Interview with Gerald Epstein

Gerald A. Epstein, PERI’s co-director, is the editor of a new volume, Financialization and the World Economy, available from Edward Elgar Publishing. PERI Research Assistant Adam Hersh conducted this interview.

AH: What is financialization? What does the term mean and from where does it come?

Gerald Epstein: By financialization, we mean the increasing importance of financial markets, financial motives and financial actors in the operations of the economy. This is but one of many different meanings that scholars ascribe to this relatively new term. The origins of the term are obscure, though it is being used with increasing frequency because of its obvious heightened relevance in modern capitalist economies. Indeed, in the last few months, a new international network has sprung up to study financialization.

AH: What evidence do we see that financialization is increasing? How much is financialization the result of innate market forces versus explicit political or policy choices?

GE: The process of financialization can be seen in a great number of ways. Evidence cited in the book include: data on dramatically increased ratios of credit to GDP in most developed and semi-industrialized economies; the increased quantity of trading in financial assets such as foreign currency exchange, where trading volumes are now above US$ 1 trillion a day; increased shares of income going to holders of financial assets and those owning financial firms in many developed countries; and the increased importance of financial motives in the governance of non-financial corporations.

We can’t really know definitively how much financialization results, respectively, from organic market processes or politics and policy. Policy definitely has been very permissive, and indeed, encouraging of financialization. But there are important technological and other structural factors that have encouraged it as well, including the development of communication and computer technology. This is certainly an important question on the agenda for future research.

AH: Why does it matter whether private growth is driven by profits in the financial sector rather than in other sectors of the economy (for example manufacturing, services, etc.)? Isn't economic growth just economic growth?

GE: This is a very important question, and one which is at the center of the controversies over financialization. Our book does not, of course, provide a definitive answer to this question. We find that financialization is associated with substantial economic costs: increased income inequality; increased shares of GDP going to owners of financial assets, who tend to be among the very rich in most countries; and the short-term orientation of financial investors who, through their power over corporate decision making, tend to undermine long term investment that can be so important for healthy economic development, to name a few.

AH: What are some consequences of increasing financialization?

GE: One of the important consequences that is well addressed in the book is the impact of financialization on financial crises in so-called "emerging market" developing countries. In Argentina, Turkey, Brazil and South Korea—among many other countries—phenomena associated with financialization contributed to massive dislocations that undermined living standards. Excessive capital inflows and then rapid capital outflows, encouraged by both internal and external financial liberalization, lead to unsustainable debt positions in some cases, and speculative "sudden stops" of lending that left companies and governments in highly vulnerable positions.

For example, in the story told by James Crotty and Kang-Kook Lee in our book, South Korea had a huge savings rate, and highly successful industrialization strategy, yet decided to liberalize their financial markets and to make themselves vulnerable to speculative capital flows. They then were confronted with a massive crisis and such intrusive structural adjustment demands by the IMF that even Martin Feldstein complained. Similarly, financial liberalization in Argentina and Turkey left those governments with insufficient tools to stabilize their economies and financial crises ensured. In the case of Brazil, as shown by Nelson Barbosa-Filho, inflows and outflows of international capital were the driving forces of the ups and downs of economic growth, rather than internal decisions about real investment.

AH: How is the phenomenon of financialization changing how regular people experience the economy? Doesn't it just mean people will have more opportunities to increase their wealth through financial investment?

GE: Yes, to some degree. But at the macro level, because of instabilities and distorted incentives, financialization can undermine the overall growth and development of the economy so that in the end, the real opportunities for investors and workers—except, perhaps for the very wealthiest members of society—are diminished.

AH: What effect—if any—did financialization have for the late 1990s stock market bubble? What about the current housing market bubble?

GE: As Robert Parenteau describes in his wonderful essay for the book, financialization had a huge amount to do with the stock market bubble. The search for financial profits, “short-termism” of investors, abundant access to credit, the distorted information provided by investment houses and brokers—who were sometimes in corrupt relationships with firms—and the desperate need for workers and middle class citizens to find vehicles for saving because their defined benefit pension plans from business and government were being eroded. All these factors really not only are affected by financialization, but in fact, constitute financialization as it has evolved in the U.S. economy.

AH: Financial markets play a central economic role in aggregating information and coordinating allocation of resources among otherwise decentralized agents in the economy. It seems financialization would make this process easier and more efficient?

GE: Certainly well functioning financial markets are crucial to a modern economy. But what economies primarily need are financial institutions that can mobilize long-term, patient capital and allocate it to dynamic and productive sectors of the economy, institutions that can help workers and investors save for important needs, such as education, housing and
retirement, and that can diversify risks. Instead financialization, as it has evolved in the U.S., has contributed to short-termism and impatient capital, diversion of resources to speculative investments, and increases in risks for most workers and middle class investors. The same forces are at work in the "emerging market" crises that are described in the book.

AH: Can the costs of financialization be mitigated or avoided? What would it take to achieve this?

GE: This is a very complex question. In some areas our knowledge is still too limited to have many definitive answers. Also, the problems connected with financialization operate at many levels: global, regional, national and local. Global problems probably require global solutions. But for regional and national problems, it is unlikely that a "one-size-fits-all" approach to managing or reversing financialization will work. At the global level—at a minimum—the IMF and other institutions need to stop peddling advice, or worse imposing through structural adjustment programs, that developing countries adopt the policies and financial structures that have promoted so much destructive financialization: financial liberalization, the elimination of capital controls, the adoption of inflation targeting by central banks.

More generally, these organizations should allow countries the space to find policy solutions drawn from real success stories and their own institutional conditions for themselves. At the regional and local levels, this policy space must be used to embed financial structures into the industrial, agricultural and social sectors of the economy to provide long-term capital and widespread financial services. In the developed countries, like the United States, governance of financial and non-financial institutions is a crucial issue. The old financial regulatory system developed under the New Deal has been destroyed, but nothing has been put in its place. There are examples in the book: securities transactions taxes; more regulation of derivatives; capital management policies. But much more is needed. Our hope is that this volume, while not having all the solutions to the problems associated with financialization, will help stimulate more research analyzing financialization and developing solutions to the problems financialization creates.