The rise of financialization

Financialization has drawn into its expanding orbit non-financial firms and the average household, with detrimental impact on production, employment and inequality. The following extract from a Transnational Institute publication on financialization explores the consequences of this phenomenon, the factors behind its ascendancy, and how it can be resisted.

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Financialization is a relatively new term which covers such a range of phenomena that it is difficult to define precisely. The most-cited definition, from Gerald Epstein, states: “financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies”.

How does financialization change the wider economy?

Financialization is a shift in the way wealth is accumulated. Whereas in the past profits were mostly derived from the mass production and sale of goods, in our financialized era a large proportion of profits comes from the buying and selling of financial securities and the interest payments they accrue.

A study conducted by the International Labour Organization (ILO) covering 17 different countries found that the portion of profits represented by the financial sector rose to over 40% in 2005.

Although the financial sector’s share in US domestic profits fell drastically during the first few years of the Great Recession, by 2010 it had recovered to almost 30%.

Financialized accumulation profoundly affects how the economy works. If companies can make more from trading financial assets than manufacturing products, they may choose not to invest in new technology or they may spend on expanding their finance department to the detriment of other areas. In other words, financialization has been shown to negatively impact on “real” investment. The trend is clear: where higher profits can be made through financial speculation, productive investment tends to decline.

Meanwhile, households have become increasingly reliant on credit in the face of declining or stagnating real wages and employment instability. Debt is now a major source of funding for people’s everyday spending, especially in countries like the US and the UK. In the past, productivity increases were tied to wage growth, which allowed for rises in spending and thus demand and growth. Over the last few decades, in contrast, demand (and hence growth) has become increasingly reliant on greater indebtedness.

Debt is not only used to sustain consumption but also to fund financial investment and speculation. Many countries’ tax codes encourage companies to increase their indebtedness by allowing interest repayments to be counted as a cost, reducing overall profits that are taxed. Many companies raise finance from debt rather than by issuing shares, because this allows them to maintain high profits per share, which helps keep share prices up. Both financial and non-financial firms have become increasingly reliant on credit for financial investments; this trend is especially evident in the US but is also matched in the UK, Japan and Ireland.

A number of studies have shown that debt-led growth, in addition to being inherently unstable and hence prone to crisis, is also ineffective in the long run. Debt-led growth, however, is just one side of the story. For while financialization has led countries such as the US and the UK to offset falling income levels with increased debt, others, such as Germany or China, have attempted to resolve similar demand problems by means of increased exports.

It is sometimes argued that financialization in the Global North simply reflects the shifting of production and manufacturing activities to other parts of the world (in the Global South), which leaves predominantly financial functions in the multinational corporation’s “home country”. However, Krippner found that US multinationals’ profits from foreign financial activities have increased relative to profits from overseas production. In other words, US companies appear to be bringing their “financialized” practices with them to other countries. In sum, corporations are reaping profits not only from relocating production but also increasingly from a boom in financial activities overseas. In both cases, the benefits to countries in the Global South are limited, which has contributed to the “persistence of the North-South divide”.

How are non-financial firms changing in the context

of financialization?

As Demir puts it, many non-financial companies have themselves “metamorphosed” into “financial rentiers”. A retail giant like Tesco may choose to buy up large parcels of land, speculating that rising prices mean it can sell the land later for a profit, without ever building a new outlet. Similarly, Sainsbury’s, another UK supermarket chain, now offers insurance and banking services to its customers. Such is the involvement of large (ostensibly non-financial) corporations in finance that many have their own departments specialized in financial activities. For example, in the case of Enron, financial assets were so central in the business strategy that the company building had its own trading floor.

Krippner shows that since the 1950s, US non-financial firms, particularly manufacturing companies, have increasingly relied on financial income streams. According to another study, US non-financial firms’ financial returns (as measured by “interest and dividend income as a percentage of internal funds”) grew from 20% for most of the 1960s to a high of over 50% from the late 1980s on into the early 2000s. Around the same period, US non-financial corporations began to invest more in financial assets (like stocks and bonds) than they did in their own non-financial assets (like machinery). Their proportion of financial assets relative to “real assets” increased from around 30% in the 1970s to over 100% in the early 2000s. Various case studies – examining coffee traders, oil companies, agribusiness and auto-assembly firms – provide concrete evidence of the “financialization of non-financial firms” from across the world.

