dafnomili nl financialization

7/27/2019 Dafnomili NL Financialization

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Setting the Scene of the Neoliberal Process

of Financialisation

Maria Dafnomili1

University of Crete, Greece

Abstract

The world is in a chaotic condition. The global financial crisis which began from the

U.S. and spread via the financial mechanisms throughout the world brought to the

fore all these known secrets about the operation of the global capitalist system and

the problematic theorizing of economic science. The capitalist system in the present

structure seems to have come to an end and its existence being is similar to that of a

zombies; ugly, persistent and dangerous. The general turmoil that prevails in the

countries around the world is unprecedented both in its magnitude and its sphere of

influence. All these, are highly related to the phenomenon of financialisation.

Keywords: financialisation, finance, neoliberalism, globalisation, financial crises.

1 Maria Dafnomili is a PhD Candidate in the Department of Economics at theUniversity of Crete.


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1. Introduction

When the historian Karl Polanyi published his masterpiece The Great Transformation

in 1944, he exerted severe criticism on the 19th century industrial, market-based

society. It is really commendable that almost 50 years ago Polanyi made an

astonishingly prophetic and modern statement arguing that "allowing the market

mechanism to be the sole director of the fate of human beings and their natural

environment...would result in the demolition of society" (Polanyi, 1944, p.73).

However, he was persuaded that such a demolition could no longer happen in the

post-war world because, as he said (p.251) "Within the nations we are witnessing a

development under which the economic system ceases to lay down the law to society

and the primacy of society over that system is secured". Unfortunately Polanyis

optimism didnt come true, as today the focal point of the whole neoliberal dogma is

that markets should dictate their orders to society, directing beliefs, actions and the

fate of human beings. A dogma that its advocates tried to put into practice with the

well-known results.

We are facing one of the most severe crises in the history of the global capitalist

economy, certainly the most severe since the Great Contraction of the 1930s

(Dumnil and Lvy, 2011a). The current crisis is unique both in its magnitude and in

its depth combining at the same time all the elements that we have seen in past crises:

a wave of bank bankruptcies comparable to those of the early 1930s; a bursting of the

real estate bubble in the U.S.A. comparable to what happened in Japan at the end of

the 1980s; a liquidity trap in the U.S.A. and, most recently, a disruption of

international capital flows and a wave of currency crises similar to those in East Asia

in the late 1990s (Allen and Gale, 2007). These events are highly related to the

process of what is calledfinancialisation.

Although the emergence of finance capital is not a new phenomenon, aging for more

than a century, the concept of financialisation is relatively new (Morera and Rojas,

2009). It emerged in the 1970s, assumed relative prominence in the 1980s and

exploded in use and frequency since the 1990s when the present phase of

globalisation began. Financialisation as a phenomenon is inextricably linked with

liberalisation, financial globalisation, privatisation, commercialisation and

marketisation (Fine, 2008). Even though it represents one of the most important


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dimensions of these phenomena about which there has been heated discussion in

recent years, very little has been written about financialisation until recently

(Lysandrou, 2008).

Financialisation as a real world phenomenon, started when the Bretton Woods system

of fixed exchange rates ended in the 1970s. From the moment the convertibility of

dollar into gold ended in August 1971, the United States has had the ability to sustain

a growing external deficit by increasing the amount of dollars in circulation,

encouraging in this way a gradual expansion of credit (Onaran, 2009). This process is

well described by P. Gowan (2009) who in his article Crisis in the Heartlandargues

that after the end of the Bretton Woods system, a long-term trend was set off towards

a new international and monetary financial system. This was based, on the one hand

on limited controls of international movements of private finance initially in the G7

countries (in the US in 1974, the UK in 1979, the Germany in 1982 etc.) and

afterwards in the rest of the world (in the European Community by 1990 as well as in

Japan and East Asia in 1995), and, on the other hand, on floating exchange rates.

In the course of time, financialisation became a basic feature of the capitalist system,

and its dominance would have been impossible had it not been for the following

circumstances which prevail during the last four decades. It accelerated dramatically

with the emergence of neoliberalism and deregulation. Its implementation was

promoted through the creation of new financial products, institutions and practices

such as securitisation, commercial paper, conduits, Credit Default Swaps (CDSs),

Collateralized Debt Obligations (CDOs), derivative markets, leveraged buyouts,

currency exchanges, and the like (Dumnil and Lvy, 2011a, p. 8). In addition, the

role of the upper managerial class and the change at the working conditions, the

freedom of capital movement seeking out more profitable outlets and, last, but not

least, the policies adopted by governments both in developed and developing nations,

were some of the elements of the new economic global order.

What is more, the banking system played a fundamental role in sustaining and

expanding the profitability of financial institutions, through the mushrooming of

financial products and of financial transactions, resulting in the vulnerability of the

real economy to debt finance (see Stever, Goetz and Upper, 2007; Lapavitsas and dos

Santos, 2008; dos Santos, 2009; Dymski, 2010). As the volume of capital has shifted


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from the productive sector of the economy to the financial sector, manufacturing and

other industrial sectors have come under pressure to increase their profits, through

policies such as mergers, acquisitions, outsourcing, downsizing or even looking for

other more profitable markets (Rattner, 2011; Blecker, 1999). The private sector is

now giving emphasis on international competitiveness, considering this to be the most

significant source of increased profits, and by taking this into account; governments

adopt the appropriate public policies to attain this goal (Adler, Forbes and Willmott,

2008).

Consequently, the global economy has become significantly financially integrated

over the last four decades. International finance grew more rapidly than trade and

income, with Eurocurrency markets playing initially a leading role (McGrew, 1011).

