In the first part of this 2-part post, some best governmental practices to support economic growth were listed:  reasonable levels of taxation, regulation to support business competition, freedom from corruption, etc. [1].  These types of policies make a good deal of sense, but surely, some policies must be more important than others.  The question is how to determine which policies are key to growth.

In other words, why do the US Nasdaq, Taiwan, and Indian National and Bombay exchanges appear toward the top of this above diagram?  And, why are the Mexican, US, Indian, and Indonesian economies farther toward the right on the diagram?  Today’s post answers those questions.

Caveat:  DiscussingTerms does not provide formal financial advice, and readers are advised to consult a strategic, legal, or financial advisor prior to making any decision about investing.

Economic and Stock Market Databases

To look at the sources of growth and limitations on it, DiscussingTerms created two databases—one for national economies [2] and one for stock markets [3]:

• The database of national economies includes 146 nations for which economic data was widely available.
• The stock market database consists of 22 stock markets.
• The dependent variables are:
  • For the database of economies, % GDP growth in the most recent year.
  • For the stock market database, stock market % growth over the last 5 years.

The independent variables were chosen to represent a host of national economic factors—they included:

• Government:
  • Taxes as a percent of gross domestic product (GDP).
  • Democracy:  This the Economist’s Democracy Index.
  • Ease 2020:  This is the World Bank’s Ease of Doing Business Index.  This index was controversial due to some nations attempting to inappropriately influence their own ranking, and so it was discontinued in 2020.  DiscussingTerms included it as a point of comparison, cognizant both of its data being somewhat dated, and the methodological problems in the overall database.
  • Economic Freedom:  The Heritage Foundation and The Wall Street Journal’s Index of Economic Freedom which ranks the protections provide by governments for individual free enterprise activity.
  • Military spending as a percent of GDP.
  • Effectiveness Index:  This is the World Bank’s index of nations based on quality of public services, civil service, policy formulation and implementation.
• Economics:
  • GDP.
  • GDP per capita.
  • Immigration:  Net migration rate; if a country is losing population, this index becomes negative.
  • Imports:  Imports in millions of USD.
  • Exports:  Exports in millions of USD.
  • Population.
  • Foreign direct investment (FDI):  Foreign direct investment in millions of USD.
  • Unemployment rate.
  • Inflation rate.
  • Logistics Performance Index:  The World Banks’ index of performance for customs and transportation infrastructure.
• Society:
  • Honesty:  Transparency International’s Corruption Perceptions Index (CPI).  DiscussingTerms will be referring to it has “Honesty” because the highest scores go to countries with little corruption, like Finland with a score of 87—so it’s really an honest index.  (If you name it for what it is, that makes it easier to remember how it works.).
  • Global Competitiveness:  The World Economic Forum’s Global Competitiveness Index.  The index was discontinued in 2020.  It turns out that the index is highly correlated with the Honesty Index (Correlation Coefficient = 85% for the countries surveyed).  After statistical analysis, Honesty was found to be more useful for its ability to predict GDP growth than Global Competitiveness.
  • Women’s Inequality Index:  This is UN’s Gender Inequality Index (GII).
  • Education:  This is the Education Index published by the United Nations Development Program.
  • Gini:  The Gini ratio is a measure of the statistical wealth inequality within a country.
  • Patent Applications:  The number of patent applications by an individual country through the international patent system—a measure of scientific innovation.

Statistical multiple linear regression was used to determine which variables were important to economic growth [4].

GDP Growth Rate

Using multiple linear regression, six independent variables in the database of 146 national economies were found to be statistically significant in determining GDP growth percent [5,6]:

Some points to note about the table are:

