Public Expenditure and Economic Growth in Ethiopia

Abstract

Using data from 1975 to 2019, this research examines the association between government spending on four sectors of the economy - education, health, agriculture, and defense - and economic growth (GDP) in Ethiopia. The study utilized descriptive statistics and panel data regression to analyze the data. Granger causality test was also used to find out the direction of causality between spending and economic growth. Panel data regression was selected because panel data estimation is better to work with entities that are observed across time. Hausman test was applied in order to select the better model from Fixed Effect and Random Effect panel regression data models. Accordingly, the result of the descriptive analysis shows that, on average, the government of Ethiopia has been spending relatively more on the education sector followed by agriculture, health, and defense sectors sequentially. The panel data regression analysis indicates that government spending on education and health sectors has a statistically significant and positive relationship with the economic growth of Ethiopia; whereas, public expenditure on agriculture and defense has a positive but insignificant association with the GDP of the country. Applying the Granger causality test with lag 2, this study also found a bidirectional causality relationship between GDP and expenditure in an Ethiopian economy thus supporting both the Keynesian theory and Wagner’s law. The study concludes that, since there is bidirectional causality between expenditure and economic growth in Ethiopia, expanding the public sector and using government expenditure as a policy instrument will promote the economic growth of the country. It also shows that the Ethiopian government should focus on expending more on the health and education sectors.

Key words: Public Sectorial Expenditure, GDP, Economic Growth, Ethiopia, Panel Regression, Keynesian theory, Wagner’s law, Granger causality