Thesis Presentation

Thesis Title:- THE IMPACT OF GOVERNMENT

EXPENDITURE ON ECONOMIC GROWTH IN ETHIOPIA

By: Berhanu Seyoum

2
 CHAPTER ONE
INTRODUCTION

1.1 Background of the Study

 Government expenditure is a term used to describe money
that a government spends from local city councils to federal
organizations and the motive of government expenditure is to
build up peace and harmony with economic development or
growth.
 The relationship between economic growth and government
spending, or more generally the size of the public sector, is an
important subject of analysis and debate. A central question is
whether or not public sector spending increases the long run
steady state growth rate of the economy ((Josaphat and
Oliver, 2000).

3
Cont.…
 Economic growth is an issue of primary concern to policy
makers in both developed and developing countries.
 As a consequence, growth theory has long occupied a central
role in economics.
 It is a dynamic process, focusing on how and why output,
capital, consumption and population change over time

4
Cont.…
 In Ethiopia the government has spent money for a major task.
Such as:-
 To supply goods and services that the private sector would fail to
do, such as public goods, including defense, roads and bridges;
merit goods, such as hospitals and schools; and welfare payments
and benefits, including unemployment and disability benefit
 To achieve supply-side improvements in the macro-economy, such
as spending on education and training to improve labor productivity.
 To reduce the negative effects of externalities, such as pollution
controls.
 To subsidize industries which may need financial support, and
which is not available from the private sector. (Mulugeta, 2017)

5
 1.2 Statement of the Problem

 Ethiopia is one of the poorest country in the world with a population of more than
88 Million (CSA, 2013) with subsistence agricultural sector.

 According to Alemayehu and Befekadu (2005),Ethiopia’s history is full of

conflict, drastic policy change and reversals. However, in the last 10years Ethiopia
is amongst the fastest growing non-oil economy as well as landlocked country int
he world.
 Today the history of Ethiopia is changing from drought, famine, war and low
economic growth to fast and sustainable economic growth
 The Ethiopian economy shows an annual growth rate of 12.7% in the year
2004/05 Gc and the annual average growth rate at a constant price was 11% for the
period 2004/05 to 2012/13 (NBE , 2011/12).

 Two decades ago, Ethiopian policy makers pursued a structural adjustment

program which shifted emphasis from public sector to private sector.
 The goal was to encourage private domestic savings, private domestic investment
and capital formation in order to enhance economic growth.
6
Cont.…
 Therefore, this study attempt to find out impacts of
government spending with a particular on agriculture,
education, health, defense, and infrastructure sectors on
economic growth and their long run and short run
relationship by adding new variable and using recent data
sets up to 2018 and fill the controversial and knowledge
gap found between researchers on the effect of public
expenditure on economic growth in Ethiopia.

7
 1.3 Hypothesis

 Depending on the theories from literature review the study test

the hypothesis express as follows:-

HO: Government expenditure have no significant impact on

economic growth

H1: Government expenditure have a significant impact on

economic growth

8
 1.4.Objective of the Study
1.4.1. General objective
 The general objective of this study was to investigate the impact of government
expenditure on economic growth in Ethiopia for the period 1990 to 2020.
1.4.2 Specific objectives
The specific objectives are: -
 To analyze the trend of economic growth with respect to government expenditure 19190-

2020
 To identify the short run and long run impact of the government expenditure on economic

growth
 To analyze the effect of government expenditure on social sectors (education and health),

defense, agriculture and infrastructure sector expenditure on economic growth .

1.5. Scope of the study
 The study was focus on Impact of Government Expenditure on (Agriculture,

Education, Health, Defense, and Infrastructure Sectors) on Economic Growth

in Ethiopia. There will be other components of government expenditure that
have impact on economic growth. However, this study will be only focus on
to the growth impact of Agriculture, Education, Health, Defense, and
Infrastructure Sectors government expenditure due the reason that these
sectors are better to support and enhance economic growth in Ethiopia 9
1.6. Significance of the Study

 Ethiopian budget finance was continues to increase year

to year, so that, it is important to investigate the impact
of public spending on economic growth of Ethiopia and
make the necessary amendments to the country’s
expenditure policies.
 Therefore this study helps to provide useful information

concerning impact of government expenditure on

economic growth in Ethiopia and used as source of
information for government and other concerning organ
for policy change and formulation of new policies
regarding government expenditure and also uses as
source of literature for other researchers.

10
 CHAPTER THREE
METHODOLOGY

3.1. Description of the Study Area

 This study aimed at establishing the effects of government
expenditure on economic growth in Ethiopia.
3.2. Type and source of data
 This study used secondary time series data.
 The source of data set were published and unpublished
National Bank of Ethiopia (NBE) reports, Ministry of
Finance and Economic development (MoFED), and CSA.
 For the purpose of investigating the impact of government
expenditure on economic growth, particular sectors including
with agriculture, education, health, defense, infrastructure,
labor and Gross capital formation a time series data were
used collected for the period 1990to 2020.
11
 3.3 Method of data Analysis

 To analyze the data collect on the impact of

government expenditure on economic growth in
Ethiopia, descriptive statistics such as Table, Chart
and graph and standard econometrical techniques
using E-view version 10 statistical software
packages were applied .
 This is because of even if E-view is less famous but,

provides much best time series analysis than other

software package like Stata software.

