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Studies on Financialization in Latin America

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By Esteban Pérez Caldentey

Studies on financialization in Latin America is a CEPAL publication in Spanish edited by Martín Abeles, Esteban Pérez Caldentey and Sebastián Valdecantos, [2018, Economic Commission for Latin America and the Caribbean (Santiago, Chile)]

It is a collection of ten chapters written by experts on economic development, macroeconomics and finance that analyze and explore the different dimensions of financialization and their economic, social and institutional implications for Latin American countries.

The various definitions of financialization highlight the prolonged decoupling between the real and financial sectors. These also emphasize the predominance and growing role of the financial sector, as well as the financial motives, and financial institutions and agents over the functioning of the real economy which is a key feature of developed economies since at least the 1980s and even the 1970s.

The divorce between finance and the real sector, among other factors, was facilitated by the emergence of large complex financial institutions in the 1990s and 2000s. These operate as a worldwide network of offices and subsidiaries, with centralized financing that is distributed within the financial group as part of a global strategic plan, and they dominate the global financial system.

Large complex financial institutions have grown substantially in the last decade. They account for the bulk of financial intermediation between countries and bring together services and institutions such as banking, insurance, securities and asset management.

These institutions and the systems they create have also proven to be highly fragile. At the same time, the disconnection between the financial and real sector has provided a solid justification for financial deregulation (since the former is assumed to be driven by forces other than those underpinning the latter) strengthening, in this way, the process of financialization.

Some authors see financialization as a recurrent process within capitalist development. In this sense, the novelty of the current process of financialization is not to be found in the phenomenon itself, but in the various dimensions in which it manifests, both in developed and developing economies, and in how it affects a broad range of actors and economic transactions in the real and/or financial spheres of economic activity.

Financialization is reflected in the high rate of growth of the financial sector above that of the real sector; and in the prominent increase in the income share of the financial sector relative to total income. The improvement in the financial sector’s profitability has led businesses to direct their activities towards financial activities, giving priority to increasing shareholder value and also to taking on higher levels of indebtedness. Moreover, indebtedness is a generalized phenomenon also involving the non-financial corporate and household sectors.

The trend towards financialization is not the result of market or financial imperfections, or frictions related to intermediation. On the contrary, it is a direct consequence of the free play of market forces and unregulated and unfettered financial markets.

As a global phenomenon, financialization is not circumscribed to developed countries but also affects the developing world. The ten chapters that make up this volume discuss, in part, the similarities between financialization in developed and developing countries. It then directs the focus onto the specific modality that financialization adopts in the countries of Latin America beginning with the identification of the most relevant actors and the economic processes that arise from their interactions.

More to the point, the book addresses a series of issues that are relevant to financialization in Latin America including: How does the type of external insertion into the region and the extent and degree of external dependency influence the region´s exposure to global financial cycles? Is financialization an obstacle or a bridge in the process of progressive structural change to which Latin American countries aspire? What is the best way to address the problems posed by financialization from the point of view of economic policy? In addressing some of these issues the book seeks to stimulate a wider discussion of how to think about social and economic development of the region within a global context, where the performance and evolution of economies seem to be over-determined by finance.

The different chapters of the book argue that financialization has increased the fragility of Latin American countries and, at the same time, created new forms of external vulnerability both in the monetary and real spheres of economic activity.

As in the case of other developing countries in the 1990’s, most Latin American governments adopted the Washington Consensus as the main guide to economic policy. Governments sought to stabilize nominal variables, liberalize trade and finance, and privatize the bulk of the productive apparatus. These policies were undertaken with the promise that they would lead to stable and sustainable growth and improved welfare.

Financialization has important effects at the macroeconomic level. Financial sector growth has become a source of instability with medium- and long-run consequences for investment, as shown by the growing number of financial crises in the developed would since the 1970s and their negative impact on growth and investment. Between 1973 and 2005 there were 41 crisis episodes in developed countries in which GDP and investment shrank by over 10% (McKinsey, 2012). To these must be added the global financial crisis (2007-2009) and the euro crisis (2009-2013).

Similarly, as a result, of increased financial liberalization and opening of the capital account, developing countries and, more specifically Latin American economies have since the 1980s, been confronted with a series of financial crises including the Mexican (1995), Asian (1997-1998), Russian-Brazilian (1997-1999), and Argentinian (2001-2002) crises with high costs in terms of output. Financial inflows, especially portfolio, debt and loan investment, have not led to increases of investment in host economies. In fact, these factors have exacerbated uncertainty and compromised the growth and sustainability of investment.

