Human Capital and Economic Growth in Ethiopia

A Time Series Analysis

Thesis (M.A.), 2014

43 Pages, Grade: Masters of Science


Table of contents

Chapter 1. Introduction
1.1. Background of the study
1.2. Statement of the Problem
1.3. Research Questions
1.4. General Objective
1.4.1. Specific Objectives
1.5. Significance of the study
1.6. Scope and Limitation

Chapter 2 Research Design and Methodology
2.1. Description of the Study Area
2.2. Type and Source of Data
2.3. Variable Selection and Definition
2.4. Hypothesis
2.5. Methods of Data Analyses
2.6. Model Specification
2.7. The Error Correction Model
2.8. Diagnostic Tests
2.8.1. Test of Stationary
2.8.2. Co-integration Test
2.8.3. Causality Test

Chapter 3 Descriptive Analysis of Human Capital Formation and Economic Growth in Ethiopia
3.1. Education as Human Capital
3.2. Health as Human Capital
3.3. Education, Health and Nominal GDP

Chapter 4 Empirical Analysis
4.1. Diagnostic Tests
4.1.1. Stationarity Test
4.1.2. Co-integration Test
4.1.3. Testing for serial correlation
4.1.4. Causality test
4.2. Static Log Run Analysis
4.3. Dynamic Analysis

Chapter 5 Summary, Conclusion and Policy Recommendation
5.1. Summary
5.2. Conclusion
5.3. Policy Recommendations


The topic of the research is Human Capital and Economic Growth of Ethiopia. The research answered questions such as “does human capital contribute to economic growth of Ethiopia?” with major objective to analyze the short run and long run effect of human capital on economic growth of Ethiopia over 1971 to 2013 using both ordinary least square (OLS) econometric and descriptive methods of data analysis. The data used for the research is secondary time series data collected by the National Bank of Ethiopia over the years 1971 to 2013. Nominal GDP is used as dependent and proxy variable for Economic growth while independent variables are physical capital, active labor force, terms of trade for measure of openness, government expenditure and human capital in the form of expenditure on health and education. Accordingly, the empirical finding shows that human capital in the form of education and health investment has consistent and significant long run effect on economic growth of Ethiopia at 5% level of significance. Keeping the other variables constant, 1% change (increase/decrease) in expenditure in human capital will change (increase/decrease) nominal output by 0.23%. In contrary short run human capital has consistent but insignificant effect on economic growth of Ethiopia. Because, either it takes time for education investment to pay off or the government’s budget for short run education and health sector development is not sufficient. The adjustment of the short run dynamics or disequilibrium to the long run equilibrium is weak, which is 36%. Thus, education and sectors ought to allocate resources for both quality of and access so that the benefit from human capital development outshines in contribution to economic growth. The sectoral contribution of human capital to Ethiopian economic growth may be future research.

Key words: Economic growth, Human capital, Ordinary least square method, error correction model, time series data

Chapter 1. Introduction

1.1. Background of the study

The concept of human capital refers to the abilities and skills of human resources of a country, while human capital formation 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. Different scholars such as Beach (2009), Garavan et al.(2001) and Youndt et al.(2004) define human capital as productive capacities knowledge and skills imputed or embedded in human being. Education either formal or informal helps to acquire the human capital. This knowledge and skills can be built intentionally from investment in education or unintentionally from the environment (social dimension).

The origin of human capital goes back to the emergence of classical economics in 1776, and thereafter developed to a scientific theory (Fitzsimons, 1999). Classical economists, such as Adam Smith (1776), David Ricardo (1817), and Thomas Malthus (1798), and much later, Frank Ramsey (1928), Allyn Young (1928), Frank Knight (1944), and Joseph Schumpeter (1934) as cited by Barro and Sala-i-Martin, 2004, p.35 provided many of the basic ingredients that appear in modern theories of economic growth Next to the manifestation of human capital concept as a theory, Schultz (1961) recognized the human capital as one of fundamental factors for economic growth in the modern economy. Since then the development of human capital as an academic field, some researchers attempted to clarify how the human capital could contribute to economic growth in different countries.

Mankiw et al, (1992) argue that decisions of investment on human and physical capital are similar; people devote their income infraction in both capitals by foregoing fractions of their consumption expenditures. They say human capital depreciates as physical capital. Lucas (1988) inserted human capital into the production function similarly to the way in which technology does in the Solow model, that is, in labor-augmenting. Lucas ignores depreciation of human capital.

