Impact of Capital Market on Economic Growth in the United Kingdom
Background
According to Parvez, Sarwar, Hoq & Chowdhury (2017), a capital market acts as a source of financing for companies all over the world. In addition, capital markets are markets that facilitate the buying and selling the instruments of equity and debt. In short, the capital market is a market where long-term debt or equity are bought and sold. The Committee on the Global Financial System (2019) economic growth can easily be financed by a developed and deep capitals market. Apart from that, they also influence the financial stability as well as the transmission of monetary policy.
Access to finance gives companies to grow their operations. This is because they can invest in new technology, open up new locations, invest in research and development to produce new and innovative products, etc. It is important to make the connection between the growth and success of companies and the economic growth of a country. When companies grow, they employ more people hence reducing the rate of poverty in the country. It also increases the country’s gross domestic product (GDP). These are factors that are necessary for an economy to grow. As such, one can easily assume that the more organizations have access to the capital markets, the more economic growth a country experiences.
Research Objectives
- To determine the factors that lead to economic growth in a country
- To determine the role played by capital markets on the growth of a country’s economy.
Research Questions
What are the effects of capital markets on the economic growth of the United Kingdom?
Literature Review
This section takes an in-depth analysis of scholarly works that surround the topic. It takes a look at the theories that inform the research topic. This includes the capital markets theory and the theory of economic growth. This will help better understand the research topic and help during the interpretation of data.
Capital Markets Theory
According to Hodnett & Hsieh (2012), the capital markets theory is important as it forms the foundation for the development of financial asset pricing models. This theory consists of various models such as the Capital Asset Pricing Model (CAPM) and the Markowitz model. CAPM was developed by William Sharpe in the mid-1960s. Generally, the model tries to explain the relationship that ought to exist between the expected returns for various securities such as stocks and the risk associated with them in terms of means and standard deviations. It acknowledges that no matter how much one’s investments are diversified, there will exist some level of risk. As such, investors will seek to get a rate of return on their investments that will cover such risk. Therefore, the capital asset pricing model helps investors calculate the risk that an investment carries as well as the expected return on investment. According to Rossi (2016), the model helps provide a framework for understanding the relationship between the expected return on investment and the risks associated with investing.
This model proposes that there are two types of risk: Systematic risk and unsystematic risk. Systematic risk is the market risk. These are the general dangers associated with investing. These risks cannot be overcome by diversifying one’s investments. These risks include wars, interest rates, recessions, etc. On the other hand, unsystematic risk is the risk that is related to specific stocks. When referring to unsystematic risk, the stock’s returns are not affected by what generally goes on in the market. Therefore, this type of risk can be reduced by diversifying one’s investments. For investors, this model presents a very simple idea that they ought to earn more when investing in riskier stocks.
However, this model makes very many significant assumptions. First, it assumes that all investors are efficient investors. As such, they are most likely going to position themselves on the efficient frontier. The theory also assumes that the inflation rate is fully anticipated and accounted for. In other cases, the inflation rate may also be absent hence resulting in no changes in the tax rate. According to Fama & French (2003), this model also assumes that investors are risk-averse. Therefore, when they are choosing the portfolios in which to invest, they only lookout for the variances and the mean to determine their investment’s return.
Economic Growth Theory
There are three theories that try to explain the economic growth and development in a country. These are the classical growth theory, the neoclassical growth theory, and the endogenous growth theory. Each theory offers a different perspective on the various factors that promote economic growth in a country.
