What was the "Great Transformation"?

Written during the international political and economic crisis of the late 1930s and early 1940s, The Great Transformation develops an explanation for the collapse of the generally peaceful and prosperous period from the fall of Napoleon in 1815 to the outbreak of World War I in 1914. According to Polanyi, the roots of the global crisis of 1914 to 1945 lie in the British Industrial Revolution of the late 18th and early 19th century, and the responses of different social groups, political elites, and economic thinkers to it. The birth of market liberalism - the idea that all of human society should be subordinated to laissez-faire, self-regulating markets - was part of this response. When Britain became the undisputed international economic and military leader after 1815, market liberalism became the organizing principle for the entire global economy.

Although Polanyi acknowledges the great gains in material living standards that commercialization and industrialization have made possible, he argues that these processes in the context of an increasingly marketized economy also generate tremendous economic instability and social dislocation. Thus, the drive to impose unregulated market capitalism on workers, farmers, and business enterprises created a society-wide counter-response designed to protect these social groups from the costs of economic development. These protective counter-moves included the growth of the trade union movement, farmer's organizations, and increasing government regulation over the economy. This social self-protection movement, in turn, interfered with the workings of the free market, unleashing increasingly severe domestic and international political tensions that eventually caused the collapse of the peace and prosperity of the 19th century and ushered in the three-decade long era of global economic and political crisis that began in the summer of 1914. The "Great Transformation" that Polanyi speaks of involved the rejection of utopian market liberalism in the 1930s, in favor of alternative national economic polices such as the New Deal in the United States, Nazi economic policies in Germany, and the first Soviet five-year plans.

Key Concepts and Themes

Embeddedness

Polanyi maintains that any economic system is inevitably "embedded" in a broader system of social norms and political regulations. These alleged "interferences" with markets are not illegitimate, as modern economics would have it, but rather they are natural facets of any economy, necessary to maintain political and economic stability. For example, most pre-modern economies were organized according to principles of reciprocal obligation or centralized redistribution; markets and strictly economic motives played secondary roles. Even the more highly commercialized economy of 16th century England saw labor markets and land use firmly regulated through legislation including the Poor Laws, various Anti-Enclosure acts, and the Anti-Settlement Law.

To Polanyi, the greatest problem with modern economic thought is that it tries to deny this reality of embeddedness. Using the concept of a self-regulating market, classical economics (beginning with Ricardo and Malthus) attempts to divorce the economy from its larger social and political context, imagining, wrongly, that the economy is its own distinct sphere of human activity.

The roots of this attempt to create a separate economic sphere of activity can be found in the changes wrought by the Industrial Revolution. The increasing sophistication of new technologies meant that full capacity utilization and large production volumes were needed to make profits. Enterprises simply had to be able to purchase all inputs, including labor, credit, and natural resources, at all times and in sufficient quantities to keep expensive plant and equipment running, while markets for output had to be large enough to justify the initial investment. In other words, more and more economic activity had to be organized through the market.

The classical economists turned this need for increasing commercialization of economic activity into a broad-based campaign to reify the self-regulating market. In this view, "market liberalism" goes far beyond simply the use of markets - networks in which goods are bought and sold. Even the ancient economies based on reciprocity and redistribution had these. No, the classical economists conceived of a market economy as one in which a society-wide system of interlocking markets for goods, land, labor, and capital automatically adjusts prices, wages, rents, and interest rates according to changing supply and demand conditions. If realized, such a vision would require the complete subordination of politics and social relations to the dictates of the market economy. Far from being a "natural" state of affairs (as we have already seen), Polanyi argues that the self-regulating market economy in practice would create a grim dystopia of economic instability and social dislocation. In fact, says Polanyi, such an economic organization could never be realized, as it would destroy the very foundations of human society and the natural environment. Nonetheless, British political elites who bought into the classical economic philosophy used the powers of the state to try to bring about the self-regulating market, through legislation including the Poor Law reform of 1834, The Bank Act of 1844, and the Importation Act of 1846 repealing the Corn Laws. Thus, contrary to the arguments of libertarian thinkers like Hayek, the market economy was actually introduced in a planned, conscious manner using state power.

The "Fictitious Commodities" and the "Double Movement"

Why can't a self-regulating market economy ever be realized in practice? Pure market liberalism requires that people, nature, and finance capital be turned into pure commodities: labor, land, and money. Polanyi's definition of a commodity, though, is anything that is produced explicitly for sale on the market. But land, labor, and money do not fit this definition, as none of them are really produced for the market. Money is a token of purchasing power that exists because of state action. Land is nature, subdivided; it is not produced by people at all. Labor is, in actuality, human activity that is ultimately undertaken for reasons other than pure material gain. Much of economic theory is thus based on a fiction. In contrast to the ideas of the classical economists, land, labor, and money cannot and will not act as real commodities do and thus their allocation can never really be organized purely through the self-regulating market.

