The Role of the Stock Exchange in the Economy

The Stock Exchange is a market that deals in the exchange of securities issued by publicly quoted companies and the Government.

The major role that the stock exchange has played, and continues to play in many economies is that it promotes a culture of thrift, or saving. The very fact that institutions exist where savers can safely invest their money and in addition earn a return, is an incentive to people to consume less and save more.

Secondly, the stock exchange assists in the transfer of savings to investment in productive enterprises as an alternative to keeping the savings idle. It should be appreciated that in as much as an economy can have savings, the lack of established mechanisms for channeling those savings into activities that create wealth would lead to mis-allocation or waste of those savings. Therefore, even if a culture of saving were to be encouraged, the lack of developed financial markets may lead to economic stagnation.

Thirdly, a robust stock market assists in the rational and efficient allocation of capital, which is a scarce resource. The fact that capital is scarce means systems have to be developed where capital goes to the most deserving user. An efficient stock market sector will have the expertise, the institutions and the means to prioritise access to capital by competing users so that an economy manages to realise maximum output at least cost. This is what economists refer to as the optimum production level. If an economy does not have efficient financial markets, there is always the risk that scarce capital could be channeled to non-productive investments as opposed to productive ones, leading to wastage of resources and economic decline.



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