EFFECT OF FINANCIAL MARKETS ON ECONOMIC GROWTH
Ukrainian-American Liberal Arts Institute «Wisconsin International University (USA) Ukraine»
Opinions differ among economists as to how much the financial markets help or hinder the economies of countries. The consensus seems to be that the effects are mostly positive, and indeed that a functional financial market is a prerequisite for less developed countries to enjoy substantial growth.1 To better understand how financial markets affect economies, we must first define what financial markets are and what this desired economic growth is.
As Kamerschen puts it, financial markets "function to collect savings and then make these funds available to those who wish to borrow money," using a variety of established standards and techniques.2 Like any market, financial markets are a virtual gathering of buyers and sellers to do exchange for mutual benefit. Specifically, they trade in money and property. As for economic growth, it is often measured by increases in total national production or, more recently, in gross national income. If more goods and services are produced than before, or more income generated by sale of those goods and services than before, economic growth has taken place. Because goods and services are kind of property and income is kind of money, a connection exists between financial markets and the economy.
You cannot make an omelette without breaking eggs; in most cases, increasing production and income will require prior investment. As Kamerschen points out, those who want to take advantage of lucrative financial opportunities and know how to do it often are not the same individuals as those who have accumulated savings. If developed financial markets do not exist, people with good business ideas have to rely on personal contacts in their local area, and often this is inadequate for utilizing the idea at full potential. On the other hand, an efficient financial market allows entrepreneurs to exploit opportunities to the maximum and to contribute to economic growth, thanks to readily available finances. Having a common market where lenders can gather makes it much easier to move resources to entities that can make the most use of them. Is it a coincidence that the most important economies in the world also have the most active stock exchanges? China is a good example, perhaps one of today's fastest growing economies, where major Euromoney Conferences are held to consider the capabilities of the Chinese financial markets. 3
So financial markets allow increasing national production. But there is also a further indirect effect. Because national production grows, new companies can spring up to take advantage of the new produce. For example, a potato farmer gets finance to be able to grow potatoes. This allows a potato chip producer to appear and generate chips. This allows a retail store to appear and sell the chips and other goods conveniently. Obviously our modern service industries would be a fair bit smaller, were it not for efficient financial markets.
Some of the specific ways in which financial markets affect economies are: 4
Improving allocation of capital; because resources are limited, they need to be used efficiently. Financial markets generally favor the most efficient business ventures, allocating more capital to them, and therefore make sure economic growth is optimized on average.
Helping to manage liquidity risks; the survival of a business may suddenly depend on being able to have cash instead of solid assets. Financial markets save many a company by providing the chance to raise and then trade financial instruments such as bonds.
Mobilizing private savings; everyone saves money, but without an adequate financial market the savings just sleep under someone's mattress. With pooled savings larger investments become possible, risk is widely shared, and people are not as constrained in case they wish to withdraw part of their savings.
Financial markets carry risk as well. While simple notes of credit and lending of pooled savings are quite boring and safe transactions, more exotic and uncertain financial functions have developed, mainly involving guesstimates of future market conditions: a lucky estimate may bring lots of easy money; a bad guess just as easily incurs hard losses. As investment professionals are increasingly pushed to make more money more quickly, riskier transactions gain popularity. The net effect may well be fractal fluctuation in the involved economies, with some risk of inhibiting their growth severely.
No doubt financial markets are a major factor in modern economies.
Economies feed themselves the money they need to grow further, and
financial markets are the silver spoons they use. A functional market
can help businesses through minor financial problems and so improves
the overall health and competitiveness of an economy. At least, as
long as the traders act responsibly, but that is a discussion for
- Growth in the Post-Bubble Economy
- Kamerschen, David R. “Money and Banking.” 9th edition.
- Euromoney conferences
- Financial Growth and Economic Development