12
 3.3 Model Specification

 This study captured the Gross Domestic Product as

the dependent variable and expenditures on
agriculture, education, health, defense, infrastructure
sector and labor force and Gross Capital Formation
on the one hand as independent variable and
evaluating their relationship with economic growth
by using Vector Auto Regressive (VAR) model
because the model is easy to estimate.
 In addition, it has good forecasting capabilities and

the researcher does not need to specify which

variables are endogenous or exogenous which means
all are endogenous variables.
13
 Cont.…
 Mankiw et al. (1992) specifies that output is a function of labor,
human capital, capital stock and productivity and proposed a
Cobb-Douglas production function with constant returns to scale
as follows.

Yt=,α+β <1 ………………….. (1)

Where:- Y is the level of output,

L -is the amount of labor;
K -is the amount of physical capital needed and
H-is the Human capital.
A- represents level of technology;
t -represents time dimension and
α, β are elasticity of physical capital 14
Cont.…
 The log model of the above equation is as follows:
LogYt = A+αLogKt+βLogHt+ (1-α-β) Log
Lt…………….. (2)
 According to Abelone (2017) we can write the model

as:
GDP = f (K, L, H, A)
……………………………………….. (3)
 In the model by Bazezaw (2004), the researcher

assume the government expenditure as the determinant

of gross domestic product (GDP) and thus in this study
the components of government expenditure included as
additional explanatory variable that determine
economic growth. 15
Cont.…
Accordingly, growth model that estimated is developed as follows in
this study:
RGDP = f (L,K,TExAg, TExEd,TExHe,TExDe,TExIn)…………. (4)
Where: RGDP-Real Gross Domestic Product,
L- Labor Force
K- Physical Capital
TExAg- Total Expenditure on Agriculture
TExEd-Total Expenditure on Education
TExHe- Total Expenditure on Health
TExDe-Total Expenditure on Defense
TExIn-Total Expenditure on Infrastructure

16
Cont.…
 Here, in this model real GDP used as a proxy for
economic growth.
 The concept of human capital refers to the abilities

and skills of human resources of a country which,

refers to the process of acquiring and increasing the
number of people who have the skills, good health,
education and experience that are critical for
economic growth.
 Thus, this study was proxied human capital, by total

government expenditure on education and on health

sector.

17
 Cont.…
 The above equation (4) converted into linear form and

the result is as below

RGDPt=β0+β1LFt+β2GCFt+β3TExAgt+β4TExEdt+β5TExHet+β6TExDet+
β7TExInt+ εt……………………………. (5)
 To be able to empirically investigate the relationship
between Dependent Variable and each explanatory
variable expressing equation (5) in Logarithm form.
Thus, the model estimated is specified as the follows:
LogRGDPit= β0+ β1logLFt+ β2logGCFt +β3logTExAgt+ β4logTExEdt+
β5logTExHet+ β6logTExDet+ β7logTExInt+. εt …………………..… (6)
Where: ln- Stands for Natural Logarithm
βi - coefficients of the explanatory variables (where i is
1,2,---7) and β0 is slope of parameter, t refers to the
number of observations over time and εtis Error term. 18
 3.5. Definition and Measurement of Variable.

In this study dependent variable is Real Gross Domestic Product (RGDP.

Real Gross Domestic Product (RGDP): This is the annual percentage
rate of increase in real gross domestic product.

