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6 years ago

Financialisation of the economy

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A new term has emerged in the lexicon of economic and business discussions for some time.  It is ''financialisation''.  It now occupies the same degree of importance as with globalisation and neo-liberalism in the contemporary discourse on the current global economic system and its future direction. But there is significant lack of clear understanding about the nature and impact of financialisation on the economy relative to our understanding of globalisation and neo-liberalism.

Financialisation is considered as a process where financial markets and institutions within those markets grow in scale and profitability leading to eking out an increased share Gross Domestic Product (GDP). This is because  financial leveraging override equity (capital) resulting in profits being accrued more through using financial leveraging rather than goods production and trade in those goods. In essence, it is all about making money out of money rather than making products.

Financial instruments can make quick profits without any complications of making and selling goods. But with such increased prominence over the economy, captains of the finance sector also gain greater influence on economic policy and economic outcomes.

The increased importance of the finance sector is impacting on the economy both at the macro and micro levels. It does so by encouraging economic activities to be guided by financial motives alone thereby enhancing the role of finance sector relative to the real economy with significant implication for income transfer from the real economy to the finance sector. At the corporate level the orientation is focused towards shareholders value. This requires significant changes to corporate strategies and structures which generally follows a very set pattern which involves outsourcing and corporate disaggregation. To give these strategies momentum to work effectively, the remuneration packages at the top are made very attractive. On the other hand, at the economy level there is empirical evidence available that suggests financialisation has contributed to newly emerging pattern of inequality and changing social behaviour and culture of acquisitiveness. There is also increasing trends towards money being intermediated from financial institutions to financial markets or, in other words, a shift from finance being intermediated by banks and other institutions to markets using mechanisms such as securitisation where debts are turned into marketable securities instead of channelling them to the real economy for productive investment.

This rapid rise of finance has diverted income from labour to capital. Now there is a growing body of evidence available to suggest that the worldwide phenomenon of rising income inequality is partly attributable to the disproportionate  rise in the share of financial sector in economic activity.

Since the 1980s financial markets have increasingly become very important in shaping how the economy operates. The most spectacular feature of this new development is the increased involvement of households (families) in financial markets quite often not knowing that they are a key player in financial markets. Household pension funds and savings are invested in mutual funds while their mortgages, car loans and university student debts are securitised and sold to global investors rather than held by banks until they are paid off. 

The finance sector's singular focus on short-term returns has prevented the sector to make long-term investment in new technology and product development which negatively impacts on the manufacturing sector with negative consequences for employment growth.

Also social contract between the state and the citizen on the one hand and employment contract between the employer and the employee, on the other, have been undergoing radical reorientation during the period coinciding with the financialisation of the economy. In fact such reorientation has further provided stimulus to acceleration of the financialisation of the economy. The state is increasingly shifting the burden of health care, education and retirement benefits on to its  citizens to take care of, thus increasing number of citizens are getting involved in financial markets through obtaining loans, saving for retirement and health care. States around the world have also adopted finance-friendly policies by deregulating financial markets and removing or reducing capital controls. At the same time there has been rising household involvement in the stock market through direct share ownership which has been facilitated by easy access to credit. In this regard the taxation system also encourages such borrowing to buy stocks. With stagnating wages, household consumption has been increasingly financed by accumulating debt, as such household indebtedness has been soaring.

Corporations (employers) are now geared towards creating value for shareholders and that involves adopting a host of structures and strategies which has resulted in displacement of long-term employment and stable retirement benefits by individual; contract employment has become the norm where retirement benefits are made the individual employee's responsibility. Obviously such a radical changeover to employment conditions pushes employees to increase their engagement with financial markets to ensure their retirement benefits. Most of these employees also possibly have mortgages and university debt owed to financial institutions.

Since the 16th century financial crises have a common phenomenon, and banking and finance have been the contributors to these crises.  As Finance is always based on promises based on settlement in some future times, and that makes it destabilising because people can renege or make some big mistakes in their calculation of risks. This is why finance can lead to serious economic crisis as we have seen in the 2007-08 global financial crisis (GFC). No two financial crises are the same as the 1929-33 crisis was very different in nature than the one of 2007-08 or any previous ones. But all previous financial crises had one aspect very common to them - which is a ''big asset bubble'' before the crunch time.  These bubbles are fed by very high levels of financial leveraging pushing debt burdens to an unsustainable level leading to the day of reckoning.

But finance is not only very vital to the functioning of economies but also to the functioning of the highly interconnected global economic system. Banking, asset management, insurance and venture capital constitute the components of the financial sector of the economy and they are all essential financial institutions for a well-functioning market-based economy. This makes finance so vital to the functioning of economies. Financial markets also have a pervasive influence on both the domestic and the global economy.  According to the Bank of International Settlement (BIS), in 2016 trade in goods and services accounted for US$ 80 billion a day but US$ 5.1 trillion foreign exchange traded a day. This huge amount of foreign exchange was largely traded for foreign financial assets including foreign exchange itself for speculative purposes. In the wake of the GFC trade contracted sharply due to the decline in demand but financial factors also contributed to exacerbate to decline in trade as there was concomitant collapse in trade finance.

As states around the world, including developing countries, have adopted finance-friendly policies, financial markets will exercise far more pervasive influence not only on the domestic economy but also on the global economy with all the consequent risks involved in it.  With wage stagnation and rising income inequality, massive and also rising corporate and household debt are symptoms of a coming market correction in many developed economies which will also spread to the rest of the global economic system because of the very close interconnectedness of economies around the world.

Muhammad Mahmood is an independent economic and political analyst.

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