Financialization in a Long-Run Perspective

This paper argues that there is a secular tendency toward financialization that is intrinsic in the development of market relations. The driving force of this evolutionary process is rooted in a fairly continuous flow of financial innovations meant to remove the existing constraints to the flexibility of economic transactions. For example, according to received wisdom, the adoption of money as a medium of exchange has removed the strictures of the double coincidence of wants, while the modern forms of credit have been developed to relax the cash-in-advance constraint on economic transactions. As these examples suggest, financial innovations aim to extend the set of exchange options in time, space, and contents for the decision makers who introduce them. Financial innovations are adopted because, ceteris paribus, a larger option set is positively correlated with higher expected returns and pay-off opportunities. Their systemic effects, however, may have negative implications such as financial instability, underinvestment in the real sector, unemployment, and stagnation. When the negative consequences accumulate beyond a tolerable threshold, the remedy has to be sought in stricter rules of self-regulation, or rather of regulation by law, or even in severe measures of financial repression. The fact that this has not happened since the recent deep crisis has further enhanced the unsustainability of the current process of financialization.