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Nicola Fuchs-Schiindeln is a Ph.D. student at Yale University and former Summer Intern at the IMF Insitute and Norbert Funke is an Economist at the IMF Institute. The authors thank Allan Brunner, Anne Epaulard, Andrew Feltenstein, Samir Jahjah, Donald Mathieson, Hyginus Leon, Eduardo Ley, Sunil Sharma, and seminar participants at the IMF Institute and at Yale University for helpful suggestions and stimulating comments on a preliminary draft. They are also thankful to Utpal Bhattacharya, Benoit Mercereau, and Ross Levine for providing them with their data sets on country credit rating, exchange rate regimes, and institutional developments.
For a general analysis of the linkages between financial development and growth, see for example, King and Levine (1993), Atje and Jovanovic (1993), Levine and Zervos (1998), and Rousseau and Wachtel (2000). Levine (1997, 1999) and Khan and Senhadji (2000) provide recent surveys of this literature.
See Henry (2000b) for a more detailed theoretical discussion of the underlying assumptions and their implications.
On the one hand, these results may reflect specific developments special to the small sample of countries. On the other hand, they may indicate that resources were not necessarily efficiently allocated during the dramatic rise in private investment or that they omitted variables that are correlated with stock market liberalization drive the results.
See http://www.duke.edu/~charvey/Country risk/chronology. For any liberalization after the mid-1990s, the post-liberalization period would be too short for a meaningful medium-term analysis. Central and Eastern Europen countries are not included in our study because stock markets in these countries only developped after the transformation process started, thus limiting the observation period. Also, in some cases, equity markets were open to foreign investments right from the beginning. For an analysis of developments in Central and Eastern Europe see Claessens, Djankov, and Klingebiel (2000).
In contrast to these measures, Edison and Warnock (2001) look more specifically at the evolution of the degree of restrictions on foreign ownership of equities over time.
Appendix III shows the same graphs with standard errors. It shows considerable country variability in the growth rates of the stock market variables. However, the standard errors do not increase during the time of liberalization, which may suggest an important growth effect from liberalization on the stock market characteristics.
Figure 1 (panels d and f on real private investment) include only 25 countries (except Zimbabwe and Nigeria). In both countries, real private investment growth was extremely volatile, reflecting the effects of periods associated with large political uncertainties. The inclusion of both countries, however, does not change the general shape and the timing of the effects.
We regressed the total return index growth on the liberalization dummies, country fixed effects, and year dummies. Liberalization also has an impact on equity prices up to the fourth year after the liberalization, but the cumulative impact amounted only to about 75 percent of the cumulative impact on market capitalization growth.
Levine and Renelt (1992) have shown that investment to GDP is the most robust explanatory variable in growth regressions. Since we showed in the previous section that real private investment growth is stimulated by liberalization, it could be argued that investment to GDP would capture an important part of the liberalization effect and thus drive out the liberalization effect. Results barely change when we drop this variable. Three reasons may account for this. First, investment to GDP also includes public investment, which in some emerging economies plays an important role and is highly variable. Second, whereas we looked at growth rates in the previous section, a level variable is included here. Third, an analysis of the correlation confirmed a positive but only weak link. In our sample, the correlation between private investment to GDP and investment to GDP is on average 0.56 percent and correlations between real private investment growth and investment to GDP is 0.21.
Due to time-series data availability we use illiteracy as a measure of human capital instead of the more frequently used secondary school enrollment. As before, we use market capitalization over GDP as proxy for financial development.