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Have we been here before? Phases of financialization within the twentieth century in the US

January 2018
Review of Keynesian Economics 6(1):34-61

January 2018
6(1):34-61

DOI:10.4337/roke.2018.01.03

Authors:

Apostolos Fasianos

Diego Guevara

National University of Colombia

Christos Pierros

Labour Institute of the General Confederation of Greek Workers (INE GSEE)

This paper explores the process of financialization from a historical perspective during the course of the twentieth century. We identify four phases of financialization: the first from the 1900s to 1933 (early financialization), the second from 1933 to 1940 (transitory phase), the third between 1945 and 1973 (de-financialization), and the fourth period picks up from the early 1970s and leads to the Great Recession (complex financialization). Our findings indicate that the main features of the current phase of financialization were already in place in the first period. We closely examine institutions within these distinct financial regimes and focus on the relative size of the financial sector, the respective regulation regime of each period, the intensity of the shareholder value orientation, as well as the level of financial innovations implemented. Although financialization is a recent term, the process is far from novel. We conclude that its effects can be studied better with reference to economic history.

Financialization in the economics literature

…

Consumption by type of expenditure as a share of GDP for the US economy (1930-2010)

…

Average share of net dividend payments and retained earning to corporate profits after tax (excluding depreciation allowances) in the US

…

Broad money over GDP for the US economy (1900-2010)

…

Corporate gross bond issuance and gross equity issuance over GDP for the US economy (1909-2012)

…

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Have we been here before? Phases of

financialization within the twentieth century

in the US

Apostolos Fasianos

Council of Economic Advisors, Greek Ministry of Finance, Athens, Greece and University of Limerick, Ireland

Diego Guevara*

School of Economics, National University of Colombia, Bogotá, Colombia

Christos Pierros

Department of Economics, University of Athens, Greece

This paper explores the process of financialization from a historical perspective during the

course of the twentieth century. We identify four phases of financialization: the first from

the 1900s to 1933 (early financialization), the second from 1933 to 1940 (transitory phase),

the third between 1945 and 1973 (de-financialization), and the fourth period picks up

from the early 1970s and leads to the Great Recession (complex financialization). Our findings

indicate that the main features of the current phase of financialization were already in place in

the first period. We closely examine institutions within these distinct financial regimes and focus

on the relative size of the financial sector, the respective regulation regime of each period, the

intensity of the shareholder value orientation, as well as the level of financial innovations imple-

mented. Although financialization is a recent term, the process is far from novel. We conclude

that its effects can be studied better with reference to economic history.

Keywords: financialization, monetary regimes, speculation

JEL codes: E42, E44, B52

1 INTRODUCTION

When did financialization start? While there is much literature on the increasing domi-

nance of finance in the United States after 1970, little work to date has attempted to inves-

tigate whether financialization was taking place earlier. Whereas few authors consider

financialization as an evolutionary process that can be traced back to pre-capitalist socie-

ties, most analysts emphasize the neoliberal period beginning in the 1980s.

Financialization, as Sawyer (2013/2014) appropriately describes it, is a process that

widely varies in form and intensity across time and space. Accordingly, by utilizing

*Corresponding author: email: dieguevarac@unal.edu.co. The views expressed in this article

are those of the authors only and do not necessarily reflect the official views of the Greek Ministry

of Finance or the Council of Economic Advisors. We thank the two anonymous referees for their

plentiful advice, as well as Stephen Kinsella, Antoine Godin, Costas Koutsikouris, Elizabeth

Dunn, and the participants of the 1st Grenoble Post-Keynesian Conference, ‘Money, Crises,

and Capitalism,’for their valuable comments. All remaining errors are ours. This work is partially

funded by the Institute for New Economic Thinking.

Review of Keynesian Economics, Vol. 6 No. 1, Spring 2018, pp. 34–61

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empirical and qualitative analytical tools coming from different schools of thought, we

identify distinct phases of financialization during the twentieth century in the US. In

particular, we examine the resemblance of financialization’s characteristics in the

early twentieth century with those of the contemporary period, questioning whether

the current phase of financialization is a vaguely different repetition of its older coun-

terpart, as observed, for example, in the early 1900s.

To carry out our task, we divide the sample period into four distinct regimes,

marked by structural breaks in the institutional setting of the economy, which affected

the functioning of the financial sector. The first period of early financialization lasts

from the beginning of the twentieth century up until 1933, as the New Deal agreement

brought significant changes in financial regulation and policy orientation. The second

period (1933–1940) reflects the transitory phase of the economy that leads to the third

period, the ‘Golden Age of Capitalist Development’(1945–1973). The crisis of 1973

heralded the end of the Golden Age. Last, we apply Dumenil and Levy’s (2011) defi-

nition of neoliberalism as ‘financialized capitalism’to link the fourth period of com-

plex financialization with 1974–2010.

We contribute to the relevant literature by exploring financialization from a historical

perspective and pointing out different varieties of financialization throughout the twen-

tieth century in the US. While most studies focus on a few criteria to establish evidence

of financialization, we employ a plethora of empirical and qualitative indicators that

allow us to formulate a synthetic argument for the pace and the form of financialization

in each distinct regime. We argue that financialization, characterized by an increased

role for the financial sector along with higher complexity across financial objectives

and institutions, is merely the current phase of a historical process that has been unfold-

ing since the dawn of the twentieth century. In our view, the early 1930s period presents

a significant resemblance to the current phase of financialization.

Financialization is associated with financial booms and busts and has a negative

impact on the real production of the economy, as it results in unemployment and high-

lights income inequalities. History shows that the degree of financialization is a policy

variable. For instance, in the postwar period, policymakers implemented a range of

policy instruments (such as full employment policies of a Keynesian flavor) and

enforced a strong regulatory environment in order to restrict the uncontrolled explo-

sion of finance. The implications of our findings could point towards policies that

could reverse the destabilizing effects that financialization has on society.

The paper is organized as follows: Section 2 discusses theoretical contributions with

respect to financialization; Section 3 looks at the data relating to the financialization pro-

cess, focusing on the importance of the US financial sector; and Section 4 provides an

analysis of the course of financialization throughout the twentieth century, paying close

attention to the interaction between financial innovations and the regulatory environ-

ment, as well as to the degree of shareholder value orientation in the US economy.

We also scrutinize the commitment of fiscal and monetary policies to full employment

and low-inflation targeting and examine whether the economic system is prone to finan-

cial collapse. The penultimate section (Section 5) summarizes our findings, which formu-

late and support our argument, while the last section (Section 6) concludes.

2 VARIETIES OF FINANCIALIZATION

Financialization is a broad concept with multiple dimensions interacting in the economic,

social, and institutional domain. The most common definition for financialization is the

Have we been here before? US financialization in the twentieth century 35

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one provided by Epstein (2005, p. 1), who refers to the process as ‘the increasing impor-

tance of financial markets, financial motives, financial institutions, and financial elites in

the operation of the economy and its governing institutions, both at the national and

international level.’In a similar vein, Vercelli (2013/2014, p. 5) defines financialization

as ‘the process of evolution which has progressively increased the crucial role of money

in the economy and society shaping the forms of exchange, circulation, distribution, and

accumulation of exchange value.’

Although both definitions are rather broad, they capture the complex nature of

financialization and its links to the underlying institutional structures. However, the

absence of a single criterion that would integrate every dimension of financialization

renders the establishment of relevant evidence a rather challenging task for empirical

researchers (Raza et al. 2016).

The broadness and the importance of financialization led several authors to an investiga-

tion of a rather wide scope regarding the origins of the phenomenon, and triggered a debate

on whether financialization dates centuries back or whether it constitutes a unique charac-

teristic of the current phase of capitalism. Following Sawyer (2013/2014), we identify two

large strands of literature on financialization. The first examines the evolution and the size

of the financial sector and has its origins in both mainstream and heterodox schools of

thought. For instance, Vercelli (2013/2014, p. 21) associates financialization with the

penetration of different forms of money in society through financial innovations, and iden-

tifies a ‘secular tendency towards financialization’that originates in ancient civilizations,

although he recognizes two distinct phases of financialization in the twentieth century.

