Stock market development and economic growth in Africa

Journal of Economics and Business 74 (2014) 24–39

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Journal of Economics and Business

Stock market development and economic growth in Africa Everlyne Ngare a,1, Esman Morekwa Nyamongo b,∗, Roseline N. Misati b,2 a Centre for Research on Financial Markets and Policy, Kenya Bankers Association, P.O. Box 73100, 00200, Nairobi, Kenya b Research and Policy Analysis Department, Central Bank of Kenya, P.O. Box 60000, 00200, Nairobi, Kenya

a r t i c l e

i n f o

Article history: Received 21 August 2012 Received in revised form 28 February 2014 Accepted 6 March 2014 JEL classification: G00 O16 F36 Keywords: Stock market development Economic growth Panel econometrics Africa

a b s t r a c t The objective of this study is to investigate the role of stock market development on economic growth in Africa. It uses annual data from a panel of 36 countries, of which 18 have stock markets, in Africa over the period 1980–2010. Panel data econometrics technique is used in data analysis. Our main findings are as follows: (i) countries with stock markets tend to grow faster compared to countries without stock markets, (ii) countries which are relatively developed and have stock markets tend to grow less faster compared to small countries with stock markets, (iii) Stock market development has a positive effect on economic growth, (iv) investment, human capital formation and openness positively influence economic growth in the Africa region, (v) macroeconomic instability (inflation) and government consumption impact economic growth negatively, and (vi) countries that are politically stable and less corrupt tend to grow faster. © 2014 Elsevier Inc. All rights reserved.

∗ Corresponding author. Tel.: +254 20 2863211. E-mail addresses: [email protected] (E. Ngare), [email protected], [email protected] (E.M. Nyamongo), [email protected] (R.N. Misati). 1 Tel.: +254 20 2221704. 2 Tel.: +254 20 2863219. http://dx.doi.org/10.1016/j.jeconbus.2014.03.002 0148-6195/© 2014 Elsevier Inc. All rights reserved.

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1. Introduction The central role of the financial sector in economic growth has received a considerable attention since the pioneering work of Gurley and Shaw (1955), who argued that financial sector development promotes economic growth by enhancing physical capital accumulation. Following this evidence, studies by McKinnon (1973) and Shaw (1973) showed that financial sector development is key to economic growth subject to dismantling financial repression. This finding generated research interest; however, such an interest was mute in Africa until after the 1980s when the financial sector was liberalised in a number of countries. This interest arose following the financial sector reforms that were initiated in the 1980s in nearly all the countries in Africa. The theoretical justification for these reforms may be traced to McKinnon (1973) and Shaw (1973). However, these two studies did not explicitly outline the role of stock markets; – in fact Shaw argued that the development of stock markets in early stages of development may be very expensive for developing economies. Stock markets impact on the economy in the following ways: (i) it helps in savings mobilisation and therefore increasing the savings rate thus facilitating higher capital formation and economic growth, (ii) it reduces investment risks owing to the ease with which equities are traded. This therefore implies that the stock markets play a central role in economic performance. A more structured analysis of the central role of stock market is due to Cho (1986) study which shows that credit markets cannot work efficiently without stock markets. More recently, the role of stock market development in macroeconomic performance has been investigated (see Adenuga, 2010; Boubakari & Jin, 2010; Carp, 2012; Enisan & Olufisayo, 2009; King & Levine, 1993; Levine, 2004; Levine & Zervos, 1998). Evidence from mature markets reveals that the stock markets development tend to be associated with key macroeconomic variables such as private investment (see Arestis, Demetriades, & Luintel, 2001; Khan & Kumar, 1997) and economic growth (see Atje & Jovanovic, 1993; Levine & Zervos, 1998; Obstfeld, 1994). In Africa, however, the contribution of stock market development on macroeconomic variables has not been adequately addressed. Most of the crosscountry studies on Africa that come close to analysing financial development and economic growth tend to be biased towards the banking sector variables (see Demirgüc¸-Kunt & Maksimovic 1998; King & Levine, 1993; Levine, 1997; Misati & Nyamongo, 2011a, 2011b; Nyamongo, Misati, Kipyegon, & Ndirangu, 2012), while abstracting from the stock market development variables. This therefore tends to give an unbalanced view of the contribution of the financial sector on economic growth in Africa. In addition, some time series studies on stock market and economic growth on specific countries in Africa are available in the literature (see Aknilo & Egbetunde, 2010; Enisan & Olufisayo, 2009; Ezeoha et al., 2009; Nurudeen, 2009; Obamiro, 2005; Osamwonyi & Kasimu, 2013); however, these studies are not rich enough to address the dynamics associated with panel datasets. The sparse nature of studies in this area on Africa may be because most countries introduced stock markets in the 1990s and therefore sufficiently long time series may not be available for meaningful analysis. In addition, the number of countries which have stock markets has increased in the 1990s and therefore good quality panel datasets were not available until recently when such datasets became available. It is in the view of these gaps in the literature that we conduct a cross country analysis targeting the African region. This may help to understand whether or not Africa is different. The rest of the paper is organised as follows: Section 1.1 discusses the evolution of stock market indicators and economic growth in Africa. Section 2 presents the model and discusses the factors that explain growth. It also discusses the concept of causality between the stock market development and economic growth. Section 3 discusses the empirical findings while Section 4 concludes. 1.1. Evolution of stock market development and economic growth in Africa The level of stock market development varies greatly in Africa as shown in Fig. 1. Based on the data on the market capitalisation to GDP for 2010, it is found that during this time, the market capitalisation to GDP was highest in South Africa at 278 percent. The rest of the countries have ratios that were far below that posted by South Africa. For example, Morocco had 75.8 percent followed closely by Mauritius at 66.8 percent and Kenya at 46.4 percent. During this time Uganda, Tanzania and Swaziland had the lowest ratios amongst the countries surveyed.

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E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Fig. 1. Market capitalisation (percent of GDP) in selected countries in Africa, 2010.