Lapavitsas argues that the financialization of corporations ties in closely to their reduced reliance on banks for credit and their pursuit of profit from unused funds. In other words, corporations sought ways to both lend and borrow money, and engaging in financial markets directly offered “lower costs” and more “flexibility” than going through banks. Gradually, non-financial firms developed financial “skills” and “acquired functions that previously belonged to financial institutions”. As discussed below, the financialization of non-financial companies also relates to the imposition of shareholder value principles and the short-term profitability of financial relative to real investments.

How does financialization impact on employment and income inequality?

The effects of financialization on investment extend to employment. Businesses, of course, invest not just in equipment but also in their staff. Whereas in the past new job opportunities and expansion of productive activity would have been an indication of economic well-being, in the era of financialization share prices often rise following the announcement of job cuts and physical capital downsizing. For example, in May 2014 Hewlett-Packard’s stock prices rose more than 6% the day after it announced that it would cut between 11,000 and 16,000 jobs. Furthermore, many businesses transfer the burden of capital market demands onto their workers, slashing wages and adding, in different ways, to the growing precariousness of employment.

Real wage growth has been stagnating or declining in countries such as the US and the UK over the last 30 or so years. At the same time, managers and CEOs within the productive sector and top-level financial sector employees have seen their pay packets swell, in large part due to stock option pay and bonuses – contributing to growing income inequality.

If the impacts are negative for labour when finance is “doing well”, they are even worse when it isn’t. Workers were the group worst affected by the global economic crisis. Not only did unemployment grow across the Global North, but wealth inequality also continued to rise. Thus, in contrast to the Great Depression when inequality fell because of declining asset values held by a minority elite, in the contemporary Great Recession asset prices recovered relatively quickly (in part due to the help of government bailouts) and the wealthy got by relatively unscathed.

The increasing importance of the financial sector overall, combined with the growing reliance of non-financial firms on financial income relative to productive activities, seems to have made capital less dependent on labour for profits and thus further tilted the balance of class power. Still, it is important not to make overly simplistic generalizations. Drawing on evidence from the German automobile industry, Kadtler and Sperling show, for example, the continued importance of collective bargaining and trade unionism in influencing key decisions within some globalized and financialized firms.

What is shareholder value and what is its role

in financialization?

One of the most important aspects of financialization is also one of the least well understood: shareholder value governance. Over the last 40 years non-financial companies have become obsessed with their share prices, and seem to dedicate more resources to improving their share price than they do to improving the products or services they sell. To do so, firms sell off divisions that are less profitable, fire staff, outsource services and often spend vast sums buying their own shares.

Many argue that shareholders – investors on financial markets – have used the stock markets to force companies to prioritize shareholder returns above all other concerns; this is often called “shareholder value maximization”. If shareholders felt managers were not delivering high enough returns, they would sell the equity and take their money to a company that did. This market pressure is supposedly exacerbated by the fact that ownership of corporate stocks is concentrated in a few hands. If a big institutional investor decided to sell all the shares it owned, share prices could tumble. In this way the stock market supposedly left managers with no choice but to obsess over share prices.

However, the reality is that the big institutional funds, bar a few isolated incidents, have actually been unable to force their will on non-financial companies. More often than not, it’s easier for them to go along with management’s decisions than to challenge them. So rather than shareholders forcing managers to make share price the main priority, it is the managers of non-financial companies themselves that have led the change.

In a financialized environment where lots of debt can be raised very quickly (thanks to securitization), it is far easier to acquire companies, restructure them and sell off divisions than it is to try and build long-term plans and improve productivity. In today’s age, many corporations’ main priority is to be able to borrow money quickly and easily, and a high share price is a good route to creditworthiness. The chase for high share prices and sound creditworthiness has made financial criteria – and financial experts and accountants – central to the strategies companies adopt. Accountants, not engineers, now decide what’s best for industrial companies.

To compound matters, managers have tied their own salaries to share prices by paying themselves partly through stock options. So when share prices increase, so do their own salaries.