Mainstream authors tend to highlight the positive consequences of financialization, for

example, in most cases arguing in favor of a long-run positive association between the

magnitude of finance and economic growth, referring to it as ‘financial development’

or ‘financial deepening.’They employ several proxies, such as the size of the economy’s

banking sector, its loan provision capacity, or measure the relative importance of the

financial sector, by going back as far as their data sources allow (see Greenwood and

Scharfstein 2013).

A few notable exceptions performed after the financial crisis of 2008 highlighted

the possibility of a non-linear relationship between financialization and economic

growth, suggesting that a stronger financial sector contributes to growth only up to

a certain threshold while further financialization affects growth adversely (see Law

and Singh 2014). Also, Schularik and Taylor (2012) explored the association between

various leverage structures, money, and the likelihood of financial crises since 1870.

They emphasize the importance of credit on financial instability and argue that the prewar

period presented much less dominance of credit and finance, acknowledging the Great

Depression as an exceptional case in that period.

Similarly, heterodox authors largely examine the destabilizing impact of financia-

lization on the economic and social domain. This literature strand, deriving mainly

from post-Keynesian and Marxist schools of thought, tends to associate financializa-

tion with the era of neoliberalism, which began in the 1980s for most developed

economies, and describes it as a different form of capitalism in which finance has

become more dominant than it previously had been and has penetrated into various

realms of society (Sawyer 2013/2014). Table 1 presents some pertinent studies in

each approach that are employed in this paper.

Next we provide an overview of several of the listed approaches to financialization,

among which is a strand of research that focuses on the submission of the production

process to the principles of financial liquidity. For instance, Palley (2007, p. 2) sug-

gests that financialization is ‘a process whereby financial markets, financial

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institutions, and financial elites gain greater influence over economic policy and econ-

omic outcomes.’This process is characterized by ‘a slight shift in income toward capi-

tal, a change in the composition of payments to capital that has increased the interest

share, and an increase in the financial sector’s share of total profits’(ibid., p. 14). Simi-

larly, Orlean (1999) associates financialization with the restructuring of the internal

organization of the firm, as a response to the increasingly powerful interests of the

stock market.

Table 1 Financialization in the economics literature

Approaches Pertinent studies

Financial development / increasing size of the

financial sector

•King and Levine (1993)

•Rousseau and Wachtel (2000)

•Greenwood and Scharfstein (2013)

•Philippon (2015)

Increasing importance of financial markets /

increasing power of financial elites and rentier

class

•Arrighi (1994)

•Epstein (2001)

•Dumenil and Levy (2002)

•Epstein and Jayadev (2005)

•Palley (2007)

•Dallery (2008)

•Vercelli (2013/2014)

Regimes of accumulation / corporations engaged

in profit-making in the financial sector

•Arrighi (1994)

•Lavoie (1995)

•Boyer (2000)

•Stockhammer (2004)

•Krippner (2005)

•Van Treeck (2008a)

•Hein (2008)

Shareholder value orientation •Lavoie (1995)

•Lazonick and O’Sullivan (2000)

•Aglietta and Breton (2001)

•Cutler and Waine (2001)

•Stockhammer (2004)

•Froud et al. (2006)

•Roberts et al. (2006)

•Dallery (2008)

•Hein (2008)

Financial innovations / debt-led consumption and

distribution

•Hilferding (1910)

•Palley (1994)

•Phillips (1996)

•Dutt (2005)

•Bhaduri, Laski, and Riese (2006)

•Montgomerie (2006)

•Hein and van Treeck (2008)

•Hein (2009)

Low-inflation targeting •Palley (1999)

•Epstein (2001)

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This approach is close to the view that financialization refers to the increasing

power of the rentier class. It derives from the earlier works of Hilferding (1910) and

Lenin (1916) and has been more recently advocated by Dumenil and Levy (2002) and

Epstein and Jayadev (2005). However, this view could be considered as too narrow, as

it focuses solely on the rentier class, while currently the firm has become the ‘battle-

ground’for different agents, including workers, managers, shareholders, and financiers

(Stockhammer 2005/2006).

According to advocates of ‘shareholder value orientation,’the growth pattern of the

firm has shifted from ‘retain and invest’to ‘downsize and distribute’(Lazonick and

O’Sullivan 2000). In particular, shareholders are considered to have a short-term orienta-

tion with respect to firms’profits, as they are interested in higher dividend payments and

higher stock prices, which is in stark contrast to the managers’aim for long-run growth of

the firm.

Higher dividend payments imply lower retained earnings, while higher stock

prices translate to low equity issuance (Hein and van Treeck 2008). Therefore, financing

of investments becomes feasible only through the use of external means, such as higher

loans and increased leverage ratios, which render the firms financially fragile.

Close to the shareholder value orientation norm is the definition provided by

Arrighi (1994) and Krippner (2005), according to which financialization is a pattern

of accumulation, where profit is accrued primarily due to financial activities and

less so due to production or trade activities. Arrighi’s and Krippner’s definitions coin-

cide with the shareholder value orientation view in the fact that productive firms

engage in financial activities, either because the expected profit in the financial market

is higher than the corresponding profit in the goods market, or because the conditions

associated with high dividend payments are so strict that they essentially force firms to

seek additional gains in the financial market. As put by Dallery (2008, p. 492), the

profit rate has become ‘an end in itself.’Nevertheless, as noted by several authors,

the impact of this process has ambiguous results on accumulation, with the institu-

tional setting of the economy defining its ultimate goal and the associated regime

(Stockhammer 2004).

A considerable amount of research has focused on financial innovations as a feature of

financialization. Hilferding (1910) looked at financial derivatives as a tool of capturing

the essence of speculation, which lies solely in the exchange value (Sotiropoulos 2012).

In addition, Phillips (1996) links the intensity of financial innovation to the volume of

trading in the financial markets.

Financial innovation has also been extended to the rise of new consumption

patterns, bound to higher household debt structures with distributional implications

(Palley 1994; Dutt 2005). Hein and Mundt (2013) suggest that stagnating wages are

linked to increased household debt and result in debt-led consumption booms, while

Bhaduri et al. (2006) focus on the wealth effect on consumption, where higher levels

of financial wealth induce households to spend more, given financial deregulation.

1. Interestingly, the shareholder value orientation fits well, and even validates, Minsky’s

financial instability hypothesis (Charles 2016). In short, Minsky advocates that modern capitalist

economies are inherently unstable due to increasing financial fragility being built up during per-

iods of prolonged financial tranquility. As indicated by Lavoie and Seccareccia (2001), the pro-

cyclical debt ratios require that the growth rate of investment is higher than the one of retained

profits, which is not necessarily always the case. In periods of financialization, however, share-

holder value orientation imposes a higher distribution of dividends, reducing thereby retained

profits. In tandem with low interest rates, this reflects the period of tranquility that allowed finan-

cial fragility to build up in the Minksyan interpretation of financial crises (Charles 2016).

2. See, for example, Boyer (2000), Hein (2008), Lavoie (1995), and van Treeck (2008b).

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Lastly, Montgomerie (2006) looks at the introduction of credit cards, which allowed

more financial institutions to enter the credit market.

Financialization varies in terms of pace and form, and one can identify periods of

financialization as well as of de-financialization (Sawyer 2013/2014). However, com-

paring distinct periods of financialization is not an easy task, since ‘there are too many

factors to account for change and capitalism cannot necessarily be characterized by

compartmentalized sub-epochs’(Orhangazi 2008, p. 24). The comparison becomes

even trickier, as different schools of thought in economics consider different indica-

tors, proxies, and definitions to measure financialization.

In identifying distinct phases of financialization in the US economy, we assume that

capitalism is a prerequisite for the process of financialization, as well as a certain

degree of financial development, in the sense that financial instruments become

commonplace.

Hence, we select the beginning of the twentieth century as our starting point, as it

satisfies our methodological assumption: (a) US capitalism had already been in place

for a significant amount of time; and (b) it was a period characterized by a fairly devel-

oped financial sector that gave birth to modern consumer credit (Calder 1999; Feretti

2008). Thereafter, we divide the period into four distinct regimes associated with struc-

tural breaks in the institutional setting of the economy in order to make comparisons in

terms of institutions, policies, and economic outcomes in each period. These structural

changes in capitalism did not occur within the period of a calendar year, rather they

took place gradually. For this reason, developments during the 1930s and 1970s

could only function as proxies of an ongoing change, the effects of which were

observed in late 1940s and early 1980s, respectively.

