Financialization and its determinants in Latin America

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Financialization and its determinants

in Latin America

By Mischa de Gier

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Foreword

Before you lies my economics thesis, the product of my work of the past seven months. I am very pleased that you, the reader, are interested in my ideas and results and therefore willing to read it. The subject of my thesis is ‘Financialization and its determinants in Latin America’. Financialization is a field that sees trends in the current economic era like globalization, capital market liberalization and stock market growth as creating income redistribution from the real sector to the financial sector. These processes are especially relevant in developing countries, and that is why I review the theory for Latin America: a region in which rapid development goes alongside inequality, instability and poverty.

At this place, I would like to thank the people that were of crucial importance for finishing my thesis. First Dirk Bezemer, my supervisor, who helped to mould my preliminary thesis-ideas in a testable hypothesis, who stimulated my thinking process and who was always available through rapid e-mail replies and last-minute meetings. Second, Dirk Akkermans, my second supervisor, who was willing to read my thesis and provided me with useful comments. Furthermore, I would like to thank my parents, for unlimited support in my studies; my roommates and friends and last but not least Marijke, for being always there when needed, and for all our talks about the future, which kept my progress in pace.

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Intro: financialization in a globalized world

Globalization plays a vital role in today’s world. It has influence in different areas, whether it is in politics, on cultural aspects, on consumers, on transport, on communication, on the environment and, last but not least, on economics. Of all of these areas, economics seems to be the field in which globalization possibly plays the most significant role. Growing international trade, multinationals’ activities, Foreign Direct Investment (FDI), the removal of import barriers, developing markets all over the world, and an increasing emphasis on international financial interaction have created a world market in which economic interaction is ever-growing (Deardorf & Stern, 2000).

Due to the importance of globalization, a big discourse has evolved around it. With regard to economics, the advocates of globalization, praise the possibilities for export-led growth, for specialisation in order to exploit competitive advantages, for capital mobility, the advantages for consumers, for employers and employees (for instance Deardorf & Stern, 2000). Globalization, can, according to them, benefit the majority of the world population (for instance World Bank, 2002, Dollar & Kraay, 2002), although most authors do admit that there are possible losers in the process as well.

Critics have, however, concerns: globalization can, according to them, create dangers for economic and financial stability; it can destroy national production through inflow of imports because of low international prizes and governments can possibly loose the control over their economy and their exchange rate. This way, globalization processes can possibly deteriorate the position of developing countries. And although the argument of globalizations’ proponents is that all risks are of a short-term nature, the idea that globalization is favourable for everyone in the long run is questioned by some authors as well (for instance Wade, 2004). Even though valuable arguments have been posed in this debate, there are certainly aspects of globalization that have been underexposed in mainstream economics. Some of these processes that have appeared in the last thirty years can be subsumed under the heading “financialization”. As I will show in this work, financialization can explain some economic processes that mainstream literature fails to account for.

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The text will be organized as follows:

1) In chapter 1, I will first discuss the mainstream economic literature on financial markets and then combine this knowledge with financialization literature: I will explain the term financialization in detail and point out the differences with the mainstream literature. The second part of chapter will describe the various processes through which financialization can possibly occur.

2) In the second chapter, I will review the empirical case of Latin America and describe the situation in the region on the fields through which financialization can possibly occur.

3) After that, I will empirically test whether and to what extent financialization indeed occurs in Latin America and which processes play in role in this.

4) Finally, I will draw conclusions from my research and discuss the aspects that need further research.

Chapter 1: Financial market theory and financialization

§1.1 The financial system

Because investment drives economic growth, it is a crucial aspect of a nation’s economy and markets that match investment opportunities with savings are crucial to exploit possible growth-opportunities. Financial markets can provide lenders and borrowers with information and an efficient matching system and therefore reduce costs (Khan, 2000). The field of modern financial systems has been of interest to researchers for over centuries (for instance Bagehot 1873), while Goldsmith (1969) was the first one to examine the quantitative relationship between financial systems and economic growth (see Levine (2003) for a thorough overview on the history of financial systems research). Although there is disagreement (see for instance Trew, 2006), empirical research that supports the importance of financial markets is readily available (Levine, 2003). According to Khan (2000), a poorly functioning financial system can hamper development, but an efficient one can boost the rate of growth of an economy above what it otherwise would have been. Levine (2003) confirms this, in stating that “Countries with

better-developed financial systems tend to grow faster – specifically those with large, privately owned banks that funnel credit to private enterprises and liquid stock exchanges” (Levine,

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and borrower more simple, 6) it is able to exert corporate control to protect the rights of investors.

Financial systems, however, do create risks for parties involved and economic growth. An important issue is the risk of over-lending, a pattern where savings are mobilized to investment projects which are not profitable enough, possibly leading to financial instability. A reason of over-lending is too much availability of deposit insurance or collateral, which creates a situation in which the financial intermediate has little to loose from investing in a project with low expected returns (Schmidt, Demirguc-Kunt, 1998). Over-lending creates situations of financial instability in which individual borrowers can become insolvent and is, according to Caprio (1998), at the root of a lot of financial crises. When a macroeconomic event occurs, such as a devaluation of the currency or an increase in global interest rates, a hidden situation of financial distress can create a bank crisis which dwarfs the initial macroeconomic event (Schmidt). Banks will call in loans because of increased credit risks and increasing deposit withdrawals. Because of the mentioned insolvency of some firms that received investment capital, the ‘credit crunch’ comes with big real effects, especially when the macroeconomic effect causes the real estate market to deteriorate, leading to a decrease in value of collateral. This kind of financial instability mainly occurs when proper regulation and monitoring of the financial system are not in place (Schmidt).

§1.2 Financialization and its relation to the financial system

Although mainstream literature has a clear view on the advantages and risks of financial systems, there are some processes in the financial system that can have deteriorating effects on real economic growth and income distribution. These processes can be subsumed under the heading ‘financialization’. But what is exactly financialization? In the most general sense, it means (according to Epstein, 2005, p. 3)

“…the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies”.

Engelen (2003) gives another general definition in which Marxist terminology is apparent:

“…financialization refers to a gradual process in which financial values (shareholder value, capital market gains) …..start to dominate cities, regions, and even national economies….This is not only in terms of employees, firms, and share of financial flows, profits, and investments….but rather in the sense of installing a new regime of accumulation.” (Engelen, p. 1367)

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the real economy to capital gains, which can be defined as the increase in value of financial assets. So I therefore define financialization as the shift in focus from profit to capital gains..

