Financial market theory of development

Last updated

Financial market theory of development is an economic theory to use private flows of capital in new stock markets to encourage domestic economic development in developing countries. The theory was put forward by the World Bank's World Development Report for 2000.

Contents

The theory states foreign investors should have access to "well-regulated" financial markets which would provide the "surest path" to economic development. Businesses in low-income countries would gain direct access to the private capital from industrialized countries. Companies in developing countries would 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. 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.

The theory has its criticisms, for example Ajit Singh, Professor Emeritus of economics at Cambridge University, states that stock market development is not an essential progression for the development of a country's financial development. He points out the post-World War II period countries of Germany, Italy, Japan, Korea and Taiwan which were able to industrialize and achieve "economic miracles with little assistance from the stock market"

Countries creating stock markets between 1960 and 2009
1960Nigeria
1961Taiwan
1964Malaysia
1966Iran
1968Jamaica
1969Ecuador, Tunisia
1974Côte d'Ivoire, Thailand
1976Jordan, Costa Rica
1977Indonesia, Paraguay
1979Bolivia
1980Fiji
1981Trinidad and Tobago
1984Saudi Arabia, Kuwait
1985Iceland
1987Bahrain, Barbados
1988Oman
1989Ghana, Mauritius, Guatemala, Yugoslavia
1990Honduras, China, Soviet Union, Malta, Swaziland, Panama, Hungary
1991Croatia, Poland, Bulgaria
1992Czechoslovakia, Ukraine, Namibia, Lithuania, Mongolia, El Salvador
1993Armenia, Latvia, Bhutan, Cyprus
1994Botswana, Uzbekistan, Nepal
1995Kyrgyz Republic, Malawi, Moldova, Zambia, Macedonia, Romania, Estonia
1996Lebanon
1997Uganda, Kazakhstan, Qatar
1998Tanzania
1999Georgia, Algeria
2000United Arab Emirates, Papua New Guinea, Azerbaijan, Vietnam, Bahamas
2002Maldives
2003Guyana
2004Iraq
2005Cape Verde
2006Suriname
2007Libya
2009Syria
In preparation as of 2009: Cambodia, Lao, Albania, Afghanistan
Source: [1]

Historical perspective

In 1950, there were 49 countries with stock exchanges, 24 were in Europe and 14 in former British colonies such as the United States, Canada and Australia. Their usefulness was seen as limited to only the wealthier countries in which they resided. Developing countries had low levels of savings and limited means to attract foreign capital; stock markets played an insignificant role in their economic growth before the 1980s. Funding for economic capital came primarily from foreign aid, state-to-state from advanced industrial countries to developing economies during the 1950s and 1960s. [2]

During the 1970s, 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 due to stagflation. In 1982, when Mexico suspended its external debt service, it marked the beginning of the debt crisis throughout the developing world; banks severely limited lending to developing nations. [3]

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 in the private sector of developing countries. The International Monetary Fund (IMF) and the World Bank spread this idea through its imposition of Structural Adjustment Programs during the 1980s [4]

The IMF and the 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). [5] These DFIs had difficulties during the 1970s economic crisis of the third world. Singh cites the World Development Report of 1989 that the poor performance of these DFIs was due to the "inefficiencies of these DFIs and the banked-based interventionist financial systems". The report arguedfor a restructuring of these systems to make them "voluntary, fiscally neutral and to being them as far as practicable under private ownership". [6] A new term was coined, "emerging markets", for third world countries which would help legitimize stock markets as a method of economic development. [7]

During the 1980s, developing countries enacted dramatic reforms to their financial systems through liberalisation to make their economies more market-oriented (financial de-repression), making capital easier to move around the world. From 1984 to 1995, global equity markets experienced an explosive growth and 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 considerably: the value of shares traded in emerging markets climbed from less than three per cent of the $1.6 trillion world total in 1985 to 17 per cent of the $9.6 trillion shares traded in all world's exchanges in 1994. [8]

As evidenced by the acommpagning table, from 1960 to about 1988, approximately one new exchange opened every year. However, in the following years, multiple exchanges opened up every year.

