The Politics of Stock Market Development

Abstract:     
This paper investigates empirically the political determinants of stock market development. We argue that those determinants are grounded in distributional cleavages among voters and interest groups. Our argument reverses the sign of the prevailing explanation about the role of partisanship in the literature, where it is usually assumed that left governments frighten investors. To the extent that financial development is translated into higher levels of investment that increases labor demand, workers and the parties representing them will adopt policies and regulations that favor the capitalization of financial markets. We explore the empirical content of our hypothesis against several competing explanations: the legal origins school, which argues common law proxies stronger investor protections than civil law; the electoral law school, which argues proportional representation provides weaker protections than do majoritarian ones; the institutional economics view, which argues that checks on policymaking discretion such as veto gates protect the property rights of investors and encourage investment. We test the implications of the different arguments on the level of stock market capitalization in a panel of 83 countries over the period 1975-2004. We find preliminary evidence in favor of the partisanship hypothesis: contrary to received wisdom, our results suggest that left-leaning governments are more likely to be associated with higher stock market capitalization than their counterparts to the right and center of the political spectrum. The association between the left and market capitalization is stronger in the 1990s. These results are consistent with recent theories emphasizing an emerging coalition of workers and owners against managers in favor of greater transparency and shareholder protection.

Keywords: politics, finance, economic development, regulation, political economy

Working Paper Series