Transitory and Permanent Effects of Capital Market Development on Capital Formation in Sub-Saharan Africa

ABSTRACT: Recent research on the relationship between capital market development and capital formation isinconsistent.This study investigates the effect of capital market development on capital formation, andtheempiricalmethodutilisedinthisstudy, the Mundlak method,decomposestheeffectsofcapitalmarket developmenton capital formation into transitory and permanent effects. This decomposition is important in order to ascertainwhether capital market development is beneficial to short-run or long-run capital formation, which is a keydeterminant of a country‟s growth level.The study investigates the capital market development-capital formationnexus byapplyingaggregate dataset from seven countries within the Sub-Saharan AfricanregionnamelyGhana,Kenya,IvoryCoast,Mauritius,Nigeria,SouthAfrica,and Zimbabwe over the period from 1980to 2021. The results indicatethat capital market development has a transitory negative impact on capitalformation,but has a permanent positive impact on capital formation. More importantly, the permanent effectseems more robust and stronger than the transitory effect. The findings conform to conventional wisdom thatSub-Saharan African countries with well-developed capital markets experience long-run benefits of increasedcapital formation and improved economic development. Based on the research findings, we recommend thatcapital market authorities of Sub-Saharan African countries should prioritise policies that will boost productivity,liquidity, and resilience. The study further recommends that Sub-Saharan African countries must improve theircapital markets‟ infrastructures, and eliminate the tax, legal and regulatory hurdles that impede the developmentof their domestic capital markets.

KEYWORDS:Capitalmarketdevelopment,capitalformation,Sub-Saharan Africa, Mundlak Methodology, Paneldata.