The Connection Between the Capital Market and Development

Abstract

Casual observation suggests that an efficient financial system is one of the salient prerequisites promoting a country#x2019;s effective development and competitiveness, or as in the case of financial system distortions, a major impediment.¹²¹ Among the components advancing a country#x2019;s welfare, capital allocation, intertemporal smoothening, and risk sharing are continuously cited.¹²² Conversely, market losses at major stock exchanges at the beginning of the new millennium demonstrated the potentially volatile impacts of financial systems on development and challenged economic policies on national and international levels. Several diverging theoretical concepts and empirical studies have investigated whether a nexus between finance and economic growth or finance and economic development actually does exist. Yet, the main focus of research has been to analyse the impact of the finance sector on growth or on economic development, and in particular, the role of banks and stock markets therein.¹²³ Other aspects, albeit they could be considered important for an overarching development point of view, have been only partially included, among them the versatile reciprocal relationship of finance and development and a capital market perspective covering both stock and bond markets.¹²⁴ The main obstacle to constructing a comprehensive model of the finance-growth or finance-development linkage consists of the complex causalities between finance and economic activity, not to mention the broader scope of developmental approaches that integrate social and environmental dimensions.

See, for instance, Jordi Canals (2003), pp. 66–67 and The World Bank (2001), p. 1.

See, for instance, Franklin Allen and Douglas Gale (2001), pp. 3–4.

See, for instance, the publications of Philip Arestis, Panicos O. Demetriades, and Kul B. Luintel (2001), Raymond Atje and Boyan Jovanovic ( 1993), Thorsten Beck and Ross Levine (2002a), Richard D. F. Harris (1997), Ross Levine (1998), Ross Levine and Sara Zervos (1998), and Paolo Mauro (2003).

In respect thereof, it needs to be taken into account that data for equity markets and banks is, in contrast to bond market data, comparatively easily accessible. (Cf. Herring, Richard J. / Chatusripitak, Nathpom (2000), p. 2.) Nonetheless, some economists have been specifically analysing the bond market impact on economic development, as, for example, Gerhard Fink, Peter Haiss, and Sirma Hristoforova (2003), Nils H. Hakansson (1999), Richard J. Herring and Nathpom Chatusripitak (2000), and George Athanassakos and Peter Carayannopoulos (2001). See also Campbell Rüssel Harvey (1989) for a study covering stock and bond markets. An overview of studies covering debt securities is provided by Gerhard Fink, Peter Haiss, and Sirma Hristoforova (2003), pp. 13–16.