The increase in share prices has also been boosted by general demand on the stock markets. This new demand is a result of the massive inflow of funds from households drawn into financial investment through pension plans or special saving schemes. Thus, as Froud et al. point out, “with financialization, stock prices are driven by the pressure of middle class savings bidding for a limited supply of securities”. This has made the underpinnings of recent shareholder gains extremely unstable. The authors even liken the operation of the US and UK financial markets to a giant Ponzi scheme, with the income of existing shareholders largely depending on the continual entrance of new players.

Overall, it is clear that financial markets have an enormous impact on corporate behaviour. In the race to increase share prices, many corporate managers have begun to mimic financial market conduct – changing the disposition of the company towards “short-termism”. Non-financial firms have chosen to seek new profit channels through financial activities, restructuring (e.g., outsourcing, takeovers and mergers) and financial engineering (e.g., share buybacks or tax dodges), instead of investing in new products or to improve productivity.

How does financialization affect the

“average” household?

A lot of people have become more dependent on financial products for their wants and needs. Though use of credit by households is not a new phenomenon, household financial activities have changed both quantitatively and qualitatively. Individuals may be involved in financial markets through their insurance cover (health, home, car, life, unemployment), their pension plans, their savings schemes, their student loans, mortgages and different consumer borrowing options such as overdrafts, short-term loans and credit cards. The reliance on loans, especially, has become habitual in many countries, the normality of credit card usage being an obvious example. Increasing use of and access to credit is sometimes treated as a symptom of affluence; however, it can also be viewed as the result of social pressures for maintaining or increasing consumption whilst facing stagnating or falling real wages.

As Montgomerie has described, retail banking innovations have integrated individuals and households into capital market networks whether they know it or not. For example, by securitizing credit card and mortgage debt and selling these securities on international markets, retail banks brought consumers and households into direct contact with investment banking. This made consumer debt a very profitable and apparently secure activity and allowed for an increase in the credit available.

Households engage in financial markets not only as debtors but also as investors. Since the 1980s and 1990s, many governments have been pushing reforms encouraging (for example, with tax incentives) the adoption of private “individual retirement plans”. There has been a drift away from “pay as you go” or PAYG (where retirees or pensioners are paid with taxes and contributions from people currently working) towards “partially funded” or “fully funded” (in which contributions are invested in a fund, later used to pay benefits) systems. As such, retirement savings have been channelled into financial institutions. Even those countries (e.g., France) that maintain relatively large public pension systems have been gradually changing from PAYG to investing state funds in financial markets.

At the same time, within companies, there has also been a shift from “defined benefit” to “defined contribution” type plans, which has implied the transfer of risk from employer to employee. Under defined benefit plans, the employer or company provides pensions for its employees. It bears the financial risks and has to pay its workers as promised even when its investments don’t perform as expected. With defined contribution plans, in contrast, individuals hold their own accounts that incur gains or losses depending on investment performance. In sum, pension reform has converted many workers into investors with a direct stake in the performance of stocks and bonds.

All in all, through debt, pension and other types of savings, households have become more closely involved in financial markets. This implies a cultural transformation in which households are supposed to adopt a “finance rationality”. In making decisions about which pension plan to choose, the type of savings scheme to invest in, between variable and fixed interest rate loans, and so forth, the individual or family is expected to act as a rational financial actor, analyzing and calculating the costs and benefits of different options. In short, he or she should behave as any other investor. Above all, the individual worker or household should allegedly assume financial risks and take responsibility for his or her own future.

Indeed, the mounting reliance of households on financial markets is the corollary of a total or partial withdrawal of state provisions such as pensions and other types of social security, subsidized housing, health and education. It is about “the transfer of risk and responsibility from the collective to the individual”. With this in mind, many governments and institutions have been aggressively advocating “financial literacy” for everyone. Neoliberal discourse calls this “financial empowerment”. However, the result has been to “naturalize ideas about self-reliance and to depoliticize more specific questions about the privatization of risk”.

How did financialization become so dominant?

Financialization is not something that simply occurred. Political decisions or non-decisions permitted the process of financialization to take off and continue apace. Although deregulation responded, in part, to “regulatory arbitrage” and loopholes that some corporations were already taking advantage of, policies at national and international level also actively encouraged activities and changes that buttressed financialization. Finally, non-action, such as the refusal to intervene in financial activities that are potentially destabilizing, has been at least as important as active policy reform.