This study chooses the following explanatory variables:-

Physical Capital Accumulation (GCF): : is defined as Gross capital
formation (gross investment) in a country and it was proxied physical
capital.
It measures the value of acquisitions of new or existing fixed assets by
the business sector, government and “pure” households (excluding their
unincorporated enterprises) less disposals of fixed asset.(Melkamu,
2019). 19
Cont.…
Labor Force (LF):Theoretically, labor force is a major element for
sustainable rate of economic expansion.
It includes people who are currently employed and people who are
unemployed but seeking work as well as first-time job seekers.
 For developing country like Ethiopia it could be the engine of growth
for labor intensive economies (Tefera, 2017).
Total Expenditure on Agriculture (TExAg): This is the total
government expenditure for buying modern agricultural equipment,
agricultural inputs such as improved seeds, trained and hiring a number
of agricultural development agents and so on which are expected to
affect RGD (Abelone, 2017). 20
Cont.…
Total Expenditure on Education (TExEd): It Consist of all the
government expenditure for higher education, by paying teachers
and lecturers, construction of learning infrastructure such as
classrooms, lecture halls, offices and purchase of learning
equipment. It also includes expenses on scholarships whether local
or abroad (Bazazew, 2004).
Total Expenditure on Health (TExHe): it is defined as the total
government expenditure for hospitals and clinics construction and
for medication, medical equipment and appliances; for applied
training for employment and salaries (Abelone, 2017).
21
 Cont.…
Total Expenditure on Defense (TExDe): This is the government
expenditure for administration, supervision and operation of military
defense affairs and forces: Land Sea, air and space defense force;
administration, operation and support of civil defense forces (James,
2017).
Total Expenditure on Infrastructure (TExIn): It is the government
expenditure on transportation, communication, electricity and
waterways as a share of infrastructure expenditure to the total public
expenditure. This is the sector having critical role to promote
RGDP(Abelone, 2017).
22
 3.6. Testing For Unit Roots
 To avoid the generation of spurious(nonsense) regression
results testing for the existence of unit roots is precondition for
the study to investigate whether the variables are stationary or
not.
 A commonly methods for testing stationarity or the presence of
unit roots were the Augmented Dickey-Fuller (ADF) and
Phillips-Perron (PP) tests (Perron, 1989).
 The ADF procedure attempts to retain the validity of the tests
based on white-noise errors in the regression model by
ensuring that the errors are indeed white-noise.
 On the other hand, (PP) procedure corrects for serial
correlation through a non-parametric correction to the standard
statistic (Stock, 1994).
 In this study the Augmented Dickey fuller (ADF) test was
applied in order to test stationarity
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 3.7. Optimal Lag Selection Criteria
In order to decide the most optimal lags of variable in the model we depend on
the variables type.
For Quarterly data 1 to 8 lags is appropriate and for annual data the number of
lags is typically small 1 or 2 lags is the appropriate one.
In order to select the appropriate number of lags for the long run underlying
equation, it is necessary to determine the optimal lag length by using proper
model order selection criterion such as; the Akaike Information Criteria (AIC),
Schwarz Information Criteria (SBC) or Hannan-Quinn Criteria (HQC) (Nkoro&
Kelvin, 2016).
According to these criterions, the VAR estimate with the lowest value of AIC,
SIC and HQ value is the most efficient one.
Here, in this study, Akaike information criterion (AIC), lags selection criteria
was applied to select maximum lag for the model. 24
 3.8. Co-Integration Test

After testing time series data for stationary, the next task should be testing
for co-integration.
Variables are said to be co-integrated if a long run equilibrium
relationship exists among them.
There are two major procedures to test for the existence of co integration,
namely, the Engle-Granger two step procedures and the Johanson Co-
integration test.
In this paper, Johansen Maximum Likelihood Estimation procedure is
used in testing for co-integration, because it can estimate and test for the
presence of multiple co-integrating vectors and also it is easy and the
superior test for co-integration. 25
3.8.1 Vector Error Correction Model (VECM)
 In order to determine the coefficient of short-run dynamics after
the determination of long-run relationships VECM is used.
 Vector Error Correction Model is estimated based on the
Johanson test of co-integration results and using a predetermined
optimal lag order. That is chosen by the appropriate information
criterion results.
 Accordingly, the VECM has two parts: the long run and short run
dynamics with co-integrating and short run coefficients that are
used for further analysis including the speed of adjustment (ECTt-
1).
 The coefficient of the error term (ECTt-1) is used to measure the
speed of adjustment towards the long run equilibrium. And
(ECTt-1) is considered to be good if the range is between 0 and 1.
 (ECTt-1) should be negative and significant number and if
positive and insignificant value means explosive and not
26
reasonable.
 3.9 Diagnostic Test
3.9.1. Serial correlation Test
 Serial correlation occurs in time-series studies when the errors

associated with a given time period carry over into future time
periods.
 There are different types of serial correlation such as first-order

serial correlation, in which the errors in one time period are

correlated directly with errors in the consequent time period and the
positive serial correlation in which errors in one time period are
positively correlated with errors in the next time period.
 In order to detect whether the serial correlation exists in the given

econometric model or not either the Durbin Watson test, or the

Breusch-God Frey Lagrangian Multiplier (LM) test can be used.
 For the case of this study analysis the Breusch-God Frey Lagrangian

Multiplier (LM) test of serial correlation used, because it was easy

to estimate using the Eviews software and also finest as compared to
DW test which has some regions with inconclusive results.
27
 3.9.2. Normality Test

 To see whether the values of the data’s are normally distributed or

not; there are several tests for normality such as histogram of
residuals normal probability plot (NPP), Anderson-Darling and
Jarque-Beratests.
 The Jarque-Bera test for normality was employed in this study.
3.9.3. Heteroscedasticity Test
 Heteroscedasticity is a situation in which the variance of the error
term varies across the data.
 One of the important assumptions of the classical linear regression
model is that the variance of ut is the same for all observations
 The existence of heteroscedasticity (absence of homoscedasticity)
can be detected by using mechanisms like the Breusch Pagan LM
test; the Glesier LM test and the Park LM test (Williams, 2015).
 The Breusch Pagan LM test was employed in this study.
28
 3.9.4. Stability Test

