Financialization

Financialization is a term that has gained widespread usage in the critical economics lit- erature since the early 2000s, and especially in the aftermath of the 2008-09 global finan- cial crisis. However, the term lacks a clear, agreed-upon definition, and its precise use and form have been ambiguous. At a general level, it refers to the increase in the size, impor- tance and power of financial markets, transactions, institutions, motives and financial elites in the functioning of the economy in the post-1980 era. Some describe the finan- cialization process as a shift from productive activities to financial activities, while others emphasize the dominance of finance in general over economic activities (see Epstein, 2005). In this framework, financial activities include borrowing and lending activities as well as dealings in financial assets such as stocks, bonds, derivatives, futures, and other types of securities. These activities are distinguished from non-financial activities, which include the production and distribution of goods and the production and distribution of services that are not directly related to financial activities.

At the firm level, financialization is used to designate changes in the relationship between the non-financial corporate sector and financial markets. These changes are twofold: on the one hand, non-financial corporations began increasing their acquisi- tion of financial assets and deriving an increasing share of their income from financial sources. On the other hand, the management of non-financial corporations came under increased pressure from financial markets to maximize short-run returns, which led to increased payments to financial markets in the forms of interest payments, dividend payments and stock buybacks (see Orhangazi, 2008).

There are also some more specific uses of the term, such as "financialization of com- modities" or "financialization of food", in which financialization refers to increased financial activity in markets where commodity or food items futures are traded and future streams of revenue from these have been transformed into tradeable financial assets.

Indicators of financialization are abundant. For example, total global financial assets as a percentage of world GDP have increased from 109 per cent in 1980 to 263 per cent in 1990, 310 per cent in 2000, and 355 per cent in 2007. The size of the financial sector with respect to GDP, financial incomes as a percentage of national incomes, financial corpo- rations' profits with respect to non-financial corporations' profits, debt-to-GDP ratios, non-financial corporations' financial incomes and financial payments have all shown sharp increases since the 1980s (see Orhangazi, 2008, 2012).

While there are different theoretical and historical explanations for the rise of finan- cialization, it is commonly associated with the demise of the Keynesian accumula- tion regime in the 1970s and the rise of global free-market neoliberalism afterwards. The crisis of the 1970s was characterized by a stagnating economy, declining rates of profit, increased inflation, and bankruptcies. All these, together with the collapse of the Bretton Woods international financial system, created two central dynamics: various attempts to recover profitability and an expansion of finance in an increasingly deregulated/unregulated environment. The collapse of the Bretton Woods system and high rates of inflation led to a number of financial innovations that aimed to address the increased levels of uncertainty and paved the way for decades of complex financial innovations. The rise of institutional investors, such as pension funds and investment funds, contributed to the shift in the balance of power in corporations from manag- ers to financial market participants; and with the contribution of the hostile takeover movement of the 1980s caused significant changes in corporate governance. As the financial sector gained in power, it became very active in pushing for more deregula- tion. Financial market liberalization and deregulation increased financial investment opportunities, while also allowing for the growth of institutional investors and a surge in non-banking financial institutions.

Financialization received support from mainstream economic and financial theory, which argues that expansion of financial markets enhances efficiency and allows for better management of risk. In addition, the corporate governance literature, which focuses on the relationship between financial markets and firms, argues that the task of firm managers should be to maximize value for shareholders. In order to do this, the interests of shareholders and managers should be aligned. This provides the theoretical background for the expansion of management compensation and stock options as well as increased takeover activity and private equity investment.

Financialization has had a number of consequences. First of all, various types of financial sector activities acquired greater significance with respect to real sector activities, and the transfer of income from the real sector to the financial sector increased. Financial decisions began to dominate real sector activity, and slower economic growth has been associated with financialization. Increased financial fra- gility and instability, both in the US economy and in the world economy, have also been seen as direct consequences of financialization. For households, it has led to an increased ability to borrow and for non-financial corporations it has precipitated a whole series of changes in firm behaviour. Financialization has also contributed to increasing income and wealth inequality, as it was effective in shifting the balance of power in favour of capital. While the rise of profits and financial incomes - interest and dividend incomes and capital gains - relative to wages was a major factor leading to a concentration of income and wealth at the top, profits made from managing this increasingly concentrated wealth further contributed to the inequalities. Inequality has also further deepened the process of financialization. Increased income and wealth inequality have directed more and more funds into speculation through institutions such as investment and hedge funds.

See also:

Bretton Woods regime; Finance and economic growth; Financial crisis; Financial innova- tion; Financial instability.