Different studies have estimated a macroeconomic production function by measure of physical capital stocks. For instance, Romer (1989) used literacy rate and found significant effect on economic growth. The same person Romer (1991) used school enrollment rate and found positive and significant effect of human capital on output growth. Similarly, Barro and Lee (1994), Barro and Sala-i-Martin (1995), Barro (1998) used years of schooling to measure human capital and found that male individuals with secondary and higher education level have positive (significant) on economic growth. Gemmell (1996) and Islam (1995) findings also showed the positive effect of human capital on economic or output growth. The idea that human capital plays an important role in explaining income differences have been presented in economists’ thinking for a long time. By some accounts, it can even be traced to the work of Adam Smith and Alfred Marshall (Wobmann, 2000; Piazza, 2002), though it was not until the middle of the 20th century when Gary Becker (1975) and the other scholars such as Schultz (1961) developed the theory of human capital.

Arora (2005) put that model of economic growth, human capital in the form of schooling or enrollment has been given a central place while the role of health has remained peripheral. Likewise, Woubet (2006) used years of schooling to analyze the effect of human capital on Economic growth of Ethiopia. One of the early contributors, Schultz (1961) put Health as one contributor in human capital models.

Given the theories of human capital when we look at Ethiopia’s human capital development one should goes back to the Sixth Century when the Sabean alphabet was introduced along with Christianity. The education given under religious auspices aimed primarily at producing teachers who would be serving in the different centers of learning in the church and the mosque (Woubet, 2006, pp.23). Teshome (1979) in Woubet (2006) puts that church education has not been impartial in the provision of Education to the public and didn’t serve the whole nation. The modern education started in 20th century by the then government to fill the high demand of trained workers for the establishment of modern institutions and industries. The modern education started in 1908 when Minilik II School opened by the effort of emperor Minilik with other intellectuals turned from abroad.

The Italian Occupation (1936-41) disrupted and later on after the occupation the education sector coordinated with the objective of increasing educated domestic citizens to replace foreign workers. Through the coordinated efforts the number of the educated people rose and the economy failed to absorb. After 1974 the structure and organization of educational activities were changed alongside the objectives of the socialist government. The new regime nationalized all private schools, except church-affiliated ones, and made them part of the public school system (Woubet , 2006).

Quality became a concern after the evaluation conducted by Ministry of Education in 1984. Problems such as low teacher to student ratio, large class size, lack of professional training to teachers, and poor management contributed to low education quality. As stated in the work of Woubet (2006) the proportion of job seeker from different level of education has been increased. The Derg regime failed to handle the situation of educated unemployment. In Ethiopia such stagnation occurred due to uneven access to human capital components mainly education and health services which made the societies toothless for more than a century since the movement to improve living got high climax in the westerns. Clear and holistic attitude towards education for all citizens as engine of economic growth were absent even after political centralization. The main scramble of the elites was over power. And their vision was of inward looking interests than encouraging and supplying favorable policy for creativity, invention, innovation and so on. The leaderships were totally lost self insight and benchmarks to catch up to the world economies over time. Actors were totally watch dogs after intrinsic economies.

In 1994 the Transitional government of Ethiopia introduced the Education and Training strategy to improve the coordination of education, training, research and development in the country. Since then different Education packages have been implementing so that student enrollment rate has been improved. Moreover, universal primary health care system has been introduced to increase access to basic health services.

In general, investment in education and health is a backbone of any country with which contribution of human capital to economic growth can be measured. It is obvious that human capital does contribute to faster economic growth by providing productive labor forces.

1.2. Statement of the Problem

The contribution of human capital to economic growth of the country remained underdeveloped. The recent data on human development index posted by United Nation Development Programme, ranked Ethiopia 173dr out of total 187 countries surveyed in July 20141. The rank is the same to the last year grade but come down from 171st in 2010. The 2014 HDI ranking process was made based on three indices namely life expectancy, education and income indices. Ethiopia is among low human development group, in which the majority African countries found except for Libya, Seychelles, Tunisia and Algeria which are included under very high human development. Ethiopia continued to be considered as least-developed country (LDC) in human capital. The country has traditionally been among the most educationally disadvantaged in the world, and the majority of its population has had little access to schooling. Only 36% of the country’s adult population (15 and over) is literate (UNESCO, 2010) and education poverty is evident among the chronically poor.

