Empirical Essays on Finance and Economic Development in Ethiopia

Abstract

Access to financial services has been shown to be associated with faster growth and the promotion of economic development. However, most developing countries have a fragile and under-developed financial sector that provides limited access to financial services. Ethiopia is one of such countries where financing constraint, inter alia, is cited as the single most important investment bottleneck reported by firms and households. Therefore, this thesis aims to show to what extent financing influences economic performance in Ethiopia, at different levels of economic entities. The thesis encompasses three related, but independent, essays. The first essay explores the effect of external financing on firm growth. Using data from the World Bank’s Ethiopian Enterprise Surveys of 2011 and 2015, we find a negative relationship between using external financing and firm growth. Specifically, we report strong evidence that firms that rely more heavily on external financing for working capital exhibit significantly lower growth, and some evidence of a similar effect with regard to fixed capital financing. The second essay examines the effect of ethnic differentiation in banking development for Ethiopian woredas (districts). Exploiting an extensive data set from the Ethiopian Central Statistical Agency (ECSA) together with unique data from the Ethiopian banking sector, we find that ethnic ties are highly important for banking development, and conditional on this effect, a number of banks exert a large positive effect on the local economy. The third essay investigates the impact of credit constraints on household welfare. Using the Ethiopian Socio-economic Survey (ESS) panel data, we construct a measure of household credit constraints by adopting a direct elicitation method. Applying various estimation methods, we find that credit-constrained households have less per capita consumption and income and are less likely to build household assets. The overall results in the thesis imply that not only is provision of financial services important in Ethiopia, but also that the allocation mechanism needs to be considered.