User:Nicholaslepan/sandbox

Financial market theory of development

Global Growth
During the 1980’s, developing countries engaged dramatic reforms to their financial systems by liberalizing them and make the more focused on the market, financial de-repression, which make easier to move around the world. From 1984 to 1995, Global equity markets experienced an explosive growth, emerging equity markets experienced an even more rapid growth, taking on an increasingly larger share of this global boom. Between 1980 and 2005, 58 countries started stock exchanges. Overall capitalization rose from $4.7 trillion to $15.2 trillion globally, the share of emerging markets jumped from less than 4 to 13 percent in this period. Trading activity in these markets surged equally fast: the value of shares traded in emerging markets climbed from less than 3 percent of the $1.6 trillion world total in 1985 to 17 percent of the $9.6 trillion shares traded in all world’s exchanges in 1994 (Mohtadi and Agarwal, 2001).

Historical Perspective
In 1950, there were 49 countries with stock exchanges, 24 were in Europe and the remaining 14 were in former British colonies such as the United States and Canada. These were legitimate and institutional but their usefulness was seen as limited to the wealthier countries. There were low levels of savings in the developing countries and they had limited means to attract foreign capital; stock markets played an insignificant role in economic development before the 1980’s. Funding for economic capital came primarily from foreign aid, state-to-state from advanced industrial countries to developing economies during the 50’s and 60’s (Weber, Davis and Lounsbury, 1321). This was underpinned the intellectual support of development as outlined in modernization theories of development.

During the 1970’s there was an increase in private bank long-term lending to foreign states that nearly equalled state aid, and as Keynesian ideas came into disrepute dues to stagflation. Lending from banks abruptly in 1982 when Mexico suspended its external debt service which began the debt crisis throughout the developing world (Weber, Davis and Lounsbury, 1322).

In response to the perceived failures of the development project and to the 1980s debt crisis, a market-based strategy of economic development was seen as the solution. Instead of bank-to-state lending or foreign aid, this model would use private investment into the private sector of developing countries. The International Monetary Fund (IMF) and the World Bank spread this idea through its use of Structural Adjustment Programs of the 1980’s (Weber, Davis and Lounsbury, 1322).

The IMF and World Bank supported stock market development not solely on the grounds of ideology but rather that the stock market is a natural outgrowth of a developing financial sector as long-term economic growth proceeds and also as a criticism of early development efforts through Development Finance Institutes (DFI) (Singh, 2, 1993). These DFI’s have been having difficulties since the 1970’s economic crisis of the third world. Singh cites the World Development Report of 1989 that the poor performance of these DFI’s was due to the “inefficiencies of these DFIs and the banked-based interventionist financial systems”. The report argued that a restructuring of these systems to make them “voluntary, fiscally neutral and to being them as far as practicable under private ownership.” (Singh, 2, 1993) A new term was coined “emerging markets” for third world countries which would help legitimize stock markets as a method of economic development. (Weber, Davis and Lounsbury, 1322)

These change helped liberalize the domestic economy as well as the external financial liberalization. These stock markets became major sources of foreign capital flows to developing countries. For example, Ajit Singh in his “Financial Liberalisation, Stock markets and Economic Development” cited international equity flows of the Economists 38 emerging markets increased from $3.3 billion in 1986 to $61.2 billion in 1993. This particular capital flow was different in nature from the previous 20 years by the dominant role of foreign portfolio flow versus bank financing. These funds have poured into developing countries through several routes as external liberalization increased; country or regional funds, direct purchase of developing countries stocks by industrial country investors, listing of developing countries securities on industrial country markets (Singh, 772, 1993).