Fig. 2 shows the evolution of economic growth in Africa and stock market indicators. From the figure the following observations may be made: (i) During the period 1996–2000 the average growth rate in Africa stood at 3.81 percent while that of the countries with stock markets stood at 4.91 percent. It is also observed that the average stock turnover stood at 18.7 percent while the market capitalisation stood at 72.4 percent of GDP during this period. (ii) During 2001–2005 the stock turnover increased to 21.6 percent of GDP while the market capitalisation to GDP declined marginally to stand at 71.7 percent. The GDP grew marginally to stand at 4.95 percent in the countries with stock markets while it increased to 4.48 percent in Africa. (iii) In 2006–2010, the market capitalisation to GDP grew to 89.9 percent and the stock market turnover ratio grew to 23.5 percent. At the same time the GDP growth in the countries with stock markets increased to 5.52 percent while the GDP growth rate in Africa increased to 4.83 percent. (iv) In 1996–2010, the average growth rate in Africa stood at 4.37 percent while that of those countries with stock markets averaged 5.11 percent. In view of this it is possible to suggest that while growth in Africa may be explained by a number of factors, those countries with stock markets tend to grow much faster. The following observations may also be made: During the period 1996–1999 the average market capitalisation to GDP ratio stood at 240.2 percent and was associated with economic growth performance of 3.4 percent. During the period 2000–2004, the average market capitalisation to GDP ratio

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

27

7

140

7

30

6

120

6

25

5

100

5

4

80

4

3

60

3

2

40

2

1

20

1

5

0

0

0

0

20

2009

MKT CAP (% of GDP)

STK turnover rao (%)

GDP growth % (Africa)

GDP growth % (Africa)

GDP growth % (countries with stock market)

GDP growth % (countries with stock market)

2010

2008

2006

2007

2004

2005

2003

2002

2001

1999

2000

1998

1997

10

1996

2010

2008

2009

2007

2006

2005

2004

2003

2002

2001

2000

1998

1999

1996

1997

15

Source: World Bank: African Development Indicators Fig. 2. Evolution of stock market indicators and economic growth in Africa: 1996–2010.

rose to 274.8 percent while economic growth accelerated to 4.2 percent. Further evidence shows that during the period 2005–2008, the average market capitalisation to GDP ratio increased further to 736.6 percent and average economic growth increased to 5.8 percent. During the entire period 1996–2008, the average market capitalisation to GDP stood at 406.2 percent while average economic growth stood at 4.5 percent. Further analysis from Fig. 2 reveals the following: (i) In 1996 the economic growth in Africa stood at 5.0 percent, however, this was associated with a very low level of stock market turnover at 7.7 percent. (ii) In 2002, while the economic growth was subdued at 3.3 percent the stock market turnover ratio stood at 39.8 percent. This may have been on the account of the good macroeconomic performance witnessed in North African countries – Egypt, Morocco, and Tunisia, which accounted for 25 percent Africa’s GDP during the period. (iii) From 2007 to 2008 the stocks traded in Africa increased marginally compared to a sharp decline in both the market capitalisation of listed companies (in US dollars) and the real GDP. This may be on the account of the global financial crisis. As shown in the literature (see Nyamongo & Misati, 2010; Nyamongo et al., 2012) the global financial crisis had devastating effects on: (a) private capital flows which in turn affected economies that were reliant on these flows to finance infrastructure investment, (b) declining commodity prices thus impacting the value of exports from Africa, (c) the amount of remittances to Africa declined during this period, for example, in 2008; remittances to Africa stood at 40.9 billion but declined to 37.8 billion in 2009 (see World Bank, 2010). From the foregoing we have demonstrated that higher economic growth in Africa tends to be associated with improved performance in the stock market. This is a preliminary evidence that economic performance is associated with stock market development. Compared to other regions of the world, evidence on stock market development in Africa is worrying. Latest statistics on stock market indicators are as follows: (i) In 2010 there were 48,785 listed companies in the world of which only 950 companies were listed in the African stock markets. In the same year, South Asia had 6271 listed companies which is the highest number followed by India with 4987 and United States was third with 4279 listed companies. (ii) The market capitalisation to GDP in Africa stood at 89.72 percent in 2000 rising to 147.74 percent in 2010. During the same period the United Kingdom, Australia and the United States had market capitalisation rates above 100 percent. (iii) The stocks traded turnover ratio in Africa rose from 5.96 percent in 1990 to 36.75 percent in 2010. Moreover, in 2010, the United States had the highest stocks turnover ratio of 189 percent. Further evidence reveals that China, Japan and Germany had a stock turnover ratio of 164.37 percent, 114.49 percent and 103.04 percent consecutively in 2010. All these indicators therefore suggest that Africa

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has a young and small but growing stock market1 which has started to assume a growing role in domestic resources mobilisation for economic growth and development in Africa. 2. Empirical strategy In this study we follow the following empirical strategy: (i) we formulate a standard growth model following the Barro (1990, 1991) tradition and augment it with a stock market dummy. The stock market dummy helps to analyse the effect of presence of a stock market in a given country on economic growth. This model will be estimated for the full sample of 36 countries, including those countries without stock markets, (ii) we then re-formulate the growth model by specialising on those countries with stock markets. However, here we augment the standard growth model with financial development indicators. Following this approach the model to investigate the full sample is as follows: YPCGi,t = ˇ1 YPCR(−1)i,t + ˇ2 INFi,t + ˇ3 PIi,t + ˇ4 GIi,t + ˇ5 GOVi,t + ˇ6 TRi,t + ˇ7 INTFi,t + ˇ8 DUMi,t + ˇ9 DUM ∗ YPCRi,t + i + εi,t

