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Munich Personal RePEc Archive
On the expansion of ﬁnance and
Russo, Alberto and Zanini, Adelino
01. October 2010
Online at http://mpra.ub.uni-muenchen.de/26828/
MPRA Paper No. 26828, posted 18. November 2010 / 17:53
On the expansion of finance
Alberto Russo,* Adelino Zanini
Università Politecnica delle Marche, Ancona
In this paper we explore the role of finance in the recent crisis noting
that its expansion, in a context of deregulation and globalisation, has boosted financial profits and capital accumulation, but at the cost of a growing systemic instability both in the leading capitalist economy, i.e. the USA, and at the international level. The expansion of finance tends to emerge in certain phases of capitalist development, in particular during periods of countries’ decline. At the same time, each phase has its peculiar aspects and, referring to the recent evolution, we focus on the phenomenon of financialisation, intended as an increasing involvement of economic agents in the working of financial markets.
* Corresponding address: Dipartimento di Economia, Facoltà di Economia “Giorgio Fuà”, Università Politecnica delle Marche, Piazzale Martelli 8, 60121, Ancona (Italy). E- mail: firstname.lastname@example.org
1. Introduction The expansion of finance is a phenomenon that historically emerges in certain phases of capitalist development, in particular during periods of countries’ decline. At the same time, each phase has its peculiar characteristics. Referring to the last decades history, we discuss some aspects of the recent phase of financialisation intended as an increasing involvement of economic agents – from financial to nonfinancial firms and households – in the working of financial markets.1 Financialisation has interacted with other evolving phenomena in last decades. The current turmoil can be interpreted as a result of the recent phase of capitalist accumulation based on a broad process of deregulation that originated in the US and UK from political decisions taken since the 1970s. In this perspective, the same elements which allowed a renewed accumulation process (labour market flexibility, decentralised production through outsourcing and offshoring, migration and trade liberalisation, international capital movements as well as the expansion of the financial sector) have created, at the same time, the basis for a series of crises both in the leading capitalist economy, i.e. the USA, and at the international level (due to growing inequality, excessive indebtedness, global imbalances, financial instability, etc.).
A particular feature of the ‘financialisation model’ which has characterised
the recent decades is the interplay between financial aspects and social ones:
increasing inequality and the precarisation of many individuals’ life have been exploited by the financial sector through providing credit consumption, sub-prime mortgages, etc. Furthermore, a rising fraction of households’ saving has been invested in pension funds and other financial activities associated to increasing levels of risk. In general, the financial sector has gradually shifted from loanbased financing of nonfinancial corporations to more market-based activities and speculative operations. In turn, nonfinancial corporations has been increasingly 1 According to Epstein (2005, p.3), financialisation can be defined as “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economies”.
2 involved in financial activities and the accumulation of capital has been even more based on “the making of financial profits by means of financial profits”.
The remainder of the paper is organised as follows. In the next section we briefly describe the evolution of the recent turmoil and discuss its potential causes. In section 3, financialisation is analysed in a historical perspective as a phenomenon that periodically tends to emerge, especially in declining hegemonic economies. The characteristics and the “stylised facts” of the recent phase of capitalist development and financialisation are presented in section 4. Then, in the final section, we provide some concluding remarks.
2. On the crisis and its causes In this section we provide a short discussion on the recent crisis episode and the potential elements involved in its evolution.2 Among the proximate causes of the crisis there are various “financial innovations” introduced in recent years – “innovative financial products” (from subprime mortgages to structured products and derivatives), the “originate-to-distribute” banking scheme (instead of the traditional one, that is “originate-to-hold”), the “shadow banking system” created to collect risks “off-balance” (to avoid the constraints of regulation on capital adequacy) and so on – which have allowed to increase financial profits in advanced economies, especially in the USA. This has happened in a context of increasing riskiness associated to financial operations which culminated in the recent crisis episode, starting from the collapse of the US subprime mortgage market.
According to many commentators, the “bad regulation” of financial markets (or the excessive deregulation) has emerged as a cause of the crisis, given that the process of origination and distribution of “private risk” has increased the complexity of financial products and interconnections, resulting in an informational opacity about the risk-yield relationship and an increase of systemic risk.
2 The following analysis is based on a contribution proposed by one of the authors (Russo, 2010).
3 The monetary policy of recent years has been indicated as a contributing cause of the crisis (“Greenspan put”): the long post-9/11 phase of “low” interest rates has supported excessive risk-taking, speculation and growing indebtedness and leverage, leading the system towards financial unsustainability.
In fact, after years during which the interest rate on fed funds has remained “low”, when the FED decided to increase it, a rise of the delinquency rate on subprime mortgages has followed while the increase of housing prices has stopped.3 Consequently, in the summer 2007, some of the primary financial institutions (in US and in Europe) has declared huge losses due to the bad performance of the housing market; then, a lack of confidence among operators has followed, leading to a grave crisis in interbank markets. In the following period the perception of risk has remained elevated – as signalled by high spreads between interbank interest rates and their risk-free counterparts (for instance, the Overnight Index Swap). However, until the mid of 2008 the instability was mainly in monetary and financial markets, without relevant effects on the “real economy”. The monetary policy interventions implemented by central banks in this period (quantitative easing, decrease of the interest rate, bailouts in collaboration with governments, etc.) have partially mitigated the effects of the “liquidity crisis”.
