Structural Economic Transition in Ethiopia: From State-Led Growth to Market-Oriented Reform

Structural Economic Transition in Ethiopia: From State-Led Growth to Market-Oriented Reform | Research Square window.SnipcartSettings = { analytics: { enabled: false } }; (function() { var accessVector = localStorage.getItem('access_vector') || ''; window.dataLayer = window.dataLayer || []; if (accessVector) { window.dataLayer.push({ user: { profile: { profileInfo: { snid: accessVector } } } }); } })(); (function(w,d,s,l,i){w[l]=w[l]||[];w[l].push({'gtm.start':new Date().getTime(),event:'gtm.js'});var f=d.getElementsByTagName(s)[0],j=d.createElement(s),dl=l!='dataLayer'?'&l='+l:'';j.async=true;j.src='https://www.googletagmanager.com/gtm.js?id='+i+dl;f.parentNode.insertBefore(j,f);})(window,document,'script','dataLayer','GTM-K279D39R'); Browse Preprints In Review Journals COVID-19 Preprints AJE Video Bytes Research Tools Research Promotion AJE Professional Editing AJE Rubriq About Preprint Platform In Review Editorial Policies Our Team Advisory Board Help Center Sign In Submit a Preprint Cite Share Download PDF Research Article Structural Economic Transition in Ethiopia: From State-Led Growth to Market-Oriented Reform wogene Markos Dumo This is a preprint; it has not been peer reviewed by a journal. https://doi.org/ 10.21203/rs.3.rs-7544652/v1 This work is licensed under a CC BY 4.0 License Status: Posted Version 1 posted You are reading this latest preprint version Abstract Ethiopia's macroeconomic performance under two different political economic regimes, the late stage Developmental State Model (DSM) (2004–2017) and the later Homegrown Economic Reform (HGER) (2018–2025), is empirically analyzed in this paper. Finding and measuring the fundamental split in the nation's growth determinants and the changing cost of macroeconomic instability are its main goals. We do a structural break analysis utilizing quarterly time-series data from 2004 to 2025, formally determining the breakpoint during the 2018 political transition through the use of a Chow test. Then, for each subperiod (2004-2017 and 2018-2025), we independently estimate a multivariate Ordinary Least Squares (OLS) regression model with lagged independent variables to reduce endogeneity. The findings show a notable structural change. Under the DSM era, GDP growth was powerfully and significantly driven by government expenditure, a finding consistent with the literature on Ethiopia’s public investment boom. In contrast, the HGER era shows a statistically insignificant growth impact from public spending, with Foreign Direct Investment (FDI) and trade openness emerging as new, significant drivers. Critically, we find that the negative coefficient of inflation on growth nearly tripled in magnitude and became highly significant in the HGER era. This substantiates warnings from prior literature and demonstrates a sharply increased economic cost of instability in a liberalizing economy. Our findings empirically validate the narrative of Ethiopia's economic transition. Directly comparing the two governments and validating the findings with existing literature, this study provides crucial evidence on the profound challenges of economic liberalization amidst inherited imbalances and severe shocks. Developmental State Model Ethiopia Homegrown Economic Reform Inflation Macroeconomic Stability Structural Break 1. Introduction For the last two decades, Ethiopia's economic path has experienced a compelling narrative of a nation undergoing a profound view and structural transformation of the economic framework and landscape in the institutional practice, as indicated by Ejigu ( 2022 ). This multifaceted journey can be distinctly delineated into two significant eras, each shaped by the strategic vision and governance philosophies of its leadership. The first period, which was terminated with the political change in 2018, was largely defined by the governance of the Ethiopian People's Revolutionary Democratic Front (EPRDF) under the ideological influence of the late Prime Minister Meles. The matured stage was our focus, which stands from 2004 to 2017, during which the Developmental State Model (DSM) was strongly functional. This model promoted a strong, interfering state that directed significant public investments into vital sectors, like infrastructure and state-owned enterprises (SOEs), intending to outgrow rapid industrialization, primarily driven by the agricultural sector (Ethiopia Ministry of Agriculture and Rural Development, 2010 ). For more than a decade, the economy experienced remarkable double-digit growth, lifting millions out of poverty and earning international recognition. However, this impressive growth came at a cost. The financial strategies that fueled it created significant imbalances, leading to a strained banking sector, a persistent shortage of foreign currency, and a worrying increase in public debt (World Bank, 2024 ). The subsequent period commenced with Prime Minister Abiy Ahmed's rise to power in April 2018. His government introduced the Homegrown Economic Reform (HGER) agenda in 2019, signifying a clear ideological shift away from the state-focused developmental model (Ethiopia Press Agency, 2019). The HGER was carefully designed to address the deficiencies of the Meles era by steering the economy towards a more sustainable and inclusive growth path. This reform plan aimed to unlock the potential of the private sector as the main driver of economic growth through the gradual liberalization of key sectors like telecommunications and banking, the privatization of SOEs, and a strong emphasis on tackling inherited macroeconomic challenges (Federal Democratic Republic of Ethiopia Ministry of Finance, 2020 ). The distinct divergence in policy offers a robust natural experimental framework, enabling an in-depth comparative study of two rival development models within Ethiopia's national context. As a result, the primary research question this paper aims to explore is how the empirical determinants of economic growth and the associated economic costs linked to instability manifest differently between the era characterized by the Developmental State Model (DSM) and the subsequent era marked by the Homegrown Economic Reform (HGER). By strategically partitioning our analytical framework around the pivotal 2018 transition, we empirically assess the multifaceted consequences of this significant policy shift, identifying elements that have changed, those that have persisted, and the novel challenges that have emerged. The following is a methodical arrangement of the remaining sections: The theoretical framework and relevant literature are described in Section 2 , while Section 3 describes in depth the data and methodology followed in this study. Empirical results are given in Section 4 . The results are thoroughly discussed, and their ramifications are thoroughly examined in Section 5 . Lastly, a comprehensive examination of the policy implications arising from our research findings is presented in Section 6 . 2. Theoretical Framework A comprehensive understanding of the two distinct eras can be achieved through an analysis of the competing economic development theories that have emerged over time. The DSM period stands as a classic example that perfectly illustrates the core ideas of developmental state theories. These theories argue that nations industrializing later can quickly grow their economies and narrow the gap with rivals by creating a capable, autonomous government. This state must actively steer the market, channel investment into crucial strategic industries, and carefully manage industrial policy (Amsden, 1989 ; Wade, 1990 ; Johnson, 1982 ). Consistent with these concepts, our empirical model shows a positive and significant effect for the DSM era by using government spending (GOVEXP) as a key growth driver. The model’s focus on state-led capital accumulation places government expenditure at the center of its theory for what propelled growth during those years. A full picture of the two different eras might emerge from exploring the competing schools of thought on economic development that have changed over time. A fuller grasp of these two separate eras can emerge from studying the competing economic development theories that have shifted over time. The Developmental State Model (DSM) period is a famous example that perfectly embodies the core ideas of developmental state theories. These theories suggest that nations industrializing later can rapidly grow their economies and narrow the gap with rivals by building a capable, autonomous government. This state must actively guide the market, steer investment into vital strategic industries, and carefully manage its industrial policy (Amsden, 1989 ; Wade, 1990 ; Johnson, 1982 ). We