This definition stresses the fact that 1) the financial sector is becoming increasingly important in comparison to the real sector and 2) that financialization can redistribute income from the real sector to the financial sector.

The growing dominance of ‘finance capital’ is already mentioned in the work of Karl Marx on capitalism. In his opinion, the financial sector’s primary purpose is to be a supplier of services and capital to the real sector, in which real value is added.1_{In a capitalist state}

however, capital increases its power relative to the real economy and in contrast to a financial sector that only makes profits through its services to the real sector, now the financial sector starts to make profits through mere speculation, which cannot, according to Marx, add value to total productivity. 2_{The opinion of Marx in this is clear:}

“In a capitalization state we have the meaningless form of capital, the perversion and objectification of production relations in their highest degree, the interest-bearing form, the simple form of capital, in which it antecedes its own process of reproduction” (Marx, 1867)

§1.3 Financialization in politics: the rentier class

One of the most important concepts in financialization theory is the rentier class. Especially authors with a Marxist or Keynesian view argue that the current process of growth of increasingly integrated and largely unregulated financial markets (Argitis, 2006) is no

coincidence. Rather, it is a government-led process, highly influenced by a group that profits most of financialization and capitalization, consisting of for instance private rentiers, private bankers, pensioners, currency speculators and portfolio investors; together referred to as the rentier class (Krippner, 2004, Epstein, 2005b, Argitis, 2004, Duménil, 2005). A common denominator that characterizes the rentier class is that it receives its income solely through financial profits like interest, dividends, capital gains, speculation, and through bond- and stock markets, instead of making productive investments, henceforth it is sometimes called ‘passive capital’. In his ‘General Theory’, Keynes describes the rentier as a ‘functionless investor’, a notion that he shares with Marx. Tobin (1997) takes the same stance in saying that macro-economically, financial investment is inferior to physical investment. Although functionless, the rentier class is an active group, as for instance Epstein and Jayadev (2005) argue, searching

1_{His famous C-M-C (Marx, 1867) formula illustrates this. In this formula, M (which stands for money) mainly} serves as a facilitation of the process of commodity exchanges (the C’s in the formula): it serves as a means of purchasing power, it mobilizes savings, collects information and monitors. The worth of money is in this situation a mere reflection of the worth of the commodities in the real sector and the financial sector only adds value to the real sector through the services it provides

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for the most profitable use of their money. Rentier income can be described, as Kalecki (1990) does: “rentier income is income received by owners of financial firms, plus the return to

holders of financial assets generally”.3

With the power the wealthy rentier class has, it is able to set up a strong lobby at the government, which is the main reason for some crucial government interventions in the last century (Duménil and Lévy, 2005). Some authors even argue that the whole process of globalization and internationalization is dictated by finance, and not vice versa, as is commonly accepted. Helleiner (1994), argues for instance that “offshore Euro markets”, were a result of the rentier lobby.4_{While in the 1960’s, the rentier class was set back due to prevalent}

Keynesian politics, it continued to struggle for its dominance (Duménil, 2005, p. 24) and eventually succeeded, mainly due to the fact that, in August 1971, the Bretton-Woods system of fixed exchange rates collapsed, which made currency speculation again a possibility for the rentier class. At the same time, floating exchange rates discourage long-term investments in the real sector and shifts funds away to short-term projects or stock portfolio’s, a process clearly positive for passive capital and negative for the real sector, and thus financial-inducing. According to Duménil (2005, p. 25), the resurgence of the rentier class was also possible because of crises and large deficits of some governments in the 1970’s and 1980’s, which created an opportunity for neoliberal reforms such as fiscal contraction, inflation-targeting, monetary austerity, labour market flexibility, privatization and deregulation (Argitis, 2004, Smithin, 1996), an optimal course for rentiers: it prevents erosion of their capital and creates profitable investment opportunities.5

§1.4 Financialization in business

Next to floating exchange rates, a second field through which financialization can occur is the field of corporate finance and management issues, more specifically the trend of increasing power of shareholders, sometimes called the ‘shareholder revolution’ (Stockhammer, 2004a): increasingly, attention is paid to the interests and wishes of the providers of capital for investment: the shareholders. As the OECD states:

"One of the most significant structural changes in the economies of OECD countries in the 1980s and 1990s has been the emergence of increasingly efficient markets in corporate control and an attendant rise in shareholders' capability to influence management of publicly

3_{The idea that financial firm income should be a part of rentier income remains debatable, as one could argue that} financial services are a commodity that is real and value-adding and therefore does not fall under the category of capital gains. The Kaleckian definition therefore gives quite a broad definition of the term financialization. 4_{Created by the USA and UK in the 1960’s, offshore Euro markets were the first capital markets totally free from} capital control, which created new opportunities for speculative capital.

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held companies. In particular, owing to the expanded possibilities for investors to use the capital market to measure and compare corporate performance of corporations and to discipline corporate management, the commitment of management to producing shareholder value has become perceptibly stronger; this represents a significant change in the behavior of large corporations." (OECD 1998, 15)

Through a market of corporate control’ (Stockhammer, 2004b, p. 11), shareholders can interfere in management’s decisions or even replace the management if they are dissatisfied with the firm’s performance. Advocates of the market of corporate control see it as a solution to classical principal-agent problems of self-interested management, that engages in wasteful activities to increase its own status (Jensen and Meckling, 1976) and to situations with discrepancies between labour wages and labour productivity (Boyer, 2000), for instance because of labour union power.6

The shareholder revolution is happening in a time with increasing possibilities for financial investment, due to privatization and booming stock-markets. According to Crotty (2005), these financial investments are all the more attractive because of increased competition and stagnant growth in the real economy in the same period, which makes it increasingly difficult to earn satisfying profits. Crotty defines this process as the ‘neoliberal paradox’: in a world where a free market economy is the main goal, tough competition can make firms resort to seeking opportunities for financial rent, and focus less on their primary product because of the limited scope for profitability in real production.

