Abstract

Using a time series data from 1990-2020, this study employs the augmented Solow human-
capital-growth model to investigate the impact of government expenditure on economic
development outcomes in Ethiopia. Expenditure on public health and education were taken as
proxy variables for human capital development in order to see their impact on economic
development. The Augmented Dickey Fuller test is employed to test for stationary and
Johansen Co integration technique is used to validate co integration among variables as a sign
of long run relationship. The error correction model is used to adjust for the short run error
correction. Further tests of autocorrelation and residual normality distribution were done. The
result of the ADF test has shown that all variables are non-stationary at level I (0) and
stationary at I (1). There are two co integrating equations implying convergence. The result of
the error correction model show that the model is adjusting at a relatively stable rate of 61 %
towards the long run equilibrium. The results of the short run causality tests show public
expenditure on education, public expenditure on health have significant effect.

Keywords: Economic Development, Human Capital, VECM, ECM, Ethiopia.

CHAPTER ONE
1. INTRODUCTION

1.1. Background of the study

Physical capital accumulation has traditionally been emphasized in economic theory as
the most important source of economic growth, at least in the short run, with exogenous
technical progress being the long-run predictor of growth. The neoclassical growth
model's exogeneity of technical advancement and the difficulty of explaining long-term
economic growth (due to diminishing returns to physical capital) have limited the
model's analytical capacity and empirical verification. The endogenous growth models
developed by Romer (1986) and Lucas (1988) were giving emphasis on human capital
accumulation and its roles for economic growth (Mankiu, 2009).
Because successful schooling depends, among other things, on appropriate health, health
is a prerequisite for increased productivity. Workers that are in better health are more
active and strong, and their production is higher. In this regard, health has a wider
concept than mere understanding of absence of sickness. It is the ability of people to
develop to their potential during their entire lives. In that sense, health is an important
asset individuals possess, which has intrinsic value (being healthy is a very important
source of well-being) as well as instrumental value (Bloom, Canning & Sevilla 2004).
A nation’s human capital endowment, the skills and capacities that reside in people and
that are put to productive use can be a more important determinants of its long term
economic success than virtually any other resource (World Economic Forum 2016).
Early neoclassical economic growth models give due attention to physical capital
accumulation and technology to bring economic growth. In this regard, it is worth to note
the Harrod (1939) and Domar (1946) models of economic growth as cited in Todaro
(2010); which give due emphasis to a higher level of saving as having key role in the
creation of better capital labor ratio (physical capital accumulation). Their assumption
stipulates that countries with higher saving rate will grow faster than those with lower
saving rate. In addition to the physical capital accumulation, they also noted the need for
technological improvement in order to have a long term effect on economic growth.
National wealth should also include the value of the skills and training of the countries residents
what economists call human capital in practice. Endogenous growth theorists have provided a
number of reasons to explain why in the firms and the economy as a whole, the marginal
productivity of capital may not be diminishing. One explanation emphasizes the role of
human capital the economist's term for the knowledge, skills, and training of individuals.

As economies accumulate capital and become richer, they devote more resources to
investing in people through improved nutrition, schooling, health care, and on-the-job
training. This investment in people increases the country's human capital, which in turn
raises productivity If the physical capital stock increases while the stock of human capital
is remains fixed, there will be diminishing marginal productivity of physical capita.
Recent research findings point to a strong connection between productivity growth and
human capital. The government affects human capital development through educational
policies, worker training, health programs, and in other ways (Andrew et al, 2001).
Health and education are both components of human capital and contributors to human
welfare. One index of human welfare, which incorporates income, education and health,
shows that Africa’s level of human development is the lowest of any region in the world.
Work can enhance human development when policies are taken to expand productive,
remunerative and satisfying work opportunities; enhance workers‟ skills and potentials;
and ensure their rights, safety, and wellbeing. Measuring aspects of work, both positive
and negative, can help shape policy agendas and track progress toward human
development enhancing work (UNDP, 2015). Public expenditure has been attracting the
attention of economists in recent times due to its effects on the level of growth (Sunday
and Elizabeth 2012). Government expenditure is expected to be a means of reducing the
negative impacts of market failure on the economy. However, allocations of public
expenditure with lack of consideration for the urgent needs of the country may endanger
greater distortion in the economy which may be detrimental to growth. Economic growth
is expected to bring about a better standard of living of the people through provision of
better infrastructure, health, housing, education services and improvement in agricultural
productivity and food security (Loto 2012).
As Ethiopia’s per capita income has just crossed $1,000 PPP based on an expected US dollar
GDP of $109.5bn for FY 2019-20 (3,422bn in Birr terms) and a population counter
official statistics above 100 million (ADB, 2020). Taking a cross-country perspective and
reviewing the record of other countries that crossed $1,000 in per capita income (this
occurred just 19 years ago in China, 13 years ago in India/Vietnam, and 7 years ago in
Bangladesh/Kenya), we see that growth can continue at its recent pace as long as it is
supported by high investment, and that Ethiopia could reach a $2,000 per capita income
(~$5,100 per capita in PPP terms) within the space of seven years. (Cepheus research,
2020)