can view these theoretical ideas as directly expressed through the HGER's coordinated push to liberalize trade rules and attract foreign investment. Because of this perspective, trade openness and foreign direct investment are anticipated to be primary growth engines throughout the HGER period. In addition to being a source of financial inflow, foreign direct investment is regarded as an essential conduit for the transfer of cutting-edge technology and the sharing of knowledge, both of which can increase overall economic productivity and innovation (Borensztein et al., 1998 ). The prevalent problem of macroeconomic instability, with a focus on the delicate relationship between growth and inflation, or the growth-inflation nexus, is the crucial thread that closely ties the two historical periods together (Fischer, 1993 ). In the context of the DSM model, inflation and debt were often seen as controllable outcomes or results of a necessary investment drive to promote growth. A central hypothesis put forth in this paper posits that during the HGER era, these pre-existing economic imbalances, when exacerbated by a series of severe new shocks including a devastating internal conflict, the unprecedented global COVID-19 pandemic, and recurrent severe droughts, ultimately transformed what was a chronic economic issue into an acute crisis, which fundamentally constrained the effectiveness and potential success of the economic reforms. This theoretical framework emphasizes why this nexus becomes more potent and damaging in a liberalizing economy burdened by inherited imbalances and facing severe shocks. 3. Methodology and Data 3.1 Data and Periodization To conduct a robust comparative analysis, this study utilizes quarterly time-series data from 2004Q1 to 2025Q2 (with 2024Q2-2025Q2 data based on IMF and national projections). Data are compiled from the National Bank of Ethiopia's (NBE) Quarterly Bulletins, the International Monetary Fund's (IMF) World Economic Outlook and Staff Reports, and the World Bank's Open Data platform. We divide the full sample into two distinct policy regimes: DSM Era : 2004Q1–2017Q4 (N = 56). This period represents the mature phase of the developmental state model, which continued seamlessly after Prime Minister Meles Zenawi died in 2012 under his successor, Hailemariam Desalegn. HGER Era : 2018Q1–2025Q2 (N = 30). This period begins with the political transition to Prime Minister Abiy Ahmed and covers the subsequent launch and implementation of the reform agenda. 3.2 Econometric Model Specification To test for a structural change in the economy's behavior between the two regimes, a Chow test was performed on the full sample. The test formally rejected the null hypothesis of parameter stability across the 2018Q1 breakpoint (F-statistic = 3.84, p-value = 0.005), providing strong statistical justification for our split-sample regression approach. We estimate a multivariate Ordinary Least Squares (OLS) model for each sub-period. To mitigate potential endogeneity and simultaneity bias, which are common in growth regressions, we specify the model with a one-quarter lag on all independent variables (Wooldridge, 2019 ). The model is: 𝐺𝐷𝑃𝐺𝑡 = 𝛽 0+ 𝛽 1 𝐼𝑁𝐹𝑡 −1+ 𝛽 2 𝑂𝑃𝐸𝑁𝑡 −1+ 𝛽 3 𝐺𝑂𝑉𝐸𝑋𝑃𝑡 −1+ 𝛽 4 𝐹𝐷𝐼𝑡 −1+ 𝛽 5 𝐸𝑋𝐶𝐻 _ 𝑉𝑂𝐿𝑡 −1+ 𝜖𝑡 Where GDPG is the quarterly real GDP growth rate, INF is the inflation rate, OPEN is trade openness ((Exports + Imports)/GDP), GOVEXP is general government expenditure as a % of GDP, FDI is net FDI inflows as a % of GDP, and EXCH_VOL is the quarterly standard deviation of the monthly Birr/USD exchange rate change. 4. Empirical Results 4.1 Descriptive Evidence: A Tale of Two Eras Table 1 presents the comparative descriptive statistics. The differences between the two periods are stark and reveal the dramatically altered economic landscape. Table 1 Comparative Descriptive Statistics Variable DSM Era (2004–2017) HGER Era (2018–2025) Mean (Std. Dev.) Mean (Std. Dev.) GDP Growth (%) 10.1 (2.1) 5.8 (3.1) Inflation (%) 14.2 (6.5) 29.5 (8.2) Gov. Expenditure (% GDP) 15.9 (2.4) 11.8 (2.1) FDI Inflows (% GDP) 3.1 (1.4) 1.9 (1.6) Exch. Rate Volatility 0.28 (0.12) 1.25 (0.75) Source: Author’s Computation The DSM era delivered exceptionally high average growth (10.1%). While inflation was a persistent challenge, its average of 14.2% was half of what was to come. In contrast, the HGER era has been defined by lower, more erratic growth (5.8%) and an explosion of instability. Average inflation more than doubled to 29.5%, and exchange rate volatility increased nearly fivefold. This descriptive evidence highlights the dramatically different and more challenging macroeconomic context in which the HGER has been implemented. 4.2 Comparative Econometric Findings Table 2 presents the core results from the split-sample regressions, allowing for a direct comparison of the growth determinants across the two regimes. Table 2 Comparative Regression Results for GDP Growth Determinants Variable DSM Era (2004–2017) HGER Era (2018–2025) Coefficient (p-value) Coefficient (p-value) (Constant) 3.50 (0.015*) 2.90 (0.051) Inflation -0.18 (0.062) -0.48 (0.005**) Trade Openness 0.25 (0.110) 0.61 (0.009**) Gov. Expenditure 0.52 (0.001**) 0.20 (0.150) FDI Inflows 0.28 (0.095) 0.45 (0.018*) Exch. Rate Volatility -0.15 (0.180) -0.28 (0.022*) Adjusted R² 0.83 0.80 Notes: * denotes significance at the 5% level; ** denotes significance at the 1% level. Source: Author’s Computation 5. Discussion: Substantiating a Structural Break The econometric results presented in this study empirically confirm a fundamental structural break in the Ethiopian economy, marking a shift in the key drivers of economic growth from the DSM to the HGER era. This section expands on these findings by comparing them with the existing literature and highlighting the implications of these changes for Ethiopia's economic strategy. During the DSM era, government expenditure emerged as the primary and highly significant driver of economic growth, as evidenced by the coefficient of 0.52 (p < 0.01) in Table 2 . These findings are consistent with earlier research highlighting the pivotal role of government expenditure in driving growth within developing nations, especially those following state-led development models (Lin and Monga, 2010 ). During this particular time frame, the proactive fiscal policies and strategies implemented by the Ethiopian government played an absolutely vital role in propelling the development of essential infrastructure and public services, both of which are incredibly important for fostering sustainable economic growth, as noted by Moges in 2013. This situation provides a solid empirical foundation that supports the theoretical framework of the developmental state, which is consistent with a growing body of literature that discusses Ethiopia's remarkable increase in public investment, along with the prominent role that state-led initiatives play in encouraging economic growth in developing nations. In stark contrast to the previous period, the time frame referred to as the HGER period represented a profound transformation in economic dynamics. During this phase, the influence of public spending on overall economic growth became statistically insignificant, as indicated by a coefficient of merely 0.20 (with a p-value of 0.150). At the same time, we witnessed the emergence of Foreign Direct Investment (FDI) and the openness of trade as new, highly significant catalysts for economic growth, boasting coefficients of 0.45 (with a p-value of less than 0.05) and 0.61 (with a p-value of less than 0.01), respectively. This noticeable shift not only supports the empirical evidence for the HGER's transition towards a market-oriented approach to economic growth but also aligns beautifully with the principles found in neoclassical and endogenous growth theories, which emphasize the importance of private investment and international trade as crucial drivers of economic expansion, as elaborated by Romer in 1990 and further refined by Frankel and Romer in 1999. This transition reflects the HGER's liberalization agenda, aiming to integrate Ethiopia more deeply into the global economy and utilize external resources for development, echoing the findings of Balasubramanyam, Salisu, and Sapsford ( 1996 ), who argue that trade and FDI are crucial for technology transfer, capital accumulation, and market access in liberalizing economies. This empirical evidence of the shift in growth drivers, particularly the reduced significance of government spending in the HGER period compared to its previous dominance, is a significant and unique discovery. One of the most striking and novel contributions of this study is the quantified, dramatically increased economic cost of macroeconomic instability in the HGER era. The coefficient for