Stock Market Development And Economic Growth In Nigeria Economics Essay

Stock market development has an key role to play in economic development. Shahbaz, et al(2008) argue that stock market development is an important wheel for economic growth as there is a long-run relationship between stock market development and economic growth. Stock market development has the straight impact in corporate finance and economic development.

  Gerald (2006) states that stock market development is essential because financial intermediation supports the investment process by mobilizing household and foreign savings for investment by firms. It ensures that these finances are allocated to the most productive use and spreading risk and providing liquidity so that firms can operate the new capacity efficiently. A growing body of literature has confirmed the importance of financial system to economic growth.

Financial markets, especially stock markets, have grown significantly in developed and developing countries over the last two decades. Claessens, et al (2004) states that several factors have aided in their growth, importantly improved macroeconomic fundamentals, such as more monetary stability and higher economic growth. Specific capital markets reforms, such as privatization of state-owned enterprises, financial liberalization, and an improved institutional framework for investors, have further encouraged capital markets development.

Similarly Mishkin (2001) affirm that a well-developed financial system promotes investment by identifying and financing lucrative business opportunities, mobilizing savings, allocating resources efficiently, helping spread risks and facilitating the exchange of goods and services. From the view point of Sharpe, et al (1999), stock market is a process through which the transaction of financial assets with life span of greater than one year takes place. Financial assets may take diverse forms ranging from the long-term government bonds to ordinary shares of various companies.

Stock market is a very vital constituent of capital market where the shares of various firms are traded Trading of the shares may take place in two different forms of stock market. When the issuing firm sells its shares to the investors, the transaction is said to have taken place in the primary market but when already issued shares of firms are transferred/traded among investors the transaction is said to have taken place in the secondary market. Stock markets are very important because they play a major role in the economy by channeling investment where it is needed and can be put to best (Liberman and Fergusson, 1998). The stock market is working as the conduit through which the public savings are channelized to industrial and business enterprises.

Mobilization of such resources for investment is certainly a needed condition for economic take off, but quality of their allocation to various investment projects is an important factor for growth. This is precisely what an efficient stock market does to the economy (Berthelemy and Varoudakis, 1996).

 Earlier research focus on the role of the banking sector in the economic growth of nation. In the past decade, the world stock markets surged, and emerging markets accounted for a large amount of this boom (Demirguc-Kunt and Levine (1996a).  Recent research has begun to focus on the linkages between the stock markets and economic development. New theoretical work shows how stock market development might improve long-run economic growth and new empirical evidence supports this view. Demirguc-Kunt and Levine (1996a), Singh (1997), and Levine and Zervos (1998) find that stock market development is playing an important role in predicting future economic growth. In underdeveloped nation like Nigeria the development and growth of stock markets have been widespread in recent times. Despite the size and illiquid nature of stock market, its continued existence and development could have important implications for economic activity.

For instance, Pardy (1992) has noted that even in less developed countries capital markets are able to mobilize domestic savings and able to allocate funds more efficiently. Thus stock markets can play a role in inducing economic growth in less developed country like Nigeria by channeling investment where it needed from public.  Mobilization of such resources to various sectors certainly helps in economic development and growth. Stock market development has assumed a developmental role in global economics and finance because of their impact they have exerted in corporate finance and economic activity. The role of financial system is considered to be the key to economic growth (Neupane, et. al. 2006).

Paudel (2005) states that stock markets, due to their liquidity, enable firms to acquire much needed capital quickly, hence facilitating capital allocation, investment and growth. Stock market activity is thus rapidly playing an important role in helping to determine the level of economic activities in most economies.

Tuladhar (1996) states that financial markets are catalyst in the development of economy. The study further added that developed economies have highly sophisticated financial institutions. Over the past decade, many developing economies have established capital markets as they moved towards more liberal economic policies. These emerging markets have shown extraordinary growth with very high volatility, which have attracted many investors into these markets. This study will attempt to dig out the empirical evidence in the context of underdeveloped nations regarding the role of stock market development on economic growth.

1.2. Statement of the Problem

 In the last two decades, the link between financial intermediation and economic growth is a subject of high interest among academics, policy makers and economists around the world. There have been attempts to empirically assess the role of stock market and economic growth. The link between stock market and growth has varied in methods and results. There exists two controversies in the predictions.