3 THE IMPORTANCE OF THE US FINANCIAL SECTOR

Our analysis begins by looking at the role of the financial sector in economic activ-

ity, as measured by a number of criteria addressed in the literature. Figure 1 shows

the sum of the profits and wages in the US financial sector as a share of GDP for the

period 1900–2012. The upward trend is clearly evident, even from the early twenti-

eth century, and is only disrupted by the run-up to World War II. Up until 1933, the

increase in the income share of finance more than doubled (111 percent), while the

associated yearly rate of growth, on average, was about 2.5 percent. Between 1934

and World War II the income share of finance indicated a tremendous drop of almost

60 percent and a yearly growth rate of –4 percent, reflecting the impact of the Great

Depression on the financial sector. In the postwar years until 1973, the increase in

the income share of finance was relatively moderate (35 percent), with the yearly growth

3. A number of researchers trace financialization to a period before capitalism, even as far

back as 5000 years (for example, Graeber 2011), by tracing the the evolution of debt instruments

along with the evolution of various social norms such as different modes of exchange, that is,

gifts. Others (for example, the Monthly Review approach) consider financialization as a form

of mature capitalism stemming from the production of an economic surplus which cannot be

absorbed in the sectors of production or consumption. Finance, therefore, facilitates the absorp-

tion of this surplus, thereby preventing the stagnation of the productive sector (see Baran and

Sweezy 1966; Lapavitsas 2013). For the purpose of this paper we follow the broader approach

of Hilferding (1910), who explored the transformation of capitalism which he termed as ‘Finanz-

kapital,’to reflect the increasingly greater role of banks as intermediaries of investment capital to

monopolistic firms.

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rate of the share being equal to 2 percent. Lastly, after 1974, the US economy witnessed an

overall rise in the share of finance by 30 percent with a yearly growth rate of about

1 percent.

The increasing importance of the financial sector is also depicted by the share of

consumption expenditure on financial goods and services, reported in Figure 2. Expen-

diture for financial products in the 1930s was slightly higher than health expenditure

and significantly higher than expenditure for medicine. In recent years, finance-related

expenditure has grown only moderately compared to other types of expenditure,

though the amount is higher in absolute terms.

Another measure of the importance of the financial sector is its level of sophistication,

otherwise known as ‘financial depth.’In the literature, the most common proxy for finan-

cial depth is broad money (M2) or the stock of liquid liabilities (M3) expressed as ratios

of GDP. Figure 3 shows the ratio of broad money over GDP in the US for the period

1900–2010. Despite the high variability throughout most of the century, broad money

over GDP indicates distinct trends across each phase of financialization we explored.

The period 1900–1933 indicated a relatively steady yearly rate of money growth of

around 1 percent. The period between the financial crash and the beginning of World

War II indicated a similar yearly rate of growth, though with extreme fluctuations due

to the higher uncertainty.

During the Golden Age of capitalism (1945–1973) the

Year

1960

0.02

0.04

0.06

0.08

19101900

Income share of finance

1920 1930 1940 1950 1970 1980 1990 2000 2010

Note: The estimations for the income share of finance refer to the value added of the factors of production,

while GDP excludes the spending on defense to adjust for the tremendous effect on spending during World

War II.

Source: Estimations based on Philippon (2015).

Figure 1 Income share of finance in the US (1900–2012)

4. The fluctuations could be explained by high uncertainty, which, as pointed out by Keynes

(1936), leads to the hoarding of money.

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1930 1940

0.00

0.05

0.10

1950 1960 1970

Year

1980 1990 2000 2010

Finance Health Insurance Medicine

Source: Estimations based on Mehra et al. (2011) and Philippon (2015).

Figure 2 Consumption by type of expenditure as a share of GDP for the US economy

(1930–2010)

Year

1960

0.5

0.7

0.8

0.9

19101900

Broad money/GDP

1920 1930 1940 1950 1970 1980 1990 2000 2010

0.6

Source: Estimations based on Schularick and Taylor (2012).

Figure 3 Broad money over GDP for the US economy (1900–2010)

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ratio of broad money to GDP plummeted, with an average yearly decline of 0.6 percent.

The neoliberal phase showed increases in the monetary base of the US economy, espe-

cially after 2000, indicating a yearly growth rate of almost 1 percent, similar to the first

phase of financialization.

These figures provided an overview of the importance of the US financial sector

during the twentieth century, providing a primary indication that finance was already

prominent in the early 1900s, that is, the first period we examine. The following sec-

tion tracks the evolution of financialization in depth, using methodological instruments

derived mainly from the post-Keynesian tradition.

4 EVIDENCE OF FINANCIALIZATION IN THE US ECONOMY IN THE

TWENTIETH CENTURY

In this section we use empirical estimates to assess the relative importance of finance

throughout the twentieth century in the US economy. Similar attempts have been carried

out by several authors. Among them, Krippner (2005) constructed two indicators for

financialization for the post-WWII period. Her first indicator relates to the ratio of profits

of corporations stemming from financial activity, while the second compares the profits

between the financial and the productive sectors. Both of these indexes provide support

for the rise of financialization in the 1970s. However, due to data limitations, the analysis

did not include the interwar period.

Stockhammer (2004), by dividing the share of interest and dividend payments by

the share of profits, empirically tested the hypothesis that short-run investment in

financial instruments is preferred to long-run investment in real capital. His hypothesis

is rejected for Germany and perhaps the UK, but is valid for France and the US. Van

Treeck (2008b) employed a Kaleckian growth rate of investment function for the US

to find that interest and dividend payments have a significant negative impact on accu-

mulation, while Orhangazi (2008) found that on a micro-firm level, financial profits

have a negative impact on large firms but a positive one on small firms, as financial

profits relax the financial constraints.

These attempts vary in methodology and in each sample’s period, yet they reach

similar conclusions. However, none of the above extends its analysis prior to World

War II. In the following sub-section, we attempt to shed some light on issues related

to financialization throughout the twentieth century in the US, with the use of descrip-

tive statistics.

4.1 Fiscal, monetary policy and capital mobility

We commence our analysis by presenting the fiscal and monetary policy framework

that underlined each distinct period under consideration, ultimately determining the

dynamics of the financialization process. In particular, we assess the role of fiscal

policy in promoting full employment and question whether monetary policy has

been accommodative to the financial sector.

Of course the scope and the implementation of fiscal and monetary policies could not

be examined in isolation but rather within a regulatory framework, which facilitates the

attainment of fiscal and monetary targets. For this reason we pay particular attention to

capital mobility as a stimulating factor of the process of financialization. According to

Crotty and Epstein (1996), capital controls have a detrimental impact on the ability of

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the rentiers and financiers to avoid regulation, simultaneously accommodating full

employment and redistributional policies. In this sense, unregulated capital mobility con-

stitutes a further argument in favor of the presence of financialization.

In the first period under examination, the global monetary system was dictated

by the ‘gold standard,’which included movements of gold between central banks,

as a response to international non-financial transactions (Eichengreen and Temin

1997). The aim of the gold standard was to secure price stability and constrain fiscal

expansion, reflecting ‘the mentality and the type of conduct of …economic elites’

(ibid., p. 187).

This condition had a considerable effect on the money supply and the balance sheet

of the central banks. As shown by Godley and Lavoie (2007, ch. 6), the system favored

the exporting countries, since a deficit in the current account of the importing country

implied a reduction of gold reserves of the central bank, which ought to be counter-

balanced by an increase in the Treasury bills held by the central bank. This effect

gave rise to the twin deficit phenomenon in the importing countries. Given that gov-

ernments did not favor budget deficits, another option for rebalancing the current

account was deflating the economy, with the main burden being laid upon wages,

as was the case before World War I (Eichengreen and Temin 1997).

In the US, the lack of a central monetary authority controlled by the government

prior to 1913 allows us to safely assume that the interests of the financial sector

were de facto accommodated. Financial regulation, carried out by the state govern-

ments, could hardly be thought of as effective (Komai and Richardson 2011). In regard

to foreign competition and imposed imbalances by the gold standard framework, the

current-account deficit at the turn of the century was reversed to a surplus in the run-up

to World War I, since the UK’s major supplier of war machinery was the US (Arrighi

1994, p. 278). This tendency was further heightened after World War I when the US

experienced massive inflows of capital due to its strong productivity growth as com-

pared to major European countries, as well as the uncertainty created by the inability of

the latter to honor their debt commitments (Arrighi 1994). Besides, the free movement

of capital under the gold standard regime posed no obstacles on these capital inflows

(Crotty and Epstein 1996).