Part of Polanyi's argument here is a practical one that relates back to the idea of embedding that we have already discussed. As unrestrained markets impose increasingly severe costs on people and nature - social dislocation, community decline, greater economic insecurity, ecological degradation - society takes steps to protect itself. This is the second aspect of Polanyi's  "double movement" - the first movement is toward market liberalism, the second is the socially protective counter-movement. Workers demand that labor markets be increasingly organized by trade unions, and the state to step in to regulate minimum wages, maximum working hours, and to provide disability and unemployment benefits. Business wants the money supply and the banking system to be regulated by a central bank. Farmers agitate for land use regulations and farm price supports to protect themselves from the ravages of the market.

There are a number of interesting conclusions here. The state is never truly separate from the economy; it must step into these key markets for the "fictitious" commodities in order to promote economic and social stability. Also, the counter-movement for social protection is not the outcome of a simple class struggle between labor and capital; all segments of society participate in it. Finally, and again, contrary to contemporary libertarian thought, this social protection is typically introduced piece-by-piece, and pragmatically, rather than though some grand socialist plan. It is the market liberals, not their political opponents, who are the true utopian planners.

Perhaps even more importantly, Polanyi is also making a moral argument here: Human life (labor) and nature (the environment) have a sacrosanct dimension, an intrinsic worth that is not simply reducible to a market price, and thus can never be fully reconciled with complete subordination to the market.

Global Rules Constrain Domestic Options

Of course, as Polanyi emphasizes, individual countries are not completely free to regulate domestic economies as they see fit, because the rules governing the global economy constrain domestic political options. During the 1815-1914 period those rules were (informally) codified into a system known as the international gold standard.

The gold standard, according to Polanyi, represented the ultimate attempt to implement the self-regulating market economy on a global scale. To do so required that people be allowed to freely conduct goods and capital market transactions across national boundaries, i.e. free international trade and free international capital flows. The solution to this problem came to be that countries agreed to back domestic currencies with gold. This meant two things:

• Fixed Exchange Rates - every country committed to setting the value of its currency at a fixed amount of gold, and to freely buy or sell gold to the public at that price. For most of the late 19th century and up through 1914, for example, people could exchange U.S. dollars for gold at the rate of $20.67 to the ounce. British pounds sterling could be exchanged at the rate of approximately £4.24 to the ounce (note that this also fixes the exchange rate between the dollar and pound at just less than $5 to the pound).

• Free International Capital Movements - there were to be no restrictions on individuals exporting gold to, or importing gold from, other countries; i.e. no restrictions on foreign investment flows into or out of a country.

These restrictions put stringent conditions on a country's monetary policy. Countries that faced a domestic price/production cost structure that was too high relative to world levels, and thus suffered "balance of payments" deficits (i.e. trade deficits or capital flight or both) and outflows of gold had only one policy option: deflate the economy by raising interest rates and shrinking the money supply until wage cuts reduced consumption enough to limit imports, and interest rates rose enough to bring back foreign capital. Essentially, a nation's money supply would be limited by its' gold supply. This meant that countries could not use monetary policy effectively to fight economic depressions, or to bail out the banking system in times of financial panic, if it were also suffering balance of payments deficits. Many European nations, including Britain and Germany, found themselves in this position during the 1920s and early 1930s, which was a significant factor behind the global spread of the Great Depression.

Polanyi's historical argument maintains that the workings of the gold standard system, by periodically inducing deflationary monetary policies, cuts in wage and farm income, rising unemployment, and increasing levels of business and bank failures, imposed costs on all sectors of society, who then demanded the protective measures to isolate themselves from the worst effects of the global economy, including higher protective tariffs. The increase in trade protectionism led nations into increasingly desperate attempts to establish overseas colonies to preserve access to markets and raw materials supplies. International political and military rivalries intensified, breaking the balance-of-powers system under the strain and culminating in economic and social disaster: two World Wars and a Great Depression. The problems, according to Polanyi, were not merely the outcome of protectionism or imperialism, as these were simply responses to the real cause of the crises: the attempt to impose utopian market liberalism on the global economy.

Modern Relevance

Hopefully it is clear by this point that, although it was written to explain events that are a century old, the ideas expressed by Polanyi in The Great Transformation continue to have plenty of contemporary relevance. The parallels between the market liberalism of the 19th century and modern neoliberalism should be apparent. The vision of the self-regulating market economy is still one that is firmly entrenched in the minds of many academic, political, and media elites. There are also parallels between Polanyi's analysis of the gold standard system and modern attempts to restrict domestic policy making such as the "Washington Consensus" or Thomas Friedman's "golden straitjacket," which are inspired by the market liberal vision.

Perhaps these lessons for contemporary progressive economic policy can be distilled from Polanyi's efforts:

1. Market economies, although capable of generating enormous increases in wealth, also impose on people and nature unsustainable levels of economic instability, social dislocation, and ecological destruction, in the absence of protective government regulation or social norms.

2. Any economic system thus depends fundamentally on an active public role; political regulation is not illegitimate interference with the workings of the market ("protectionism"), it is absolutely necessary to ensure acceptable functioning of the system.

3. Some degree of public management of markets for the "fictitious commodities" - labor, capital, and land - will be especially important.

4. The global economy also needs strong regulatory institutions to avoid the recurrence of crippling economic crises.