The crisis of 2007-2009 arose after the burst of an enormous bubble in real estate in the USA and the UK. But the underlying trends that led to it are characteristic of financialisation in developed countries. The crisis also drew in a range of developing countries via the mechanisms of global trade and finance. It became clear that financialisation has also made significant advances in developing countries in recent years.
Financialisation has several meanings in social science literature. In this article the term is used to indicate structural transformation of capitalist economies. In a nutshell, the sphere of finance has grown enormously in mature countries during the last three decades, spurred by technological advance and the lifting of regulations. In contrast, production in mature countries has continued to face problems of profitability and productivity.
As the financial sphere has expanded, large industrial enterprises have become proficient at raising external finance in open financial markets. Big business has acquired independent financial functions and lessened its reliance on banks. Consequently, banks have sought new fields of profitability, including, first, investment banking in open markets and, second, lending to individual workers.
The turn of banks toward households has been facilitated by gradual withdrawal of public provision in housing, health, education, pensions, and so on. Financial institutions have become social mediators of consumption and other personal spending.
In short, these changes have amounted to the ‘financialisation’ of productive enterprises, banks and households. Needless to say, the institutions of monetary and credit policy have also changed greatly, particularly central banks. Furthermore, governance of corporate enterprises has been transformed, with strong emphasis on ‘shareholder value’, share prices and short-term results.
Financialisation has also had distributional, ethical and moral repercussions across society. Nonetheless, the characteristic features of financialisation across developed countries are not homogeneous and reflect institutional, historical and political factors, including norms of business and personal income expenditure.
Financialisation has also had an integral international aspect. International financialisation is a complex issue, ranging from the accounting standards of global financial transactions, to the altered role of international organisations, including the IMF, the World Bank and the WTO, to exchange rate policy and adoption of inflation targeting across the developing world, to the functioning of the dollar as quasi-world-money. The current crisis has touched upon all these dimensions of international financialisation.
A striking feature of the crisis, however, is that it has revealed new links between domestic financialisation in developed countries and international financialisation affecting developing countries. These links have derived in large part from the international capital flows between developed and developing countries. Capital flows were important to sustaining the bubble in developed countries particularly during 2004-2007, while providing an effective subsidy to the USA as main provider of world means of payment.
Moreover, international capital flows appear to have induced domestic financialisation in several developing countries, led by expansion of domestic bond markets and entry of foreign banks. By the same token, capital flows and domestic financialisation have contributed to the emergence of crisis across a range of developing countries.
Financialisation in developing countries is, in the first instance, a phenomenon of international transactions. Liberalisation of capital flows has integrated developing countries more closely into world capital markets since the early 1990s, FDI being the most stable component of capital flows from rich to poor. The flows of FDI were sustained during and after the Asian crisis of 1997-8, but the overall character of capital flows has become significantly different in the 2000s. Developing countries have been obliged to hoard international means of payment – primarily dollars – as a result of participating in international capital transactions. The unprecedented extent of such hoarding has resulted in negative flows of capital on a net basis.
During the 2000s, poor countries have been effectively financing rich countries, mainly the USA. Capital has been ‘flowing uphill’ in the financialised global economy. This is one of the most paradoxical, as well as pathological, outcomes of international financialisation.
The form taken by negative capital flows has resulted from the need to sterilise inflows into developing countries, thus leading to the acquisition of foreign exchange reserves. Sterilisation was also spurred by the pressures of inflation targeting, which has been widely adopted across the developing world, and has created a secure terrain for foreign capital to flow into developing countries. The safest way to sterilise and accumulate reserves is, of course, to acquire public debt issued by mature countries, primarily the USA. In effect, the monetary authorities of developing countries have been lending directly to the state in the US and other mature countries.
Consequently, international financialisation has meant substantial costs for developing countries. Interest rates on public debt issued by the USA have typically been lower than interest rates on either international borrowing, or on domestic public securities in developing countries. Put differently, developing countries have been paying an implicit subsidy to the USA as issuer of the pre-eminent form of international means of payment.
International financialisation has also acted as a spur for accelerated domestic financialisation, particularly in middle income countries. Sterilisation has encouraged growth of domestic bond markets, thus providing scope for expansion of domestic financial institutions. During the same period large-scale entry of foreign banks has led to adoption of practices common in financialised developed countries. In particular, lending to individuals for mortgages and consumption has become prominent in several developing countries, resulting in rapid growth of personal debt. Domestic banks have also entered this field. The development results of directing credit toward personal income are unlikely to be positive.
The effect of the crisis on developing countries has varied according to the mode and extent of integration of each in world trade and capital flows. Developing countries were hit by a combination of worsening current account and sudden reversal of short-term capital flows. The impact of the blow depended on the size of foreign exchange reserves. Countries with substantial reserves were afforded a measure of protection from sudden reversal of capital flows, and some even attracted fresh flows as financial conditions in mature countries became worse.
The impact of has also depended on entry by foreign banks and the extent of domestic financialisation in particular developing countries. Central and Eastern Europe represented a particularly acute combination of these pressures.
The crisis has reopened the issue of reforming the international financial system. Developing countries were hit by a storm that was not of their own making. This was after undertaking policies throughout the 2000s that had resulted in capital flowing from poor to rich, on a net basis, thus imposing substantial costs on the poor. Meanwhile, the domestic economy in several developing countries has become increasingly financialised and credit has been direct toward consumption. The crisis has posed again the issue of alternative institutions and mechanisms to regulate international flows of capital.
*Prof. Lapavitsas is member of Research on Money and Finance, a network of political economists that have a track record in researching money and finance. It aims to generate analytical work on the development of the monetary and the financial system in recent years. A further aim is to produce synthetic work on the transformation of the capitalist economy, the rise of financialisation and the resulting intensification of crises.