Neoliberal policy, in particular, bolstered financialization. The focus in the last few decades on maintaining low inflation, as opposed to the post-war Keynesian-era macroeconomic goal of maintaining full employment, has particularly benefited the financial sector because inflation erodes the value of financial assets. Of course, inflation affects everyone; it eats away at savings and makes salaries lose their purchasing power, but the priority it has been given, the goals that have been set and the methods (austerity or interest rate hikes) by which it has been contained, skew benefits to the financial sector.

A rise in interest rates, for example, worsens debt loads (for governments, companies and households) and can contribute to a stifling of growth as a result of increasing credit costs. Yet at the same time, high interest rates tend to benefit the financial sector and may encourage investors to flock to financial assets at the expense of long-term productive investment in the “real” economy.

The relation between financial gain and interest rates, however, is not straightforward. It is important to note that it was extremely low interest rates that initially fuelled the financial bubble in the US. Financial institutions took advantage of low federal funds rates by leveraging their investments. This is reflected in the high levels of debt taken on by these firms during the boom.

Some governments have become resigned to such economic policies, arguing that they have little choice in the matter. Once financial liberalization has taken place and capital is unshackled from its chains, national policy autonomy is limited to an extent. On the one hand, the ability to tap into private financial sources depends on “creditworthiness” as assessed by international institutions and rating agencies. On the other hand, countries that don’t comply with investor interests are punished by “capital flight” where investors take their money out of a country to pursue greater returns elsewhere.

There are, however, significant differences between countries in this regard, depending on global political economic positioning and power. Some governments are more restrained by capital market valuations than others, while how countries respond to these pressures depends upon outcomes of conflicts and negotiations between different actors within specific contexts. Examining the case of Argentina, Jimenez observes that neoliberal restructuring in the 1990s “reflected an alliance of political power between the state and transnational financial power at the expense of industry”. Financialization, she argues, was imposed by a particular coalition of interest groups who intended to encourage a finance-led growth regime in the Argentine economy. This created a boom in the mid-nineties followed by a bust in 2001.

Many economists celebrate the restrictions imposed on public policy through capital mobility; Thomas Friedman, for example, calls this the “golden straitjacket”. From this point of view, capital mobility serves as a “disciplinary instrument” forcing governments to adopt the “appropriate” monetary and fiscal policies such as balanced budgets (which may require harsh austerity measures), low inflation, generous tax codes and deregulated financial markets. Ironically, rules of fiscal austerity do not apply in the event of a financial crisis in which the government is expected to bail out private investors and institutions. Thus market discipline dictates not the desired amount of government spending but the desired form: budgets which include funds for health, education or social security, for example, are seen as objectionable, whilst in the case of a financial crisis the government is expected to empty its purse.

The financial institution bailouts imposed by the US and various European governments following the 2008 crisis are a good example. In autumn 2008 the US Congress passed the Troubled Asset Relief Program or TARP which provided up to $700 billion for buying up or insuring “troubled” financial assets. For Palley, the purpose was not necessarily to save investors from incurring losses but to prevent a wider crisis, since under financialization the fortunes of the broader economy depend on the financial system.

Despite the US government’s injection of cash, the financial system remained reticent to lend and the “credit crunch” dragged on. At the same time, financial institutions quickly recovered profitability and were not so reticent about paying out large “rewards” to their top employees.

How have political and economic interests promoted financialization?

Notwithstanding those examples where regulators’ choices were (apparently) constrained, there are countless cases from across the world that clearly point to political and economic interests as the ultimate determinants in financially biased policymaking. Pension reform is a good example. In many countries an ageing population is said to pose an imminent risk of a pension crisis. There are many different possible solutions to this problem, but un-coincidentally most governments have veered in the same direction: a closer integration of the pension system with global financial markets. Put simply, more and more people’s retirement savings are now invested in capital markets.

This has three main impacts favourable to financial firms. First, it provides them with new income and profit channels. Second, in contributing to demand for financial assets, it encourages asset price inflation that props up finance-led accumulation. Third, the growing number of individuals with a stake in the financial markets facilitates support for policies that end up benefitting large financial firms. Financialized pension regimes help to cultivate a culture of finance among the population that normalizes the finance-dominated society in which we live.

