Financialization

What Is Financialization?

Financialization refers to the increase in size and importance of a country’s financial sector relative to its overall economy. Financialization has occurred as countries have shifted away from industrial capitalism. The term also describes not just the increase of the market and financial sector's presence in our lives but the increasing diversity of transactions and market players as well as their intersection with all parts of the economy and society. 

Understanding Financialization

Financialization impacts both the macroeconomy and the microeconomy by changing how financial markets are structured and operated and by influencing corporate behavior and economic policy.

In the United States, the size of the financial sector as a percentage of gross domestic product (GDP) grew from 2.8% in 1950 to 21% in 2019.

Financialization has also caused incomes to increase more in the financial sector than in other sectors of the economy. Individuals working in the U.S. financial sector have experienced a disproportionately huge increase in their incomes relative to workers in other sectors since 1980.

Since the 1980s, the financial industry has chased short-term financial returns over long-term goals, which would require investment in technology and product development. One of the biggest reasons for this was simply a matter of Wall Street following its capitalistic instincts, which told them there was more profit in making money from money rather than in engineered products.

Financial instruments provided quick returns with little fuss, so they invested in software that facilitated this approach rather than investing in costly brick and mortar needed to build factories. They were also supportive of products that could be sold at Wal-Mart and manufactured overseas. As a result, the financial industry has played a major role in the decline of manufacturing in the U.S.

History of Financialization

While the beginnings of financialization in the United States can be traced as far back as the 1950s, the financial sector really started to grow later in the 20th century, particularly after the fall of the Bretton Woods system. This, along with the rise in neoliberalism and the free-market principles of Milton Friedman in the 1980s and onward contributed to financialization in the United States.

The Bretton Woods agreement — which tied international currencies to the US dollar and anchored the dollar to gold — created predictable exchange rates and limited speculation. Thus, when this fell, a new period marked by free trade and the free movement of capital began. This also created instability in the global markets from which the financial industry has profited.

Furthermore, as the US paid off its debts to other countries and printed more money, there was a huge surge in global liquidity. This allowed banks to extend more credit to consumers and opened up additional opportunities for profits in the private lending market.

Characterizations of Contemporary Financialization

Since the beginnings of financialization in the 70s and 80s, the overall value of global financial assets has sky-rocketed. In 1990, the value of global financial assets stood at $56 trillion, 263% of global GDP. 20 years later, that number reached a staggering $219 trillion.

In recent years, deregulation and new financial technologies have had a major impact on the financial sector. Even after the 2008 recession, the laws regarding the methods and amount banks are able to borrow are relatively lax, creating further liquidity.

The last decade in particular has seen a massive increase in securitization, which occurs when an originator packages various financial assets into one group then sells this group of repackaged assets to investors. As financial institutions and their clients are constantly seeking new avenues of profit, the financial instruments they offer have grown more and more diverse.

Generally, as liquidity and borrowing increase, so does inflation. This means that consumers who aren't investing a sufficient amount of their savings in these financial instruments will lose money, creating a further need for the financial sector. Furthermore, more people have access to financial information and the market than ever before thanks to the Internet.

Finally, the advent of beginner investing apps such as Robinhood has brought non-traditional investors into the financial marketplace.

Fascinatingly, while the financial industry has become a bigger part of our lives, the percent of Americans invested in the stock market hit a record low in 2019, at 52%.

How Financialization Helps Build Economies

Financial services are also an important source of exports for the United States. While the United States has the world’s largest and most liquid financial markets, financialization has also occurred in many other countries around the world, even in emerging markets such as Mexico and Turkey.

In the United States and abroad, the growth of banking, asset management, insurance, and venture capital — the components that make up the financial sector — can contribute to growth in other sectors of the economy as well. Large and liquid financial markets with a diverse offering of financial products make it easier to fund investment and growth and protect purchases and investments through insurance.

Financial markets also facilitate international trade. The daily volume of foreign exchange transactions has increased from $570 billion in 1989 to $6.6 trillion in 2019, according to the Bank of International Settlements (BIS).

Financialization has also led to significant job growth in the financial sector, and this job growth is expected to continue.

Criticism of Financialization

Critics of financialization focus on its emphasis on short-term profits. According to them, such focus can disrupt a company's long-term goals and negatively affect product quality.

For example, MIT Professor Suzanne Berger wrote about the case of Timken, an Ohio-based manufacturer of power transmission, gears, and specialty steel that was forced to break up its vertically integrated business due to shareholders' intent on maximizing profits. Management, which was against the breakup, argued that it would affect overall product quality. Controlling the attributes of each component used in the final assembly helped the manufacturer provide a superior product to consumers.

Others claim that financialization has led to "unproductive" capitalism. According to economist Michael Roberts, "financialization is now mainly used as a term to categorize a completely new stage in capitalism, in which profits mainly come not from exploitation in production, but from financial expropriation (resembling usury) in circulation."

Other research focuses on the ways in which big firms have come to dominate economies due to financialization. Their dominance, according to research authors, is primarily a result of their ability to cater to and play in financial markets. The playing field is not a level playing field for small firms because they are unable to produce the massive monetary returns demanded by large investors.

Financialization FAQs

Is the Financialization of Housing Good?

The financialization of housing refers to the idea that housing is seen as a vehicle for investment and wealth rather than a social good. Many people who believe safe, stable housing is a human right take issue with the increasing financialization of housing.

What Is the Financialization of Food?

The financialization of food refers to the way the financial sector has encroached on various aspects of the food supply chain. The term reflects various financial actors' impact on the ways in which food is produced, distributed, and consumed.

How Are Universities Affected by Financialization?

Higher education has also been impacted by financialization. Many of today's universities rely more on tuition than state funding to pay for their expenses. This has forced some schools to borrow large amounts of money to pay for luxurious facilities and student housing in order to attract more potential students. The cost of tuition has also soared since the advent of financialization in the 1970s.