(1a)

where YPCG is the growth rate of real GDP per capita; YPCR is real GDP per capita which proxies the level of development and in this model it is lagged in order to capture the notion of conditional convergence – it is expected to have a negative sign; INF is the inflation rate which proxies macroeconomic instability and is expected to be negatively related to economic growth; PI is the gross primary school enrolment rate which proxies human capital formation – it is expected to have a positive sign; GI is the gross investment to GDP ratio is a measure of the share of investment in GDP; GOV is the government consumption to GDP, which measures the crowding out/in aspect associated with government expenditures; TR is the trade openness which measures the extent to which a country is integrated with the rest of the world; INTF is a measure of the quality of institutions; DUM is the stock market dummy which takes a value of 1 if a country has a stock market in a particular year and 0 otherwise. In this study it is postulated that countries with stock markets tend to grow faster compared with those without stock markets, and DUM * YPCR is an interaction dummy to control for the level of development of the country. In the literature it is shown that while stock markets are important for economic growth they may not necessarily be growth enhancing in relatively poor countries when considering the amount of investment required to initiate such a market. Therefore the interaction dummy will capture this aspect, and if this view is true, then we expect the interaction dummy to have a positive and significant relationship with economic growth;  is the time invariant error term while ε is the idiosyncratic error term (Table 1). In the second step we filter out countries without stock markets. Here we seek to interrogate countries with stock markets to see if their growth performance is associated with the existence of stock markets. This calls for modification in Eq. (1a) by augmenting it with stock market variables. In this regard, the model to be estimated is similar to the one shown in Eq. (1a) but augmented with the stock market indicators as follows: YPCGi,t = ˇ1 YPCR(−1)i,t + ˇ2 INFi,t + ˇ3 PIi,t + ˇ4 GIi,t + ˇ5 GOVi,t + ˇ6 TRi,t + ˇ7 SMDi,t + ˇ8 INTFi,t + ˇ9 BSDi,t + i + εi,t

(1b)

where BSD is the banking sector variable which is represented by either the ratio of M2 to GDP or credit to private sector to GDP. SMD is a stock market development indicator. Stock market indicators commonly used in the literature include: Market capitalisation to GDP, the total value of shares traded to GDP ratio and turnover ratio (total value of shares traded/market capitalisation). The stock market

1 This is not surprising, since prior to 1989 there were five stock markets in Africa of which three were in North Africa. In 2010 there were 19 stock exchanges as shown in Table A.1 in the appendix. Except, for The Alexandria Stock Exchange (in Egypt) which was officially established in 1883, Cairo in 1903, Johannesburg Stock Exchange founded in 1887; Casablanca Stock Exchange (in Morocco) founded in 1929, and Nairobi Stock exchange (in Kenya) founded in 1954, all the other stock markets are fairly young.

Listed domestic companies, total 1990 European Union North America South Asia Sub-Saharan Africa World Australia China Egypt, Arab Rep. Germany India Japan South Africa United Kingdom United States

4847 7743 3231 25,424 1089 573 413 2435 2071 732 1701 6599

1995

2000

2005

2010

7542 8867 6654 1047 36,566 1178 323 746 678 5398 2263 640 2078 7671

14,064 8964 7269 1088 47,751 1330 1086 1076 1022 5937 2561 616 1904 7524

14,421 8886 6050 911 50,936 1643 1387 744 648 4763 3279 388 2759 5143

11,363 8098 6271 950 48,785 1913 2063 213 571 4987 3553 360 2056 4279

Source: World Bank: African Development Indicators.

Market capitalisation of listed companies (% of GDP)

Stocks traded, turnover ratio (%)

1990

1990

31.03 52.14 10.79 47.48 34.71 4.08 20.71 12.16 95.49 123.20 83.85 53.21

1995

2000

2005

2010

41.44 91.11 29.66 126.46 61.22 66.12 5.78 13.44 22.89 35.70 69.66 185.64 121.66 93.45

100.26 150.06 26.15 89.72 101.59 89.42 48.48 28.79 67.34 32.18 67.64 154.24 174.45 152.58

74.12 134.52 58.77 128.59 96.61 115.45 34.59 88.83 44.15 66.31 104.05 228.86 134.10 134.91

64.68 119.36 81.87 147.40 88.70 128.54 80.36 37.69 43.58 93.56 75.10 278.24 137.38 117.50

48.30 51.32 60.51 5.96 53.09 32.09 7.26 139.39 66.52 43.84 6.07 33.26 53.31

1995

2000

2005

2010

58.82 83.96 17.97 6.58 62.13 42.52 116.36 10.97 109.47 17.21 33.34 6.73 38.97 85.68

83.34 194.68 308.85 31.74 140.19 56.55 158.29 36.12 79.12 306.50 69.93 33.16 66.61 200.78

125.21 124.34 111.64 37.31 116.33 77.97 82.55 42.97 145.97 92.23 118.78 39.32 141.88 129.21

92.78 176.49 74.31 36.75 127.65 90.08 164.37 43.04 103.04 75.62 114.49 39.60 101.86 189.06

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Table 1 Global comparison of leading stock market indicators.

29

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impacts economy in the following ways: (i) Aiding in savings mobilisation and therefore increasing the savings rate thus facilitating higher capital formation and economic growth (see Greenwood & Smith, 1996; Levine & Zervos, 1998; N’zue, 2006). (ii) Reducing investment risks owing to the ease with which equities are traded. (iii) Providing liquidity that lowers the cost of the foreign capital and boosts investor motivation which is necessary for facilitating growth (see Bencivenga, Smith, & Starr, 1996; Holmstrom & Tirole, 1993). In addition, Demirguoc-Kunt and Levine (1996) and Liang and Teng (2006) show that countries with developed stock markets tend to encourage establishment of developed banks and nonbank financial intermediaries as well. All these taken together suggest that stock markets support economic growth. In this study therefore we expect to find a positive relationship between stock market development and economic growth in Africa. In addition to the stock market development, banking sector development is also prominent in the literature as driving economic growth. This is because a well-developed financial market improves the accessibility of funds to support domestic borrowers, and channel such funds to high return ventures. Some studies have shown that the banking sector development has a positive influence on economic growth (see Arestis et al., 2001; Misati & Nyamongo, 2011a; Nyamongo et al., 2012; Singh, 1997). 2.1. Causality tests A variable X is said to cause Y if the history of X can explain variation in Y. In our context economic growth is said to cause stock market development, if the past history of economic growth is able to explain stock market development. On the other hand, stock market development is said to cause economic growth, if the past history of stock market development is able to explain economic growth. In this study therefore we investigate whether (i) stock market development causes economic growth, (ii) economic growth causes stock market development, and (iii) causality runs in both directions. This may be stated as: YPCGi,t = ˇ1

