The Effect Of Stock Market On Economic Growth In Nigeria

This study examines the effect of stock market on economic growth in Nigeria.Ordinary least squares regression (OLS) was employed using the data from 1989 to 2008. The results indicated that there is a positive relationship between economic growth and all the stock market development variables used. With 99 percent R-squared and 98 percent adjusted R-squared, the result showed that economic growth in Nigeria is adequately explained by the model for the period between 1989 and 2008. By implications 98 percent of the variation in the growth of economic activities is explained by the independent variables. The study affirmed positive links between the stock market and economic growth; and suggests the pursuit of policies geared towards rapid development of the stock market.

Keywords: Growth, market, stock, economic

A well developed financial system is often at the centre of any modern free enterprise economy. An efficient financial system helps to increase the standard of living and thus the society ’s well-being, by providing an efficient system of allocation of available resources or funds for the production of goods and services. The financial markets bring together the savers and the investors and by interaction of these two groups in an open market, the accumulated aggregate savings are channelled into viable and most desirable investment for the growth and development of the economy. In financial markets, financial assets are exchanged. A stock market is a public market for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.

Mobilization of resources for national development has long been the central focus of development economists. The stock market is an economic institution, which promotes efficiency in capital formation and allocation.

The stock market enables governments and industry to raise long-term capital for financing new projects, and expanding and modernizing industrial/commercial concerns. If capital resources are not provided to those economic areas, especially industries where demand is growing and which are capable of increasing production and productivity, the rate of expansion of the economy often suffers. A unique benefit of the stock market to corporate entities is the provision of long-term, non-debt financial capital. Through the issuance of equity securities, companies acquire perpetual capital for development. Through the provision of equity capital, the market also enables companies to avoid over-reliance on debt financing, thus improving corporate debt-to-equity ratio.

In recent times there was a growing concern on the role of stock market in economic growth. The stock market is in the focus of the economist and policy makers because of the perceived benefits it provides for the economy. The stock market provides the fulcrum for capital market activities and it is often cited as a barometer of business direction. An active stock market may be relied upon to measure changes in the general economic activities using the stock market index (Obadan, 1995). The stock market is viewed as a complex institution imbued with inherent mechanism through which long-term funds of the major sectors of the economy comprising households, firms, and government are mobilized, harnessed and made available to various sectors of the economy (Nyong, 1997). The development of the capital market, and apparently the stock market, provides opportunities for greater funds mobilization, improved efficiency in resource allocation and provision of relevant information for appraisal (Inanga and Emenuga, 1997).

There is a boom in the developed and emerging stock market with a substantial part of the growth accounted for by the emerging market. The reasons adduced for this are that: one, investing firms enjoy lower cost of equity when the stock market functions efficiently; two, the opportunity to trade securities and also hedge allows for relative reduction in risk; three, the ability of the market to adjust share prices almost instantaneously imposes control on the investment behavior of firms; and lastly, countries that are desirous of foreign investment are able to secure it, through the stock exchange (Demirgüç-Kunt and Levine, 1996).

Stock market contributes to economic growth through the specific services it performs either directly or indirectly. Notable among the functions of the stock market are mobilization of savings, creation of liquidity, risk diversification, improved dissemination and acquisition of information, and enhanced incentive for corporate control. Improving the efficiency and effectiveness of these functions, through prompt delivery of their services can augment the rate of economic growth.

At any stage of a nation's development, both the government and the private sectors would require long-term capital. For instance, companies would need to build new factories, expand existing ones, or buy new machinery. Government would also require funds for the provision of infrastructures. All these activities require long-term capital, which is provided by a well functioning stock market.

Stock market may also affect economic activities through the creation of liquidity. Liquid equity market makes available savings for profitable investment that requires long-term commitment of capital. Hitherto, investors are often reluctant to relinquish control of their savings for long periods. As asserted by Bencivenga, Smith and Starr (1996), without liquid capital market there would be no industrial revolution. This is because savers would be less willing to invest in large, long-term projects that characterized the early phase of industrial revolution.

Closely related to liquidity is the function of risk diversification. Stock markets can affect economic growth when they are internationally integrated. This enables greater economic risk sharing. Because high return projects also tend to be comparatively risky, stock markets that facilitate risk diversification encourages a shift to higher-return projects (Obstfeld, 1994). The resultant effect is a boost in the economy leading to growth through the shifting of society’s savings to higher-return investments. Accelerated economic growth may also result to acquire information about firms. Rewards often come to an investor able to trade on information, obtained by effective monitoring of firms for profit. Thus, improved information will improve resource allocation and promote economic growth.

Demirguc-Kunt and Levine (1996) observed that there are some channels through which liquidity can deter growth: Firstly, savings rate

may be reduced, this happens when there is increasing returns on investment through income and substitution effect. As savings rate falls and with the existence of externality attached to capital accumulation, greater stock market liquidity could slow down economic growth. Secondly, reducing associated with investment may impact on savings rate, but the extent and the direction remain ambiguous. This is because it is a function of the degree of risk-averseness of economic agents. Thirdly, effective corporate governance often touted as an advantage of liquidity of stock market may be adversely affected. The ease with which equity can be disposed  off  may  weaken  investors’ commitment and serves as a disincentive to corporate control and vigilance on the part of investors thereby negating their role of monitoring firm’s performance. This often

culminates in stalling economic growth.

Edo (1995) asserts that securities investment is a veritable medium of transforming savings into economic growth and development and that  a  notable  feature  of  economic development in Nigeria since independence is the expansion of the stock market thereby facilitating the trading in stock and shares.

Osinubi (1998) reported that Harry Johnson in 1990 recognized that one of the conditions of being developed pertains to having a large stock of capital per head, which must always be replaced and replenished when used up.

Where this is lacking the condition of being under developed prevails. The Structural Adjustment Programme (SAP) promoted by

the  World  Bank  and  the  International Monetary Fund, embarked upon by the developing countries, according to Soyode