Financial Market Theory of Development
The use of private flows of capital and stock market creation began to shape into a new theory of development put forward by the World Bank’s World Development Report for 2000. Foreign investors should have access to “well-regulated” financial markets which would provide the “surest path” to economic development. At the receiving end, businesses in low-income countries gain direct access to the enormous stocks of private capital generated in industrialized countries. Companies in developing countries do not have to rely on loans or aid that are negotiated through political means and receive capital directly from private investors. This would free capital from exposure to inefficient or corrupt government structures, unleash local entrepreneurial potential and hopefully improve economic growth. This would encourage policy and corporate managers to make “future-oriented decisions about the governance of their economic system.” Capital-deprived developing countries can craft policies to convince investors about the future prospects of their country. Instead of relying on the slow process of domestic capital accumulation, they can sell equity to or borrow from foreign investors and spur economic development faster.

“Moreover, stock markets generate a wealth of intelligence through the operation of the price system, which helps guide decisions of both managers and investors. The benefits to investors are rooted in prospective growth rates unattainable in advanced economies and high returns matching the risks involved.”

This is known as the “financial market theory of development.” There is an assumption that accompanies this theory; it implies that stock markets will improve economic growth to the degree based on how integrated they are into an “institutional matrix” that sends signals to decisions makers who would look for growth opportunities.

Some Criticism:
found. But when nations started exchanges due to international pressure, the new systems tended be adopted only superficially.” (Ross, 2011) Ajit Singh notes that stock markets are “potent symbols of capitalism but paradoxically capitalism often flourishes better without their hegemony.” He states that contrary to the World Bank that stock market development is not an essential progression of the development of a country’s financial development. He notes the post WW-II period countries of Germany, Italy, Japan, Korea and Taiwan were able to industrialize and achieve “economic miracles with little assistance from the stock market”. (Singh 780, 1997) He ends his criticism with a quote from Keynes “when the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done."

References:
Mohtadi, Hamid and Sumit Agarwal. Stock Market Development and Economic Growth Evidence from Developing Countries. University of Wisconsin-Milwaukee, 2001. University of Wisconsin-Milwaukee, Depart. of Economics. Web. 12 Feb 2013. https://pantherfile.uwm.edu/mohtadi/www/PA1-4-01.pdf

Ross, Valerie. Developing Stock Exchanges in Developing Countries. Kellogg Insight. Kellogg School of Management at Northwestern University, June 2011. Web. 12 Feb. 2013. http://insight.kellogg.northwestern.edu/article/developing_stock_exchanges_in_developing_countries/

Singh, Ajit. The Stock Market and Economic Development: Should Developing Countries Encourage Stock Markets?. UNCTAD Review, No. 4. 1993. Web. http://cedeplar.ufmg.br/economia/disciplinas/ecn933a/crocco/Criacao_expansao_mercado_capitais/SINGH~31.PDF

Singh, Ajit. Financial Liberalisation, Stockmarkets and Economic Development. The Economic Journal. May, 1997: 771-782. Web. 12 Feb. 2013.http://www.jstor.org/discover/10.2307/2957801?uid=3739400&uid=2134&uid=4578330007&uid=4578329997&uid=2&uid=70&uid=3737720&uid=3&uid=60&sid=21101802418957

Weber, Klaus, Gerald F. Davis and Michael Lounsbury. Policy as Myth and Ceremony? The Global Spread of Stock Markets, 1980-2005. Academy of Management Journal. 52 (6): 1319-1347. Web. 12 Feb. 2013. http://www.kellogg.northwestern.edu/Faculty/Directory/Weber_Klaus.aspx#research

Further Reading:
Noble, Gordon and Andrew White. Stock Exchange Development & Strengthening in Least Developed Countries. Inflection Point Capital Management, Toronto. Web 12 Feb. 2013. http://inflectionpointcm.com/downloads/SEDSLDCs.pdf

Seetanah, Boopen, Rojid Sawkit, Vinesh Sannassee and Binesh Seetanah. Stock Market Development and Economic Growth in Developing countries: Evidence from Panel VAR framework. CSAE Conference 2010 Economic Development in Africa. Center for the Study of African Economies Oxford Dept. of Economics, 2010,. Web. 12 Feb 2013. http://www.csae.ox.ac.uk/conferences/2010-EDiA/papers/041-Seetanah.pdf