T 

YPCGi,t + ˛i

t−1

SMDi,t = ˇi

T 

YPCGi,t + ˛i

t−1

T 

SMDi,t + i,t

(2)

t−1

T 

SMDi,t + i,t

(3)

t−1

where YPCG is the growth of real GDP per capita and SMD is stock market development indicator. 2.2. Data sources and type This study uses a panel data set of 36 countries in Africa, of which 18 have stock markets, covering the period 1996–2010. The choice of the period is governed by the availability of data. It uses annual data obtained from secondary sources. These sources include the on-line version of the World Bank’s Development Indicators and IMF’s – International Financial Statistics. The definition of variables and respective sources is as follows: • Market capitalisation of listed companies (percent of GDP) is the share price times the number of shares outstanding. Listed companies do not include investment companies, mutual funds, or other collective investment vehicles rather than they are the domestically incorporated companies listed on the country’s stock exchanges at the end of the year. Stocks traded, turnover ratio (percent) is the total value of shares traded during the period divided by the average market capitalisation for the period. These variables are obtained from the World Bank’s African Development Indicators (ADI). • GDP per capita growth used in this study is obtained from the World Bank: African Development Indicators (ADI). It is defined as annual percentage growth rate of GDP per capita based on purchasing power parity (PPP). This definition is preferred because it enables international comparison. In this

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

•

•

•

•

•

31

regard, an international dollar has the same purchasing power over GDP as the US dollar has in the United States. Primary school enrolment rate used in this study is obtained from United Nations Educational, Scientific, and Cultural Organisation (UNESCO) Institute for Statistics. Gross primary school enrolment rate is the ratio of children of official school age based on the International Standard Classification of Education 1997 who are enrolled in school to the population of the corresponding official school age. Inflation is measured by the annual growth rate of the GDP implicit deflator shows the rate of price change in the economy as a whole. It is sourced from World Bank online version data. Trade is the sum of exports and imports of goods and services measured as a share of gross domestic product. It is sourced from World Bank national accounts data. Control of Corruption index, provided by World Bank, is used to measure the extent to which public power is exercised for private gain, including petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. The political stability and absence of violence index, provided by the World Bank, measures the likelihood that the government will be destabilised or overthrown by unconstitutional or violent means, including domestic violemce or acts of terrorism. Money and quasi money (M2) (percent of GDP) encompass the sum of the currency outside banks, demand deposits other than those of the central government, and the time, savings, and foreign currency deposits of resident sectors other than the central government. Domestic credit to private sector (percent of GDP) refers to financial resources provided to the private sector. As provided by World Bank, for some countries these claims include credit to public enterprises. Gross private investment (percent of GDP) covers gross outlays by the private sector (including private non-profit agencies) in addition to its fixed domestic assets. Openness which is given as trade of goods and services (percent of GDP) is also used in this study. Trade as described by World Bank is the sum of exports and imports of goods and services measured as a share of gross domestic product. General government final consumption expenditure (percent of GDP) includes all government current expenditures for purchases of goods and services (including compensation of employees). It also includes most expenditure on national defence and security, but excludes government military expenditures that are part of government capital formation.

3. Empirical results Fig. 3 gives preliminary evidence regarding the role of stock market development on growth of GDP per capita in the panel of 15 countries in 2007. In this study stock market development is defined

Stock turnover and GDP per capita growth

Market Capitalisaon and GDP per capita growth

7.00

7

6.00

6 MAR

EGY

NGA

2.00 CIV

MUS

1.00

NAM SWZ TUN MWI TZA UGA KEN GHA ZMB BWA NGA

5

ZAF GDP per capita (%)

GDP per capta (%)

NAM SWZ TUN 5.00 MWI TZA KEN 4.00 UGA GHA ZMB 3.00 BWA

4 3

ZAF

EGY MAR

2 CIV MUS 1

0.00 0.00

-CMR 10.00

20.00

30.00

40.00

-1.00 Stock turnover rao (%)

50.00

60.00

0 0 -1

100

200

300

Market capitalisaton to GDP (%)

Fig. 3. Stock market development and economic growth in Africa, 2007.

400

32

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Table 2 Empirical evidence on causality between economic growth and stock market development. (A) Dependent variable: YPCG PM YPCG(−1) MC(−1) R2

***

0.508 (8.448) −0.000 (−0.271) 0.27

(B) Dependent variable: MC REM

FEM ***

0.186 (2.637) 0.024*** (4.054) 0.47

***

0.271 (4.404) 0.000 (0.003) 0.08

(C) YPCG YPCG(−1) ST(−1) R2

0.343*** (10.85) 0.039*** (2.331) 0.41

PM

FEM

REM

−0.042 (−0.267) 0.934*** (29.520) 0.81

0.115 (0.712) 0.743*** (14.990) 0.85

−0.296 (−0.799) 0.972*** (43.050) 0.89

(D) Dependent variable: ST 0.088 (1.247) 0.087*** (4.029) 0.53

0.343*** (5.732) 0.039*** (2.541) 0.16

0.018 (0.310) 0.962*** (30.13) 0.82

0.108 (1.367) 0.745*** (15.45) 0.83

0.246** (1.730) 0.951*** (27.89) 0.78

t-Values in parenthesis. YPCG = growth rate of real income per capita, ST = stock market turnover to GDP, MC = market capitalisation to GDP, PM = pooled model, FEM = fixed effects model and REM = random effects model. ** Significant at 5 percent. *** Significant at 1 percent.