In this context, the specific conditions of that time favored the US financial sector;

however, in terms of monetary policy, the outcome is ambiguous. Although there are

considerable elements in favor of an accommodative monetary policy, they arguably

do not suffice to reach reliable conclusions. Nevertheless, in regard to fiscal policy,

non-commitment to full employment was clearly evident.

The fiscal policy inaugurated under the leadership of Franklin Roosevelt in 1933

marked a regime change in terms of policy goals, when a set of acts was implemented

to combat recession and unemployment. According to Papadimitriou (2008), these fis-

cal interventions were a close approximation to an employer of last resort policy

schemes, even though they were not sufficiently successful as to render demand for

labor inelastic.

However, fiscal targets were not the only structural change that had taken place.

The dogma of central-bank independence had been abandonded, with the Fed being

5. According to Minsky (1968) a direct job creation policy, such as an employer of last resort

scheme, creates a perfectly inelastic demand for labor, since individuals in the labor force will be

employed regardless of the wage level or the unemployment level. For a thorough discussion on

the theoretical background of the employment of last resort policies, see Kaboub (2007).

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now under the direct control of the government (Epstein and Schor 1995).

More impor-

tantly, capital controls were imposed simultaneously in several economies in search of

an alternative to the already collapsed pegged exchange rates regime policy (Mitchener

and Wandschneider 2013). Therefore we observe a coordinated shift in the framework

under which economic policy was conducted, which, in its several aspects, contrasted

with the process of financialization. As noted by Orhangazi (2008, p. 28), the dominance

of financial capital had come to an end, inaugurating a new stage of capitalism and

bringing forth a new phase of financialization.

The system that emerged under the Bretton Woods Conference agreement ensured

the convertibility of the US dollar to gold, effectively providing stable exchange

rates. The Bretton Woods exchange-rate regime reflected the dominance of the dollar,

by allowing it to function as inconvertible world money and, hence, of the Fed in the

global monetary framework.

In addition, a clear distinction between the interests of productive and financial

capital could be observed, with the former supporting the maintenance of effective

capital controls which clearly opposed the interests of the latter (Ferguson 1984).

The agreement was accompanied by a set of policy goals, in which the maintenance

of full employment had a central role, while the monetary policy was bound to serve the

fiscal (Marglin and Schor 1990). Particularly for the US, we observe a clear detach-

ment from processes related to financialization.

Nevertheless, the collapse of Bretton Woods brought a new political agenda, set

forth by Thatcher and Reagan in the 1980s, that gradually led to central-bank indepen-

dence, zero inflation targeting, free capital movements, and the abandonment of full

employment. The new order in the area of global finance increased the level of

instability in the global financial system, while triggering the growth of international

financial markets (Lapavitsas 2013).

According to Palley (1999, p. 106), central banks were characterized by a clear

deflationary policy bias. Given that the majority of the board members were previously

employed in the financial sector, the institutionalization of central-bank independence

implied the promotion of financial interests by the monetary policy. In addition, Palley

(ibid., p. 120) refers to three regimes of monetary policy in a Phillips curve: (a) high

inflation and low unemployment, which implies high bargaining power for labor;

(b) moderate inflation and unemployment, which boosts aggregate demand in the

short-run, with moderate inflation reflecting sufficient demand; and (c) low inflation

with high unemployment, which favors the financial sector. In this context, zero inflation

policies and central-bank independence promote the interests of the financial sector

against labor and productive capital.

In addition, the 1980s marked a period of abolition of barriers to trade and capital

movement which gained ground after the legally binding General Agreements on Tariff

and Trade (GATT) and North American Free Trade Agreement (NAFTA) treaties, while

fiscal policy was downgraded, given the tax cuts on business and rich households

(Crotty and Epstein 1996). Hence, we observe a new shift of the economic policy fra-

mework towards the opposite direction of the corresponding framework in the 1930s.

Overall, the fiscal and monetary framework of conducting policy experienced dramatic

changes within the twentieth century, where a phase of free-market orientation was suc-

ceeded by a policy regime in which the fiscal instruments had a critical role in economic

6. It should be noted that even though monetary policy was conducted in order to support the

full employment fiscal target, its potentials were not fully exploited (Mitchener and Wandsch-

neider 2013).

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activity. The roots of this change can be traced both in the economic and the political

sphere; however, free-market orientation resurged in the latest phase of financialization,

with its main features in terms of policymaking resembling those in the early 1900s.

4.2 Shareholder value orientation

The shareholder value orientation can be viewed as the pressure on managers to ensure

short-term profits at the expense of firms’long-run growth.

This distribution of cor-

porate profits in favor of the shareholders could potentially have a considerable impact

on the non-financial corporations’(NFCs’) accumulation rate since the lower level of

retained earnings ought not to suffice so as to finance investment in the productive

activity. By using this approach, the similarities between the first and the fourth per-

iods of financialization are striking.

The rise of the joint stock company in the first period provided financial institutions

with the option to control corporations by placing their representatives on corporations’

boards, by holding their stocks, and by the provision of higher loans (Orhangazi 2008,

p. 24). As an immediate result of this condition, financing capitalists were actually

monitoring managers (DeLong 1991). From a similar point of view, the productive

capital was financialized (Pineault 2001, cited in Orhangazi 2008, p. 27), which, in

combination with the developments in the stock market, had a detrimental impact

on the sustainability of the economic system (Keynes 1936, p. 160).

The intense regulation and interventionist policies in the second period paid off in

the third, where the boom in fixed capital formation signified a transition towards a

long-run orientation with respect to firms’growth (Marglin and Schor 1990). Overall,

this period was characterized by financial tranquility, where the pressure on managers,

by financiers and stockholders, was reduced (Orhangazi 2008, p. 30).

However, in the last period, this pressure once again resurged, in a rather ‘formal’

manner, as compared to the first one. For instance, the imposition of the so-called

return-of-equity (ROE) norm was indicative of the ultimate goal of management,

which was to maximize the return value to shareholders.

To proxy the level of shareholder value orientation, we focus on the controversy

that arises between the dividend payments and the internal financing of investments.

Table 2 presents the average shares of net dividend payments and retained earnings

over corporate profits after tax. The first period spans the years 1929 to 1932; there-

fore, the related values are a mere reflection of the irregularity of the Great Depression,

where corporations were distributing sums that exceeded their profits, presumably to

sustain the price of their shares.

However, the blurred depiction of the first period is somewhat restored in view of

the second period, where no dramatic changes in the institutional framework of the

associated variables were observed. Specifically, distributed profits accounted for 87

percent of the overall profits, implying an overwhelming ‘originate and distribute’

orientation (Sawyer 2013/2014).

7. The switch in the mentality of entrepreneurs towards the pursuit of prospective, and even

speculative, profit as compared to the mentality of the entrepreneurs in the late nineteenth century

was already noted by Keynes (1936, p. 159) in the interwar period.

8. Possibly the most notable feature of the shareholder value orientation relates to the increasing

short-run investment in financial assets at the expense of investing in real assets (Stockhammer

2004). Nevertheless, due to data limitations regarding interest payments between sectors, we

were unable to assess this feature for the period under examination.

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This condition is reversed in the third period, with retained earnings accounting for

61 percent of profits, which comes in line with the investment boom in the Golden

Age. However, in the latest period, the pressure on managers is depicted in the higher

share of net dividends, accounting for 53 percent of profits. In advance, the intensity of

the distribution of profits becomes higher in the period close to the Great Recession.

For instance, the average shares of net dividend payments and retained earnings in the

period between 1995 and 2008 were equal to 64 percent and 36 percent, respectively.

Subsequently, we examine corporations’external debt, paying much attention to the

corporate bond and equity issuance. Corporate bond issuance, depicted in Figure 4a,

presents high volatility in the first period of financialization, yet it fluctuates at a

considerably higher level than equity issuance. This pattern is followed in the second

period; in the third, bond issuance stabilizes around 1.5 percent of GDP, to explode in

the latest phase of financialization.