inflation in the DSM era (-0.18, p = 0.062) was modest and only borderline significant. However, in the HGER era, the coefficient nearly tripled to -0.48 (p < 0.01), highlighting the heightened sensitivity of economic growth to inflationary pressure. This pattern is consistent with Barro ( 2013 ), who emphasized that high inflation can erode purchasing power, distort investment decisions, and undermine economic stability. This finding directly substantiates our hypothesis that pre-existing economic imbalances, when exacerbated by severe new shocks including an internal conflict, the global COVID-19 pandemic, and recurrent severe droughts transformed what was a chronic economic issue into an acute crisis, fundamentally constraining the effectiveness of economic reforms. This is a new and crucial extension of existing knowledge, highlighting that inherited imbalances, when exacerbated by severe shocks, transformed a chronic issue into an acute crisis that fundamentally constrained the effectiveness of economic reforms. Similarly, exchange rate volatility not a major obstacle to growth during the DSM period emerged as significant in the HGER era (-0.28, p < 0.05). This finding supports Aghion et al. ( 2009 )'s view that exchange rate fluctuations can create uncertainty for trade and investment, slowing economic growth, especially in developing economies. The research builds on this by showing empirical proof of the Ethiopian economy's heightened sensitivity, which was less relevant under the former state-controlled system. Moving from a state-led growth model to one that is more market-oriented requires a stable macroeconomic environment. Yet, the greater vulnerability to inflation and exchange rate movements implies that Ethiopia's present economic framework may not be strong enough to handle these external pressures. This highlights the critical need for effective macroeconomic policies to curb such volatility and foster conditions conducive to sustained economic expansion. The paper offers a detailed dynamic perspective on how the significance and impact of various economic factors evolve with structural reforms and external shocks, providing insights into the complex development of economic systems during transformative periods. 6. Conclusion and Policy Implications This comparative analysis reveals that Ethiopia's economy has undergone a profound structural break between the DSM and HGER eras. The engine of growth has fundamentally changed, shifting away from state expenditure towards an emerging reliance on private investment and trade. This confirms that the HGER is, at least directionally, succeeding in reorienting the economy. However, the transition has been dangerous. The HGER era inherited the macroeconomic imbalances of the DSM era, but these were then amplified to crisis levels by a flood of internal and external shocks. Our empirical results show that the economic cost of this instability, particularly inflation, is now far more damaging to growth than ever before. Ethiopia is attempting to build a new, liberalized economic house on a foundation of macroeconomic quicksand. The central policy challenge is therefore clear. The goal should not be to reverse the reforms and return to the unsustainable state-led model of the past. Rather, policymakers must recognize that macroeconomic stabilization is not a separate, secondary goal but the absolute prerequisite for the success of the entire HGER project. Given our finding that inflation's negative impact has tripled, controlling inflation is not merely desirable but an essential and immediate policy imperative. Without a credible and sustained effort to bring inflation under control and stabilize the exchange rate, the potential of a more open, dynamic, and private-sector-driven economy for Ethiopia will remain tragically unrealized. This study is subject to several limitations, which open avenues for future research. First, while quarterly data improves upon annual series, macroeconomic data in developing countries can be subject to revisions and measurement error. This implicitly highlights the study's contribution of using higher-frequency data as an improvement. Second, our model is necessarily parsimonious and could be subject to omitted variable bias. This parsimonious nature allowed for a clear comparison of the primary variables of interest, reinforcing the study's specific focus on identifying the key drivers of growth and the evolving cost of macroeconomic instability. Future research could incorporate proxies for institutional quality, human capital, and, critically, the distinct impacts of conflict and climate shocks, which are highly relevant to Ethiopia's context. Third, the linear specification may not fully capture the growth-inflation relationship. It is highly probable that this effect is non-linear, and future studies could employ threshold regression models to identify the specific inflation levels beyond which the damage to growth accelerates, thereby providing more granular insights for policymakers. Statements and Declarations Funding: This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors. Declaration of Competing Interest : The author declares that he has no known conflicting financial interests or personal relationships that could have influenced the work reported in this paper. References Aghion, P., Bacchetta, P., Ranciere, R., & Rogoff, K. (2009). Exchange rate volatility and productivity growth: The role of financial development. Journal of Monetary Economics, 56(4), 494-513. Amsden, A. H. (1989). Asia's next giant: South Korea and late industrialization. Oxford University Press. Balasubramanyam, V. N., Salisu, M., & Sapsford, D. (1996). Foreign direct investment and growth in EP and IS countries. Economic Journal, 106(434), 92-105. Barro, R. J. (2013). Inflation and economic growth. Annals of Economics and Finance, 14(1), 121-144. Borensztein, E., De Gregorio, J., & Lee, J.-W. (1998). How does foreign direct investment affect economic growth? Journal of International Economics, 45(1), 115-135. https://doi.org/10.1016/S0022-1996(97)00033-0. Deressa, T. T., & Koirala, K. H. (2021). The impact of real exchange rate misalignment on economic growth in Ethiopia. Journal of Economic Structures, 10(1), 29. https://doi.org/10.1186/s40008-021-00259-3. Ejigu, W. G. (2022). Structural Change and Economic Growth in Ethiopia, 1991-2017. Journal of Business and Administrative Studies, 14 (1). https://doi.org/10.20372/jbas.v14i1.4381 Ethiopia Ministry of Agriculture and Rural Development. (2010). Ethiopia’s Agricultural Sector Policy and Investment Framework (PIF) 2010–2020 . [Prepared by Demese Chanyalew, Berhanu Adenew, and John Mellor]. Retrieved from https://land.igad.int/index.php/documents-1/countries/ethiopia/legislation-and-policies-1/policies-1/268-ethiopia-s-agricultural-sector-policy-and-investment-framework-pif/file Ethiopia Press Agency. (2019, July 10). Prime Minister Abiy Ahmed outlines the Homegrown Economic Reforms agenda. Retrieved from https://www.ena.et/web/eng/w/eng_4869646 Federal Democratic Republic of Ethiopia Ministry of Finance. (2020). A Homegrown Economic Reform Agenda: A Pathway to Prosperity (Public Version – March 2020). Retrieved from https://www.mofed.gov.et/media/filer_public/38/78/3878265a-1565-4be4-8ac9-dee9ea1f4f1a/a_homegrown_economic_reform_agenda- a_pathway_to_prosperity - public_version -_march_2020-.pdf Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3), 485-512. https://doi.org/10.1016/0304-3878(93)90027-D. Frankel, J. A., & Romer, D. H. (1999). Does trade cause growth? American Economic Review, 89(3), 379-399. https://doi.org/10.1257/aer.89.3.379. Geda, A., & Kibret, K. (2020). The Galloping Inflation in Ethiopia: A Cautionary Tale for Aspiring 'Developmental States' in Africa. Institute of African Economic Studies (IAES). International Monetary Fund. (2024a). World Economic Outlook: April 2024. IMF. International Monetary Fund. (2024b). Ethiopia: 2024 Article IV Consultation and Request for a Stand-By Arrangement and an Arrangement Under the Resilience and Sustainability Facility—Press Release; Staff Report. IMF Staff Country Reports. Johnson, C. (1982). MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975. Stanford University Press. Lin, J. Y., & Monga, C. (2010). Growth identification and facilitation: The role of the state in the dynamics of structural change. Policy Research Working Paper No. 5313, World Bank. Ministry of Finance, Federal Democratic Republic of Ethiopia. (2019). Ethiopia's Homegrown Economic Reform Agenda: A Pathway to Prosperity. Moges, A. G. (2013). The role of government in economic development: The Ethiopian experience. Addis Ababa University Press. National Bank of Ethiopia. (n.d.). Quarterly Bulletin. Retrieved August 1, 2025, from the National Bank of Ethiopia publications page. Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5, Part 2), S71-S102. https://www.jstor.org/stable/2937632. Wade, R. (1990). Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization. Princeton University Press. Wooldridge, J. M. (2019). Introductory Econometrics: A Modern Approach (7th ed.). Cengage Learning. World Bank. (2024). Ethiopia Overview. Retrieved from https://www.worldbank.org/en/country/ethiopia/overview. Additional Declarations No competing interests reported. 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Also discoverable on Platform About Our Team In Review Editorial Policies Advisory Board Help Center Resources Author Services Accessibility API Access RSS feed Manage Cookie Preferences © Research Square 2026 | ISSN 2693-5015 (online) Privacy Policy Terms of Service Do Not Sell My Personal Information {"props":{"pageProps":{"initialData":{"identity":"rs-7544652","acceptedTermsAndConditions":true,"allowDirectSubmit":true,"archivedVersions":[],"articleType":"Research Article","associatedPublications":[],"authors":[{"id":515115100,"identity":"9a0b7c5f-18bf-4687-b4c0-e997a7dc484e","order_by":0,"name":"wogene Markos Dumo","email":"data:image/png;base64,iVBORw0KGgoAAAANSUhEUgAAAZAAAAAyAQMAAABI0h/eAAAABlBMVEX///8AAABVwtN+AAAACXBIWXMAAA7EAAAOxAGVKw4bAAAA1ElEQVRIiWNgGAWjYJCCAyCCH0QkFBCtJYGBQbIBpMWAaHuAWgzAdhGjxeB4+8WDP3/Y5BufX5344YEBgzy/2AECWs6cKTjMk5Bmue3G280SQIcZzpydgF+L2Y2chMMMCYcNzG6c3QDSkmBwmwgtB38k/DcwnnF28w8itaQfOMCTcMDAgL93G3G22J85w3CYJy3ZQOIG7zaLBAMJwn6RbG9//PGHjZ0Bf//ZzTd/VNjI80sT0MLAwAONCwmwSglCykGA/QGE5j9AjOpRMApGwSgYiQAA/wRKHmxV7ygAAAAASUVORK5CYII=","orcid":"","institution":"Hawassa University","correspondingAuthor":true,"prefix":"","firstName":"wogene","middleName":"Markos","lastName":"Dumo","suffix":""}],"badges":[],"createdAt":"2025-09-05 13:23:12","currentVersionCode":1,"declarations":{"humanSubjects":false,"vertebrateSubjects":false,"conflictsOfInterestStatement":false,"humanSubjectEthicalGuidelines":false,"humanSubjectConsent":false,"humanSubjectClinicalTrial":false,"humanSubjectCaseReport":false,"vertebrateSubjectEthicalGuidelines":false},"doi":"10.21203/rs.3.rs-7544652/v1","doiUrl":"https://doi.org/10.21203/rs.3.rs-7544652/v1","draftVersion":[],"editorialEvents":[],"editorialNote":"","failedWorkflow":false,"files":[{"id":92616894,"identity":"df76ff41-e70f-4592-b692-54aef7e062ef","added_by":"auto","created_at":"2025-10-01 17:41:30","extension":"docx","order_by":0,"title":"","display":"","copyAsset":false,"role":"acdc-reference","size":44461,"visible":true,"origin":"","legend":"","description":"","filename":"SETENew23.docx","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/4e4be0b05ee1261f53dcf7b2.docx"},{"id":92616893,"identity":"5e384593-0af5-4dee-ae49-9bef1e210caa","added_by":"auto","created_at":"2025-10-01 17:41:30","extension":"json","order_by":1,"title":"","display":"","copyAsset":false,"role":"acdc-reference","size":3727,"visible":true,"origin":"","legend":"","description":"","filename":"5b8816bb6b394405a28b2171f4d1ab43.json","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/a507e0e57a39daa4d910f9c8.json"},{"id":92617396,"identity":"0a01c12f-841a-4a22-9212-363bf966215a","added_by":"auto","created_at":"2025-10-01 17:49:30","extension":"xml","order_by":2,"title":"","display":"","copyAsset":false,"role":"acdc-reference","size":54895,"visible":true,"origin":"","legend":"","description":"","filename":"5b8816bb6b394405a28b2171f4d1ab431enriched.xml","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/d09553060691072ebc97cb4e.xml"},{"id":92616896,"identity":"0cb10f6b-59b4-4f96-af54-19aca443ead7","added_by":"auto","created_at":"2025-10-01 17:41:31","extension":"xml","order_by":3,"title":"","display":"","copyAsset":false,"role":"acdc-reference","size":53650,"visible":true,"origin":"","legend":"","description":"","filename":"5b8816bb6b394405a28b2171f4d1ab431structuring.xml","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/f4228f6ada36e9b89602f603.xml"},{"id":92617397,"identity":"59c428b8-0ccb-4407-8977-d9db16ac9f60","added_by":"auto","created_at":"2025-10-01 17:49:31","extension":"html","order_by":4,"title":"","display":"","copyAsset":false,"role":"acdc-reference","size":58217,"visible":true,"origin":"","legend":"","description":"","filename":"earlyproof.html","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/f5cd77d22705a96e48a416fc.html"},{"id":93828200,"identity":"c39ed4cb-2199-4e44-ac2d-57a38f960975","added_by":"auto","created_at":"2025-10-18 07:31:54","extension":"pdf","order_by":0,"title":"","display":"","copyAsset":false,"role":"manuscript-pdf","size":493245,"visible":true,"origin":"","legend":"","description":"","filename":"manuscript.pdf","url":"https://assets-eu.researchsquare.com/files/rs-7544652/v1/993f1c43-2f24-42a5-9a73-5d9b98b591c0.pdf"}],"financialInterests":"No competing interests reported.","formattedTitle":"Structural Economic Transition in Ethiopia: From State-Led Growth to Market-Oriented Reform","fulltext":[{"header":"1. Introduction","content":"\u003cp\u003eFor the last two decades, Ethiopia's economic path has experienced a compelling narrative of a nation undergoing a profound view and structural transformation of the economic framework and landscape in the institutional practice, as indicated by Ejigu (\u003cspan citationid=\"CR7\" class=\"CitationRef\"\u003e2022\u003c/span\u003e). This multifaceted journey can be distinctly delineated into two significant eras, each shaped by the strategic vision and governance philosophies of its leadership.\u003c/p\u003e\u003cp\u003eThe first period, which was terminated with the political change in 2018, was largely defined by the governance of the Ethiopian People's Revolutionary Democratic Front (EPRDF) under the ideological influence of the late Prime Minister Meles. The matured stage was our focus, which stands from 2004 to 2017, during which the Developmental State Model (DSM) was strongly functional. This model promoted a strong, interfering state that directed significant public investments into vital sectors, like infrastructure and state-owned enterprises (SOEs), intending to outgrow rapid industrialization, primarily driven by the agricultural sector (Ethiopia Ministry of Agriculture and Rural Development, \u003cspan citationid=\"CR8\" class=\"CitationRef\"\u003e2010\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eFor more than a decade, the economy experienced remarkable double-digit growth, lifting millions out of poverty and earning international recognition. However, this impressive growth came at a cost. The financial strategies that fueled it created significant imbalances, leading to a strained banking sector, a persistent shortage of foreign currency, and a worrying increase in public debt (World Bank, \u003cspan citationid=\"CR24\" class=\"CitationRef\"\u003e2024\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eThe subsequent period commenced with Prime Minister Abiy Ahmed's rise to power in April 2018. His government introduced the Homegrown Economic Reform (HGER) agenda in 2019, signifying a clear ideological shift away from the state-focused developmental model (Ethiopia Press Agency, 2019). The HGER was carefully designed to address the deficiencies of the Meles era by steering the economy towards a more sustainable and inclusive growth path. This reform plan aimed to unlock the potential of the private sector as the main driver of economic growth through the gradual liberalization of key sectors like telecommunications and banking, the privatization of SOEs, and a strong emphasis on tackling inherited macroeconomic challenges (Federal Democratic Republic of Ethiopia Ministry of Finance, \u003cspan citationid=\"CR10\" class=\"CitationRef\"\u003e2020\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eThe distinct divergence in policy offers a robust natural experimental framework, enabling an in-depth comparative study of two rival development models within Ethiopia's national context. As a result, the primary research question this paper aims to explore is how the empirical determinants of economic growth and the associated economic costs linked to instability manifest differently between the era characterized by the Developmental State Model (DSM) and the subsequent era marked by the Homegrown Economic Reform (HGER). By strategically partitioning our analytical framework around the pivotal 2018 transition, we empirically assess the multifaceted consequences of this significant policy shift, identifying elements that have changed, those that have persisted, and the novel challenges that have emerged.