Financial capital movements became global, surpassing both the borders of national

economies and the controls that were initially imposed, and were accompanied by the

growing perception that financial liberalisation was a desirable objective, associated

with advantages at both the national and international level (Camacho and Nieto,

2009). Thus, demand for international finance increased and economic activity

became inextricably linked with global financial flows. This can be confirmed by the

following figure which shows the dramatic increase in foreign assets and liabilities asa share of GDP in both industrial and emerging markets from 1970 to 2004 (Lane and

Ferretti, 2005). Especially, it can be observed that around the 1990s, when the present

phase of globalisation began, we have an increasing explosion of foreign assets and

liabilities as a share of GDP.


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To continue with, this increasingly international dimension of financial capital is

highly related to the emergence of financial and banking crises globally (see Sweezy,

1997; Stiglitz, 2000; Rodrik, 2004; Isard, 2005; DArista, 2005; Morand, 2006).

Financial requirements exceeded the typical requirements of trade of goods and

services. For instance, the crises in Argentina, Mexico, Japan, South East Asia,

Turkey, Brazil and Russia were a direct result of the financialisation process (see

Brenner, 2002; Haldane, 2004; Foster, 2008; Felton and Reinhart, 2009).

Consequently, in order for someone to understand how financialisation emerged and

increased both in magnitude and influence, a deeper analysis is called for. The present

paper aims to illustrate that financialisation in combination with the neoliberal

policies that had played a critical role in the current crisis led in the inefficient

regulation of financial markets, the increasing inequality in the distribution of income

Figure 1: Foreign Assets and Liabilities as a share of GDP

Industrial Group and Emerging Market DevelopingCountries Group, 1970- 2004


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and in the rising imbalances in the global economy. Section 1 refers to some

introductory comments of the phenomenon, while Section 2 presents on the one hand

an excursion into the history of economic thought where the intellectual roots of the

concept of financialisation can be traced and, on the other hand, its unique relation to

the American economy. Section 3 shows the main features of financialisation and

Section 4 the existing relation to the emergence of global financial crises.

Furthermore, Section 5 continues with the presentation of the neoliberal framework

where financialisation arose and increased its sphere of influence as well. Section 6

offers some concluding remarks.

2. Financialisation: Setting the Scene

As it was stated in the introduction, a diversion into the history of economic thought is

a necessary condition for understanding the concept of financialisation. Knowledge of

questions that have plagued modern economic science is important for setting the

framework within which this phenomenon should be analysed.

The beginning of modern economics is associated with the works of Adam Smith who

analysed economic factors in broader contexts. The publication of The Wealth of

Nations in 1776 has been described as "the effective birth of economics as a separate

discipline (Wahl, 2008, p. 150). This book can be characterised as a reaction to the

crisis of Mercantilism brought about by the first Industrial Revolution, and was in

tune with the beliefs and interests of the emerging bourgeoisie. New ideas were

introduced with the self-regulation of markets being among the most important ones.

That view had a substantial effect in the history not only of economic thought, but

also of the emerging capitalism (Fine, 2000). With the passage of time, as production

and economy became more and more complex, new interpretations emerged,

accompanied by the import of concepts and methods from other sciences, especially

from mathematics and physics. Economic models were then developed in order to

fulfill the wish to move towards an approach in accord with the physical sciences

(Fine and Milonakis, 2009).

This resulted in another revolution that took place in economics with the 1870s being

an important threshold in this direction. The new ideas took shape, among others, in


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the writings of the so-called Marginalist School2. Writing simultaneously and

independently of one another, the Frenchman Leon Walras, the Austrian Carl Menger

and the Englishman Stanley Jevons developed the following theory: the price of

goods or services instead of reflecting the labour content reflects the marginal

usefulness (utility) of the last purchase. This meant that, in equilibrium, people's

preferences determined prices including indirectly the price of labour (Weintraub and

Mirowski, 1994).

In the 1930s the world was plunged into the vagaries of the Great Depression. After

the 1930s, the faith in the self-regulation of the market and in the invisible hand came

into question and the terrain was set for the Keynesian Revolution. Keyness General

Theory gave a new insight in economic policy emphasising the role of the state in the

broader economic and social context, aiming primarily to restore full employment

(Spence, 2011). In the 1950s, Keynesian theory became the mainstream

macroeconomic theory but two main drawbacks made it susceptible to criticism. The

first one concerned the hypertrophy of public expenditure, while the second one

referred to the increase in the rate of inflation due to the strengthening of labour

unions (Taylor, 1998).

In their 1963 bookA Monetary History of the United States, 1867-1960 Milton

Friedman and Anna Schwartz challenged Keyness foundation regarding the role of

the state. They supported monetary policy rather than fiscal, and introduced the notion

of the natural rate of unemployment. Then, the real business cycle theory

introduced by Kidland and Prescott, became the role-model of New Classical

Macroeconomics which maintained that the way to get out of the crises could be

found in a mix of deregulation and privatisation (Arrighi and Silver, 1999). In 1971

the Bretton Woods monetary regime was brought to an end. President Nixon

2By marginalism we denote the use of marginal concepts within economics. According to Zablotsky

marginal concepts are associated with a specific change in the quantity used of a good or of a

service, as opposed to some notion of the over-all significance of that class of good or service, or of

some total quantity thereof (Zablotsky, 1995, p.12). The central concept of marginalism proper is that

of marginal utility, but marginalists, following the lead of Alfred Marshall, also developed the

concept of marginal physical productivity in their explanation of cost; and the neoclassical tradition

that emerged from British marginalism generally abandoned the concept of utility and gave marginal

rates of substitution a more fundamental role in analysis (Ghiselin, 1987, p.21).