The combined effect of increasing shareholder power and a low expected profit on investments in real production results in a shift from investment in physical capital into investment in financial capital, which is obviously in line with the idea of financialization. While ‘managerial capitalism’7_{(Chandler, 1977) was prevalent in the 1960’s and 1970’s, the}

situation gradually changes to one with anonymous shareholders, who can buy or sell the stocks of the firm in a split second. The relationship between owner and the firm has thus become increasingly financially oriented. It can be argued that this creates more short-term interest on financial rewards instead of long-term commitment to the firm. Furthermore, with increasing flexibility in the labour market for high-level management and the possibility to earn a lot of money when being successful, it is difficult for a firm to hire and retain internal managers for a

6_{An excellent example of the increasing shareholder power is the current debate around the Dutch multinational}

bank ABN AMRO, which has been under pressure for the past months after two hedge funds demanded the bank to be split into different parts, in order to boost the share price, which was, according to them, grossly undervalued. Separation of the bank would thus be profitable for the shareholders. The demands of the hedge funds, in addition of pressure of the shareholders, unified in the Dutch organization for shareholders (V.E.B.), drove the panicking management to start merger talks with a variety of parties like the British bank Barclays and a consortium of three continental banks. The possible validity of the hedge funds’ position set aside, it is clear that the current debate and possible split will have real economic consequences: a great brand name will be lost and the merger will very probably lead to a loss of thousands of jobs due to reorganization operations.

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long time, which has effect on the in-depth, firm-specific knowledge of the firm’s management (Engelen, 2003), while introduction of new financial instruments in the 1970’s like tender offers and junk bonds (allowing hostile take-overs) makes the management listen to shareholders even more (Stockhammer, 2004a).

Critics argue that the shareholder revolution hinders innovation because it creates unwillingness to do long-term deep investments (Engelen, 2003, p. 1368). This is disastrous, according to Stockhammer (2004a), because “physical capital and skills are often

complementary and technological progress has to be embodied in new machinery”. In general,

the shareholder revolution can possibly create financialization because it can shift funds away from productive investments, which will probably cost jobs and will have a negative effect on wages.

Engelen (2003) adds another force that works in quite the same way as the shareholder revolution but because of quite a different reason: the demographic changes that pension-funds have to cope with. Because of the aging-problem (a growing group of pension-entitled people combined with a declining workforce), there is a need to make a bigger profit per dollar invested and this cannot be achieved by the investment in low-risk assets that pension funds normally invest in. So, with the aging-process comes a more profit-oriented and less risk-averse pension fund (Engelen, p. 1366), possibly creating financialization. Engelen (2003) cites Toporowski (2000) in saying that the process in pension funds had a large influence in transforming entrepreneurial capitalism into rentier capitalism in the past decades.

§1.5 Financialization in financial systems

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However good liberalization can be for the private sector, the parallel development of increasing market-based financial systems and the shareholder revolution creates an increasing short-term focus of capital, and thus finding long-term investment capital can still prove to be hard. A downside of the opening up of a capital market is the instability it can bring. Dangers of speculation and herding, as for instance Minsky (1978) argues, make a financial market already vulnerable to instability and this risk is only increased when foreign capital is allowed to enter the market. Foreign capital will generally look for its most rewarding use and that is why it can leave a country just as fast as it enters when it sees other opportunities or becomes suspicious of economical weaknesses of a country. According to Greenstein (1998), authorities fear they can lose their autonomy for the conduct of macroeconomic policy through financial market liberalization and are therefore hesitant to expose their home financial markets to market pressures and speculation on a grand scale, but worldwide practice sometimes forces them to. A special case in this regard are hedge funds, which can be defined, according to Eichengreen (1998), as “eclectic investment pools, organized as private partnerships and often resident

offshore for tax and regulatory purposes...free to flexibly use a variety of investment techniques...to raise returns and cushion risk”. Hedge funds aim to diversify the risk of

investors and therefore spread their holdings across equities, bonds, currencies and countries. They have significant power mainly because of the activity (sometimes even aggression) they show in situations where macroeconomic fundamentals are out of line, for instance through taking position against an unsustainable currency peg of a specific country. This has created a concern that financial markets (especially foreign exchange markets) and central banks can be manipulated or even dominated by hedge funds, especially when capital controls are loosened.8

With capital market liberalization in the 1980’s and 1990’s has come a sharp increase in the entrance of foreign banks in especially developing countries, with Latin America as the finest example (Domanski, 2005). The results of foreign banks entering a country is generally regarded as positive, both for the country and for the foreign bank (Leigh, 2006): the banks are generally among the most efficient in their country of origin, have a technological advantage and more risk-diversifying possibilities, so that they are more efficient than native banks, despite possible informational disadvantages. The result is an improvement away from inefficient state-owned and private banks to a more efficient and competitive banking market with increased credit availability, lower interest rates and best-practice banking (Leigh, 2006, Detriagache, 2006, Barajas, 1999, Domanski, 2005). Furthermore, foreign banks are generally

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regarded as safer than domestic banks, because backed up by their parent banks and less susceptible to political pressures (Detragiache, 2006). Critics, however, argue that increased foreign bank entrance distorts the long-term relationship between native banks and firms, because foreign banks may possibly exclude native firms from credit because foreign banks limit their lending to only the most trustworthy and transparent customers. The result is a situation in which profitable investment opportunities for more ‘opaque’ firms will be lost. Detragiache (2006) and Barajas (1999) show empirical evidence that a larger foreign bank presence is associated with shallower credit markets in poor countries, although Domanski gives empirical evidence that what he calls “cherry-picking” the most trustworthy customers is not a significant problem.

A third development in financial markets in the 1980’s and 1990’s, as already shortly mentioned in the last paragraph, is a replacement of bank-based capital systems by market-based capital systems, for instance stock markets. This trend mainly appears in OECD-countries (Demirguc-Kunt and Levine, 2000), but Eastern Europe and Latin America see a similar development (Chakraborty and Ray, 2002). Like owner-manager positions, according to Stockhammer (2004a), firm-bank relations

“are characterised by long-run relations between banks and firms, based on trust and a

long time horizon. Market-based systems, on the other hand, exhibit decentralised ownership and relations with short time horizons” (p. 721).

Levine (2002) adds to this that bank-based systems are generally better in ameliorating moral hazard through monitoring and the fact that long-run relationships ease asymmetric information distortions. Proponents of market-based financial systems however, argue that these systems enhance corporate governance by easing takeovers and transmitting relevant information to investors and facilitate risk management (Beck and Levine, 2002), and stress the problems of a system with powerful banks that can protect firms with close-bank ties (Levine, 2002), creating the risk of over-lending (Chakraborty 2002). In his 2002 paper, Levine does not find support however, for the stance that either of the systems is more conducive to growth and neither do Beck and Levine (2002) and Demirguc-Kunt and Levine (1996). Arestis e.a. (2004) however, do find evidence that financial structure matters significantly and that it can indeed explain economic growth. Their conclusion is that for most countries a market-based approach is more conducive to economic growth, while a bank-based approach works better in only very few countries.