1.2. Statement of the Problem

Human capital is acquired mental and physical ability to human being through education,
skill development, training, health care and other capacities of people to enhance their
productivity and efficiency. It refers to any aspects of person that produces economic
values which includes personal attributes such as health, nutrition status, knowledge and
skills (Todaro, 2012). The dream of guaranteeing justifiable and persistent development
in alleviating mass poverty at a meaningful and measurable manner, in one way or
another, in the government’s development strategy. (Kaleb, 2019). The predominant aim
of every government’s spending is to guarantee a long and healthy life for the citizens,
ensure they are knowledgeable and enjoy a decent standard of living.
Ethiopia is a landlocked nation with the second most populous country in Africa after
Nigeria with a total population of about more than 100 million in 2020 (ADB,2020). It is
one of the poorest countries in the world ranking 174 out of 186 countries in the Human
Development Index (HDI) and its human HDI index is around 0.48 in 2020 which clearly
shows a lower level stature ranking around the world (UNDP, 2020). According to
Ministry of Finance and Economic Cooperation report on FY 2000-2019, looking across
the data trend, Ethiopia experienced a determined rise in their level of public expenditure
and consequent increase in budget deficits and public debt as the country GDP is also
growing at higher rate from 67,351Million in 2000/2001 to around 2,696,223 Million in
2018/19 enjoying an annual around
7.2 percent average growth rate in per capita gross domestic product. However,
Ethiopia’s HDI index is around is 0.485 in 2020 which means it is below the average of
0.547 for countries in Sub-Saharan Africa. Meaning GDP growth and HDI are not
growing harmoniously.
Empirical and theoretical literature mentioned above by different researchers at different
time period and country experience majority of them used real GDP as proxy variable for
measuring economic growth and analyzed how the different components of government
expenditure at aggregate level (education, health) impact economic growth and end up
with different finding and conclusion using different measurement.
So, what will be the contribution of this research to the existing body of knowledge
development/What makes it peculiar from prior studies /?.on the one hand several
domestic and foreign empirical studies on government expenditure have been focus on
economic growth (Chandran al, 2011; Al-Bataineh, 2012; Gangal & Gupta, 2013;
Hasnul, 2015; Al-Shatti,

2014; Lahirushan & Gunsekara, 2015; Torki, 2016; Jelilov & Musa, 2016; Meguro,
2017) among others. On the other hand, theoretical views like Wagner’s law and
Keynesian theory opposite view on government expenditure and economic growth,
because economic growth is necessary but not sufficient condition for economic
development but failed to classify government expenditure into development and non-
development in order to determine their specific effect on HDI.

Hence, this study come up with new perspective in addition to the existing literature to
address the relationship between the consistent increase in components of government
expenditure and its developmental outcomes in Ethiopia by considering human
development index as proxy for measuring economic development outcomes with
particular focus on health, GDP Per capita & education as the major element to be
affected by expenditure made by government
1.3. Research question
 What is the impact of government spending on Ethiopia's economic development
outcomes?
 What are the short run and the long run impact of human capital on economic
development in Ethiopia?
  What are causal relationship between human capital and economic development in
Ethiopia?

1.4. Objective of the Research

1.4.1. General Objective
The study's overall goal is to examine the impact of government spending on Ethiopia's
economic development outcomes by focusing on the structure rather than the size of public
spending.

1.4.2. Specific Objective

The specific objective of the thesis work includes: -

 To examine expenditure on human capital (Education and heath)

affects economic development in Ethiopia.

 To analyze the short run and the long run impact of human capital on
economic development in Ethiopia; and
 To examine the causal relationship between human capital and
economic development in Ethiopia.

1.5. Research Hypothesis

Modern theory of economic growth argues that human capital, especially education and health has the
principal role on achieving economic growth and development. Proponents of endogenous growth theory
lay emphasis on human capital formation and regard it a factor which explains difference in growth
performance of under developed and developed nations (Romer, 1992). Becker (1962), who believes
that human capital is just like physical capital and one, can invest in it by means of education,
health and training which, in turn, will raise output and contribute to economic growth.

Then the study tests the hypothesis:

Ho: βs=0 (i.e. human capital have no short run and long run significance impact on
economic development)
H1: βs≠0 (i.e. human capital has short run and long run significance impact on
economic development).
 Similarly,
Ho: βs=0 (i.e. there is no causality between human capital and economic
development). H1: βs≠0 (i.e. there is causality between human capital and economic
development).

The researcher expects that there will be a short and long run significant association between
human capital and economic growth, as well as causation between human capital and economic
development, based on the empirical findings of this study.

1.6. Significance of the study

The aim of this study is that it will deploy most recent & update data as well expected to
apply quantitative analysis and multiple regression models to study the impact of
government expenditure on economic development outcomes whether it can be positive,
negative or neutral. This study updated information and the findings of this study can be
used as a guide for researchers, policy developers and provide important information on
the current performance of the public sectors for budget allocation. In addition to this, the
study could be as an essential resource for further researches on this area and for the
researchers to employ theoretical knowledge of research into practice.

1.7. Scope and Limitation of the Study

Undertaking research on the impact of government expenditure on economic
development is a vast area since it requires time, and sufficient knowledge. These
constraints force the study to undertake a research at national level (in Ethiopia) and
examine the relationship between human capital and economic development in Ethiopia
between 1990 to 2020 fiscal years. Availability of data is usually a challenge for
researcher because United nation release data on HDI for Ethiopia starting from FY
2000.

1.8. Organization of the thesis

The study is organized into three sections: First section explains the introduction part,
second review of theoretical and Empirical literature, continued with research
Methodologies are the contents this proposal thesis.
CHAPTER TWO
LITRATURE REVEW
2. Introduction
Human capital represents the productive capacity of the people. Just like land or
machinery, workers are an essential requirement for production. As such, human capital
denotes the skill of the labor force, how well and efficiently workers can transform raw
materials and capital into goods and services. These skills such as literacy, numeracy,
cognitive, and analytical skills can be learned and honed through education; thus, any
discussion of human capital has to touch upon education (Son, 2010). Human capital
plays a critical role in economic growth and poverty reduction. From a macroeconomic
perspective, the accumulation of human capital improves labor productivity; facilitates
technological innovations; increases return to capital; and makes growth more
sustainable, which, in turn, supports poverty reduction. Thus, human capital is regarded
at the macro level as a key factor of production in the economy wide production
function.