Stock markets of developing countries 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 Economist's 38 emerging markets increased from $3.3 billion in 1986 to $61.2 billion in 1993. This particular capital flow was different from the previous 20 years by the increasing role of foreign portfolio flow versus bank financing. These funds 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. [9]

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. Businesses in low-income countries gain direct access to the private capital from 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. [10]

Some criticism

Ajit Singh, Professor Emeritus of economics at Cambridge University, notes that stock markets are "potent symbols of capitalism but paradoxically capitalism often flourishes better without their hegemony". He states that stock market development is not an essential progression for the development of a country's financial development. He points out the post-World War II period countries of Germany, Italy, Japan, Korea and Taiwan which were able to industrialize and achieve "economic miracles with little assistance from the stock market". 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". [11]

See also

Related Research Articles

<span class="mw-page-title-main">International Finance Corporation</span> World Bank Group member financial institution

The International Finance Corporation (IFC) is an international financial institution that offers investment, advisory, and asset-management services to encourage private-sector development in less developed countries. The IFC is a member of the World Bank Group and is headquartered in Washington, D.C. in the United States.

<span class="mw-page-title-main">Capital market</span> Finance

A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. Financial regulators like Securities and Exchange Board of India (SEBI), Bank of England (BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties.

<span class="mw-page-title-main">Financial market</span> Generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

<span class="mw-page-title-main">Stock market</span> Place where stocks are traded

A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as stock that is only traded privately, such as shares of private companies which are sold to investors through equity crowdfunding platforms. Investment is usually made with an investment strategy in mind.

<span class="mw-page-title-main">Overseas Private Investment Corporation</span> Government agency of the United States of America

The Overseas Private Investment Corporation (OPIC) was the United States Government's Development finance institution until it merged with the Development Credit Authority (DCA) of the United States Agency for International Development (USAID) to form the U.S. International Development Finance Corporation (DFC). OPIC mobilized private capital to help solve critical development challenges and in doing so, advanced the foreign policy of the United States and national security objectives.

<span class="mw-page-title-main">Global financial system</span> Global framework for capital flows

The global financial system is the worldwide framework of legal agreements, institutions, and both formal and informal economic action that together facilitate international flows of financial capital for purposes of investment and trade financing. Since emerging in the late 19th century during the first modern wave of economic globalization, its evolution is marked by the establishment of central banks, multilateral treaties, and intergovernmental organizations aimed at improving the transparency, regulation, and effectiveness of international markets. In the late 1800s, world migration and communication technology facilitated unprecedented growth in international trade and investment. At the onset of World War I, trade contracted as foreign exchange markets became paralyzed by money market illiquidity. Countries sought to defend against external shocks with protectionist policies and trade virtually halted by 1933, worsening the effects of the global Great Depression until a series of reciprocal trade agreements slowly reduced tariffs worldwide. Efforts to revamp the international monetary system after World War II improved exchange rate stability, fostering record growth in global finance.

<span class="mw-page-title-main">Financial services</span> Economic service provided by the finance industry

Financial services are economic services provided by the finance industry, which together encompass a broad range of service sector firms that provide financial management, including credit unions, banks, credit-card companies, insurance companies, accountancy companies, consumer-finance companies, stock brokerages, investment funds, individual asset managers, and some government-sponsored enterprises.

<span class="mw-page-title-main">Foreign direct investment</span> Purchase of an asset

A foreign direct investment (FDI) refers to purchase of an asset in another country, such that it gives direct control to the purchaser over the asset. In other words, it is an investment in the form of a controlling ownership in a business, in real estate or in productive assets such as factories in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment or foreign indirect investment by a notion of direct control.

The main elements of Japan's financial system are much the same as those of other major industrialized nations: a commercial banking system, which accepts deposits, extends loans to businesses, and deals in foreign exchange; specialized government-owned financial institutions, which fund various sectors of the domestic economy; securities companies, which provide brokerage services, underwrite corporate and government securities, and deal in securities markets; capital markets, which offer the means to finance public and private debt and to sell residual corporate ownership; and money markets, which offer banks a source of liquidity and provide the Bank of Japan with a tool to implement monetary policy.

<span class="mw-page-title-main">Tehran Stock Exchange</span> Iranian stock exchange

The Tehran Stock Exchange (TSE) is Iran's largest stock exchange, which first opened in 1967. The TSE is based in Tehran. As of May 2012, 339 companies with a combined market capitalization of US$104.21 billion were listed on TSE. TSE, which is a founding member of the Federation of Euro-Asian Stock Exchanges, has been one of the world's best performing stock exchanges in the years 2002 through 2013. TSE is an emerging or "frontier" market.

Economic liberalization, or economic liberalisation, is the lessening of government regulations and restrictions in an economy in exchange for greater participation by private entities. In politics, the doctrine is associated with classical liberalism and neoliberalism. Liberalization in short is "the removal of controls" to encourage economic development.

