Educational Institute
Research Objective
The objective is to determine and examine the role of the stock market in economic development. This research would analyze data gathered and demonstrate the significance of stock markets in the development of economies. Insights would be gathered on what factors can support the notion that the stock market is an indicator of economic health and a guidepost for a better understanding of economies.
Literature Review
Kelly, 2010
The article is a direct expository address to the relation between the stock market and the economy. It focuses on the conceptual aspects rather than on the data and analysis and as such, is a good material to complement more rigorous material. The significance of rising and falling prices is discussed to explain the state of the stock market and the economy. The link between the stock market and the economy is succinctly explained and provides the thesis for this paper. The factor of money supply is then discussed as how it affects the movement of the stock market and the economy.
Levine, 1996
Levine had observed that a boom of the stock market in developing countries had been triggered by investors keen on new markets and these had positively contributed to economic benefits. He collected data within the period of 1976 to 1993 from 38 countries with varying levels of development. The study sought to establish a link between stock market liquidity and economic growth by comparing the data and identifying correlations. Banking as an alternative indicator of growth was also examined as well as the link between stock market liquidity and investments. Finally, Levine posed possibilities for policy makers on actions to spur economic growth.
Ake Boubakari, 2010
The causal relationship between stock market and economic growth is examined in 5 European countries who are in the Euronext exchange (Belgium, France, Portugal, Netherlands and United Kingdom) in the years from 1995 to 2008. The Euronext was formed from the merger of the Amsterdam Stock Exchange, Paris Bourse and Brussels Stock Exchange in 2000.
Tests were made considering market capitalization, total trade value, turnover ratio and economic growth. The main question being posed is whether the Euronext affects the economies of the participating countries. Boubakari determined a positive correlation for the countries which have a highly liquid and active stock market.
Levine and Servos, 1998
The state of banking has traditionally been the indicator for economic growth. The authors are making the case that the stock market is as strong an indicator for economic growth as banking is. Liquidity is also being highlighted as a major factor.
The paper investigates two sets of factors from both the stock market and the economy that will hopefully show linkages. 47 countries were studied from 1976 to 1993 to provide the empirical evidence that had been lacking for so long. This study also extends the findings of another study which suggests links of the stock market to banking as well.
Wang, 2013
The Chinese economy had risen from the ashes of Communism and it is a compelling study on how its stock market developed vis-à-vis its economy. The market was established only in the 1990’s when privatization began. The study investigates data gathered from 1996 to 2011 and has proven to be an exceptional case where the correlation is negative due to the nature of China’s stock market as being administratively-driven. The focus of this essay is on the nature of the effect of government intervention that gave the exceptional negative effect to the China market which can be replicated in other stock markets.
Research Philosophy, Approach and Strategy
Philosophy
The study of the stock market and the economy wholly lend themselves to a positivist philosophy in research wherein knowledge can only come from quantifiable economic data. The objects are the performances of the stock market and economy whose observations are completely unaffected by the activities of researchers. Subjective feelings and perceptions are out of the picture entirely which is the domain of phenomenology. In terms of treatment, the study of finances and economics is as much an objective science as that of the physical sciences. Data comes only measurements of financial quantities and their derivatives. Analysis can then produce logical relationships whose intensity are measured oftentimes by statistical methods. (Saunders et. al. 2009)
Approach
The research objective of determining the relationship of the stock market and the economy is ideal for the deductive approach which consists of the steps of hypothesis, measurement, testing and confirmation or rejection. The hypothesis is: The stock market has a significant role in economic development wherein it acts as a positive indicator. For measurement, we can choose certain aspects of the stock market and the economy and see how they react to one another. For example, data on market capitalization of the stock market and the GDP of a country can be analyzed for a period of several years and see if there are patterns.
Strategy
The data required would come from the collection, collation and summary from a vast amounts on a nation-wide scale as in the economy or even regional as in the case of the Euronext stock exchange. The access to such magnitude of data can only be achieved through archival research which will make use of the research efforts of others who may be working on other research objectives. The primary source would be the official statistical reports of countries and the regulatory commissions of stock markets. Secondary sources would be the research reports citing the original sources.
