerating growth and reducing volatility in Africa growth. The study uses data of 36
countries to examine the main determinants of manufacturing share in total output and its
relation with real gross domestic product growth and growth volatility. The model used in the
paper is the modified form of Chenery- Syrquin model of economic transformation by both cross
sectional and time series data. A cross sectional data from 1980 to 2007 is used to estimate the
regression analyzes.

The result of the study shows that initial level of income has a positive and significant impact on
the share of manufacturing value added in aggregate output, which gives insight to the
importance of income variable in stimulating manufacturing and directly supports the argument
that the failure of the import substitution strategy and consequent deindustrialization in many
African countries in 1980s and 1990s had more to do with policy mistakes than income and
market opportunities as sited on Aryeetey 2003 and Das gupta and Sigh 2006. Initial population
has a positive impact on manufacturing value added as indicated on the paper.

The researcher also states that countries with large population are more likely to industrialize
than others, because, large population means larger market for manufactured goods. It also
suggest regional integration for African countries as a means to expand market and promote
global competitiveness in the region because, many African countries have small population. The
result also suggest domestic investment has the most significant impact on the manufacturing
sector followed by growth in Africa's major trading partner (OECD countries) and the labor
force variable.

As indicated above; large population is related with increased share of manufacturing to the total
output. But, population by its own does not mean increase market and productivity. The increase
in population may adversely affect the environment, because when population increases the need
for basic necessities increase which is not described on the paper. On the other hand labor force

20
has positive relation with growth in the manufacturing share in total output as described earlier.
However, there must be distinction between productive labor and non productive labor as well as
employed labor and unemployed labor.

MansSoderblom (2011) he uses a firm level data to analyze the change in Ethiopian
manufacturing sector structure between 1998 and 2008. The main focus of the paper was on firm
size and their economic performance measured by value added per worker. The study tried to
answer the question such as; why large firms produce more physical output than small firms. As
the researcher studied, one possibility is that workers in large firms are more skilled than small
firms. But the researcher does not test this possibility because of lack of data on human capital of
employees.

The other possible reason for large difference in physical labor productivity across small and
large firms is that large firms have more capital and use electricity per worker than small firms.
MansSoderbom also added raw material per worker by using the Cobb-Douglass production
function expressed by labor productivity form. The result indicates strong relationship between
raw material per worker and output per worker. The researcher at the same time tried to
investigate the relation between firm size and product selection of firms. Based on the data of
central statistical agency over the year 1998 - 2008; there are 17000 firms year product
observation in formal manufacturing firm.

The main issue of the paper is that whether the product category is reasonably homogenous or
not. As investigated by the researcher product selection difference exists across small and large
firms. For 14 products under consideration, the size coefficient is statistically significant at 10%
level of significance or better. As a result, large firms are likely to produce beer, soft drink,
cotton, cotton fabrics, cotton yarn, leather garment, hides, cement and wires. On the other hand,
small firms are more likely to produce edible oil, cakes, bread, gravel, plastic, foot wear and
cement blocks. The study give little hint to the Ethiopian manufacturing. Drawback of the paper
are, first; it uses cross sectional data, so it does not show the long run trend of the sect oral
change, in which many variables that affect investment in the manufacturing sector can be
included under the study. To indicate the long run trend of the sector, we have to use long run

21
determinants of investment such as; GDP, inflation, interest rate etc. Second; the paper mainly
focuses on firm size while there are many variables which affect industrial performance. Some
the main factors are capital expenditure to the manufacturing sector, real GDP policy of the
industry and inflation. And the model used OLS method.

BezaworkHailu, (2007) with the objective of investigating the main determinants of investment
in the manufacturing sector she tried to include variables such as real gross domestic product,
inflation rate, real exchange rate, budget deficit, policy and Capital expenditure in her analysis.
The data used was from 1975/76 to 2004/05 with simple OLS regression method of analysis. The
result of the paper shows that variables such as real interest rate, inflation rate and policy of the
country have negative relation with investment in the manufacturing sector.

On the hand, variables such as real GDP and gross domestic saving have positive relation with
investment in the manufacturing sector. The paper lacks description of all variables included in
the model. For example, budget deficit and capital expenditure were included in the model but in
the regression analysis there is no any result showing the relationship between these independent
variables and the dependent variable. The other limitation is that the study did not show tests of
regression such as stationary test, co integration test and the paper did not indicate normality of
the variables. The research also did not describe anything about the skewness and kurtosis of the
variables. As my knowledge is concerned, there are not enough studies that show the main
obstacles for investment in the manufacturing sector. But there exists the continuous study of
Mans Soderblom in the Ethiopian manufacturing.

2.3. Conceptual Framework

The current study was conducted based on a conceptual framework drawn from the theoretical
and empirical literature reviewed and explained above. The main determinant variables at
macroeconomic and microeconomic levels in various research literatures were identified but the
study only makes use of independent variables at a macroeconomic level. From the literature
review above, the following schematic representation of the conceptual framework or model for
this study was developed. It depicts the relationship of independent variables within the
dependent variable which is investment in manufacturing sector.

22
 Financial
Inflation rate
Availability

Real
Real gross Investment in Capital interest rate
domestic product Manufacturing expenditure
sector

Real exchange
Bureaucracy rate

Diagram 2.1 conceptual frame work

Source:

2.3.1. Determinates of Investment in Manufacturing Sector

High inflation rate high rate of inflation adverse effect (but not necessary)
investment activity by increase the risk of long term investment project, reducing
the average maturity of commercial loan, and distorting the information converted
by price in the economy. In addition, high inflation rate are often consider sign of
macroeconomic instability and the inability of government to control
macroeconomic police, both of which contribution to an adverse effect on
investment climate.

 Interest rate if interest rates are high then it makes it expensive to borrow money. This
will decrease investment because investment is often financed through borrowing. Also
23
 when interest rates are high it makes it more attractive to save money. Investment is often
financed out of retained profit. High interest rates mean that investment is relatively less
attractive than saving money in a bank

Gregory mankiw on investment and interest rate

Mankiw 2007, the quantity of investment is determinant by the level of interest rate if the interest
rate is rise, fewer investment projects are profitable and the demand of investment in good is
decline. When the overall changes of price level is essential to make distinction between the
nominal and the real interest rate nominal interest rate is the rate at which the inventory pay for
borrowing money, while the real interest rate is the rate at which is after adjusted the rate of
inflation. Mankiw summarized that inverse relationship between investment and the real interest
rate.

 Financial availability in LDCs the firms are not strongly enough to finance their
expenditure and or the firms are failing to adequate self financing. This may be due to two
reason, first is the low level of per capital income of population which is result low level of
saving and low demand of investment, second is the insufficient operation of financial
system and absence of capital market which could be mobilize saved resource and direct
toward productive investment.

