Do Stock Market Liberalizations Cause Investment Booms?

By Peter Blair Henry
1998| Working Paper No. 1504

Stock market liberalizations lead private investment booms. In a sample of 11 developing countries that liberalized, 9 experience growth rates of private investment above their non-liberalization median in the first year after liberalizing. In the second year after liberalization this number is 10 of 11. The mean growth rate of private investment in the two years immediately following stock market liberalization exceeds the sample mean by 23 percentage points. The relationship between private investment and stock market liberalization persists after controlling for world business cycle effects, contemporaneous economic reforms, and domestic fundamentals. Because the possibility of reverse casuality cannot be ruled out, we cannot conclude that stock market liberalizations cause investment booms. Nevertheless, the evidence stands in sharp contrast with recent work that suggests capital account liberalization has no effect on investment.