Important economic issues in China are coming to center on its share markets. These include proposals for wider availability of short selling, the suggestion China's pension funds should increase share purchases, and the fact that while China is the world's most rapidly growing major economy its share index is lower than in 2007 and almost no higher than 10 years ago. Consequently ordinary people putting money into shares have suffered loses - a recent survey found that 86.6 percent of investors were "very dissatisfied".

The background is that for three decades China has had the world's best performing economy, but this naturally does not mean every individual policy avoids difficulties. Some are rapidly dealt with - for example, the government is currently implementing a program of social house building to deal with inadequacies in the housing market. But some issues remain to be resolved - a misunderstanding of share market dynamics being one.

The central issue is simple. Many commentators appear to believe that if an economy, for example China, grows strongly this will be reflected in a strong performance by shares. But the international evidence shows the exact opposite. Rapid economic growth leads to worse performance by shares - put technically, economic growth is negatively correlated with returns on shares. In short, China's share market performs badly not despite rapid economic growth but because of rapid economic growth. Furthermore, economic analysis explains this.

Before dealing with the explanation, however, the facts should be clearly understood. This involves setting out slightly more numbers than usual, but the relation between economic growth and share prices is so important both for individual investors and economic policy that it should be clearly understood. Furthermore, because of that significance, it has been extensively studied. These studies arrive at the same conclusion:

��Jeremy Siegel's standard work Stocks for the Long Run, surveying 200 years of share market returns, found: "Real GDP growth is negatively correlated with stock market returns. That is, higher economic growth in individual [developed] countries is associated with lower returns to equity investors. Similarly, [when] the stock returns for the developing countries against their GDP growth are plotted... there is a negative relation between the returns in individual countries and the growth rates of their GDP."

��Dimson, Marsh and Staunton's study Triumph of the Optimists, covering a 100 year period, found regarding the real return on shares and GDP per capita growth: "statistically, the correlation is -0.27 for 1900-2000 and -0.03 for 1951-2000" - i.e. the higher the economic growth rate the lower the return on shares.

��Ritter's study Economic Growth and Equity Returns found regarding the relation between GDP per capita growth and share price increases: "My calculations for�� 16 countries over the 1900-2002 period gets a correlation of -0.37."

��Jain and Kranson's survey The Myth of GDP and Stock Market Returns noted: "The data shows clearly that�� stock market returns and GDP per capital growth are negatively correlated."

��Goldman Sachs recently noted this negative correlation between GDP per capita growth and share price growth and concluded: "Our�� analysis for emerging market countries since 1991 showed the equity markets of the slowest growing countries within emerging markets outperformed those of the fastest growing countries by nearly 5 percent a year."

As rapid economic growth is associated with poor performance by shares, China, the world's most rapidly growing major economy, is no exception. Goldman Sachs noted: "China probably provides one of the best examples of the lack of correlation between strong economic growth and equity returns�� Whether it is 1 year, 3 years or 18 years, economic growth has not translated into better investment returns in China �� evidence shows that faster economic growth rates do not result in higher equity returns. In fact, if faster growth is priced into the equity markets, the equity markets are most likely going to lag those of slower growth economies."

The reason for the negative correlation between return on shares and economic growth is clear. The return on shares is ultimately the dividend stream expected from them and its reflection in their price. Therefore, as would be expected, Dimson, Marsh and Staunton noted: "a high correlation (0.87) between real equity returns and real dividend growth."

But dividends are part of a company's profits which are not invested, and economic research shows investment is the most important part of economic growth. Therefore high dividend payments, while creating high returns on shares, result in lower investment and therefore lower economic growth. Low dividend payments, leaving more funds for investment, are correlated with high economic growth but low returns on shares.

It is important to be clear on the implications of this. It does not predict whether shares will rise or fall. It merely establishes that shares in high growth economies, such as China, will underperform shares in slowly growing economies. That China's share prices are lower in inflation adjusted terms than 10 years ago is in line with the fact that shares internationally have been a terrible investment - in real terms the US S&P 500 is 36 percent below its peak. China's shares have simply underperformed share markets which have themselves been losing money for over a decade.

What are the practical conclusions?

First, it is no surprise that China's rapid economic growth is associated with a poor comparative international performance by its share markets. Commentators explaining this by bad market regulation etc. miss the fundamental point that the poor performance of China's share markets is not due to secondary factors but is to be expected from rapid economic growth.

China cannot aim for slow economic growth to boost shares - the overwhelming majority of the population relies on rising incomes from economic growth for its living standards and not on returns on shares. For living standards to rise strongly the economy must grow rapidly - a side effect of which is relatively poor return on shares.

But the real situation must be factored into policies. China's rapid economic growth means inward investment in the productive economy can yield good results, but return on inward investment on shares will be poor in terms of international comparisons. Pension funds must weigh up that China's shares will perform poorly.

It is therefore important both for individual finances and economic policy that the actual factual relation between economic growth and share prices is understood.