in two ways: stock market turnover and market capitalisation. From the figure it appears that higher levels of stock market turnover rate and market capitalisation to GDP are characterised by higher level of GDP per capita growth, which signifies that stock market development improves economic growth. This is consistent with literature (see Greenwood & Smith, 1996; Levine & Zervos, 1998; N’zue, 2006) where it is pointed out that stock market development positively impacts economic growth. 3.1. Empirical evidence on causality Table 2 presents causality tests when the market development is proxied by market capitalisation as a ratio of GDP. Model A shows GDP as the dependent variable while the explanatory variables include lagged GDP and lagged market capitalisation. Model B specifies market capitalisation as the dependent variable while the explanatory variables are lagged GDP and lagged market capitalisation. In model A, the estimated coefficient of lagged GDP is significant across the pooled, fixed effects and random effects models while the lagged market capitalisation is found significant only in the fixed effects model. This shows that there is some weak evidence that market capitalisation causes economic growth. In Model B, the lagged market capitalisation is significant in all the specifications at 1 percent significance level. It is also found that the estimated coefficients of GDP growth are not significant at the conventional levels. This therefore suggests that there is no causality running from economic growth to market capitalisation. Stock market turnover ratio as proxy for stock market development is shown in Table 2. Based on Model C it is found that the estimated coefficients of stock market development are significant at the conventional levels. Meaning there is causality running from stock market turnover to economic growth. On the other hand, in Model D where the dependent variable is stock market turnover, the estimated coefficients of lagged GDP are not found to be significant at the conventional levels. Meaning there is no causality running from economic growth to stock market turnover. In view of these findings we conclude that there is one-way causality running from stock market development to economic growth. 3.2. Estimation results The estimation results are reported in Tables 3–5 and A.2 in the appendix. In Table 3 the results from the full sample estimation are reported. The logic is that we first estimate a growth model where

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

33

Table 3 Growth and existence of stock market: Fixed and random effects models (full sample). Fixed effects models

YPCR(−1) Gl INF HUM GOV TR

Random effects model

Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

−3.703 (4.862) 0.041* (1.864) −0.030*** (−4.845) 0.047*** (5.648) −0.110*** (−3.156) 0.028*** (3.606)

***

−0.702 (−3.530) 0.091*** (5.678) −0.040*** (−2.958) 0.006 (1.080) −0.061* (−2.406) 0.007** (−2.085)

−1.092 (3.090) 0.096*** (6.120) −0.033*** (−2.584) 0.009 (1.491) −0.071*** (−2.814) 0.009** (2.525)

−1.041 (−3.749) 0.110*** (−3.749) −0.035*** (−2.730) 0.008 (1.368) −0.077*** (−2.968) 0.006* (1.623) 0.001 (0.055)

−0.551 (−1.920) 0.102*** (3.994) −0.014 (−1.541) 0.028*** (3.172) −0.115*** (−2.870) 0.007 (0.941)

−0.735 (−2.498) 0.118*** (4.923) 0.005 (0.309) 0.013* (1.679) −0.075** (−2.028) 0.004 (0.588)

−1.214 (−3.149) 0.113*** (4.796) 0.008 (0.520) 0.019** (2.257) −0.081** (−2.237) 0.007 (1.079)

−1.200*** (−3.098) 0.114*** (4.841) 0.007 (0.465) 0.019** (2.241) −0.081*** (−2.202) 0.008 (1.145) 0.002 (0.145)

0.0.021*** (2.959) 1.767*** (6.313)

0.017** (2.223) 2.634 (1.385) −0.696** (−2.280)

3.946 (1.986) −3.946** (−1.986)

0.014 (1.154) 1.939*** (3.831)

0.007 (0.581) 1.147 (1.469) −0.878* (−1.783)

3.994 (1.179) −0.934* (−1.769)

***

***

DC M2/GDP DUM DUM * YPCR

***

*

**

***

***

R2 NXT

0.58 972

0.61 972

0.65 972

0.62 972

0.42 972

0.49 972

0.62 972

0.61 972

F-test

6.257 [0.000] –

7.324 [0.000] –

6.874 [0.000] –

7.156 [0.000] –

–

–

–

–

30.836 [0.000]

15.579 [0.029]

32.884 [0.000]

30.152 [0.000]

Hausman test

t-Values in parenthesis. YPCR = real income per capita, GI = gross investment to GDP, INF = inflation rate, HUM = Gross primary school enrolment rate, GOV = government consumption to GDP, TR = volume of trade to GDP; DC = Domestic credit to GDP, M2/GDP = broad money supply to GDP, Dum is stock market dummy. * Significant at 10 percent. ** Significant at 5 percent. *** Significant at 1 percent.

countries with and without stock markets are included. In that estimation we use a stock market dummy to analyse the contribution of stock market on economic growth. The estimation results based on the full sample are reported in Table 3. Here the fixed effects (models 1–4) and random effects (models 5–8) are reported. Models 1 and 5 are based on the standard variables in growth models. In models 2 and 6, the stock market dummy is included. In these regressions it is found that the estimated coefficients of the stock market dummy are positive and significant at 1 percent level. This therefore suggests that, generally, countries with stock markets tend to grow much faster compared to those without stock markets. In models 3 and 4 and 7 and 8, the interaction dummy is introduced to control for the level of economic development. In all the estimations, the coefficients of the interaction dummy are found to be negative and significant at the conventional levels of testing. These findings suggest that while the presence of a stock market in a country boosts economic performance, however, highly developed countries (of course with stock markets) in our sample tend to grow at a slower pace compared to the small countries with stock markets in place. This finding is not surprising in Africa, at least among the countries we have investigated. While the stock market is critical for growth in a number of countries, those small countries with stock markets tend to have unique characteristics. Some of these countries have benefited from the international support from both the multilateral and bilateral arrangements. For example, the Highly Indebted Poor Countries (HIPC) initiative of the IMF benefited a number of small countries such as Uganda, Rwanda and Mozambique. This initiative enabled the

