Competition and International Equity Returns: Some Empirical Tests of “Turbulent Arbitrageâ€

The idea that capital flows accelerate and decelerate in response to differential rates of return on real investment is common to virtually all of economic theory. This paper examines the nature of this process, especially the relationship between returns in the stock market and returns on real investment. Shaikh (1998) makes the case that the rate of return on new physical (real) investment is the “required†rate of return for the stock market and that competitive forces produce a rough equalization between these two rates of return, what he terms “turbulent arbitrage.†In contrast to neoclassical theories of perfect competition, with its notions of perfect information and convergence to a uniform rate of return, the notion of “turbulent arbitrage†is a dynamic process that requires a tendency toward convergence as well as the constant differentiation of profit rates (Botwinick 1993). Data on rates of return at the country, industry, and firm level for Japan, Germany, the United Kingdom, and the United States are analyzed and correlated with Shaikh’s “incremental rate of return on real investment†which, it is argued, is the target of the equalization process. Statistical and econometric tests based on time series methods and pooling techniques support the hypothesis that the rate of return on equity prices is linked to the incremental return on real investment. In addition, this association is examined for two industries—steel and retail trade—across these same four countries. Global and domestic equity markets are found to be significantly correlated with the incremental returns for the steel industry but not for the retail trade sector. JEL classification: G15, F02, C33