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Journal of Economics and Sustainable Development www.iiste.org
ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online)
Vol.5, No.15 2014
181
The Effects of Stock Market on Economic Growth and
Development of Nigeria
Popoola, Oladayo Timothy
Department Of Economics, Ahmadu Bello University, Zaria, Nigeria
Abstract
This research study seeks to examine whether the stock market promotes economic growth and development in
Nigeria. The stock market is a common feature of a modern economy and it is reputed to perform some
necessary functions, which promote the growth and development of the economy.
To achieve this objective, Ordinary Least Squares regression (OLS) was employed using the data from 1984 to
2008. The results indicated that there is a positive relationship between economic growth and the stock market
development variables used. With almost 95.77 percent R-squared and 94.92 percent adjusted R-squared, the
result showed that economic growth in Nigeria is adequately explained by the model for the periods of 25 years
(i. e. from 1984 to 2008). By implications 95.77 percent of the variation in the growth of economic activities is
explained by the independent variables.
The results of the research, established positive links between the stock market development and economic
growth, suggests the pursuit of policies geared towards rapid development of the stock market. Also, all sectors
of the economy should act in a collaborative manner such that the optimum benefits of linkages between stock
market and economic growth can be realized in Nigeria.
Keywords: Nigeria, Stock Market, Economic Growth
1.0 INTRODUCTION
The determination of the overall growth of an economy depends on how efficiently the stock market
performs its allocative functions of capital. As the stock market mobilizes savings, concurrently it allocates a
larger proportion of it to the firms with relatively high prospects as indicated by its rate of returns and level of
risk. The importance of this function is that capital resources are channeled by the mechanism of the forces of
demand and supply to those firms with relatively high and increasing productivity, thus enhancing economic
expansion and growth (Alile, 1997). Mobilization of resources for national development has long been the
central focus of development economists. As a result, the centrality of savings and investment in economic
growth has been given considerable attention in the economic literatures (Rostow, 1960; Aigbokan, 1995;
Demorgue-Kent and Levine, 1996). The stock market enables governments, and industries to raise long-term
capital for financing new projects, and expanding/modernizing 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.
The existing literature clearly shows that developed economies had explored their stock market through
resources mobilization to enhance economic growth and development (Demorguc-Kunt and Levine, 1996). This
is not the case in Nigerian economy where emphasis was placed on money market with little consideration for
capital market (Nyong, 1997). And, with the increasing size and liquidity of stock markets, their relationship to
economic growth is worth examination. There are two schools of thought: one holds that stock market
development is important for economic growth, the other holds that it is not. Greenwood and Smith (1996)
showed that stock markets lower the costs of mobilizing savings and facilitate savings thus promoting economic
growth. Bencivenge et al. (1996), Levine (1996), and Levine and Zervos (1997), argued that stock market
liquidity plays important role in economic growth. On the other hand, Demirgue-Kunt and Levine (1996) pointed
out that increased liquidity may reduce growth via the reduction in saving rates due to uncertainty about savings
and adversely affect corporate governance on account of investors’ myopia about market liquidity. This research
therefore tends to assess the stock market development and economic growth by examining the long-run
relationship between the two variables.
In an extensive work done by Golden Sachs in 2001, he identified Nigeria as one of the economies in
Africa that has the potential of becoming one of the 20 largest economies by year 2020 and that Nigeria poised
to emerge as part of the next eleven “N11” economies after the BRIC (Brazil, Russia, India, and China). To
achieve the vision 2020, Nigeria must maintain an annual average growth rate of 12.4% over the next 10 years
and translate the growth into meaningful development.
The stock market is to serve as the driver and catalyst to achieving the vision and to help attain full
diversification of the economy. The idea is to strengthen the domestic financial market by developing
competence and skills for financial services industry, improves access to finance and build an integrated
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Journal of Economics and Sustainable Development www.iiste.org
ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online)
Vol.5, No.15 2014
182
infrastructure for the financial industry. Create a vibrant capital and stock markets and help more Nigerian make
more livings through the markets.