According to a microeconomic point of view, training expands the likelihood of being

utilized in the labour market and further develops income limit. Hence, at the miniature
level, human resources is viewed as the part of instruction that adds to a person's work
usefulness and income while being a significant part of firm creation (Andrawetal,
2001).Although the conceptual definition of human capital is clear, its measurement is
difficult because it is practically impossible to observe individual skill, and even harder
to design a metric that is comparable across individuals and countries. Thus, various
proxy measures of human capital have been proposed in the empirical literature, such as
literacy rates (Azariadis and Drazen 1990); school enrollment rates (Barro 1991, Mankiw
et al. 1992); years of schooling (Barro and Lee 1996, 2001, and 2010; Cohen and Soto
2007); and test scores (Hanushek and Kimko 2000, Hanushek and Woessmann 2009).
While the literacy rate, which measures the proportion of the population who can read
and write, is an important measure of well-being, it does not measure the educational
attainment or skill level of the workforce. On the other hand, school enrollment rate is a
relevant metric only for school-age children and has little relevance for the workforce.
Definition of the fundamental elements to be used in estimation and measurement as
dependent and independent variables

Human Development Index (HDI): According to Human development report (2020),

which stated that the HDI is one approach to measure the success rates of human
development. It started to be used since 1990 to measure the achievement of human
development of a country. Although not able to measure all dimensions of development,
however, able to measure basic dimensions of human development which is considered
to reflect the status of basic skills of population. HDI consists of 3 (three) components
that are considered essential for humans and operationally easily calculated to produce a
measure that reflects the effort of human development. The components are: (i). the
chance of survival (longevity); (ii). Knowledge, and
(iii). a decent living (living standards). Chances of survival is calculated based on life
expectancy at birth, knowledge is measured by the average length of the school and the
literacy rate of the population aged 15 years and above, and a decent life is measured by
expenditure per capita based on purchasing power parity.

Health and Health expenditure: Ethiopia’s total health expenditure (recurrent and
capital) was estimated at ETB72 billion (US$3.10 billion)in 2016/17, total health
expenditure accounted for 4.2% of the country’s GDP, which is lower than the expected
average of 5% for low-income countries, and well below the global average of 9.2%.
However, it represented a considerable improvement over the situation in the late 2000s,
when it stood at around 3.8%. The share of recurrent health spending in 2016/17
increased to 87.95% from 86.3% in 2013/14, while the share of spending on training and
research remained about the same. On the other hand, the share of capital spending has
decreased to 8.6% in 2016/17 from 10.4% in 2013/14 (Berihun, 2014).

GDP per capita: GDP per capita is gross domestic product divided by midyear
population. GDP is the sum of gross value added by all resident producers in the
economy plus any product taxes and minus any subsidies not included in the value of the
products. It is calculated without making deductions for depreciation of fabricated assets
or for depletion and degradation of natural resources.

2.1. Theoretical Review

Human capital impacts economic growth only if it is utilized in the labor market: those who
have attained schooling need to be employed so that their skills can be used to produce goods
and services. However, there may be a mismatch between the skills taught by the educational
system and the skills needed by the labor market, so highly educated workers may end up
doing low productivity jobs. Thus, despite a country’s achievements in accumulating human
capital through the education system, this achievement may not lead to economic growth and
poverty reduction if the labor market is not considered (Son, 2012).

From the early 1990s, various studies have attempted to identify the determinants of economic
growth; long-run growth is endogenous rather than exogenous (Romer, 1986; Lucas, 1988;
Mankiw et al., 1992). The idea of human resources alludes to the capacities and abilities of
human resource of a nation, while human resources arrangement alludes to the most common
way of gaining and expanding the quantity of individuals who have the right stuff, great
wellbeing, schooling and experience that are basic for monetary development. Thus,
investment in education and health are considered as human capital development. Human
capital plays a special role in a number of models of endogenous economic growth. In Romer
(1990) human capital is the major input to the research sector, which generates the new
products or ideas that underlie technological progress. Thus, countries with greater initial
stocks of human capital experience a more rapid rate of introduction of new goods and thereby
tend to grow faster.

One particular source of externalities that has been emphasized in the recent growth literature
is the accumulation of human capital and its effect on the productivity of the economy. Lucas
(1988) provides one of the best-known attempts to incorporate the spillover effects of human
capital accumulation, in a model built upon the idea that individual workers are more
productive, regardless of their skill level, if other workers have more human
capital(Montieletal, 2008). Economic theory suggests that human capital would be an
important determinant of growth, and empirical evidence for a broad group of countries
confirms this linkage. Many economists use different measurement to proxy human capital,
however, the assumptions and results are, nevertheless, basically the same. The study
conducted in 735 developing countries during 1960 to 1985 by Barro (1991) was the famous
one. In his study the average number of years of education attainment (School attainment) was
used as measurements of human capital. The result indicates that Countries that start with a
higher level of educational attainment grow faster for a given level of initial per capita GDP
Education has been considered a key determinant of economic growth since the introduction
of Solow‟s (1956) growth model. Although Solow did not explicitly factor in education in his
growth theory, the central role of technology in his model provided the impetus for the focus
on education; after all, an educated population was necessary for technological innovation.
The endogenous growth models played the central role of human capital in technological
development and economic growth. According to these new growth theories such as Lucas
(1988); Romer (1990); Mankiw, Romer, and Weil (1992); Barro and Sala-i-Martin (1997) the
accumulation of human capital through education and on- the-job training fosters economic
growth by improving labor productivity, promoting technological innovation and adaptation,
and reducing fertility. Economic growth takes place due mainly to two factors: labor
productivity growth and employment growth (Son, 2010).

