In the world’s developed economies, there’s a positive feedback loop between stock markets and the real economy, but that relationship doesn’t necessarily hold in emerging markets, new research has found.
In a paper released Monday, the World Federation of Exchanges (WFE), the global industry trade group for securities exchanges and market infrastructure, examined the link between stock markets and economic growth.
Among other things, the study — which looked at data in 36 countries from 2003–2022 — found that there’s a two-way relationship between economic growth and stock market capitalization in high-income countries. But while rising market capitalization boosts economic growth in developing markets, higher growth doesn’t necessarily feed through to equities.
Instead, in low- and middle-income countries, the study found that there’s a “unidirectional relationship” between stock markets and economic growth — while higher market caps are associated with stronger short-term growth in these countries, economic growth doesn’t necessarily boost stock markets.
Structural differences between developed and emerging economies, such as lower savings rates and lesser investment capacity in emerging markets, “inhibits the feedback loop from economic growth to stock market development,” the WFE said.
“Limited investment capacity reduces businesses’ ability and appetite to expand. In these environments, the lack of investor participation and limited business growth may inhibit the ability of economic growth to foster stock market development, and in turn, economic output,” said Dr Pedro Gurrola-Perez, head of research at the WFE, in a release Monday.
“Policymakers, particularly in low- and middle-income countries, should therefore focus on strengthening their stock markets to harness these growth benefits and support sustainable economic development,” he added.
Similarly, the WFE argued that policymakers in high-income countries should also seek to support healthy stock markets to preserve the positive feedback loop between their economies and financial markets.
“A growing stock exchange means a growing economy,” said Nandini Sukumar, CEO of the WFE, in the release.
“Policymakers must take heed of these findings and better tailor financial regulations and economic strategies to maximize the benefits stock markets bring.”