• The confidence levels are high, so it is unlikely that the results occurred by chance.
• GDP per capita has a negative regression coefficient, indicating that as GDP per capita rises, economic growth is limited.  This common observation that developed industrial economies grow more slowly could be because:  1) high wages drive some companies to establish manufacturing operations in low wage countries or 2) workers in high wage economies are making choices to do less work, prioritizing other aspects of their lives such as family and leisure while slowing economic growth.
• Inflation has a negative regression coefficient, indicating that inflation acts as a drag on economic growth.  Economists tell us two contradictory things about inflation:  1) it limits economic growth by driving up interest rates and increasing uncertainty and 2) it increased economic growth by encouraging spending.  The negative regression coefficient shows that overall inflation is damaging to economic growth, and central bankers are correct in attempting to limit it.
• Effectiveness Index looks at quality of public services, civil service, policy formulation and implementation.  Because the coefficient is positive, it indicates that more effective government encourages economic growth.
• Democracy Index:  The Economist’s Democracy index rates governments based on pluralism, civil liberties, and political culture.  This coefficient is negative, so democratic governments have slower growth.  This may indicate that commitment to labor unions, environmental protection, and other regulations slows growth, but presumably those are things that most people want—so this may be the price we pay for democracy.
• Logistic Performance index (LPI):  The World Bank’s LPI has a negative coefficient.  On the surface, one would think that better ports and roads increase growth, but it may be that higher LPI is correlated with variables that slow growth (like high per capita GDP and democracy).  This is a hazard of linear regression—some variables with low P values are merely correlated, rather than causative.  At the very least, this observation is interesting because many would expect a strongly positive coefficient—the negative coefficient could signal that even in economies with low LPI, businesses are skilled at compensating for poor logistics.  Perhaps, strategies such as building dedicated private roads when national road networks are filled with potholes allow businesses to continue to grow.
• Unemployment has a negative regression coefficient, indicating that full employment is a useful goal in maximizing economic growth—it is difficult to build a vibrant economy in which there are two populations (the “haves” and the “have-nots”).  This economic observation undergirds the rationalization of investment in education, public health, and infrastructure—to bring up the entire nation and avoid the haves supporting the have-nots in perpetuity.

The model predictions and residuals (i.e., model prediction minus actual value) appear below.  As can be seen from the figure, the residuals are quite small with a few exceptions—on average the residuals have a magnitude of 19% of the model prediction.  A small number of countries (for example, India and Niger) are what could be called “positive” deviations, with growth increases significantly greater than the regression model predicts.  Others (for example, Argentina, Ecuador, and Haiti) are what could be called “negative” deviations, with growth increases significantly less than the regression model predicts.

Stock Market Growth Rate

In suggesting that democracy may not always be compatible with the highest levels of economic growth, the last section was a little disappointing.  This next section is more encouraging for democracy.  Applying multivariable regression to stock market growth [3, 8], two separate independent variables were shown to be statistically significant:

Some points to note about the table are:

• The confidence levels are statistically significant, so it is unlikely that the results occur by chance.  Also, the coefficients are high (as high as the highest coefficients in the 146-nation economic database statistical analysis), so these are strong effects.
• Democracy Index has a positive coefficient which presumably shows that innovators, entrepreneurs, and investors like to create new companies in nations with a degree of transparency and rule of law.
• Military Spending has a positive coefficient, indicating that stock market companies benefit from military spending.  It’s not an effect measurable in increased growth of the overall economy in the 146-nation database.  Perhaps, stock market listed companies are better able to position themselves to benefit from military contracts for logistics and civilian support services to the military.  An important caveat is that actual military conflict is a huge waste of national resources—having a bunch of shiny tanks may help a country’s stock market, it is generally a terrible mistake to employ the tanks in battle because wars quickly spin out of control destroying lives and national economies.

The model prediction and residuals (i.e., model prediction minus actual value) appear below:

Some points to note about the figure are:

• The model captures the general trends for the market growth rates, though residuals are relatively higher compared to the model of 146 national economies.  The magnitude of the residuals is on average 55% of the model prediction.  Still, the model is quite good for a two-variable model, attempting to capture a complex behavior across stock markets.
• India, Taiwan, and the US Nasdaq markets represent significant “positive” deviations due to factors that are not captured by the model.  Stock markets like Philippines, Thailand, and the UK are significant “negative” deviations.  Comparison of governmental actions supporting competitive markets in the positive and negative deviation countries would likely be enlightening.  Undoubtably, the Indian, Taiwan, and US Nasdaq markets benefit from such legislation and regulations.  If these features are quantifiable, an improved model could be generated which reduced the residuals.
• “Delisting” is a complex issue that undoubtably has an effect on stock market returns [9].  In delisting, high performing companies are sold to private equity, either before or after becoming public companies.  It is noted here as being relevant and maybe the subject of a future post on DiscussingTerms.