 Lack of infrastructure the supply of infrastructure facilitate such as electricity, telephone,

water and road are ply a significant role to the development of investment however those
institution which concerned with the privation of physical infrastructure in the country have
weak capacity and there is no coordination between institution those poses several problem
on the development of manufacturing sector. In addition to this the cost of
telecommunication and electricity also affected the investment activity

 Foreign exchange shortage due to shortage of foreign exchange which caused by inelastic
export supply, exogenous rise in price export good, external credit rationing by international
financial institution and increase interest rate. (Martian and Wanon.B, in 1992). Hence, in
developing countries there are a shortage of foreign exchanges for investment in
manufacturing sector so these is one of the factor for under development of manufacturing
sector

24
 Administrative constraint (Bureaucracy), the bureaucratic procedures in many
government office of the country also act as a bottleneck to the flourish of private sector in
the country. The tradition which the huge socialistic bureaucracy left is still there in many
government offices. Even though the government have taken appropriate policy measure to
slim the huge socialist bureaucracy through reorganization of government institution and the
introduction of one stop service of investor still unnecessary administrative procedure and
corrupted are seen in many government office.

 Limited access of raw material, are the main ingredient in production process of any
activity. The availability of wide alternatives of raw material is primary question of firm to
produce and supply their output time. In other word, the presence of will functioning input
market and early access to their imported raw material help for the growth of privet
investment. Many industrials are established in the area where availability of market,
transportation facilities. Low cost of labor and other production input is conducive. But
availability of raw material should be given priority, because, in order to bring this raw
material to the production area there are many cost; such as, transported cost, loading and
unloading etc.

CHAPTER THREE

III. The Trend and Structure of Investment in Manufacturing Sector

25
Introduction

It is fact that Ethiopia has made a considerable progress in economic and social development
since the reform period of 1992. Modernization in the agriculture sector, government led to
development investment, improvement in the performance of privet sector and strong global
commodity demand are among the core reason of such progress. Building on the expanding
economic base and working with the developmental state model, the government seek to
transform the economies based on the major investment in economic infrastructure (such as
energy, transportation, telecommunication, educational attainment, hospital, etc ), economic
management reform, strategic public sector involvement and the development of private sector
on capital formation in the economy. For example, the development of industry parks or
industrial development zone, this was taken as a model of from 20 year back history of china and
South Korea are starting to spring across Ethiopian with relatively massive engagement of privet
investment in to industrial sector.

Even though, Ethiopians business climate rank relative low globally, export are growing (for
example Ethiopia has becomes one of the largest exporter of flower product since 2005 with
privet investor playing the leading role). In addition to this FDI flow in to the country is also
rising. Ethiopia is now seeking for labor and capital intensive manufacturing just what has been
achieved the economic growth target.

3. Trend of the Investment in Manufacturing Sector

Pre 1974 the economic strategy of the country during this period was export trade development
aiming to earn more foreign currency to finance the import of more capital good to accelerate
the overall development process. Manufacturing in Ethiopia was, before 1957, dominated by
cottage and handicraft industries which met most of the population's needs for manufactured
goods such as clothes, ceramics, machine tools, and leather goods. Manufacturing in Ethiopia’s
5 years plan began in 1957. These policy measures, in effect, were able to attract both domestic
and foreign investors to participate in various industrial and agricultural activates. Despite, the
development efforts made by the private and public sectors, the overall performance of the
economy in the imperial regime had been at low level. Among other the main reasons
responsible for that were; the policy was in favor of foreign investors.

26
The command economy policy of the Derg (1974-1992), which was centered on the socialist
economic system, gives the dominant role to public sector than privet sector. All of the
manufacturing activities are controlled by the central authority. The policy of military
government started to be implemented by the nationalizing private properties and institutional
central planning as means of allocating resource. The outcome of such policy were weak and
together with internal and external conflict on Ethiopia a substantially lower level of economic
growth has been registered and the progress of manufacturing sector also sharp decline
particularly in the first few year from 1977-1980 and stagnant type of growth rate after
formulating of ten year prospective plan (TYPP) from 1983/84-1993/94 this plan is focused on
promoting import-substitution and labor intensive industry in this period small industrial
progress. In the last year of Derg regime occurred another shape decline in the Ethiopian
economy particularly the manufacture sector was more affected. Finally just before the dawn
fall of the regime in 1990/91, mixed type of economy was introduced.

In 1991/92 EPRDF comes to power and declared the new market oriented policy so that the
greater participation of privet sector in the economy was taken place. Some of the reform, which
including short term economic stabilization and structural adjustment measure the favorable
policy environment created by the economic reforms, coupled with macro-economic stability,
increasing the manufacturing sector and the economy in general. For example, in 1993 the
industry and manufacturing value added grew by about 31 per cent and 49 per cent respectively,
reversing the declining trend in the three preceding years The high growth period, however, did
not last long and started to slow down by 1996. The value added growth of the industry and the
manufacturing sector in the period 1996-2003 was only 5 and 3 per cent annual average,
respectively, which is only modest in comparison to the preceding years.

The industrial policy was more concerned into action by various sub-sector strategies and by the
successive development plans such as Sustainable Development and Poverty Reduction Program
(SDPRP) 2002/03-2004/05, the Plan of Action for Sustainable Development and Eradication of
Poverty (PASDEP) 2005/06-2009/10, and the Growth and Transformation Plan (GTP) 2010/11-
2014/15. The first development plan gave great emphasis to smallholder agriculture while in the
second and third ones the policy scope was broadened to encompass urban and the industrial

27
sector development. The main emphasis of the industrial strategy is to actively support the
export-oriented and labor-intensive sectors

Fig 3.1. The Trends of Investment in Manufacturing sector in (million)

3500
IMS
3000
2500
2000
IMS
1500
1000
500
0
75 977 979 981 983 985 987 989 991 993 995 997 999 001 003 005 007 009 011 013 015 017
19 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Source: NBE,CSA, EIC and MOFEC we can understand from the graph above that investment
in manufacturing has increasing trends through the period from 1991-2010 and has sharp
increase trend through period 2011-2017.

3.1 The structure of manufacturing sector

Ethiopia’s economy is based on traditional agriculture and service sector in 2013/14 the
agriculture which accounts 40.2 % of GDP, 60 % of the export earning, and 80 % of total
employment and the service sector accounts for 46.2% of GDP while The industrial sector which
accounts very low which are 14.3% of GDP, 9.5 % of total employment, and 21.2 % of export
earnings.

Ethiopia’s manufacturing sector is among the key productive sectors of the economy identified
under GTP I (2010-2015) which can spur economic growth and development because of its
immense potential for wealth creation, employment generation and poverty alleviation. The
manufacturing sector makes an important contribution to the Ethiopian economy and employs
about 173 thousand people in the year 2012/2013. The sector had about 2,610 manufacturing
establishments in the same year and for this study purpose it divided into eight broad subsectors

28
namely food and beverage products, textile and apparel products, leather and leather products,
wood and pulp products, chemical and chemical products, rubber and plastic products, other non-
metallic minerals products and metal and engineering products industries.