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E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Table 4 Growth and stock market development: Fixed effects models (based on countries with stock markets). Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

Model 9

−0.114 (−1.377) −0.034 (−3.625) 0.035 (2.559) −0.150 (−2.858) 0.077 (2.545) 0.026 (2.334)

−0.007 (−0.083) −0.053*** (−2.144) 0.053*** (3.042) −0.138*** (−2.085) 0.041 (1.053) 0.022** (1.697)

−0.069 (−0.426) −0.033*** (−3.535) 0.038*** (2.632) −0.173*** (−3.118) 0.072** (2.350) 0.031*** (2.629)

0.093 (0.579) −0.034 (−3.636) 0.036 (2.573) −0.152 (−2.749) 0.075 (2.462) 0.026 (2.314)

−0.141 (−0.890) −0.049* (−1.933) 0.052*** (2.975) −0.159** (−2.283) 0.043 (1.112) 0.027** (1.991)

–

–

−0.295 (−2.117) −0.022*** (−0.74) 0.006 (0297) −0.038 (−0.474) 0.069 (1.502) 0.043*** (2.351) 0.028*** (3.933) –

−2.242* (1.974) −0.024 (−0.805) −0.023 (−1.315) −0.015 (−0.197) 0.078** (1.841) 0.026 (1.472)

0.064*** (4.458) –

−0.151 (−0.975) −0.073*** (−2.918) 0.044** (2.537) −0.122* (−1.781) 0.043 (1.077) 0.031** (2.543) 0.030*** (4.468) –

0.028 (1.336)

–

ST

–

−0.099 (−0.934) −0.075 (−3.071) 0.042 (2.464) −0.115 (−1.736) 0.042 (1.060) 0.031 (2.567) 0.031*** (5.199) –

DC

–

–

YPCR(−1) INF HUM GOV GI TR MC

0.009 (0.454)

0.060*** (3.974) 0.021 (1.063)

1.474*** (2.968) 1.836*** (2.193)

0.595 (1.398) 1.774*** (2.278)

0.512 151 6.39

0.524 161 5.72

0.003 (0.141)

M2/GDP PS CORR R2 NxT F-test

–

0.071*** (4.249) –

0.425 304 7.26

0.543 198 8.57

0.534 205 6.91

0.426 303 6.60

0.423 304 7.25

0.540 198 5.21

0.538 205 4.75

t-Values in parenthesis. YPCR = real income per capita, GI = gross investment to GDP, INF = inflation rate, HUM = Gross primary school enrolment rate, GOV = government consumption to GDP, TR = volume of trade to GDP; DC = Domestic credit to GDP, MC = market capitalisation to GDP, ST= stock market turnover ratio, M2/GDP = broad money supply to GDP, PS= political stability index, CORR = corruption control index. * Significant at 10 percent. ** Significant at 5 percent. *** Significant at 1 percent.

affected countries to redirect their budgets towards poverty reduction and growth enhancing projects. In addition, some of the small countries in the region are mineral resource rich and therefore able to utilise these resources to foster their growth performance. Following the full sample estimation results, further analysis was conducted with a sample of countries with stock markets and the results are reported in Tables 4, 5 and A.2 in the appendix. Based on these estimations it is found that in cases where the stock market development is proxied by the stock market turnover ratio, the estimated coefficients are positive and significant at the conventional levels of testing. When the stock market capitalisation to GDP is used as the proxy for stock market development, the findings are not unanimous. The fixed effects model results show the estimated coefficients of stock market capitalisation to GDP (models 2, 6 and 8) are positive and significant at 1 percent level. In the case of random effects models in Table 5, it is found that most of the estimated coefficients of stock market capitalisation to GDP are positive but not unanimously significant. Based on this evidence therefore, it may be inferred that stock market development has a significant role to play in the growth of these economies. This evidence collaborates that obtained in Table 3, for the full sample estimations, where it is found that countries with stock markets tend to post higher growth compared to those without these markets. This finding supports the idea that as the economy grows, the equity markets tend to expand in terms of the number of listed companies and in terms of stock market turnover (see Atje & Jovanovic, 1993; Levine & Zervos, 1998). The fact that most of the estimations show that the stock market development indicators have positive and significant

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

35

Table 5 Growth and stock market development: Random effects models (based on countries with stock markets). Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

Model 9

−0.102 (−0.735) −0.025** (−2.516) 0.027* (1.874) −0.133** (−2.492) 0.070* (1.720) 0.002 (0.225)

−0.008 (−0.070) −0.061** (−2.047) 0.054*** (2.681) −0.108* (−1.818) 0.061 (1.118) 0.013 (1.292) –

−0.171 (−0.966) −0.025** (−2.549) 0.028* (1.876) −0.126** (−2.300) 0.073* (1.768) 0.001 (0.087) –

0.091 (0.549) −0.025** (−2.519) 0.027* (1.856) −0.134** (−2.493) 0.068 (1.620) 0.003 (0.251) –

0.111 (0.780) −0.061** (−2.055) 0.058*** (2.993) −0.083 (−1.438) 0.063 (1.204) 0.009 (0.921) –

–

−0.126 (−0.784) −0.011 (−0.342) 0.038** (1.926) −0.025 (−0.404) 0.081 (1.535) −0.000 (−0.013) 0.009 (1.304) –

−0.200 (−1.232) −0.023 (−0.680) 0.023 (1.138) −0.034 (−0.508) 0.077 (1.432) 0.003 (0.301) –

–

−0.170 (−1.396) −0.081*** (−2.865) 0.051*** (2.991) −0.067 (−1.350) 0.080* (1.719) 0.001 (0.227) 0.026*** (2.82) -

–

ST

–

−0.045 (−0.413) −0.069** (−2.501) 0.053*** (3.227) −0.096** (−2.027) 0.090** (1.981) 0.005 (0.709) 0.002 (0.499) –

