Impact of Capital Markets on Economic Growth

Capital Markets plays a key role in the development of an economy. To demonstrate the impact of capital markets on economic growth we will explore the concept of the circular flow of income, what is financial capital, how companies access financial capital, the uses of financial capital and the link to economic growth.

An economy consists of households and businesses. The circular flow of income follows the money in an economy, i.e., how money moves from businesses (producers) to households, back to producers and again to households and the cycle continues over and over again.

Businesses need human capital, financial capital, and social capital. Human capital refers to skills and abilities of the employees of a company, social capital refers to the relationships people have with each other and their desires to work with each other and financial capital, the focus of this article, is the most tangible of the three and refers to cash, credit or other funding purchasing power. These include, debt or equity as the most basic forms.

A country’s financial system include the banking sector, non-bank lenders such as building societies, microcredit institutions, insurance companies and the securities industry. It also includes counterparties, payment providers, financial regulators, and supervisors. While all areas of the financial system are important, we will take a brief look at Capital Markets.

According to the Oxford Dictionary, the capital market is “the part of the financial system concerned with raising capital by dealing in shares, bonds and other long-term investments”. This is like any other market which is a place where buyers and sellers meet to transact business. In this case buyers are the users of capital and sellers are the providers of capital i.e., investors. Capital markets, therefore, play an important role in mobilizing resources and allocating them to the most productive uses that leads to economic growth.

The market can be further broken down into two, the primary market and the secondary market. The primary market is where new securities (stocks and bonds) are sold for the first time. For example, an initial public offering where shares of a particular company are being sold for the first time is considered to be offered in the primary market. These very same securities, now in existence can be traded (bought and sold) in what is called the secondary market. For example, shares that have already been listed on the Jamaica Stock Exchange and are now being traded daily is part of the secondary market.

The capital markets play a significant role in an economy. These include:

• Helping to accelerate the process of economic growth
• Promoting saving habits
• Providing stable and systematic security prices
• Providing access to capital for businesses

In Jamaica, the Capital market is regulated by the Financial Services Commission. Companies can raise capital within the FSC’s Exempt Distribution Framework which provides the rules and guidelines to brokers who provide advice to these companies who are seeking to raise capital. Different types of securities are structured and offered to investors. Once the funds are raised, these funds are used by companies to:

• Purchase equipment
• Provide working capital
• Mergers and acquisitions
• Expand business activities

These activities contribute directly to the economic growth of a country by providing income to households by way of a return on capital to the owners of capital and by means of wages to household participants.

In conclusion, capital markets are an important part of the financial system of a country helping to mobilize and direct scarce economic resources to its most productive use which in turn results in economic growth of that country. Businesses seeking financing should consider the capital markets as a medium to raise funds. We encourage them to engage with a licence securities dealer who provide these services.

Colando Hutchinson is an Executive Consultant at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm

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