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.

Securitization is the process in which certain types of assets are pooled so that they can be repackaged into interest-bearing securities.  The interest and principal payments from the assets are passed through to the purchasers of the securities. For further reading refer:  https://www.iasgyan.in/daily-current-affairs/sarfaesi-act#:~:text=Securitization%20and%20Reconstruction%20of%20Financial,financial%20institutions%20from%20incurring%20losses.

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

PRACTICE QUESTION Q) Economists have cautioned that financialisation might distort the macroeconomic outcomes in India. In this context analyse how financialisation could have significant repercussions on the Indian economy and what are ways to manage these issues. ( 250 words)