Professional Documents
Culture Documents
3, 525548
doi: 10.1093/ser/mwv009
Advance Access Publication Date: 13 May 2015
*Correspondence: tomaskovic-devey@soc.umass.edu
Abstract
We explore the consequences of increased nancial investment by non-nancial
rms, nding consistent evidence that nancialization in the non-nance sector
reduced economic growth in that sector. Employing an expanded conceptualization
of value added which identies internal (capital, labour) and external (creditors, gov-
ernment, charities) stakeholders with claims on the value generated in production and
exchange, we nd that the declining value added produced by nancialization was
born most strikingly by labour and the state, while increasing value was channelled
to corporate debt and equity holders. Corporate charities also had a net gain asso-
ciated with increased nancial investments by the non-nancial rms.
Key words: growth, corporate nance, income distribution, economic sociology, nancialization,
nancial economics
JEL classication: D24 production, E02 Institutions and the Macroeconomy, E25 aggregate factor
income distribution
1. Introduction
By nancialization we refer to the post 1980 expansion of both the nancial service sector and
increased investment in nancial instruments by the non-nancial sector (see Van der Zwan,
2014 for a review). After 2008 it became clear that nancialization had the capacity to intro-
duce instability into the US and other economies. When the US nancial sector collapsed so
did much of the global economy. It also seems to be the case that contemporary nancializa-
tion increases inequality, at least in advanced industrial societies. Instability and inequality are
not, however, evidence that nancialization has been harmful to general economic growth. In
a capitalist system shocks and cyclic destruction, as well as rising inequality are not inconsist-
ent with long-run growth in standards of living.
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526 D. Tomaskovic-Devey et al.
This paper asks if the increased nancial asset investments by US non-nancial rms were
associated with growth or decline in total production. It is possible that nancial investment
strategies, despite increasing inequality, lifted all boats. If this is what happened then the policy
case against nancialization is weakened. If nancialization of the assets of non-nancial rms
had no inuence on value added, then the case against it rests on the social costs associated with
increased income inequality and systemic risk. On the other hand, if nancialization of the non-
nance sector is associated with decreased total production, then contemporary movements
towards a nancialized non-nance sector are economically as well as socially destructive.
The social processes we are investigating happen at the level of rm investment and produc-
tion decisions. In the USA rm level data on value added are not available, so our empirical strat-
2. Financialization
It is well established that since 1980 the USA has undergone a fundamental transformation
from a manufacture-driven to a nance-orientated economy, during which increased shares
Did nancialization reduce economic growth? 527
of national income accrue through nancial channels (Krippner, 2005), corporate governance
is increasingly responsive to and disciplined by nancial rather than product markets
(Fligstein, 2001; Fligstein and Shin, 2004, 2007; Davis, 2009), and national economic
policy is oriented increasingly towards the well-being of large nancial service rms
(Hacker and Pierson, 2010; Krippner, 2011).
Correspondingly non-nancial corporations came to be seen as bundles of assets, rather
than rms with product centred identities (Fligstein, 1990). During the 1980s, as shareholder
value goals began to dominate corporate strategy, market share as the metric of CEO success
was displaced by goals of short-term protability and stock price gain (Dobbin and Zorn,
2005; Krier, 2005; Davis, 2009; Goldstein, 2012). These shareholder value norms encouraged
Robert C. Lucas warned that studying inequality was a distraction from the core goal of sound
economic analysis: studying economic growth (Lucas, 2004). Standard economic theory sees
the problem of inequality in the context of economic growth. Rising or falling inequality is less
important than rising or falling standards of living. Rising inequality accompanied by rising
standards of living or falling poverty is in this view not inherently problematic.
Current ndings that nancialization is associated with rising inequality in the USA
(Hacker and Pierson, 2010; Kaplan and Rauh, 2010; Nau, 2011; Philippon and Reshef,
2012; Lin and Tomaskovic-Devey, 2013) and in other high income countries (Zalewski
and Whalen, 2010; Dnhaupt, 2012, 2013; Godechot, 2012; Kus, 2012) does not address
the issue of whether nancial developments actually made anyone absolutely worse off.
increased in the USA and several Western countries consistent with the rent-seeking behaviour
described in Tomaskovic-Devey and Lin (2011).