Adjasi and Biekpe (2005) found a significant positive impact of stock market development on economic growth in countries classified as upper middle-income economies. In the same way, Chen et al (2004) elaborated that the nexus between stock returns and output growth and the rate of stock returns is a leading indicator of output growth Arestic et al. (2001) using time-series on five industrialized countries also indicate that stock markets play a role in growth. Various studies such as Spears, (1991); Levine and Zervos, (1998); Atje and Jovanovic, (1993); Comincioli, (1996); Levine and Zervos, (1998); Filer et al, (1999); Tuncer and Alovsat, (2001). Levine and Zervos (1995) and, Demirguc-Kunt (1994) has supported the view .stock markets promote economic growth..With well-functional financial sector or banking sector, stock markets can give a big boost to economic development (Rousseau & Wachtel, 2000; Beck & Levine, 2003). Bahadur and Neupane (2006) concluded that stock markets fluctuations predicted the future growth of an economy and causality is found in real variables.

There are also alternate views about the role stock markets play in economic growth. Apart from the view that stock markets may be having no real effect on growth, there are theoretical constructs that show that stock market development may actually hurt economic growth. For instance, Stiglitz (1985, 1994), Shleifer and Vishny (1986), Bencivenga and Smith (1991) and Bhide (1993) note that stock markets can actually harm economic growth. They argue that due to their liquidity, stock markets may hurt growth since savings rates may reduce due to externalities in capital accumulation. Diffuse ownership may also negatively affect corporate governance and invariably the performance of listed firms, thus impeding the growth of stock markets.

Despite of alternative views empirical works continue to show largely some degree of positive relationship between stock markets and growth. These studies largely based on developed countries only. Only few studies have been conducted in context of Nigeria stock market, and those conducted studies do not show clear conclusion regarding its impact on economy. Yadhav (2002) finds that firms with higher investment have higher saving and higher capital formation. Though his study may be significant in other cases it is of less significance here. Similarly Wagle (2002) also carried out the study on trends of saving, investment, and capital formation in Nepal, but his study fails to provide any specific link between saving, investment and capital formation with stock market development. Similarly Sindhurakar (2004) has carried out the study on relationship between the stock market and economic growth without analyzing the econometric models.

The study specifically deals with the following issues:

1. What is the relationship between the Gross Domestic Product (GDP) and government investment, government expenses, foreign aid, savings, and foreign direct investment

2. Is there any relationship between the market capitalization and Gross Domestic Product (GDP)?

3. What is the impact of concentration ratio on economic growth of a nation?

4. What is the significance of liquidity on economic growth? What is its impact in capital market?

5. Is there any co-integration between the stock development index and economic growth?

6. Is there any Granger causality between the stock development and economic growth?

7. Is the Levine and Zerovos model valid in underdeveloped nation like Nigeria?

8. Can the small group of investors manipulate a Nigeria capital market easily?

9. How can the government able to develop the stock market in coming days?

One group of study argues that stock market does not help in economic development of a nation while the other group argues that it helps in economic development. However, empirical investigations of the link between financial development in general and stock markets and growth in particular have been relatively limited. Various empirical researches have suggested a possible connection between stock market development and economic growth, but are far from definitive.

1.3. Objective of the Study

 The main objective of this study is to examine the impact of stock market development in the economic development and growth of the nation in context to Nigeria. The specific objectives of the study are as follows.

1. To conduct the empirical analysis of stock market by investigating the link between stock markets and economic growth.

2. To further analyze the link based on set of different variables of economic indicators and stock market indicators.

3. To examine the importance of liquidity for the economic growth.

4. To analyze the impact of firm concentration ratio on economic growth.

5. To examine the validity of model of Levine and Zervo’s study on stock market in developing nation like Nigeria.

6. To determine and analyze the co-integration and causality between the stock market development index and economic growth.

The objective of this research is to examine the impact of stock market development in the economic development and growth of the nation in context to Nigeria. The research is organized on the following lines. The second chapter will be concerns with review of important empirical works, concerning stock market development and economic growth starting from 1873 to 2008,while the third chapter analysis of relationship between the stock market development and economic growth descriptive, co-relational and time series research design will be employed, the fourth chapter outlines the modeling methodology employed for the study and reports the results, fourth and final section presents some conclusion with policy implications.