The top two manufacturing subsector; food and beverage and metal and engineering industries
accounted for 51% of the sector’s contribution to GDP and the food and beverage sector alone
accounted 38% of the employment in the sector in the year 2012/2013.The manufacturing sector
contribution to the GDP in 2012/2013 was 4.8%. The manufacturing industries in Ethiopia have
not shown the fundamental structural change. the Ethiopian investment on manufacturing sector
very low but also productivity existing industry are too deteriorated because of technological
backwardness, uneducative and unskilled labor force, low productivity of workers and use of
obsolete technologies which is attributed to the poor state of physical infrastructure, limited
access to finance, limited research and development, poor institutional framework, and
inadequate managerial technical skills.
The size of manufacturing industries

The average growth rate of establishment are a dramatically change in each industry group The
number of manufacture which was 408 in 1980/81 increased to 2,610 in 2012/1 Declining
growth between 1980 and 1991(408 to 283), lower growth between 1991 and 2001 (283 to 909),
modest growth between 2001 and 2013(909 to 2610) Among the large and medium
manufacturing processors, which total 2,610 manufacturers,670 establishments are the food and
beverage sub sector it account as that 26.72% up to 42.7% of the total establishment registered in
the specific year and employed more than 67,000 people, followed by non-metallic mineral
products, metal and engineering products, wood and paper products, rubber and plastic products,
chemical and chemical products, leather and leather products and textile products industries with
544, 433, 196, 154, 143, 141 and 104 total establishments for each and 17,230, 13,238, 14,064,
10,984, 9,801,14,019 and 19,233 total jobs created again by each categories of the year (CSA
report 2012). These implies that good business environment, access of international market, easy
loan from the bank access of land and transportation service and other vital for well functioning
manufacturing sector.

The level of employment

29
Despite that the fact the most of Ethiopian industry are labor intensive but the job creating
capacity is quite insignificant in the country with population of about more than 100 million, the
manufacture as the whole proved employment for only 1,882000 this was about 4.7 % of the
total population over the post reform period annul employment increase 3.9%. The stricture of
the weakness of the sector is reflected by employment pattern the four industries such as food,
non metal, mineral, leather tanning and textile contributed to the large proportion of employment
of manufacturing.

It shows the total employment generate from each industry categorize the trend are fluctuate
from year to year during economic reform period since 1991 – 2013/14 the total employment
increase after the reform period the policy reform under take in 1991 was consider a factor for
the enhancement of number of employment in the country food and beverage, textile shows the
same characteristic in other word industry is generating the maximum number of employment in
the period. In addition to these the industry that Show decline in the first phase and finally
increase while the minimum number of person engaged in the most of manufacturing sector was
registered in the year in 1991 and 2000 compared to the previous period.

Although the share of agricultural production in the total GDP has been decline over the time and
falling over below 50% it remained the primary source of foreign exchange earnings and
employment opportunity further more industry contributed to the economy in terms of
employment generating according to the given data the huge number of person engage was
observed n 2013/14 this linked with the advancement of the performance of industry at the
specific year favorable whether condition and positive macroeconomic policy measurement
taken by the government have leads to the significant growth in the sector.

Gross value output in manufacturing sector

The growths of the sector refer to the growth of the net output or gross output of the sector rather
than the number of establishment of the sector. The manufacturing sector consist of the small
portion of the economic contribution of manufacturing to the national income in 2012/2013 was
4.8%. That means 7 times less than agricultural contribution.

Gross value of production by manufacturing sector worth about 113 billion birr in 2012/2013;
and value added generated is estimated to reach 32 billion birr in the same year, which was about

30
4% of the value addition to the entire economy in the same year. The largest value addition was
come from the food and beverage subsector, which was around 8 billion birr in 2012/2013,
followed by non-metallic mineral subsector (4.3 billion birr) and metal and engineering
subsector (3.9 billion birr) while the smallest contribution came from textile and apparel industry
(396 million birr).

The top two manufacturing subsector; food and beverage and metal and engineering industries
accounted for 51% of the sector’s contribution to GDP it is the most prominent group in term of
gross value of production next to it follow in the significant contributed by the industry like;
textile, chemical, robber, plastic, metal and tobacco industry.

3.2 Determinants of Investment in Manufacturing Sector and Their trend

Here in this section the relationship between investment in manufacturing sector and its
determinants has been analyzed using statistical data and graph. This due to the fact that the
investigation expects that investment in manufacturing is to be affected by the determinants that
are included in the study positively or negatively.
Real GDP Growth and Investment in Manufacturing Sector
According to the data from the graph over the last ten consecutive years i.e. during 2005-2015
the economy has registered rapid growth. As the graph indicated above, growth of investment in
manufacturing sector and growth of GDP positively related. In the period 1992, 1998 and 2003
respectively the growth of GDP and investment in manufacturing sector decreased as the graph
indicated. This is because of during this period in Ethiopia there is drought and famine. And also
in the year 1991/92 the growth of GDP and investment in manufacturing sector decreased, this is
due to the political change. Generally the graph shows that the relation between growth of
investment in manufacturing sector and GDP is positive.
Fig 3.2 Trends in Real RGDP (in million birr)

31
 RGDP
12,000.00
10,000.00
8,000.00
RGDP
6,000.00
4,000.00
2,000.00
0.00
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20

Source: MOFEC, NBE, EIC and CSA Hence, from the graph above we can conclude that GDP
has increased from time to time from 2004 to 2017

Inflation Rate and Investment in Manufacturing Sector

The graph presented below shows in the year 1992, 2003 and 2008 and level of inflation is
increased and in the same year the level of growth rate of private investment is decreased. Owing
to tight monetary and prudent fiscal policy measure as well as other structural corrective
measures taken by the government, the general inflation rate come down to 2.8% in 2010. This
shows that the macroeconomic policy measures taken by the government had been effective in
reducing inflation and stabilizing by the end of 2010. In this year the level of investment in
manufacturing sector growth increased. However the inflation problem does not long lasting
recurring; the general inflation was raised to 34.1%, 13.5%, 8.1% and 8.4% in 2012, 2013, 2014
and 2015 respectively. In the same year growth rate of investment in manufacturing sector
decreased.

Figure 3.3 Trend of inflation rate

32
 INF
60.0
50.0
40.0
30.0 INF
20.0
10.0
0.0
-10.0 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0
-20.01 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Source: NBE, EIC, CSA and MOFEC: we can conclude that inflation rate and growth of
investment in manufacturing sectors is negatively related as shown on the graph.

Growth Rate of Real Effective Exchange Rate and Investment in Manufacturing Sector

As shown in the graph below, real effective exchange rate growth increasing slowly because of
the command economic policy at that time the exchange rate was fixed. The investment in
manufacturing sector growth in this period was shown very small increase because the policy of
government blocked foreign direct investment according to national bank of Ethiopia foreign
direct investment decline from 65million in 1974 to 12million in 1977. Immediately, the current
government came to power the exchange rate policy was change from fixed to flexible effective
then Exchange rate is depreciate this depreciation of exchange rate reduce cost of domestic labor
and other productive input relative to foreign production cost and increase labor demand and
employment there by raising the return on capital. Thus Greenfield foreign direct investment
increases in respond to depreciation. Among other thing Ethiopia has cheap labor ,cheap
electricity, conducive investment climate and duty free custom service .due to these and other
incentive Chinese, indian,turkey and other countries manufacture industry shifting their plant to
Ethiopia. For example during investment in manufacturing sector show progress from 2010 to
2015 the FDI , net flows (% of GDP) increase from 0.96 to 5.51 in Ethiopia. This in opposite of
my expectation of real exchange rate decrease investment in manufacturing sector increase the
growth of investment in manufacturing sector as the graph shows above. Generally, growth rate
of real effective exchange rate and growth rate of investment in manufacturing sector are
positively related.

