Financialization: Definition, Examples, Consequences, and Criticisms

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.

The term also describes the increasing diversity of transactions and market players as well as their intersection with all parts of the economy and society.

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.

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.

Greater Profits at Less Expense

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 financial institutions that there was more profit in making money from money than in engineered products.

Loss of Manufacturing Jobs

Financial instruments provided quick returns with little fuss, so the financial industry invested in software that facilitated this approach rather than in costly brick and mortar factories.

It also supported products that could be sold at Walmart (WMT) and manufactured overseas. As a result, the financial industry has played a major role in the decline of manufacturing in the U.S.

History of Financialization

While the beginnings of financialization in the U.S. can be traced to the 1950s, the financial sector saw greater growth later in the 20th century, particularly after the fall of the Bretton Woods system. This, along with the rise in neoliberalism and the free-market principles of Milton Friedman in the 1980s and onward contributed to financialization in the U.S.

The Bretton Woods agreement, which tied international currencies to the U.S. dollar and anchored the dollar to gold, created predictable exchange rates and limited speculation.

Thus, when this system fell, a new period marked by free trade and the free movement of capital began. Its absence also created instability in the global markets from which the financial industry has profited.

Furthermore, as the U.S. paid off its debts to other countries and printed more money, there was a huge surge in global liquidity. This allowed banks to extend more credit to consumers and opened up additional opportunities for profits in the private lending market.

Characteristics of Contemporary Financialization

Soaring Value of Financial Assets

Since financialization began in the 1970s and '80s, the overall value of global financial assets has skyrocketed. In 1990, the value of global financial assets stood at $56 trillion, 263% of global GDP. That number reached a staggering $219 trillion two decades later.

Increased Liquidity

Deregulation and new financial technologies have had a major impact on the financial sector. Even after the 2008 recession, the laws regarding the methods and amount that banks can borrow are relatively lax, creating further liquidity.

Securitization

There has been a massive increase in securitization, which occurs when an originator packages various financial assets into one group and sells this group of repackaged assets to investors. As financial institutions and their clients are constantly seeking new avenues of profit, the financial instruments they offer have grown more and more diverse.

Inflation

As liquidity and borrowing increase, so does inflation. So consumers who aren't investing a sufficient amount of their savings regularly for growth purposes will lose money, creating a further need for the financial sector.

More Investors

Furthermore, more people have had access to financial information and the markets than ever before, thanks to the the growth of the financial sector and the internet. The advent of beginner investing apps like Robinhood has brought non-traditional investors into the financial marketplace.

How Financialization Helps Build Economies

Financial services are also an important source of exports for the U.S. These services amounted to $15.51 billion in June 2024. While the U.S. 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 U.S. 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 to protect purchases and investments with insurance.

Financial markets also facilitate international trade. The daily volume of foreign exchange transactions increased from $570 billion in 1989 to $7.5 trillion in April 2022, 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

1. Critics of financialization focus on its emphasis on short-term profits. According to them, such focus can disrupt a company's or organization'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 the final assembly helped the manufacturer provide a superior product to consumers.

2. 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."

3. 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 stronger ability to cater to and operate in financial markets.

The playing field is not level for small firms because they are unable to produce the massive monetary returns demanded by large investors.

The Bottom Line

When economies have expanded and moved away from industrial capitalism, their financial sectors have grown, too. As a result, financial institutions have grown in size and importance.

Financialization has also expanded the number of individuals who participate in the market and the types of transactions that take place. It has affected various aspects of life in unexpected ways.

While financialization may be a blessing to some, it doesn't come without criticism. In fact, financialization has made a mark on more than the financial services. Other industries, such as education and housing, have also been impacted by it, and not necessarily for the better.