The Lehman Brothers’ default in September 2008 has resulted in a serious deterioration of the crisis. The confidence among financial operators has dramatically fallen. From this episode on, in a situation of liquidity hoarding, the real economy has began to go down. In a context of high uncertainty, the lack of confidence has resulted in a vicious circle of reduced propensity to lend money 3 More in general, in last decades the US financial system has faced growing difficulties to work with “high” interest rates because of the excessive leverage of financial operators and, as maintained by Fitoussi and Stiglitz (2009), to finance households’ consumption in years of growing inequality (in a sense, monetary policy has become “endogenous” to income distribution). The transformation of financial institutions, the introduction of new financial products and the process of deregulation have made the US financial system very fragile, while many players have become convinced “that a steady flow of liquidity will be, at all times, made available by the authorities and, in particular, by the US Federal Reserve, to face emergencies the market has come to experience almost daily. The LLR can thus be said to have become a lender of first resort” (de Cecco, 1999, p.6).
4 (and deleveraging) at different level (from interbank markets to the lending to firms and households). In other words, a credit crunch has resulted in a reduction of investments, production and, subsequently, employment in various sectors and countries. All in all, after September 2008, the “liquidity crisis” has transformed in a “global economic recession”.4 Central banks and governments have contrasted the worsening of the crisis by putting significant resources in the economy. As a consequence, the deficits and public debts of many countries have raised remarkably – consisting in a large socialisation of private losses. Currently, there is a problem of public debt sustainability in a number of countries and some difficulties emerge with respect to the implementation of “exit strategies”. Finally, various countries are discussing over the necessity of reforming the regulation of national and international financial markets and some progress has been done towards the approval of the “Basilea 3” agreement.5 Besides the above aspects – financial innovations, regulation and monetary policy – other (long-term) factors contributed to the evolution of a highly unstable economic and financial system, both at the level of the core-country and globally.
In recent decades a progressive decline of the labour share has occurred in advanced economies (about 10% in Europe and Japan and 3-4% in Anglo-Saxon countries since 1980), especially in unskilled sectors (IMF, 2007, chap. 5).
Among the possible causes we list the following: skill-biased technological change, labour market reforms (aimed at increasing “flexibility”, especially in 4 More in general, in a Keynesian perspective, money and finance play a fundamental role in generating instability and crises: in a period of turmoil agents’ confidence falls and the “preference for liquidity” goes up with significant “real” effects: as a matter of fact, in a monetary production economy capitalists aim at accumulating wealth; when they believe that the safest way to store up and increase wealth is no longer to produce commodities, but instead to hold liquid money, an unemployment crisis occurs (Graziani, 2001). However, while “western economies” have faced a vast financial and economic crisis, “eastern economies”, after a minor deceleration, have continued to grow at high rates: in 2009 the GDP growth rate was equal to -2.4 in the US, -5.2 in Japan, and -4.1 in the Euro area; the contraction has then produced an increase of the unemployment rate around 10% in the US as well as in Europe; in the same period China has grown at 8.7% and India at 5.7% (IMF, 2009, 2010).
5 Some commentators have rightly noted that the long time before the enforcement of some Basilea 3 norms is enough to see in the meanwhile the occurrence of a couple of financial crises.
5 some European countries); national and global reorganisation of production through outsourcing and offshoring, import of commodities from low-cost countries, migrations, etc.6 The decrease of the labour share may cause a lack of effective demand in a context of growing inequality. Actually, consumer credit and other form of indebtedness have prevented this to happen at the cost of an increasing financial instability, eventually leading to a large crisis.7 The flexibility of labour markets and the decentralisation of production have interacted with a political process of deregulation which, starting from the US and UK, has gradually eliminated the rules created after the Great Depression aimed at segmenting financial markets to preserve financial stability. From the 1980s financial deregulation (or the “new” regulation) has boosted financial profits, but the expansion of finance has also provoked a series of crises in the “core-country” (Wall Street in 1987, savings & loans in the 1980s and 1990s, the “new economy” bubble, until the subprime mortgages one). At the same time, the deregulation of the international financial system has opened new investment channels (“financial globalisation”) at the cost of rising global instability (especially due to short-run speculative operations), leading to various crises (Mexico in 1994-5, south-east Asia in 1997, Russia and LTCM default in 1998, etc.).
Moreover, the outsourcing-offshoring dynamics, the flow of capitals as foreign direct investments (FDIs) and the working of MNEs have supported a 6 “Changes in labor market policies have had a positive effect on the labor share in Anglo-Saxon countries, but a much more modest effect on average in Europe, particularly in large European economies where labor policies are estimated to have actually contributed to a decline in the labor share” (IMF, 2007, p. 177). In particular, “[…] labor globalization has negatively affected the share of income accruing to labor in advanced economies (labor share). […] Rapid technological change – especially in information and communication sectors – has had a bigger impact, particularly on the labor share in unskilled sectors” (IMF, 2007, p. 180).
7 In a Marxian perspective, the expansion of the financial sector, the increasing role of credit to sustain consumption and, in general, of indebtedness, jointly with financial innovation, labour market flexibility, outsourcing and offshoring, privatisations, etc. are all factors which have allowed a recovery of capitalist accumulation after the crisis of the 1970s (see Uctum and Viana, 1999, on the decline of US profits and the successive recovery in the 1980s). As a matter of fact, at some point the contradiction between the individual goal of maximising profits (“micro”) and the collective one (“macro”), consisting in the valorisation of capital (through selling commodities in markets), gives rise to an overproduction crisis. In this perspective the financial collapse is the most apparent manifestation of a more general crisis whose realisation has been postponed and amplified by financial factors (Marx, 2009).