\u003c/p\u003e\u003cp\u003eThe following is a methodical arrangement of the remaining sections: The theoretical framework and relevant literature are described in Section \u003cspan refid=\"Sec2\" class=\"InternalRef\"\u003e2\u003c/span\u003e, while Section \u003cspan refid=\"Sec3\" class=\"InternalRef\"\u003e3\u003c/span\u003e describes in depth the data and methodology followed in this study. Empirical results are given in Section \u003cspan refid=\"Sec6\" class=\"InternalRef\"\u003e4\u003c/span\u003e. The results are thoroughly discussed, and their ramifications are thoroughly examined in Section \u003cspan refid=\"Sec9\" class=\"InternalRef\"\u003e5\u003c/span\u003e. Lastly, a comprehensive examination of the policy implications arising from our research findings is presented in Section \u003cspan refid=\"Sec10\" class=\"InternalRef\"\u003e6\u003c/span\u003e.\u003c/p\u003e"},{"header":"2. Theoretical Framework","content":"\u003cp\u003eA comprehensive understanding of the two distinct eras can be achieved through an analysis of the competing economic development theories that have emerged over time.\u003c/p\u003e\u003cp\u003eThe DSM period stands as a classic example that perfectly illustrates the core ideas of developmental state theories. These theories argue that nations industrializing later can quickly grow their economies and narrow the gap with rivals by creating a capable, autonomous government. This state must actively steer the market, channel investment into crucial strategic industries, and carefully manage industrial policy (Amsden, \u003cspan citationid=\"CR2\" class=\"CitationRef\"\u003e1989\u003c/span\u003e; Wade, \u003cspan citationid=\"CR22\" class=\"CitationRef\"\u003e1990\u003c/span\u003e; Johnson, \u003cspan citationid=\"CR16\" class=\"CitationRef\"\u003e1982\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eConsistent with these concepts, our empirical model shows a positive and significant effect for the DSM era by using government spending (GOVEXP) as a key growth driver. The model\u0026rsquo;s focus on state-led capital accumulation places government expenditure at the center of its theory for what propelled growth during those years. A full picture of the two different eras might emerge from exploring the competing schools of thought on economic development that have changed over time.\u003c/p\u003e\u003cp\u003eA fuller grasp of these two separate eras can emerge from studying the competing economic development theories that have shifted over time. The Developmental State Model (DSM) period is a famous example that perfectly embodies the core ideas of developmental state theories. These theories suggest that nations industrializing later can rapidly grow their economies and narrow the gap with rivals by building a capable, autonomous government. This state must actively guide the market, steer investment into vital strategic industries, and carefully manage its industrial policy (Amsden, \u003cspan citationid=\"CR2\" class=\"CitationRef\"\u003e1989\u003c/span\u003e; Wade, \u003cspan citationid=\"CR22\" class=\"CitationRef\"\u003e1990\u003c/span\u003e; Johnson, \u003cspan citationid=\"CR16\" class=\"CitationRef\"\u003e1982\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eWe can view these theoretical ideas as directly expressed through the HGER's coordinated push to liberalize trade rules and attract foreign investment. Because of this perspective, trade openness and foreign direct investment are anticipated to be primary growth engines throughout the HGER period. In addition to being a source of financial inflow, foreign direct investment is regarded as an essential conduit for the transfer of cutting-edge technology and the sharing of knowledge, both of which can increase overall economic productivity and innovation (Borensztein et al., \u003cspan citationid=\"CR5\" class=\"CitationRef\"\u003e1998\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eThe prevalent problem of macroeconomic instability, with a focus on the delicate relationship between growth and inflation, or the growth-inflation nexus, is the crucial thread that closely ties the two historical periods together (Fischer, \u003cspan citationid=\"CR11\" class=\"CitationRef\"\u003e1993\u003c/span\u003e). In the context of the DSM model, inflation and debt were often seen as controllable outcomes or results of a necessary investment drive to promote growth.\u003c/p\u003e\u003cp\u003eA central hypothesis put forth in this paper posits that during the HGER era, these pre-existing economic imbalances, when exacerbated by a series of severe new shocks including a devastating internal conflict, the unprecedented global COVID-19 pandemic, and recurrent severe droughts,\u003c/p\u003e\u003cp\u003eultimately transformed what was a chronic economic issue into an acute crisis, which fundamentally constrained the effectiveness and potential success of the economic reforms. This theoretical framework emphasizes why this nexus becomes more potent and damaging in a liberalizing economy burdened by inherited imbalances and facing severe shocks.\u003c/p\u003e"},{"header":"3. Methodology and Data","content":"\u003cdiv id=\"Sec4\" class=\"Section2\"\u003e\u003ch2\u003e3.1 Data and Periodization\u003c/h2\u003e\u003cp\u003eTo conduct a robust comparative analysis, this study utilizes quarterly time-series data from 2004Q1 to 2025Q2 (with 2024Q2-2025Q2 data based on IMF and national projections). Data are compiled from the National Bank of Ethiopia's (NBE) Quarterly Bulletins, the International Monetary Fund's (IMF) World Economic Outlook and Staff Reports, and the World Bank's Open Data platform.\u003c/p\u003e\u003cp\u003eWe divide the full sample into two distinct policy regimes:\u003c/p\u003e\u003cp\u003e\u003cul\u003e\u003cli\u003e\u003cp\u003e\u003cb\u003eDSM Era\u003c/b\u003e: 2004Q1\u0026ndash;2017Q4 (N\u0026thinsp;=\u0026thinsp;56). This period represents the mature phase of the developmental state model, which continued seamlessly after Prime Minister Meles Zenawi died in 2012 under his successor, Hailemariam Desalegn.\u003c/p\u003e\u003c/li\u003e\u003cli\u003e\u003cp\u003e\u003cb\u003eHGER Era\u003c/b\u003e: 2018Q1\u0026ndash;2025Q2 (N\u0026thinsp;=\u0026thinsp;30). This period begins with the political transition to Prime Minister Abiy Ahmed and covers the subsequent launch and implementation of the reform agenda.\u003c/p\u003e\u003c/li\u003e\u003c/ul\u003e\u003c/p\u003e\u003c/div\u003e\u003cdiv id=\"Sec5\" class=\"Section2\"\u003e\u003ch2\u003e3.2 Econometric Model Specification\u003c/h2\u003e\u003cp\u003eTo test for a structural change in the economy's behavior between the two regimes, a Chow test was performed on the full sample. The test formally rejected the null hypothesis of parameter stability across the 2018Q1 breakpoint (F-statistic\u0026thinsp;=\u0026thinsp;3.84, p-value\u0026thinsp;=\u0026thinsp;0.005), providing strong statistical justification for our split-sample regression approach.\u003c/p\u003e\u003cp\u003eWe estimate a multivariate Ordinary Least Squares (OLS) model for each sub-period. To mitigate potential endogeneity and simultaneity bias, which are common in growth regressions, we specify the model with a one-quarter lag on all independent variables (Wooldridge, \u003cspan citationid=\"CR23\" class=\"CitationRef\"\u003e2019\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eThe model is:\u003c/p\u003e\u003cp\u003e\u0026#119866;\u0026#119863;\u0026#119875;\u0026#119866;\u0026#119905; = \u0026#120573; 0+ \u0026#120573; 1 \u0026#119868;\u0026#119873;\u0026#119865;\u0026#119905; \u0026minus;1+ \u0026#120573; 2 \u0026#119874;\u0026#119875;\u0026#119864;\u0026#119873;\u0026#119905; \u0026minus;1+ \u0026#120573; 3 \u0026#119866;\u0026#119874;\u0026#119881;\u0026#119864;\u0026#119883;\u0026#119875;\u0026#119905; \u0026minus;1+ \u0026#120573; 4 \u0026#119865;\u0026#119863;\u0026#119868;\u0026#119905; \u0026minus;1+ \u0026#120573; 5 \u0026#119864;\u0026#119883;\u0026#119862;\u0026#119867; _ \u0026#119881;\u0026#119874;\u0026#119871;\u0026#119905; \u0026minus;1+ \u0026#120598;\u0026#119905;\u003c/p\u003e\u003cp\u003eWhere GDPG is the quarterly real GDP growth rate, INF is the inflation rate, OPEN is trade openness ((Exports\u0026thinsp;+\u0026thinsp;Imports)/GDP), GOVEXP is general government expenditure as a % of GDP, FDI is net FDI inflows as a % of GDP, and EXCH_VOL is the quarterly standard deviation of the monthly Birr/USD exchange rate change.\u003c/p\u003e\u003c/div\u003e"},{"header":"4. Empirical Results","content":"\u003cdiv id=\"Sec7\" class=\"Section2\"\u003e\u003ch2\u003e4.1 Descriptive Evidence: A Tale of Two Eras\u003c/h2\u003e\u003cp\u003eTable\u0026nbsp;\u003cspan refid=\"Tab1\" class=\"InternalRef\"\u003e1\u003c/span\u003e presents the comparative descriptive statistics. The differences between the two periods are stark and reveal the dramatically altered economic landscape.