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

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.