Stock Market: Boon or Bane to the Philippine Economy?

``But innovation, in Schumpeter’s famous phrase, is also “creative destruction”. It makes obsolete yesterday’s capital equipment and capital investment. The more the economy progresses, the more capital formation will it therefore need. Thus, the classical economist-or the accountant or the stock exchange-considers “profit” is a genuine cost, the cost of staying in business, the cost of a future in which nothing is predictable except that today’s profitable business will become tomorrow’s white elephant.”- Peter F. Drucker, Profit’s Function, The Daily Drucker.

Admittedly, the Philippine financial markets are small relative to its neighbors, to say the least UNDERDEVELOPED, since we principally rely on the banking system for most of its financing needs, as shown in figure 9.

Figure 9: IMF (2006): The Need to Develop Stock and Bond Markets

It is why the IMF argues that we need to develop our local markets (stocks and bonds) as a vital part of our economic development. Remember, the lifeblood of an economy is the financing sector.

However, to project our market’s past into the future, and use this as basis to censure Philippine markets as some burden to the economy obviously disregards today’s evolving trends.

For instance, we have consistently pointed out that the Phisix, the Peso and its bond markets have closely tracked the movements of world markets. To wit, foreign money has been a principal driver of our markets today. All these suggest to us that our financial markets have been undergoing transitional integration following the “financial globalization” model, which is why we remain structurally bullish on the domestic markets.

Going back to basics; how does a market work?

According to Wikipedia.org, ``A market is a social arrangement that allows buyers and sellers to discover information and carry out a voluntary exchange of goods or services. It is one of the two key institutions that organize trade, along with the right to own property.” In short it is place to conduct exchanges to satisfy one’s needs.

Our community marketplace, where we usually source the food for our daily meals, is a basic example of a functioning market. Here, suppliers of chicken, beef, fish, vegetables and others consumer staples congregate to meet buyers who trade their supplies for money.

Prices of the items traded fluctuate daily depending on demand and supply as well as other factors driving the exchange mechanism (competition, profits etc…). Credit is likewise a part of operations depending on the arrangements of the economic agents.

If such marketplace is indispensable to one’s community, then the financial markets do not DIFFER from its functionality except for the products that it exchanges—financial securities.

Going to a broader perspective, if financial markets are a bane to the economy, then why have economies that have espoused varied degrees of the capitalistic model worldwide, from former communist countries of China and Vietnam, to Eastern Europe as Slovenia or Estonia, to Africa like Kenya or Nigeria or to Latin America as Peru or Costa Rica, necessitate having stockmarkets?

Historically, stock markets around the world have had important contributions to the national economy, let me cite D. W. Mackenzie in an article published at Mises.org (highlight mine), ``Stock exchanges played an important role in the development of the industrial West. Initially, these stock exchanges were informal and unsophisticated. The London Stock Exchange developed in the eighteenth century. The stock market in Amsterdam emerged in the seventeenth century. The financial system of Belgium began in the fourteenth century, but the Brussels Stock Exchange opened in 1801. These early stock markets developed into sophisticated institutions with formal rules. These early stock markets in major cities began to direct capital investment throughout the West and in parts of Asia. Statistical studies indicate that the economic development of Belgium was driven by the development of Belgian financial markets, including the Brussels Stock Exchange. Financial development in Belgium began with the country’s independence in 1830, and was accelerated by the liberalization of the Belgian stock market in 1867. This pattern was paralleled in many nations. Statistical studies show that well-developed stock exchanges have enhanced long-run economic growth, increased capital investment, and raised productivity throughout the industrialized world.”

So in essence, the stock market functions as a channel to REDIRECT SAVINGS into investments or an important part of the capital formation process, it also serves as an ALTERNATIVE ROUTE FOR RAISING OR ACCESSING CAPITAL, it works to PROVIDE LIQUIDITY for company owners as well as for public investors, it LOWERS THE COST of capital, and importantly PLACES PRICE MECHANISM from which the investors values a company or an enterprise.

Stock market investing, unlike the currency markets is NOT A ZERO SUM WIN-LOSE outcome because it has value added components such as dividends, aside from the actual ownership in the company itself.

Allow us to quote more of D. W. Mackenzie (highlight mine) ``Financial markets are important in capitalism because they redirect resources towards the satisfaction of the most urgent consumer demands. As Ludwig von Mises noted “it is above all necessary that capital be withdrawn from particular undertakings and applied in other lines of production … [This] is essentially a matter of the capitalists who buy and sell stocks and shares, who make loans and recover them, who speculate in all kinds of commodities” (Mises 1922 [1936] p121). A study by Borsch-Supan and Romer (1998) finds that competitive financial markets reinforce product market competition by cutting off funds to unproductive companies, but only in the face of competitive threats. Borsch-Supan and Romer also find that government regulation and ownership are important causes of low capital productivity, both directly and indirectly through limitations of competition. For example, the trade protection of the German and US auto industries and Deutsche Telekom enabled these companies to earn high profits, despite low productivity. Many less developed nations are now emulating the West by forming more sophisticated financial markets. One study (Agarwal 2001) of nine African nations indicates that stock exchange development has led to increased economic growth. Another study (Aragarwal 2007) of twenty-one developing nations shows that the development of stock exchanges increases private investment and economic growth. This study indicates that stock exchanges contribute to economic development by stabilizing productivity and liquidity shocks.”

To add, Mr. Rodrigo de Rato, Managing Director of the International Monetary Fund, in his latest speech likewise underscored the significance of financial markets development in the age of financial globalization to the national economy (emphasis mine), ``it is no coincidence that the countries—in Latin America and elsewhere—where financial market development has been the most advanced are also those that have been among the most successful economies. The causality runs both ways. As macroeconomic policies have become more credible, and confidence grows that inflation will remain low, demand for financial services increases. As financial markets grow, the availability of credit increases, spurring faster noninflationary growth. And as financial markets become more sophisticated, and risk management and hedging become easier, economies become better able to manage volatility.”

As you can see, for many reasons cited above, financial markets including the stock markets signify an integral part of capitalism, hence the sine qua non presence to any economy that aspires to move up to the ladder of economic prosperity.

It would be better for us to face up with these unfolding trends especially in the light of the massive technological advances which have largely underpinned today’s accelerated integration process.

Denying their significance or restricting our insights to the past paradigms simply leads to misdiagnosis, faulty assumptions and eventually, misleading and unjust generalizations.