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Economic Growth before and after an Exchange Is Opened
Source: Baier, Scott L., Gerald P. Dwyer, Jr. and Robert Tamura, ‘‘Does Opening a Stock Ex-change Increase Economic Growth,’’ Journal of International Money and Finance 23 (2004), 311–331. Figures are reprinted with permisson from Elsevier.
Stock Markets Abroad 117
exchange in the United States. The Chicago Stock Exchange represents the merging of several smaller exchanges located in St. Louis, Cleveland, Minneapolis,andNewOrleans.Whiletheexchangescontinuetooperate,the national exchanges like the NYSE dominate trading activity.
One implication of this ﬁnding is that small countries may ﬁnd it ad-vantageous to forego the apparent beneﬁts of opening a local stock exchange. Instead, it may be better to invest those resources to create an environment that facilitates the issuance and trading of shares abroad. Generally, this can be done by reducing domestic barriers to securities trading. Governments should attempt to improve corporate governance issues that may exist be-tween the local and global markets. They also can alter accounting practices to be more universally acceptable and enforce securities rules in a manner consistent with other countries. If the natural outcome of economic and ﬁnancial development is the migration of activity to the larger, more efﬁcient markets, it may be more efﬁcient to use the exchanges already in existence.
Stock exchanges do not open in an economic vacuum. It simply is not the case that stock markets open and economies then expand. Stock exchanges are formed to help allocate ﬁnancial capital in an efﬁcient manner. This is done through the trading of ownership rights in ﬁrms, whether through IPOs or throughsecondarytrading.Inallcases,stockmarketsprovideverybeneﬁcialprice signals to ﬁrms and investors of the expected success of different ventures. The longhistoryofthemajorstockexchangeshighlightedinthischapteristestament to the importance of these markets to the economic well-being of a country.
The fact that new exchanges are opened even today suggests that there probably is some economic gain from having an exchange compared to not having one. Indeed, the evidence from many studies indicates that opening a stock exchange has a positive effect on a country’s growth. Even after ac-countingforotherﬁnancialandsocietaldevelopments,thepresenceofastock market explains why some countries are economically better-off than others. Stock exchanges appear to be an indispensable component in the modern global economy.
1. This discussion is based on information from the ofﬁcial website of the Tokyo exchange, accessed at www.tse.or.jp. A source of additional information is Richard J. Teweles and Edward S. Bradley, The Stock Market, 5th ed. (New York: John Wiley, 1987).
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2. Tokyo Exchange Fact Book, 2005.
3. This discussion is based on information from the stock exchange’s ofﬁcial website. It can be accessed at www.londonstockexchange.com. Additional infor-mation was obtained from Teweles and Bradley (1987).
4. This discussion is based on information from Ron Yiu-wah Ho, Roger Strange, and Jenifer Piesse, ‘‘The Structural and Institutional Features of the Hong Kong Stock Market: Implications for Asset Pricing’’ (The Management Centre Research Papers, King’s College, London, 2004).
5. This discussion is based on information taken from the ofﬁcial website of the Deutsche Borse Group. It can be accessed at http://deutsche-borse.com.
6. This discussion is based on information taken from the ofﬁcial website of the TSX Group. It can be accessed at www.tsx.com.
7. This discussion is based on material available at the ofﬁcial Euronext website. It can be accessed at www.euronext.com. Source: World Federation of Exchanges Annual Report and Statistics (2004).
8. Gerald P. Dwyer, Jr. and R.W. Hafer. ‘‘Are National Stock Markets Linked?’’ Federal Reserve Bank of St. Louis, Review (November/December 1988): 3–14.
9. Ross Levine and Sara Zervos, ‘‘Stock Markets, Banks and Economic Growth,’’ American Economic Review 88, no. 3 (1998): 537–58.
10. Scott L. Baier, Gerald P. Dwyer, Jr., and Robert Tamura. ‘‘Does Opening a Stock Exchange Increase Economic Growth?’’ Journal of International Money and Finance (April 2004): 311–331.