More direct evidence can be found in Cecchetti and Kharroubi (2012). They show that the
inuence of nance sector size on economic growth turns negative when nancial services
become too large a share of an economy and in those cases rapid growth in nancial services
is associated with declines in non-nance sector growth and that high levels of nancial activ-
ity crowd out investment and R&D in the non-nance sector. In a later paper, Cecchetti and
Kharroubi (2015) conclude that nancial sector growth competes with the real economy.
They nd for a sample of fteen OECD countries that increased rates of nancial sector
growth are associated with decreased productivity growth, particularly in R&D and capital
and Lin, 2011). In our prior work we did not ask where these rents came fromhouseholds,
the non-nancial sector, tax revenue, or elsewhere in the global economybut our argument
in that paper was consistent with an expectation that nancial investments in the non-nancial
sector might lead to a transfer of income out of the productive sector and into nancial service
rms. Philippon (2007) suggests that more than half of the rapid growth in the US nancial
sector is a result of non-nancial rms increased use of debt to nance investment (see also
Orhangazi, 2008). It seems plausible to suspect that the nancialization of non-nancial
rms has led to a transfer of income from the real economy to the nance economy, from
main-street to wall-street via dividends, stock buybacks and interest payments on increased
corporate debt nancing.
H1: Increased nancial investment strategies by non-nancial rms are associated with lower
total value added.
Did nancialization reduce economic growth? 531
rms and the state over corporate tax rates and the struggle between the state, households, and
rms as to the distribution of tax burdens between rms and households. Taxes on both inter-
mediate production and prots are clearly part of the value stream distributed out of produc-
tion. In addition, rms can get subsidies from the state, so that their value stream includes
payments from the state. Finally, rms also have the opportunity to make charitable donations
and in a RIT framework these should be seen not as costs of production, but as distribution of
the pool of income accumulated in the rm.
In this paper we examine the impact of nancialization on value added as traditionally con-
ceived and an RIT conception of an expanded income pool, which adds to the conventional
measure income distributed to charities, interest payments on corporate debt, taxes, and state
dividend payments. The literature on the increased political power of nancial services might
suggest that nancial investments by the non-nance sector might also act to reduce tax pay-
ments as they beneted from the political muscle of the nancial service sector. If nancializa-
tion reduced total production, this would lead to decreased tax revenue on intermediate
production and corporate prots as well.
where Yt denotes the rst difference YtYt1, 0 denotes the grand mean, 1,i denotes
industry-specic deviation in change, and 2,t denotes year-specic deviation, 1 denotes the
adjustment or error correction rate of Y, and 2 denotes that the direct effect of Xt1 on Yt.
3Xi,t is treated as a control for short run investment allocations. Conditional on other cov-
ariates, a unit increase in Yt1 leads to 1 unit decrease in Yt and therefore 11 unit increase
in Yt. Furthermore, because the dataset is unbalanced (the NAICS have more industrial cat-
egories), we equalize the importance across years by assigning a year-specic inverse probabil-
ity weight to each observation
1
Wi;t ;
Nt
where W denotes the weight of observation i, and N denotes the total number of observations
in year t.
534 D. Tomaskovic-Devey et al.
ECM models estimate both an instantaneous and long-run effect for all covariates. We take
a conservative approach focusing only on the long-run effects in our analysis. Interpreting the
contemporaneous coefcient as an instantaneous effect is only appropriate when the causal
direction is rmly established. Financialization, total assets and income distribution decisions
are all plausibly simultaneous. The interpretation of the long-run effect, by contrast, does not
require an implausible causal assumption and is consistent with our theoretical argument that
nancialization reshapes the long-term social relation between actors. To compute the
long-run effect 2 is divided by the error correction rate 1. We report these long-run effects
in Tables 2 and 4; standard errors are calculated via the Bewley transformation (see Lin and
Tomaskovic-Devey, 2013 for the precise calculation).