With respect to equity issuance, there was a clear negative trend close to the 1920s,

where an extreme short-term rise took place due to the stock-market rally, as reported

Table 2 Average share of net dividend payments and retained earning to corporate

profits after tax (excluding depreciation allowances) in the US

Dividends Retained earnings

1st period 10.41 –9.39

2nd period 0.87 0.13

3rd period 0.39 0.61

4th period 0.53 0.47

Source: National Income and Product Accounts.

Year

1960 1970

0.00

0.02

0.03

1910 1920 1930 1940 1950 1980 1990 2000 2010

0.01

0.04

Gross equity issuance Gross corp. bond issuance

Source: Estimations based on Baker and Wurgler (2000) and Philippon (2015).

Figure 4a Gross equity issuance and gross corporate bond issuance over GDP for

the US economy (1910–2010)

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in the abrupt increase of the market value, which led to the financial collapse in 1929.

After World War II, equity issuance remained relatively stable, with a small increase in

the average level in the fourth period, while following a cyclical pattern. By contrast,

the market value of equities (see Figure 4b) presented both an upward-sloping trend

and a cyclical pattern, with a widely increasing volatility of the latter. These are

well illustrated in Table 3, which provides an overview of the average bond and equity

issuance and the corresponding volatilities for each period.

Lastly, we focus on mergers and acquisitions, which according to Hein (2009)

reflect the pressure on managers by the use of hostile takeovers. Figure 5 depicts

the value of mergers and acquisitions for the period 1900–2013. The intensity of mer-

ger activity is clearly evident during the 1920s, followed by a period of tranquility after

the financial collapse of the late 1920s. However, after the late 1960s, and especially

around the millennium, a second explosive wave of mergers takes place.

0.00

1.00

1900

Market value of equity

1920 1940 1960

Year

1980 2000

0.50

1.50

Source: Estimations based on Baker and Wurgler (2000) and Philippon (2015).

Figure 4b Market value of equity over GDP for the US economy (1900–2012)

Table 3 Corporate gross bond issuance and gross equity issuance over GDP for the

US economy (1909–2012)

Gross bond issuance over GDP Gross equity issuance over GDP

Mean Volatility Mean Volatility

1st period 2.25% 25.24% 1.09% 62.13%

2nd period 1.62% 38.24% 0.24% 51.17%

3rd period 1.51% 17.59% 0.44% 34.55%

4th period 2.41% 31.10% 0.62% 37.64%

Source: Estimations based on Baker and Wurgler (2000) and Philippon (2015).

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Overall, evaluating shareholder value orientation in a consistent manner is not an

easy task, given the data limitations and the distinct institutional framework in each

period. However, our analysis suggests that common elements are present between

the first and the fourth period under consideration, providing support for the argument

in favor of financialization in the early 1900s.

4.3 Financial regulatory framework, financial innovations, and household credit

4.3.1 Regulatory framework

The banking sector’s involvement in securitization has been extensively regulated since

the mid-nineteenth century. However, a loophole in the associated regulatory framework

allowed national banks to enter the securities market by setting up affiliated trusts (White

1986). Numerous banks had already broadened their operations through their bond

departments; nevertheless, the growing securities market

seemed at that time a source

of considerable profit, in which traditional banks were not allowed to participate (ibid.).

The introduction of affiliates as an institutional partner of the commercial banks allowed

the latter to overcome regulation and gain access to this profitable market.

The number of US national banks engaged in securitization was 11 times higher in

1931 compared to 1921, while the banks that were mostly interested in the bond market

rather than commercial activity more than doubled (Peach 1941). The participation of

Year

1960

0.00

0.10

0.15

19101900

M&As value

1920 1930 1940 1950 1970 1980 1990 2000 2010

0.05

Source: Estimations based on Jovanovic and Rousseau (2005) and Philippon (2015).

Figure 5 Value of mergers and acquisitions in the US (1900–2013)

9. Securitization commenced around 1860, with the introduction of railroad bonds and a

further introduction of mortgage-backed securities in the 1880s (Chancellor 1999). In the

early 1900s the term’s meaning shifted, mostly referring to the use of uninsured deposits as col-

laterals for issuing new loans which in turn were used for the purchase of stocks or bonds. After

the 1970s, issued securities were backing every single debt instrument, a practice not irrelevant

to the financial regulatory framework. Nowadays, the term is mostly employed to refer to com-

plex financial products, especially asset-backed securities such as collateralized debt obligations

(CDOs).

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banks and their affiliates in bond issuing rose from 36.8 percent to 61.8 percent, while

the share of bonds issued by all banks increased from 22 percent to 44.6 percent (US

Senate 1931, cited in White 1986). A contributing factor was also the increased com-

petition for deposits (White 1986). According to Dymski (1991), during the 1920s,

immense competition for deposits increased interest costs, leading banking institutions

on a quest for high return, that is, riskier loans.

The higher leverage structure also served the purchase of stocks, which implies

higher stock prices and, therefore, capital gains. Speculation during the 1920s rendered

the US economy financially fragile. The intensive securitization, with the use of unin-

sured deposits as collateral in combination with the stock-market rally, led to the stock-

market crash in 1929.

The outbreak ofthe Great Depression was followed both by interventionist policies and

legislative initiatives, which aimed to prevent any further deterioration of the economy

and control the potentially destabilizing threats of the financial activity in the productive

sector. The most critical policy response with respect to the functioning of the financial

sector was the Glass–Steagall Act, passed in 1933.

Specifically, policymakers were particularly concerned with the involvement of banks

in the securities market, as they were identified as one of the major causes for the massive

bank failures during the Great Depression (Crawford 2011). For this reason, banks were

offered the choice to engage in either commercial or investment banking activities. The

introduction of the Federal Deposit Insurance Corporation (FDIC) ensured the protection

of depositors from defaults in commercial banks, while the newly established Securities

and Exchange Commission (SEC) regulated financial practices.

The intense regulation, in combination with weak foreign competition, resulted in

financial tranquility, where the pressure on managers by financiers and stockholders

was reduced (Orhangazi 2008, p. 30).

In the first two decades after World War II, the US economy achieved an almost full

employment state, experiencing only minor recessions and modest inflation periods

(Minsky 1986, p. 50), while financial activity was carried out under the control of the

Fed with the use of the Fed’s discount window and open-market operations (ibid., p. 52).

However, the institutional changes in the financial sector and, in general, the attempts

to regulate its functioning lacked a coherent theoretical framework that would allow for

a dynamic and continuous regulating process (Minsky 1986, pp. 43–45). This argument

is verified by the fact that during the 1960s, a period characterized by strong invest-

ment growth, financial innovation in the money market –that is, by introducing the

certificate of deposits, real estate investment trusts (REITs), and the commercial

paper –rendered the Fed’s controlling instruments ineffective, since the latter were

not adapted to the new financial environment.

More importantly, the structure of debt had a critical role in the period at hand. As

a follow-up to the Great Depression, government debt started rising and even sur-

passed private debt during World War II, reaching a record level of 113 percent of

GDP (see Figure 6). Indeed, it was the first time that public debt penetrated into

firms’and households’balance sheets as a financial asset (Minsky 1986, pp. 37–38).

A seemingly financially tranquil period was disrupted by a wave of financial episodes.

Minsky (1986, pp. 97–101) described in detail the developments in the financial sector

that led to the credit crunch of 1966 and the liquidity squeeze in 1969–1970. Focusing

particularly on the money market, financial institutions collateralized the liability side of

their balance sheet for the first time after World War II; this resulted in high levels of

instability in the financial sector and reduced financing of tangible capital investments.

Also, rising public debt in the hands of the public and other financial institutions, along

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with an increasing rate of financial innovations, suggests a deeply rooted transformation

that consequently resulted in a debt-oriented financial environment during the neoliberal

era of financialization (fourth period).

In 1975, the Securities Amendment Acts were passed in order to set up the National

Market and the National Clearing System, aimed at enhancing liquidity and competition,

yet they failed to deliver results (Komai and Richardson 2011). In the same year, the

fixed minimum commission rates were repealed as anti-competitive regulation.

In the 1980s, a large-scale deregulation process took place, with the Glass–Steagall

Act being gradually relaxed by the Fed

and eventually repealed in 1996

(Crawford

2011). At the same time, US financial institutions, keen on becoming aggressively

competitive on a global scale, lobbied for loose regulation (Komai and Richardson

2011). Finally, the reform of FDIC to FDICIA (Federal Deposit Insurance Corporation

Improvement Act), in 1991, institutionalized the ‘too big to fail’doctrine (ibid.). The

remaining regulations were carried out on the basis of addressing moral hazard and

information asymmetries.

