Financial Taxation and Equity Market Development– Optimal Financial Market Tax Policies for Developing Countries Prepared for the Public Finance and Business Development Branch United Nations Department of Economic and Social Affairs ======================================================== Financial markets contribute to the growth process in several fundamental ways: 1. Effects on Efficiency. The primary channel in which this occurs is through improvements in the efficiency of domestic investment and capital allocation. By enhancing the liquidity of domestic investments and pooling risk, financial markets limit the duration of any individual’s required commitment or exposure. This encourages “patient” (as opposed to speculative) capital and increases the likelihood that investment will be directed towards the most profitable projects regardless of their time horizons. Furthermore, financial markets generally increase the amount of corporate monitoring undertaken by the private sector, thereby increasing transparency and information quality. 2. Effects on the Rate of Investment. Although the effect of financial market development on aggregate private investment has yet to be conclusively demonstrated, there are plausible reasons to expect this to be positive. By increasing the option for savers to diversify their portfolios and to “opt out” of investments, well-developed financial markets should attract those savers previously subjected to a liquidity constraint as well as those who, merely fearing such, may otherwise choose not to invest. 3. Decreased Reliance upon Bank Lending: Stability. Financial markets increase the stability of financing available to firms relative to that in a bank-dominated economy. This leads to smoother growth of output as well as reductions in employment variability. This is so because, by preventing bank lending from largely determining aggregate investment levels, financial markets reduce the potential for the economy to experience pro-cyclical overheating or credit crunches. 4. Decreased Reliance upon Bank Lending: Efficiency. Equity financing decreases the cost of funds relative to borrowing. This both eliminates the cost of refinancing or rolling over bank loans for long-term projects and precludes investment projects from diluting a company’s value. 5. Decreased Reliance upon Global Capital. By developing a degree of self-sufficiency in investment financing, developing economies can insulate themselves from the destructive effects of massive capital inflows or reversals, such as those that helped to cripple the Asian NICs in the wake of 1997. 6. Decreased Domestic Risk Premiums. By providing a stable, liquid destination for international investors, mature financial markets may decrease the risk premiums a nation may be required to pay to attract global capital.
Posted on: Sun, 01 Jun 2014 13:30:56 +0000
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