The following outline is provided as an overview of and topical guide to finance:

<span class="mw-page-title-main">TA Associates</span> American private equity firm

TA Associates, founded in 1968, is one of the early modern-era private equity firms in the United States. The firm leads buyouts and minority recapitalizations of profitable growth companies. TA invests across five industry groups: technology, healthcare, consumer products, financial services and business services.

EFG Hermes Holding S.A.E. is an Egyptian financial services company present in the Middle East, North Africa, Sub-Saharan Africa, and South Asia regions and specializes in securities brokerage, asset management, investment banking, private equity and research in addition to finance lease, factoring, microfinance, Financial technology, mortgage, and insurance. EFG Hermes serves a range of clients including sovereign wealth funds, endowments, corporations, financial institutions, high-net-worth clients and individual customers. EFG Hermes is listed on the Egyptian Exchange (EGX) and London (LSE) stock exchanges. EFG Hermes has offices in Egypt, the United Arab Emirates (UAE), the Kingdom of Saudi Arabia (KSA), Pakistan, Oman, Kuwait, Jordan, Kenya, Nigeria, UK, United States and Bangladesh with over 4,500 people from 25 nationalities. They serve clients from the Middle East, North Africa, Europe and the United States. Currently, EFG Holding is listed as number 13 in Forbes' Top 50 Listed Companies in Egypt 2023.

<span class="mw-page-title-main">Development finance institution</span> Banking company that provides risk capital for economic development projects

Development financial institution (DFI), also known as a Development bank, is a financial institution that provides risk capital for economic development projects on a non-commercial basis.

Cultural economics is the branch of economics that studies the relation of culture to economic outcomes. Here, 'culture' is defined by shared beliefs and preferences of respective groups. Programmatic issues include whether and how much culture matters as to economic outcomes and what its relation is to institutions. As a growing field in behavioral economics, the role of culture in economic behavior is increasingly being demonstrated to cause significant differentials in decision-making and the management and valuation of assets.

A Stock exchange is a corporation or mutual organization which provides facilities for stockbrokers and traders to trade stocks and other securities. It may be a physical trading room where the traders gather, or a formalised communications network. Creation of a stock exchange is a strategy of economic development: it provides a means of raising capital for investment. Stock markets may enhance economic activity through the creation of liquidity: a liquid equity market makes investment more attractive because it allows individuals to acquire equity and when required to sell it quickly and cheaply. At the same time, companies enjoy permanent access to capital raised through equity issues. It has been found that countries that open stock markets grow faster, on average, than the control groups.

The East Asian model, pioneered by Japan, is a plan for economic growth whereby the government invests in certain sectors of the economy in order to stimulate the growth of specific industries in the private sector. It generally refers to the model of development pursued in East Asian economies such as Japan, South Korea and Taiwan. It has also been used by some to describe the contemporary economic system in Mainland China after Deng Xiaoping's economic reforms during the late 1970s and the current economic system of Vietnam after its Đổi Mới policy was implemented in 1986.

Impact investing refers to investments "made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return". At its core, impact investing is about an alignment of an investor's beliefs and values with the allocation of capital to address social and/or environmental issues.

Financial integration is a phenomenon in which financial markets in neighboring, regional and/or global economies are closely linked together. Various forms of actual financial integration include: Information sharing among financial institutions; sharing of best practices among financial institutions; sharing of cutting edge technologies among financial institutions; firms borrow and raise funds directly in the international capital markets; investors directly invest in the international capital markets; newly engineered financial products are domestically innovated and originated then sold and bought in the international capital markets; rapid adaption/copycat of newly engineered financial products among financial institutions in different economies; cross-border capital flows; and foreign participation in the domestic financial markets.

References

  1. ↑ Weber, Davis and Lounsbury, p. 1320
  2. ↑ Weber, Davis and Lounsbury, p. 1321
  3. ↑ Weber, Davis and Lounsbury, p. 1322
  4. ↑ Weber, Davis and Lounsbury, p. 1322
  5. ↑ Singh, 2, 1993
  6. ↑ Singh, 2, 1993
  7. ↑ Weber, Davis and Lounsbury, p. 1322
  8. ↑ Mohtadi and Agarwal, 2001
  9. ↑ Singh, p. 772, 1993
  10. ↑ Weber, Davis and Lounsbury, p. 1322)
  11. ↑ Singh, p. 780, 1997

Works cited

Further reading

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.