The stability of the model could affect the validity of the

estimated model; therefore, it should be tested stability
before preceding it further.
 There are two types of test are there in order to find out if
the model are stable or not over the sample period, the
CUSUM and CUSUM square tests.
The CUSUM test is useful for detecting systematic changes
in the regression co-efficient and this study applied CUSUM
test to test stability of the model.
29
 CHAPTER FOUR: RESULT AND DISCUSSION

4.1. Descriptive Analysis

4.1.1 Real GDP growth from 1990 to 2020
According to the below figure 3 the real GDP of Ethiopia was increasing at smooth
level during Derg regime and indicates highly fluctuation of ups (increasing in an
increasing rate) after becoming of EPDRF.

The real GDP of Ethiopia at the time was 134,308.81 million birr in 1990 and it
reaches 1,834,066.49billion birr in 2020.

This is due to the reason that Government of Ethiopia designed and implemented
different strategy and plans such as Sustainable Development and Poverty Reduction
Plan( SDPRP, 2002/03-2004/05), Plan for Accelerated and Sustained Development to
End Poverty(PASDEP, 2005/06–2009/10),Frist phase GTP (2010/11 to 2014/15) and
Second phase GTP (2014/15to 2020/21) to register high economic growth rate and
enabling Ethiopia to reach middle income country status by 2025. 30
Cont.…

Source: own calculation based on MOFED and World Bank data

31
 4.1.2 Total Government expenditure from 1990 to 2020

When we see Ethiopian total government expenditure during 1990-2020 for some period of time
there is somewhat a stable movement.
The total government expenditure at the time was 3,111.42 million dollar in 1991 and reach
3,069.30 million dollar in 1992. However, after the fall of Derg regime the level of total
government expenditure start to decline consequently for five years from 1992/93 until 1998/99
that was decrease from 3,069.30 million dollar to 3,103.01 million dollar respectively..
This was because of the EPRDF government decided to take policy measure that minimize the
size and role of the government in the economy where by the government strategy was focused
towards facilitating growth indirectly by supporting the private sector.
Thus the period was marked by the privatization of government owned sectors so as to reduce its
direct involvement in the production and provision of services while the private participation is
enhanced.
 However, the government began to rise its spending starting from 2002. The government of
Ethiopia spent totally 2,472.39 million dollar in 1990 and reaches about 12,907.60 million
dollarin2020. 32
Cont.…

Total Government
Expenditure in USD
16,000.00
14,000.00
12,000.00
10,000.00 Total Government Expenditure
8,000.00
6,000.00
4,000.00
2,000.00
0.00
90 92 94 96 98 00 03 05 06 08 10 12 14 16 18 20
19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20

Source: own calculation based on World Bank data

33
4.1.3 Trends of Government Expenditure and Real GDP

As it can been seen in the below figure, the relationship between Real GDP and
Total Government expenditure is stable movement starting from 1990 to 2005.
 Here, we can understand that starting from 2005 Real GDP increase in an
increasing rate, that was about 218,873.23 million birr in 2005 and reaches
1,834,066.49billion birr in 2020
while Total Government expenditure increase in a decreasing rate that was
about 8,425.05 million dollar in 2005 and reaches about 12,907.60 million
dollar in 2020 .
The Government of Ethiopia Targeted in its first phase GTP (from 2010/11-
2014/15) and Second phase GTP (from 2014/15-2020/21) to continues its
heavy public investment into priority sectors and register high economic
growth rate.
34
Cont.…

Source: own calculation based on MOFED and World Bank data

35
 4.2 Time series Econometrics Result

4.2.1. Unit root test Analysis

 As mentioned in the previous chapter one of the most and the first

step for applying a VAR model was testing stationary problem to

avoid the problems faced with spurious regression.
 To test unit root ADF was applied and results are discussed below

According to this ADF test if the critical value of test statistic are less
than the ADF test statistic and if the variable perspective p-values are
greater than the conventional significance level of α =0.05 in level we
accept the null hypothesis of non stationarity or unit root.
But if the ADF test statistics is Greater than the critical value, and if the
variable perspective p-values are less than the conventional significance
level of α =0.05 in level we reject the null hypothesis of non-stationary
or unit root. 36
 Cont.…
At level I (0) Mackinnon (1996)
Critical value

Variable LogRGD LogLf LogGCF LogTExAg LogTExEd LogTExHe LogTExDe LogTExIn 1% 5% 10%
P

With t-statistic 4.671337 1.691680 2.298218 0.388834 0.283587 1.973246 0.144662 1.941877 - - -
Intercept 3.59246 2.9314 2.60
2 04 3944

Prob.* 1.0000 0.9995 0.9999 0.9802 0.9747 0.9998 0.9656 0.9997

With t-statistic 4.173444 -0.101530 0.563707 -1.412624 -1.727408 -2.108394 0.277795 - - -