Also, the reliance on external flows has not induced a more efficient allocation of resources from a dynamic perspective, since the sectors that benefitted from the influx of foreign capital have usually been the primary sectors and services, mainly financial and real estate.

Foreign direct investment has traditionally been portrayed as an ideal external financing source for the developing countries, for various reasons, including its greater stability (compared with portfolio investment) and its potential to develop greenfield investment. According to Studies on financialization in Latin America, the growing importance of the portfolio investments by subsidiaries of transnational corporations tends to overshadow the positive attributes of foreign direct investment as a source of more stable external financing. In addition, the behavior of foreign direct investment has become more volatile and similar to that of quicksilver capital flows.

Furthermore, capital inflows are usually associated with policy regimes intended to liberalize the labor and goods markets, giving more flexible employment regulation and reduced trade union bargaining power. This is because financial liberalization processes tend to be accompanied by a decline in the relative size of the wage bill.

In this sense, the growing importance of the financial sector has also been associated with the rise in inequality. In the developed economies and some developing ones, including some of those in Latin America, inequality is at its highest in three decades as indicated by the rise in the Gini coefficient and wealth indicators. Moreover, financialization has not only been accompanied with a greater thrust towards the inequality of personal incomes but also of the functional distribution of income, favoring profits over wages. The commodity super-cycle has contributed to increased inequality through higher capital gains that remain concentrated in few hands.

Turning to the domestic conditions, in particular, within the monetary sphere, the book shows that central banks’ efforts to neutralize excess liquidity derived from incoming capital flows during the boom cycle lead to a change of behavior in local banks and households that replicate on a smaller scale the pattern of growth and debt (debt-led growth) observed in advanced countries.

Also, the fact that a high proportion of debt denominated in domestic currency, by far the largest component of total debt, is held by foreigners makes the countries of the region subject to potential and sudden outflows of capital with disruptive effects on credit and real activity. This shows that increased international financial integration can have a detrimental impact on the behaviour of the most relevant actors of the system, not just of commercial banks but also firms and even households.

At the firm level, the book underscores the increasing indebtedness of the non-financial corporate sector in the larger economies of the region which is another facet of the external vulnerability of Latin America. The increase in leverage has weakened the nexus between finance and investment through different channels including the tendency of firms to redistribute profits to shareholders rather than use it to expand fixed capital formation.

More importantly some of the evidence presented in the book reflects the fact that, beyond a certain threshold, leverage and investment are negatively correlated. Similarly, the evidence shows a stronger and positive association between foreign direct investment flows and the stock of financial assets. In turn the increase in the proportion of financial assets in firms´ total assets which reflects precautionary but also speculative strategies is also linked to carry-trade operations.

The impact of financialization in Latin America is not confined to the effects derived from the free flow of external capital and the restrictions imposed upon the domestic financial system and the reduction in policy space. It also involves the deepening of a historical problem of the region: its high exposure to shocks in the terms of trade. The volatility of international prices of raw materials, which has grown in recent decades, pari passu with the financialization process, directly impacts on the outcome of the current account of the countries of Latin America.

The wide fluctuations in the prices of raw materials reflects their increasing role as financial assets in the sense that prices respond to changes in expectations about future demand conditions rather than to actual supply and demand market conditions.   Some of the manifestations of the growing role of commodities as financial assets include the growth in activity in commodity future markets including commodity derivatives, the strengthening of the co-movement among different commodity prices and between commodities and stock markets, and the use of commodities as collateral for loans and credit. In this way, financialization affects Latin America not only through capital revenues but also through its impact on the dynamics of the prices of raw materials.

The book propounds, among other things, rethinking financial regulation, both external and internal, to tame the process of financialization and protect Latin American countries from the wide variations in the global economic cycle. Confronting financialization also requires institutional changes within the financial system. Moreover, it also asserts that controlling financialization is not a purely monetary or real phenomenon but also involves changing the productive structure of the countries through conscious and guided industrial policies. The effective implementation of industrial policies requires in turn regulating the financial system to serve the interests of the ´real´ economy.

From: pp.2-4 of WEA Commentaries 8(4), September 2018


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