4.3.2 Financial innovations’growth rate

Financial innovations stand at the core of financialization, as they allow the financial

sector to overcome regulatory barriers and therefore increase its relative economic

power (Bhaduri 2011). Until recently, numerous authors perceived them as a

Year

1960

0.0

2.0

19101900 1920 1930 1940 1950 1970 1980 1990 2000 2010

2.5

0.5

1.0

1.5

Total debt Private debt Government debt

Source: Estimations based on Philippon (2015).

Figure 6 Total debt-to-GDP, private-debt-to-GDP, and government-debt-to-GDP

for the US economy (1900–2012)

10. According to Crawford (2011) the Fed reinterpreted the Act in the 1980s, allowing com-

mercial banks to have 5 percent gains from holding securities. The threshold was further relaxed

to 10 percent by the end of the decade and in 1996 the margin was set to 25 percent.

11. Officially the Glass–Steagall Act was abandoned in 1998.

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contributor to economic development and prosperity (Bernstein 1996), as they

‘increase risk sharing, lower transaction costs, and reduce information and agency

costs’(Merton and Perold 1997, p. 108). Only a few scholars highlighted the other

side of the coin. One of them was Hyman Minsky (1990, p. 60), who stressed that

‘economies with financial innovations that are driven by market prospects are structu-

rally conducive to booms and busts.’

The quantitative assessment of the role of financial innovation as a contributing fac-

tor to the financialization process is a complicated task, as it is not possible to point out

which innovation contributed to the process to what extent. Figure 7 represents the

share of financial patents registered in the US economy as a share of all registered

patents in the country for most of the twentieth century as a proxy of the relative

share of growth of financial innovations.

It is evident that the trend of new financial patents is steadily increasing throughout this

period, representing what Minsky (1986, p. 111) described as an internal process of a

capitalist system with a sophisticated financial sector. This steady rate of growth in

financial innovation suggests that the links between financial innovation and financiali-

zation should not be rooted in technological improvement per se. Instead, the institu-

tional and policy forces, which allow the financial innovations to be employed by the

financial institutions, should be more important. To assess the contribution of financial

innovations in the expansion of the financial sector’s role in each period, we track pre-

ceding innovations moving in tandem with regulatory developments in the domain of

finance throughout the twentieth century.

4.3.3 Household indebtedness

Today, perhaps the most notable example of financial innovations affecting the macro-

economic environment is household credit. For instance, Palley (2007, p. 24) suggests that:

Borrowing is also supported by steady financial innovation that ensures a flow of new finan-

cial products allowing increased leverage and widening the range of assets that can be

Year

1960

0.012

0.022

19101900 1920 1930

Share of patents and inventions in finance

1940 1950 1970 1980 1990 2000 2010

0.014

0.018

0.020

0.016

Source: Estimations based on Jovanovic and Rousseau (2005).

Figure 7 Patents on inventions and trademarks in finance as a share of all patents

registered in the US (1900–1996)

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collateralized. Additionally, credit standards have been lowered in recent years, which has

made credit even more easily available to households, firms, and financial investors.

Figure 8 depicts the fluctuations in household debt as a percentage of income through-

out the twentieth century. Household debt peaked at almost 60 percent of GDP in the

early 1930s (the first period of financialization), a record that was not surpassed until

the mid 1980s. Later on, the accumulation of secured debt progressed sharply and

reached a peak at the origins of the subprime crisis, when mortgage borrowing col-

lapsed along with real-estate prices. Interestingly, the level of household indebtedness

comoves largely with inequality, another outcome of finanicalization.

From a

demand viewpoint and in a context of stagnant real wages, this result might either

be because households tend to preserve demand at stable levels (see Iacoviello

2008; Krueger and Perri 2006), or because low- and middle-class households get

indebted to imitate the consumption norms of the upper classes

(see Christen and

Morgan 2005; van Treeck 2014). A similar conclusion is reached by Kapeller and

Schütz (2014), according to whom the need of lower-income households to preserve

Time

1960

0.8

1910 1920 1930

Household debt to GDP

Income inequality

1940 1950 1970 1980 1990 2000 2010

1.5

2.0

2.5

3.0

3.5

1.0

0.2

0.6

0.4

Household debt Inequality

Source: Estimations based on Philippon (2015) and The World Top Income Database.

Figure 8 Household debt to GDP and income inequality for the US economy

(1912–2012)

12. For a discussion on the links between financialization and inequality, see for example Lin

and Tomaskovic-Devey (2013).

13. Nevertheless, it has been pointed out that the association between income inequality and

household debt is not necessarily symmetric in the case of the twentieth-century US (Fasianos

et al. 2017).

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consumption at subsistence level induces their level of indebtedness. In this sense,

income inequality ultimately leads to financial fragility.

It was the early 1900s that gave birth to what is known today as modern ‘consumer

credit.’As reported by Feretti (2008, p. 17), two innovations in consumer credit, iden-

tified during the 1920s, were the following: ‘a peculiar method for credit based on the

instalment plan, where money is lent or a good is sold on the condition that the bor-

rower or purchaser repays the loan with fixed payments to be made at regular times

over a specified period’and ‘an array of particular sources of credit other than the tra-

ditional historic pawnbrokers and/or illegal money lenders.’

The levels of household credit in the economy were also noteworthy in the early

1930s. As Calder (1999, p. 18) indicates:

American household finance was remade after 1915 [leading to] rising level[s] of consumer debt

…. [P]ersonal debt increased at rates well ahead of the rate of population growth ….From

1920 to 1929, the volume of consumer debt soared upward 131 percent, from $3.3 billion to

$7.6 billion outstanding. The Depression interrupted this rising curve, but by 1937 consumer

debt reached its pre-Depression levels and continued rising upwards, until it was halted by

credit controls during World War II.

However, in contrast to today’s consumer borrowing, debt was hardly used for con-

sumption of non-essential things or goods of minimum value. Instead, it was primar-

ily used for purchases of assets with increasing value or with productive purposes

(Feretti 2008).

Possibly the most notable innovation boosting household credit is the promotion

of risk management techniques. Asymmetric information (moral hazard and adverse

selection) in the credit market reduces lenders’ability to estimate the capacity of

borrowers to service their debts. Indeed, the primary aim of risk management is to

handle this risk of default (Langley 2008). As such, risk management allows for

greater credit expansion with supposedly minimal risk to the resilience of the finan-

cial system.

Until the third period under examination, the risks involved in the process of col-

lateralized and consumer borrowing were monitored primarily through relational

and ‘face-to-face practices’(Leyshon and Thrift 1999). Contemporary techniques

in risk management (for example, credit reporting and scoring) removed the physical

proximity hitherto required for managing such uncertainties (Guseva and Rona-Tas

2001; Marron 2007). A typical example of higher sophistication in the credit market

is the launch of risk-based pricing, in other words, the tailoring of the loan’spriceto

a borrower’s probability of default, with the borrower’s probability being estimated

upon their past credit records. Lastly, advancements in marketing techniques for

advertising financial products increased the customer base of banks and other finan-

cial institutions (Bertrand et al. 2010).

Indeed, financial liberalization played a large role in unlocking the landscape so that

financial innovations could come into play. A direct effect of financial liberalization

was the large-scale removal of credit constraints for a big portion of households.

The process of removing credit constraints was termed the ‘democratization of credit’

by former Federal Reserve Governor Lawrence Lindsey in 1997, as it reflects the

increasingly wider access to credit by middle- and lower-income households. While

the extent to which credit constraints are binding varies over time, across countries,

and across financial institutions within each country, their presence has a considerable

effect on the composition and magnitude of debt holdings on balance sheets of house-

holds (Kent et al. 2007).

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4.4 Leverage structures and financial crises

Before taking a final step in the assessment of the financialization process, we examine

a last condition for the aggregate economy, related to the leverage structures of banks

and corporations. In particular, we follow the notion provided by the two most distin-

guished authors of the Old Institutionalist School, namely Veblen (1904) and Minsky

(1986), who both highlighted the inner tendency of the macrofinancial system towards

financial fragility, due to the imposition of increasing leverage, which renders the eco-

nomic system prone to financial collapse (Argitis 2013).