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announced the end of the dollar standard regime and the systematic liberalisation of

the markets started in the mid- 1970s. In 1973 and 1979 the two oil crises resulted in

the aggravation of the economic situation. It was at that time that neoliberalism and

phenomena such as privatisation and marketisation emerged (Kotz, 2008; 2002;

1978).

Last but not least, a significant facet of this new scene in the US was the Washington

Consensus. Briefly, in November 1989, the Institute for International Economics

convened a conference to investigate the progress of economic reforms in Latin

America. At that time, there was a general misconception, based on Williamsons

assessment, that Latin America countries were unwilling to undertake significant

reforms to overcome the debt crisis. In this conference, Williamson coined the term

Washington Consensus. The Washington Consensus was initially what most

people in Washington believed Latin America (not all countries) ought to be

undertaking as of 1989 (not all times) (Williamson, 2002, p.1), and, was

originally used to describe a list of ten reforms that I [Williamson] argued were

practically universally agreed in Washington to be desirable in most Latin American

countries (Williamson, 2004, p.195).It is clear that the Washington Consensus set of

policies are a mirror image of the policies adopted by US neoliberalism. Nevertheless,in the international economy, neoliberalism in the form of the Washington Consensus

has been imposed around the world; by powerful financial institutions and interest

groups particularly based in US Washington Consensus is a kind of US exported

neoliberalism (Hailu, 2009).

In general, the lax monetary policy adopted firstly in the US and then in other

countries around the world after the 1970s, had the effect of doping the economy.

Speculation, moral hazard and risk-taking became endogenous characteristics of the

global economic system. The growing financial instability was inextricably related to

the emergence of crises including the current global crisis, the most severe economic

crisis since the Great Contraction of the 1930s, which led to the unexpected

catastrophic results that took by surprise the bulk of the economists, politicians,

commentators and the public (Lapavitsas, 2010; Reinhart and Rogoff, 2008).


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2.1 The Roots of Financialisation

That we live in a world of finance is an undeniable fact. Financial news rules in the

business press. The management of American corporations is in accordance with the

rhythm of Wall Street. Consumers are confronted daily with new financial products.

Significant increases in financial transactions, financial assets and in the profits of

financial and non-financial firms as well as increases in the shares of national income

accruing to the holders of financial assets set the framework of financialisation. At the

same time, the 1970s represent an intellectual break point with the emergence of new

ideas which were meant to affect the global economic, social and political system.

Dramatic shifts of a massive scale have taken place in countries of both the developed

and the developing world (Panceira, 2010; 2009).

Financialisation as a phenomenon arose in the United States and through various

financial mechanisms has spread in many countries all over the world. In order to

illustrate this we have first of all to establish whether and how the US economy

became financialised. As Merton once remarked, it might at first seem needless to

say that before social facts can be explained, it is advisable to ensure that they actually

are facts (Merton, 1959, p. ix).

During the last four decades, the US has entered the neoliberal phase3 of capitalism

with the following main features. First and foremost, the deregulation of financial

businesses both at the domestic and the international level; secondly, the privatisation

of many state services in combination with a deep reduction in social spending, and,

last, but not least, the decrease in the power of trade unions and a general shift of

power from labour to capital, with the increase of part-time workers, labour contracts

with unfavourable working conditions and stagnant or even decreasing wages. This

3 In the course of time, capitalism has undergone many changes and passed through different stages,

each one characterised by a specific set of institutions and structures. After the Second World War ahighly regulated form of capitalism arose in the industrialised world. The main features of this phase ofcapitalism are the emergence of a welfare state; the increase in the power of trade unions; theimposition of capital controls and, in some countries, the public ownership of a significant portion ofthe enterprise sector (Kiely, 1994; Arrighi, 2008). During the 1970s which turned to be a turning pointin the evolution of the global capitalist system, a transformation took place. A new structure of theeconomy emerged consisting of a complex nexus of relations between finance and different sectors ofthe economy. The characteristic feature of this period was the increasing importance and power of thefinancial sector which started to become more and more independent and sat on top of the productionsystem (Kiely, 1998). Since 1980 we have entered the neoliberal phase of the capitalist system. This

involves privatisation of state enterprises, a reduced welfare state, limited state regulation and weaktrade unions (Arestis and Sawyer, 2003).


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was the direct consequence of financial deregulation in conjunction with the severe

competition from low-wage countries. Output per hour has risen faster than real

earnings. In other words, productivity surpassed compensation growth during the

period 1979-2000 (Hein and Achim 2010; Wallerstein 2008;2004).

Figure 2 displays the remarkable increase of financial profits in comparison with

manufacturing profits, specifically in the US. Over the period 1981-2004, when the

financial sector was beginning to recover from the previous period of recession, the

relative shares of financial equities were more than triple, while, as it can be observed,

there was a steady implosion of the manufacturing sector.

Similar conclusions can be drawn from Figure 3. In 1965, manufacturing accounted

for 31 percent of total overall private industry output in the USA. By 1997, this sharehad dropped to 20 percent, with the financial and services sector replacing

manufacturing as the leading contributors to private industry output. Between 1965

and 1997, services grew by 2.115 percent and finance, insurance and real estate grew

by 1.473 percent. By comparison, manufacturing grew by 619 percent during the

same period (American International Trade Administration,

http://trade.gov/manufactureamerica/facts/tg_mana_003019.asp#P13_602 ).