\u003c/p\u003e\u003cp\u003e\u003cdiv class=\"gridtable\"\u003e\u003ctable float=\"Yes\" id=\"Tab1\" border=\"1\"\u003e\u003ccaption language=\"En\"\u003e\u003cdiv class=\"CaptionNumber\"\u003eTable 1\u003c/div\u003e\u003cdiv class=\"CaptionContent\"\u003e\u003cp\u003eComparative Descriptive Statistics\u003c/p\u003e\u003c/div\u003e\u003c/caption\u003e\u003ccolgroup cols=\"4\"\u003e\u003cdiv align=\"left\" class=\"colspec\" colname=\"c1\" colnum=\"1\"\u003e\u003c/div\u003e\u003cdiv align=\"char\" char=\".\" class=\"colspec\" colname=\"c2\" colnum=\"2\"\u003e\u003c/div\u003e\u003cdiv align=\"char\" char=\".\" class=\"colspec\" colname=\"c3\" colnum=\"3\"\u003e\u003c/div\u003e\u003cdiv align=\"left\" class=\"colspec\" colname=\"c4\" colnum=\"4\"\u003e\u003c/div\u003e\u003cthead\u003e\u003ctr\u003e\u003cth align=\"left\" colname=\"c1\" morerows=\"1\" rowspan=\"2\"\u003e\u003cp\u003eVariable\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c2\"\u003e\u003cp\u003eDSM Era (2004\u0026ndash;2017)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c3\"\u003e\u003cp\u003eHGER Era (2018\u0026ndash;2025)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/th\u003e\u003c/tr\u003e\u003ctr\u003e\u003cth align=\"left\" colname=\"c2\"\u003e\u003cp\u003eMean (Std. Dev.)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c3\"\u003e\u003cp\u003eMean (Std. Dev.)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/th\u003e\u003c/tr\u003e\u003c/thead\u003e\u003ctbody\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eGDP Growth (%)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e10.1 (2.1)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e5.8 (3.1)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eInflation (%)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e14.2 (6.5)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e29.5 (8.2)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eGov. Expenditure (% GDP)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e15.9 (2.4)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e11.8 (2.1)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eFDI Inflows (% GDP)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e3.1 (1.4)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e1.9 (1.6)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eExch. Rate Volatility\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e0.28 (0.12)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e1.25 (0.75)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003c/tbody\u003e\u003c/colgroup\u003e\u003ctfoot\u003e\u003ctr\u003e\u003ctd colspan=\"4\"\u003eSource: Author\u0026rsquo;s Computation\u003c/td\u003e\u003c/tr\u003e\u003c/tfoot\u003e\u003c/table\u003e\u003c/div\u003e\u003c/p\u003e\u003cp\u003eThe DSM era delivered exceptionally high average growth (10.1%). While inflation was a persistent challenge, its average of 14.2% was half of what was to come. In contrast, the HGER era has been defined by lower, more erratic growth (5.8%) and an explosion of instability. Average inflation more than doubled to 29.5%, and exchange rate volatility increased nearly fivefold. This descriptive evidence highlights the dramatically different and more challenging macroeconomic context in which the HGER has been implemented.\u003c/p\u003e\u003c/div\u003e\u003cdiv id=\"Sec8\" class=\"Section2\"\u003e\u003ch2\u003e4.2 Comparative Econometric Findings\u003c/h2\u003e\u003cp\u003eTable\u0026nbsp;\u003cspan refid=\"Tab2\" class=\"InternalRef\"\u003e2\u003c/span\u003e presents the core results from the split-sample regressions, allowing for a direct comparison of the growth determinants across the two regimes.\u003c/p\u003e\u003cp\u003e\u003cdiv class=\"gridtable\"\u003e\u003ctable float=\"Yes\" id=\"Tab2\" border=\"1\"\u003e\u003ccaption language=\"En\"\u003e\u003cdiv class=\"CaptionNumber\"\u003eTable 2\u003c/div\u003e\u003cdiv class=\"CaptionContent\"\u003e\u003cp\u003eComparative Regression Results for GDP Growth Determinants\u003c/p\u003e\u003c/div\u003e\u003c/caption\u003e\u003ccolgroup cols=\"4\"\u003e\u003cdiv align=\"left\" class=\"colspec\" colname=\"c1\" colnum=\"1\"\u003e\u003c/div\u003e\u003cdiv align=\"char\" char=\".\" class=\"colspec\" colname=\"c2\" colnum=\"2\"\u003e\u003c/div\u003e\u003cdiv align=\"char\" char=\".\" class=\"colspec\" colname=\"c3\" colnum=\"3\"\u003e\u003c/div\u003e\u003cdiv align=\"left\" class=\"colspec\" colname=\"c4\" colnum=\"4\"\u003e\u003c/div\u003e\u003cthead\u003e\u003ctr\u003e\u003cth align=\"left\" colname=\"c1\" morerows=\"1\" rowspan=\"2\"\u003e\u003cp\u003eVariable\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c2\"\u003e\u003cp\u003eDSM Era (2004\u0026ndash;2017)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c3\"\u003e\u003cp\u003eHGER Era (2018\u0026ndash;2025)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/th\u003e\u003c/tr\u003e\u003ctr\u003e\u003cth align=\"left\" colname=\"c2\"\u003e\u003cp\u003eCoefficient (p-value)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c3\"\u003e\u003cp\u003eCoefficient (p-value)\u003c/p\u003e\u003c/th\u003e\u003cth align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/th\u003e\u003c/tr\u003e\u003c/thead\u003e\u003ctbody\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003e(Constant)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e3.50 (0.015*)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e2.90 (0.051)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eInflation\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e-0.18 (0.062)\u003c/p\u003e \u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e-0.48 (0.005**)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eTrade Openness\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e0.25 (0.110)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e0.61 (0.009**)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eGov. Expenditure\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e0.52 (0.001**)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e0.20 (0.150)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eFDI Inflows\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e0.28 (0.095)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e0.45 (0.018*)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eExch. Rate Volatility\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e-0.15 (0.180)\u003c/p\u003e \u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e-0.28 (0.022*)\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd align=\"left\" colname=\"c1\"\u003e\u003cp\u003eAdjusted R\u0026sup2;\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c2\"\u003e\u003cp\u003e0.83\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"char\" char=\".\" colname=\"c3\"\u003e\u003cp\u003e0.80\u003c/p\u003e\u003c/td\u003e\u003ctd align=\"left\" colname=\"c4\"\u003e\u0026nbsp;\u003c/td\u003e\u003c/tr\u003e\u003c/tbody\u003e\u003c/colgroup\u003e\u003ctfoot\u003e\u003ctr\u003e\u003ctd colspan=\"4\"\u003eNotes: * denotes significance at the 5% level; ** denotes significance at the 1% level.\u003c/td\u003e\u003c/tr\u003e\u003ctr\u003e\u003ctd colspan=\"4\"\u003eSource: Author\u0026rsquo;s Computation\u003c/td\u003e\u003c/tr\u003e\u003c/tfoot\u003e\u003c/table\u003e\u003c/div\u003e\u003c/p\u003e\u003c/div\u003e"},{"header":"5. Discussion: Substantiating a Structural Break","content":"\u003cp\u003eThe econometric results presented in this study empirically confirm a fundamental structural break in the Ethiopian economy, marking a shift in the key drivers of economic growth from the DSM to the HGER era. This section expands on these findings by comparing them with the existing literature and highlighting the implications of these changes for Ethiopia's economic strategy.\u003c/p\u003e\u003cp\u003eDuring the DSM era, government expenditure emerged as the primary and highly significant driver of economic growth, as evidenced by the coefficient of 0.52 (p\u0026thinsp;\u0026lt;\u0026thinsp;0.01) in Table\u0026nbsp;\u003cspan refid=\"Tab2\" class=\"InternalRef\"\u003e2\u003c/span\u003e. These findings are consistent with earlier research highlighting the pivotal role of government expenditure in driving growth within developing nations, especially those following state-led development models (Lin and Monga, \u003cspan citationid=\"CR17\" class=\"CitationRef\"\u003e2010\u003c/span\u003e).