Investor Protection, Equity Markets and Economic Growth in Emerging Economies: A Study of the Bullish Period between 2003 and 2007

Abstract

Emerging markets are increasingly coming to the centre of attention in global economic issues as emerging stock markets and economies have seen impressive growth in the last 20 years. The relation between financial markets and economic growth has been object of extensive research and, more recently, the relation between investor protection, legal origins and financial development has been empirically proven, although these studies do not specifically compare emerging to developed countries. Although many studies were dedicated to explore investor protection, economic growth and financial markets, the comparison between emerging and developed economies (particularly in the more recent context of emerging growth) are not common in these works. This study intends to analyze the relation between equity markets development and growth and economic growth, comparing emerging and developed economies in the period between 2003 and 2007, in a sample of 72 emerging countries and 30 developed economies. Furthermore, what is called here the ‘moderating effect’ of investor protection on the relation between finance and economic growth (acting not only as a catalyst of stock market growth but as a catalyst of its positive contagion in the economy) is an innovative idea of this work that hasn’t been explored before. The methodology used is multivariate regression analysis using the measures of stock market depth and growth as explanatory and real GDP growth as dependent variable, controlling for several other variables. Empirical results lead us to believe that while in developed and more sophisticated economies the level of stock markets development can indeed improve the smart allocation of resources in society and thus contribute to economic growth, in emerging economies this is not true, although market cap growth goes side by side with economic growth even in these markets. If we observe that emerging markets had an average market cap/GDP of 50% in the period while developed economies had an average of 107.8%, it is possible that a maturity period is necessary until an economy reaches a certain level of market cap development so it can effectively contribute to growth. In addition, there is encouraging evidence of the ‘moderating effect’ idea, given that in low protection countries the relation between finance and growth was not significant, whereas in high protection countries it was, even when controlling for a minimum market cap/GDP level. The fact that market cap growth was a significant explanatory variable for economic growth regardless the level of investor protection is a further indication that in a first period of development economic growth is the leading factor, whereas after a certain level of institutional and financial development stock market capitalization can indeed spur growth and it plays this role more efficiently in countries with higher level of investor protection.