33
Fig 3.4 Trends of Real Effective Exchange Rate

400 REER
300
200
100
0 REER
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20

Source: NBE, EIC, CSA and MOFEC: Generally, growth rate of real effective exchange rate
and growth rate of investment in manufacturing sector are positively related.

Capital Expenditure and Investment in Manufacturing Sector

As the graph below show capital expenditure increase slowly from 1975-2010 and also
investment in manufacturing sector show the same trend in those year but from 2011-2017 both
capital expenditure and investment in manufacturing sector show sharp increase. Therefore
capital expenditure an investment in manufacturing sector has positive relationship.

Figure 3.5 Trend of Capital Expenditure

CXP
200000
150000
CXP
100000
50000
0
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20

Source: NBE, EIC, CSA and MOFEC: Hence, from the graph above we show that CXP has
increased slowly from 1975 to 2003. But from 2004 to 2017 it has increased sharply.

34
Real Interest Rate and Investment in Manufacturing Sector
The growth rate nominal interest rate was zero over the period 1975-1986 because there was
fixed interest rate i.e. 8.8%. Immediately nominal interest rate decreased to 6.8 the growth rate of
investment in manufacturing sector fall in 1987 again the growth rate is zero for the next five
years until 1992. In 1993 the current government changed lending interest rate from 6.8 to 14.9
then growth rate increase to 119% in 199. From the graph below, since 1994 growth rate of
interest rate fluctuates throughout the period. Investment in manufacturing sector and real
interest rate fluctuates in opposite direction.

Fig 3.6 Trends of Real Interest Rate

RINR
30
20
10
0 RINR
-10 975 977 979 981 983 985 987 989 991 993 995 997 999 001 003 005 007 009 011 013 015 017
1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2
-20
-30
-40
-50

Source: NBE, EIC, CSA and MOFEC: thus we conclude that Real interest rate and investment
in manufacturing sector are negatively related

35
 CHAPTER FOUR

VI. METHODOLOGY OF THE STUDY AND ECONOMETRICS ANALYSIS

4. Methodology of the Study

4.1. Method of data analysis

Good data alone have no meaning if we not use appropriate method of data analysis
accordingly with the secondary data both descriptive and econometrics method of analysis will
be made.

4.1.1. Descriptive Analysis

To show the effect of different factor on investment of manufacturing sector a descriptive

analysis is used. In here the graphical relationship of the factor and of investment in
manufacturing sector and trend of investment in manufacturing sector distribution of investment
in manufacturing sector and output and employment contribution of manufacturing sector is
discuss in order to explain this the graph method is implemented and to understand some
characteristics of variables descriptive method analysis such as mean, standard deviations,
variance, and covariance, minimum and maximum are used to show the structure of the variable
and also Skewness and kurtosis is use to understand the distribution of the variable and it also
indicate the kind of trend exists between them and Investment in manufacturing sector.

4.1.2. Econometrics Analysis

In addition to the descriptive analysis, in order to capture the degree of influence of some of the
determinants of investment in manufacturing sector econometrics analysis is applied. This study
will use time series econometrics regression to analyze the relationship between explained
variable which, is investment in manufacturing sector, and explanatory variable. Based on OLS
method and also the econometrics analysis of their regression will discuss both long run and
short run. The time series data taken to run the regression covers the year between 1975 and
2017.

4.2. Model specification

36
The Econometrics model

In order to capture the degree of influence of some determinant of investments in manufacturing

sector are use econometrics analyses will be applied.

The general model of this study

IMS =f (RINR, REER, INF, CXP, RGDP)

Where, IMS = investment in manufacturing sector CXP = capital expenditure

RINR = real interest rate RGDP = Real Gross domestic product
INF= inflation rate REER =Real exchange rate
The specific model for this study performed as follow

LnIMSt = α - β1LnRINRt+ β2LnREERt –β3LnINFt+ β4LnCXPt + β5LnRGDPt + υt

Where; β= is coefficient of variable

α, = is constant term

υt = is error term

4.3. Data and Source of Data

The data set will be use to analysis of this paper from 1991- 2016/17 it cover about 26 year’s
data and all data are time series data will be collect from central static agency (CSA), national
bank of Ethiopia (NBE), minister of fiancé and economic commotion (MOFEC) and Ethiopian
investment commotion (EIC).

4.3.1. Variables, Description of Variable and Expected Sign

The data will be collect on the following variable such as investment on manufacturing, real
GDP, real interest rate, inflation rate, budget deficient, capital expenditure, and exchange rate.

 Dependant variable

Investment in manufacturing sector (IMS) a variable as used in this analysis is taken as the sum
of all manufacturing sector, including all privet and public investment activity in manufacturing
sector, the manufacturing activity that including from cottage and hand craft up to large and
medium scale of manufacturing industry.

37
  The independent variable

Inflation rate; sustainable increase in the overall level of prices is called inflation, and inflation
rate is the positive percentage change in the price level on an annual basis. According to the
existing theory asserts that inflation in the country can adversely affected the level of investment
due to risk associated with the long term investment activity.

Real GDP; is the value of all final goods and services produced in the country within a given
period, Real GDP measures the total output produced in any one period at the prices of some
base year. and will be used in regression analysis the coefficient term of real GDP is expected to
have positive relation with IMS because the real GDP is increase the aggregate demand will
increase their by stimulating increase production of good and service by understanding
investment activity.

Real interest rate; its calculated from reducing the inflation rate from nominal interest rate for
each period the lending interest rate is used in generating the real rate of interest and used in
generating the real rate of interest, the coefficient term of real interest rate is expected to have
negative sign because he lower interest rate will induce economic agent to undertake investment
activity due to low cost of borrowing fund associated with lower level of leading interest rate.

Real exchange rate; the exchange rate is the rate at which one currency exchanges for another,
the coefficient term are expected negative sign because depressions of devaluation of the
domestic currency, since the majority of investment capital in developing country constitute
import machine, this will increase the cost of investment and hence result in decreasing
investment activity.

Capital expenditure; capital expenditure in manufacturing sector are a factor that determine
investment in the sector. It is expected that capital expenditure will have positive relation with
the dependant variable of IMS, because as more investment fund are available for the sector
economic agent are initiated to enter in to activity.