1 Corporate subsidiaries are aggregated into the parent companys balance sheet categories. Thus
nancial investments by subsidiaries appear in our nancialization measure. When a corporation
holds its own stock, on the other hand, it is not counted as a nancial investment.
Did nancialization reduce economic growth? 535
Conventional value added 1270 190 591.4 220 659.5 6568.6 1 202 941.0
Expanded income pool 1270 204 092.8 228 717.1 7469.2 1 221 185.0
Capital compensation 1270 58 474.0 61 948.8 1.3 413 821.1
Labour compensation 1270 115 823.9 141 491.8 3528.4 903 185.8
Dividends 1270 6678.7 9221.6 1.1 56 741.3
Interest paid 1270 13 134.7 14 568.5 310.4 116 003.6
Total taxes to all governments 1270 23 090.2 42 460.4 434.4 258 433.0
Note: All amounts measured in millions of 2014 dollars unless otherwise specied.
To check the robustness of our results we estimate the same models separately for manu-
facturing and service sectors of the economy. Although nancialization grew to some extent in
all industries during our observation period, the growth was steepest in manufacturing. For
the extractive and manufacturing sectors we explore an additional control for global compe-
tition in the domestic market (import penetration). All variables measured in dollars are
ination-adjusted and logged. The employment measure is also logged. Variables are
dened formally in the Appendix B. Table 1 provides descriptive statistics for all variables
in the analysis.
Table 2 The long-run effect and error correction rate predicting value added, employment, and
assets, 1970-2008
Ln conventional Ln expanded
value added income pool Ln employment Ln assets
Variable COEF/SE COEF/SE COEF/SE COEF/SE
Note: The underlying estimate includes xed effects for year and industry, Yi,t1, Xi,t1, Xi,t and is weighted by
number of Industries present per year, with industry clustered standard errors. Long-term effects reported here are
computed by dividing the lag effect by the error correction coefcient; standard errors are calculated via the
Bewley transformation.
***P < 0.001, **P < 0.01, *P < 0.05.
and decreased employee commitment (see Freeman and Medoff, 1984, on unions efciency
enhancing inuence via labour effort and tenure, as well as technical and managerial innov-
ation). Increased college level employment is associated with higher value added, consistent
with conventional intuitions that more educated labour is more productive for a given level
of investment and employment. And, of course, increased total assets and employment are
associated with increased long-run growth in value added.
The third and fourth models in Table 2 report estimates of the relationship between the
shifting investment and employment composition and both total full-time equivalent employ-
ment and total xed assets. We treat these models as exploratory, since we do not have a strong
sense of what confounders that might drive employment and investment dynamics are missing
from the model. The key result is that nancialization is associated with sharply reduced em-
ployment, as one would expect as investment is shifted away from production, as well as some-
what reduced non-nancial asset investment. Firm level models have shown similar declines in
employment (Lin, 2013) and investment (Davis, 2014) strengthening our sense that non-
nancial corporate nancial investment is associated with lower employment and production
investment, although we are not convinced that these models are robust to omitted variable
bias. Unionization and computer investment are associated with more employment and xed
Did nancialization reduce economic growth? 537
asset investment, presumably because they are linked to commitments to production. An in-
creasingly college educated workforce is associated with lower total employment, plausibly
through an increased productivity mechanism.
In order to examine if the nancialization-value added link was temporally dynamic we
re-estimated the long-run effect of nancialization on value added using locally weighted re-
gressions (except 1970 which drops out because of the lag structure). To estimate the equation
for year q, we assign an exponential weight to each observation based on the distance between
the observation year t and q. That is
owners. Labour realizes its claims via employment income and benets. In the RIT conceptu-
alization additional stakeholders have claims on rm income, including government claims on
income via taxation during production, taxes on corporate prots, interest paid to the owners
of corporate debt, and corporate contributions to charity. Table 3 reports these models.
Table 4 reports the long-term effect estimates. The estimate suggests that by 2008 increased
nancial investments by non-nancial rms are associated with around a 4% decline in total
value added. Thus, for these rms, nancial investment strategies appear to have been in the
aggregate economically destructive compared to foregone investments in production.