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opening up markets for foreign capital, the entrance of foreign banks and the change to a market-based approach seem to be favourable for rentiers (more opportunities for capital gains, while through risk-diversifying operations speculation is made more safe) while the effects on the real economy are more doubtful, mainly due to the risk of instability and the problems of finding investment capital for opaque firms.

§1.6 Financialization through taxation

Tax reforms are another possible cause of financialization. Especially governments of developing countries see the need for Foreign Direct Investment, which can create jobs, economic growth and best-practice technological knowledge. Because there is a lot to gain, over the last decades, most of them started to give tax incentives to encourage foreign firms to invest in their country, creating what is sometimes called ‘tax-competition’ between countries (FitzGerald, 2002). Incentives range from tax rate reductions for specific types of activities to allowances for specific investments (UN, 2000), but are all aimed to create a favourable environment for FDI. 9_{However, giving tax breaks means a loss of income for governments in}

the short run, and this can be especially harmful for poor and developing countries. The government has three options to solve this problem: 1) to run a deficit and increase its debt, which is on the long-term not a good option and almost impossible in neoliberal regimes, 2) to cut its spending, or 3) to receive income from another tax-base. Both of the latter options are negative for the real economy because the government will either stimulate its economy less, or the tax burden is shifted to income and profit. Michael Hudson shows empirical evidence of the last option for the case of Latvia:

“The problem is that Latvia’s low tax rates for real estate and debt service subsidize property speculation and financial leveraging, while high taxes on income, Social Security and sales turnover make labour and capital more expensive. The “real” economy shrinks as property speculation by running into debt offers higher returns than can be made by direct investment and employment. Government budgets are squeezed, forcing them to sell off of public enterprises.” (Hudson, p.2)

Fitzgerald (2002) sees the same process for Latin America: “a shift in the incidence of taxation

from capital to labour as governments have tried to maintain levels of both fiscal revenue and private investment”. The idea of taxing the relatively non-movable factor labour instead of the

highly mobile factor capital, economically makes sense at the short-term (Rodrik, 1997).

9_{Although tax competition in developing countries is generally supported by the Western world,}

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Because of all possible harmful effects of tax-competition on the real sector however, Grabel (2005) argues for introduction of so-called Tobin-taxes – taxes on domestic asset and foreign exchange transactions, to relieve the industrial sector at least partially, while FitzGerald (2002) favours so-called “Double-taxation treaties (DDT’s) to avoid international tax competition on a harmful scale. It seems clear that a process in which capital sees a tax-relieve and in which income and/or profit taxes increases are financialization-inducing in a very direct form.

§1.7 Privatization

Another effect that can be explained in the framework of financialization is the trend of privatization since the 1980’s. Privatization can be defined as “a shift from public to private

production of goods and services” (Starr, 1988). The reasons for privatization from the point of

view of a government can be numerous: 1) to achieve gains in economic efficiency, because of the extensive prevalence of poor performing public enterprises, 2) to improve a governments fiscal position10_{, 3) to finance fiscal deficits with the proceeds of the privatization, 4) to develop}

domestic capital markets (Davis, e.a. 2000, Starr 1998) to strengthen the private sector, 5) to free resources for allocation for other government activities (Sheshinski and López-Calva, 2003), 6) to subject state-owned enterprises to market-discipline (Megginson and Netter (2001) and 7) to tie managers to government policy in a more efficient way (Shleifer, 1998).

There are numerous objections against privatization as well. First, some authors argue that privatization is not the answer to inefficiency. According to Hudson, inefficiency is a management problem, not an ownership problem and efficiency can be easier reached with labour flexibility than with privatization, while Starr (1998) gives examples of state-owned enterprises in Malaysia that work without any efficiency problem. Second, privatization is followed by reorganization in most cases, which often means a loss of jobs (Katsoulakos, 2002, Davis, 2000). This is generally positive for the efficiency of the overstaffed enterprises, e and Katsoulakos shows that in the long run, unemployment is negatively correlated with privatization as well. Davis (2000) however states that, although aggregate unemployment may decrease following privatization, particular groups of workers still may be adversely affected. Third, while in case of government-ownership, the enterprises’ profits will be at least partially injected in the economy or the tax-burden will alleviated, in the case of investment by a foreign investor, it is very probable that profits of the privatized firm will at least partially be repatriated to the country of origin, failing to create any multiplier effects in the host country.

The positive aspects of privatization for rentiers are clear: it adds to their opportunities for speculative investment with possible high pay-offs due to the effect that in general, state-owned firms have much to gain in efficiency. In combination with the aforementioned

10_{Katsoulakos (2002) however does not find a significant relationship between privatization and an improved fiscal}

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processes in shareholder power and the change to a market-based approach, rentiers can treat the privatized firms increasingly as assets on which to make capital gains. Second, the privatization process, in combination with the wave in mergers and acquisitions, gives the financial sector the opportunity to provide services and lend capital for the mergers and takeovers. For the real sector, however, a merger and takeover process is not necessarily profitable: unless clear efficiency gains from a merger or a takeover are apparent, mergers and takeovers only create extra costs. Net, it is therefore arguable that rentiers gain more through

privatization than the real sector and thus is it possible that privatization creates financialization.

§1.8 Financialization through interest rates

A final process through which financialization can occur that that will be mentioned here is the height of interest rates. Interest rates can both be seen as profit from capital and as a cost for the real economy. The latter effect is in the literature subsumed under the title ‘ the cost channel of monetary transmission’ (for instance Christiano e.a., 1994) and is proven empirically, for instance by Barth III (2000): a monetary contraction in the form of rising interest rates increases the cost of investment and thus of production; it lowers a firm’s profitability and deteriorates its capability to produce. Argitis shows that it is arguable that in the USA in the last two decades, “the interest burden has been an obstacle to economic expansion” (Argitis, 2002). Duménil and Lévy (2005, p. 27-32) show in their empirical work that especially in the 1970’s, interest rates ate up a significant part of the profit rates of firms worldwide, especially of those in developing countries.

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§1.10 Stakeholders in financialization

As can be seen from the paragraphs above, a shift in focus from profit to capital gains can proceed through a variety of processes. All these processes thus have a redistributional effect for different stakeholders. The rentier class clearly gains from financialization. When it comes to groups in the real sector that suffer, two groups come naturally to ones mind: industrialists and workers.11_{Who bears the biggest burden of the expected fall in income share through}

financialization probably depends on the amount of power both parties have.