Figure

Source: Bureau of Economic Analysis
http://trade.gov/manufactureamerica/facts/tg_mana_003019.asp#P13_602http://trade.gov/manufactureamerica/facts/tg_mana_003019.asp#P13_602


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Source: Bureau of Economic Analysis, U.S. Department of Commerce

Figure 3: Private Industry Output from 1965 to


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In addition, the role of the dollar in the arrangement of international transactions was

of particular importance in this process. This is confirmed by the fact that nowadays

the dollar enters in about 76 percent of foreign international transactions whereas the

euro enters only in 24 percent. What is more, 66 percent of the total foreign exchange

reserves are held in dollars, while only the 25 percent of them are held in Euros

(Taylor, 2011, p. 95). In accordance with this, a series of events has led to the

establishment of the dollar as world money. The proliferation of financial

instruments resulted in a remarkable increase in financial assets. Specifically, the

latter (the sum of equity, bonds and bank assets) reached 425 percent of the US GDP,

and this increase helped preserve the role of the dollar internationally (Dumnil and

Lvy, 2004a, p. 660).

Apart from this, debt crises became the means by which a further impetus was given

to financialisation through the terms and conditions (adoption of austerity measures,

cutting public spending, increase in taxes, layoffs in the public sector) imposed by the

IMF structural adjustment and stabilisation packages (Kindleberger and Aliber,

2005, p. 68). Since the beginning of the 1970s the debt of developing countries

doubled from 8 percent of GDP in 1972 to about 22% in 1982 with Mexico, Brazil,

Venezuela and Argentina together accounting for nearly 75 percent of the totaldeveloping world-debt during this period (Marshal, 2011, p. 20). In the 1980s, the

Plaza and the Louvre Accord secured the commitment of foreign banks to defend the

dollar and around the 1990s the emerging countries witnessed a huge influx of private

capital leading to the well-known Asian Crisis in the 1998 and then a reverse flow

from the developing countries to the US (Dodd, 2004). This set of features resulted in

three significant outcomes: first, the increase in income inequality; second, the

growing trend in speculative and risky activities and, last, the emergence of severe

global asset bubbles (Hahn, 2005). Figure 4 highlights the transformation of the

American economy during the rising debt era. From the 1950s until the 1980s

financial profits as a share of GDP floated over the level of 1 percent. This changed

during the 1980s, as the financial sector grew its profit-margins in a period in which

the bulk of the American population was borrowing and going into debt in order to

finance a lifestyle that was initially set up for the upper classes (Johal and Leaver,

2007).


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Figure 4: Debt leverage and banking profits go hand in hand

Source: Peak Watch

Another significant aspect of financialisation is the changing character of the

american banking system and consequently of the international banking system

(Stever, von Peter and Upper, 2007). A well developed financial system can emerge

only when the infrastructure of the banking system is well established. The stability of

the Gold standard period provided the basis for massive financial flows from the

surplus to deficit-countries in the pre-1914 period. Central banks during that period,

rather than imposing new international policies, brought about changes in national

policies by adjusting interest rate-premia and exchange rates (Taylor, 2011). In

accordance with the growth of financial institutions and international banks, globalfinance also developed and imposed changes in the regulations of the national

authorities (Michl, 2011). Central banks around the world cooperated with national

authorities and developed a global system of international transactions. The

innovation of new financial instruments made the regulations difficult to implement.

Consequently, the process of financial deregulation led banks and large corporations

to boost the openness to financial markets preparing the ground for the general

deregulation. This trend had as a result the increasing involvement of workers and


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others in the mechanisms of finance. The increase of consumerism led them to take

loans from financial institutions in order to meet elementary needs, such as housing,

education, health, and provision for old age. In other words, their income has been

financialised. Only then could banks extract significant profits directly from wages

and salaries (Lapavitsas, 2009).

The international character of the banking system became more pronounced after the

1980s and was further boosted during the 1990s and especially in the 2000s. What is

more, during the process of financialisation both commercial and investment banks

have been transformed. As finance expanded, relations between industrial enterprises,

financial institutions (such as banks) and the state also changed. These changes

determined the content of financialisation in a decisive way.

Table 1

Source: UNCTAD, World Development Report 1994, p. 128


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Growth of six big banks

Source: Company Annual Reports, 2009

Additionally, investment banks focused on the subprime mortgages considering this

to be a sector of high profitability. For this reason, Morgan Stanley purchased

Advantage Home Loans, Merrill Lynch bought Mortgages Plc and Lehman Brothers

acquired South Pacific Mortgages. Being helped by the use of the techniques of

financialisation the banks repackaged debts obtaining remarkable high returns.

Corporations playing in this way were transformed into giant casinos, taking more

and more leveraging- sometimes they were betting for instance thirty or more

borrowed dollars for every dollar of their own that was used (Foster and Magdoff,

2008). Lastly, as Galbraith (2008, p.48) has claimed that the first rule of central

banking is that when the ship starts to sink, central bankers must bail like hell.

Another figure which confirms even more why the American economy can be

characterised as financialised and why financialisation as a phenomenon began in

the US is the following. During the course of financialisation the US workforce has

shifted from manufacturing to finance. In Figure 5 two contrasting trends can be


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observed. In 1947, the manufacturing sector was 25.6 percent of the entire US GDP

base whereas the FIRE sector only 10.5 percent. In contrast, in 2009 FIRE reached

21.5 percent while manufacturing was down to 11.2 percent (Gowan, 2009, p. 361).

Source: Bureau of Economic Analysis

3. Main features of financialisation

Financialisation is a multifaceted phenomenon, both in terms of its meaning and its

sphere of influence, by affecting a wide range of social, political and economic

aspects of human life, imposing the latter upon a risky environment of financial

fragility and economic instability (Kotz, 2008a; Martin, 2002). Finance rests on

promises which by definition can be broken, and all the participants know that. This

makes the financial system vulnerable to expectations about the fulfillment of these

promises.

