The connection between countries with substantial stock markets and wealthy economies raises questions about whether stock markets enhance economic performance. Efficient financial markets are expected to support company growth, contributing to economic expansion. A recent study by the World Federation of Exchanges (WFE) supports this notion, building on extensive research.
Developed Financial Markets and Economic Growth
Data indicates that wealthier nations often have larger stock markets, even when accounting for population size through metrics such as GDP per capita and market capitalization per capita. Conversely, low-income countries exhibit an opposite trend.
Institutions and Investor Participation in High-Income Countries
High-income countries differ by fostering environments where investors trust institutions and regulatory bodies, encouraging capital investment. These countries typically score higher in "Rule of Law" as assessed by the World Justice Project, compared to their lower-income counterparts. This environment, along with developed financial market infrastructure, promotes capital attraction.
Countries with higher income levels generally have advanced financial markets, although some smaller European nations deviate from this pattern.
Investor Participation and Economic Feedback
The U.S., Sweden, and Australia, among other high-income countries, report significant household investment in equities. Strong legal frameworks and developed financial markets create environments conducive to capital attraction, leading to a feedback loop that supports GDP growth. Research indicates that higher domestic equity ownership correlates with increased valuations, benefiting companies by reducing capital costs and encouraging public offerings.
Channels Through Which Equity Markets Influence Growth
Equity markets contribute to economic growth via several channels:
- Capital Allocation and Mobilization: Public offerings provide companies with funds for investment and expansion, supporting job creation and economic development.
- Liquidity: Increased market liquidity draws investors, expanding the capital pool and economic growth potential.
- Information: Markets that price available information help investors and creditors make informed allocation decisions.
- Diversification: Stock markets allow risk management through diversified investments, enhancing capital efficiency and growth.
- Wealth Effect: Rising asset prices improve owners’ financial confidence, spurring economic activity.
Equity Markets and Long-Term Economic Growth
Research links growing equity markets to stronger GDP growth across 37 countries over 20 years. In high-income countries, there is a mutual reinforcement between market cap ratios and economic growth. For low- and middle-income countries, increased market cap ratios predominantly drive economic growth.
Over time, a 10% increase in market cap ratio leads to a 0.028% increase in long-term economic growth globally and a 0.045% increase in high-income countries.
Policy Implications
Promoting robust equity markets is crucial for economic development and financial security across all income levels. The WFE study substantiates the role of healthy equity markets in supporting economic growth and capital formation.