Intercept 0.099979 4.18648 3.5180 3.18
and trend 1 90 9732

Prob.* 1.0000 0.9932 0.9992 0.8430 0.7217 0.9963 0.5263 0.9977

Without t-statistic 4.052782 2.822480 3.168215 1.250675 2.095051 2.725637 1.282098 2.795485 - - -
Intercept 2.61985 1.9486 1.61
and trend 1 86 2036
(None)

37
Cont.…
At first difference I(1)
Mackinnon (1996)
Critical value

Variable LogRGDP LogLf LogGCF LogTExA LogTExE LogTExHe LogTExDe LogTExI 1% 5% 10%
g d n

With t-statistic -12.54167 - -5.249227 -6.281567 -5.065339 -5.997545 -5.423846 - - - -

Intercept 6.141958 4.498941 3.5966 2.93 2.6048
16 3158 67

Prob.* 0.0000 0.0000 0.0001 0.0000 0.0002 0.0000 0.0000 0.0010

With t-statistic -12.97362 - -6.099725 -6.546156 -5.385029 -7.009482 -5.529879 - - - -

Intercept 6.580662 4.713873 4.1923 3.52 3.1912
and trend 37 0787 77

Prob.* 0.0000 0.0000 0.0000 0.0000 0.0004 0.0000 0.0002 0.0033

Without t-statistic -12.47004 - -4.859253 -5.972175 -5.939798 -5.446775 -5.206137 - - - -

Intercept 5.494258 4.019564 2.6211 1.94 1.6119
and trend 85 8886 32
(None)

Prob.* 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0002

Order of I(1) I(1) I(1) I(1) I(1) I(1) I(1) I(1)

Integration

38
Source: Own calculation using Eviews 10
Cont.…

As it is shown, the above table.2, indicate that all variables are stationary at
first difference which mean that null hypothesis of non-stationary or unit root
was rejected because, all the three critical value results are greater than their
respective ADF test statistic and also their respective p-values are less than the
conventional significance level of α =0.05 (5%) in level.

39
 4.2.2 Optimal Lag selection

 As discussed in the chapter three in order to determine the most

optimal lags of variable in the Model we depend on the variables
type.
And, here in this study Akaike information criterion (AIC), applied
Lag LogL LR FPE AIC SC HQ

0 -7.762092 NA 2.93e-10 0.750576 1.081561 0.871895

1 232.6049 377.7195 6.95e-14 -7.647852 -4.668990* -6.555981*

2 307.8437 89.56999* 5.72e-14* -8.183032* -2.556292 -6.120609

Source: Authors Own computation, 2020…Note: *, shows the lag order selected
by information criteria’sags selection criteria was applied
40
Cont.…
 As shown in the table , the results of AIC test tells as
lag 2 as the appropriate optimal lag length while SC
and HQ test tell us lag 1 as the maximum lag.
 However, as discussed before in this study, AIC was the

appropriate method and results of lag selection criteria

under the VAR model tell us to use lag 2 as the
maximum lag for our model.
 This is because the value of AIC at lag 2; which is -

8.183032is lower than the AIC values at lag0 and lag 1

which is 0.750576 and -7.647852 respectively

41
 4.2.3. Co-integration test
 After testing time series data for stationary, the next task
should be testing for co-integration, to investigate whether
there is co-integration relationship between the variable.
 Variables are said to be co-integrated if a long run equilibrium
relationship exists among them.
The co-integration tests include RGDP as dependent variable
health expenditure, agriculture expenditure, defense expenditure,
education expenditure, and infrastructure expenditure, Labor
force and Gross Capital formation over the period of 1975-2018.

42
Cont.…
Unrestricted Co-integration Rank Test (Trace)
Hypothesized Eigen value Trace Statistic 0.05 Critical Value Prob.**
No. of CE(s)

None * 0.877788 247.2360 159.5297 0.0000

At most 1 * 0.700533 161.0540 125.6154 0.0001

At most 2 * 0.565497 111.6183 95.75366 0.0026

At most 3 * 0.496121 77.44260 69.81889 0.0108

At most 4 * 0.379030 49.34044 47.85613 0.0360

At most 5 * 0.325341 29.80505 29.79707 0.0499

At most 6 0.275554 13.66956 15.49471 0.0925

At most 7 0.010995 0.453286 3.841466 0.5008

Trace test indicates 6 co-integrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level 43
Cont.…
Unrestricted Co-integration Rank Test (Maximum Eigen value)
Hypothesized Eigen value Trace Statistic 0.05 Critical Value Prob.**
No. of CE(s)