Figure


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First and foremost, financialisation can be understood as the increasing expansion of

financial assets and financial activity relative to the other sectors of the real economy

(Fine, 2007). In a nutshell, there has been a significant financial deepening since

1980, which has accelerated after 1990 (McKinsey, 2008, p. 10). Some indicative

data that depict the immense growth of the financial sector relative to the other sectors

of the real economy are the following. The FIRE (Finance, Insurance and Real Estate)

sector in the US increased from 2.5 percent in 1947 to 4 percent in the end of the

1970s and reached 8 percent in 2007 (Philippon, 2008, p. 6). The same results also are

concluded for the case of UK where finance increased from 5 percent of gross value

added in 1970 to 8 percent in 2007 (Haldane, 2010, p. 4). Rates are more or less

similar for the Anglo-Saxon economies and Australia too (Weale, 2009, p.6).

Regarding corporate profits, a significant increase is also being documented, reaching

the level of 27 percent in 2006 from 15 percent that it was in 1980 (Lazonick and

OSullivan, 2000, pp. 30). This increase was even more pronounced in the UK where

financial intermediation increased from 1.5 percent in 1978 to 15 percent in 2008

(Haldane, 2010, p.4). In addition, there was a close connection between US and UK,

on the one hand and China and Japan on the other. The former considered to be the

main exporting economies of the latter, leading to a growth in financial flows and to

the establishment of a financial system that would play a leading role in the global

economy (Ward, 2011).

Secondly, apart from the expansion of financial assets, this period has witnessed the

proliferation of different types of assets through the expansion of securitisation.

Swaps, CDOs, options and derivatives are some of the commodities created for the

implementation of the new financial policies. These instruments had as their initial

purpose hedging and risk management (Morin, 2000). In the course of

financialisation, derivative markets have allowed participants to make bets aimed at

managing risk, or simply speculating. The rise of Black and Scholes model has given

to an air of objective reality to derivative prices (Froyd and Williams, 2007).

Thirdly, in the course of financialisation the relationship between finance and industry

has changed. As Rossman and Greenfield (2006, p. 2) put it:

Of course, companies have always sought to maximise profits. What is new

is the drive for profit through the elimination of productive capacity and the


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reduction of employment. Transnational food processors, for example, now

invest a significantly lower proportion of their profits in expanding

productive capacity. Financial markets today directly reward companies for

reducing payroll through closures, restructuring and outsourcing. This

reflects the way in which financialisation has driven the management of non-

financial companies to act more like financial market players.

Under the dominance of finance, enterprises must, as is well understood, not only

generate profits, but primarily guarantee that profits would be higher than those

defined by international parameters of the financial markets. For instance, companies

transfer their plans to countries with low production costs or even close production

units that have insufficient profitability. What is more, the existence of high

profitability criteria enables industrial groups through the process of market

centralisation to dominate a bigger portion in the world market. The objective is to

increase gains in productivity at all costs. Enterprises take advantage of the decline of

the resistance of the work force due to the existing threat of unemployment, being in

this way able to put their practices in force and stimulating strong speculative

activities. This new mode of enterprises function is known as the financialisation of

the enterprise (Weale, 2009).

Additionally, it has been observed that financialisation has a bilateral effect on

corporations. On the one hand, it imposes constraints on their investment strategies

and, on the other hand, obliges them to find new customers and increase profits.

Concerning the former, it is well-known that corporate credit-worthiness is

determined by banks and ratings agencies. Corporations may be able to make the

investments that they wish but in the end they are always accountable to the pressures

exerted by financialisation. The investment plans they draw up should now meet the

expectations imposed by the financial sector. No matter what the size of the

corporation is, the submissions to the examinations and inspections of the rating

agencies- Standard and Poors, Moodys and Fitch Ratings- are an unavoidable fact if

they want to reassure investors and have cheap access to capital (Blackburn, 2006).

Making a profit is not enough anymore; a triple A rating is also needed. By the same

token, most of the biggest corporations nowadays try to reduce their workforce by

out-sourcing and sub-contracting. Another catalyst of financialisation is that


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companies that were facing difficulties in selling their goods and services opened up

their activities by selling finance too (take as example HSBC and Citigroup).

Fourthly, undoubtedly, financialisation is inextricably related to consumer booms and

busts with the recent housing boom in the US being an aspect of financialisation

provoking the consequent speculative bust. Given the fact that real wages were

stagnant, in order to fulfill the lifestyle that were dreaming for, homeowners started

borrowing from financial and non-financial institutions. Low interest rates fuelled

even more the housing speculation (Woodford, 2010, p. 207).

Fifthly, financialisation has penetrated into a variety of aspects of social life such as

pensions, education, health and provision of economic and social infrastructure. For

instance, the extension of healthcare insurance represents one of the unwelcome

effects of financialisation. Even the weather can be financialised. The World Food

Programme (W.F.P.) proposed to issue catastrophe bonds which are linked to low

rainfall. This organisation would pay principal and interest when rainfall was

sufficient; if there was no rainfall, the W.F.P. would cease making payment on the

bonds and would instead fund relied efforts (Wray, 2009).

Sixth, financialisation, in combination with deregulation, privatisation andcommercialisation has set a particular set of cultures and policies with the efficacy of

markets taken as the foundation of the core of neoliberal theories. Cultural norms,

ways of behaviour and thinking, lifestyles have considerably changed from the 1980s

onwards.

Seventh, in the course of financialisation the process of work has been transformed,

partly due to technological and regulatory changes. In Marxist terms, the labour has

been intensified and unpaid labour stretched. Also, the bargaining position of both

working-class and middle-class has been seriously weakened, and there has been a

major shift in the distribution of income in favour of the top 20 percent (Hein, 2011;

Lapavitsas, 2009).

Eighth, financialisation has made income inequality more pronounced. For instance,

inequality in the US increased dramatically over the past 30 years (Lindert and

Williamson, 2003).


