In the current era of financialization, asset-based capital is being transformed from an adjunct of economic growth into a central force wreaking havoc on the global economy. This transformation has ramifications beyond the capital markets and even beyond the capitalist system. It has implications for the roles of government and the economy more generally. In an article for the Washington Post, the economist Dani Rodrik warned that the resulting financialization of the world economy makes it more prone to instability. Financialization, he wrote, is the process by which financial markets — and more specifically, financial intermediaries such as banks and financial advisors — come to dominate the economy. This takeover, Rodrik argued, has two causes. The first is that financial players first acquired the money to take over the economy through the process of financialization. The second is that financialization makes existing capital insufficient to sustain the economy — and in turn, makes financial intermediation the solution to the liquidity problem. Financialization is the transformation of capital markets from an agricultural and industrial economy into an asset-driven one. The result is a financialization of the economy. This transformation has implications beyond the capital markets and even beyond the capitalist system. It has implications for the roles of government and the economy more generally.
The Transformation of the Capital Markets
The transfer of value that characterized the growth of capitalism in the 20th century was transformed during the 1980s and 1990s. The explosion of financial assets in the wake of the Great Recession of 2007-09 accelerated this process of transformation. This process was attributed to innovations in accounting and financial markets law that made financial assets more like physical assets. Traditionally, financial assets were liabilities, but accounting rules allowed for an asset-like categorization of financial assets. The financialization of the U.S. economy accelerated during the oil crisis of 1973-74, which prompted the Securities and Exchange Commission to issue a special order outlining the accounting treatment required for investments in petroleum and petroleum products.
Financialization and Instability
Financialization has generated instability in two ways. First, it makes existing capital insufficient to sustain the economy — and in turn, makes financial intermediation the solution to the liquidity problem. This dynamic is best understood through an example. Suppose an oil company experiences a 30 percent drop in revenue because of a decline in crude oil prices. To survive, the company will have to cut expenses, but which expenses? To cover the revenue decline, the company will have to raise its production. This, in turn, will require more investment, and more investment usually means more risk. In short, a financial crisis may result when an entire industry is uneconomic because, at a particular moment in time, demand for its products is lower than expected.
The Solution to the Liquidity Problem
The solution to the liquidity problem that financialization presents is to increase the amount of funds held by investors. Increased investor funds allow for easier and more frequent replacement of old funds with new funds, which in turn permits investors to take more risks with their money. Increased risk in turn may generate more profit, which may, in turn, justify an increase in financial intermediation. A key feature of financial intermediation is that it is not consumed by production. As an asset-based business, Proctor and Gamble has the ability to raise funds through equity offerings, bond offerings, and even a public stock offering. By contrast, a factory that produces goods for the retail market does not have such an option. A manufacturer that is not expected to produce goods for the retail market can issue debt freely without the worries that this may lead to financial fragility.
The Rise of Financial Advisors
The rise of financial advisors is another example of the way that financialization transforms the economy and the role of government. Financial advisors are not financial analysts. They are not even investment advisors. Instead, they are salespeople for the financial products that they sell. If financial advisors are salespeople, it is not because they are not capable or motivated enough to meet the demands of their clients — far from it. Rather, financial advisors’ sales pressure comes from within the financial industry itself. The financial industry is pressured to increase market share, so it can expand its clientele, expand its profit margins, and increase the return on equity that it achieves.
The financialization of the economy has had far-reaching and far-term consequences, not the least of which has been the transformation of the banking sector. As a Wall Street Journal article explains, the advent of financial intermediaries that intermediated loans and investment opportunities transformed banking from an inherently risky activity into one that was safe and reliable. That said, the most obvious impact has been on the financial markets themselves. The more-than-ample availability of liquidity in the capital markets has enabled financial players to buy and sell assets with near impunity, creating an environment more favorable to Wall Street than ever before. This transformation has implications beyond the capital markets and even beyond the capitalist system. It has implications for the roles of government and the economy more generally. The financialization of the economy has created a new class of stakeholders—financial intermediaries—that in turn affects the role of government and the nature of the economy as a whole.