City Size and Financial Development
Stock markets tend to be few in each country, often unique, and located in the largest cities. Typically, much of the economic activity relating to the stock market takes places in this large city. These facts suggest that agglomeration economies are important. In other words, productivity is enhanced for stock market-workers and -firms located in a large city. After discussing this prima facie evidence of agglomeration economies, we consider the cross-country implications. Countries with larger cities will have better developed stock markets because they can benefit from stronger agglomeration economies surrounding the stock market. This provides an economic theory of financial development which is complementary to the standard legal and political theories of financial development. We establish that city size is a robust determinant of stock market size and activity, but not of other types of financial development (banks). We show that this is not driven by reverse causality and that it is not driven by small or new stock markets. Finally, we show that alternative measures of a country's geography, such as urbanization and the population of the second largest city, do not predict stock market development, implying that we do not capture some alternative geographic effect. We conclude that there is a significant positive effect of city size on stock market development, that this reflects agglomeration economies. This explains why countries with large cities have better developed stock markets.
|Date of creation:||15 Sep 2006|
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