Financialization

Article byKosha Mehta
Reviewed byDheeraj Vaidya, CFA, FRM

Financialization Meaning

Financialization refers to a country’s advancement in terms of financial capital. It is characterized by the increasing contribution of financial services to national income. It is the process through which financial markets, firms, and elites have a larger influence on economic policy and results.

Financialization

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The operation of economic systems is altered on both the macro and micro levels due to financialization. The process of financialization utilizes three distinct channels: alterations to the structure and functioning of financial markets, shifts in the actions taken by non-financial firms, and modifications to economic policy.

Key Takeaways

  • Financialization refers to the process through which the financial sector of an economy grows both in size and significance compared to the rest of the economy.
  • In recent years, the process referred to as “securitization” has emerged as a consequence of “financialization,” which led to tremendous growth in the quantity and variety of financial instruments marketed.
  • The collapse of the Bretton Woods system and the advent of neoliberalism marked the beginning of the financialization of the economy.

Financialization Explained

Financialization refers to the rising diversity of market transactions and participants and their interaction with all aspects of the economy and society. This also describes the growing presence of the market and the financial sector in our everyday life. It is the process through which financial markets, companies, and elites have a larger influence on economic policy and results. As a result, economic systems’ operation is significantly altered due to financialization on both the macro and local levels.

Financialization affects the macro and microeconomy because it alters how financial markets are formed and run. Also, it affects the behavior of corporations and economic policy. It refers to the growing dominance of finance in the economy. Financialization is characterized by the increased use of financial instruments and markets in managing risks.

Financialization leads to the increased importance of the financial sector in the economy. Critics argue financialization leads to increased economic instability and inequality. Financialization affects the corporate sector by focusing on short-term financial performance.

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History

All currencies were defined concerning the dollar, which was itself convertible into gold. This system of payments was formed at Bretton Woods and was based on the dollar. The currency of the United States of America (USD) has now replaced all other currencies as the global standard.

The beginnings of financialization in the United States can be traced back to the 1950s. However, the financial sector didn’t expand until much later in the 20th century, especially after the collapse of the Bretton Woods system. Nevertheless, the beginnings of financialization in the United States can be traced back to as early as the 1950s. This, along with the emergence of neoliberalism and the free-market ideals of Milton Friedman, was a contributing factor to the financialization of the U.S. economy.

The Bretton Woods agreement, which anchored the dollar’s value to gold and bound other currencies to the value of the U.S. dollar, established stable and predictable exchange rates and restricted speculation. The fall of this signified the beginning of a new age that was characterized by free commerce. Also, it started the unrestricted movement of capital. Additionally, as a result of this, global financial markets became unstable, which resulted in profits for the banking industry.

In addition, there was a massive increase in global liquidity since the U.S. paid down its debts to other countries. It also simultaneously printed additional money. This enabled financial institutions to issue more credit to end users. This opened up new avenues leading to profitable prospects in the private lending sector.

Examples

Let us look at the following examples to better understand the concept.

Example #1

A paper published in Yale University’s e-library focuses on the financialization of responses to the COVID-induced recession. It says that the established economic policies followed the trend of financialization occurring in the United States’ fiscal policy. It provided broad macroeconomic support to consumers and companies. However, a significant reliance was placed on the Federal Reserve and banking/financial systems in the U.S.

Households and companies with better linkages to the banking system got higher economic assistance as an immediate effect. Those individuals with fewer and weaker links to the financial system got relief more slowly. In other cases, they did not receive any assistance.

As a result, there will be a blurring of the lines between engaging in monetary policy and fiscal policy. This will result from the repercussions of depending on the Federal Reserve to support the recession through the financial system. This response is a continuation of the U.S. trend that started during the previous recession and is likely to continue. This can impact the central bank‘s independence and raise concerns regarding the Federal Reserve’s role in society.

Example #2

An article published by Industry Week focuses on how the financialization of the American economy has been detrimental to both workers and the economy. It was stated that the level of debt has increased. The debt is the fuel that keeps the financialization machine running.

The article concludes that there are more desirable strategies for the government or the economy to pursue over the long run than financialization. It is not a coincidence that the development of financialization occurred during the same time as the fall of manufacturing, middle-class income, and capital investment. It is also not a coincidence that wealth was distributed toward the highest earnings over the same period at the expense of those in the lowest 90% income distribution.

Financialization is about engaging in risky trading and maximizing returns on net assets. This is for the advantage of the company’s shareholders. It does not consider the benefit of those aspects of the economy having the potential to contribute to long-term growth. The financialization of the manufacturing industry or the economy could be a better long-term plan.

Benefits

  • Financialization has been responsible for a large increase in the number of jobs available in the financial industry, and this trend is anticipated to continue.
  • Increased reliance on various financial intermediaries.
  • Increased participation in the futures markets. Including, but not limited to, futures contracts on bonds, equities, currencies, and interest rates.
  • In the financialization process, profits are generated more through financial channels as opposed to trade and the production of commodities.
  • If the financial sector is healthy, it will be able to contribute to a more equitable allocation of money and risk across the economy.

Frequently Asked Questions (FAQs)

Did financialization reduce economic growth?

A significant drop in employment is one of the side effects of financialization. Financialization warps the allocation of economic resources and lessens the degree to which labor and capital are interdependent; as a result, it undermines the social contract that requires capitalism to deliver profits to those who own capital while raising the general standard of living for citizens.

How does financialization affect the economy?

Financialization affects both the macro and microeconomy because it alters how financial markets are formed and run and affects the behavior of corporations and economic policy. The financialization of the economy has led to a growth in revenues in the financial sector that is greater than that seen in other parts of the economy.

What is financialization of commodity market?

Consumers of physical commodities could mistakenly believe that a rise in commodity prices due to capital inflows from investors indicates that the economy is doing well. Instead, the demand for commodities from customers temporarily increases because of the expectation of increased economic activity.

This article has been a guide to Financialization and its meaning. We explain it in detail with its examples, benefits, and history. You may also find some useful articles here –

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