It is wrong to treat financial capitalism as the dysfunctional child of neoliberalism and so misdirect a progressive policy focus.
It is no exaggeration to say financialisation has been one of the defining changes in the structure of capitalist economies over the past four decades or so. It is also little exaggeration to say it has evoked major debate on the left.
There is intense discussion about what the role of the financial sector in today’s world is or should be, its appropriate size, how it might be used to tackle the existential threat of climate change and so on. As healthy as many of these conversations are, the rise of finance is widely misunderstood: critical economists, analysts and policy-makers have got many of its essential features basically wrong.
Financialisation is a structural change in advanced economies, not unlike the shift from manufacturing to services. Though it has few positive features—it undermines democracy, increases inequality, heightens instability and so on—and it has been magnified by neoliberalism, it is not a result of the latter. A larger financial sector was the inevitable outcome, on the one hand, of demographic changes which have swept across the developed world over the last few decades and, on the other, the rise of economic inequality.
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There is, of course, no unanimity on why the financial sector has grown, and what the implications are for the economy and society. The unifying thread among progressives, however, is that the rise of finance is essentially dysfunctional, a burden on the functioning of the real economy. One oft-cited datum is the scale of financial transactions in relation to the real economy—for instance, foreign-exchange trading is many, many multiples of trade in actual goods and services.
In line with this, many studies correctly show that profits accruing to the financial sector have grown spectacularly over the past few decades, including within the putative casino that is investment banking. Revenues and profits in the financial sector however basically track the growth of financial markets. To understand the rise of finance, and its distributional implications, one therefore has to understand why financial markets have grown.
Considering the size of securities markets, there are two basic types of security—stocks and bonds—and both supply and demand factors are important. Take bonds. As to their supply, public-debt markets dominate in the major European countries and have grown in line with increased government spending over the past 50 years or so. As populations have aged this has necessitated greater public-pension and healthcare spending.
In terms of demand, both demographic and distributional factors are central. Specifically, societal ageing in developed countries has been driven by increasing longevity and falling fertility. The former creates a need for income-yielding savings in old age, in the form of financial assets, which are drawn down upon retirement. And as one’s savings increase with age, the decline in birth rates means a greater share of the population has accumulated pension wealth, with a consequent need for financial services such as pension funds.
The growth of inequality under neoliberalism heightens the demand for finance. The ultra-rich in particular require financial assets and funds to store and manage their wealth. This has been among the reasons for the growth of hedge funds, for instance.
Moreover, as the share of income accruing to the upper-middle classes swells, the public-pension system becomes an increasingly inadequate replacement for working-life earnings in retirement, especially as policy-makers encourage the use of private funds through tax and other incentives. Particularly in the Anglo-Saxon world, where state benefits in old age are more decoupled from lifetime earnings, this creates a demand for private finance.
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More generally, as the supply of and demand for traditional financial assets have grown, such securities have become traded much more intensively than ever before. Securities are now mostly held by institutional investors, rather than directly by households.
Careful analysis (by progressive economists) shows that the core of financial-trading volume is not however speculation. Rather it is investors, such as pension and other funds, intensively trading the most liquid securities—such as government bonds and high-capitalisation stocks—as this is the most cost-effective way to abide by their strict investment mandates.
This, in turn, has helped spur the growth of money and derivatives markets, which facilitate financial trading. Opportunities for speculative and parasitic trading have grown, and trading in derivatives markets is particularly lucrative. But ultimately the size of financial markets today, and the substantial increase in the associated profits, is not a dysfunctional outgrowth of neoliberalism but related to real phenomena. It is a result of demographic shifts and the rise in inequality—where only the latter is reversible.
To be clear, efforts should be made to curb the growth of finance, as should efforts be made to curb the growth of low-paid service work at the expense of well-paid manufacturing jobs. But just as there is little chance of returning to the days when manufacturing accounted for such a high share of employment, given automation and other developments, a larger financial sector is set to be a permanent feature of the landscape.
Perhaps the most pressing development in European countries has been the financialisation of housing, a long-term trend which has taken off again in the aftermath of the crisis. But to base policy on the notion that the rise of finance is simply a neoliberal excrescence undermines attempts to craft a better way forward.