\u003c/p\u003e\u003cp\u003eDuring this particular time frame, the proactive fiscal policies and strategies implemented by the Ethiopian government played an absolutely vital role in propelling the development of essential infrastructure and public services, both of which are incredibly important for fostering sustainable economic growth, as noted by Moges in 2013. This situation provides a solid empirical foundation that supports the theoretical framework of the developmental state, which is consistent with a growing body of literature that discusses Ethiopia's remarkable increase in public investment, along with the prominent role that state-led initiatives play in encouraging economic growth in developing nations. In stark contrast to the previous period, the time frame referred to as the HGER period represented a profound transformation in economic dynamics. During this phase, the influence of public spending on overall economic growth became statistically insignificant, as indicated by a coefficient of merely 0.20 (with a p-value of 0.150). At the same time, we witnessed the emergence of Foreign Direct Investment (FDI) and the openness of trade as new, highly significant catalysts for economic growth, boasting coefficients of 0.45 (with a p-value of less than 0.05) and 0.61 (with a p-value of less than 0.01), respectively. This noticeable shift not only supports the empirical evidence for the HGER's transition towards a market-oriented approach to economic growth but also aligns beautifully with the principles found in neoclassical and endogenous growth theories, which emphasize the importance of private investment and international trade as crucial drivers of economic expansion, as elaborated by Romer in 1990 and further refined by Frankel and Romer in 1999.\u003c/p\u003e\u003cp\u003eThis transition reflects the HGER's liberalization agenda, aiming to integrate Ethiopia more deeply into the global economy and utilize external resources for development, echoing the findings of Balasubramanyam, Salisu, and Sapsford (\u003cspan citationid=\"CR3\" class=\"CitationRef\"\u003e1996\u003c/span\u003e), who argue that trade and FDI are crucial for technology transfer, capital accumulation, and market access in liberalizing economies. This empirical evidence of the shift in growth drivers, particularly the reduced significance of government spending in the HGER period compared to its previous dominance, is a significant and unique discovery.\u003c/p\u003e\u003cp\u003eOne of the most striking and novel contributions of this study is the quantified, dramatically increased economic cost of macroeconomic instability in the HGER era. The coefficient for inflation in the DSM era (-0.18, p\u0026thinsp;=\u0026thinsp;0.062) was modest and only borderline significant. However, in the HGER era, the coefficient nearly tripled to -0.48 (p\u0026thinsp;\u0026lt;\u0026thinsp;0.01), highlighting the heightened sensitivity of economic growth to inflationary pressure. This pattern is consistent with Barro (\u003cspan citationid=\"CR4\" class=\"CitationRef\"\u003e2013\u003c/span\u003e), who emphasized that high inflation can erode purchasing power, distort investment decisions, and undermine economic stability. This finding directly substantiates our hypothesis that pre-existing economic imbalances, when exacerbated by severe new shocks including an internal conflict, the global COVID-19 pandemic, and recurrent severe droughts transformed what was a chronic economic issue into an acute crisis, fundamentally constraining the effectiveness of economic reforms. This is a new and crucial extension of existing knowledge, highlighting that inherited imbalances, when exacerbated by severe shocks, transformed a chronic issue into an acute crisis that fundamentally constrained the effectiveness of economic reforms.\u003c/p\u003e\u003cp\u003eSimilarly, exchange rate volatility not a major obstacle to growth during the DSM period emerged as significant in the HGER era (-0.28, p\u0026thinsp;\u0026lt;\u0026thinsp;0.05). This finding supports Aghion et al. (\u003cspan citationid=\"CR1\" class=\"CitationRef\"\u003e2009\u003c/span\u003e)'s view that exchange rate fluctuations can create uncertainty for trade and investment, slowing economic growth, especially in developing economies. The research builds on this by showing empirical proof of the Ethiopian economy's heightened sensitivity, which was less relevant under the former state-controlled system. Moving from a state-led growth model to one that is more market-oriented requires a stable macroeconomic environment. Yet, the greater vulnerability to inflation and exchange rate movements implies that Ethiopia's present economic framework may not be strong enough to handle these external pressures. This highlights the critical need for effective macroeconomic policies to curb such volatility and foster conditions conducive to sustained economic expansion.\u003c/p\u003e\u003cp\u003eThe paper offers a detailed dynamic perspective on how the significance and impact of various economic factors evolve with structural reforms and external shocks, providing insights into the complex development of economic systems during transformative periods.\u003c/p\u003e"},{"header":"6. Conclusion and Policy Implications","content":"\u003cp\u003eThis comparative analysis reveals that Ethiopia's economy has undergone a profound structural break between the DSM and HGER eras. The engine of growth has fundamentally changed, shifting away from state expenditure towards an emerging reliance on private investment and trade. This confirms that the HGER is, at least directionally, succeeding in reorienting the economy. However, the transition has been dangerous. The HGER era inherited the macroeconomic imbalances of the DSM era, but these were then amplified to crisis levels by a flood of internal and external shocks. Our empirical results show that the economic cost of this instability, particularly inflation, is now far more damaging to growth than ever before. Ethiopia is attempting to build a new, liberalized economic house on a foundation of macroeconomic quicksand.\u003c/p\u003e\u003cp\u003eThe central policy challenge is therefore clear. The goal should not be to reverse the reforms and return to the unsustainable state-led model of the past. Rather, policymakers must recognize that macroeconomic stabilization is not a separate, secondary goal but the absolute prerequisite for the success of the entire HGER project. Given our finding that inflation's negative impact has tripled, controlling inflation is not merely desirable but an essential and immediate policy imperative. Without a credible and sustained effort to bring inflation under control and stabilize the exchange rate, the potential of a more open, dynamic, and private-sector-driven economy for Ethiopia will remain tragically unrealized.\u003c/p\u003e\u003cp\u003eThis study is subject to several limitations, which open avenues for future research. First, while quarterly data improves upon annual series, macroeconomic data in developing countries can be subject to revisions and measurement error. This implicitly highlights the study's contribution of using higher-frequency data as an improvement. Second, our model is necessarily parsimonious and could be subject to omitted variable bias. This parsimonious nature allowed for a clear comparison of the primary variables of interest, reinforcing the study's specific focus on identifying the key drivers of growth and the evolving cost of macroeconomic instability. Future research could incorporate proxies for institutional quality, human capital, and, critically, the distinct impacts of conflict and climate shocks, which are highly relevant to Ethiopia's context. Third, the linear specification may not fully capture the growth-inflation relationship. It is highly probable that this effect is non-linear, and future studies could employ threshold regression models to identify the specific inflation levels beyond which the damage to growth accelerates, thereby providing more granular insights for policymakers.\u003c/p\u003e"},{"header":"Statements and Declarations","content":"\u003cp\u003e\u003cstrong\u003eFunding:\u003c/strong\u003e This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.\u003c/p\u003e\n\u003cp\u003e\u003cstrong\u003eDeclaration of Competing Interest\u003c/strong\u003e: The author declares that he has no known conflicting financial interests or personal relationships that could have influenced the work reported in this paper.\u003c/p\u003e"},{"header":"References","content":"\u003col\u003e\n\u003cli\u003eAghion, P., Bacchetta, P., Ranciere, R., \u0026amp; Rogoff, K. (2009). Exchange rate volatility and productivity growth: The role of financial development. Journal of Monetary Economics, 56(4), 494-513.\u003c/li\u003e\n\u003cli\u003eAmsden, A. H. (1989). Asia\u0026apos;s next giant: South Korea and late industrialization. Oxford University Press.\u003c/li\u003e\n\u003cli\u003eBalasubramanyam, V. N., Salisu, M., \u0026amp; Sapsford, D. (1996). Foreign direct investment and growth in EP and IS countries. Economic Journal, 106(434), 92-105.\u003c/li\u003e\n\u003cli\u003eBarro, R. J. (2013). Inflation and economic growth. Annals of Economics and Finance, 14(1), 121-144.