The Role of Stock Market Development in Economic Growth: Evidence from Some Euronext Countries

In this article we explore causality relationship between stock market and economic growth based on the time series data compiled from 5 Euronext countries (Belgium, France, Portugal, Netherlands and United Kingdom) for the period 1995:Q1 to 2008:Q4. Granger causality test was used to find causality relationship between stock market proxies through market capitalization, total trade value, turnover ratio and economic growth (GDP and FDI). Causal relations were investigated for each country. The results of the study suggest a positive links between the stock market and economic growth for some countries for which the stock market is liquid and highly active. However, the causality relationship is rejected for the countries in which the stock market is small and less liquid.


Introduction
The link between financial stock market and economic growth becomes the field of research more and more explored. Luintel and Khan (1999) explored bi-directional causality test between financial development and economic growth; they found that the financial stock market affects economic growth. Levine and Zervos (1996a, b), in their research on the relationship between the stock market development and economic growth provided empirical evidence on the major theoretical debates about the linkages between stock markets and long-run economic growth using data on 41 countries from 1976 to 1993. Their result showed that stock market liquidity is positively and significantly correlated to current and future rates of economic growth, capital accumulation, and productivity improvements, even after controlling for economic, political and other factors. The main question is: Does Euronext stock market affects European countries' economic growth? According to what has been found in the literature, we can answer by positive correlation between financial stock market and economic growth measures by GDP and FDI (Rajan and Zingales, 1998;Bencivenga, 1991;Spears, 1991;Wachtel, 2002;Trabelsi, 2002;Rioja and Valev, 2003;Paudel, 2005;Demetriades and Hussain, 1996).  measure stock market development along various dimensions: aggregate stock market capitalization to GDP and the number of listed firms (size), domestic turnover and value traded (liquidity), integration with world capital markets, and the standard deviation of monthly stock returns (volatility). The results provide a strong and significant relationship between stock market development and economic growth. Numerous studies have been analyzing the role of stock markets in economic growth; most of them have focused on individual stock market, and some on merged market. This paper we will focus theoretically and empirically on the role of Euronext stock markets on the economic growth of the European countries (Belgium, France, Netherlands, Portugal and the United Kingdom). Section I presents a theoretical and empirical overview of stock market development and economic growth, while section II describes the Euronext stock market and section III provides an econometric assessment for the role of Euronext stock markets in economic growth during the period 1995-2008. Levine (1991) found a positive relation between financial stock market and economic growth by issuing new financial resources to the firms. Filer et al. (1999) examined stock market-growth nexus and exhibited positive casual correlation between stock market development and economic activity. Spears (1991) reported that in the early stages of development, financial intermediation induced economic growth. The financial stock market facilitates higher investments and the allocation of capital, and indirectly the economic growth. Sometimes investors avoid investing directly to the companies because they cannot easily withdraw their money whenever they want. But through the financial stock market, they can buy and sell stocks quickly with more independence.  measured stock markets development along with different magnitude and have suggested strong statistically significant relationship between initial stock market development and subsequent economic growth. An efficient stock market contributes to attract more investment by financing productive projects that lead to economic growth, mobilize domestic savings, allocate capital proficiency, reduce risk by diversifying, and facilitate exchange of goods and services (Mishkin 2001;and Caporale et al, 2004). Stock market liquidity is still a reliable indicator of future long-term growth (Levine, 1996). Wachtel (2002); Trabelsi (2002); and Rioja and Valev (2003) have shown empirically that the financial system has a significant role and provides an important contribution to economic growth. Many other researchers argue that there is a positive correlation between financial development and economic growth (Goldsmith, 1969;Shaw, 1973;McKinnon, 1973 andKing &Levine, 1993). They found that financial development is an important determinant of future economic growth of a country. Atje and Jovanovic (1989) found also a significant impact of the level of stock market development and bank development. Rajan and Zingales (1998) argued that stock market size is correlated to growth of financial dependent firms.  and Bencivenga (1991) believe that more liquid markets can create long-term investment and hence economic growth through lower transaction cost. Similarly, Atje and Jovanic (1993) concluded that stock markets have long-run impacts on economic growth. Paudel (2005) states that stock markets, due to their liquidity, enable firms to acquire much needed capital quickly, hence facilitating capital allocation, investment and growth. Luintel and Khan (1999) found also bi-directional causality relationship between financial development and economic growth in the sample of 10 countries.

