Financialization of the Economy

Financialization of the Economy

Since the 1980s, the financial sector has begun to play an unprecedentedly important role in the economy and society. This phenomenon—financialization—has transformed the economy, politics, and everyday life.

What is financialization? Financialization is a polysemous term:

Quantitative definition: the growth of the share of the financial sector in GDP, employment, and profits. In the US, the share of finance in corporate profits has increased from 10% in the 1950s to 40% in the 2000s.

Qualitative definition: the increasing role of financial motives, financial markets, financial actors, and financial institutions in the functioning of the economy (Epstein).

Manifestations of financialization:

• Growth of financial markets and instruments
• Increase in household and corporate debt
• Orientation of non-financial companies towards financial income
• “Shareholder value” as the main goal of business
• Penetration of finance into everyday life

Causes of Financialization

Financialization is the result of several processes:

• Deregulation:

  • Repeal of Glass-Steagall (1999)—banks are allowed to engage in investment activities
  • Liberalization of interest rates
  • Easing of capital controls
  • Expansion of permissible financial instruments

• Technologies:

  • Computerization of trading
  • Complex risk management models
  • Global networks of instant transactions

• Globalization:

  • Growth of cross-border capital flows
  • Offshore financial centers
  • Arbitrage between jurisdictions

• Neoliberal ideas:

  • Efficient Market Hypothesis—markets are always right
  • Financial innovations are beneficial
  • Regulation hinders efficiency

Shareholder Value and Corporate Governance

Financialization has transformed business:

The ideology of shareholder value. The sole purpose of the company is maximization of value for shareholders. Other stakeholders (workers, society) are secondary.

Practical consequences:

• Share buybacks instead of investment
• High dividends
• Cost-cutting (including labor)
• Short-termism—a quarterly time horizon
• Growth of CEO salaries tied to stock prices

Criticism. Shareholder value undermines long-term investments, innovation, and product quality. Workers and communities suffer. Even some CEOs (Business Roundtable, 2019) have declared a shift toward stakeholder capitalism.

Financialization of Households

Finance has penetrated into everyday life:

• Growth of debt. Mortgages, consumer loans, student loans. US household debt rose from 60% of disposable income in 1980 to 130% in 2007.
• Pension financialization. The shift from defined benefit (guaranteed pension) to defined contribution (accumulative) transfers risks onto individuals. Pensions depend on financial markets.
• Asset-based welfare. Well-being increasingly depends on asset ownership (housing, stocks), rather than salaries or government programs.
• Financial literacy. Responsibility for complex financial decisions is shifted onto individuals, often unprepared.

Consequences of Financialization

Financialization has large-scale consequences:

• Inequality:

  • Financial income concentrates at the top
  • Capital income grows faster than labor income
  • Financial bonuses increase the gap

• Instability:

  • Financial bubbles and crises
  • Systemic risks
  • “Too big to fail”—socialization of losses

• Undermining of the real economy:

  • Diversion of talent into finance
  • Lack of investment in production
  • Pressure on workers

• Political influence:

  • Financial lobbying—one of the strongest
  • Regulatory capture
  • Revolving door between Wall Street and government

The Crisis of 2008

The global financial crisis was the culmination of financialization:

• Mechanism. Subprime mortgages were packaged into complex instruments (CDOs), receiving high ratings. When housing prices fell—collapse.
• Systemic consequences. Bankruptcy of Lehman Brothers, AIG crisis, paralysis of credit markets, global recession.
• Bailouts. Governments saved the banks—trillions of dollars. “Privatization of profits, socialization of losses.”
• Reforms? Dodd-Frank in the US, Basel III worldwide. But the financial sector remains huge and influential. The lessons have not been fully learned.

Alternatives

How can we move away from excessive financialization?

• Regulatory reforms:

  • Separation of commercial and investment banks
  • Financial transaction tax (Tobin tax)
  • Strict capital requirements
  • Limitation of derivatives

• Corporate governance:

  • Stakeholder governance instead of shareholder primacy
  • Limiting buybacks
  • Worker representation on boards of directors

• Financial alternatives:

  • Public banks
  • Credit unions
  • Pension systems with guarantees

De-financialization is a difficult task. The financial sector is deeply entrenched and politically influential. But the crisis of 2008 and its consequences have shown that alternatives must be sought.