What is money?

Dr. Peter Bowman

Tutor at the School of Economic Science, and member of the Council of Management of Henry George Foundation reflects on Karl Polanyi's 1943 book "Great Transformations"


Although the calamitous events of Autumn 2008 did not in the end result in total collapse of the financial system, fifteen months later the sense still remains of an economy in crisis. Those events were symptomatic of a deeper malaise. It was certainly not the case that before that time all had been well. The appearance of growing prosperity over the previous decade proved to be largely a sham.

When the bubble broke the underlying instability of the present system was revealed. Even if the goal of a return to growth of GDP is achieved two deeper issues that rankle beneath the surface will not be driven away by simply reinstating ‘business as usual but with more regulation.’

The first is the growing gap between the rich and the poor that is present both between different countries and also within each country itself. It is this inequality rather than poverty that is now recognized (Wilkinson & Pickett 2009) to be the source of a whole range of gradually worsening social ills, particularly in the developed world. The second is the effect of growth-impelled economic activity on the environment. This is resulting in both the rapid depletion of natural resources and the excretion of growing quantities of pollutants that the world’s eco-system cannot cope with.

The crisis has produced for some a waking up to the reality of our present situation. In so doing it provides the opportunity to examine critically our whole economic system and review the depth of reform needed to deal effectively with these underlying issues as well as the inherent instability. Is it the case, as some have suggested, that the free market hypothesis is inherently flawed and that our system is rotten to the core? Behind the drive for growing material prosperity at any cost that our present market economy facilitates is an overtly materialist worldview. Could it be that this is a cultural crisis and that nothing short of a change of this fundamental stance can provide the change of direction that is needed?

After acknowledging the possibility this essay will leave that question to others and focus just on the economic realm. It will attempt to look holistically at the present situation to uncover its underlying shortcomings and what could be done to remedy them.

The most helpful tool in such an examination would be a model or framework that is capable of fulfilling three functions simultaneously:

(1) to provide a basis for analyzing the underlying faults in the present system that have led to the destructive crisis,

(2) to provide a basis for a better system, one that is fairer, more stable and sustainable and

(3) to provide a "roadmap" to take us from the former to the latter.

Karl Polanyi and The Great Transformation.

The thesis is that such an analysis of our present free market system was provided by the political economist Karl Polanyi, in his classic work: The Great Transformation written some 60 years ago (Polanyi 1944). Through his comprehensive analysis that combined social, economic and historic perspectives this author identified the critical weakness that would inevitably lead to the self-destruction of the free market system. When, contrary to his prediction, the world’s economy got back to its feet after the Second World War there seemed to be a good reason to ignore his analysis but sixty years on its prescience is again being recognized (Spratt et al. 2009).

In its essence Polanyi's argument is very simple. It cuts right to the heart of the present crisis. Polanyi did not criticize the market system in itself. He recognized that markets have been a social phenomenon throughout man’s history. What he gave original thought to was the natural limit of the market system, what should be included in it and what excluded.

The traditional function of a market is the exchange of commodities, a term which implies man-made goods. These range from extracted raw materials and agricultural produce through intermediate goods to complex finished products. According to Polanyi what happened to sow the seeds of self-destruction in our present free market system was a deception. It was the pretence that the primary elements of the economy, namely land, labour and credit, are commodities that can be traded in the market in the same way that actual commodities can. He pointed out that these primary elements of the economy are patently not commodities in that they are not man-made goods. Markets in labour, land (the distinguishing aspect of ‘property’ and ‘real estate’) and credit are artificial and will behave totally differently to markets in commodities.

These basic elements are of an entirely different category to man-made goods and the economic laws they follow are entirely different.

For Polanyi, the admission of this pretence that these factors would follow market theory was not only unreasonable but ultimately destructive. Here is the heart of the problem with the current free market system. This underlying pretence is the cause of its inherent instability and has given rise to the (often unrecognized) characteristic feature of its history which is a series of cycles of ‘boom and bust.’ It is in the markets in these primary elements that the difficulties of our present economic system lie. Note the main features of the last crisis: the self-destruction of the credit market, the stagnation of the closely connected property (i.e. land) market, shortly to be followed by a significant increase in unemployment. With the primary factors so de-stabilized the real market economy then suffers consequently as an innocent victim.

Since economists themselves have taken up the pretence the subject of economics as it is presently taught has rendered itself incapable of describing the real working of the economy and hence of explaining and predicting the recurring cycles of boom and bust that frustrate it (Bezemer 2009).

Why is it fundamentally wrong to have markets in these basic elements?