There has been some empirical testing on the relation between financialization and the share of labour and rentier income in national income. Harrison (2002) finds significant negative relationships between the income share of labour and (1) swinging exchange rates (2) the decline of capital controls (3) a decline in government spending (4) foreign investment flows. Furthermore, Epstein and Jayadev find a negative relationship between the share of labour income and a reduction in the power of labour and labour unions. On the other hand, Duménil and Levy (2005) find empirical evidence that the returns to holding financial assets, as a share of disposable income, rose in the past decades, as did Argitis (2006).

Chapter 2: The effects of financialization in Latin-America

In chapter one, various areas have been described in and through which financialization can occur. The aim of the rest of the thesis is to empirically test the hypothesis that at least some of the mentioned processes create financialization. Tests like these have been carried out in OECD-countries (for instance Epstein & Power (2003). In this work however, I will be specifically interested in the effects of financialization in a developing part of the world, in this case Latin America. This region represents some of the fastest developing economies of the world, while at the same time, inequalities between the rentier class (mainly land-owners) and the labour class have been always particularly high. More importantly however, most of the economic processes that I have described seem to occur in the region when one looks to general trends, which makes the region a good test case in my opinion. First, the aim of this chapter is to discuss some details and background of the Latin American situation.

Latin American countries can historically be characterised as centralised when it comes to their financial system, with strong controls on foreign capital, with a bank-based approach and in which, due to dominance of powerful banks and inequality, only a small fraction of the population and industry has access to sources of credit. Since the 1980’s, however, the Latin

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American financial systems gradually opened up, with Chile and Uruguay as the first initiators at the end of the 70’s, followed by Argentina and Colombia (Morley, 1999). Due to the Latin American debt crisis of 1982, progress came to a standstill and even to a reversal. From the mid-80’s however, structural reforms were adopted throughout the continent, with trade liberalization, financial liberalization and tax reforms as the main areas of interest. Ignoring the first factor because of the specific focus on financialization, I will describe the evolutions in these areas, alongside relevant trends in exchange and interest rates in privatization.

§2.1 Financial sector reform

One of the aims of the financial reforms in Latin American countries has been to improve competition between banks, in order to reduce the cost of credit and to make credit available to a larger part of the population and firms, through deregulation (Moguillansky, 2004), reducing state interventions in the financial markets, privatization of national banks and capital market liberalization (ECLAC, 2002). The reforms did not immediately yield the expected result, due to unsustainable credit booms and mismatches between currencies and maturities (Stallings & Studart, 2003). Tensions between the macroeconomic climate and the changed situation in the financial market created various banking crises, and mainly due to one of them, the so-called Mexican “Tequila-crisis” in 1994, Latin American governments were forced to initiate a further round of reforms. Through, increased transparency of banking transactions and deposit insurance, they tried to enhance stability through improved regulation, in an attempt to prevent future crises (Stallings & Studart, 2003). In the 1990’s, the accelerating economic growth, capital liberalization and the improved regulation started to attract foreign banks and lending to the private sector finally started to rise, Venezuela being a notable exception (see table 2.1), only to decrease again after 2000. Through mergers, take-overs and privatization, foreign banks gradually acquired a major share of the Latin American banking sector, ranging from 34% in Colombia to up to 90% in Mexico in 2001 (see table 2.2).

1985 1994 1998 2002 2004 Argentina _0.17 _0.20 _0,24 _0,15 _0,11 Brazil _0.37 _0.66 _0,32 _0,33 _0,02 Chile _0.56 _0.46 _0,58 _0,69 _0,37 Colombia Not available _0.32 _0,36 _0,25 _-0,01

Peru _0.15 _0.14 _0,28 _0,23 _0,01 Venezuela _0.52 _0.13 _0,14 _0,10 _0,11

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1990 1994 1999 2000 2001 Argentina Brazil Chile Colombia Mexico Peru Venezuela 10 6 19 8 0 4 1 18 8 16 6 1 7 1 49 17 54 18 19 33 42 49 23 54 26 24 40 42 61 49 62 34 90 61 59

Table 2.2: Latin American Countries: Foreign bank’s share of banking, 1990-2001 (Moguillansky, 2004)

Due to instability, the big foreign banks, with their high risk-aversion and prudent behaviour, preferred to invest in low-risk assets, thereby limiting credit availability. Native banks imitated the behaviour of foreign banks with the result that the cost of capital remained high, with for instance interest rates over 45 percent in Brazil (Moguillansky, 2004), which produced a slowdown in Brazilian growth and a lower level of investment (Williamson, 2006).

1995 1998 2000 2002 2004 Bolivia _35.5 _30.22 27.95 16.98 _5.51

Brazil Not available 77.68 44.73 47.85 43.16

Colombia 20.08 23.93 5.95 9.31 7.49

Equador 45.67 55.21 2.07 2.92 5.33

Paraguay 18.55 16.06 13.6 19.10 22.32

Uruguay 36.87 41.18 40.47 84.05 15.11

Table 2.3: Real interest rate in selected Latin American Countries 1995-2004 (source: World Development Indicators, the World Bank)

With regard to non-bank foreign capital, two areas are important: stock-market activity and Foreign Direct Investment. Stock markets developed only recently in Latin America, with Brazil, Argentina, Chile, Colombia, Mexico and Venezuela having the longest established ones of the region. According to De La Torre (2007) however, Latin American stock markets are still small and underdeveloped relatively to their OECD and Asian counterparts, and in relation to their nation’s GDP and macroeconomic fundamentals as can be seen from table 2.4.

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buy-and-hold-strategies (De La Torre, 2007). Both effects created problems for firms who wanted to raise funds for their operations.

1995 1998 2000 2002 2004 Argentina _1.78 _5.29 _2.10 _1.33 _4.99 Brazil _11.25 _18.62 _16.83 _10.46 _15.49 Chile _16.98 _5.56 _8.03 _4.64 _12.32 Colombia 1.36 1.55 0.47 0.33 1.50 Mexico _11.99 _8.11 _7.80 _4.27 _6.33 Venezuela _0.68 _1.68 _0.59 _0.11 _0.41 Korea, Rep. _35.81 _42.14 _208.73 _144.84 _94.00 Singapore _72.03 _61.94 _100.01 _63.58 _76.12 Thailand _33.95 _19.33 _18.95 _37.79 _68.00 Malaysia _86.48 _41.41 _64.77 _29.00 _50.61 Philippines _19.87 _15.53 _10.80 _4.04 _4.33

Table 2.4: Total value of stocks traded as a percentage of GDP, selected Latin American and South East Asian countries 1995-2004 (source: World Development Indicators, The World Bank)

As problematic as capital market developments in general seem to have been, Foreign Direct Investment did not seem to be sensitive to the macroeconomic downturn: FDI stock rose in the mid-90’s from 6 to 85 billion dollar and sky-rocketed around 1999, when for instance Bolivia and Chile had a FDI stock-to-GDP ratio of more then 12% (see table 5), compared to levels of 5% and lower in East Asia (with Singapore being a notable exception). Moguillansky explains the FDI-upsurge by the long-term commitment that Foreign Direct Investment usually has, with an interest in building-up a position in the market for the future, in contrast with the short-term interest of net capital transfers. This is a very attractive characteristic for governments who were eager to avoid financial instability.