\u003c/li\u003e\n\u003cli\u003eBorensztein, E., De Gregorio, J., \u0026amp; Lee, J.-W. (1998). How does foreign direct investment affect economic growth? Journal of International Economics, 45(1), 115-135. https://doi.org/10.1016/S0022-1996(97)00033-0. \u003c/li\u003e\n\u003cli\u003eDeressa, T. T., \u0026amp; Koirala, K. H. (2021). The impact of real exchange rate misalignment on economic growth in Ethiopia. Journal of Economic Structures, 10(1), 29. https://doi.org/10.1186/s40008-021-00259-3.\u003c/li\u003e\n\u003cli\u003eEjigu, W. G. (2022). Structural Change and Economic Growth in Ethiopia, 1991-2017. \u003cem\u003eJournal of Business and Administrative Studies, 14\u003c/em\u003e(1). https://doi.org/10.20372/jbas.v14i1.4381\u003c/li\u003e\n\u003cli\u003eEthiopia Ministry of Agriculture and Rural Development. (2010). \u003cem\u003eEthiopia\u0026rsquo;s Agricultural Sector Policy and Investment Framework (PIF) 2010\u0026ndash;2020\u003c/em\u003e. [Prepared by Demese Chanyalew, Berhanu Adenew, and John Mellor]. Retrieved from https://land.igad.int/index.php/documents-1/countries/ethiopia/legislation-and-policies-1/policies-1/268-ethiopia-s-agricultural-sector-policy-and-investment-framework-pif/file\u003c/li\u003e\n\u003cli\u003eEthiopia Press Agency. (2019, July 10). Prime Minister Abiy Ahmed outlines the Homegrown Economic Reforms agenda. Retrieved from https://www.ena.et/web/eng/w/eng_4869646\u003c/li\u003e\n\u003cli\u003eFederal Democratic Republic of Ethiopia Ministry of Finance. (2020). \u003cem\u003eA Homegrown Economic Reform Agenda: A Pathway to Prosperity\u003c/em\u003e (Public Version \u0026ndash; March 2020). Retrieved from https://www.mofed.gov.et/media/filer_public/38/78/3878265a-1565-4be4-8ac9-dee9ea1f4f1a/a_homegrown_economic_reform_agenda-\u003cem\u003ea_pathway_to_prosperity\u003c/em\u003e-\u003cem\u003epublic_version\u003c/em\u003e-_march_2020-.pdf\u003c/li\u003e\n\u003cli\u003eFischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3), 485-512. https://doi.org/10.1016/0304-3878(93)90027-D. \u003c/li\u003e\n\u003cli\u003eFrankel, J. A., \u0026amp; Romer, D. H. (1999). Does trade cause growth? American Economic Review, 89(3), 379-399. https://doi.org/10.1257/aer.89.3.379. \u003c/li\u003e\n\u003cli\u003eGeda, A., \u0026amp; Kibret, K. (2020). The Galloping Inflation in Ethiopia: A Cautionary Tale for Aspiring \u0026apos;Developmental States\u0026apos; in Africa. Institute of African Economic Studies (IAES).\u003c/li\u003e\n\u003cli\u003eInternational Monetary Fund. (2024a). World Economic Outlook: April 2024. IMF.\u003c/li\u003e\n\u003cli\u003eInternational Monetary Fund. (2024b). Ethiopia: 2024 Article IV Consultation and Request for a Stand-By Arrangement and an Arrangement Under the Resilience and Sustainability Facility\u0026mdash;Press Release; Staff Report. IMF Staff Country Reports.\u003c/li\u003e\n\u003cli\u003eJohnson, C. (1982). MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975. Stanford University Press.\u003c/li\u003e\n\u003cli\u003eLin, J. Y., \u0026amp; Monga, C. (2010). Growth identification and facilitation: The role of the state in the dynamics of structural change. Policy Research Working Paper No. 5313, World Bank.\u003c/li\u003e\n\u003cli\u003eMinistry of Finance, Federal Democratic Republic of Ethiopia. (2019). Ethiopia\u0026apos;s Homegrown Economic Reform Agenda: A Pathway to Prosperity.\u003c/li\u003e\n\u003cli\u003eMoges, A. G. (2013). The role of government in economic development: The Ethiopian experience. Addis Ababa University Press.\u003c/li\u003e\n\u003cli\u003eNational Bank of Ethiopia. (n.d.). Quarterly Bulletin. Retrieved August 1, 2025, from the National Bank of Ethiopia publications page.\u003c/li\u003e\n\u003cli\u003eRomer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5, Part 2), S71-S102. https://www.jstor.org/stable/2937632. \u003c/li\u003e\n\u003cli\u003eWade, R. (1990). Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization. Princeton University Press.\u003c/li\u003e\n\u003cli\u003eWooldridge, J. M. (2019). Introductory Econometrics: A Modern Approach (7th ed.). Cengage Learning.\u003c/li\u003e\n\u003cli\u003eWorld Bank. (2024). Ethiopia Overview. Retrieved from https://www.worldbank.org/en/country/ethiopia/overview.\u003c/li\u003e\n\u003c/ol\u003e"}],"fulltextSource":"","fullText":"","funders":[],"hasAdminPriorityOnWorkflow":false,"hasManuscriptDocX":true,"hasOptedInToPreprint":true,"hasPassedJournalQc":"","hasAnyPriority":true,"hideJournal":true,"highlight":"","institution":"","isAcceptedByJournal":false,"isAuthorSuppliedPdf":false,"isDeskRejected":"","isHiddenFromSearch":false,"isInQc":false,"isInWorkflow":true,"isPdf":false,"isPdfUpToDate":true,"isWithdrawnOrRetracted":false,"journal":{"display":true,"email":"[email protected]","identity":"researchsquare","isNatureJournal":false,"hasQc":true,"allowDirectSubmit":true,"externalIdentity":"","sideBox":"","snPcode":"","submissionUrl":"/submission","title":"Research Square","twitterHandle":"researchsquare","acdcEnabled":true,"dfaEnabled":false,"editorialSystem":"","reportingPortfolio":"","inReviewEnabled":false,"inReviewRevisionsEnabled":true},"keywords":"Developmental State Model, Ethiopia, Homegrown Economic Reform, Inflation, Macroeconomic Stability, Structural Break","lastPublishedDoi":"10.21203/rs.3.rs-7544652/v1","lastPublishedDoiUrl":"https://doi.org/10.21203/rs.3.rs-7544652/v1","license":{"name":"CC BY 4.0","url":"https://creativecommons.org/licenses/by/4.0/"},"manuscriptAbstract":"\u003cp\u003e\u003cem\u003eEthiopia's macroeconomic performance under two different political economic regimes, the late stage Developmental State Model (DSM) (2004–2017) and the later Homegrown Economic Reform (HGER) (2018–2025), is empirically analyzed in this paper. Finding and measuring the fundamental split in the nation's growth determinants and the changing cost of macroeconomic instability are its main goals. We do a structural break analysis utilizing quarterly time-series data from 2004 to 2025, formally determining the breakpoint during the 2018 political transition through the use of a Chow test. Then, for each subperiod (2004-2017 and 2018-2025), we independently estimate a multivariate Ordinary Least Squares (OLS) regression model with lagged independent variables to reduce endogeneity. The findings show a notable structural change. Under the DSM era, GDP growth was powerfully and significantly driven by government expenditure, a finding consistent with the literature on Ethiopia’s public investment boom. In contrast, the HGER era shows a statistically insignificant growth impact from public spending, with Foreign Direct Investment (FDI) and trade openness emerging as new, significant drivers. Critically, we find that the negative coefficient of inflation on growth nearly tripled in magnitude and became highly significant in the HGER era. This substantiates warnings from prior literature and demonstrates a sharply increased economic cost of instability in a liberalizing economy. Our findings empirically validate the narrative of Ethiopia's economic transition. Directly comparing the two governments and validating the findings with existing literature, this study provides crucial evidence on the profound challenges of economic liberalization amidst inherited imbalances and severe shocks.\u003c/em\u003e\u003c/p\u003e","manuscriptTitle":"Structural Economic Transition in Ethiopia: From State-Led Growth to Market-Oriented Reform","msid":"","msnumber":"","nonDraftVersions":[{"code":1,"date":"2025-10-01 17:41:26","doi":"10.21203/rs.3.rs-7544652/v1","editorialEvents":[{"type":"communityComments","content":0}],"status":"published","journal":{"display":true,"email":"[email protected]","identity":"researchsquare","isNatureJournal":false,"hasQc":true,"allowDirectSubmit":true,"externalIdentity":"","sideBox":"","snPcode":"","submissionUrl":"/submission","title":"Research Square","twitterHandle":"researchsquare","acdcEnabled":true,"dfaEnabled":false,"editorialSystem":"","reportingPortfolio":"","inReviewEnabled":false,"inReviewRevisionsEnabled":true}}],"origin":"","ownerIdentity":"3d79faa8-c88d-40a7-bd3c-27a0cd799ee3","owner":[],"postedDate":"October 1st, 2025","published":true,"recentEditorialEvents":[],"rejectedJournal":[],"revision":"","amendment":"","status":"posted","subjectAreas":[],"tags":[],"updatedAt":"2025-10-18T07:23:47+00:00","versionOfRecord":[],"versionCreatedAt":"2025-10-01 17:41:26","video":"","vorDoi":"","vorDoiUrl":"","workflowStages":[]},"version":"v1","identity":"rs-7544652","journalConfig":"researchsquare"},"__N_SSP":true},"page":"/article/[identity]/[[...version]]","query":{"redirect":"/article/rs-7544652","identity":"rs-7544652","version":["v1"]},"buildId":"8U1c8b4HqxoKbykW_rLl7","isFallback":false,"isExperimentalCompile":false,"dynamicIds":[84888],"gssp":true,"scriptLoader":[]}