4.4. Econometrics Analysis of the Study

In previous section the trend and challenge of investment in manufacturing sector have been
presented. Giving an empirical content to study and its model specification as written in the

38
above section of chapter four variable and their expected signs and estimation techniques of the
data will be presented in a clear and understandable manner. Finally, analysis and interpretations
of the regression result will be followed to access of important conclusion of the research.

The model

The model is specified with the objective of measuring the extent of effect that determinant of
investment in manufacturing sector variable like GDP, capital expenditure, interest rate, inflation
rate and exchange rate have on investment in manufacturing sector. Since the desired coefficient
is elasticity to the measure sensitiveness of the dependent variable to change in the independent
variable, the linear model will be used with the multiple linear analyses based on OLS estimates
is employed. The study is based on time series data for 42 year (1975-2017) for the entire
variable. These variables which are used in the regression are come from the National Bank of
Ethiopia (NBE), Ethiopia investment commotion (EIC), Central static agency (CSA) and
MOFEC. The specification of the model is as is present in above section, therefore the model
take the following form

LnIMS = α - β1LnRLIRt+ β2LnREERt - β3LnINFRt + β4LnCXPt + β5LnRGDPt + υt

Were, IMS=investment in manufacturing sector, RINR= real interest rate, REER= real exchange
rate, INFR= inflation rate, CXP= capital expenditure, RGDP= real Gross Demotic Product and ut
stochastic error term. The strategy used for empirical investigation is as follows; first, time series
properties of the data are discussed. And then the regression results are discussed.

4.5. Estimation Techniques

Since the study employs a time series data, it is a crucial that stationary of the data be tested. A
stochastic process is said to be stationary if the mean and the variance are constant regardless of
the actual time taken. Stationary test make sure that there will not be exist a spurious result
which is often forward in non stationary time series. If the data is non stationary, for casting the
result to other time period may not have any practical significant (Gujarati, 2004). In doing of
this time series regression the following classical regression techniques are under the
consideration.

39
Unit root test

The implications of unit root test in the macroeconomic data are at least potentially, profaned. If
a structural variable, such as real output is truly I (1), and then shocks to it will have permanent
effect. It confirmed and then this observation would mandate some rather serious reconsideration
of the analysis of macroeconomic policy (William H. Greene, 2006)

Augmented dickey fuller (ADF) test

This test is useful to know whether or not there existing a unit root. If time series data is
stationary at level, it is integration of order zero I (0), which means that it is not spurious. If the
data is not stationary at level we take first deference and second deference and so on until it
became stationary. If the non stationary time series data becomes stationary after taking a
deference, its deference stationary data. A time series data is said to be stationary if the
calculated ADF is greater than the critical ADF at given level (Gujarati, 2004).

Co –integration Analysis
The regression model assumes both the dependent and independent variables to be Stationary
over time. However most economic variables exhibit long run trend movement and only became
stationary after they are differenced. Therefore co-integration confirms the existence of long run
relationship and takes care of non-stationary of the variables. The concept of co –integration
basically states that despite being individually non stationary a linear combination of two or
more time series can be stationary. The economic interpretation of co integration is that, if two or
more series are linked to form long run relationship between dependent and independent
variables. Therefore, the concept of the co-integration tells us the existence of long run
equilibrium which an economic system converge overtime (Gujarati; 2004).

The Error Correction Model (ECM)

In a bid to avoid spurious regression results, some researchers run there regression on the
difference of non-stationary series. This is not advisable because the variable at their level is lost.
The best solution is to use an error correction mechanism which can help to capture the long run
and the short run relationship between variables. The ECM can either be constructed from the
co-integrating equation or one can impose long run homogeneity directly and construct the ECM
40
directly without estimating the parameters. This two scenarios yield the same result. One
problem can be encountered in estimating the ECM is the choice of appropriate lag structure of
the variable in the model. If different combinations of the lag structure produce white noise
residual than the test for rival models will be used to select the best. Simply ECM models
incorporate the equilibrating error (ECM t-1) to capture the adjustment towards the long run
equilibrium.

Heteroskedasticity
An important assumption of the linear regression model is that the disturbance ui appearing in
the population regression function is homoscedastic i.e. they all have the same Variance. But
when there exist an outlaying observation in relation to the observation in the sample the
assumption of constant variance is violated and this violation is referred to as heteroskedasticity.
The problem would lead the least square estimator to be inefficient and the estimate of the
variance also biased which invalidates the test of significance. Breusch-Pagan or Weisberg test
for heteroskedasticity is used which the null hypothesis of constant variance and it is possible to
reject this hypothesis when p value is greater than 5% significance level. Suggested to correct the
problems of heteroskedasticity are transforming the data to the log and deflating the variable by
some measures of size (Maddala, 1992).

Testing for Normality

Normality test is used to determine if the data is well-modeled by a normal distribution and to
compute how likely it is random variable is underling the data is set to be normally distributed.
In descriptive statistics terms, one measure of goodness of fit a normal model of the data.

Autocorrelation
The correlation between residuals is called autocorrelation which is induced by the
transformation of the original data and manipulation of the data through interpretation and
extrapolation. The simplest and most widely used model is one where the error term ut and ut-1
have a correlation ρ. For this model one can think of testing hypothesis about ρ on the base of
estimated correlation coefficient between the residuals. A commonly used statistic for this
purpose is the Durban-Watson (DW) statistic which is denoted by d. when DW statistic is zero

41
(d=0) the estimated correlation coefficient is 1 and d=4 when the correlation coefficient which is
estimated is -1. If d is closer to 0 or 4, then the residual are highly correlated.

The standard d statistic that serves as a rule of thumb is d =2 which indicates that the estimated
correlation coefficient is 0 and hence the residual are not correlated. As explained earlier DW
test is the most often used test for existence of autocorrelation, and if there exist autocorrelation,
it is customary to transform the data on the base of estimated first order autocorrelation and use
ordinary least square with the transformed data. If it pure autocorrelation one can use appropriate
transformation of the original model so that there we do not have problem of autocorrelation in
the transformed model. In this regard we will have to use the generalized least square (GLS)
method (Madala, 1992).

Multicollinearity
Multicollinearity refers to the condition that independent variables are intercorrelated and it is
the future of sampler not for the population. The linear regression model assumes that here in
Multicollinearity among the explanatory variables are indeterminate and there standard errors are
infinite. On the other hand if Multicollinearity is less than perfect, the regression coefficient,
although determinate, have larger standard error (in relation to the coefficient themselves) which
means the coefficient cannot be estimated with greater precision or accuracy. Variance inflated
factor (VIF) is used to determine whether there exist the problem of Multicollinearity in making
inferences. When VIF>10, there is the problem of Multicollinearity and hence we cannot reject
the hypothesis of no correlation among explanatory variables. There are some remedial measure
suggested to the problem of Multicollinearity such as priori information from previous empirical
works, combining both cross section and time series data. One of the simplest things to do is
dropping the variables which are highly correlated and specification bias. The variables should
also be transformed when they tend to move in the same direction (Gujarati, 2004)

4.6. The Regression

Under this section of multiple regression, the relationship between IMS and the explanatory
variable such as real GDP, RINR, INFR, CXP and REXR.

