Why has the growth of financial markets become one of humanity's key problems?

The rapid development of financial markets allows for faster redistribution of resources. This is why countries such as the US, UK, Ireland and other capitalist states that have opened and liberalized their financial markets have enjoyed strong economic performance over the past three decades. Liberalized financial systems enable economies to respond quickly to opportunities without slowing down their development and creating conditions for more sustainable growth.

However, financial markets should not be sought to be restricted solely because of rare financial crises that occur once a century and are unpredictable, no matter how large in scale. The financial market is the key to economic prosperity.

 

So what is wrong with financial markets?

 

The current problems with financial markets are related to their over-exploitation. Reforms in recent years have led to a host of new financial instruments that have made the U.S. financial sector more efficient at creating short-term profits for itself. However, as the global crisis of 2008 showed, these instruments led to a decrease in the stability of both the economy as a whole and the financial system itself.

In addition, the high liquidity of financial assets forces their owners to react quickly to changes, which creates difficulties for the real economy. Companies need “sustainable capital” for long-term growth, but the gap in rates between the financial and productive sectors needs to be narrowed. This means that the efficiency of financial markets should be deliberately limited.

 

Policy implications of the growing influence of financial markets

 

The growing influence of financial markets and the increased financialization of the U.S. economy have led to significant changes in the distribution of political power. The financial sector, having become the dominant force in the economy, has been able to increase its political influence through lobbying, large-scale campaigns, and close ties to political elites. Large financial companies and banks have become key players in shaping economic policy, often influencing legislative processes. This has led to an environment that favors financial interests, such as deregulation and tax breaks for large corporations.

Financialization has also changed government priorities, shifting the focus from production and the real sector to meeting the needs of financial institutions. Politicians are increasingly under pressure to implement reforms favorable to banks and investment funds, often putting the interests of financial elites ahead of those of the general public. As a result of this process, economies become more vulnerable to financial crises, as increased reliance on financial markets increases the risks of speculation and volatility, which ultimately affects the welfare of most citizens.

 

 

In the United States, the financial sector has become so attractive that many originally industrial companies have actually become financial corporations. Famous American economist Jim Crotty has done an analysis that the ratio of financial assets to non-financial assets in the balance sheets of U.S. non-financial corporations has increased from about $400 billion in the 1970s to nearly $1 trillion. Even companies such as General Electric, General Motors, and Ford, which were once symbols of America's industrial might, have become embroiled in financialization and continue to increase their financial assets.

In parallel, industrial production has steadily declined. By the beginning of the 21st century, these industrial giants were no longer deriving the bulk of their revenues from manufacturing, but from financial activities. For example, in 2003, 45% of General Electric's revenues came from its financial division General Electric Capital. In 2004, 80% of General Motors' revenues came from its GMAC finance arm, and Ford's profits between 2001 and 2003 were entirely from Ford Finance.

The catastrophic effects of financialization on the real economy

 

The result of all these “successes” has been a tremendous growth of the financial sector worldwide, especially in the rich countries. This growth is not only reflected in absolute terms. A paradoxical fact has occurred: the financial sector has grown many times larger and faster than the real economy, which served as its foundation. 

According to calculations based on IMF data by Cambridge University economists and authorities on financial crises, the ratio of the stock of financial assets to world output rose from 10.2% in 1980 to 40.4%. 

In many rich countries with developed financial markets, the gigantic financial sector superstructure was simply exorbitant. Economists in the UK calculated that the ratio of financial assets to GDP in 2007 was 700%. France is emblematic of the continental model of capitalism and is often contrasted with the Anglo-Saxon version, failed to demonstrate immunity to the financial plague and was only slightly behind the UK in the scale of the financial bubble.

 

 

Relying on U.S. government data, economists have estimated that the ratio of financial assets to U.S. GDP fluctuated between 400 and 500 percent between 1950 and 1970. In the early 1980s, when deregulation of financial markets was introduced, this ratio grew rapidly each year and reached 900% by the beginning of the 21st century.

Conclusions

 

Financialization led to significant changes in the structure of the economy, where many industrial companies focused on financial operations, which weakened their core productive capacity. This process worsened the long-term sustainability of the real sector, creating a gap between financial and industrial development. As a result, instead of investing in innovation and production, companies have become more focused on short-term profits through financial speculation, making the economy more vulnerable to crises and reducing its ability to grow sustainably.

Read also our piece on what can be done to the global economy to mitigate the effects of financialization.