1. Yale School of Management 1 Emerging Market Finance Lecture 1: The Big Picture By Zhiwu Chen Professor of Finance Yale School of Management

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3. 3 Why Do Countries Differ in Wealth?

4. Yale School of Management 4 Relationship between Average Number of Hours Worked in 1998 and Per-capita GDP in 2001 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

5. Yale School of Management 5 What determines national wealth? Traditional view: physical assets (e.g., natural resource endowments) China Russia India Taiwan HK Japan U.S. Saudi Arabia Singapore 2002 per-capita GDP in units of $10,000

6. Yale School of Management 6 What determines national wealth? physical capital or something else? 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).

7. Yale School of Management 7 Difference in Growth 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

8. Yale School of Management 8 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, ……

9. Yale School of Management 9 Lack of mass transportation means made each place’s income depend on its natural endowment, but not any more World’s sea-going ship capacity in 10,000’s of tons

10. Yale School of Management 10 Total number of vessels departed from Europe for Asia Total trips in each century

11. Yale School of Management 11 Maybe, the ability to innovate financially also makes a difference

12. Yale School of Management 12 What a difference financialization makes!

13. Yale School of Management 13 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 $ trillions

14. Yale School of Management 14 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 1900 For each $ GDP, how many $ of financial claims floating? Phase I Phase II: stagnationPhase III: globalization

15. Yale School of Management 15 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

16. Yale School of Management 16 Source #1: capitalization of corporate assets & future cashflows Equity mkt capitalization to GDP ratio Sources: Federal Reserve Flow-of- Funds Similar trend in bonds

17. Yale School of Management 17 Source #2: more capitalization of Land and real assets Sources: Federal Reserve Flow-of-Funds Total mortgage loans outstanding to GDP ratio

18. Yale School of Management 18 Source #3: capitalization of future labor income Sources: Federal Reserve Flow-of-Funds $billions Consumer credit outstanding

19. Yale School of Management 19 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?”

20. Yale School of Management 20 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.

21. Yale School of Management 21 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?

22. Yale School of Management 22 But, you need Quality Institutions for this to be feasible. Example: Press Freedom and Service Sector Development Country1990 Press Freedom Rating Service Sector's Contribution to GDP in 2002 U.S.A.1270.70% Hong Kong3086.50% Singapore6064.10% China8927.50% Press freedom rating is on a 1-100 scale, with 1 representing the freest press.

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