The rest of the paper is structured as follows: a conceptual and empirical overview of stock market
development – meaning and variable; economic growth, role of stock market in Nigerian Economy, how to raise
capital on the stock market are discussed in section two. Section three provides the data source and the
methodology. Section four presents and discusses the results. Conclusion and recommendations are contained in
the last section.
2.0 CONCEPTUAL AND EMPIRICAL OVERVIEW
2.1 CONCEPTUAL ANALYSIS OF STOCK MARKET AND ECONOMIC GROWTH
2.1.1 MEANING OF STOCK MARKET:
Simply put, stock market is a market place where buyers and sellers meet to exchange a unique intrinsic
commodity – shares, stocks, bonds – for the purpose of raising long-term capital for the modernization and
expansion of projects by companies, governments, and allied parastatals. Stock market is different from a stock
exchange, which is an entity (a corporation or mutual organization) in the business of bringing buyers and sellers
of stock together. Those who invest their monies in buying shares get in return share (or stock) certificates as
evidence of their ownership of some proportion of the issuing companies as well as get dividends.
2.1.2 STOCK MARKET VARIABLES:
Market Capitalization:
Market Capitalization is the total value of listed shares of companies in the stock market. Market Capitalization
Ratio (MCR) measures the value of listed shares divided by GDP.
Total Value of Shares Traded:
Value of Shares Traded is the total value of shares traded in the stock market. Total Value of Shares Traded ratio
(STR) measures total value of shares traded on the stock market exchange divided by GDP.
Turnover Ratio:
This ratio equals the value of total shares traded divided by market capitalization.
2.2.1 ECONOMIC GROWTH
Fundamentally, economic growth is an increase in the productive capacity of an economy, that is, an
increased in the level of output, which can be achieved when all the factors of production are fully employed.
McGraw Hill dictionary of modern economics defines economic growth as an increase in a nation’s goods and
services. Growth is therefore discussed in relation to real output. GDP is the total monetary value of goods and
services produced within a country in a given period, usually a year. On the over hand, GNP is the total
monetary value of goods and services produced and earned by or transferred to resident nationals of a country.
NNP is obtained when the value of depreciation is deducted from the GNP. In determining by how much output
produced per person expands over time, GDP must be corrected for population increases. This gives the GDP
per capita.
2.2.2 ECONOMIC GROWTH DETERMINANTS
There are three main determinants of a country’s rate of economic growth, which are as follows: (1)
Labour Force Growth; (2) Growth of the capital stock and (3) Technical progress.
A growing labour supply may enable a community to produce bigger combinations of goods and
services and so bring about an outward shift in its production possibility frontier. This, in turn can lead to an
increase in output per head and hence a potential improvement in social welfare. The growth of the labour force
depend on, the natural increase in the population, international migrations and the participation rate. The growth
of the capital stock on the other hand, is determined by an expansion of a country capital stock through net
investment. This expansion increases the country’s stock of productive resources and so represents another
possible source of economic growth.
The third determinant of economic growth is technical progress. It improves the quality of the capital
stock of labour force and this is another possible source of economic growth, which takes the form of improved
techniques of production, improved machinery, invention or improvements in education. The effect of technical
progress is to raise the productivity of the stock of capital and labour. In Nigeria, the three determinants are all
used to determine the economic growth or well-being.
2.3 THEORETICAL FRAMEWORK
HISTORICAL GROWTH: Since the Industrial Revolution a major factor of productivity was the substitution
of energy for human and animal labour. By the late 19
th
Century, Power and machinery were creating over-
production which eventually caused a reduction of the hourly work done. Mass production of the 1920s created
over-production, which was one of several causes of the Great Depression of the 1930s economic growth
resumed later aided by demand for entirely new goods and services, creating enough new demand to stabilize the
work done.
CLASSICAL GROWTH THEORY: The modern conception of economic growth began with the critique of
Journal of Economics and Sustainable Development www.iiste.org
ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online)
Vol.5, No.15 2014
183
Mercantilism especially by the Physiocrats. The theory of Physiocrats was that productive capacity, itself,
allowed for growth and the improving and increasing capital to allow that capacity was “The Wealth of Nation”.
David Ricardo argued that trade was a benefit to a country, because if one could buy good more cheaply from
abroad, it meant that there was more profitable work to be done here.
