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Economy  

Economic Growth and Share Returns

By HU JIANGYUN

DESPITE gloomy times for the world economy in the wake of the global financial crisis, China's economy continues to lead the world by growing at over nine percent per year. However, when it comes to its stock market, China has nothing to boast about. The nation's stock market did once sustain an upward trend for a short period of time. However, after that brief burst, prices nose-dived to almost where they had started from. Nowadays, the situation shows little sign of improving. The long-term depression of China's stock market has meant low dividend payments to shareholders. Some equity investors have suffered huge losses.

Many domestic and overseas scholars have examined share market returns in relation to the economic growth. The majority of these studies have shown that the two phenomena are in fact negatively correlated or occur independently from each other. This flies in the face of lay opinion.

Examining correlation between economic growth and share market returns involves a comprehension of the following two questions: what is the driving force of economic growth, and by which means and how well are economic returns on investment distributed?

A simple summing up of this as being negative does not accurately portray the full picture of the relationship between the two occurrences. A closer examination of the intrinsic link between them is needed. The capital market is the most important of all markets for factors of production in a well-oiled market economy. Sound capital markets can go a long way to promoting sustainable economic development. Investment, consumption and trade usually fuel an economy's growth. Investment can be divided into private and public – capital invested in the stock market falls into the category of private investment.

China's history of capital markets (and especially stock markets) is still quite short. Only after the goal of creating a socialist market economy system was announced did China begin to foster capital markets. The Shanghai and Shenzhen Stock Exchanges were both opened for business in 1990.

Economic growth arises from the productive interplay between various macro-economic factors, and is a reflection of changes in the momentum and scale of an economy. In reality, listed companies only account for a fraction of an economy's businesses, and development in and returns from the stock market only reflect the fortunes of listed companies. In short, economic growth represents the macro-economy while share market returns reflect certain micro-economic factors.

Nevertheless, capital markets do play a critical role in a country's economic development as they link investors with enterprises. When individuals plow more money into shares, companies gain access to more capital – liquidity increases and companies' competitiveness can be enhanced. Capital markets can be viewed as crucial intermediary links promoting the free flow and efficient distribution of various production factors, of which capital is only one.

But rapid economic growth doesn't necessarily result in rapid increases in people's income. Across-the-board income gains depend on how well income is distributed nationally. Likewise, share market returns also depend on other, non-capital-market-related considerations. The first of these pertains to indicators of company performance such as revenues and profits. A company's growth plan also plays a key role, as does its investment in research and development and marketing. Corporate governance issues, i.e. a company's management of the conflicting motives of shareholders, the board of directors and day-to-day company managers are of critical importance to a company's performance. This performance may also be influenced by supervising and regulatory departments and other laws.

China's capital markets have only been around for 20 years and in that time many problems have continued to crop up vis-à-vis market stability and supervision. Some critics have suggested that neither China's supervisory authorities nor listed companies themselves have been acting in a way that encourages long-term investments.

The interests of small shareholders are often suppressed. For instance, some companies have raised salaries of their top executives, who are usually also big shareholders, to unjustifiably high levels, thereby unfairly eating into the dividends of average shareholders. Moreover, in China the share prices of listed companies have been woeful indicators of companies' operating situations, their competitiveness or of capital market trends.

In recent years, China has introduced a series of macroeconomic policies especially designed to tackle the nation's finance industry challenges. Beijing has raised required capital reserves for financial institutions, adjusted interest rates and bank reserve ratios many times and has been improving the country's exchange rate mechanism. Nevertheless, income distribution policies have not lived up to the high hopes placed on them, and unequal income distribution has become a top concern for investors.

How to promote strong economic growth with solid share market performance is a much-debated issue among economists around the world. Developed countries have not really done any better than China in linking these two occurrences in positive correlation.

The Chinese government has been steadily continuing with its reform and opening-up drive, a part of which has been to nurture and improve China's capital markets and increase share market returns. The National Financial Work Conference held in January 2012 declared that China would further open up its financial sector by reducing market access barriers, improving macro-controls on finance, streamlining the coordination and productive interactions between monetary, financial, supervisory and industrial policies, and by further improving the exchange rate mechanism. It is predicted that China's capital markets will develop more healthily in the future.

By suring up their ability to weather challenges and crises and by raising their efficiency, China's capital markets should become better equipped to promote economic development, improve share market returns and bring better results to shareholders.

 

HU JIANGYUN is a researcher with the Development Research Center of the State Council.

VOL.59 NO.12 December 2010 Advertise on Site Contact Us