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Part I
Financialization: impact on the structure of economy and economic mechanisms
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1Financialization and economic and social performance
Malcolm Sawyer1
Introduction
The growth and evolution of the nature of financial systems over the past few decades have a multitude of effects for good or ill on the real economy. In this chapter the focus is on the effects which financialization in the present era has had on the performance of the real economy. Financialization has involved the growth of the financial system in its economic scale, its growing political and social importance, the development of new financial instruments, securitization and derivative trading. Financialization has changed the relationships between the financial sector and the real sector, and as ownership of corporations passes into the hands of the financial sector there is increasing the emphasis on the āpursuit of shareholder valueā.
The growth of the (formal) financial sectors has often been viewed as involving positive effects on economic growth ā through stimulating savings opportunities, allocating and monitoring the use of funds, and thereby promoting more investment in terms of quality and quantity and contributing to faster growth. However, the ways in which the financial sector has grown in the past decades has shifted their activities (in relative terms) away from the savingsāinvestment linkages and towards creating, managing of and trading in financial assets. The question arises whether those changes have undermined the financial developmentāeconomic growth linkage. There are other ways through which financialization (particularly in the guise of ownership by the financial sector of the corporate sector and the pursuit of shareholder value) sets the framework for a wide range of decisions taken by corporations including investment and employment.
The processes of financialization are intimately wrapped up with the operations of capitalist economies, and the recent decades of financialization have been accompanied by globalization and neo-liberalism. Disentangling the effects of financialization on the economy from the broader operations of capitalism is particularly difficult, if not impossible. However, we attempt to provide some partial answers to the question of the effects of financialization on economic performance. In this regard, economic performance is broadly interpreted, and it is specific aspects of financialization such as the growth of the financial sector and the rise of the pursuit of shareholder value which can be examined.
Financial deepening and economic growth2
There has been a large literature extending back many decades on the relationship between finance and economic growth, notably using measures such as bank deposits to GDP, stock market value to GDP as measures of financial deepening. This literature has used the terminology of financial development and deepening but can be viewed as one significant component of financialization. Financial deepening focuses on the growth of the formal financial sectors and does not reflect the role of informal financial sectors and ācurb marketsā. In a similar vein, economic growth (and development) often relates to the formal sector and (implicitly) industrialization. This literature has generally found a positive relationship between financial deepening and economic growth, though the causal relationships involved are matters of debate. A more recent literature has tended to find weaker relationships than hitherto and now is often finding negative relationships at high levels of financial deepening. There is a sense in which the financial sector has become too large which is also considered, and particularly in terms of the scale of financial asset transactions (relative to the levels of savings and investment).
Levine (2005) in his extensive review of the empirical literature concluded that
a growing body of empirical analyses, including firm-level studies, industry-level studies, individual country-studies, time-series studies, panel-investigations, and broad cross-country comparisons, demonstrate a strong positive link between the functioning of the financial system and long-run economic growth. ā¦ Furthermore, microeconomic-based evidence is consistent with the view that better developed financial systems ease external financing constraints facing firms, which illuminates one mechanism through which financial development influences economic growth. Theory and empirical evidence make it difficult to conclude that the financial system merely ā and automatically ā responds to economic activity, or that financial development is an inconsequential addendum to the process of economic growth.
(p. 921)
Arestis et al. (2015) conclude from their meta-analysis of the empirical evidence on the effects of financial development on growth that āthe results suggest the existence of a statistically significant and economically meaningful positive genuine effect from financial development to economic growthā (p. 559). However, there is considerable heterogeneity in the results, and that
the usage of market-based proxies of financial development seems to result in lower correlations than the usage of either liquid liabilities or market-based variables. [However], the estimated coefficients of bank-based measures and complex indices are found statistically insignificant in all specifications. ā¦ Additionally, panel data, which are frequently used from the late 1990s onwards, produce smaller correlations.
(p. 558)
The relationship between financial development and economic growth during the era of financialization (from circa 1980) is of particular interest.3 Casual observation may suggest that the general growth of the financial sector and the enhanced size of that sector have not obviously been associated with any faster economic growth. Further, the literature on financialization has indeed suggested a variety of ways in which the processes of financialization may have diminished investment, as further discussed below.
Authors have reported on at least some weakening of the links between financial deepening and economic growth. Rousseau and Wachtel (2011, p. 276) argue that āwe show that it [the finance-growth link] is not as strong in more recent data as it was in the original studies with data for the period from 1960 to 1989ā. Another study finds āthat in the long run financial intermediation increases growth and reduces growth volatility. Both effects have, however, become weaker over timeā (Beck et al., 2014, p. 62). A study of
the complex real effects of financial development ā¦ come[s]ā to two important conclusions. First, financial sector size has an inverted U-shaped effect on productivity growth. That is, there comes a point where further enlargement of the financial system can reduce real growth. Second, financial sector growth is found to be a drag on productivity growth. Our interpretation is that because the financial sector competes with the rest of the economy for scarce resources, financial booms are not, in general, growth enhancing. ā¦ More finance is definitely not always better.
(Cecchetti and Kharroubi, 2012, p. 14)4
Sahay et al. (2015, p. 5) use a broad measure of financial development and find that
the effect of financial development on growth is bell-shaped; it weakens at higher levels of financial development. This weakening effect stems from financial deepening, rather than from greater accessor higher efficiency. The empirical evidence also suggests that this weakening effect reflects primarily the impact of financial deepening on total factor productivity growth, rather than on capital accumulation. [Further] the pace of financial development matters. When it proceeds too fast, deepening financial institutions can lead to economic and financial instability.
CournĆØde et al. (2015, p. 6) based on 50 years of data for OECD countries conclude that āin most OECD countries, further expansion [of the financial sector] is likely to slow rather th...