Ethical Implications
The research topic involves large impersonal entities in stock markets and ecomonies and would not allude to individuals or target groups. It would be safe to say that there are no ethical implications in terms of offending a country or organization in terms of possible conclusions. Even a negative confirmation would not necessarily shed a negative light on a country or a stock market (as in the case of China) unless one would attribute the negative correlation on the general capabilities of the population. One possible area of misconduct is in the use of references to studies without acknowledgement as these studies had been done with great and exacting effort.
Purpose and Design of Questionnaire
Five small stock markets and their host countries were selected because small markets show more volatility to economic changes (Desjardins 2016). Changes after a 10 year period (2000 to 2010) were tracked for the following economic quantities of five countries and their respective stock exhanges to analyze the movement of the stock market in relation to the economy: market capitalization, GDP, population, government debt and currency exchange. Market capitalization is the product of the sums of stock prices and their outstanding shares and represents the monetary value of the exchange. GDP is the single best indicator for the health of the economy showing that people have the means to purchase products and services that are being produced.
The other factors are major considerations that can affect the performance of the stock market. They can show if stock performance can be an indicator for the overall health of the economy. Population affects employment, income per capita and overall quality of life in the country. A high income per capita shows that people can have disposable income that be invested in the stock market. The currency exchange rate is an indication for inflation which can reduce the GDP eventually by inhibiting people to spend. A weakening can discourage investors to the stock market. Government debt correlates with external debt and reflects the government’s ability to generate income. Too large a deficit may mean inability of many private firms to pay taxes which is a bad sign for sustainability and can erode investor confidence. A composite index was created to represent the other factors other than the GDP and market capitalization. These three values then can be analyzed for their relations.
The qualitative question is aimed to get an overall impression on the state of the economy considering all economic factors.
Data Analysis and Interpretation
Quantitative Analysis
The following graphs can be referred to in the discussion.
Figure 1 - Changes in Stock Market and Economy from 2000 to 2010
Figure 1 - Changes in Economic Factors 2000 to 2010
Indonesia is a prime example of a stock market that has responded very well to the economic growth. The GDP only multiplied four fold over the 10 year period but the market capitalization increased by 13 times (TheGlobalEconomy.com 2016). This was complemented most impressively by a reduction of government debt by almost three fourths (index mundi 2016) which is a clear indication of revenues from taxes from new companies and growing incomes of people.
Malaysia also showed a positive correlation wherin the market capitalization grew 3 times with a corresponding growth in the GDP of two times. This is still a good example for positive linkage as Malaysia had to grapple with an 21% increase in population, an 10% weakening of its currency and 40% increase in government debt. The increase in market capitalization to GDP ratio is commendable and the other economic factors are unremarkable and can be manageable.
Greece’s stock market shrunk by 33% in spite of a its GDP more than doubling over the 10 year period. It had been suffering from a reputation of poor debt structure, narrow foreign revenues limited to tourism and an economy half of which is made up of the government. It fared well in population control and in currency which strengthened by 30%. Malaysia had a bigger increase in government debt so the Greek exchange should had performed just as well.
Nigeria is the smallest economy in the sample but has a large population of more than 150 million people. This is a negative fundamental which can discourage investors who will think that there are too many impoverished people. This was aggravated by an alarming increase in population of 30%. This is in spite of an impressive growth in the GDO of seven tiimes over 10 years and equally impressive reduction in government debt of 85%. Having a small economy with a large population is a hindrance in growing a stock exchange which can attract foreign investors.
It can be said that Colombia’s stock market performed as well as Indonesia wherein its increase in market capitalization is more than three times the increase in the GDP. It has controlled its population and had a favorable foreign trade which resulted in a stronger currency. Export generating firms must be the driver in the stock maket performance overshadowing the large increase in government debt. This can be taken as positive if there were investments in infrastructure which can drive further growth.