Another issue regarding studies on the relationship between education and economic growth is
the lack of consistency between human capital theory and empirical testing. While the Solow
and Nelson-Phelps models defined the basis of human capital theory, testing them in practice
has been a problem. Mincer (1974) tested this relationship by measuring human capital as
years of schooling, and derived a log-linear specification for output and schooling,
respectively. The Solowian exogenous growth theory that was developed in the 1950s, at the
height of the wave of newly independent countries, can be considered the immediate
predecessor of the new growth theories that emerged in the 1980s and 1990s. Originally, it
only included labour, L, physical capital, K, and technology, A, the latter exogenously
explaining long-run growth. However, with the human capital revolution also human capital
was augmented to this model. Yet, because also for human capital diminishing returns were
assumed, no real difference took place in the structure of the theory (Mankiu, 2009). In the
neo-classical growth model from the 1950s have no special attention was given to human
capital. Basically, it was argued that the growth of physical capital had an effect on the growth
of GDP while the unexplained residual, labeled Total Factor Productivity (TFP), explained
economic growth in the long-run. The rise of human capital theory (Schultz 1961; Becker
1964) led to the inclusion of human capital. In contrast to neoclassical models, endogenous
growth models explicitly incorporate technology and attempt to recognize that technological
change depends on economic decisions in the same way as capital accumulation. In particular,
technological change is most commonly related to the stock of human capital. In the
endogenous models, economic growth can continue indefinitely because the returns on
investment in a broad class of both physical and human capital goods do not necessarily
diminish through time. Spillovers of knowledge across producers and external benefits from
improvements in human capital are part of this process because they offset tendencies to
diminishing returns. Growth frameworks have also incorporated R&D concepts, as well as
imperfect competition (Romer, 1986).

Endogenous growth theory argues that, as an economy's physical capital stock increases, its
human capital stock tends to increase in the same proportion. Thus, when the physical capital
stock increases, each unit of physical capital effectively works with the same amount of
human capital, so the marginal productivity of capital need not decrease. The result that the
saving late affects the long-run growth rate of output stands in sharp contrast to the results of
the Solow model, in which the saving rate does not affect the long-nm growth late. Saving
affects long run growth in the endogenous growth framework because, in that framework,
higher rates of saving and capital formation stimulate greater investment in human capital and
R&D. In comparison to the Solow model, the endogenous growth model places greater
emphasis on saving, human capital formation, and R&D as sources of long-run growth
(Andrawetal, 2001). One particular source of externalities that has been emphasized in the
recent growth literature is the accumulation of human capital and its effect on the productivity
of the economy. Lucas (1988) provides one of the best-known attempts to incorporate the
spillover effects of human capital accumulation, in a model built upon the idea that individual
workers are more productive, regardless of their skill level, if other workers have more human
capital(Montiel etal,2008). The world‟s poor countries have average levels of income per
person that are less than one-tenth the average levels in the world’s rich countries. These
differences in income are reflected in almost every measure of the quality of life from the
number of televisions and telephones per household to the infant mortality rate and life
expectancy. Much research has been devoted to the question of whether economies con- verge
over time to one another. If they do, then the world’s poor economies will tend to catch up
with the world’s rich economies. This property of catch-up is called convergence. If
convergence does not occur, then countries that start off behind are likely to remain poor. The
Solow model makes clear predictions about when convergence should occur. According to the
model, whether two economies will converge depends on why they differ in the first place. On
the one hand, suppose two economies happen by historical accident to start off with different
capital stocks, but they have the same steady state, as determined by their saving rates,
population growth rates, and efficiency of labor. In this case, we should expect the two
economies to converge; the poorer economy with the smaller capital stock will naturally grow
more quickly to reach the steady state. On the other hand, if two economies have different
steady states, perhaps because the economies have different rates of saving, then we should not
expect convergence. Instead, each economy will approach its own steady state (Mankiu,
2009). Human capital is accumulated through explicit “production”: a part of individuals‟
working time is devoted to accumulation of skills. The growth of physical capital depends on
the saving rate (I =sy), while the growth rate of human capital is determined by the amount of
time devoted to its production. In the long run, the level of income is proportional to the
economy’s initial stock of human capital. In this particular formulation, the saving rate has no
effect on the growth rate. The important implication of the external effect captured in the
model presented by Lucas (1988) is that under a purely competitive equilibrium its presence
leads to an underinvestment in human capital because private agents do not take into account
the external benefits of human capital accumulation. The equilibrium growth rate is thus
smaller than the optimal growth rate, due to the existence of externalities. Because the
equilibrium growth rate depends on the rate of investment in human capital, the externality
implies that growth would be higher with more investment in human capital. This leads to the
conclusion that government policies (subsidies) are necessary to increase the equilibrium
growth rate up to the level of the optimal growth rate. A government subsidy to human capital
formation or schooling could potentially result in a substantial increase in the rate of economic
growth (Montieletal, 2008). Lucas’s (1988) original formulation is cast in an optimizing
framework in which private agents determine their consumption path by maximizing their
utility subject to an intertemporal resource constraint. The main point of his analysis, however,
can be made by assuming a constant saving rate, as in Lucas (1993). Lucas (1988) also
develops a second model that assumes a different structure of techno- logical change. In this
alternative framework all human capital accumulation occurs through on- the-job training, or
learning by doing, rather than through the time allocated by workers to this accumulation.
Thus, it is the time devoted directly to production activities that determines the rate of growth.
An alternative approach to assessing the role played by external effects in the growth process
was proposed by Romer (1986). In his framework the source of the externality is the stock of
knowledge rather than an aggregate stock of human capital. Knowledge is produced by
individuals, but because newly produced knowledge can be, at best, only partially and
temporarily kept secret, the production of goods and services depends not only on private
knowledge but also on the aggregate stock of knowledge.15 Firms or individuals only partially
reap the rewards to the production of knowledge, and so a market equilibrium results in an
underinvestment in knowledge accumulation. To the extent that knowledge can be related to
the level of technology, Romer framework can be viewed as an attempt to determine
endogenously the rate of technological progress. In subsequent work, Romer (1990) also
explained endogenously the decision to invest in technological change, using a model based on
a distinction between a research sector and the rest of the economy. In that framework, firms
cannot appropriate all the benefits of knowledge production, implying that the social rate of
return exceeds the private rate of return to certain forms of capital accumulation. A tax and
subsidy scheme can thus be utilized to raise the rate of growth. Following David Romer , a
simplified version of Romer (1990) model can be described as follows. Consider an economy
with two production sectors: a goods-producing sector, which uses physical capital,
knowledge, and labor in the production process, and a knowledge-producing sector, where the
same inputs are used to expand the stock of knowledge (Romer, 1991).