42
LnIMSt = α - β1LnRINRt + β2LnREERt - β3LnINFRt + β4LnCXPt + β5LnRGDPt + υt
Investment in manufacture sector, real gross demotic product, capital expenditure and are
measured in million birr. And real lending interest rate, real exchange rate and inflation rate are
measured in percentage.
4.6.1. Econometrics Result and Discussion
4.6.2. Summary Statistics and Distribution Issues
The summery statistics is used to measure the central tendency to measure it we use mean and
standard deviation and the distribution is used to measure dispersion by using skewness and
kurtosis .
Table 4.1 summery statistics
Variable Obs Mean Std. dev Min max
IMS 43 850.54 669.28 291.34 2928.35
INFR 43 9.73 13.22 -11.82 55.24
RINR 43 o.81 13.73 -43.7 24.08
CXP 43 21929.88 40310.58 204.7 152583.8
REER 43 152.91 53.35 86.8 320.2
RGDP 43 279139.4 313712.3 97651.09 1577107
Source; own computation using STATA software
In this section summery statistics (mean, SD, min, max) as we observe from the table 1.4 the real
gross domestic variable are more dispersed with the highest value of standard deviation of
313712.3and the mean are 279139.4 and also the maximum and the minimum value are 1577107
and 97651.09 respectively this variation shows that the variable are less consistent and less
uniform. And the inflation rate have lowest value of coefficient of variation with standard
deviation of 13.22 and mean are 9.73 and also with maximum value 55.24 and minimum value -
11. This shows that the inflation rate is more consistence and uniform.
Table 4.2: Distributive Statistics of the Variable

Variable Obs Pr(skewness) Pr(kurtosis) adj chi2 Prob>c h i2

IMS 43 0.0000 0.0030 20.97 0.0000
RGDP 43 0.0004 0.0056 15.41 0.0004
REER 43 0.0012 0.0107 13.34 0.0013

43
 INFR 43 0.0000 0.0037 21.18 0.0000
CXP 43 0.0001 0.0162 16.45 0.0003
RINR 43 0.0047 0.1005 9.04 0.0109

Source; own computation using STATA software

On distribution issues, kurtosis and skewness give information about the distribution of sample
point before running the regression. Skewness is a measure of symmetry and kurtosis is a
measure of peakedness or flatness relative to the normal statistical distribution. A symmetric data
has a skweness close to zero. A negatively skewed data means it is skewed to the left while a
positively skewed data means it is skewed to the right. According to the result from the above
table, both the probability of skewness and kurtosis are near to zero for all variables. Generally,
all the variables are normally distributed. Therefore, more or less there is no problem of
normality.

4.6.3. Test Statistics

Test of stationary

Table 4.3: result of ADF test for unit root test

Variable T-statics 1% critical 5% critical 10% critical Level of

value value value
integration
LnIMS -4.924 -3.641 -2.955 -2.611 Difference
LnINFR -4.589 -3.634 -2.952 -2.610 Level
LnCXP -6.078 -3.641 -2.955 -2.611 Difference
LnREER -6.167 -3.641 -2.955 -2.611 Difference
LnRGDP -4.26 -3,611 -2.955 -2.611 Difference
LnRINR -5.229 -3.634 -2.952 -2.610 Level
Source; own computation using STATA software

The null hypothesis in this test is that there is a unit root, the decision criteria of ADF test is
when the absolute value of the computed ADF statistic is greater than the absolute value of
critical statistic.We conclude that the given variable is stationary otherwise we say non-

44
stationary. Based on the ADF test tabulated above, the LnRINR and LnINFR are stationary at
level on other hand LnIMS, LnCXP, LnREER and LnRGDP are stationary at the first difference.

Co-Integration test

The concept of co-integration is employed to show the existence of long run or equilibrium
relationship to which an economic system converges, overtime. The existence of the co
integration relationship implies the existence of long term relationship in the variable. In order to
check for the existence of long run relationship, in the model a unit root test on the residuals
from the regression has been conducted using dickey fuller (DF) test.

Table 4.4: co-integrated test

Variable Test statics 1% critical value 5% critical value 10% critical

value
Residual Term -3.849 -3.634 -2.952 -2.610
Source; own computation using STATA software
According to the table 4.4 result the residual from the long run is stationary at the level, that
implies that the variable under consideration of have long run or equilibrium relationship.

Multicollinearity test

Multicollinenarity refers the existences of a perfect or exact linear relationship among the some
or all explanatory variable of a regression model. If the result of VIF (variance inflation factor)
the approach that use to test multicollinearity is greater than 10 there is a problem of
multicollinearity but when the result of VIF less than 10 there is no problem of multicollinearity,
that means there is no perfect or exact relationship among the explanatory variable.

Result of LnRGDP LnREER LnINFR LnCXP RINR Mean

Test of co value
of vif
Vif 3.23 1.45 2.57 3.72 2.41 2.68
1/vif 0.30 0.689 0.388 0.268 0.41
Table 4.5: Multicollinearity test

Source; own computation using STATA software

So the Mean VIF of the model is2.68 that means less than 10 so there is no problems of
multicollinearity

45
Heteroskedasticity:

In testing heteroskedasticity, the null hypothesis of this test is constant variance which it is tested
against the alternative hypothesis of no constant variance. If the p-value is greater than the
chosen significance levels then no worry about hetroskedasticity. The test of this result is shown
as follow

Chi2 (1) =0.43

Prob>chi2=0.5102

From this result the p-value is greater than the three conventionally used levels of significance it
follows that there is no hetroskedasticity problem.

Autocorrelation Test
The Durbin Watson (d) statistic is a number that tests for autocorrelation in the residuals from a
statistical regression analysis. The Durbin-Watson statistic is always between 0 and 4. Therefore,
as a rule of thumb, if Durban Watson d-statistic is found nearer to the value 2 in an application,
one may assume that there is no first order autocorrelation, either positive or negative. Values
approaching 0 indicate positive autocorrelation and values approaching toward 4 indicate
negative autocorrelation (Gujarati, 2004).
Durbin-Watson d-statistic (7, 42) = 1.74313 = 2

4.7. Long run and Short run Estimation of the Model

Estimation of Long run model

The model specified for estimation was the following

LnIMS = α - β1LnRINR+ β2LnREER - β3LnINFR + β4LnCXP + β5LnRGDP+ υt

Where; α is constant
υt is error term

Modeling IMS by OLS method of estimation

46
The present sample is: start from 1974/75-2016/17

The estimation result of the above model is presented in the following table

Table 4.6: Regression Result of the Long run Model: the Dependant Variable is IMS

Variable Coeff Std. err T p>(t)

LnRGDP 1.146 0.151 7.58 0.000
LnCXP 0.128 0.029 4.32 0.000
LnINFR -0.031 0.027 -1.12 0.270
LnRINR -0.024 0.021 -1.11 0.275
LnREER 0.75 0.107 6.98 0.000
CONSTAT -7.702 1.089 -7.07 0.000
Number of obs = 43
R-square = 0.91 Adj R-square =0. 89.9
Root MSE = 0.19 Prob > = 0.000
F(5,37) =76.56

Source; own computation using STATA software

The overall significant of the model tested by using R2. It’s an estimated of how mach of the
variation in the dependant variable is explained by explanatory variables. As a result from the
long run as it’s observed R2 is 0.91 this implies that 91% of the variation in investment in
manufacturing sector is explained by the explanatory variables including in the model, but 9%of
variation not explained by the explanatory variables including in the model.

