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Yale School of Management Emerging Market Finance Lecture 1: The Big Picture By Zhiwu Chen Professor of Finance Yale School of Management 1 Yale School of Management 2 Yale School of Management Why Do Countries Differ in Wealth? 3 Yale School of Management Relationship between Average Number of Hours Worked in 1998 and Per-capita GDP in 2001 Per-capita GDP in 2001 U.S. 40000 35000 Japan 30000 25000 20000 Latin America Holland 15000 China 10000 5000 0 1300 1500 1700 1900 2100 2300 Average Number of Hours Worked by the Employed in 1998 Data source for the working hours is Angus Maddison,2001, The World Economy:A Millennial Perspective. 4 Yale School of Management What determines national wealth? Traditional view: physical assets (e.g., natural resource endowments) 2002 per-capita GDP in units of $10,000 4 3 3.63 2.34 2.8 2.67 2.47 2 1 0.47 1.11 0.78 0.58 国 本 Japan U.S. 美 HK 日 港 香 加 坡 湾 Taiwan 新 阿 拉 伊 沙 特 俄 中 China Russia India 台 伯 朗 罗 斯 国 0 Saudi Arabia Singapore 5 Yale School of Management What determines national wealth? physical capital or something else? Per-Capita GDP ($) 15000 12739 11546 10901 10000 5000 2562 3419 4027 0 Countries with Least Oil Countries with Average Countries with Most Oil & Gas Reserves Oil & Gas Reserves & Gas Reserves Based on per-capita oil and natural gas reserves, 44 countries are divided into three groups. The average per-capita GDP for each country group is reported respectively for the year 1975 (in BLUE) and 2001 (in RED). 6 Yale School of Management Difference in Growth 7.00% 6.14% 5.10% 5.00% 4.18% 3.00% 储藏最少的国家 Oil+Gas Poor Countries 中等储藏的国家 Oil+Gas Avg. Countries 储藏最多的国家 Oil+Gas Rich Countries Based on per-capita oil and natural gas reserves, 44 countries are divided into three groups. The average GDP growth is reported for the 1975-2001 period 7 Yale School of Management How do we explain this? Natural physical wealth is a “curse”? Lower transportation costs and higher transportation capacity make resource endowments less of an advantage? But, …… 8 Lack of mass transportation means made each place’s income depend on its natural endowment, but not any more Yale School of Management World’s 世界历年海运总容量(万吨) sea-going ship capacity in 10,000’s of tons 17100 18000 15000 9610 12000 9000 6000 3000 32 73 145 395 588 1460 0 1470 1570 1670 1780 1820 1850 1900 1913 9 Total number of vessels departed from Europe for Asia Yale School of Management (按每世纪汇总计算) Total trips in each century 9000 6661 6000 3161 3000 770 0 1500-1600 1601-1700 1701-1800 10 Yale School of Management Maybe, the ability to innovate financially also makes a difference 11 Yale School of Management What a difference financialization makes! 12 Yale School of Management A century of American Financial Revolution: Total value of all financial claims $ trillions 150 128.5 130 110 90 70 52.5 50 23.5 30 10 -10 0.06 1.0 1.8 3.5 7.6 1900 1945 1955 1965 1975 1985 1995 2006 Sources: For 1900, Goldsmith (1969), Financial Structure and Development. For post-1945, Federal Reserve Flow-of-Funds 13 Yale School of Management American Financial Capitalism: Ratio of all financial claims to GDP For each $ GDP, how many $ of financial claims floating? 10 8 6 1900 4 2 Phase I Phase II: stagnation 2005 2002 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 1969 1966 1963 1960 1957 1954 1951 1948 1945 1929 1880 0 Phase III: globalization Sources: Prior to 1945, Goldsmith (1969), 14 Financial Structure and Development. For post-1945, Federal Reserve Flow-of-Funds Yale School of Management More financialization => more capital to create wealth But, how did capitalization increase so fast? 4 primary sources of capitalization: – Corporate assets and cashflows – Land and real assets – Future labor income flows – Future government tax flows 15 Yale School of Management Source #1: capitalization of corporate assets & future cashflows 250% Equity mkt capitalization to GDP ratio 200% 150% 100% 50% 2005 2002 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 1969 1966 1963 1960 1957 1954 1951 1948 1945 0% Similar trend in bonds Sources: Federal Reserve Flow-of16 Funds Yale School of Management Source #2: more capitalization of Land and real assets 120% Total mortgage loans outstanding to GDP ratio 100% 80% 60% 40% 20% 2005 2002 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 1969 1966 1963 1960 1957 1954 1951 1948 1945 0% Sources: Federal Reserve Flow-of-Funds 17 Yale School of Management Source #3: capitalization of future labor income $billions Consumer credit outstanding 3000 2000 1000 05 20 02 20 99 19 96 19 93 19 90 19 87 19 84 19 81 19 78 19 75 19 72 19 69 19 66 19 63 19 60 19 57 19 54 19 51 19 48 19 19 45 0 Sources: Federal Reserve Flow-of-Funds 18 Yale School of Management What pushed financial development? A 1920’s ad by Julian Goldman Stores Inc. “Wouldn’t it be nice if Jim Jones could use some 19 of that money now?” Yale School of Management As financialization has increased in developed countries, capital flow into funds grows. Has this capitalization trend peaked? No. Other countries are only starting to follow. 20 Yale School of Management Puzzles Why doesn’t every country engage in financial innovations? Why growth does not always translate into stock returns? Why capital flow differs across countries? 21 But, you need Quality Institutions for this to be feasible. Example: Press Freedom and Service Sector Development Yale School of Management Country 1990 Press Freedom Rating Service Sector's Contribution to GDP in 2002 U.S.A. 12 70.70% Hong Kong 30 86.50% Singapore 60 64.10% China 89 27.50% 22 Press freedom rating is on a 1-100 scale, with 1 representing the freest press. 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