A key development in many economies, particularly the Anglo-Saxon ones, during the last 30 years, has been an increase in what heterodox economists have termed ‘financialization’. That is, the increased importance of financial markets in economic life. This has been encouraged by government policies of deregulation and privatisation. Shareholder value has become more dominant in assessments of company performance and dividend payments have hugely increased as a percentage of profits in the US and UK.
Many heterodox economists have been critical of these developments, citing them as part of the reason for stagnating wages and sluggish growth in output and productivity, especially compared with the ‘Golden Age’ of capitalism in the 1950s and 60s. Mainstream economists tend to be more supportive of the shareholder revolution, arguing that it acts to improve the allocation of investment, thus contributing to improved economic performance. It cannot be denied that there has been a slowdown in the growth of output and productivity across the capitalist economies since the crises of the 1970s, albeit one which has happened unevenly. One might argue that the Golden Age reflected a ‘catching-up’ phase of growth after the devastation of two world wars and the Great Depression. And it is difficult to prove that growth would have been faster in recent decades without particular elements of financialization. Economists cannot engage in the controlled experiments used in the natural sciences.
When firms increase their output, productivity and profits, the latter can be distributed in different ways. They could be used to reward some or all of the workforce by increasing wages. They could be used for new investment to try to further boost productivity and potential output. They can also be paid to shareholders as dividends. When carried out across the economy, the effect of these alternatives on aggregate demand and future growth can vary, depending on the propensity to consume of the recipients and the relationship between aggregate consumption, investment and growth.
Those more concerned with issues of social justice might favour lower dividend payments and higher wages, as this would tend to favour those on lower incomes. They might also argue that this would boost consumption and hence aggregate demand and growth, as the lower earners are more likely to spend their higher income than higher income shareholders. Where shareholders are not necessarily wealthy, the argument has less force in terms of social justice but to the extent that dividends are saved rather than spent, the argument about demand would still hold.
The degree to which boosting aggregate consumption contributes to growth also depends on whether investment is constrained by saving, by a lack of consumption demand or whether it is too high or misallocated.
If insufficient aggregate saving is the constraint, higher wages may prevent investment from rising, whereas dividend payments that are subsequently saved could allow investment to rise.
If a lack of consumption is constraining investment, higher wages and dividends that are consumed rather than saved would increase the incentive for firms to invest in new capacity, boosting growth.
If, on the other hand, investment is being allocated inefficiently or is perhaps too high, then dividend payments that are reinvested in alternative, potentially more profitable stock could help to reallocate funds to firms which can find a better use for the funds. Some economists argue that the stock market rewards short-term profitability, which could be based on down-sizing of the labour force or share buybacks rather than longer-term performance, based on investment in new capacity, products and processes. If this is the case, the increased proportion of profits paid out as dividends could hinder improved performance.
It is also argued that if a higher share of profits were reinvested rather than redistributed, then this would result in faster economy-wide growth. This really depends on the efficiency of the financial markets in their role of allocating savings to profitable investment. If valuing the share price from day-to-day determines the allocation of investment and this conflicts with longer-term profitability, then financialization could indeed be a hindrance to economic growth. If this is the case, some of the structural change which has taken place in economies in recent decades involving down-sizing and reduced wages to boost profits could be inefficient. If change of this sort ultimately allows new investment, growth and employment then it could be seen as efficient over the longer term, despite the negative consequences for those who have lost jobs and income. It is these negative consequences that make it vital to determine whether or not financialization has improved the allocation of investment. If it has, and the labour force is stuck with the downsides, then government labour market and welfare policies such as retraining and unemployment pay are clearly necessary.
If financialization can be shown to be harmful to economic performance and encourages short-termism in firm decision-making, then reforms to corporate governance to move the economy away from the influence of financialization would be important.
A clue to the relevance of this debate can be seen in the huge level of funds accumulated by firms in Japan and South Korea. These funds have to date not been spent as higher wages, investment or dividends. The Japanese economy has been stagnating for over two decades after a burst asset price bubble, despite (intermittent) boosts to demand from low interest rates and government budget deficits. The government has recently tried to encourage firms to raise wages to boost economy-wide consumption. But private sector spending has refused to take off in a sustained manner. If firms have the funds to invest but are not doing so, this does suggest that they cannot see sufficient investment opportunities. Rising consumption from higher wages could provide the latter, as could a reallocation of funds to firms with greater potential for investment and growth. Changes to corporate governance could help this process, and indeed the current government has recognised this and begun to act. Could the long stagnation finally be at an end? Japan grew very rapidly during the Golden Age and its growth model served it well while it was catching-up with richer countries. But institutional change has been needed for some time so that it can perform well as a rich country. In this case the mainstream may be right, and the heterodox camp, arguing against financialization, somewhat misguided.