Financial stock market's impact on the economic growth: theoretical and empirical overview
Further,  found strong statistically significant relationship between stock market development and economic growth. The result of Filer et al. (1999)' studies show that there is positive causal correlation between stock market development and economic activity. Rajan and Zingales (1998) argued also that stock market size is correlated to growth of financial dependent firms so that stock markets can give a big boost to economic growth (Levine, 1996;Garcia and Liu, 1999). Mauro (2000) concluded that stock market is a stable predetermining factor of economic growth in emerging economies.  showed the positive effect of the financial market on the economic growth in the figure 3. The data analyzed in this paper consists of economic and financial time series of some European countries. These include Gross Domestic Product (GDP) in current USD, Foreign Direct Investment (FDI), stock Total Traded Value (TTV), Turnover Ratio (TR) and Market Capitalization (MC). Stock market development is a multi-dimensional concept. It is usually measured by stock market size, liquidity, volatility, concentration, integration with world capital markets, and the legal rules (regulation and supervision) in the market (Garcia and Liu, 1999). Markets that are liquid should be able to handle heavy trading without large price swings (Levine, 1996). Data have been collected from Word Development Indicator Website. The data set of the study consists of 14 annual observations covering 1995 to 2008. In order to obtain more data for our statistics analysis, we used Boot, Feibes and Lisman (1967) derivative method to change annual data to quarterly data, using the following matrix:  Granger (1969) for testing statistical causality between stock market development and the economy growth. Granger causality may have more to do with precedence, or prediction, than with causation in the usual sense. It suggests that while the past can cause/predict the future, the future cannot cause/predict the past.

Euronext Stock market
The hypothesis of interest is: H0: Stock market does not Granger-causes economic growth.
According to Granger, X causes Y if the past values of X can be used to predict Y more accurately than simply using the past values of Y. In other words, if past values of X statistically improve the prediction of Y, then we can conclude that X "Granger-causes" Y.
The hypotheses are tested in the context of VAR of the following form: (1) Where, EG is economic growth proxies by real GDP and FDI, and SM is stock market proxies by market capitalization trade value and turnover ratio. To test the hypotheses, the restricted F-test is applied, which is given by: Where, m is number of lagged terms and k is the number of parameters and RSSR and RSSUR are residual sum of squares of restricted and unrestricted models respectively. The appropriate lag length is established by Akaike Information Criterion (AIC) and Schwarz Information Criterion (SIC).

Results interpretation
The results suggest Granger causality relationship between financial market proxies and GDP for France and United Kingdom at 5% level of significance. It is also found that the market capitalization "Granger causes" Foreign Direct Investment at 5% level of significance. Further the null hypothesis that the stock market development does not "Granger cause" economic growth is rejected at 10% level of significance. The results in tables 2, 3 and 4 indicate that the stock market development does significantly "Granger cause" economic growth in France and United Kingdom. Furthermore, it is found that stock market development does "Granger cause" but not significantly the economic growth of Netherlands. Nevertheless, our findings are negative for Belgium and Portugal, thus, even with the fact that must studies have shown, positive relationship between stock market development and economic growth, we believe that the results are only valuable for develop and liquid financial stock market. The proof has been shown in our results by the case of Belgium and Portugal. The results corroborate with existing empirical works , Mauro 2000, De Gregorio and Guidotti 1995, G.RSOY, C. T., Al-Aali, H. 2000. Bencivenga et al. (1996) maintain that equity markets can increase the average productivity of capital and, in turn, positively affect growth by decreasing liquidity costs.

Conclusions
The paper makes a modest contribution on the role of stock market development on economic growth in some Euronext countries for the period from 1995:Q1 -2008:Q4. The results of the study suggest that the stock market growth and economic growth have long-run relationship. It reveals that the stock market liquidity do help to improve the future economy. The findings are consistent with existing theoretical framework as illustrated by several authors about the relationship between financial market development and economic growth. Nowbutsing (2009) also found that stock market development is an important ingredient for growth in Mauritius since the stock market gives a general idea of an economy health. However, the stock market development effect is not found significant for causation of economic growth in Belgium and Portugal. The causality has been observed only in the countries where the stock market in significantly active and highly liquid. More precisely, the causality runs from stock market proxies to economic growth shows a significant relation between market capitalization, total trade value and turnover ratio on the GDP and FDI. The funds raised by the corporate from the financial markets during the study period thus played an important role for the appreciable growth registered by the Euronext countries economy. Thus, the finding that changes in economic growth is "Granger caused" by changes in financial stock market proxies is important in the sense that it supports to justify the leading role of the stock market in determining economic activities even in developed countries like France and United Kingdom. This study has been constrained because the causality used in the study is "Granger causality". Thus, the need of further research is obvious in order to get more evidence about the bi-directional relationship between the stock markets and economic growth in Euronext countries.