NEOCLASSICAL GROWTH MODEL: The notion of growth as increased stocks of capital goods was
codified as the Solow-Swan Growth Model, which involved a series of equations which shows the relationship
between labour-time, capital goods, output, and investment and accordly, the role of technological changes
became crucial. The model which was the first attempt to model long-run growth analytically. This model
assumes that countries use their resources efficiently and that there are diminishing returns to capital and labour
increases. Important predictions were: (i) increasing capital relative to labour creates economic growth; (ii) poor
countries with less capital per person will grow faster because each investment in capital will produce a higher
returns than rich countries with ample capital; (iii) because of diminishing returns of capital economies will
eventually reach a point at any increase in capital will no longer create economic growth; (iv) countries can
overcome steady state and continue growing by investing new technology; and (v) output per-capita depends on
the rate of savings.
HARROD-DOMAR GROWTH MODEL: The Harrod-Domar Growth Model gives some insights into the
dynamics of growth. The equilibrium growth rate of output is equal to the ratio of the marginal propensity to
save and the capital-output ratio. E.g. [g = ] where, g is the rate of output and productivity in the economy; s
the marginal propensity to save and the capital-output ratio. This is very important, because it tells us how the
economy can grow such that the growth in the capacity of the economy is matched by the demand for the
economy’s output.
2.4 EMPIRICAL LITERATURE REVIEW
Hicks (1969) argued that the industrialization process in England was promoted by the development of
the financial sector which increased the access of the government and people to funds that were used to finance
capital projects which led to the development of the economy. Levine (1991) argued that developed stock
market reduces both liquidity stock and productivity stock of businesses. This in turn increases the access of
businessmen to investment funds as well as enhancing the production capacity of the economy, thereby leading
to higher economic growth. Bartov (1992) highlighted the relationship that exists between stock prices and
expected earning using the earnings expectation models to predict expected earnings.
Atje and Jovanoic (1993) present a cross-country study of stock market and economic growth over the
period 1980-1988. They found a significant correlation between average economic growth and stock market
capitalization for forty countries. World Bank (1995) opined that stock market development does not merely
follow economic development, but provides the means to predict future rates of growth in capital, productivity
and per capita GDP. The conclusion of the Bank is that increases in banking and stock market development lead
to increases in real per capita growth. Levine and Zervos (1996) examines whether there is a strong empirical
association between stock market development and long-run economic growth. The study used pooled cross-
country time-series regression of forty-one countries from 1976 to 1993 to evaluate this association. The study
toe the line of Demirgue-Kunt and Levine (1996) by conglomerating measures such as stock market size,
liquidity, and integration with world markets, into index of stock market development.
Irving (2004) considered the links between stock exchanges and the overall socio-economic
development to be tenuous, non-existent or even harmful. He advised African countries not to devote further
scarce resources and efforts to promoting stock exchange, since there are many wealthier problems to address in
African: high poverty levels, inadequate social services and undeveloped infrastructure. Adam and Sanni (2005)
examined the role of stock market in Nigeria’s economic growth using Granger-Causality test and regression
analysis. They discovered a one-way causality between GDP growth and market capitalization. They advised
that government should encourage the development of the capital market since it has a positive relationship with
economic growth. Obamiro (2005) investigated the role of the Nigerian Stock Market in the light of economic
growth. He reported that a significant positive effect of stock market on economic growth and thereby suggested
that government should create more enabling environment so as to increase the efficiency of the stock market,
and to attain higher economic growth. In the light of the above arguments, it has become very necessary to
examine the importance which stock market play on economic growth and development of Nigeria.
2.5 ROLE OF STOCK MARKET IN NIGERIAN ECONOMY
Briefly, the Nigerian Stock Exchange plays the following roles within the economy: (a) It provides a
platform for raising long-term capital for expansion and modernization of companies and government investment
activities; (b) It nurtures and provides capital to small and medium-scale enterprises via its Second-tier Securities
Market; (c) It is a means of allocation the nation’s real and financial resources, between various industries and
companies; (d) It provides liquidity for the conversion of investments into cash; (e) It is a measure of confidence
in the economy and serves as an important leading index of economic activity; (f) It provides industrial
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