Liberalising capital markets encourages economic development

Opening capital markets encourages economic development in poorer countries because the inflow of capital from richer countries reduces investment costs and boosts productivity. Opponents of liberalising capital markets argue that it does not generate greater efficiency, but invites speculation and other damaging scenarios. A recent article by Peter Blair Henry finds that liberalising capital markets is a decidedly productive thing.

In the late 1980s and early 1990s a number of developing countries liberalised their stock markets, opening them to foreign investors for the first time. Henry uses these 18 countries as the basis of his research. He found that:

Capital was significantly cheaper to obtain in countries that liberalized – with the aggregate dividend yield falling by an average of 240 basis points.

The growth of capital stock rose from an average of 5.4 percent per year in the pre-liberalisation period to 6.5 percent in the post-liberalisation period.

Productivity – the yearly growth in output per worker – rose from an average of 1.4 percent to 3.7 percent.

Since the cost of capital falls, investment booms, and the growth rate of output per worker increases when countries liberalise the stock market, the increasingly popular view that capital account liberalisation brings no real benefits seems untenable.

Source: Les Picker, Capital Account Liberalisation, The Cost of Capital, and Economic Growth,National Bureau of Economic Research, NBER Digest, August 2003; based upon Peter Blair Henry, Capital Account Liberalisation, The Cost of Capital and Economic Growth, National Bureau of Economic Research, Working Paper, No. 9488, May 2003; also published as Capital Account Liberalisation, The Cost of Capital, and Economic Growth, American Economic Review, May 2003, pp. 91-96.

For article: http://www.nber.org/digest/aug03/w9488.html
For abstract: http://papers.nber.org/papers/w9488
For more on Private Investment: http://www.ncpa.org/pi/internat/intdex12.html

FMF Policy Bulletin/ 14 October 2003