According to 2005 data of Demographic and Health Survey (DHS), 78% of all 23-27 year olds in the bottom income quintile, and 86% of women in this age and income group, have never been to school. The main hindrances to progress have included the country’s vast territory, diversity within the population (consisting of over 80 different ethnic groups), frequent economic shocks and natural disasters and persistent political turmoil (Yamada, 2007 in Engel J, 2011). During Ethiopia’s imperial regime, the Ethiopian Orthodox Church opposed the establishment of modern education system, and schooling remained available to small urban elite only (Teshome, 2008). The system was considered highly bureaucratic, inequitable, wasteful, rigid and not relevant to the lives of most Ethiopians (Teferra, 1996, in Teshome, 2008).

Regardless of the number of populations jammed in the overlapped poverty, the recent efforts are what would have made before. Here despite to their low performance in global comparison in HDI, the report shows that between 2000 up to 2013, Sub-Saharan African countries had the second highest rate of progress in HDI. Ethiopia and Rwanda achieved the fastest growth. How far we can jump is not limited by how high it would be, but how to safely land would be is the great requisition. Not to be contested HDR reported SSA as most unequal region. Income inequality is indicating the requirement of redistribution of welfare from better off to the poor. Human capital development as a major tool for maintaining income distribution is little in application.

Structural transformation is a very recent concept in Ethiopia. Moreover, Policies before a couple of decades less focused to tackle the root causes of poverty through human capital development. This can be evidenced by the public investment on education and health over time when compared to the total government expenditure. Privatizations of those sectors have no long history. Less competitiveness and uneven entrance of the private sector into the sectors were also the result of citizens’ low purchasing power.

Education and health services offered have not made solve the problems of farmers, pastoralist, and change the lives of the overwhelming majority of the people. As a result the contribution of human capital to economic growth remained insignificant in Ethiopia. In Ethiopia, the importance of human capital development in socio-economic development of the country has got better attention principally following the change of government in 1991.

In different researches, conclusions were reached depending on the definition of human capital, the methodology used, and the time period and set of countries over which the model is estimated. Frequent measure of human capital of growth is the quantity of formal education each adult member of society possesses. The concept of human capital, however, is much broader, including the quality of education and the general state of health of the working population. Human capital is one component from the determinants of economic growth; however, all the other problems are often happening due to the problems related with quality and quantity of human capital.

Much empirical studies advocate that the level education by the labor force measures human capital. However, the joint contribution of general health and education of the labor force arising from the government investment in the sectors is even more important. Thus, since, the research works showing the effect of human capital on economic growth of Ethiopia using educational and health investment, to the best knowledge of the researcher, does not exist so far, the aim of this thesis is to analyze the effect of human capital, in the form of government educational and health expenditure, on the economic growth of Ethiopia in both long run and short run.

1.3. Research Questions

The research questions to be answered are:

How does human capital affect economic growth?

Does human capital consistently and significantly affect economic growth in both short run and long run?

What policy recommendations necessary to improve the human capital contribution to economic growth of Ethiopia?

1.4. General Objective

The general objective of the study is to examine the relationship between human capital and economic growth of Ethiopia using a time series data from 1971 to 2013.

1.4.1. Specific Objectives

The specific objectives of the study are:

To measure the contribution of human capital to economic growth in Ethiopia.

To examine the short run and long run effects of human capital on economic growth.

To forward policy recommendation to enhance the contribution of human capital on economic growth of Ethiopia.

1.5. Significance of the study

The research paper will provide empirical evidence with respect to the contribution of human capital to economic growth by assessing the specific situation for Ethiopia.

The theoretical argument is based on empirical evidences which study the direct and indirect impacts of human capital on economic growth. The study will contribute to recent Ethiopia macroeconomic study archive and will be used as reference on areas of human capital development. Thus it will be an input for policy makers and reference for the forward studies.

1.6. Scope and Limitation

The study focuses on human capital as a determinant of economic growth. Even though human capital includes education, training, health, social capital, and more, the focus of the present study is on education and health from public expenditure side in the model specification.

Geographically, the study is macro level. Total expenditure on education and health will be used as proxy variable in to measure human capital. Limitation to access to data can affect the analysis there by the conclusion due to problems related to secondary data.

