Financialisation

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Context: 

Chief Economic Adviser (CEA) has cautioned that financialisation, the dominance of the role of financial markets in public policy, might distort macroeconomic outcomes.

What is Financialization:

• Financialization is a process that describes the growing influence of financial markets, institutions, and motives on a country's economy. It can affect the economy at both the macro and micro levels. 
• The record profitability of the Indian financial sector and high levels of market capitalisation, or the ratio of market capitalisation to GDP, gave rise to financialisation.

Impacts of financialisation:

Greater Profits at Less Expense: 

• Since the 1980s, financial institutions have prioritised short-term financial returns over long-term goals like technology and product development.
• The stock market’s growth favoured profit from financial instruments over investments in engineering and manufacturing.

Loss of Manufacturing Jobs: 

• Financial instruments, which offered quick returns, led to investments in software rather than in physical manufacturing. 

• This shift contributed to the decline of U.S. manufacturing as companies increasingly outsourced production to cheaper overseas facilities. 

Short-Term Focus: 

Prioritising short-term profits disrupts long-term goals and product quality.

Unproductive Capitalism: 

Financialization may lead to profits from financial manipulation rather than production. 

Market Dominance: 

Large firms dominate due to their ability to operate effectively in financial markets, disadvantaged smaller firms. 

Sector-Specific Impacts: 

• Housing: Financialization has turned housing into an investment vehicle, rather than focusing on its role as a basic social need. 
• Education: Higher education is increasingly valued for financial returns, with rising tuition costs and greater reliance on private funding rather than state support.

Historical Context: 

• Financialization in the U.S. intensified after the Bretton Woods system ended in the early 1970s, which had previously controlled currency stability and limited speculation. 
• The rise of neoliberalism and free-market principles further accelerated financialization.
• LPG reforms in India increased the investment in the services sector which further provided a boost to investment in the stock market.

Characteristics of Financialization: 

Soaring Value of Financial Assets: 

Global financial assets grew from $56 trillion in 1990 to $219 trillion by 2010. India’s stock market capitalisation was about 140% of the GDP in 2023.

Increased Liquidity: 

Deregulation and advances in financial technology have expanded liquidity, even post-2008 recession. 

Securitization: 

There’s been a massive rise in securitization, where financial assets are bundled and sold to investors. Index funds and mutual funds are one such example.

Inflation: 

Increased liquidity and borrowing have contributed to inflation, which affected consumers' purchasing power and increased demand for financial services. 

More Investors: 

More people are investing due to easier access to financial markets through apps and the internet. 

Important articles for reference 

https://www.iasgyan.in/daily-current-affairs/index-fund#:~:text=An%20index%20fund%20is%20a,what%20happens%20in%20the%20market.

https://www.iasgyan.in/daily-current-affairs/exchange-traded-fund

https://www.iasgyan.in/daily-current-affairs/record-inflows-into-indias-equity-mutual-funds

https://www.iasgyan.in/daily-current-affairs/stock-market-regulation-in-india

https://www.iasgyan.in/daily-current-affairs/lpg-reforms

Sources

https://www.thehindu.com/incoming/cea-warns-of-financialisation-of-capital-markets/article68597228.ece

https://www.investopedia.com/terms/f/financialization.asp