1995 1998 1999 2000 2002 Argentina 2.17 2.44 8.46 3.67 2.11 Bolivia 5.85 11.17 12.20 8.76 8.54 Brazil 0.69 4.05 5.33 5.45 3.60 Chile 4.53 5.83 12.00 6.41 3.79 Ecuador 2.24 3.74 3.88 4.52 5.24 Singapore 13.84 9.04 20.40 18.01 6.48 Korea, Rep. 0.34 1.57 2.10 1.81 0.44 Malaysia 4.70 3.00 4.92 4.19 3.36 Thailand 1.23 6.54 4.99 2.74 0.75

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§2.2 Tax reform

Another major part of the structural reforms of the mid-80’s was to revise tax systems. Generally, it can be said that tax reforms in Latin America, just as financial sector reforms, were designed to attract foreign capital, mainly FDI. Morley & Machado (1999) shows that the progressivity of tax was significantly reduced over the past two decades, while FitzGerald (2002) states that “the present situation reflects a general downward trend in tax burdens in the

major economies of the region: the average for Argentina, Brazil, Mexico and Venezuela declined from 50% in 1983-1986 to 25% in 1993-1997. This is undoubtedly the result of tax competition in order to attract foreign investment.” The fear of Latin American governments is

that placing too high a tax burden on interest income will increase the cost of borrowing for the national population and industry, because the going rate is internationally determined in a situation of integrated capital markets. Fitzgerald (2002) argues however, that countries will not necessarily attract the Foreign Direct Investment they aim for when reducing tax burdens because the type of multinational companies that are attracted by taxation advantages are mostly the ones driven by short-term cost minimization, tending to emphasize low value-added production (FitzGerald, 2002). Last but not least, he argues that due to the fierce tax competition, governments in Latin America see the problem of raising enough resources becoming reality.

§2.3 Privatization

With regard to privatization, one can see a very heterogeneous pattern throughout the different countries in the region: while Chile already started to privatize state-owned firms in the 1970’s, countries like Bolivia, Argentina, Mexico and Peru followed at least a decade later. Privatization has been particularly important in the banking, utilities and infrastructural sector in Latin America. With regard to the magnitude of the privatization, Mexico and Argentina have been the largest reformers until the mid-90’s, while especially Brazil engaged in significant privatization operations near the year 2000 (see table 8).

1988 1990 1993 1996 1998 Argentina 0.014 _4.13 1.92 _0.24 _0.17

Bolivia _{Not available} _{Not available} _0.20 _0.46 _0.12 Brazil _0.05 _0.01 _0.54 _1.04 _5.67 Chile _0.78 _0.24 _0.20 _0.28 _0.25 Mexico _0.51 _0.76 _0.47 _0.33 _0.19 Peru _{Not available} _{Not available} _0.33 _3.64 _0.94 Venezuela _{Not available} _0.01 _0.03 _1.79 _0.09 Colombia Not available n.a. 0.54 2.54 0.61

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§2.4 Exchange rates

A last important factor in Latin America is the exchange rate, more particularly, the effects of the variability of the exchange rate. Fluctuations have been enormous throughout the region. Historically, some of the countries in the region have adopted a policy of pegging their exchange rate (for instance Argentina), while others have opted for a floating regime, like Chile. A third group is somewhere in between, in that it adopts a policy of floating exchange rates within a given bandwidth, as Mexico did. Moguillansky (2003) states that volatility has not so much to do with the particular exchange-rate policy, but more with the consistency with the macroeconomic situation of that policy. Notwithstanding Moguillansky’s comment, it seems to be highest in countries with floating exchange rates.

Interviews in the banking sector in Chile indicate that the suspicion for the enormous variability of exchange rates is on financial firms, which are said to have an active, speculative exchange risk management (Moguillansky, 2003). This indicates that not it is not only the case that exchange rate variability can create financialization, but that the financial sector actively engages in this process as well.

1980 1985 1990 1995 2000 2005 Argentina _0,00 _0,00 _0,24 _1,49 _1,30 _4,31 Bolivia _0,00 _1,86 _3,92 _7,34 _8,33 _11,49 Brazil _0,00 _0,00 _0,00 _1,45 _2,55 _3,34 Chile _49,74 _201,74 _389,75 _605,20 _746,15 _734,95 Colombia _64,94 _189,15 _570,24 _1468,13 _2849,49 _3264,77 Equador _31,89 _105,17 _852,13 _4345,75 _32572,70 _35731,80 Peru _0,00 0,00 _0,01 _3,43 _4,60 _4,90 Venezuela _5,48 _8,24 _56,61 _431,08 _911,71 _3068,64

Table 9: Exchange rates of Latin American countries 1980-2005 (National Currencies per SDR (source: IMF International Financial Statistics). Note: Rates for Argentina and Venezuela are official rates; the rates for Brazil, Colombia and Ecquador are principal rates and the rates for Bolivia, Chile, Paraguay, Peru and Uruguay are market rates

Chapter 3: Testing the financialization hypothesis

§3.1 Testing the hypothesis

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1) The change in rentier income

2) The change in wages

3) The change in the unemployment rate

The first indicator tests financialization directly through measuring the income of financial activities. The second and third indicator are somewhat indirect, in that they measure the effect of a shift in income from the real to the financial sector for workers and not the shift itself. Together however, I believe that these three processes capture the main concerns regarding financialization: that rentiers gain and that workers lose, either through a deterioration of their income or through decreased job availability. Formally, I use the following regressions:

1)

Y

rentier

=

a*X

fin

+

2)

Y

wage

=

a*X

fin

+

3)

Y

urate

=

a*X

fin

+ ,

where

Y

rentier is the change in rentier income,

Y

wage the change in wages in the real

sector,

Y

urate the change in the unemployment rate, where

X

fin represents a vector of

financialization-inducing effects and policies and is an error or disturbance term. Paragraph 3.2 will explain the exact definition of the different dependent variables. For the vector

X

fin

,

I

have nominated a set of eight determinants, which will be described in paragraph 3.3. I choose the period between 1975 and 2005 for the empirical test. This because the end of the 1970’s was the first period that saw significant reforms taking place.