2.3. Empirical Literature review

Reviewing and exploring an empirical studies conducted on the response of government expenditure to
potentially impact human development index were assessed by respected scholars at different time,
taking in to account various research methodology to come up with their own finding and conclusion,
this study reviews some authors research work to be taken as supplement or compliment for this study.
Most results are consistent but showing various finding depending up on the variable selection, model
formulation as well country specific problems so, most of them inclined to hybrid. Even though
education and health major pillars for economic development there is no universal consensus
compositions of public expenditure directly promote economic development significantly and create
fertile ground for economic wellbeing. Scholars examined the relationship between government
expenditure on economic development outcomes
Anbelaetal (2014) identified as human capital is one of the main determinants of economic growth and
plays an important role in the technological progress of countries. Based on econometric panel data
estimations involving a set of OCDE countries over 1960-2011, found that the countries‟ productive
specialization dynamics is a crucial factor for economic growth. It is also shown that the interaction
between human capital and structural change towards high knowledge-intensive industries impacts on
the economic growth. However, the sign of this effect depends on the type of country and length of the
period of analysis. Specifically, in the long term and in developed countries, where knowledge-
intensive industries already account for a great share of the economy, the impact of the interaction
between human capital and structural change is positive. In the case of less developed countries, and
considering a shorter time period, the effect of human capital via specialization in high-tech and
knowledge intensive activities emerged as negative Muhammad &Asfaw (2014) as cited in Smith
(2012), Public spending can boost economic productivity by assisting with the start-up of new
sectors or the introduction of activities that have yet to be introduced by the private sector. It
can also have a direct impact on education,,health,, housing, and basic needs provision. It has
the ability to facilitate economic development by providing infrastructure in both theoretically
and empirically.

Arabi et al (2013) investigate the impact of human capital on economic growth in Sudan for
the period 1982-2009 by using a simultaneous equation model that links human capital i.e.
school attainment; and investment in education and health to economic growth, total
productivity, foreign direct investment, and human development index. Based on three-stage
least squares technique, the empirical results of the paper show that quality of the education
has a determinant role in the economic growth; health quality factor has a positive impact on
economic growth as expected and total factor productivity which mainly represents the state of
technology has adverse effect on economic growth and human development due to the
obsolete and old fashion technology.

Haldaretal (2007) examined the time series behavior of investment in physical capital, human
capital (comprising education and health) and output in a co-integration framework, taking
growth of primary gross enrolment rate and a dummy for structural adjustment programme
(openness which has been initiated in 1991) as exogenous variables in India from 1960 to
2006. The results suggest that physical capital investment has no long-run nor short-run effect
but the human capital investment has significant long-run effect on per capita GNP; the stock
of human capital measured by primary gross enrolment rate (lagged by three years) and
openness is found to have a significant effect on growth of per capita GNP.

Atardi and Sala-i-Martin (2003) argue that Africa's growth tragedy of the 20th century can be
explained by low endowments of human capital, poor external environment, and political
instability. Cited in Hippe (2013) according to Becker (2002), human capital is the most
decisive type of capital in contemporary economies. He refers to studies showing that human
capital accounts for over 70% of total capital accumulation in the US representing more than a
fifth of total GDP. Consequently, “technology may be the driver of a modern economy,
especially of its high-tech sector, but human capital is certainly the fuel” (ibid).

Paul Romer (1990) on the other hand notes that an important distinction should be made
between human capital and abstract technological knowledge. He further notes that although
human capital involves the acquisition of knowledge, it differs in one respect from abstract
knowledge such as invention or design. As such, human capital is a private good in that it is
tied to a person and is therefore rival and excludable.

Kidanemariam (2015) on the other hand, using the ARDL approach to co-integration showed a
stable long run relationship between real GDP per capita, education human capital and health
human Capital. Accordingly, the estimated long run model indicated that human capital in the
form of health have big positive impact on real GDP per capita rise followed by education
human capital, among other things.

