Last Updated on 13 January, 2021 by Samuelsson
Stock trading helps the economy in a number of ways such as increasing its productivity, creating a wealth effect, linking it with the global economy and many similar effects. These benefits extend to all the major players in the economy including consumers, producers, and the government. However, like all markets, the stock market has some disadvantages as well.
So let’s have a look at the different ways in which stock trading helps the economy while touching upon a few of its perceived disadvantages.
How Stock Trading Helps the Economy?
So, here we have listed some of the ways that stock trading helps the economy!
Wealth effect creates Economic Booms
Economics 101 says that an increase in the wealth of consumers leads to increased consumption. Stocks are part of that wealth and stock traders are also consumers in the economy. Therefore, as the returns from bought stocks keep increasing, it has a stimulating effect on consumer spending. Since consumers have engaged in stock trading, they no longer have to save extra for future needs such as college tuitions, and can afford to spend more money in other areas of the economy!
Of course, this increased spending also means that businesses also see an increase in their profits. This increase in profits leads to higher share prices which can become a self-feeding cycle which is known as an economic boom.
Stock trading also allows the general population to fund investments by businesses. These investments are funded via companies issuing stocks to fund expansion programs. In this way, stock trading becomes a conduit for business growth. Such investments generate jobs which increases employment and growth in the economy.
In the absence of trading, businesses would have to wait to repeatedly earn profits and re-invest them in the business. This might push off important investments many years down the road.
Great Equalizer in the economy
By engaging in stock trading, middle-class investors can hope to become rich one day. In this way, the stock market becomes a ladder on which hardworking individuals from lower strata can climb into a life of comfort, which strengthens society and decreases inter-class tensions. In the long run, such social harmony leads to a more stable political climate that helps the economy by lowering the risk premium on investments in the economy. Apart from financiers, the government is also happy with a more equal society. This especially holds true considering that stock trading is a good source of taxation in the economy.
Reduced Need for Government Intervention in the Economy
The government is like a nanny with many responsibilities and ensuring adequate investments in the economy is one of those responsibilities. However, stock trading ensures that the government does not have to step in every now and then to fund investments within the economy. This is always a blessing because the market does not have a habit of working with the bureaucracy that comes with all forms of government investments. This allows the government to better focus on strategic initiatives such as preparing the economy for the next industrial revolution rather than micro-managing the everyday affairs of the market.
Creates an Honest Thermometer for the Economy
The stock market can act as a thermometer for the economy which is visible to all the important players within and outside the economy. This includes foreign investors that want to take the plunge into the economy. It also includes businesses that want to asses the state of affairs as they decide to commit their investments in the medium to long term.
Most importantly, the stock market also allows the government to assess the health of the economy. The government can then use its assessment to decide on its policy and can either introduce expansionary or contractionary fiscal policy. Expansionary policy will boost economic growth while contractionary policy will focus on stabilization. Therefore, the stock market also helps the economy by becoming information input in the decision making of important economic players.
Creates Liquid Assets in the Economy
All investors look at investments using three judgement rules. They are potential returns, risks involved and liquidity of the investment.
The “Liquidity of the investment” is the ease with which an investment can be sold in the market. For example, a house can have a good return and low risk. However, the investor will not be able to immediately sell the house without offering a good discount to potential customers. In such a situation, the asset is non-liquid i.e. it cannot be easily converted into cash without giving a discount.
On the other hand, stock trading is a highly liquid form of investment. This especially holds true for US-based stock exchanges, which are the busiest exchanges in the world. which allows investors to remit money from the sale of stocks within an hour. This makes stock trading a highly liquid form of investment.
When a large number of these investors are engaged in stock trading, the economy benefits from high liquidity. High liquidity allows higher consumer spending since assets can be liquidated with fair ease. This consumer spending boosts growth in the economy.
Connects the Local Economy to the Global Economy
Stock trading allows the economy to benefit from a healthy global financial environment. There are two ways that investment can come into an economy. The first method is Foreign Direct Investment which includes the purchase of factories and setting up of production facilities. The second, more liquid method is Portfolio Investment. Portfolio Investments include investments into stocks via stock trading. Performing Portfolio Investment is more convenient as it can be performed with the click of a button.
Due to its ease, Portfolio Investments allow the economy to benefit from temporary positive vibes within the global economy. These investments from outside can either complement or counteract local investment trends. If the local economy is booming, then stock trading helps further accelerate the funding of local investments. However, in case the local economy is going through a slump then the investment flow can help provide some buoyancy to local investment funding needs.
Makes the Workers Work Harder
Stock trading can become a reason for workers to work harder. There are many companies that choose to issue Employ Stock Options, which are contracts that give the employee the right to buy a predetermined amount of stocks at a predetermined price and date. Thus, the employees want the stock to trade higher than than the strike price of the option, and will work harder to make the company perform better.
Therefore, stock trading helps the economy by increasing its productivity.
Unfortunately, not all impacts of stock trading are positive for the economy. Stock trading has diverted investment away from critical technologies towards non-productive actions such as share buybacks.
Furthermore, the stock market has been a victim of emotion-based investing that has led to a cycle of boom and bust. Many victims of these volatile boom and bust cycle are part-time investors that do not know how to navigate the markets, and subsequently lose money.
All in all, the stock market plays a very important role in the economy. It can help the economy become more liquid while at the same time pushing its workers to become more productive. At the same time, it also reduces the need for spending on investments. Unfortunately, all these advantages come with a few unwanted side effects.