The countries of observation will be restricted to the Southern American cone and Mexico, thereby excluding Central America, the Caribbean, Suriname and French and British Guyana. The reason for excluding these countries lies in 1) the significance and magnitude of each country compared to the world market and 2) data availability. Therefore, I will test my financialization hypothesis for eleven Latin American countries: Argentina, Bolivia, Brazil Chile, Colombia, Equador, Mexico, Paraguay, Peru , Venezuela and Uruguay.

§3.2 Dependent variables

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give sufficient data for Latin American countries to build up an indicator for rentier income that is consistent for a reasonable group of countries and over a reasonable period of time.

Therefore, in this thesis, I resort to an approach that is less complex and has therefore less explanatory power, but has the advantage of a consistent time-series from 1975 to 2005 for most of the selected countries. This approach is to take, as a proxy of rentier income, the annual added value (i.e. value of their final product minus costs) of the financial sector (more specifically known as the “Finance, Insurance and Real Estate sector”, henceforth FIRE-sector, an abbreviation that Hudson uses for instance) as a percentage of GDP. Of course, this less sophisticated approach fails to capture trends in for instance property income or financial activities in non-financial industries and also includes financial sector profit, which is debatable as shown in paragraph 1.3. Altogether, it is a rough approach at best, but it is in my view the only possible option to run a test in this situation with a lack of data. In paragraph 3.6, I will come back to this issue. For the dataset, I make use of the Groningen Growth & Development Centre (GGDC) 10-sector database, which is presented in De Vries and Timmer (2007). This database gives the added value of different sectors of the economy for the time-span 1950-2005 for eight Latin American countries: Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. For the three remaining countries, Ecuador, Paraguay and Uruguay, I have constructed a dataset from UN (1994 & 2003), but due to the mentioned lack of data in these publications, the time span of these datasets is significantly shorter.

With regard to a quantification of

Y

wage and

Y

urate, quantification is more

straightforward. As for wages, the purpose of the test is to determine whether workers in specifically the real sector suffer from financialization inducing processes. Therefore, as a proxy, I choose to use the wage income in the manufacturing sector. A dataset for this indicator is available through the International Labour Organization’s KILM-library (Key Indicators of the Labour Market, ILO 2005) and it gives the real wage either per hour or per month, depending on the country.12_{For the unemployment rate, I also make use of the KILM-database,}

which contains a rate of unemployed to the total labour force.13

12_{This difference per country proves to be no problem however, because the dataset also} contains an index from a base year for each specific country.

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§3.3 Some general trends

Before describing the components of my financialization-vector, I will first give an impression of some broad trends in the three dependent variables. Starting with the added value of the FIRE-sector, figure 3.1 shows us a mixed pattern, but one in which at least in most countries, the share of the FIRE-sector has gone up over the last three decades.

FIRE-sector as a % of GDP 0 5 10 15 20 25 30 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Year P er ce nt ag e Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

Figure 3.1 The share of the added value of the FIRE sector as a percentage of total GDP (based on De Vries & Timmer, 2007)

This especially holds for Chile and Uruguay, but Argentina, Bolivia, Colombia, Peru and Mexico show a peak in the 90’s as well. Brazil is the main exception: here the FIRE-sector shows an increase until the mid 80’s, after which it plunges more than 10% in a decade, quite a remarkable pattern for a country that is generally seen as on of the fastest developing countries of the 21st_{century. It is probably due to the already mentioned prudence of both foreign and}

native banks, which created incredible high interest rates since the late 1990’s, leading to a slowdown of lending.

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Real manufacturing w ages

0 50 100 150 200 250 300 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Year R ea l w ag e in de x Argentina_Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay

Figure 3.2 Real manufacturing wages in Latin America (source: ILO, 2005)

Finally, when looking to unemployment rates, we can see a remarkably similar pattern in all countries: in the 1980’s in all countries, the unemployment rate decreased fairly rapidly. This period saw capital markets opening and banking reforms. Afterwards, in the 1990’s, a period in which growth in privatization, FDI and stock markets significantly gained momentum, almost all countries (Mexico is the only exception) show an unemployment rate that increased at least as fast as it decreased in the 1980’s (and sometimes much faster). This observation could be supporting financialization theory that states that financialization-inducing processes do indeed play an important role in employment in the real sector. Regression analysis will tell us more about this. Unemployment rate 0 5 10 15 20 25 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 Ye ar U ne m pl oy m en t ra te (% ) Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

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§3.3 Set of financialization-inducing effects

After determining indicators for the dependent variable, I need to find measures of quantification for the set of financialization-inducing effects. Knowing that a complete list with all the possible financialization-inducing effects may be impossible to achieve and that every attempt is an approximation at best, I define, based on the chapters above, the following indicators (with their quantification and data source) as possibly financialization-inducing, together with their expected effect, their data source and the general trends over the past decades:

1) The growth of stock market activity: I expect this indicator to have a positive effect on

rentier income, because increased stock market activity creates an opportunity for speculative behaviour and capital gains. However, an increased activity in the stock market means more short-term ownership and therefore generally less attachment of shareholders to a firm. The mentioned concept of the shareholder revolution therefore creates the expectation that increased stock market activity will create a situation with less long-term investment and will therefore have a negative impact on industrial wages and job availability.

As a proxy for the activity in stock markets, I take from the World Development Indicators the indicator “Amount Traded in Stocks as a Percentage of GDP”, and the indicator “Market Capitalization” (i.e. the stock price per share times the number of outstanding shares) as a second indicator.

Total value of traded stocks as a % of GDP

0 0,05 0,1 0,15 0,2 0,25 0,3 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Year To ta l v al ue a s a % o f G D P _Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Uruguay Venezuela Figure 3.4 Total value of traded stocks as a % of GDP (source: World Development Indicators)

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in the most recent years. Each peak was followed by a decline afterwards. Noteworthy in this regard is that Mexico did not participate in the most recent peak, but continued its declining trend, probably because of the effects of the Tequila crisis. 2) Capital market liberalization: because an open capital market means more opportunities

for investment, I expect a positive result for both real and rentier income. However, because of the above mentioned process of growing international capital liquidity and the problems that these processes bring in the real sector, I expect a dubious result for the manufacturing wages. For rentier income, an absolute positive effect is expected, because the opening up of international capital markets means more possibilities for speculation and rentier income. An indication for this is given by Epstein and Jayadev (2007), who show that a reduction in the interest controls (which is part of capital market liberalization) is correlated with a significant increase in rentier return, while Harrison (2002) shows that openness of capital markets is negatively correlated with the share in income of labour. For the openness of capital markets, I will make use of the Ito Financial Openness dataset, the details of which can be found in Chinn-Ito (2005).