Ketema (2006), an Ethiopian author, has also attempted to analyses how spending could
potentially effect growth throughout the period 1961-2004, using an empirical econometric
study, and has come to the conclusion that human capital plays a critical role in the long run.
Active government spending has a negative and negligible impact on real GDP.

Adewara and Oloni (2011) argue that government spending on well-being influences the
country's economic development in a good direction, but that schooling has the exact opposite
effect, with a negative and irrelevant commitment. Government spending has a critical and
significant role in reviving a depressed financial situation by adjusting monetary arrangement
gauges and contributes significantly.

Looking at Ethiopian government fiscal policy measures related to government spending on

improving the composition of spending that affects development outcomes, many attempts
have been made over the last ten years, and it has become a policy concern (Bayew, 2014).
According to Beauty (2016), respected writers' theories can serve as a stepping stone in
supporting our findings, but they do not guarantee the genuine relationship between the
variables of interest. Indeed, the vast majority of economists would reach a certain level of
comprehension on the subject.

In 2016, Beauty noted in his work that education is one of the major capacities that are valued,
due to its impact on social orders and government support in a country. As a result, the
government should take into account the execution of government spending portions in order
to provide quality training, both in terms of the foundation of instruction and the character of
the schooling framework. Wellbeing is the core in talk of making social government assistance
achievement in a way that medical services is a conspicuous component to clarify the nature of
human improvement in a country for the explanation that it is likewise assume noteworthy part
as the solid state of a general public, on the off chance that it helps the advancement exertion
of a country in a significant way.

According to BPS (2008, as cited by Beauty, 2016), achieving better socioeconomic wellbeing
and development is the goal of any benevolent government of various sizes across regions and
countries; additionally, government spending on developmental areas can be more pronounced
in low income generating peoples than higher income categories due to the fact that labor is
the only asset for low income generating peoples.

“How fiscal and monetary policies effect economic growth and development,” Patricia and Izuchukwu
(2013, as cited in Olopade and Olepade (2010). The goal of their research was to figure out which
aspects of government spending contribute to growth and development, which ones don't, and which
ones should be removed or reduced to the bare minimum. An analgesic is used in this research. They
find no significant relationship between most of the components of expenditure and economic growth.
Smith (2014) investigated the role of government finance in economic development in 56 developing
countries, emphasizing on the implications of different types of government spending and revenue
(mostly taxes). The findings suggest that government finance has aided development, contrary to some
economists' assertions that the government has failed to do so. Belgrave and Craig well (1995) used the
Augmented Dickey Fuller and Engle and Granger co integration technique to examine the impact of
government expenditure on economic growth in Barbados from 1969 to 1992, disaggregating the level
of government on economic growth into functional and economic categories. Their studies
demonstrated that capital expenditure and earnings have a positive association.

Deverajan et al. (2010) examined the composition of public expenditure and economic development for
a panel of 43 developing countries from 1970 to 1990 using Ordinary Least Squares. Increasing the
share of current expenditure has a positive and statistically significant impact on growth, according to
the data. As a component of government spending, capital, on the other hand, has a negative influence.
Ghali (2000) studied the effects of government spending on economic growth. The study used time-
series data for OECD countries from 1970 to 1995. The factors were government investment, exports,
and imports. Government spending, according to the data, causes growth in the majority of countries.
Tanninen (2000) analyzed panel data from 52 nations from 1970 to 1992. The study used the General
Methods Moments method of estimation (GMM). Investment, government spending categories, and
income disparity were the factors used. Government spending and consumption had a negative
influence on economic growth, according to the study, and public spending on public goods slowed
growth. Using long annual data from the United States, Islam and Nazemzadeh (2001) investigated the
causal relationship between government size and economic development. They claimed that there was
a causal link between economic growth and relative government size.

Dar and Khalkali (2002) looked at OECD countries from 1970 to 1999 to see how government
size affects economic growth. The study, which used panel data, suggested that the size of
government had a negative and statistically significant impact on economic growth. With their
coefficients, the only countries that did not come under the aforesaid conclusion were the
United States, Sweden, and Norway. Dilrukshini (2002) used the Johansen co integration
approach and the Granger causality test to examine the link between public expenditure and
economic development in Sri Lanka from 1952 to 2002. The data imply that economic growth
in Sri Lanka does not directly affect and dictate the growth of governmental expenditure.

Using panel data from Sub-Saharan Africa, Yasin (2003) investigated the relationship between
government spending and economic growth. He built his empirical model of the study on the
basis of the neoclassical production function. Government spending on capital formation,
private investment, and foreign aid for development, population increase, and trade openness
are all stipulated clearly.

From 1965 to 2000, Bagdin et al. (2003) investigated the relationship between government
spending and economic development in Turkey. The Engel Granger co integration test was
used to examine the long-run relationship between public spending and GDP, and it was
discovered that the two variables were not co integrated. They discovered that neither national
income growth nor national income growth had a causal relationship.

Bose et al. (2003) used the Seemingly Unrelated Regression technique to assess the effects of
government spending for a panel of 30 developing countries over the 1970s and 1970s, with a
particular focus on sectorial spending. Government capital expenditure as a proportion of GDP
is positively and strongly related to economic growth, according to their findings.

Wondaferahu (2003) conducted an econometric analysis of the impact of capital and current
government spending on economic development from 1960/1961 to 2002/2003, using the
Johan son Maximum Likelihood estimate technique. Capital expenditure has a favorable and
significant impact on economic growth, according to the research, whereas current spending
has a short-term negative impact on growth.

