Bernard and Austin (2012) argue that traditional theorists believed that financial market in general has no correlation with economic growth, this proposition aroused studies on finding the effect of financial market on growth. Ample of studies have conducted on the traditionalists and established association between stock market and economic growth. In developing economy like Bangladesh and Nigeria, the development and growth of stock markets have been widespread in recent times. Despite the size and illiquid nature of stock market, its continued existence and development could have important implications for economic activity. For instance, Pardy (1992) has argued that in less developed countries capital market are able to allocate funds mora efficiently. For that reason, stock market can play a role in inducing economic growth in less developed country like Bangladesh, Nigeria, Ghana by channeling investment where it is needed from public. The economic development and growth are increased by mobilization of such resources to various sector. Stock market development has presumed a development role in economics and finance because of their impact they have applied in corporate finance and economic activity.
Recent theoretical studies have already conducted that the first step to connect the financial market and the rate of economic growth; it intends that higher per capita income may affect many sections of the economy and stock market performance (Masoud, 2013). Gurley and Shaw (1955, 1960, 1967) argued that financial improvement is a positive function of real income and wealth. This study supports the quantitative work of Goldsmith (1969), who invented that, in most of the 35 countries investigated both developed and developing, the ratio of financial organization to GDP tends to increase with supported by more recent evidence from the World Bank (1989). Much of the research within empirical studies conducts that finance is strongly associated with economic growth rate.
Stock Exchanges and Economic Development
Overview of Modern-Day Stock Market
A stock exchange is an organized market place, recognized by a relevant regulatory body, where companies are listed and traded financial securities such as stocks (share) listing of companies at first indicates ‘primary market’ where a portion of company’s shares are made available to the public. The company often exercises the listing to accumulate funds through issuing new equity shares (an initial public offering). Investors can buy and sell easily these listed shares in the so-called ‘secondary market’ while listing in the primary market may result in a flow of funds from investors to the firm, the transaction between investors in the secondary market does not. The activity in both the primary and secondary market operates within a framework of laws, rules and regulation, aimed at ensuring the existence of fair, transparent and orderly markets. Stock exchanges are supervised by a securities market regulator, different jurisdictions have different models of who is responsible for what elements of market regulation. There are many requirements taken by regulatory body such as the listings requirement, the membership requirement, the trading rules, the process for clearing and settlement of transactions etc. to stipulate markets (UNCTAD, 2015).
A Review of Academic Literature
It is one of the most contentious issues in economics that the stock market whether is able to serve as a key indicator for the future economic growth and vice versa (Choong et al., 2003; Mun et al., 2008). Many believe that future economic growth or recession respectively could be changed due to increasing or decreasing in stock prices significantly (Mun et al., 2008). A significant number of studies have been carried out so far on the issue relationship between stock markets and economic growth, and “there is no clear-cut solution in which policy-makers could rely upon” (Choong et al., 2003). “Results of the studies on the issue can be summarized as followings: 1) there exists both long-term and short-term relationships between stock markets and economic growth; 2) there exists only a long-term relationship between stock markets and economic growth; 3) there only exists only a short-term relationship between stock markets and economic growth; 4) there exists bi-directional causality between stock markets and economic growth; 5) there exists only unidirectional causality between stock markets and economic growth, i.e., stocks markets cause economic growth or economic growth causes stock market growth; 6) there exists no directional causality at all between stock markets and economic growth. Therefore, findings of the study failed to suggest homogeneous results. The fundamental reason behind the diverse results is due to the factor that different research has been carried out on different countries ‘economic growth and stock markets. i.e., every country’s economic policy and stock market characteristics are unlike others” (Hossain, 2013).
“Levine and Zervous (1996) carried out a study based on data of 24 countries where they found that a strong positive correlation exists between stock market development and economic growth. Later they conducted another expanded study (1996) on 49 countries for the period of 1976-1993 where they used several variables such as the stock market liquidity, economic growth rate, and capital accumulating rate and output growth to ascertain correlation among them. They found that all the variables were positively correlated with each other. The same authors (1998) argued that both stock market and banks have an impact on economic growth” (Levine and Zervous, 1996, 1998).
Stock Exchanges and the Real Economy
In 2016, there were approximately 50,000 companies listed on 81 exchange groups around the world, the combined market capitalization of these companies was nearly $70 trillion, while many people think of stocks markets as representing large companies, the companies listed in these markets (which in many instances include dedicated markets for small and medium size companies) range in size from a market capitalization of less than $1 million to well over $100 billion (Economic, 2016). The author argues that the companies enlisted in stock market come from all economic sectors: services, manufacturing, mining, and information technology. They earn revenues that buy goods and services from other companies, pay salaries, pay taxes and return dividends to shareholders. They are also important employers: WFE calculations suggest that the 24000 companies across just 26 of the WFE’s equity market exchanges employee over 127 million people.
Role and Function of a Stock Market
This is the section based on theoretical overview in the previous study by describing how modern stock exchanges may contribute to economic development (SSE, 2015). Basically, the ability of entrepreneurs is increased by exchanging as well as establishing corporations with expansion plans (SSE, 2015). The same authors argue that the saving of domestic investors who are looking for investment growth is used as the source of funds, stocks markets are able to perform this ‘saving mobilization’ function for a number of reasons like: investment horizon, transparency, pooling funds, investor protection etc.
Stock markets provides investment opportunities to investors by accessing trading securities, by which stock markets enable investors (through diversification) to reduce their risk of income volatility by diversifying their investment portfolios.
Financial Stock Market’s Impact on the Economic Growth: Theoretical and Empirical Overview
Levine (1990) argued a positive relationship between financial stock market and economic growth by issuing new financial resources to the organizations. Filer et al. (1999) examined stock market-growth nexus and exhibited positive casual correlation resources to the firms. In early stages of development, financial intermediation induced economic growth (Spears, 1991). The financial stock markets make economic growth indirectly, facilitates higher investments and the allocation of capital. Sometimes investors investing directly to the firm because they cannot easily withdraw their money, rather they can buy and sell stocks quickly with more independence. Levine and Zervous (1998) investigated stocks market development associated with different magnitude and have recommended that strong statistically significant relationship between initial stock market development and subsequent economic growth. “An efficient stock market contributes to attract more investment by financing productive projects that to economic growth, mobilize domestic savings, allocate capital proficiency, reduce risk by diversifying, and facilitate exchange of goods and services” (Mishkin, 2001). Further, Levine and Zervous (1999) discovered strong statistically significant positive relationship between stock market development and economic growth. “The result of Filer et al.’s (1999) studies show that there is positive causal correlation between stock market development and economic activity”. Finally, we can conclude that the stock market development and economic growth of a country strongly positively correlated to each other. The stock market plays a very important role in the development of an economy.
Discussion and Conclusion
As a conclusion, we can be summarized that the role and significance of a stock market for the betterment of a country’s economy can never be ignored. It plays a role of nexus between individual investors and the corporations. Stock markets ensures the availability of funds for a corporation by which mobilization of savings is possible. As a result, it is able to add extra benefits to economy of a country by producing goods and offering employment opportunities. Evidence collected from theoretical and empirical studies, the stock market has played an important role within both the advanced economy and the emerging market, more specifically, this study argues that the connection between economic variables with growth and stock market. Finally, we can say that the findings of this study contribute toward a better understanding of stock market development related to economic growth.