Figures 9a and 9b present the leverage ratios of the non-financial corporations and

the banking sector. It is evident that both sectors follow a similar pattern in terms of

building leverage structures: enormous debt in the first period, equally massive

deleveraging in the second, upwards tendency of leverage in the third that continues

in the last period, reaching unprecedented levels and thus dramatically increasing

financial fragility.

Figure 10 presents the frequency of financial crises between 1870 and 2012.

Although it refers to financial crises on a global scale, the importance of the US

financial sector in the global economy during the twentieth century is such that

most of the important financial episodes were domestic. In particular, the most

severe financial crises (those of 1906–1907, 1929, and 2007–2008) occurred in

the US. No crises were reported in the third period under examination (1945–

1973), as the liquidity levels were sufficient and the leverage was low. Indeed the

low-leverage period, evident in Figures 9a and 9b, coincides with financial tranqui-

lity, and is located mainly in the Golden Age, thus providing evidence for Veblen’s

and Minsky’s analyses. Nevertheless, in the period of early financialization and the

period of re-financialization, banks and NFCs increased their leverage, and crises are

much more frequent.

Non-financial corporations

1925

0.15

0.20

0.25

0.30

0.35

1945 1965

Year

1985

Note: We estimate the non-financial corporations’leverage ratio as NFCs’short- and long-term debt over

capital stock, with all variables expressed in real terms.

Source: Estimations based on Schularick and Taylor (2012).

Figure 9a Leverage ratio of US non-financial corporations (1926–1996)

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0.2

1900

Banks

0.4

0.6

0.8

1.0

1920 1940

Year

1960 1980 2000

Note: To measure the leverage ratio of the US banking setor, we follow Schularick and Taylor (2012)

using the ratio of bank loans over money. Bank loans are defined as the end-of-year amount of outstanding

domestic currency lending by domestic banks to domestic households and non-financial corporations.

Money is defined as broad money.

Source: Estimations based on Schularick and Taylor (2012).

Figure 9b Leverage ratio of the US banking sector (1900–2010)

Year

1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Frequency of financial crises

Source: Estimations based on Bordo et al. (2001) and Schularick and Taylor (2012).

Figure 10 Frequency of global financial crises (1878–2012)

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5 ASSESSING THE FINANCIALIZATION PROCESS IN THE US ECONOMY

DURING THE TWENTIETH CENTURY

In this section, we evaluate the preceding analysis to formulate an argument in favor of

or against the existence of financialization in the periods under consideration. Table 4

presents our findings. Each row denotes a characteristic of financialization and each

column the corresponding period. Note that the bar in the cells indicates that the exam-

ination of data and characteristics could not provide conclusive results.

It is straightforward from the table that during the first period under consideration

key features of financialization (such as the dominance of the financial sector over the

economic activity, financial deregulation, shareholder value orientation, and household

indebtedness with distributional effects) were already in place, thus justifying the

notion of a period of early financialization. Economic policy orientation also appeared

to stimulate the process of financialization, even though the results for monetary policy

are only suggestive and not conclusive.

In the third period, the conditions are clearly reversed, with most features highlight-

ing the ongoing process of de-financialization. The end of the Golden Age initiated a

second wave of financialization in the final period under consideration, in a more con-

crete form, as is evidenced in the last column of Table 4.

6 CONCLUDING REMARKS

This paper explored the process of financialization throughout the last century and pro-

vided evidence of its deep roots at the beginning of the twentieth century. In order to

carry out our analysis, we divided our sample period into four distinct phases: the

first period ends with the initiation of the New Deal in 1933, the second covers the

remainder of the 1930s until the outbreak of World War II, the third is the Golden

Age (1945–1973), and the fourth refers to the neoliberal phase of capitalism, following

the oil crisis of 1973 and the beginning of financial deregulation in the US.

Table 4 Evidence for financialization

1st period 2nd period 3rd period 4th period

(1900–33) (1934–40) (1945–73) (1974–2010)

Dominance of financial sector Yes No No Yes

Income share/size of the

financial sector

Moderate high Moderate low Moderate low High

Financial regulation No Yes Yes No

Shareholder value orientation Yes –No Yes

Intensity of financial

innovation

Moderate Moderate High High

Household indebtedness Moderate high Low Moderate High

Income inequality High Low Low High

Commitment to full

employment

No Yes Yes No

Low inflation targeting ––No Yes

Free capital mobility Yes No No Yes

Leverage structures/inclina-

tion to financial crises

High Low Low High

56 Review of Keynesian Economics, Vol. 6 No. 1

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The resemblance in the conditions between the first and the fourth period is remark-

able. In spite of institutional and formal differences, the presence of primary indicators

of financialization, as discussed in this paper, satisfy our main hypothesis, which is

that the first period under consideration indeed constitutes an early form of financia-

lization. The second period can be viewed as a transitional phase to de-financialization,

which occurred in the third period under our consideration.

We have shown that the income share of the financial sector rises considerably in the first

and the last period, while being significantly lower in the second and third periods. There-

fore, it is not an exaggeration to conclude that the period starting from 1973 till the global

financial crisis of 2008 could be termed as a period of ‘re-financialization,’considering the

large resemblance to the 1920s in terms of the importance of finance in the economy.

Pressure on managers to attain short-term profits, contrary to the firms’long-run

growth, was evident both at the beginning of the twentieth century and in the modern

period. This condition has a severe impact on the financial stability of the economic sys-

tem, since it reduces fixed capital formation or pushes the leverage ratios upwards, indu-

cing financial fragility.

It seems also that financial innovations, which historically constitute a means for

the financial system to avoid regulation and thus a significant feature of financialization,

do not work in a vacuum. We showed that the rate of growth of financial patents and innova-

tions grew at a steady pace throughout the twentieth century. Of the utmost importance, how-

ever, is whether the implemented regulatory framework allows financial intermediaries to

apply new technologies in order to skirt regulation. In line with Minsky (1986), we suggest

that the adoption of new technologies in finance ought to be backed by an institutional

regulatory framework, and properly addressedbypromotingregulationasadynamicpro-

cess. The empirical investigation of this relationship serves as a topic for further research.

There are also significant discrepancies in terms of economic policy between the

four periods under examination. For example, the full employment goal was a key

priority for policymakers in the second and third periods. Additionally, the dominance

of the productive sector and the strengthening of unions are also key features of the

third period of de-financialization. In advance, monetary policy conducted under a

financialized regime, as is the case in the fourth period, emphasizes the interests of

the financial sector, while neglecting those of the productive sector and the working

class. In full contrast, monetary policy in the second and the third period aimed to sup-

port fiscal stimulus, and therefore enhanced aggregate demand.

Lastly, the first and especially the last period of financialization shows tremendous

rises in the levels of household credit, while in the second and third periods the levels

are moderate. Apart from the purely economic outcomes, such as households ending

up indebted and financially fragile, this issue becomes critical when considered as an

infringement on the cultural setting of the society, with households being bound to the

interests of the financial sector. Further, more vast accumulation of household debt

leads to financial booms and busts, such as the ones the US witnessed in 2007. There-

fore, the need for regulation is evident in this domain as well.

This paper shows that financialization is not a modern facet of neoliberal capitalism, but

a multi-dimensional process present throughout the twentieth century. Considering the

large resemblances with the 1920s in terms of the importance of finance in the economy,

it is not an exaggeration to conclude that the period running from 1973 until the global

financial crisis of 2008 could be termed as a period of ‘re- financialization.’Economic his-

tory teaches us that the destabilizing consequences of the financialization process can

only be moderated by appropriate policies and institutional changes, possibly similar to

those implemented during the Golden Age of Capitalism.

Have we been here before? US financialization in the twentieth century 57

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Urban Expansion and Food Security in New Zealand: The Collapse of Local Horticulture

Book

Jun 2023

Benjamin Felix Richardson

The effect of dividend payouts on firm-level R&D

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Oct 2022

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Monetary policy is inevitably operated by a central bank in the context of a specific banking and financial system and responding to the economic issues of the time. Financialisation in the present era, broadly the past four decades, has not only involved the continuing growth of the financial sector but also a more market-orientated banking system, development of securitisation, and growth of shadow banking. The past decade has also seen the adoption of quantitative easing (QE) and other forms of ‘unconventional’ monetary policy. This chapter explores the implications of aspects of financialisation for the transmission mechanisms of monetary policy and the objectives of monetary policy. It also considers the future of inflation targeting in light of experience, and financial stability as a key objective of monetary policy. The challenges of climate change and the possible implications for monetary policy are also considered.