One of the countries with the worst fame for its politicians pandering to financial sector interests is the US. Apart from the extensive congressional lobbying by big banks and the huge sums financiers “donate” to political campaigns, there is a “revolving door” between Wall Street and Washington in which individuals move between positions as politicians and regulators and high-end jobs in the financial sector.

In 2004, the US Securities and Exchange Commission (SEC) heeded to the largest investment banks’ lobby for an exemption from the established “net capital rule”. The regulation required brokers to maintain a certain level of liquid asset reserves relative to their liabilities, ensuring their ability to meet payments even under unforeseen circumstances of severe investment losses. In effect, the regulation limited the amount of debt the brokers could take on and thus restricted their participation in lucrative leveraging strategies; it also tied up money in reserves that could otherwise be used for different profiteering ventures. From the investment bank’s perspective, then, this was something worth lobbying about. The exemption was eventually applied to big investor banks with assets of more than $5 billion. In exchange for being released from these rules, the banks promised to allow the commission access to their books, but the SEC basically left them to self-regulate. These decisions were later questioned in light of the 2008 crisis and the enormous amount of taxpayer money spent on bailing out large investment banks. It is worth noting that one of the big investment banks pressuring for this change was Goldman Sachs, which at the time was headed by Henry Paulson, who in 2006 became Treasury Secretary of the US. In 2008, Paulson supported the government move to use public money to cover private financial losses, including those of Goldman Sachs.

In most countries, gestures of reform since the financial crisis have been meagre – at best. Without a significant change in power dynamics, it is unlikely that governments will do much to halt the financialization process. Indeed, financial institutions’ profitability recovered not long after the financial meltdown, and some of these profits were quickly put to work lobbying congress to block reforms considered detrimental to their interests.

What is “financial democracy” and why is it problematic?

The growing involvement of “ordinary” people in financial markets is sometimes celebrated as the dawn of a “financial” or “investor” democracy. Wealth is supposedly constantly redistributed from corporations to the millions of worker-shareowners. Policies that favour Wall Street or the City now allegedly represent the public good instead of a narrow minority.

Yet only a small percentage of the population is able to invest enough savings for financial gains to be truly relevant. The impression made by the statistic of more than half of North Americans having a “stake in” the financial markets quickly deflates when considering that 40% of stockowners hold only “negligible” amounts in shares: “70 per cent of US households still own few or no stocks.” In sum, most people do not benefit in a significant way from rising share prices or increasing dividend payments. Furthermore, the notion of financial democracy distracts from the fact that the sector is actually highly concentrated. If before the crisis many institutions were considered “too big to fail”, this only worsened with restructurings: as of 2009 just five investment banks controlled 37% of financial assets in the US.

Still, the mere impression of financial democracy, regardless of the fact that it is not backed by the figures, consolidates the hegemony of finance: “As investors, many workers now appear to have a direct material interest in neoliberal policies such as capital mobility, price stability, low capital-gains tax and shareholder value.” In reality the losses suffered by the majority under these policies are more than the measly gains obtained from them.

The financial democracy thesis is also questionable given that workers and large corporations are clearly un-equals in the finance game. Most big firms cannot easily be taken advantage of by financial institutions, given they have a similar level of power and information access, but individuals often use finance to meet basic needs and may have few alternatives. For example, a company may take out credit as part of a calculated leveraging strategy (i.e., in order to multiply gains), whilst an individual may have little option but to take on a student loan or even use a credit card to pay for groceries when his or her derisory salary runs out. Furthermore, workers continue to be mere consumers of financial products, while large firms have the capacity not only to buy in the financial markets but also to sell. Finally, “limited liability” gives corporations exceptional power compared to the household: unlike with workers, the homes of shareholders are not expropriated in order to pay the debts of an insolvent company. There is clear evidence of this inequality when considering the outcome of the Great Recession: a lot of families lost homes and jobs, while the state used public funds to rescue many companies.