DC

–

–

0.036* (1.798) –

M2/GDP

–

–

–

−0.010 (−0.638) –

PS

–

–

–

–

0.002 (0.120) –

CORR

–

–

–

–

R2 NxT Haussmann test

0.07 304 4.73

0.16 198 24.39

0.13 205 4.96

0.07 303 5.16

YPCR(−l) INF HUM GOV GI TR MC

−0.050*** (−3.116) –

0.046** (2.155) −0.020 (−1.417) –

–

–

–

–

–

0.07 304 4.73

0.19 198 13.65

0.15 205 6.85

–

0.046*** (2.181) –

–

–

0.637 (1.387) 0.888 (1.297)

0.504 (1.128) 1.117 (1.610)

0.12 151 23.31

0.11 161 12.81

t-Values in parenthesis. YPCR = real income per capita, GI = gross investment to GDP, INF = inflation rate, HUM = Gross primary school enrolment rate, GOV = government consumption to GDP, TR = volume of trade to GDP; DC = Domestic credit to GDP, MC = market capitalisation to GDP, ST = stock market turnover ratio, M2/GDP = broad money supply to GDP, PS = political stability index, CORR = corruption control index. * Significant at 10 percent. ** Significant at 5 percent. *** Significant at 1 percent.

coefficients suggests that the stock market development plays a role in economic growth. Our findings are similar to earlier studies such as Levine and Zervos (1998) and Rousseau and Wachtel (2000), who examined stock market-growth nexus and found a positive correlation between stock market development and economic activity. This study uses two proxies for the banking sector development, namely, credit to private sector to GDP (DCTPS) and broad money (M2 to GDP). Table A.2 in the appendix, shows a strong positive link between the banking sector and economic growth. Here models 4, 6 and 7 show evidence that direct credit to private sector has a strong and positive impact on economic growth. As in model 6 and 7 where market capitalisation is used to proxy stock market, credit to private sector is found to have positive and significant coefficients. In the fixed effects models in Table 4, it is found that, largely, credit to private sector has positive but insignificant coefficients. Turning to the random effects models in Table 5, all estimations yield coefficients that are positive. The other proxy of banking sector is M2 to GDP. In all estimations reported, it is found that the estimated coefficients of M2 to GDP are positive but largely not significant at the conventional levels of testing. Further evidence is shown in Table 5 where the estimated coefficients are also found to be positive but not significant. Literature tends to argue in different ways regarding the role of banking sector development. Some studies find very strong evidence of banking sector development on economic growth. However, there are some studies such as Arestis et al. (2001) that find no strong evidence of the role of banking sector development and economic growth. Apparently, this is the view that our findings support.

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E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Turning to the standard variables in the growth literature, it is found that in the full sample estimations, as shown in Table 3, the estimated coefficients of the lagged GDP per capita is negative and significant at the conventional levels of testing. The lagged level of GDP per capita proxies the initial level of development. This finding supports the conditional convergence theory where it is shown that poor countries tend to grow faster compared to the richer countries. However, turning to countries with stock markets, there is no strong evidence to support this view. This may be on the account of the limited sample of countries being investigated in our current study. In these estimations it is found that seven out of the nine estimated coefficients are positive but not significant. The crowding out effect of government consumption is established in these findings as well. In the full sample estimations, it is found that the estimated coefficients of the government consumption to GDP are negative and significant across all the estimations. Turning to the sample of countries with stock markets, it is also found that the coefficients are negative and significant at the conventional levels across all specifications. This therefore suggests that as expected, government consumption in Africa crowds out the private sector and therefore injures economic growth. This finding is largely in support of Barro (1990), Lin and Wu (2010), Furceri and Sousa (2011), Misati and Nyamongo (2011a, 2011b), and Nyamongo et al. (2012) studies which assert that government expenditure negatively impacts economic growth because of high and wasteful resource use. Other variables: human capital accumulation and gross investment to GDP ratio are found to be significant and positive as expected across all the specifications. This therefore suggests that human capital accumulation and investment are critical to the growth of countries in our sample. The positive contribution established here supports a host of studies such as Barro (1991), Mankiw, Romer, and Weil (1992), and Barro and Salai-Martin (1995). In the case of the positive effect of investment, our finding supports such studies such as Levine and Renelt (1992), Mankiw et al. (1992), and Barro and Sala-i-Martin (1995). Openness to trade (TR) has been recognised in literature as a major determinant of economic growth performance. In the full sample estimations, reported in Table 3, such a positive relationship is clear. However, such an evidence is significant in the fixed effects specifications. In the sample of countries with stock markets, the evidence is largely consistent with earlier studies which find that trade openness tends to support economic growth (see Barro, 1991, 1997; Misati & Nyamongo, 2011a; Sghaier & Abida, 2013). Inflation (INF) as used in this study is used as a proxy of macroeconomic instability. In this study all models have shown that inflation (INF) has a negative relationship with economic growth. In the full sample estimations, the estimated coefficients of inflation are found with mixed signs. In the fixed effects models (models 1–4) the estimated coefficients are found to be negative, as expected, and significant at the conventional levels. However, in cases where the random effects models are estimated, the estimated coefficients are mixed in signs and are not significant at the conventional levels of testing. The same results are obtained in the estimations for the sample of countries with stock markets. These findings therefore suggest that the evidence of the damaging effect of inflation on economic growth in Africa has started to weaken. This could be on the account of the low levels of inflation being witnessed in a number of countries in the region. This finding tends to support the 1960s view that inflation is not damaging (see Fountasa & Karanasos, 2007), but conflicts with Levine and Renelt (1992), Rousseau and Yilmazkuday (2009), Barro (1991), and Fountas (2010) studies which found inflation to have a negative effect on economic growth. In literature, the link between institutional development and economic growth has gained increasing attention among researchers (see Demirgüc¸-Kunt & Maksimovic, 1998; King & Levine, 1993; Knack & Keefer, 1995). This study uses political stability index and control of corruption index in a quest to capture the relationship between institutions and economic growth. The quality of institutions was investigated in the sample of countries with stock markets. This was not done for the full sample because it was anticipated that because the quality of institutions will be more useful in cases where we have more direct and measurable indicators of the stock market performance. As shown in Tables A.2, 4 and 5, the estimated coefficients of political stability index (PS) are positive and significant at the conventional levels of testing. This therefore suggests that countries that enjoy higher level of political stability tend to post good economic growth. Further evidence of the role of quality of institutions is shown using the control of corruption index, which also turns out to be positive as well but not significant.

