Economic fitness: How equity market returns reflect the realization of economic growth potential

Ted H. Chu, Marshall L. Stocker and Brandon Tan

International Journal of Finance & Economics, 2021, vol. 26, issue 1, 1550-1562

Abstract: The relative complexity of a country's economy explains relative per capita wealth. Measures of complexity have also been used to improve the estimation accuracy of gross domestic product (GDP) growth forecasts. Why complexity matters is settled in the theory of gains from trade. Not settled are the determinants of complexity and how complexity can be unleashed to facilitate economic growth. We explore how economic institutions, as measured by an index of economic freedom, and economic complexity interact and impact a country's equity market return. We find complex economies where realized per capita GDP is lower than comparably complex economies experience an acceleration in GDP growth when economic freedom is increased. Simultaneous to the gains in economic institutions and complexity, equity markets outperform, suggesting the wealth of a nation rests on the institutions that facilitate complexity.

Date: 2021
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