Financialization Overload

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Financialization Overload

There’s no question that the financial industry is critical to the strength of the economy. Without it, many businesses wouldn’t be able to raise the capital they need to hire more employees, invest in new technologies, or expand into new markets.

The problem is that the financial industry is growing in size and influence, and this is reshaping the priorities of businesses, forcing CEOs to focus on short-term profits instead of creating long-term value. According to an International Monetary Fund (IMF) study, once the financial sector becomes too large, it actually inhibits growth and increases volatility.

How large is too large? The IMF’s study found that the economy is damaged when private-sector credit reaches 80 percent to 100 percent of GDP.1 In 2012, private-sector credit was 183.8 percent of GDP.

The growth of the financial sector as a share of gross domestic product is called “financialization.” Between 1950 and 2006, financial services as a share of GDP increased from 2.8 percent to 8.3 percent.2 That’s an increase of nearly 300 percent.

Profits in the finance and insurance industries are also outpacing the rest of the economy, growing from 24 percent of the profits of all other sectors combined in 1970, to 37 percent in 2013.3

This doesn’t even include the financial units of otherwise nonfinancial companies. Throughout the 20th century, Ford and GE were classic manufacturing companies, mass-producing automobiles and appliances, respectively. By the early 21st century, however, Ford was generating more profit on the loans its customers used to buy its cars than on the cars themselves, and GE Capital accounted for roughly 50 percent of GE’s total earnings.4

When nonfinancial corporations are included, the total value of U.S. financial assets was five times the country’s GDP in 1980. By 2007, it had doubled to ten times GDP.

The reason all of this is cause for alarm is that there is a historical pattern in which excessive financialization is followed by economic collapse. This happened to Spain in the 14th century, to the Netherlands in the late 18th century, and to Britain in the late 19th and early 20th centuries.5

Just as with those cases, in the U.S. today the preferred path to building wealth is to “make money out of money,” instead of producing real goods and services...

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