Chinn Ito indicator of capital market openness

-2 -1,5 -1 -0,5 0 0,5 1 1,5 2 2,5 3 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Year C hi nn It o In di ca to r _Argentina Brazil Chile Colombia Mexico Venezuela

Figure 3.5 Chinn-Ito Indicator of capital market openness (Chinn-Ito 2005)

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3) The amount of privatization: I expect a positive effect of this indicator on rentier

income, because privatization operations mean more opportunities for capital gains and financial services. For real sector income, the expected effects are more dubious: while privatization generally means more efficiency (and therefore a possible higher labour productivity and a higher wage), it can also mean a loss of jobs. Besides, with privatization, the long-term interest of the owner generally decreases, which means less long-term investment and lower expected wages. However dubious, I therefore expect the total effect of privatization to be negative.

The amount of privatization can be measured as the amount in dollars received by the government in privatization operations. This dataset is taken from the World Bank Privatization Database, located at http://rru.worldbank.org/Privatization. Although the sheer magnitude of the privatization operations in Brazil overwhelms the data in other countries, the trend is still clear: while the 1980’s where relatively quiet in terms of privatization, the first peak started in the beginning of the 1990’s, with a second, bigger, peak following in the late 1990’s, after which the yearly operations declined again steadily, because the most important state-owned firms were privatized by then.

Privatization operations in millions of dollars

0 5000 10000 15000 20000 25000 30000 35000 1988 1990 1992 1994 1996 1998 2000 2002 2004 Year P ri va tiz at io n op er at io ns Argentina_Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela Figure 3.6 Absolute value of privatization operations (source: http://rru.worldbank.org/Privatization)

4) The growth of the banking sector: I expect this indicator, although it could be viewed

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Total banking claims as a % of GDP 0 0,5 1 1,5 2 2,5 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Year To ta l b an ki ng c la im s _Argentina Bolivia Brazil Chile Colombia Ecuador Paraguay Peru Uruguay Venezuela

Figure 3.7 Total banking claims as a percentage of GDP (source: International Financial Statistics)

A proxy for the growth of the banking sector is the IMF International Financial Statistics Indicator “Total of claims of banks on the economy relative to GDP”.

From figure 4.6, one cannot discern a clear trend in the data. While there some distinguished peaks, at the least the one for Ecuador looks suspicious and seems rather induced by methodology revision than by an economic trend. Concerning Latin America as a whole, it looks like total banking claims on the economy have been relatively stable over the past decades, with the exception of Brazil.

5) The percentage of foreign banks in the banking sector: this indicator is expected to

have a positive effect on rentier income (especially on foreign rentier income), because of the increased opportunities for capital mobilization and, besides, as entrance of foreign banks generally creates a more efficient, stable and sounder banking-system, so that the system is less vulnerable to crises. For real sector income, the effect is supposed to be positive as well: through the entrance of foreign banks, a more competitive market develops, in which the availability of credit increases and its cost decreases. The effect also has its downturn, as is argued in chapter 1: the danger of ‘cherry-picking’ only the most transparent and safe firms when offering credit. Besides, from chapter 2 it became clear that entrance of foreign banks did not automatically lead to increased credit availability in Latin America.

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available. In general, although the shares are quite different from those in table 2.2, the trend is grossly the same: a gradual increase, that speeds up around 2000. In this graph, especially Mexico and Uruguay show a remarkable increase in asset share of foreign banks, while Colombia is the only country that does not show a significant increase

Assets of Foreing Banks as a share of total bank

assets

0 10 20 30 40 50 60 70 80 90 100 1995 1996 1997 1998 1999 2000 2001 2002 Year S ha re Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

Figure 3.8 Asset share of foreign banks in host country (source: Micco 2004)

6) The variability of exchange rates: this effect has advantages for rentier income because

it opens up a window for speculation, as for instance Argitis (2006) argues. However, with increased variability comes uncertainty which is negative for both rentiers and the real economy. So although dubious for rentier income, one can expect the exchange rate variability to be negative for real sector income, as an unstable exchange rate discourages foreign investors in making long-term investment, while it encourages short-term financial investments. Furthermore, while rentiers have to possibility to hedge against exchange rate swings through portfolio’s and hedge funds, in general workers do not have this opportunity. Harrison (2002) shows indeed empirical evidence that swings in exchange rates place a disproportional burden on labour.

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Exchange rate variability 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19791981 198319851987 19891991 1993199519971999 200120032005 Year S .D . t o pe ri o d-m ea n Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

Figure 3.9 Standard deviation of exchange rate (source: International Financial Statistics)

When plotting the exchange rates for all countries, one can see that until the 1990’s, exchange rates were quite stable. From the mid 1990’s, the variability of the exchange rate has risen steeply and continued to do so after 2000 with no real exceptions. This is probably partly due to the second round of financial market reforms, which stimulated global interaction and speculation, and partly to country-specific characteristics, like crises, of which the steep increase in variability in Argentina in 2003 is a marked example.

7) The height of the interest rate: I expect a high interest rate (either followed or not by a

lower rate) to have a positive impact on the shares of rentier income, as is for instance argued in Argitis (2002) and shown in Epstein and Jayadev (2007) for OECD countries. I expect an obvious negative effect on industrial wages, because increased cost of capital decreases both profitability of production labour productivity .

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Annual lending rates

0 50 100 150 200 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Year % r at e of le nd in g Argentina Bolivia Brazil Chile Colombia Ecuador Mexico Paraguay Uruguay Venezuela

Figure 3.10 Annual lending rates (source: International Financial Statistics)

8) The increase in housing prices. While having an expected direct and positive

relationship with rentier income, the effect on real sector income is in my expectations negative, because the cost of production becomes higher with more expensive property prices and thus profitability will be lower.

Log of renting prices

2 2,5 3 3,5 4 4,5 5 5,5 6 6,5 7 1990 1992 1994 1996 1998 2000 2002 2004 2006 Year R en tin g P ri ce s Argentina

Brazil, Rio de Janeiro Brazil, Sao Paulo Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

Figure 3.11 Log of renting prices in capital (source: EIU ALACRA data services, City Database)

Financialization and its determinants in Latin America