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Corporate financialization (CF) comprises a major subfield of financialization studies centered on the belief that significant changes in corporate governance and business models have been driven by financial imperatives, profoundly impacting investment habits, labor policies, organizational practices, and the distribution of revenues. Experiencing explosive growth in recent years, the field has become mired in conceptual ambiguity, mirroring problems with financialization studies as a whole. While seeking to restore some conceptual clarity and clearly delineate the boundaries of the concept, this paper attempts a comprehensive review of empirical work on CF. At the core of the field we identify four sub-fields, each addressing distinct aspects of the way business models have become financialized under the influence of shareholder value principles. Our dissection of the literature shows, however, that these theories mostly remain under substantiated. The connection of financialization strategies to key outcomes of interest, like declining investment and rising inequality, remains nebulous in most cases. Beyond this, we identify key weaknesses in the way shareholder value orientation-the causal lynch pin of CF accounts-has been theorized. The field as a whole has paid insufficient attention to the variegated and uneven nature of the shareholder revolution, which has prevented a single uniform set of governance principles from diffusing. The critique concludes with a call for caution and nuance in employing the corporate financialization framework, emphasizing its role as just one part of a multifaceted transformation within capitalism. Alongside it, other pivotal structural forces, such as intangibilization, monopolization, and globalization, demand equal attention. The overarching aim of this review is to urge greater clarity, conceptual discipline, and a holistic perspective in future investigations into the dynamics of financialized capitalism.

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Aug 2022

The literature on financialization tends to overemphasize the increasing size of the financial sector vis-á-vis the rest of the non-financial business sector, usually excluding from the analysis the inter-sectoral relationships between firms. Moreover, few studies have utilized the analytical tools of network theory and the notion of centrality, despite the fact that they conceptualize financialization as the rising centrality of the financial sector. This paper attempts to address these issues and explore the evolution of financialization in the US economy before and after the subprime crisis, investigating the changes in the position of the financial sector. Informed by financial geography and the framework of Global Financial Networks (GFN), we also shed light on the impacts of financialization on those advanced business services sectors that complement financial activity, such as accounting, law, business consulting, and other business services firms. Empirically, we estimate backward and forward inter-sectoral linkages, clustering coefficients, and measures of centrality, utilizing a long time-series of input–output tables at a highly disaggregated level, in order to study the inter-sectoral evolution of financialization in the US.

Capital productivity and the decreasing wage share in the United States: a Keynesian Approach

Article

Nov 2022

We argue that in the US there is a causal relationship running unidirectionally from negative shocks in capital productivity to negative variations in the wage share. We sustain that, faced with a capital productivity decrease, the US firm sector pushes wages down to maximize the rate of profit. Through asymmetric SVAR techniques that are robust to endogeneity and structural breaks; we show that decreases in capital productivity unidirectionally cause decreases in the wage share. We offer some possible explanations for that.

Exploring the link between household debt and income inequality: an asymmetric approach

Article

Full-text available

Jul 2016

We investigate the relationship between household debt and income inequality in the USA, allowing for asymmetry, using data over the period 1913–2008. We find evidence of an asymmetric cointegration between household debt and inequality for different regimes. Our results indicate household debt only responds to positive changes in income inequality, while there is no evidence of falling inequality significantly affecting household debt. The presence of this asymmetry provides further empirical insights into the emerging literature on household debt and inequality.

Conspicuous Consumption, Consumer Debt and Economic Growth

Chapter

Jul 2019

Amitava Krishna Dutt

The profit rate: Where and how much did it fall? Did it recover? (USA 1948-2000)

Article

Jan 2002

The decline of the profit rate since World War II, up to the early 1980s, is now widely acknowledged, and a new upward trend has been identified. This study presents new computations of profit rates using a definition like that used by Marx in Volume III of Capital, where profits correspond to total surplus-value, as well as a definition of the rate of profit that impacts individual firms, taking account of interest, taxes, and inventories. We show that both the level and trend of a specific group of industries (such as Railroads), called Highly Capital Intensive Industries, whose capital-labor ratio is very large, are totally different from that of other industries. (Their profit rate is very low and did not decline.) When these industries are removed from the data set, the downward trend of the profit rate and the limited recovery can be more clearly observed. Overall, between 1948 and 1982, the profit rate was divided by a coefficient ranging between 2 and 7, depending on the sector and definition of the profit rate. The profit rate in 2000 is still only half of its value in 1948. Finally, we show that the decline of the productivity of capital was the main factor in the fall of the profit rate, though the decline of the share of profits also contributed to this evolution.

Maximising shareholder value: A new ideology for corporate governance

Article

Jan 2002

Is the crisis problem growing more severe

Article

Jan 2001

Two thorns of experience: financialisation in Iceland and Ireland

Article

Jul 2016

We explain the 2008 crisis in Iceland and Ireland with an emphasis on the role financialisation played in destabilising these countries’ economies. The two small open economies share similarities in that both countries had capital inflows before the crisis, ending with a sudden stop. However, the mechanisms of the crisis, which induced the capital flows, the factors that influenced them and their effects on the real economy differed due to differences in currency regimes and the response to the crises. We investigate the link between financialisation and the transmission channels of financialisation on the macroeconomy, using ARDL methodology. Finally, we suggest policy prescriptions to limit the scale and scope of similar crises in the future while highlighting the institutional differences between the two economies.

Financialization, the Financial and Economic Crisis, and the Requirements and Potentials for Wage-led Recovery

Chapter

Jan 2013

In 2008/09 the world economy was hit by a decline in real GDP, the scale of which had not been seen for generations. The so-called ‘Great Recession’ started with the collapse of the sub prime mortgage market in the United States in summer 2007, and it gained momentum following the collapse of Lehman Brothers in September 2008. Under the conditions of deregulated and liberalized international financial markets, the financial and real crisis spread rapidly across the world, reaching another climax with the euro crisis which began in 2010. Although recovery has already started in late 2009 — albeit with different speeds in different countries — the world economy is far from having overcome the causes of the crisis which are rooted in long-run developments since the early 1980s. We hold that the severity of the present crisis is due to the following medium- to long-run developments, in particular in the advanced capitalist economies but also affecting the emerging market economies: the inefficient regulation of financial markets; an increasing inequality in the distribution of income; and rising imbalances at the global (and at the euro area) level.1 These developments have been dominated by the policies aimed at the deregulation of labour markets, the reduction of the level of government intervention in the market economy and of government demand management, the redistribution of income from (lower) wages to profits and top management salaries, and the deregulation and liberalization of national and international financial markets.

Debt: The First 5000 Years

Book

Jul 2011

David Graeber

Every economics textbook says the same thing: Money was invented to replace onerous and complicated barter systems—to relieve ancient people from having to haul their goods to market. The problem with this version of history? There’s not a shred of evidence to support it. Here anthropologist David Graeber presents a stunning reversal of conventional wisdom. He shows that 5,000 years ago, during the beginning of the agrarian empires, humans have used elaborate credit systems. It is in this era, Graeber shows, that we also first encounter a society divided into debtors and creditors. With the passage of time, however, virtual credit money was replaced by gold and silver coins—and the system as a whole began to decline. Interest rates spiked and the indebted became slaves. And the system perpetuated itself with tremendously violent consequences, with only the rare intervention of kings and churches keeping the system from spiraling out of control. Debt: The First 5,000 Years is a fascinating chronicle of this little known history—as well as how it has defined human history, and what it means for the credit crisis of the present day and the future of our economy.

Debt, Aggregate Demand, and The Business Cycle: an Analysis in the Spirit of Kaldor and Minsky

Article

Mar 1994

Thomas I. Palley

Financialization and the US Economy

Article

Jan 2008

Ö. Orhangazi

Özgür Orhangazi brings together a comprehensive analysis of financialization in the US economy that encompasses the historical, theoretical, and empirical sides of the issues. He explores the origins and consequences of the dramatic rise of financial markets in the US economy and focuses on the impacts of this process of 'financialization' on the operations of the non-financial corporate sector.

Have we been here before? Phases of financialization within the twentieth century in the US

Abstract and Figures

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