Hence; the model is rewritten as the follows;

LnIMS = -7.702 - 0.024LnRINR + 0.75LnREER - 0.031LnINFR + 0.128LnCXP +
1.146LnRGDP +υt
Short run estimation model
Table 4.7: Short run Estimation Model
Variable Coeff Std.err T p>(t) 95% conf. interval
LnRGDP 1.0820 0.4116 2.63 0.013 0.2464_1.9177
LnREER 0.4176 0.2032 2.05 0.047 0.0050_0.8303
LnINFR -0.0061 0.0189 -0.32 0.748 -0.0447_0.0324

47
 LnCXP 0.0777 0.1539 0.50 0.617 -0.2348_0.3903
LnRINR -0.0273 0.0152 -1.80 0.080 -0.0582_-0,0034
Et-1 -0.3954 0.1803 -2.19 0,035 -0.7615_-0.0294
Constant 0.0096 0.0334 -0.29 0.774 -0.0581_0.0774
Number obs = 42
R-square = 0.38 Adj R-square = 0.28
Root MSE=0.159 Prob >F = 0.0060
F (6 ,35) = 3.69

Source; own computation using STATA software

Short run regression result model in linear form presented as follows:
LnIMS = 0.0096-0.027LnRINR+0.417LnREER-0.006LnINFR+0.077LnCXP+1.082LnRGDP
+0.39Et-1

From the result of short run estimation model, is clear to understand that all variable have the
same to long run effect on investment in manufacturing sector. The short run estimation model of
2
R is 0.38 this implies that 38% of the variation of dependant variables are explained by the
explanatory variables and the 62% is unexplained by this model in short run. The estimation
result shows that inflation rate and real exchange rate are insignificant while all other variables
are significant in short run. As it can be seen from the above short run regression model the
coefficient of ECM is -0.395 which is positive and statistically significant. The positive sign
shows that the short run investment in manufacturing sector dynamics is below the long run
equilibrium level.

4.8. Interpretation of the Results of Both long run and short runs Model

Real GDP; the long run and short run relationship between the real GDP and the investments in
manufacturing sector is positive and significant. If the real GDP is increase by 1% the investment
in manufacturing sector increase by 1.146% in the long run and it increase by 1.082% in the
short run.

48
Real interest rate; the relationship between real interest rate and investment in manufacturing
sector is inversely related at long run and short run and insignificant. The effect of interest rate
on investment is expected to be negative. This is because as the interest rate (lending rates)
increases, it deters or discourages prospective investors, makes the cost of borrowing costly and
the resultant outcome will be decline/fall in level of investment undertaken.

From the test of the hypotheses, the test revealed negative impact shown by interest rates. As
earlier mentioned, high interest rates discourages the tendency to borrow. From above analysis
1% increase in real interest rate, the investment in manufacturing sector decrease by0.024% at
long run and 0.027% at short run.

Real exchange rate; real exchange rate has positive relation with investment in manufacturing
sector in long run and short run. As the result the regression show 1% increase in real exchange
rate increase investment in manufacturing sector by 0.75% in long run and increase by 0.41% in
short run

The devaluation of real exchange rate increase investment in manufacturing sector by increasing
foreign direct investment the sense that a devaluation of nation’s currency means a fall of labor
and other productive input cost then foreign direct investment increase this increase the demand
for labor this lead to increase income of people this boost demand for manufacturing goods.
Therefore increase investment in manufacturing sector.

Inflation rate; inflation rate is adverse effect on the investment in manufacturing sector both in
long run and in the short. It’s effect on investment in manufacturing sector is 0,031% and
0.006% decrease respectively as the inflation rate increase by 1%.and it is insignificant in both
short run and long run. Inflation rate is expected theoretically to be negatively related to
investment. This is due to the fact that as inflation rate increase, the value of economic activity
reduces, performance drops and ultimately reduces investment. The Model revealed an inverse
relationship between inflation rate and level of investment.

49
In the test, the negative and insignificant impact shown by inflation rate can be attributed to
macroeconomic stability. This entails those enterprises in Ethiopia responds to higher prices of
goods and services by increasing output, so as to take advantage of soaring prices and instability.

Capital expenditure; as obtain from the regression result capital expenditure has positive at
both long run and short run and significant in long run and insignificant in short run impact on
investments in the manufacture sector. The positive relationship shown by capital expenditure,
with level of investment in manufacturing was validated by the formulated hypotheses. This
shows that capital increased expenditure in recent times have to a greater extent encouraged
manufacturing investment and hence the need to sustain the trend. From regression result when
capital expenditure increase by 1% the investment in manufacturing sector increase by 0.128% at
long run and by 0.077% at short run.

50
 CHAPTER FIVE
5. Conclusion, Recommendation and Limitation of the Study
5.1 Conclusions
The study identifies the main determinant of investment in manufacturing sector and the level of
investment in the sector that very low and its trend has increased but it’s not an expected. Its
obvious that investment plays a crucial role to the sustainable growth of the country. Ethiopia as
one of the developing country that need to large amount of investment to achieve its economic
growth. It’s also clear that the country endowed with wide variety of resource including; with
fishery, factory, and other diversified resources.

Even if there is high need to use the resource and utilized for economic growth, Ethiopian
economy as dominated by public sector during the military regime. As a result industries are
limited and cover only small proportion of domestic production. However with the coming to
power of EPRDF accompanied by shifting in economic policy from socialist to the market
oriented, the objective of economic policy has changed to focused on the right direction of
sustainable development. The long run the policy focused on the transforming the highly
centralized and planned economic system in to market oriented one.

In order to raise the level of investment in an economic system, there should be sustainable
capital formation. Sustainable capital formation can be achieved by introducing the factors,
which plays the crucial role in process of capital formation such as the institution that mobilized
saving so as to channel in to the investment. It should be noted that the output of the agricultural
product and the manufactured consumer goods tends to rise with an increases in the rate of
capital formation in addition to leads to further utilization of resource. In these respect, capital
formation plays a key role in process of economic development.
Manufacturing industry plays a pivotal role in the transformation of the economic in Ethiopia in
ha more developed, industrialized modernized, technical up to date diversified domestic
economic structure. A lion share of gross values of production (GVP) value added was generated
from manufacturing industries next to agriculture. Even though these were the cause there was a
crucial bottleneck, which sets a limit to the contribution of manufacturing industries. The reason
is that, there are a factors like real interest rate and inflation rate are adverse effect on investment

51
in manufacturing sector but real GDP, real exchange rate and the capital expenditure are positive
effect on investment in manufacturing sector and also test the relationship of the variable by
using deferent testing method like stationary test, co-integration test, and multicolliniarty test are
use.