The results of the Bounds Test, where real GDP is employed as the dependent variable, reveal
that there is no long-run relationship between government expenditure and economic growth
in Nigeria, according to Nasiru (2012). Furthermore, the findings of causation suggest that
government capital investment is a cause of economic growth. While there was no indication
of a link between government recurrent spending and economic growth, there was evidence of
a link between government recurrent spending and economic growth.

From 1971 to 2011, Tofik (2012) investigated the relationship between official development
assistance, government spending, and economic growth in Ethiopia. Consumer spending has a
negative impact on economic growth, while public spending on physical investment and
human capital development has a positive [Link] and Wolde-Rufael (2013)
investigated the relationship between government expenditure and economic growth in
Ethiopia using the bounds test approach to co integration and the Granger causality test in
order to test Wagner's Law, which states that as real income rises, the share of public
expenditure rises relative to national income.
2.4. Conceptual Framework of the thesis
Source: Author’s Framework (Modified from Eleonora Sofilda, 2015): Conceptual Framework
based on Human Development Report 2020.
Figure 1: Researcher Conceptual framework

CHAPTER THREE
3. RESEARCH METHODOLOGY
This section of the thesis applies econometric model as methodological framework by taking
aside variable of interest as target variable and other variables for the study properly explained,
in the same way the dataset used in the study are clearly defined in this part of the research
work

3.1. Research Design

This research work is designed to bring plausible argument regarding the spending of
government on economic development outcomes in Ethiopia. in order to give sensible proof or
disprove to the specified hypothesis with some degree of evidence the researcher applied
quantitative data analytics for the collected data taking a time frame form FY 1990/91-2019/20
in analysing expenditure on education and health sector by the government for analysis of the
data the researcher used Vector error correction method and co-integration model to analyse the
short and long run dynamics that the spending could impact on economic development
outcomes in Ethiopia context on the specified period.

3.2. Data Type and Data Source

The type of data to be used in this study is secondary data for 30 years (1990/1991-2019/20)
Annual time serious date is applied for the study. Time series econometrics has applications in
macroeconomics, but mainly in financial economics where it is used for price analysis of
stocks, derivatives, currencies, etc. (Boru, 2017). Dataused in this study are purely secondary
data where no primary data is collected. The data are mostly be derived from the website of
Central Statistics Authority (CSA) of Ethiopia, Ethiopian Ministry of Finance & Economic
Cooperation, Ethiopian National Plan Commission National bank of Ethiopia, United Nation
Development Report (UNDP), IMF &World Bank including published documents relevant for
the study.

3.4. Method of data Analysis

Descriptive and trend analysis of the dataset were discussed as well econometric analysis were
also applied to clearly understand the relationship among the variables using statistical software
package EVIEWS Version 10.

3.5. Econometrics Model Specification

Human capital plays a critical role in a number of models of endogenous economic growth
(Barro, 1991). Endogenous growth theory as developed by Lucas (1988) basically represents an
extension of the Solow (1956) neoclassical growth model incorporating positive externalities
related to the accumulation of human capital through knowledge

This research study, to better and clearly understand the long run and short run relationship
between the variables of our interest, the researcher used vector error correction method as an
econometric methodological framework developed by Johansson (1999) where all the variables
are integrated of order (I) and unable to employee other method not used due to the fact that,
researcher is unable to apply other methods like OLS , ARDL because to apply OLS the series
has to be stationary at a unit while to apply ARDL series has to be stationary at different level,
so the researcher use vector error correction and co-integration for analysis purpose. Estimate
regression is applied to investigate the impact of GDP Per capita, health expenditure, and
education expenditure on HDI.

The econometric model will be constructed with time serious on years 1999/2000 to 2019/20.
The implications of education in economic development have been investigated since the early
 1960s by the so-called Human Capital School, which originated at the University of Chicago
(Schultz, 1961; Becker, 1964), where expenditure on education was regarded as an investment.
Spending on education and health has also been justified in endogenous growth theory (Lucas,
1988; Romer, 1990). In the endogenous growth model, technological progress, which increases
productivity and accelerates the pace of growth, can be determined within the model through
the formation of human capital. Spending on education and health helps promote efficiency,
knowledge and inventions, all of which contribute to the economic growth of a country. Lucas
(1988) states
y = AKα (uh)1- α (ha )γ….......................................…………………Equation (1)
Where y is output, K is physical capital, u is the fraction of time devoted to productive
activities (and the rest to accumulation of knowledge), h is the human capital input and ha is
the average human capital in the economy. Spending on education and health care proceed as
human capital inputs.

These inputs contribute to human capital and therefore to output growth through either direct
accumulation (uh) or the existing stock of knowledge (ha ), which leads to innovation and spills
over into the rest of the economy. Moreover, if γ > 0, then the production function involves
increasing returns to scale, where productivity growth is endogen zed in human capital inputs.

The Cobb- Douglas production function was used in the study, with output growth as a
dependent variable and human capital growth as explanatory variables. Based on the standard
growth accounting model, the influence of human capital on economic development in
Ethiopia is examined in this paper.
α β
Yt = AEt Ht εt; α , β > 0………… ……………………….Equation (2)

Equation (2) represents a Cobb-Douglas production function, where Yt is output (HDI) per unit of
labour, A is total factor productivity, Et is the spending on education and Ht is the spending on health
care, while α , β are the shares of education and health-care spending respectively

Taking log,
InYt = InA + αInEt + βInHt + Inεt

Differentiating with respect to “t ”, we have:

1 dYt 1 dA 1 dEt 1 dHt 1 dε

= + α +β +
 ………….Equation (3)

Yt=A+ αEt+ β Ht+ ϑt....................................Eq(4)

Based on theoretical framework developed by mankiw,romer and weil(1992) the following

model is specified.

