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Emerging Market Finance

Lecture 1: The Big Picture

By Zhiwu Chen

Professor of Finance

Yale School of Management

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Why Do Countries Differ in Wealth?

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Relationship between Average Number of Hours Worked in 1998 and Per-capita GDP in 2001

0

5000

10000

15000

20000

25000

30000

35000

40000

1300 1500 1700 1900 2100 2300

Per-capita GDP in 2001

Holland

China

U.S.

Japan

Latin America

Data source for the working hours is Angus Maddison ， 2001, The World Economy ： A Millennial Perspective.

Average Number of Hours Worked by the Employed in 1998

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What determines national wealth? Traditional view: physical assets (e.g., natural

resource endowments)

0. 47 0. 58 0. 781. 11

2. 34 2. 47 2. 67 2. 8

3. 63

0

1

2

3

4

China Russia India Taiwan HK Japan U.S.

Saudi Arabia Singapore

2002 per-capita GDP in units of $10,000

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What determines national wealth? physical capital or something else?

25623419

4027

10901

1273911546

0

5000

10000

15000

Countries with Least Oil& Gas Reserves

Countries with AverageOil & Gas Reserves

Countries with Most Oil& Gas Reserves

Per-Capita GDP ($)

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).

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Difference in Growth

6.14%

5.10%

4.18%

3.00%

5.00%

7.00%

储藏最少的国家 中等储藏的国家 储藏最多的国家Oil+Gas Poor Countries

Oil+Gas Avg. Countries

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

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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, ……

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Yale School of ManagementLack of mass transportation means made each place’s income depend on its natural endowment,

but not any more

( )世界历年海运总容量 万吨

32 73 145 395 588 1460

9610

17100

0

3000

6000

9000

12000

15000

18000

1470 1570 1670 1780 1820 1850 1900 1913

World’s sea-going ship capacity in 10,000’s of tons

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Yale School of ManagementTotal number of vessels departed from Europe for Asia

( )按每世纪汇总计算

770

3161

6661

0

3000

6000

9000

1500-1600 1601-1700 1701-1800

Total trips in each century

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Maybe, the ability to innovate financially also makes a difference

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What a difference financialization makes!

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A century of American Financial Revolution:Total value of all financial claims

Sources: For 1900, Goldsmith (1969), Financial Structure and Development. For post-1945, Federal Reserve Flow-of-Funds

1.0 1.8 3.5 7.623.5

52.5

128.5

0.06

-10

10

30

50

70

90

110

130

150

1900 1945 1955 1965 1975 1985 1995 2006

$ trillions

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American Financial Capitalism:Ratio of all financial claims to GDP

Sources: Prior to 1945, Goldsmith (1969), Financial Structure and Development. For post-1945, Federal Reserve Flow-of-Funds

0

2

4

6

8

10

1880

1929

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

1900

For each $ GDP, how many $ of financial claims floating?

Phase I Phase II: stagnation Phase III: globalization

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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

More financialization => more capital to create wealth

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Source #1: capitalization of corporate assets & future cashflows

0%

50%

100%

150%

200%

250%

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

Equity mkt capitalization to GDP ratio

Sources: Federal Reserve Flow-of-Funds

Similar trend in bonds

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Source #2: more capitalization of Land and real assets

Sources: Federal Reserve Flow-of-Funds

0%

20%

40%

60%

80%

100%

120%

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

Total mortgage loans outstanding to GDP ratio

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Source #3: capitalization of future labor income

Sources: Federal Reserve Flow-of-Funds

0

1000

2000

3000$billions

Consumer credit outstanding

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What pushed financial development?A 1920’s ad by Julian Goldman Stores Inc.

“Wouldn’t it be nice if Jim Jones could use some of that money now?”

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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.

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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?

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Yale School of ManagementBut, you need Quality Institutions for this to be feasible. Example: Press Freedom and Service

Sector DevelopmentCountry 1990

Press Freedom RatingService 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%

Press freedom rating is on a 1-100 scale, with 1 representing the freest press.

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Yale School of Management Which Countries Prosper?Per-capita GDP is expressed in terms of Purchasing Power Parities

(Source: Heritage Fountation)

-0.32%

-1.44%

0.97%

2.88%

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

Free Mostly Free Mostly Not Free Repressed

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