None * 0.877788 86.18195 52.36261 0.0000

At most 1 * 0.700533 49.43577 46.23142 0.0220

At most 2 0.565497 34.17566 40.07757 0.1988

At most 3 0.496121 28.10216 33.87687 0.2088

At most 4 0.379030 19.53539 27.58434 0.3742

At most 5 0.325341 16.13549 21.13162 0.2170

At most 6 0.275554 13.21628 14.26460 0.0727

At most 7 0.010995 0.453286 3.841466 0.5008

Max-eigen value test indicates 2 co-integrating eqn(s) at the 0.05 level

 * denotes rejection of the hypothesis at the 0.05 level 44
Cont.…
From the above Johansen Co-integration test table :-
The trace statistics could reject the null hypothesis at none to at most 5 while the maximal
Eigen value points could not reject the null hypothesis at most 2, 3, 4 and 5, in such
situations it is better to rely on the maximal Eigen value statistics since it is argued that the
trace test is less powerful than the maximal Eigen value test (Yuan and Kochar, 1994).
We have the guide line that when the p value is less than 5% or if maximal Eigen value
and Trace Statistic is greater than Critical Value at 5% we reject the null hypothesis there
is no co integration and when the p values greater than the 5% or if maximal Eigen value
and Trace Statistic is less than Critical Value at 5%we can’t reject the null hypothesis.
Here we have 2 co-integrating vectors equation among the variables based on the most
powerful test of maximal Eigen value test at 5 %.
This means that, there is co-integration among the eight variables or these eight variables
have long run association meaning that in the long run they move together.
If the variable has a long run association ship or co-integrated we can run restricted VAR,
which is VECM. 45
4.2.4. Long run and Short run impact of expenditure on
economic growth

After testing of existence of long run association among the variable by using
co-integration test the next step in VAR model is to estimate the long run
coefficients.

To investigate the long-run effects in this model, the estimated normalized
co-integration coefficient vectors is presented in the below table.

46
 Cont.…

Note: values in the parentheses are t-stat:*indicates significant.

47
Cont.…
 As the long run estimated result of the above table showed the R-
squared of the model is 77.3% .
 Which tells us about 77.3% of the variation in dependent variable (real
GDP) is explained by all the independent variables included in the
model and
 The F-statistical probability is very significant the model is fitted
good.
The results show that in the long-run:-

 gross capital formation which is proxied of physical capital, spending on

education, spending on infrastructure and labor force has an expected
positive impact and statically significances except labor force which is
statically insignificance,

 while spending on health, spending on defense, and agriculture has

48
negative impact on economic growth.
 Cont.…
◦ The physical capital which is proxied by gross capital formation has a positive and
significant impact on economic growth.

◦ A result Consistency with the results revealed by Tefera, (2017); Melkamu, (2019) and
Tewodros, (2015) and on other the result was contradicted with previous findings of
negative or insignificant effects found by Teshome 2006.

◦ According to classical and neo- classical growth theory capital (investment) is the major
determinant of economic growth.

◦ As they were theorized an increase in investment will result in an increase in output and
the accumulation of the capital is supposed to favor the growth of the real GDP by

fostering further production of new goods and services.

◦ Since the coefficient of gross capital formation (GCF) is 3.35.

◦ This indicates that, in the long run, being other things constant, a one percent change in
gross capital formation leads 3.35 Percent changes in RGDP. 49
 Cont.…
In this study it revealed that there is positive and significant relationship between economic growth and
expenditure on education, which support the argument of endogenous growth theories and other different
scholars that states human capital have positive and statistically significant impact on economic growth.
Numerous economist points out that education directly have positive effects on economic growth they
suggest that societies with a large number of highly skilled workers generate more idea, innovation
technology and become more productive.
Government expenditure on education sector in Ethiopia helps promote economic growth in the long-
run, which is the fact that the more the people acquire education, the more they become experienced
and the more there experience increases the more their productive capacity and they were more
productive and promote Economic Growth.
This is inconsistent with the result revealed by Bazezaw, (2004); Tefera, (2017) and Melkamu, (2019).
The coefficient of government expenditure on education was 5.21, which mean that other things
remaining constant a one percent increase in government expenditure on education will result an
increase in economic growth by 5.21 percent.

50
Cont.…
Labor force is also one important factor that affects economic
growth of a country and an independent variable in this study.
 It could be the engine of growth for labor intensive economies like
Ethiopia.
The result of this study revealed that the impact of labor on Ethiopian
economic growth during the study period, was positive relationship
and it is not statistically significant.
This insignificant result might be associated with high population
growth and low productivity of the labor force and it’s due to the
fact of that the majority of the population is characterized by
dependency. 51
 Cont.…
The other factor that affects GDP in this study is expenditure on agriculture.

It has a negative and significant impact on economic growth in long run, which
similar with the result of Abelone, (2017) and Bazezaw, (2004).

 This will be, because of small-scale farmer fail to use modern technology,
improved seed, due to periodic drought, poor infrastructure that often makes it
hard and expensive to get goods to market, weather and climate change.

Since coefficient of government expenditure on agriculture was -2.27, meaning

that other things remaining constant a one percent increase in government
expenditure on Agriculture will result a decrease in economic growth by 2.27
percent.

52
 Cont.…
Government expenditure on infrastructure have positive impact on Ethiopian
economic growth and statistically significant.