E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

37

4. Summary of findings and conclusion This study investigates the role of stock market development on economic growth in Africa in the period 1980–2010 using a panel of 36 countries, of which 18 have stock markets, in Africa. It uses panel data econometrics in the analysis. The main findings of the study are as follows: (i) countries with stock markets tend to grow faster compared to those countries without stock markets, (ii) countries with higher levels of development and have stock markets tend to grow less faster compared to small countries with stock markets, (iii) human capital accumulation and investment are key to economic growth in the region, (iv) macroeconomic instability and government consumption are harmful to economic growth in the region and (v) the quality of institutions is key to growth performance as well. In the view of these findings it is recommended that countries in the region to grow they need to put in place policies to establish stock markets and foster their growth. Appendix A. See Tables A.1 and A.2. Table A.1 List of Stock markets in Africa. Stock exchange

Country

Founded

Bourse Régionale des Valeurs Mobilières Algiers Stock Exchange Botswana Stock Exchange Douala Stock Exchange Egyptian Exchange Bolsa de Valores de Cabo Verde Ghana Stock Exchange Nairobi Stock Exchange Libyan Stock Market Malawi Stock Exchange Stock Exchange of Mauritius Casablanca Stock Exchange Bolsa de Valores de Mozambique Namibia Stock Exchange Nigerian Stock Exchange Rwanda Stock Exchange Johannesburg Stock Exchange Khartoum Stock Exchange Swaziland Stock Exchange Dar es Salaam Stock Exchange Bourse des Valeurs Mobilières de Tunis Uganda Securities Exchange Lusaka Stock Exchange Zimbabwe Stock Exchange

Cote D’Ivoire Algeria Botswana Cameroon Egypt Cape Verde Ghana Kenya Libya Malawi Mauritius Morocco Mozambique Namibia Nigeria Rwanda South Africa Sudan Swaziland Tanzania Tunisia Uganda Zambia Zimbabwe

1998 1997 1989 2001 1883 1999 1990 1954 2007 1995 1988 1929 1999 1992 1960 2005 1887 1994 1990 1998 1969 1997 1994 1993

Listings 39 3 44 2 – – 28 50 7 8 40 81 – 223 4 410 – 10 11 56 14 16 81

Table A.2 Growth and stock markets: pooled model (based on countries with stock markets).

YPCR(−1) INF HUM GOV GI

1

2

3

4

5

6

7

8

9

−0.113** (−2.311) −0.019* (−1.904) 0.028*** (2.679) −0.123*** (−3.710) 0.097*** (4.366)

−0.142** (−2.408) −0.059** (−2.512) 0.058*** (4.265) −0.119*** (−3.277) 0.103*** (3.915)

−0.065 (−1.237) −0.30 (−1.315) 0.065*** (4.682) −0.107*** (−2.959) 0.083*** (3.254)

−0.287*** (−3.706) −0.021** (−2.050) 0.030*** (2.799) −0.116*** (−3.519) 0.109*** (4.726)

−0.097 (−1.384) −0.018* (−1.760) 0.026** (2.275) −0.119*** (−3.242) 0.102*** (4.469)

−0.346*** (−4.208) −0.075*** (−3.228) 0.056*** (4.194) −0.130*** (−3.640) 0.108*** (3.901)

−0.274*** (−3.479) −0.035 (−1.617) 0.067*** (4.803) −0.092*** (−2.657) 0.089*** (3.400)

−0.126 (−0.784) −0.011 (−0.342) 0.038** (1.926) −0.025 (−0.404) 0.081 (1.535)

−0.200 (−1.232) −0.023 (−0.680) 0.023 (1.138) −0.034 (−0.508) 0.077 (1.432)

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E. Ngare et al. / Journal of Economics and Business 74 (2014) 24–39

Table A.2 (Continued) 1

2

3

4

5

6

7

8

9

MC

−0.001 (−0.398) –

0.011** (2.310) –

−0.007 (−1.630) –

−0.001 (−0.263) –

–

–

DC

–

–

0.037*** (3.067) –

−0.000 (−0.013) 0.009 (1.304) –

0.003 (0.301) –

–

−0.005 (−1.227) 0.016*** (2.658) –

0.006 (1.197) –

ST

−0.002 (−0.436) −0.004 (-1.145) –

–

M2/GDP

–

–

–

0.022*** (3.141) –

PS

–

–

–

–

0.0007 (0.096) –

CORR

–

–

–

–

R2 NxT

0.21 322

0.355 216

0.382 223

0.231 320

TR

0.047*** (4.391) –

0.059*** (5.443) 0.032*** (4.609) –

–

–

–

–

–

0.218 304

0.393 198

0.436 205

–

0.046** (2.181) –

–

–

0.637 (1.387) 0.888 (1.297)

0.504 (1.128) 1.117 (1.610)

0.115 151

0.108 161

t-Values in parenthesis. YPCR = real income per capita, GI = gross investment to GDP, INF = inflation rate, HUM = Gross primary school enrolment rate, GOV = government consumption to GDP, TR = volume of trade to GDP; DC = Domestic credit to GDP, MC = market capitalisation to GDP, ST = stock market turnover ratio, M2/GDP = broad money supply to GDP, PS = political stability index, CORR = corruption control index. * ** ***

Significant at 10 percent. Significant at 5 percent. Significant at 1 percent.

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