Chart of the Day: Financial Development & Economic Growth

July 8, 2015 0 Comments

There may have been a few gripes about my comments on the Greek financial sector and economic growth. I was discussing how a ‘Grexit’ would take away the ability of Greece banks to have access to the ‘lender-of-last-resort.’ This would give the financial sector access of less liquidity, which means less financial sector growth, which is bad for economic growth.

Most people who are against financial integration in the economy (anti-wall streeters) object to the idea of the need for a financial sector, and how it is dependent upon economic growth and overall living standards.

There is no shortage of politicians, pundits and activist regurgitating anti-financial rethoric. We’ve heard things about the financial sector (mostly Wall Street) being a drag on the nation, creating a disconnect from main street and possessing corrosive crushing power that cripples the economy.

None of these claims provide a complete picture of financial development and its role in economic growth. I’ve already cited the numerous studies that have concluded growth in equity markets are greatly correlated with economic development. In addition to this, a report conducted by Citigroup, Public Wealth of Nations, also mentions the relationship between equity markets and economic living standards.

Naturally, the section in the report confirms what I’ve already known: financial development tends to be associated with economic growth.

Citigroup illustrates this by plotting 53 of the largest wealth economies (in terms of GDP per capita) against their equitization (stock-market capitalization relative to GDP). Market Cap/GDP is located on the X-axis, while GDP per capita is located on the Y-Axis.

The scattered plot chart shows nations with a greater amount of equity development and economic development will be plotted further up and to the right. Of course, there are a few nations that stand out among the rest, in terms of GDP per capita. You’ll notice that nations like Norway and Qatar have relatively large underutilization of equity relative to the population’s wealth (Less than 20% of GDP). Conversely, you’ll see that South Africa has higher share of equity development, with a very small national wealth ($10,000 GDP/Capita).

These are what we would call outliers (exceptions to the rule). The research mentions that all three of these cases are driven by privatization policy towards natural resources. Whereas South African miners are the main source of wealth in the region (also having a significant portion of their wealth overseas), the public sector has control of all the energy resources in nations like Norway and Qatar. These resources are also tied up in assets such as their Sovereign Wealth Funds.

Then you also have Switzerland, considered the world’s wealthiest nation according to GDP per capita. We used nominal GDP, not Purchasing Power Parity (PPP) because we are only looking at national wealth within their nation’s boarders. PPP measures wealth relative to other nations in terms of Cost of Living, Inflation, and other metrics.

The relationship between equity development and wealth correlates perfectly with the Switzerland economy, with equity markets being at least 160% of GDP. At the total opposite of Switzlerland, you have nations like Greece, Argentina, China, etc. Despite everything that is happening with the Chinese economy, it is still one of the fastest growing emerging markets. Although, total wealth is in the hands of a very few and equity markets are still a very small part of its economy (much of its economy is still agricultural and industrial).

When considering this correlation, its best to keep in mind how regulations and populist rhetoric to hinder equity development, such as the resurrection of Glass Steagall (more on this later), can effect overall economic growth.

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