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Figure 6: The purchasing power of two income fractiles of U.S. households

(thousands of dollars of 2006)

Source: Bureau of Economic Analysis as cited in Dumnil and Lvy, 2011, p. 47.

The figure above illustrates the purchasing power of the bottom 99 and the top 1

percent of the US households income. The spectacular difference in the trends of the

purchasing power observed in the two fractiles between the first post-war and

neoliberal decades is clearly illustrated (based on income statements to the Internal

Revenue Service). The first line () measured on the left axis represents the average

purchasing power (in 2006 dollars) of the bottom 99 percent of U.S. households while

the second one (--) measured on the right axis, describes again the average purchasingpower of the top 1 percent of U.S. households in terms of income. From the figure it

can be concluded that at the beginning as well as in the end of the period the average

purchasing power of the top 1 percent is 20 times larger than that of the bottom 99

percent (the scale on the right axis is 20 times larger than the scale on the left axis).

Another observation is that the purchasing power of the bottom increased enough

until the 1970s and then stagnated. To the contrary, the purchasing power of the top 1

percent hardly grew between the pre-war and the 1970s, and then it dramatically

increased. This shift of income patterns to the benefit of upper income brackets


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described for the United States is actually a global phenomenon (Piketty and Saez

2003, p. 24-27.)

Ninth, financialisation is related not only with a slowing rate of growth but also with

an impressive drop in the level of private savings. The collapse of personal savings in

combination with the decline in corporate savings led to a huge decline in the overall

level of private saving. From the following figure we can draw the following

conclusions. Between the Second World War and the beginning of the 1980s, both the

rates of savings and investments remained stable, around an average of 4.5 percent

with highs of 7 percent for some years (1952-1979). In the 1980s, it suddenly fell to

about 1 percent or even almost to zero during recessions. The Reagan administration

played a significant role in this decrease. This fact highlighted the gradual

metamorphosis of the functioning of the US economy in the course of the

neoliberalism. What is more, the figure also illustrates the diminishing rate of

investment. As it can be seen, again during the neoliberal decades the rate of

investment also decreased from an average of 4.1 percent from 1952 to 1979, to an

average of 3.5 percent (Dumnil and Lvy, 2004a, p. 23).

Figure 7: Ratio of net savings and investment to the Net Domestic Product (%):

US: total economy

Source: NIPA (BEA); Flow of Funds (Federal Reserve) as cited in (Dumnil andLvy 2004a, p.23)


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4. Financialisation and Crises

The increasing power of financialisation is inextricably linked with the imposition of

financial openness in both developed and developing countries. In turn, the main

accusation against the dangers posed by financial openness is related to the increased

potential for financial risks. It is observed that when countries liberalise their financial

systems, removing any capital controls previously being implemented, there is a

strong possibility of a financial crisis (Bordo and Eichengreen, 1999). This approach

is in contrast to the verdict of the neoclassical orthodox theory, which argues that

financial instruments and economic integration should lead to smooth consumption

rather than to financial crises- the outcome in most of the countries of the developing

world during the last decades (Chinn, 2011). It is true, that speculative attacks occur

when market fundamentals deteriorate and, in the case of the emerging economies

which have removed their capital controls too quickly, capital liberalisation had a

tremendous impact on their national economies (Rodrik and Subramanian, 2008).

What is more, the problem is that developing countries by definition exist in a second-

best world, meaning that they suffer from distortions and corruptions. In a world still

struggling with problems of underdevelopment, it is difficult for developing countries

to strengthen financial regulations and governance (Schmuckler, 2004). The reasonwhy these countries are poor is because there are many things that go wrong with

them. They do not have well established property rights and legal system; they have

high levels of corruption and poor financial information. As a consequence,

significant economic and financial crises have taken place in developing countries

since the 1990s: Mexico (1994); Indonesia, Korea and Thailand (1997); Brazil and

Russia (1998); Argentina and Turkey (2000); Brazil (2002). According to Henry

(2007, p. 890) these crises have usually followed capital account liberalisation and

are powerful testimony to the extent to which the costs of financial globalisation have

fallen disproportionately upon the bigger so-called emerging market countries. This

is consistent with a study by Eichengreen and Bordo, conducted in 2001, according to

which the probability of a financial crisis occurrence has doubled after the 1970s.

Another interesting survey, conducted by Bordo, Eichengreen, and Peria in 2001,

presents the frequency of financial crises and their duration during the last 120 years.

They distinguish between four different time-periods. The first one runs from 1880

until 1913 (the gold standard era); the second from 1919 to 1939 (inter-war years); the


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12

third from 1949 to 1971 (Bretton Woods era) and the last one from 1973 until 1997

(neoliberal era of capitalism). It can be observed that, during the last time-period the

world has experienced most financial crises: ninety-five financial crises took place in

the periphery and forty-four in countries of the advanced world.

Table 2. Financial Crises in the Core and Periphery

PeriodFinancial Crises in

Advanced countries

Financial Crises in

Emerging Markets

18801913 7 25

191939 36 13

194971 21 17

197397 44 95

Source: Michael Bordo and Barry Eichengreen, Crisis Now

and Then: What Lessons from the Last Era of Financial

Globalization, NBER Working Paper 8716, 2002.

Furthermore, in 2001, Kaminsky and Schmukler conducted a research about the

emergence of boom and bust episodes in stock markets. They observed that, three

years after the liberalisation process which both developed and developing countries

followed, most of them experienced the burst of financial crises with significant

impacts. What is more, the emergence of most of these crises can be found in good

times before the collapse. Indeed, it is observed that, at an early stage in the

financialisation process, most of the emerging economies experienced high levels of

economic performance. More specifically, inflation was low and economic growth

was high. However, as the authors argue the good times often have a dark side

(Kaminsky and Schmukler 2001, p. 67).