The above factors can affect by making the return on investment by making cost of capital higher
and by lowering the return on investment. In addition to this the result will lead to the constraint
of the development of manufacturing sector and we can find a lot of issues in it. This might
include the issue of protection versus trade liberalization deferent policy use related to the factor.
This may show as that there is still a lot to be done in the manufacturing sector and bring up the
dynamics of the sector

5.2 Policies Recommendation

The study comes up with the following recommendation to address the problem of constraint
reframe.
 Improving macroeconomic variable through adjusting fiscal policy. And in the same way
through the monetary channel control of inflation and reduces the real lending interest
rates believes to create stimulating and rewarding effect for investment in manufacturing
sector activities in Ethiopia.
 Government must give incentive on provision of loan, imported input, acquired
technology, research and development subsidy, and reduction of tax tariff.
 Encourage the participation of private sector as far as the economic policy government is
concerned the private sector was expected to pay a leading role in management of the
economy
 Effective industrial policy in the process of having effective policy plays a key role. The
industrial policy must focused on encourage of domestic investor and foreign direct
investment (FDI) need to encourage and directed.
 The public investment on the road, education, health, power supply and other sector must
be increase in order to develop the capacity of the economy to absorb the product of the
manufacturing sector

52
  Encourage the agricultural productivity; since the Ethiopian economy is agrarian in
nature, the policy forwarded in terms of encourage agriculture should also have to be
formulate to expand the manufacturing sector proved input such as fertilizer, extension
and training program lead to efficiency form of production in agriculture sector enhance
the production of manufacturing industry.
 Encourage capital good based on industry in Ethiopia both large and medium sector of
industry concerned on production of consumer good, so the government should be
formulate the policy to encourage investment on capital goods industries
 The institution capacity must be develop for monitoring and coordinating the industries
linkage with the other sector of the economy

5.3 Limitation of the Study

The study is basically macro in nature, which comprise of most components of investment.
Given the short period of time provided, assessing most components of could be something
unattainable. Specific study for a specific component would be more important. Another
limitation is which is related to this study is that there is no as much satisfier time series data
available on investment in manufacture sector and it determinant in Ethiopia. And also since the
research face financial, time, and limited knowledge of constraint.

53
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Appendix
/__ / ____/ / ____/
___/ / /___/ / /___/ 13.0 Copyright 1985-2013 StataCorp LP
Statistics/Data Analysis StataCorp
4905 Lakeway Drive
MP - Parallel Edition College Station, Texas 77845 USA
800-STATA-PC http://www.stata.com
979-696-4600 stata@stata.com
979-696-4601 (fax)

3-user 8-core Stata network perpetual license:

Serial number: 501306208483
Licensed to: IDRE-UCLA
IDRE-UCLA

Notes:
1. (/v# option or -set maxvar-) 5000 maximum variables

. import excel "I:\my research\LN ORGANIZED.xlsx", sheet("Sheet1") firstrow

. tset year
time variable: year, 1975 to 2017
delta: 1 unit

. dfuller dLNIMS

Dickey-Fuller test for unit root Number of obs = 41

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -4.924 -3.641 -2.955 -2.611

MacKinnon approximate p-value for Z(t) = 0.0000

. dfuller LNINF

Dickey-Fuller test for unit root Number of obs = 42

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -4.589 -3.634 -2.952 -2.610

MacKinnon approximate p-value for Z(t) = 0.0001

56
. dfuller LNRINR

Dickey-Fuller test for unit root Number of obs = 42

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -5.229 -3.634 -2.952 -2.610

MacKinnon approximate p-value for Z(t) = 0.0000

. dfuller dLNCXP

Dickey-Fuller test for unit root Number of obs = 41

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -6.078 -3.641 -2.955 -2.611

MacKinnon approximate p-value for Z(t) = 0.0000

. dfuller dLNRGDPP

Dickey-Fuller test for unit root Number of obs = 41

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -4.260 -3.641 -2.955 -2.611

MacKinnon approximate p-value for Z(t) = 0.0005

. dfuller dLNREER

Dickey-Fuller test for unit root Number of obs = 41

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -6.167 -3.641 -2.955 -2.611

MacKinnon approximate p-value for Z(t) = 0.0000

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. dfuller ehat

Dickey-Fuller test for unit root Number of obs = 42

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -3.849 -3.634 -2.952 -2.610

MacKinnon approximate p-value for Z(t) = 0.0024

. hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of LNIMS

chi2(1) = 0.43
Prob > chi2 = 0.5102

. vif

Variable VIF 1/VIF

LNCXP 3.72 0.268662

LNRGDPP 3.23 0.309195
LNINF 2.57 0.388655
LNRINR 2.41 0.415389
LNREER 1.45 0.689041

Mean VIF 2.68

. estat dwatson

Durbin-Watson d-statistic( 7, 42) = 1.74313

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. reg LNIMS LNINF LNRINR LNCXP LNRGDPP LNREER

Source SS df MS Number of obs = 43

F( 5, 37) = 76.56
Model 13.8426515 5 2.7685303 Prob > F = 0.0000
Residual 1.33805969 37 .036163776 R-squared = 0.9119
Adj R-squared = 0.8999
Total 15.1807112 42 .361445505 Root MSE = .19017

LNIMS Coef. Std. Err. t P>|t| [95% Conf. Interval]

LNINF -.0312814 .0279478 -1.12 0.270 -.0879089 .0253461

LNRINR -.0243251 .0219553 -1.11 0.275 -.0688107 .0201605
LNCXP .1285486 .0297291 4.32 0.000 .0683117 .1887854
LNRGDPP 1.146384 .1511674 7.58 0.000 .8400895 1.452678
LNREER .7503934 .1078781 6.96 0.000 .5318117 .9689752
_cons -7.702647 1.089414 -7.07 0.000 -9.910009 -5.495286

. reg dLNIMS dLNCXP dLNRGDPP dLNREER dLNINF dLNRINR ehat_01

Source SS df MS Number of obs = 42

F( 6, 35) = 3.69
Model .566698681 6 .09444978 Prob > F = 0.0060
Residual .8958634 35 .025596097 R-squared = 0.3875
Adj R-squared = 0.2825
Total 1.46256208 41 .035672246 Root MSE = .15999

dLNIMS Coef. Std. Err. t P>|t| [95% Conf. Interval]

dLNCXP .0777649 .1539972 0.50 0.617 -.2348661 .3903958

dLNRGDPP 1.082048 .4116266 2.63 0.013 .2464016 1.917694
dLNREER .4176727 .2032738 2.05 0.047 .005005 .8303404
dLNINF -.006147 .018996 -0.32 0.748 -.0447109 .0324169
dLNRINR -.0273861 .0152079 -1.80 0.080 -.0582598 .0034877
ehat_01 -.3954927 .1803116 -2.19 0.035 -.7615447 -.0294408
_cons .0096708 .0334086 0.29 0.774 -.0581523 .077494

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