For Bryan, Martin and Rafferty, far from constituting a “financial democracy”, financialization can be likened to an “enclosure” of the household: “the realm of reproduction and domesticity” has been converted into “a scene for further accumulation”. In many cases, households are forced to work more (e.g., additional employment or overtime) in order to sustain growing levels of debt. As argued by Lapavitsas, there is an “evident contradiction at the core of this phenomenon”: the growing reliance of banks on extracting profit from workers’ income corresponds with stagnating real wages – in essence, it is not a sustainable strategy as eventually workers may not be able to meet debt payments, which can lead to wider economic crisis, as in the 2007-08 housing market crash.

Despite hopes that greater financial inclusion and literacy could foster wealth creation (by channelling idle savings directly into capital markets) that filters to all rungs of society, and could even provide a mechanism for people (as equity holders) to hold large companies to account, the practice has turned out quite differently. Instead, “financial democracy” has meant the money of the many fuelling the profits of the few.

How can financialization be resisted?

Financialization has imposed new pressures on everyday life and made old pressures worse. But it has also opened up new possibilities for resistance.

One is debt itself. Just as striking coalminers once used their access to the engine of the economy – coal – to flip the balance of power and demand better conditions, so now debtors can use their access to credit by declaring a debt strike. A refusal to accept unfair quantities of debt lumbered on people in financialized economies can force creditors to back down or change their terms of payment. In early 2015, a group of 15 students in the US refused to pay back the student loans they took out to attend the for-profit Corinthian colleges. Outstanding student debt in America is over $1 trillion and organizations like Strike Debt and the Debt Collective hope to organize mass refusals to help counter the debt-laden financialized norms they live under. Refusing repayment and demanding a write-off of debt is not unfamiliar and has a long history. Anthropologist David Graeber’s thorough history, Debt: The first 5000 years, shows how debt jubilees have been common since the debt slates were wiped clean in ancient Mesopotamia.

Another route of resistance is the attempt by campaigners to foster solidarity and a sense of collective identity among debtors. Rolling Jubilee, a collective that grew out of Occupy Wall Street, is using the financial markets to this end. It is organizing debt jubilees by collecting donations to buy distressed personal debt (money that banks have given up trying to collect) at discount on the secondary debt market. Instead of allowing it to fall into the hands of debt collectors, the group steps in, buys the debt and writes it off. Those who have had their outstanding loans cleared are then encouraged to donate to keep it moving. Because the debt is worth much less than the value of the initial loan, they are able to buy up large quantities. By March 2015 Rolling Jubilee had raised over $70,000 to abolish almost $32 million of distressed debt. They hope that such actions will make even more radical debt strikes possible.

Another way of exercising pressure on large banks is by simply “moving your money” to smaller institutions with different operating logics. The Move Your Money campaign created a “Bank Ranking Scorecard” which ranks UK banks and building societies according to criteria including “honesty, customer service, culture, impact on the real economy and ethics” in order to help consumers decide which institution to hold an account with. Crowdfunding and peer-to-peer lending, in which individuals lend or donate directly to the project or enterprise of their choosing, is also a means of bypassing large financial institutions. However, the growing popularity of these schemes puts them at risk of corporate takeover; in this sense, it is worth investigating how different platforms operate before jumping on the bandwagon.

There are also a number of different campaigns aimed at addressing the problems wrought by financialization. Most of these campaigns focus on lobbying governments to regulate specific aspects of the financial industry. For example, the US “Stop Gambling on Hunger” and the European campaign against “Food Speculation” (which combines the work of a number of civil society organizations and NGOs) have been pressuring for the introduction of new rules to roll back the financialization of agricultural commodity markets. The latter campaign contributed to the European Union’s decision to impose position limits, capping the number of contracts on agricultural commodities that any one financial trader or group of traders can hold. Unfortunately, opposition to the regulations, especially from the UK government, watered down the agreement and left key loopholes open. There are also multiple campaigns for implementing or strengthening more general financial transaction or “Tobin” taxes, aimed at stifling speculation.

We have outlined just a few channels through which financialization is being challenged. Throughout history people have responded to coercion in creative and unexpected ways. Just as financialization is a recent historical phenomenon, so resistance to it has just begun.                                 

The above is extracted from “Financialization: A Primer”, published by Transnational Institute (October 2015) and written by Frances Thomson and Sahil Dutta. The full report with references is available on the Transnational Institute’s website (www.tni.org).

Third World Economics, Issue No. 606, 1-15 December 2015, pp12-16, 11