This is the reason that the government expenditure on infrastructure such as,
improvement of airport, build large highways and roads across the
country to raise export level and if good electricity, transportation and
communication have been for industry processing the economic growth
were promoted.

The result was Consistency with the result of Abelone, (2017) and Bayew,
(2015).

As a result; on average ceteris paribus one percent increases of government

expenditure on infrastructure will result in 2.55 percent increase in real GDP. 53
 Cont.…
The other factor that affects GDP in this study is expenditure on Health.
That was found to have a Negative and statistically significant impact on
growth.
This will be, because of slow adoption of technology, inefficiencies of
health institution, corruption and embezzlements and brain drain.
This result was consistency with the result of Abelone, (2017) and
Bazezaw, (2004) while controversial with the result that was revealed by
Tefera, (2017).
Holding other things remain constant when the government expenditure on
health increases by one percent economic growth is fall by 2.53 percent.
54
 Cont.…
Another most important variable which is expected to explain economic growth and
employed in this model was the Government expenditure on Defense (Military).

 It has a negative and significant impact on economic growth in long run.

This may be due to the fact that Ethiopia is net importer of defense equipment and
logistics and hence this directly affects the foreign currency accumulation of the
country and indirectly it has a negative impact on economic growth.

The result was consistency with the result revealed by Bazezaw, (2004), while
controversial with the founding of Abelone, (2017).

As a result on average ceteris paribus one percent increases of government

expenditure on Defense will result in 39.6 percent decrease in real GDP.

55
 Cont.…
The result of the long run coefficient of VAR model can be shown in equation form
as follows:
LogRGDP=24.00025 + 0.321309Log(LF) + 3.345991Log(GCF) - 2.270563Log(TExAg) +
5.212893Log(TExEdu) - 2.533379Log(TExHe) - 0.396043Log(TExDe) + 2.546705Log(TExInf)+εt …….
(7)

This equation is the long-run equation for economic growth (RGDP) which is explained by
logarithm of real gross domestic product, Labor Force, Capital Formation, total Government
expenditure on Agriculture, total Government expenditure on Education, total Government
expenditure on health, total Government expenditure on defense and total Government
expenditure on Infrastructure sectors, and finally the error term Ut that the long-run analysis is
based on.

From the above long run equation LogLf, LogGCF, LogTExEdu and LogTExInf has a positive
sign which means they have positive impact on Economic growth While LogTExAg, LogTExHe
and LogTExDe has a negative sign meaning that they have negative impact Economic growth. 56
 4.2.4.2. Short Run impact and Error Correction Model (ECM)

After testing the variables co-integration or presence of long run association ship the next step was
running vector Error Correction Model VECM.

Here ECT is represent error correction term or speed of adjustment and the guideline suggest that it
should be negative in sign and significant.

The negative sign of vector error correction term implies that any shock in the system will return back
to its long run path.

Thus, in the table 7 the coefficient of the error correction term (ECTt-1) is significant and negative in
sign that is correctly signed and indicating the existence of long-run association ship among the
variables.

Here in this model the coefficient of the error correction term or the speed of adjustment towards
equilibrium value is about -0.119347 and this shows that about 11.9% of the deviation from the long run
equilibrium is corrected during each year when there is a shock to a steady state relationship.

 The ECT coefficient value determined in this study was low that indicates that there is slow speed of
adjustment that it takes many years to all deviations /errors to be corrected.
57
 Cont.…
Variables Coefficient Std. Error t-Statistic Prob.

D(LOGRGDP)t-1 -0.706793 0.194867 -3.627047 0.0014*

D(LOGLF)t-1 -0.582871 0.369065 -1.579317 0.1279

D(LOGINF)t-1 -0.362513 0.099310 -3.650317 0.0013*

D(LOGHE)t-1 0.260097 0.091943 2.828900 0.0095*

D(LOGGCF)t-1 -0.291011 0.123377 -2.358711 0.0272**

D(LOGEDU)t-1 0.065146 0.141560 0.460201 0.6497

D(LOGDE)t-1 -0.082386 0.056526 -1.457501 0.1585

D(LOGAGR)t-1 0.327645 0.093089 3.519677 0.0018*

ECT(t-1) -0.119347 0.024545 -4.862421 0.0001*

Note: *, ** shows that the probability values of the coefficients are significant

at 1 percent and 5 percent respectively. 58

Cont.…
 As it was shown in the above table:-
 The coefficient of expenditure on education found to be positive
and statistically not significant.
 This is due to the fact that the rate of unemployment is very high
in Ethiopia, and there was no room for the majority of graduates
in the Ethiopia labour market.
 Furthermore, according to different scholars that states human
capital has positive and statistically significant impact on
economic growth in long run government investment on building
of schools, colleges and universities were expenditure on the core
functions, and therefore this study agree with it and shows long-
run relationship shows spending on education has positive and
significant effect on economic growth

59
 Cont.…
On the other hand, labor force is negative relationship with real
GDP and statically insignificance;
it will be due to the fact that at the economy consists of the majority
of the young population which is characterized by more
dependence and less productivity.
Like the long run model in the short run expenditure on defense are
also found to have negative impact on economic growth but
statistically not significant.