Qualitative Analysis
The general impressions on the economy can shed further light on the interprations of the quantitative data. Indonesia was able to leverage on its resilience during the 2008 financial crisis which gave it a robust image by 2010. Its dmeststic troubles had also simmered down. Malaysia had a strong economy which only got better after 10 years earning it a ranking. Greece had too many issues like unemployment, the Olympics shortfall, prevalent tax evasion that discouraged investment. Its national debt eventually passed its annual GDP. It was found out that Nigeria was also suffering from poor government. Colombia still showed a positive growth in spite of the 2008 financial crisis and was poised for growth like Indonesia.
Reliability and Validity
The choice of small stock markets uncovered several factors which can contradict the assumed positive link between the stock markert and the economy. GDP can not be just the only indicator for the economy as investors would also be looking for other fundamentals. This also suggests that the choice of economic indicators in this study may still be enhanced to me more comprehensive.
Out of the five countries, Nigeria disappointed in its stock market performance but we realized that market size is an issue. Greece had a negative correlation due to structural issues. One value we realized for examining the stock market is that there is a valid expectation for it to reflect economic performance but if it does not, it compels further aanlysis on other factors which contributes to better understanding of the country’s economy. With this caveats in mind, this research can proceed with reliability and validity.
References
Boubakari, A. & Jin, D. The Role of Stock Market Development in Economic Growth: Evidence from Some Euronext Countries. International Journal of Financial Research, Vol. 1, No. 1; December 2010. [Online] Available at: <http://www.sciedu.ca/journal/index.php/ijfr/article/view/70> [Accessed 3 Jan. 2017].
Desjardins, J., 2016. All of the World’s Stock Exchanges by Size. The Money Project. [Online] Available at: <http://money.visualcapitalist.com/all-of-the-worlds-stock-exchanges-by-size/> [Accessed 3 Jan. 2017].
index mundi, 2016. Indonesia Public debt. [Online] (updated 4 Feb. 2010) Available at: <http://www.indexmundi.com/indonesia/public_debt.html> [Accessed 3 Jan. 2017].
Kelly, K., 2010. How the Stock Market and Economy Really Work. Mises Daily Articles, 09/01/2010. [Online] Available at: <https://mises.org/library/how-stock-market-and-economy-really-work> [Accessed 3 Jan. 2017].
Levine, R., 1996. Stock Markets: A Spur to Economic Growth. Finance & Development, March 1996. [Online]. (updated Mar. 1996) Available at: <http://www.imf.org/external/pubs/ft/fandd/1996/03/pdf/levine.pdf> [Accessed 3 Jan. 2017].
Levine, R. & Zervos, S., 1998. Stock Markets, Banks, and Economic Growth. The American Economic Review, Vol. 88, No. 3. (Jun., 1998), pp. 537-558. [Online] Available at: <http://www.isid.ac.in/~tridip/Teaching/DevEco/Readings/07Finance/06Levine%26Zervos-AER1998.pdf> [Accessed 3 Jan. 2017].
Saunders, M., Lewis, P. & Thornhill, A., 2009. Research Methods for Business Students, Fifth edition. Essex, England: Pearson Education Limited.
TheGlobalEconomy.com., 2016. Indonesia: Stock market capitalization, in dollars. [Online] Available at: <http://www.theglobaleconomy.com/Indonesia/stock_market_capitalization_dollars/> [Accessed 3 Jan. 2017].
Wang, B. & Ajit, D., 2013. Stock Market and Economic Growth in China. Economics Bulletin, Volume 33 (2013): Issue (1). [Online] Available at: <https://ideas.repec.org/a/ebl/ecbull/eb-12-00940.html> [Accessed 3 Jan. 2017].
Appendix 1 - Questionaire
Quantitative
What was the market capitalization for the year 2000 and 2010?
What was the GDP for the year 2000 and 2010?
What was the currency exchange with the USD for the year 2000 and 2010?
What was the population for the year 2000 and 2010?
Qualitative
Had there been an improvement in the economy from 2000 to 2010?
Appendix 2 – Stock Market and Economic Data
