File Name: financial markets and the economy .zip
- Financial Markets
- Financial market
- Please explain how financial markets may affect economic performance.
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds , raw materials and precious metals , which are known in the financial markets as commodities.
The paper examines how direct foreign investments and local investors interlink to optimize on the growth of the economy. A financial market is a form of a specialized market that channels financial resources from surplus entities to deficit entities for the sole purpose of carrying out economic activities Jalloh, ;4. In this regard, financial markets include all financial institutions that propagate financial resources from savers surplus units to entities that require financing to undertake financial activities.
The process of transferring financial resources is referred to as financial intermediation; the process of directing financial resources between surplus and deficit entities.
In this regard, financial markets constitute an important resource in economic growth Jalloh, ; Foreign direct Investment stimulates economic growth of a country while the financial markets play as intermediaries for the flow of investment, be it local or foreign investment from external entities into the local economy.
The foreign investment is not only in the form of finances but also knowledge transfer, technological spillovers as well as argumentum human capital. It is a wide spread belief that foreign direct investment FDI leads to positive productivity effects for the host country through various mechanisms including adoption of foreign technology, and direct capital financing Alfaro et al, In the recent past, findings have shown that the capacity of a country to utilize externalities occasioned by FDI is limited by local conditions such as the local levels of education and financial markets development Borensztein et al, The paper by Alfaro, Chanda, Kalemli-Ozcan and Sayek provides evidence to the fact that FDI only facilitates growth in countries which have well developed financial markets.
AnalysisFinancial markets are important in enabling economic growth in any economy. They are closely connected to all markets and almost all individuals in an economy Winkler, This amplifies the importance of financial markets which lies with the fact that they are linked to all spending decisions in an economy.
A flow of funds analysis is certainly the best way of highlighting the close interlinkage between real activity and financial markets. The funds circulating in a financial market on the other hand are either from locals or from foreign direct investment. On the case of local investments, the gain of an economic agent for example a household or firm results from the loss in another financial agent, i.
Contrary foreign direct investment does not affect two agents in the economy the investment is from external sources, thus it propagates a gaining situation for the local economy. The sum of all financial balances includes the investment from external sources thus does no add up to zero Winkler, Financial markets perform the primary function of intertemporal and interpersonal resource transfer, and are monetary markets Merton and Bodie, ; Although foreign direct investment can be in different forms, it still embodies the fact that it adds financial value to the local economy.
FDI induces a number of positive effects to the local economy in the form of technological transfers, managerial skills, introduction of new process and productivity gains Alfaro et al, FDI generally relies on capital from abroad, thus the spillovers for the host country significantly rely on the domestic financial markets development. Consequently, spillovers will not be restricted to the improvements in a local business by taking advantage of the new knowledge, purchases of new machines and equipment and the hiring of skilled labor and management.
Local investment is capable of availing the required financial resources but might be constrained in providing the new technological advancements and potential entrepreneurial needs. Foreign direct investment has the potential to create backward linkages but in the absence of developed financial markets, this is rigorously hampered. FDI through linkages that multinationals create allows existing firms in a host economy to achieve economies of scale and even help in creation of new firms Hirschman, Effects of Foreign Direct Investment As Opposed to Local Investment to an EconomyBasically, foreign direct investment influences economic growth by increasing the total factor productivity of the host economy and generally by raising the efficiency of resources in use in the host country Odenthal, As mentioned earlier, local investment has little effect on the growth of the economy due to the zero sum game which occurs since any gains by an agent result in a loss by another agent.
Local investment on the other hand has minimal effect on import of new technologically advanced equipment and machinery and export of newer and improved domestically manufactured products. Domestic investment does not impact the need for better and improved equipments and machinery. The industries are contented with the usual machinery and furthermore there is lack of finances to purchase newer equipment.
If the host country does not realize the importance of foreign direct investment, it will not advance the educational needs of its citizens thus locking out economic development triggered by human capital enhancements. Local investment maintains the status quo since the owners of the industries face low competition from new entrants thus they perform at the same level of production and operation.
Conclusion and RecommendationsAs depicted in the paper, studies have shown that foreign direct investment in a country with a well developed financial market contributes to economic growth at a higher rate as compared to local investment Odenthal, It is however difficult to evaluate the magnitude of foreign direct investment on a host country, since the high growth rate might be as an influence of other unrelated factors.
Also the crowding out effect associated with foreign direct investment is yet to be clearly studied. Foreign direct investment also boosts domestic investment in that it creates an entrepreneurial effect in the local investors who imitate the new technologies advanced by foreign investment. In less developed economies with low educational, technological and infrastructure development, foreign direct investment has a relatively smaller effect on growth, commonly characterized b threshold externalities which include less developed financial markets Morisset, Governments especially in less developed countries need to enhance and develop robust financial markets in order to realize the full potential of foreign direct investment.
Financial markets act as linkages between the foreign financial markets and the economy. With better managed financial markets, the spillovers from direct foreign investment are capable of influencing great economic development in host countries. For a country to attract foreign direct investment it requires policies and mechanism that make it conducive for the investment. This includes human capital development, streamlining government bureaucracies, development of the financial markets to mirror the international financial markets which are competitive and devoid of corruption.
Most developing and third world countries fail to provide these incentives to multinationals and foreign investors. Related Papers. By AmanUnited Africans. By Olafur Margeirsson. Financial GlobalizationA Reappraisal. By Ayhan Kose. Download pdf. Remember me on this computer. Enter the email address you signed up with and we'll email you a reset link. Need an account? Click here to sign up.
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Abstract and Figures · In addition, local financial markets have been found to promote public-private sector · pursuit of economic efficiency, shifting.
Please explain how financial markets may affect economic performance.
What do you need to know about macroeconomics to interpret financial market volatility? Successful trading, speculating or simply making informed decisions about financial markets means it is essential to have a firm grasp of economics. Financial market behaviour revolves around economic concepts, however the majority of economic textbooks do not tell the full story. To fully understand the behaviour of financial markets it is essential to have a model that enables new information to be absorbed and analysed with some predictive implications.
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Great question. The simple response is that well-developed, smoothly operating financial markets play an important role in contributing to the health and efficiency of an economy. There is a strong positive relationship between financial market development and economic growth.
Skip to search form Skip to main content You are currently offline. Some features of the site may not work correctly. DOI: Ndikumana Published Economics. This paper reviews the theory and evidence on the links between financial development and economic activity in the context of African countries. The paper presents stylized facts on the trends and patterns of financial development in Africa since the s, discusses the size and performance of African stock markets, and summarizes the findings from existing empirical studies on the effects of financial development on economic growth in African economies. View on SSRN.
Financial System also consists of interrelationships among the persons and the bodies that make up the economy. Learn how Debitoor makes it simple to manage your business finances and optimise growth: try it free for 7 days. Thus, financial instruments are classified into financial assets and other financial instruments. Money, one of the components, of the financial system is the backbone of all financial activities within a financial organization. Financial system comprises of set of subsystems of financial institutions, financial markets, financial instruments and services which helps in the formation of capital. Special emphasis is given in two chapters on stock and bond underwriting, as well as to financial engineering and mergers and acquisitions. It provides a mechanism by which savings are transformed to investment.
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