Over the observation period increased nancial investments were, however, highly select-
ive in their consequences. Increased nancial investment by non-nance rms was strongly
9. Discussion
Our estimate is that the nancialization of the non-nance sector of the economy depressed
non-nance sector value added by 3.9%, roughly the equivalent of 3 years of lost economic
growth. For the expanded income pool economic growth is positive and the benets went to
corporate stock and debt holders. Thus from the point of view of the non-nance sector nan-
cial investments appear to have been economically destructive. From the point of view of -
nancial capital, these shifts have been a source of increased income.
Estimates are only as good as the underlying data and models. We believe that, with the
lagged variables and xed effects for both industry and year, our core estimates are likely to be
conservative and robust to omitted variable bias. More concerning is our use of industry data
to proxy a rm level process. Davis (2014) and Lin (2013) both point to the largest corpora-
tions as the primary non-nancial rms pursuing nancial investment strategies. Since indus-
try estimates are averaged over all enterprises in an industry our results probably
underestimate the impact on larger rms and tell us nothing about the relative productivity
Did nancialization reduce economic growth?
Table 3 The long-run effect and error correction rate predicting value added components, 19702008
Note: The underlying estimate includes xed effects for year and industry, Yi,t1, Xi,t1, Xi,t and is weighted by number of Industries present per year, with industry clustered standard
errors. Long-term effects reported here are computed by dividing the lag effect by the error correction coefcient; standard errors are calculated via the Bewley transformation.
***P < 0.001, **P < 0.01, *P < 0.05.
539
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540 D. Tomaskovic-Devey et al.
Table 4 Cumulative percentage change in value added and stakeholder value components as a
function of estimated long-run effect of nancialization, 19702008
Note: Effect estimates calculated by the change in nancial investments 19702008 (0.1146) multiplied by the
long-run coefcient estimates in Tables 2 and 3. Per cent change calculated as the exponent of this estimate
minus 1.
of rms in the same industry with different investment strategies. Measurement at the level of
the rm would clearly be preferable if appropriate measures of value added and distribution to
stakeholders were available.
We are less condent in the estimates of the impact of nancial investments on employment
and xed asset investment. We simply do not know how accurate these estimates are. On the
other hand, other researchers have documented decreased xed investment (Stockhammer
2004; Orhangazi, 2008; Davis, 2014) and employment (Lin, 2013) with increased non-
nancial corporate nancial investment. So while we are unsure of the magnitude of the
effect, we are fairly condent that both xed investment and total employment, as well as
value added net of both, are undermined by the trend towards nancialization among non-
nance corporations.
One concern about these results might be that the counterfactual world in which more
money had been invested in production and as a result more value would have been produced
is somewhat difcult to imagine in an era of increased global competition. The results for com-
puter investment, however, show that increased investment in production technologies was
associated, for the same industries and the same time period, with increased value added.
Thus, these models suggest that productive investment during this period was possible and
effective. The same can be said for human capital investments via college education.
The contrast in results for the conventional notion of value added and the expanded RIT
conceptualization is worth exploring. The difference in results reects that the expanded def-
inition includes creditors. Firms that pursued internal nancial investment strategies also paid
increased shares of their total production value to creditors. The conventional measure of
value added overstates the negative effect of nancial investments on total outputs, because
it overlooks the growing interest payments associated with corporate debt. The period of -
nancialization was one in which nancial asset holders became increasingly powerful in their
claims on the income of the non-nancial sector.
Wall Street harvested an increase share of the outputs from Main Street. Since we do not
observe equity buybacks in these data, which were also rising during this period (Davis, 2014),
it is probably safe to conclude that the increased capital returns to debt and equity holders
reduced the volume of retained earnings available for new investment and as a result squeezed
out investment in new production. At the same time, employees compensation dropped as a
Did nancialization reduce economic growth? 541
result of nancialization of the non-nance sector. While our estimates focus on income drops
net of employment, nancialization is also associated with decreased employment.