Chapter 2 Research Design and Methodology

2.1. Description of the Study Area

Ethiopia is located in Horn of Africa sharing boundaries with South and North Sudan from West, Eritrea from the North, Djibouti from the North East and Somalia from the Eastern part. Astronomically found on 8 00 N, 38 00 E. The population of the country estimated in 2012 is 91.7 million and its capital city is Addis Ababa that serving as capital of Africa and home for African Union. Ethiopia got UN membership on 13 November 1945. Ethiopia is one of the multi ethnic and lingual countries in the world. There are 54 ethnic groups and more than 80 spoken languages in Ethiopia. According to 2007 census report Oromo (official working language in the State of Oromiya) 33.8%, Amharic (official national language) 29.3%, Somali (official working language of the State of Sumale) 6.2%, Tigrigna (Tigrinya) (official working language of the State of Tigray) 5.9%, Sidamo 4%, Wolaytta 2.2%, Gurage 2%, Afar (official working language of the State of Afar) 1.7%, Hadiyya 1.7%, Gamo 1.5%, Gedeo 1.3%, Opuuo 1.2%, Kafa 1.1%, other 8.1%. English is major foreign language taught in schools.

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Fig 3.1: Geographical map of Ethiopia and its neighboring countries


Its economy is based on agriculture and about 85% of the population is employed in the sector with current push to diversify into manufacturing, textiles, and energy generation. Coffee is a major export crop. Birr (ETB) serves as domestic currency for domestic exchange.

In the 2012/13 fiscal year, Ethiopia’s economy grew by 9.7%, the tenth year in a row of robust growth. In 2012, Ethiopia was the twelfth fastest growing economy in the world. Average annual real GDP growth rate for the last decade was 10.9%. Agriculture, which accounts for 42.7% of GDP, grew by 7.1%, while industry, accounting for 12.3% of GDP, rose by 18.5% and services, with 45% of GDP, increased by 9.9% in 2012/13. This momentum is expected to continue in 2013/14 and 2014/15, albeit at a slower pace because of constraints on private-sector growth.

2.2. Type and Source of Data

Secondary data is required to analyze the impact of human capital. These were collected from World Bank data base, NBE, Ethiopia Education Information System data base (Ministry of Education, Ethiopia Economic Association, different articles and books written on human capital). Data of 43 years were used.

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Table 3.2.1: Descriptive Statistics Summary

Source: NBE and computed by stata statistics/data analysis version 10 results for summary statistics

2.3. Variable Selection and Definition

The number of empirical studies use proxy variables to capture the most character of human capital in their growth regressions is large and growing. Those studies have focused on education. Different proxy variables were used to capture human capital behavior. Among the most popular proxies for human capital; school enrollment rates (i.e., the percentage of the relevant part of the population enrolled in school) and educational attainment measured in years of schooling (i.e., the average years of formal education of the working-age population) are widely used.

For instance, average years of schooling of the labor force have been used by Barro and Sala-i-Martin (1995), Barro (1997, 1999), Benhabib and Spiegel (1994), Gundlach (1995), Islam (1995), Krueger and Lindahl (2000), and Temple (1999). However, education attainment is only part of regular (school) education and it is difficult to show productivity. With regard to enrollment rate, a student’s effectiveness can be recognized after participating in production activities. It does not show productivity too as years of schooling does.

Romer (1990) uses adult literacy rates as a proxy for the stock of human capital. Barro’s findings for the period of 1960 – 1985 and a sample of 98 countries indicate that the rates of primary and secondary school enrollment in 1960 are significantly positively related to subsequent growth (when controlling for initial income and other variables). But literacy rate shows productivity slightly because productivity can be increased through personal efforts such as on the job training informally.

Dependent variable

Nominal Gross Domestic Product (GDP): the total goods and services produced within boundary of Ethiopia without taking price effect. The variable is used as proxy variable for economic growth in the study. Economic growth is an increase in the level of output in a year when compared to its base year level of output. Thus, GDP is appropriate indicator to measure the level economic growth. Economic growth (GDP) is dependent variable and defined as a function of production inputs and policy decisions presented as follows.



Excerpt out of 43 pages


Human Capital and Economic Growth in Ethiopia
A Time Series Analysis
Wollega University  (School of Economics)
Development Economics
Masters of Science
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ISBN (eBook)
ISBN (Book)
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human, capital, economic, growth, ethiopia, time, series, analysis
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Mulugeta Tefera (Author), 2014, Human Capital and Economic Growth in Ethiopia, Munich, GRIN Verlag,


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