So, What About All Those Other Variables?

The variables which strongly affect growth were the focus of the discussion above, but what about all the other variables that did not rise to statistical significance?  Here are some thoughts:

• GDP growth is not the only motivation to undertake a national program.  Democracy, economic freedom, improved roads and ports, reduced corruption, and increased numbers of useful inventions are ends in themselves that do not need to be justified based on economic arguments.  They can be justified based on:  1) how democracy increases a population’s experience of human rights and equality, 2) how economic rights increase individuals’ ability to provide for their families and communities, 3) how functioning transportation networks offer citizens a greater variety of goods and services, 4) how corruption destroys people’s sense of solidarity and faith in justice, and 5) how investment in higher education leads to not only increased numbers of patents, but to improvements in society by application of science, engineering, and medicine to the problems that confront a nation.  Not everything can be measured out in dollars—though economic measures are important.
• Taxes are a topic that receives frequent attention in the context of economic growth.  The fact that taxes did not reach statistical significance is likely an indication of the limited efficiency of taxation as a mechanism of national investment.  Investment in education, ports and roads, and other sensible national investments undoubtably boosts the GDP, but other uses of taxes can be a drag on the economy (such as continued spending on programs that the government has already terminated [10] and spending on military conflict).

Conclusions

Some of the key variables to support economic and stock market growth include:  low inflation, government effectiveness, low unemployment, and democracy.  These are all values that can be included in national legislative and regulatory priorities.  Other variables undoubtably have a positive effect, though one that is harder to measure.  These include:  support for education, public health, and support for infrastructure, as well as engagement with the world economy and encouragement of investment.

[1] Gallant, S.R.  “Economic Development and Stock Markets (1 of 2),” June 27 (2024).  discussingterms.com/2024/06/27/economic-development-and-stock-market-growth-part-1/

[2] Table of 146 economies:

[3] Table of stock markets:

[4] Orlov, Michael L.  “Multiple Linear Regression Analysis Using Microsoft Excel,” Chemistry Department, Oregon State University (1986).

[5] GDP Growth model statistics for 146 economies:

[6] The data was scaled to values between 0.0 and 1.0 prior to regression.  This allows the coefficients to be more easily compared.  Scaling was performed using the formula:

Scaled data = (Original data – Min value)/(Max value – Min value)

[7] Gupta, S., Davoodi, H., and Alonso-Terme, R.  “Does Corruption Affect Income Inequality and Poverty,” IMF Working Paper, May (1998).

[8] Stock market model statistics:

[9] Ljungqvist, A., Persson, L., and Tåg, J.  The Incredible Shrinking Stock Market: On the Political Economy Consequences of Excessive Delistings,” European Corporate Governance Institute (ECGI) – Finance Working Paper No. 458/2016, IFN Working Paper No. 1115

[10] Congressional Budget Office.  “Expired and Expiring Authorizations of Appropriations for Fiscal Year 2022,” August 2022.  (www.cbo.gov/system/files/2022-08/57760-EEAA.pdf)

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post Dynamics Underlying Economic Growth (2 of 2) appeared first on discussingterms.com.

DiscussingTerms has been thinking about economic growth as economies expand in the post-Covid-19 world.  Clearly, some things are the same:  people still need homes, durable goods, and food.  Other things are changed, perhaps forever:  remote work has become more common, and the role of city centers in the economy is being questioned.

In today’s post, DiscussingTerms takes a step back to look at economic metrics and consider what they mean for national economies and for individual investors. This is the first of a 2-part series.

Caveat:  DiscussingTerms does not provide formal financial advice, and readers are advised to consult a strategic, legal, or financial advisor prior to making any decision about investing.