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Source: Kaminsky and Schmukler (2001)

Figure 8 depicts the average boom and burst cycle in the financial markets.

Industrialised countries are: Italy, France, Canada, Germany, United States, UnitedKingdom, Japan, Ireland, Finland, Denmark, Spain, Portugal, Sweden and Norway

Figure


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and developing countries are: Brazil, Argentina, Chile, Mexico, Columbia, Peru,

Hong-Kong, Korea, Venezuela, Indonesia, Malaysia, Taiwan, Philippines and

Thailand. Date 0 is the date of the peak when normalization reaches 100.

In a nutshell, undoubtedly there are direct and indirect channels between financial

globalisation and financial crises. When a countrys financial system is liberalised, it

becomes subject to foreign discipline and because financial markets are imperfect by

nature, countries become more prone to financial crises independently of their

fundamentals. Imperfections can generate speculative attacks, bubbles, irrational

behaviour and crashes.

5. Financialisation and Neoliberalism

The concept of neoliberalism has, during the past thirty years or so, become quite

widespread in many political and academic debates. Several authors have even

suggested that neoliberalism is the dominant ideology that shapes our world today,

and that we live in an age of neoliberalism. The overshadowing importance

accorded by some to the phenomenon of neoliberalism does not signify, however, that

it is a clearly defined concept. I suggest in this paper the definition of Dumnil and

Lvy which relate neoliberalism to the increase of the financial impact towards the

real economy, arguing that neoliberalism is a new stage of capitalism that emerged in

the wake of the structural crisis of the 1970s. It expresses the strategy of the capitalist

classes in alliance with upper management, specifically financial managers, intending

to strengthen their hegemony and to expand it globally (Dumnil and Lvy, 2011,

p.1). In this way, it is clearly understandable that financialisation was an integral part

of the neoliberal process and that it wouldnt have this strength and power had it not

been for the neoliberal policies that were implemented in a global scale.

In the 1940s and 1950s the current neoliberal policies and ideas would have been

inconceivable, causing the laugh of most of the people, facing difficulty in finding

believers and followers (Dumnil and Lvy, 2011b; 2005). At that time, everyone was

a Keynesian, a social-democrat, a social-Christian democrat or some kind of

Marxist. Ideas such as the establishment of an international free trade environment

with the removal of any restrictions and the limitations of any capital and financial


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12

controls would have undoubtedly been out of the spirit of the time. The world at that

time was functioning in a very different way. The synchronized impacts of the New

Deal, the Marshall Plan, and the Welfare State established a new order of social-

democratic power (Dumnil and Lvy, 2004a).

Neoliberalism as an ideology was shaped at the University of Chicago in the 1970s.

With the figures of Friedrich von Hayek and Milton Friedman at the centre, the

neoliberals created a gigantic international network of institutes, foundations,

publications, writers, scholars and public relations necessary in order to promote their

ideas and establish them as a doctrine (Felix, 2003). The built up of this ideological

cadre can be considered to be a case of what the Italian Marxist thinker Antonio

Gramsci called cultural hegemony. As Gramsci puts it if you can occupy peoples'

heads, their hearts and their hands will follow

(http://thinkexist.com/quotes/antonio_gramsci/ ).

After World War II the political conditions at a global level were uncertain. It was

without doubt a transitional period, not only for the US, but also for several European

countries which were balancing between a kind of social-democracy (socialism) and

a free-market capitalist system. What is more, economic recovery was associated with

the creation of large deficits and the increase in flows of capital from Europe and the

rest of the world to the US.

The failure of Keynesian policies to confront efficiently the structural crisis of the

dollar in the early 1970s led not only to the suspension of the convertibility of the

dollar into gold (August 1971), forcing European countries to let their currencies to

float, but generally to a new international deregulated financial framework with

financial institutions and multinational corporations increasing their power and their

sphere of influence. This clear break with the Bretton Woods system enhanced the

existing freedom of trade and of capital movements. The IMF Articles of Agreement

were modified saying now that the essential purpose of the international monetary

system is to provide a framework that facilitates the exchange of goods, services, and

capital among countries. What is more, the crisis of the 1970s created the conditions

of a new bout of class struggle during which the income of the capitalist class was

restored. A new discipline was imposed on workers, placing them in the global

competitive framework (Thomson, 2010).
http://thinkexist.com/quotes/antonio_gramsci/http://thinkexist.com/quotes/antonio_gramsci/


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12

In 1974 the US removed the controls it had established during the 1960s. Britain,

Germany and France followed suit. Britain remained consistently focused on making

London a financial centre, where neoliberalism would promote the interest of the

upper class (managers and capitalists) to the rest of the world. Germany has always

had as a major objective the implementation of orthodox, monetary measures that

would bring price stability. France, traditionally a nation characterised by a significant

amount of state protectionism, after the election of Mitterand in 1981 moved toward a

free-market economy within the general social, economic and political framework of

a unified Europe (Rogoff, 2006). A classical and indicative example of a politician

that promoted the neoliberal ideology and policy was Margaret Thatcher, who came

to power in Britain in 1979 under the slogan There Is No Alternative.

Since the 1980s, neoliberalism both as an ideology and policy has ruled the countries

of developed and developing world, becoming the main form of expression of the

capitalist system. Financialisation, as it was stated before, has been an integral part of

this procedure. The quantitative changes brought about by financialisation were

matched by even deeper qualitative changes. Financial activity penetrated into a

widening range of economic and social activities (Fine, 2009). Thus, the primary

role of individuals in society has been transformed from workers-consumers toworkers-consumers- investors (Casey, 2009, p. 260), put differently, the distance

between high finance and everyday life, between global banking and household

finance, has been drastically reduced (Finlayson, 2009, p. 420).