LnHDIt =f (LnLFt, LnEDUEX t, LnHEALTHEX,Ln GDP Per

capita t,) LnHDIt = Natural logarithm of HDI at time t.

LnE t =Natural logarithm of education expenditure at time t.

LnH t =Natural logarithm of health expenditure at time t.

Ln GDP Per capita= Natural logarithm of GDP Per capita at time t as Controlled variable

In this study HDI used as a proxy for economic development outcomes. The study also proxy
human capital by total government expenditure on education, total government expenditure on
health, GDP per capita as controlled variable based on theoretical and empirical literature.

3.6. Estimation technique

This part manages the assessment methodology followed successively in this analysis to
appraise the Co integration models. Fixed and non-stationary, traces the systems for the
assessment of unit root of the factors. Then again, it characterizes co integration, examines the
various techniques for Co integration, choosing Johansen strategy and blueprints the vector
Error Correction (VECM) model utilized in this examination utilizing EVIEW Versions 10.

3.7. Unit root Test

Stationary is bedrock for time series econometric analysis neglected to have such characteristic
can bring unwanted result and result for the estimation of our dataset, to get rid of such
upsetting outcome, the investigation led test utilizing Augmented Dickey Fuller test to
confirmation the information is fixed or not at level or order (1) for al variables under study.
Augmented Dickey Fuller (ADF) to test the request for incorporation of both the reliant and
autonomous factors

3.8. Stationary series and integrated process

Observational work dependent on time arrangement information frequently accepts that the
arrangement is fixed in their levels. To stay away from the circumstance of false regression, it
is basic to see whether the connection between financial factors is typical and prepared for
examination. To decide the non-fixed property of these time arrangement factors, both in the
levels and in the primary distinction, the applicable Dickey Fuller (DF) and Augmented Dickey
Fuller (ADF) tests have been applied. A period genuine variable is supposed to be fixed if the
difference variance and mean are consistent and time free inability to meet the predefined
prerequisite the entire calculation will be non-sense or unfit to give the fundamental outcome to
the examination work under investigation. The fixed interaction is supposed to be joining of
request one, indicated by I(1) and the arrangement is fixed, differencing, isn't needed it is
coordinated of request zero, meant by I(0). Similarly, a non-fixed arrangement which can be
changed in to fixed by differencing it "d" times is supposed to be incorporated of request "d"
i.e. I(d)(Tewodros, 2019)

3.9. Error Correction Model and Co-Integration

To judiciously analyze the degree to which monetary improvement is identified with government
spending, the hypothesis of co-integration and Error correction model (ECM) is applied, with the
assistance of this method; it's feasible to look at the short run and since a long run connection between
the factors.

Co-integration
Co-integration can arise from change in the short run with a long run equilibrium. Existenceof
co- integration variables in our Eviews output shows that all the variables are non-stationary;
the deviations (i.e. the residuals from the estimation of the equation) are stationary.

The coefficient estimate from regressions is interpreted as the long-run effects. This thesis
basically uses econometric model to come up with its own empirical finding. By applying this
model, the researcher able to analyst short-run and long-run dynamics across human
development index and developmental expenditure made by government particularly on
spending made on education and health sector using co-integration and VECM so as to arrive at
sound finding from the time serious data collected across time from FY 1990/1991-2019/20.

Finally, verify for unit root, the most widely applicable tool is applying ADF or PP but most
literature in this area apply ADF in for testing a unit root performed in the levels with and
without time trend as well as with first difference.

RESULT AND DISCUSSTION

The time series information model particular and henceforth plan given in the philosophy area
isn't reasonable for VECM assessment. This is a result of the way that most macroeconomic
time series contain unit roots and the relapse of one non-fixed series on another is probably
going to yield false outcomes. The macroeconomic information for Ethiopia isn't an exemption
in such manner. This implies, the information may not be fixed at a level I (0) and subsequently,
we can't run. Considering the above avocation, prior to running for any time series assessment
technique, the information is prescribed to be checked for fixed.

Descriptive Analytics
Ethiopian Government Trends in Total Government Spending Looking across an ideal
opportunity for as long as twenty years, public uses have ascended at a higher speed in
outright terms, yet this is certifiably not a superior perspective on development as it
doesn't consider price development after some time (Inflation) into thought, Thus, in the talk of
breaking down the patterns of government spending, decision is made to consider ascending in
open consumptions as far as rising public area share. For this situation, the way of generally
government use is exhibited by considering the proportion of absolute government use to
improve HDI, which estimates the measure of government spending comparative with the
size of its economy and its formative results in the opposite side of the condition. Strategy and
activities taken after toppled of military system, the new government (EPRDF) has taken
arrangement instruments and measures on the expenditure side which for the most part centers
around controlling the development and justifying its utilization (Berihun,2014).
In controlling the development of use, the public authority utilizes measure to pull out from
direct inclusion underway and administration conveyance while opening the entryway for
private area interest along these lines, there was a sharp decrease in the overall size of
government during the early post-1991 periods. Then again, in Expenditure, the public authority
needs to shape its capital and intermittent use to redistribute assets to essential social
administrations including Education and wellbeing. It is accepted that these are regions where
public speculation is relied upon to work with generally speaking financial exhibitions including
private area support (MoFEC, 2019).

The figure 3: below delineate the pattern of government use during past year time spans and its
pattern line to take a gander at the bearing of government spending towards it formative results
in the nation in making significant and quantifiable change in the country.