According to Harris (2007), the classical theory of economic growth deals with a country’s population and the amount of resources it has. The population of a country affects the amount of resources being used up thus affecting economic growth. The theory argues that due to the fact that resources are always scarce in any given country, an increase in the population of a country will reduce the country’s economic growth. The theory was proposed during the industrial revolution As such, its founders believed that an increase in real GDP for individuals would lead to a sharp increase in the population hence; this would limit the already scarce resources in the country. Consequently, this would lead to slow economic growth. However, this theory has several limitations. First, the theory does not account for technological advancements. The classical theory of economic growth was proposed during the industrial revolution thus it could not account for the present-day technology that makes work more efficient and minimizes diminishing returns. Second, the theory has inaccuracies when determining the total wages. The theory wrongly assumes that total wages do not exceed or fall below the subsistence level. According to Harris (2007), the workers spent their wages on subsistence, capitalists reinvested their profits, and landlords spent the rent paid to them on ‘riotous living’. The theory did not account for the role that trade unions played in determining the workers’ wages
The Neoclassical theory of economic growth looks at the factors of production that result in economic growth. These are capital, labor, and technology. Economic growth, according to this theory, is as a result of the varying levels of labor and capital in the process of production. Technology is important as it determines the level of productivity of labor. Generally, technology increases the efficiency of labor thus increasing its productivity and total output. The aspect of capital accumulation and the manner in which individuals use the capital they accumulate is crucial in determining economic growth. However, the theory does makes some assumptions. First is that in a closed economy, capital is subject to diminishing returns (Hernandez, 2003). This means that the more capital is pumped into the production process will reach a point where it does not translate to economic growth. The theory also assumes that in the short-term, the growth rate slows down as diminishing returns are experienced. Here, the economy does not grow. Rather, it is in a constant state.
On the other hand, the endogenous growth theory stipulates that economic growth is generated through endogenous forces that are within the economy. Economic growth within this theory is as a result of internal processes. They include innovation, human capital, and investment capital. It is important to note that the theory points to the enhancement of human capital as a means to economic growth. This is because it leads to the development of technology and effective and efficient production methods. The theory does argue that not all government policies will lead to economic growth. The policies that increase competition within the market and help enhance innovation in products and services are more likely to spark economic growth. The private sector, therefore, is very important to a country’s economic growth specifically because of its investment in research and development, which leads to advancements in technology.
Research Design
According to Akhtar (2016), the research design is a short plan of the proposed research work. The research design outlines the structure of the research and holds all the elements of the project together. As such, the researcher will adopt a descriptive research design in the study. This is because this research design can be used to describe the current status of a phenomenon.
Sampling
According to Taherdoost (2016), a sampling frame is the actual list of cases from which one can draw a sample. It must be representative of the population. For this study, the sampling frame will consist of companies that are within the United Kingdom. The companies should also be listed in the United Kingdom Stock Exchange market. This study will make use of stratified random sampling to obtain its sample size. According to Auka, Bosire & Matern (2013), this sampling technique ensures all elements within the population are adequately sampled. The study’s final sample size will consist of 25 companies that satisfy the requirements.
Data Collection
This study will make use of secondary data. As such, the researcher will use the companies’ past financial statements. The researcher will compare financial statements before the companies were listed in the United Kingdom Stock Exchange Market and after they were listed. This will provide a clear distinction between the companies’ performances before and after they were listed. This information will be accessed on the companies’ websites.
References
Parvez, S., Sarwar, A., Hoq, R., & Chowdhury, R. (2017). Capital Market: Opportunities and Challenges. Scholars Journal of Economics, Business, and Management, 4(10), 729–738. https://doi.org/10.21276/sjebm.2017.4.10.10
Akhtar, I. (2016). Research in Social Science: Interdisciplinary Perspectives (1st ed.).
Taherdoost, H. (2016). Sampling Methods in Research Methodology; How to Choose a Sampling Technique for Research. SSRN Electronic Journal,5(2), 18-27. doi:10.2139/ssrn.3205035
Auka, D. O., Bosire, J. N. & Matern, V. (2013). Perceived Service Quality and Customer Loyalty in Retail Banking In Kenya. British Journal of Marketing Studies Vol.1 (3), 32-61
Committee on the Global Financial System (2019). Establishing viable capital markets. Bank for International Settlements.
Harris, D. (2007). THE CLASSICAL THEORY OF ECONOMIC GROWTH. Stanford University
Hodnett, K., & Hsieh, H.-H. (2012). Capital Market Theories: Market Efficiency Versus Investor Prospects. International Business & Economics Research Journal (IBER), 11(8), 849. https://doi.org/10.19030/iber.v11i8.7163
Rossi, M. (2016). The capital asset pricing model: a critical literature review. Global Business and Economics Review, 18(5), 604. https://doi.org/10.1504/gber.2016.078682
Fama, E. & French, K. (2003). The CAPM: Theory and Evidence.
Hernandez, R. (2003). Neoclassical and Endogenous Growth Models: Theory and Practice. 1–41. https://doi.org/10.13140/RG.2.1.5069.1600