Capital Market and Economic Growth in Transition Countries: Evidence from South East Europe

Influence of capital market on economic growth has been proven to be positive by majority empirical studies up to now. Throughout these studies, only secondary capital market indicators were used, while neglecting primary market activities. This empirical research uses PCSE model to test the significance of three capital market indicators on economic growth in SEE region, for ten years, from 2003-2012. The sample included six countries from SEE region and was extended with eight countries from Central and Eastern Europe to stabilize the model. A country dummy variable was used to distinguish between two regions. Data for panel regression was taken from GFDR, WDI (both from World Bank database) and one variable from UNECE. Results show that only market capitalization indicator is found to be significant, which is contrary to preliminary expectations. It was hard to expect secondary market activities to spur growth in transition countries, where primary issues almost do not exist. However, this result could be explained through an indirect effect that capital market had on economic growth concerning increased liquidity injections from foreign portfolio investments during a transition period. LSDVC regression tested endogeneity and reverse causality, and no significant reverse relationship was detected. The main conclusion of this study is that more qualitative research has to be done to discover the main limitations to capital market development in transition countries with more emphasis on primary issues, what could be of better use for policymakers.