11. Stijn Claessens, Daniel A. Klingebiel, and Sergio L. Schmulker. ‘‘The Future of Stock Exchanges in Emerging Economies: Evolution and Prospects’’ (Brookings-Wharton Papers on Financial Services, 2002), 167–202.
Summing It Up
By getting to this point you have covered quite of bit of territory. Believe it or not, the foregoing chapters only touched the surface of all there is to know aboutthestockmarket.Still,youshouldnowbearmedwithenoughinforma-tion tounderstand whatastock price isandwhy itchanges,whatthedifferent stock price indexes are, and on which exchanges, both domestic and foreign, they trade. Now, if one only had a copy of tomorrow’s ﬁnancial pages!
An important aspect of the stock market is that it is dynamic. The treat-ment of the market’s development in Chapter Two reveals the hum of con-stantchange.Notonlyisthestockmarketabusiness—thedifferentexchanges competeforbusinessjustlikeshoecompaniescompeteforyourdollar—butit is a business on which the fortunes of many individuals and corporations depend.
The stock market promotes an efﬁcient allocation of ﬁnancial capital. Firms that are proﬁtable and well managed see their stock prices rise while those ﬁrms losing money usually see their stock prices fall. These movements in stock prices reﬂect investors’ preferences for how the two companies are managed or maybe what business they are in. So-called tech stocks did well in the 1990s because investors viewed them as the industry of the future. While this may be true, investor zeal in discovering the next Microsoft may have led some investors to lose site of the fundamentals upon which stock prices typ-ically are based. Still, we have seen the stock market rally and fall back many times in its history. The good news is that its advances have always exceeded its declines. Today the stock market, measured by the Dow Jones Industrial Index (DJIA), is many times higher than it was just a decade ago. This translates into greater wealth for stockholders, of which most citizens can be counted. Indeed, more than ever before, more citizens have some stock
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ownership. While most of us may not directly own stock in any one ﬁrm, many have indirect ownership through mutual funds. Whether through our employer’s retirement plan or through self-directed 401K plans, the ﬁnancial well- being of an increasing number of U.S. households is related to events in the stock market. Perhaps that explains why a cable channel is dedicated to covering the stock market.
The ability of the market to allocate funds to their best use is one reason why most countries, big and small, advanced and emerging, have a stock exchange. The most cogent argument for this fact is the ﬁnding of scholarly studies that having a stock market usually is associated with improved eco-nomicgrowth.Eventhoughitisdifﬁculttodisentanglethedirectionalaspects of this relation—does having a stock market lead to better economic growth or does better growth give rise to the desire to trade stocks?—the evidence suggests that not having a stock market may slow economic advancement. This is not lost on many governments of countries that traditionally have not had market-oriented economies. For instance, the newly emerging economies of Eastern Europe and China all have opened stock exchanges. Although they pale in comparison to the activity of the U.S. market, they have not been ac-tive for two centuries either.
This allocative role of the stock market also shows up by the ever-increasing variety of ﬁnancial instruments traded. Today, the market is linked to a much wider variety of instruments traded. For example, historically, the futures market dealt largely in agricultural goods, like corn and cattle, and raw materials such as copper and gold. That has changed. The futures market and the stock market are linked by contracts based on market indexes or even stocks in individual ﬁrms. This link increases the depth of the market and allows investors to spread risk. While some argued that this link was a major factor leading to the 1987 stock market crash, that notion has been dispelled by the performance since then.
The stock market is a major factor in any country’s ﬁnancial and economic health. This is why governments wish to prevent major catastrophes from occurring, like the crashes that we have covered. Following each major epi-sode in the stock market, there arose some new set of government regulations. And while these regulations are meant to curtail some untoward behavior— from insider trading to outright manipulation and fraud—the stakes are so great that some see the potential gains as outweighing the possible costs. Gov-ernment oversight and watchdog agencies, like the Securities and Exchange Commission (SEC) in the United States, exist to make ﬁnancial markets and the transactions within as transparent as possible. Reducing the asymmetric information problem that arises between buyers and sellers—between inves-tors and corporations, for example—is a key role for regulation.