60
 Cont.…
In contrast to the long run model, government expenditure on
agriculture in the short run has positive and significant impact
on economic growth.
Agriculture is the most important sector in the Ethiopia economies
given its contribution to employment, foreign exchange, food, and
its linkages with other sectors of the economy.
Since its coefficient was 0.327645 one percent changes in the
government expenditure on agriculture will increase growth rate of
an economy on average by about 32.8%.
61
Cont.…
 The other variable for which the estimated short run result
differs from the long run result is the government
expenditure on health.
 The coefficient of this variable becomes positive and
statistically significant.
 This is because a healthy population is productive, which is
necessary in increasing both the industrial and the
agricultural production.
 Holding other things remains constant when the government
expenditure on health increases by one percent economic
growth on average increase by 26 percent.

62
 Cont.…
 Like government expenditure on health, government expenditure on
infrastructure and on capital formation that was the proxied of physical
capital ,estimated short run result contrast with the result estimated in
long run .
 Accordingly the coefficient of Growth capital formation (GCF) and
government expenditure on Infrastructure tells negative impact and
statistically significant.
 This will be due to corruption and embezzlements.
 Since the coefficient of government expenditure on Infrastructure was -
0.362513, meaning that on average remaining other thing constant one
percent increase government expenditure on Infrastructure will decline
growth rate of an economy by about 36.2% in short run.
 Similarly the coefficient of Growth capital formation (GCF) was about
-0.291011, meaning that other things remaining constant the short run
coefficient for Growth capital formation (GCF) tells us that when
capital formation increases by one percent economic growth decrease
by 29.1 percentages. 63
 4.2.5.1. Heteroskedasticity test

According to Breusch-Pagan-Godfrey test result in this study shows that the probability
value is 5.3 percent which is greater than 5% which indicated that, we are fail to reject
null hypothesis meaning that there is no heteroscedasticity problem in the residual and the
model is desirable.

4.2.5.2 Serial Correlation Test

As tested by Breusch-Godfrey Serial Correlation LM Test there is no serial correlation

problem in this model because the value of probability was 98.69% which was greater than
5% and we couldn’t reject null hypothesis rather we accept null hypothesis that say no
serial correlation.

4.2.5.3 Normality Test

 The Jarque-Bera test results show that the residual is normally distributed and the model
is desirable because probability value is 27.89 percent which is greater than 5% so we
couldn’t reject null hypothesis against alternative hypothesis rather we accept null
hypothesis.
4.2.5.4 Stability Test
 In order to guarantee the goodness of the model stability of the model should be tested 64
 5.3 Recommendations

1). Since spending on infrastructure sector contributes to the

economy growth significantly and positively, the government
should allocate more resources to areas of infrastructural sector
development in order to stimulate economic growth.

 This is because additional expenditure on infrastructure

sector in such areas of roads, railways, ports, communication,
water and electricity contribute significantly to the economic
growth by increasing the marginal productivity of inputs in
the private and public sectors.
65
 Cont.…
2). The study found that government expenditure on education is
positively related to economic growth and it brings a significant effect in
the long run.

 Beside the findings the government of Ethiopia should increase its

expenditure allocation to the education sector.

 This could be done through provision of proper education facilities such

as schools, colleges and universities, training and employing more
teachers and ensuring access education to all citizens.

 This is because quality education creates positive externalities and

increases the productive capacity that helps to raise the steady state rate
66
of economic growth.
Cont.…
3). Since government spending on Agriculture has
negative impact on economic growth ;the government
should building the capacities of the small-scale farmer by
providing the smallholder farmers with technology and
better farming practices, improved seeds, fertilizers,
irrigation, rural roads, and marketing services were
introduced to increase agricultural production and rise in
expected to stimulate industrial production that promote
economic growth.
67
Cont.…

4). Based on the findings the higher expending on health

sector do not necessarily lead to rapid economic growth
because of brain drain, inefficiencies of health institution,
low technology adoption, corruption and embezzlements
the government should ensure a supportive and efficient of
socioeconomic structure for efficient utilization of resources,
build good governance, stop the outflow of skilled manpower
and control the final destination of the birr that it spends on
health sector. 68
 Cont.…
5). The government should increase its investment in areas that
are beneficial to the private sector and eschew from those that
compete with or crowd it out.
 It should Increase its expenditures on those items that enter

private production functions as productive public inputs that

enhances economic growth.
 Such productive government investment expenditure includes

expenditure on buildings, plant, machinery and equipment all of

which generate positive externalities that raise private
investment and thus economic growth rate.
6). Ethiopian economy is labor intensive. Therefore, the
government should focus on job opportunity for labor. If this
condition is fulfilling, economic growth will achieve the targeted
goal.
 This improves economic well-being of the country 69
 THANK YOU!!
Success is the reward of hard work !!

70