Development of Stock Markets, Societal Norms and Legal Institutions

We explain the development of stock markets by both legal and societal determinants and analyze the relevance of both determinants in the Levine-Zervos (1998) cross-sectional growth regressions. We argue that the legal indicators as developed by La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998) are not covering all the aspects of alternatives to financial contracting as suggested by Levine (2000). The basic argument is that the legal classification of countries does not completely cover the cross-country variation in the societal desire to use contracting in financial transactions. After establishing the determinants of stock market development we analyze the impact of stock market development on economic growth. We use a 2SLS approach to correct for the endogeneity of stock market development. We contradict the positive view of Levine-Zervos on the impact of liquidity of stock markets on economic growth. Our conclusions are in line with Levine (2000) who argues that it is not financial structure but the development of the deep structural legal and societal characteristics that is instrumental to economic growth.