The main form of the neoliberal policies decade was the lessening of capital controls.

Liberalisation has been extensive in countries that were in a highly restricted financial

situation in 1975 leading to their full openness by the 2000s. In Figure 9 we can

observe the gradual removal of capital controls. From the bottom panel in Figure 9, it

can be observed that countries in all income groups on average- have relaxed their

capital controls though the level of capital controls had a reverse relationship with

their income per-capita (Joshi, 2003).


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Figure 9: Capital Controls by Financial Openness and Income Group, 1975-

2005

Source: Annual Report of Exchange Arrangements and Exchange Restrictions

(AREAER), IMF; and staff calculations.

Another study conducted again by Kaminsky and Schmukler in 2001, documents the

gradual lift-up of restrictions in the course of the neoliberalism. Figure 10 depicts

exactly the evolution of financial restrictions on financial movements of capital.

Figure


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During the last thirty years, both industrialised and emerging countries have followed

the same procedure of financial integration, by lifting their controls and restrictions.

What is more, developed countries have always been more liberalised than developing

ones. A significant element worth mentioning is that, over time, some periods of

reversals can be observed, especially in the aftermath of financial crises, such as the

crises in Mexico and in East Asia.

Source: Kaminsky and Schmukler, 2001, p. 35

Analysing the above figure, restrictions vary from level 1 (no restrictions) to level 3

(High restrictions). Developed countries are Italy, France, Canada, Germany, United

States, United Kingdom, Japan, Ireland, Finland, Denmark, Spain, Portugal, Sweden

and Norway while developing countries are Brazil, Argentina, Chile, Mexico,

Figure


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Columbia, Peru, Hong-Kong, Korea, Venezuela, Indonesia, Malaysia, Taiwan,

Philippines and Thailand (Kaminsky and Schmukler, 2001, p. 35).

Summarising, during the transitional period between the 1970s and the 1980s

capitalism entered into a new phase which has been called the neoliberal stage. One of

the so-called key characteristics of this phase, the disengagement of the state from

economic affairs through the perception that the state did not have any role in the new

economic status quo, is misleading. Indeed, the state was the agent of implementation

of the new neoliberal policies worldwide. At the international level, financial

institutions such as the World Bank and the Internationally Monetary Fund played a

quasi-state role in the imposition of the neoliberal new order in the planet. Another

characteristic of this new order has been the adoption of a general neoliberal ideology

which is related not only to the adoption of free trade and the imposition of a free

international circulation of capital, but also to the freedom being given to the

enterprises to hire and fire according to their needs and the rules being imposed by the

global entrepreneurial competition (Wolfgang, 2011). Thus, neoliberalism emerged as

a result of both the ideas and policies that were implemented during the last thirty

years. It is not only a belief, an ideology, or even a doctrine, but also a mode of

economic governance and a policy package (Steger and Roy, 2010).

The application of these ideas implemented by the Thatcher and Reagan regimes

varied, but the founding principle was the shift from governments control to the

private sector of the economy, and the adoption of policies that will remove the

barriers to capital flows and financial investments. In this line of thinking,

financialisation emerged as a post hoc addition becoming gradually the theoretical

central tenet of the neoliberal growth model (Froyd et all., 2000). For many

economists, the existing relationship between neoliberalism and financialisation

involves both the explanation and the solution of the current financial crisis.

Simplifying, we could say that the crisis began in the financial sector because of the

broader phenomenon called financialisation which is the heart of neoliberalism.

No one can deny any longer that the current financial crisis was not merely a crisis of

the financial sector of the economy, but also a crisis of the neoliberal capitalist system

which dominated over the last three decades. According to Fine (2009, p.1) The

current crisis, and the response to it, seem to have delivered a death blow to


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neoliberalism. Economists were responsible for the creation of elegant mathematical

models of (im-)perfectly self-regulating markets that were disconnected from the

reality of actual functioning markets. One of the focal point of modern economics is

the efficient markets hypothesis which, according to Quiggin (2010, p.44) implies

that there can be no such thing as a bubble in the prices of assets such as stocks or

houses. Further, the bulk of the evidence illustrates that they continued with highly

risky strategies even though they knew that they were on a bubble. Citigroups CEO

Charles Prince told the Financial Times in July 2007 as long as the music is playing,

youve got to get up and dance. Consequently, financial firms that took excessive

risk, found themselves overleveraged and instead of markets punishing this behaviour

they promote policies that will help to continue operating in the same way

(Geanakoplos, 2010, 2010b).

6. Conclusions

Nowadays, the role of the capitalist state has been transformed aiming to meet the

new requirements of financialisation. The states role is fully incorporated in a system

which supports finance with all possible means. Capitalists, politicians and

intellectual networks attempt to transform capitalism into a system with minimal

constraints for big business. They have the perception that in order for capital to gain

the upper hand, the economic environment has to be unstable and highly insecure for

the bulk of the population and the state. What is more, although financial

liberalisation is inextricably linked with bubbles and crashes, especially after the stock

market crash of 1987, it is an astonishing fact that the policies being implemented

have little effect in slowing down the financialisation trend. Half of the losses in stock

market valuation from Wall Street blowout between March and October 2002 was

regained within a couple of years. What is even more astonishing is that the average

daily volume of foreign exchange transactions rose from $570 billion in 1989 to $ 27

trillion dollars in 2006. Since 2001, the global derivatives market has grown at a rate

of over 100 percent per year (Dymski, 2009, p. 43). Martin Wolf of the Financial

Times claims that another ideological God has failed. Yes, no doubt, but the idolatry

seems to go on and on and within it financialisation?


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