Background

Economic development and stock market growth both constitute the outcomes of negotiation processes.  In the case of national economic development, gross domestic product (GDP) growth is supported by four types of activities:

• Government and society:
  • Reasonable levels of taxation, regulation to support business competition, freedom from corruption
  • Maintenance of utilities, highways, ports, and transportation services
  • Support of an advanced education system, participation of women in the economy
• Regional diplomacy:  Low military spending, absence of military conflict
• Investment:  Private sector investment from local investors and/or international investors
• Markets:  Engagement in the world economy

In the case of business growth of public and private companies, increased enterprise value is supported by the sensible national policies listed above, as well as by three additional factors:

• Entrepreneurs:  A community of business founders and leaders who can develop and execute business strategies to deliver products and services their clients want and to deliver returns to their investors.
• Access to Capital:  Banks and investors (international investors, private equity, angel investors, retirement funds, brokers, and individuals) provide the funds for businesses to establish themselves and expand.
• Workers:  Businesses need managers, scientists and engineers, financial specialists, regulatory staff, logistics personnel, manufacturing and maintenance staff, and others with the training and experience to allow companies to achieve their strategic goals.

Data on Economic Growth

DiscussingTerms was reviewing the data on stock market growth and comparing it with national GDP growth—some interesting trends popped out [1].  Here is a graphical presentation of the data:

Some points to note about the graph:

• On the vertical axis, appears stock market index growth percent for 24 major stock markets.  The specific stock market indices are noted in the table which appears as a note [1].
• On the horizontal axis, appears GDP growth percent for the specific nation in which the stock market is located.  For instance, Toronto Stock Exchange is located in Canada and seen on the plot near Switzerland and Saudi Arabia.  Most countries have a single stock exchange, but a few have more than one.
• The red diagonal dashed line is the line of equal stock market and GDP growth.  So, markets which appear above the line are growing faster than the GDP of their country, and the markets which appear under the line are growing slower than the GDP of their country.
• The two red sold lines are at the 100% growth limits.  Economies to the left of the vertical red line (Japan, South Africa, and South Korea) shrank over the last 5 years.  Stock markets below the horizontal red line (Hong Kong, Thailand, Philippines, Malaysia, and China (SSE)) lost value over the last 5 years.

One way of thinking about this plot is that stock markets and overall economies do not necessarily move in synchrony.  Stock markets which appear above the diagonal dashed line are pulling up overall economic performance, while stock markets appear below the dashed line hold back economic growth.

Stocks Which Promote Growth

Let’s consider some of the stocks that drive growth in markets:

• Nasdaq is an exchange that has had tremendous growth (221%) over the last 5 years.  Leading Nasdaq stocks include:  Microsoft, Apple, NVIDIA, and Amazon are key stocks in e-commerce and technology with strategies to enter AI and other growth areas of the economy.
• Important companies in both the Bombay and National stock exchanges are:  Reliance Industries (a conglomerate with interests in petrochemicals, as well as telecommunications), Tata Consultancy Services (a major IT services company), HDFC Bank (a major Indian bank), and ICICI Bank (another major Indian bank).

These companies are dynamic—seeking to expand and develop new business strategies to allow long term growth.  This type of company contrasts with companies that are typically thought of as low growth companies—companies caught in older stagnant areas of the economy, without strategies for competing beyond national borders, engaging in “rent seeking behavior” to maintain revenue.

Middle Class Investment

Wealthy families will always have options for what to do with their capital—including investing overseas.  But, middle class families often have fewer options.  Let’s contrast two national economies, one with rapid growth in its stock market and one without rapid growth in its stock market.  In both cases, middle class families may be able to earn more than their daily requirements for food, lodging, clothing, healthcare, education, and other immediate needs.  But, what they do with their surplus capital differs markedly:

In the case of a rapidly growing stock market, a virtuous circle results with middle class investments helping to power economic growth.  In the case of a slow growing stock market, assets of middle-class families may be trapped in dodgy low growth investment schemes.  Certainly, some investments outside the stock market can provide growth—family businesses undoubtably power dynamic local economies in low and high per capital GDP countries—but, the investment options are significantly narrower.

Conclusions

In countries like the United States, Taiwan, India, Japan, South Africa, Germany, and others, the stock markets are lifting up the overall economy.  This is an important dynamic to nurture which governments can encourage through best practices in legislation and regulation, intelligent diplomacy, and economic policy.

[1] Table of stock market data:

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post Economic Development and Stock Markets (1 of 2) appeared first on discussingterms.com.