The most sure-fire way to create real economic growth is to transform wealth from savers into productive investments for entrepreneurs and businesses. Savings that people are willing to delay present a resource for increased future consumption – an important and often overlooked factor for economic coordination – and they also fund talented people who invent things, build machines or buildings, and offer better goods and services.
The most important capital markets in the world are in the United States, but other major players include Europe, China and Japan. Businesses and government compete for investors through the issue of debt and equity securities, the most common of which are stocks and bonds.
Understanding Capital Markets
For economies to grow, wealth and savings need to flow where they can be put to the most valuable use. Capital markets exist to match those who demand funds to those who supply them. At the smallest level, a worker might save $1,000 and decide to invest it in a stock to save for retirement; the company receiving that $1,000 will try to use the money to create jobs, build infrastructure or create new goods. A larger example is a company such as Twitter, which went public in November 2013 and raised $1.82 billion during its initial public offering (IPO).
Most capital markets in the modern age are centered around huge financial hubs, such as New York or Hong Kong. There, huge computers stockpile inputs from investors, investment banks, brokers and other security issuers. New cloud computing services allow for dynamic, adaptable and scalable transactions, which means capital markets are more liquid and less expensive to trade in than ever before.
The United States
As of January 2016, the United States possessed the world's largest debt and equity markets in terms of market capitalization and as a percentage of gross domestic product (GDP). No other country or region comes close in terms of aggregate size, and only Japan is comparable in terms of bond and equity markets as a percentage of GDP.
It's a little tricky to estimate the exact value of capital markets; the numbers change by the minute. Sifma Research estimated total market capitalization on U.S. stock exchanges was $27 trillion in 2014, with another $7.7 trillion in corporate bonds. These figures didn't include government issues or private market (non-listed) issues. Goldman Sachs estimated total market capitalization in the United States was approximately $50 trillion by 2014. The Financial Times and the International Monetary Fund's Financial Stability Report provide similar data.
America is home to the world's two largest stock exchanges in the New York Stock Exchange (NYSE) and the NASDAQ. Compared to other capital markets, U.S. exchanges are more flexible and offer more variety. American companies and individuals are far more likely to look for alternative funding sources, which adds depth and competition to U.S. capital markets.
U.S. capital market depth and participation is striking compared to the rest of the world, especially countries like Japan. Japanese savers are extremely conservative and, as a consequence, very little of their wealth is effectively channeled into capital markets. The investment-fund sector of the U.S. market accounts for nearly 75% of total banking sector assets; only 5% of Japanese banking-sector assets are tied up in its investment-fund sector.
China, A Capital Market in Turmoil
In 1989, China was an impoverished developing country with little capital market to speak of. Its GDP was smaller than that of Spain or Brazil despite China's massive population. The Shanghai Stock Exchange, the first of its kind in China, opened in 1990. Fast forward 25 years, and China is home to the second-largest capital market in the world. It's been a remarkable turnaround since the death of communist leader Mao Zedong and the institution of pro-market reforms in the late 1970s.
China's capital markets are still underdeveloped by Western standards. Foreign investors were still largely excluded by 2016, although residents of Hong Kong, Macau and Taiwan were allowed to open some accounts in 2013 as long as they resided in mainland China.
China's communist party still controls capital flows and participants, but opening China's capital markets has allowed enough investment to turn China into the world's leading manufacturer. Even though investor exposure is limited, the pressure from shareholders has already forced Chinese corporations to institute best practices and cut down on corruption.
The European Union
European capital markets are less developed and more heavily regulated than American markets. According to 2015 research by New Financial, a London-based think tank, there is a "shortfall in capacity of more than $1 trillion a year between what European companies raise" and what they "could potentially raise if capital markets were as developed as in the U.S."
Nevertheless, the EU still has a larger total capital market than China and Japan combined. In terms of global importance, London is probably the second-most impactful capital-markets sector behind New York.
European capital markets are dominated by bank lending, largely because European savers are less likely to take their money out of the bank and use it to buy securities. Some of this is cultural; New Financial believes many Europeans "have a cultural suspicion of risk-taking, entrepreneurialism and 'Anglo-Saxon' capital markets." Generally speaking, borrowers and investors in Europe are less knowledgeable and more reluctant to engage in risk capital than their counterparts in the United States.