Government revenue in the form of taxes on production and corporate prots dropped as
well. Financialization was economically destructive for labour and society more generally,
and benecial for nancial capital.
10. Conclusions
The shifting of non-nancial rms investment towards nancial instruments and away from
production decreased total value added in the non-nance economy. This negative effect on
these investment strategies produced a positive feedback loop for the owners of corporate
equity and debt, in which slack labour markets caused by reduced production investment
further strengthened their bargaining power over economic surpluses.
There is also substantial evidence of nancial services extracting increased resources from
the non-nancial sector via interest payments. This is consistent with the well documented
movement from equity to debt nancing in the productive sector. This result is also consistent
with the nding that there has been a large transfer of income into the nancial services indus-
try (Krippner, 2011; Tomaskovic-Devey and Lin, 2011; Philippon and Reshef, 2012) but no
increase in nancial service productivity (Philippon, 2012). That is, the nance sector prots
mostly from the increases in intermediated volume, not from innovative nancial devices
production investment, and as a result growing income shares to capital and declining employ-
ment and tax revenue.
Since prior literature has made clear that both the increased rent taking by the nancial
services rms and nancial behaviour on main-street have exacerbated both instability and in-
equality, it seems plausible to conclude that the newest phase of capitalismnancializationis
both socially and economically problematic. Workers and the society (via state capacity) have
been harmed, shareholders of non-nance rms have beneted and income streams to debt-
based securities have increased. A smaller, less equal, more unstable, but more Wall-Street
friendly economy has been the result.
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Appendix A
Mining
Metal mining
Coal mining
Oil and gas extraction
Continued
Did nancialization reduce economic growth? 547
Table A1 Continued
Business services
Personal services
Auto repair, miscellaneous repair services
Professional, scientic and technical services
Administrative and support services
Waste management and remediation services
As displayed in the table for Appendix A, Standard Industrial Classication (SIC) coding for years 19701997 was
combined with coding from North American Industrial Classication System (NAICS), years 19982008. Since
industrial categories are not entirely congruent across the two classication systems, the combination strategy
involved matching or combining industries when easily accomplished, and leaving industries separate from one
another in cases where the industrial classication of rms changed or became more detailed. The table is shaded
to indicate which industries match, are components of each other, or are unique to each classication system across
the two periods. In the data, this produced the effect of some industries spanning the entire period, while some
ended in 1997 and others began in 1998.
Appendix B
Continued
548 D. Tomaskovic-Devey et al.
Table B1 Continued
The Bureau of Economic Analysis (BEA) holds the National Income and Product Accounts (NIPA) variables.
NIPA variables are estimates for the entire US economy. Measures include value added, subsidies, gross
operating surplus, employee compensation, computer investment components, xed assets, full-time equivalent
employees, taxes on income, and taxes on production and imports less subsidies. Data is available at:
http://www.bea.gov/industry/index.htm.
Internal Revenue Service (IRS) variables are estimates of corporate economic output. Our IRS measures
included interest paid on debt, charitable contributions and nancial assets as a proportion of total assets
(nancialization). IRS data are available at: http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Complete-
Report. Years preceding 1994 are not available in digital format, but are available from the authors upon request.
Current Population Survey (CPS) variables were used as demographic employment controls. The rst of these
included union density, which is housed at the National Bureau of Economic Research (http://www.nber.org/),
collected through CPS May Extracts from 1970 until 1982 and through CPS Merged Outgoing Rotation
Group (MORG) in years 1983 onwards. The other variable, college educated workers and total workers, were
obtained through CPS Integrated Public Use Microdata Series (IPUMS), available at: https://cps.ipums.org/cps/
index.shtml. Union members and college educated workers are divided by IPUMS total workers to obtain
variables measured as proportions.
The Organization for Economic Cooperation and Developments (OECD) Structural Analysis (STAN) data
provide a measure for import penetration, which covers industries in the manufacturing sector. OECD-STAN data
can be obtained at: http://stats.oecd.org/Index.aspx?QueryId=22211.