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.

Key Takeaways

  • Financialization is the increase in size and importance of a country's financial sector relative to its overall economy.
  • The financial industry, and its emphasis on short-term profits, has played a major role in the decline of manufacturing in the U.S.
  • A booming financial services industry has, however, led to growth in other sectors.
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Financialization

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.

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 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.