Markets and Industrialization

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

I just finished reading Karl Polanyi’s The Great Transformation, part of an effort to actually read through some classic texts in economics. He gives an account of the rise of capitalism in order to set himself up to describe the crisis in capitalism that he sees around him (he is writing in 1944 and for obvious reasons things don’t seem so rosy at that point).

His ultimate point regarding the role of the gold standard as a kind of organizing principle around which capitalism revolves is dated, but there is some value in thinking about how the flow of funds and trade between countries does have some distinct social implications. However, I found myself struggling with the description of industrial development he lays out as background for his discussion of the gold standard. He begins by highlighting the lack of money-based transactions in pre-industrial Europe, and how this indicates that markets did not exist.

Polanyi makes a common error, which is confusing money as a unit of account with money as a medium of exchange. When we talk about supply and demand, and equilibrium prices and quantities, we almost always talk in terms in some currency (e.g. the number of pizzas is 15 and they each are sold for $10, for a total value of $150). But this is using currency as a unit of account only. It is convenient to talk about dollars, but not necessary. I could just as easily draw supply and demand diagrams, and find out equilibrium prices and quantities using another commodity as the unit of account (e.g. the number of pizzas is 15 and they each are sold for 3 beers, for a total value of 45 beers).

So while modern economies use money to make exchanges in markets, that does not meant that an absence of money implies the absence of a market. You can have a fully functioning market even though no slips of paper or little metal coins are used in any transaction. Most importantly, the logic of supply and demand is perfectly valid even without money being used as the medium of exchange.

Further, the absence of observed exchanges does not imply the absence of a market either. It is quite possible to have a market in which the equilibrium outcome is for everyone to consume their endowment of goods. In fact, I think this is more likely to occur in very simple economies where the number and types of goods are limited. If we all produce one chicken and four sacks of wheat, and we all have similar preferences, then in the end we’ll all end up eating one chicken and four sacks of wheat. If we’re smart, we’ll make waffles and fry the chicken, but that’s a different topic.

In the chicken/wheat economy, there is an implicit price for chicken and a price for wheat, even though we don’t observe any transactions at this price. The absence of transaction data means it is hard to estimate what demand or supply curves look like, and therefore makes it hard to predict what would happen in the event of some kind of demand or supply shock, but the curves are still there.

Polanyi makes much of the shift from non-money to money exchanges, assumning that this suggests a move from autarkic production (all households acting individually) to market production (households taking prices as given). But the absence of money doesn’t mean autarky and an absence of markets, and so his underlying premise just doesn’t hold up. While there are still some fascinating passages to consider in the book, as a functional story of industrial development it isn’t terribly useful.

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