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The market's uses

I say this is unusual because equity issues have for years been small and rare. Bank of England figures show that, in the last 10 years, net equity issues by UK companies averaged only £8.7bn a year. That's just 4 per cent of total capital spending during this time. And most of those issues were banks recapitalising themselves after the crisis.

In the US, things have been worse. In the last 10 years, non-financial companies have been net buyers of shares - to the tune of $345bn (£225bn) a year on average.

The stock market, then, has long ceased to be a means whereby investors provide capital to companies and thus promote investment in the real economy. Indeed, new research suggests it has become the opposite - a means of depressing capital spending and growth. Alexander Ljunqvist and John Asker of New York University and Joan Farre-Mensa of Harvard Business School compared US-listed companies with similar privately-owned ones, and found that listed companies invest "substantially less" than their private counterparts.

The difference, they found, is most pronounced in industries where share prices are most sensitive to fluctuations in current earnings. This, they say, suggests that listed companies are victims of short-termism. Managers try to impress investors by maintaining short-term earnings, and they do so by avoiding the costs of capital spending and by neglecting long-term projects.

Maynard Keynes famously complained that "when the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done". Things might be worse than he thought. The problem isn't so much that the stock market misallocates capital, but that it doesn't allocate it at all.

This might help explain two facts.

First, very few companies are listed. There are 2.34m companies in the UK, but only 1,904 quoted on the stock market. That's less than one in a thousand. Professor Ljunqvist says the proportion is similar in the US. Of course, one reason for this is that many companies are too small to interest equity investors (although this in itself is more curious than it seems) - but another reason is that many owners feel, perhaps rightly, that the stock market serves little purpose.

Second, 'growth' stocks have, on average, disappointed investors for long periods. This might be because of a selection effect. If a company had really great growth prospects, it might not want to be listed on the stock market, where it would have to pander to semi-informed analysts interested only in the next quarter's earnings. In this sense, the stock market selects against truly good growth companies, leaving them in private hands.

This poses the question: if the stock market doesn't allocate capital, what does it do? We can discount the possibility that it successfully monitors management. The fact that it failed to rein in the catastrophic managers of banks in the run-up to the crisis tells us this much. And basic social science tells us why this should be. When ownership is dispersed, we have a problem of collective action. The costs of learning about managers are borne by an individual shareholder while the benefits accrue to all shareholders. Everyone therefore has an incentive to free-ride on the monitoring work of others, with the result that such monitoring is under-done.

All this said, I can think of three functions of the stock market.

First, it provides an incentive for some entrepreneurs and private equity owners. The knowledge that one might be able to float one's business on the stock market - often at an over-priced level after the company has enjoyed its best growth - gives some an incentive to start and invest in small businesses.

Second, the stock market is a laboratory for studying human behaviour. Yes, we can learn a lot about economic activity from actual laboratory experiments. But these are always vulnerable to the question: does this apply to the real world? Stock market behaviour often gives us the answer. If stock markets didn't exist, we wouldn't have the field of behavioural finance. We would therefore know a lot less about cognitive biases and the limits of rationality.

Third, stock markets give savers - we cannot call ourselves investors - a way of gambling in a positive-sum game; it's positive-sum because the equity premium means that shares outperform safe assets over long periods. This is not merely a Ponzi scheme, whereby we make money thanks to future savers coming into the market. Share prices rise over time because they are a claim upon the dividends of (a minority of) companies, and those dividends should grow as the economy does. In this sense, equities are an alternative to the GDP-linked securities advocated by Yale University's Robert Shiller. Given the dangers involved in governments issuing such securities, they might even be a superior alternative.

So, yes, stock markets still have a function.