Consider land. In economics this term is used to include all natural resources. In other words, it denotes the part of the economy that is not man-made. It is, in the words of Alfred Marshal, the ‘free-gift of nature.’ It follows that because it is not man-made one of its fundamental economic characteristics is that its supply is inelastic, (‘they’re not making it anymore’ to quote Mark Twain). Therefore land does not respond to the law of supply and demand in the way manufactured goods do. Unlike motor cars or toothbrushes, when the demand for land increases the supply cannot be increased to match, it is perfectly inelastic and all that happens is the price goes up.

To be traded land must first be claimed. To many cultures of the world, such as the North American Indians, the notion that land can be owned and hence bought and sold was incomprehensible but it has become ingrained in Western thinking despite the reasoning of philosophers such as Locke.

In his view (Mazor, 2009), the basis of a claim to a property in anything lies in the work done (directly or indirectly, for example through trade) to produce it. There can be no such claim for land, since by definition; man does not make it. However the tendency to ignore this and claim land as private property is difficult to resist. Because it is such an essential pre-requisite to all human activity and has an inelastic supply it is one of the most valuable of assets.

In addition there is the fact that at this time on this planet, with its current human population, land of quality good enough to sustain a high level of human well-being is scarce. As such it enters the market place to become an irresistible object of speculation and because it is so fundamental, since everyone needs somewhere at least to live, the asset bubble has to follow and take precedence over the real needs of the economy.

The market in land can never come to equilibrium in the way that markets in manufactured goods do.

Credit is almost as fundamental to economic production as land. Its essential function is to provide a bridge to cross the time gap between the start of any economic activity and its point of completion when it can provide a return for the producer in the marketplace. The farmer has to sustain himself between the time he plants his crop and when he harvests it, the craftsman and builder must purchase their materials before they can even start their work. Even the shopkeeper must purchase his goods before he can sell them on to his customers.

For all these and other productive activities credit is absolutely essential.

In the hands of the banking system this primary function has become privatized and effectively monopolized. It has been distorted from an essential economic service into a method of making returns for its owners and a few select employees at the expense of the rest of society.

One effect of this distortion is that credit is directed not where it is actually needed but where it can gain the largest returns for its issuers. Even where it is for productive purposes these are usually of a large scale and of questionable overall social and environmental benefit: mechanized energy intensive large-scale agriculture, large-scale production of short-lived consumer goods driven by advertising rather than real need, large centralized energy schemes.

A high proportion of credit issued is not for production at all but for speculation on assets or even just to finance consumption. The removal of the separation between the credit-creation of conventional banking and the operation of investment banking has led to the use of bank credit in leveraged operations to greatly expand the power of financial institutions to engage in highly profitable what was recently described ‘socially useless activity.’ (Hosking 2009)

In the hands of the private banking cartel credit has been transformed from an essential economic service into the pretence of a commodity whose price is the rate of interest. The pretence overlooks the underlying economic truth that, like land, credit does not obey the law of supply and demand in the way that manufactured goods do. The ‘cost of production’ of credit is negligible and its supply is without any natural limit. Once the agreement with the customer has been made a bank ‘loan’ can be produced simply at the stroke of a pen or the pressing of numbers on a computer keyboard.

The market in credit can never come to equilibrium, it can never clear in that way that markets in goods do, and hence it always remains under the control of its producers, the banks (Werner 2005), until they overreach themselves.

The existence of a ‘labour market’ where human beings are themselves treated as little different from a commodity contributing one of the costs of the productive process is largely a result of the monopolies of privatized land and credit. Under conditions where the land and the other natural provisions of nature are no longer freely available but only accessible at the monopolist’s price and the basis of the extension of credit is to maximize the return to the issuer the relative bargaining power of employers and employees is so uneven that the latter have little choice but to accept what is offered.

In most modern economies it has become acceptable to maintain a significant proportion of the workforce unemployed. Having excess ‘supply’ helps to keep the cost of labour low. In developed countries the worst effects of this commodization of labour have been ameliorated through social provision by the state but taking humanity as a whole the effect of this has simply been to export the worst effects to less developed countries.

In the process known as globalization multi-national companies continually move their production to where lower wages can be paid and poor working conditions remain acceptable. This has generally depressed earnings of labour everywhere. In the developed countries, to maintain what they regard as an adequate standard of living workers have been pressed to supplement their inadequate earnings with debt using their homes as collateral.

The effects are worsened by the way most governments have chosen to use wages as the basis for taxation, diminishing yet further the proportion of the wealth that workers produce that they are able to retain for themselves.

These are the economic effects of the commoditization of labour. The human consequences go much deeper. The nature of work has fundamentally changed. For many it is no longer something that is fulfilling and satisfying in its own right, it becomes just a means to an end. People now work not for what they can contribute but for what they can get out of the system and attempt seek their satisfaction in other avenues.

What is the solution?

If Polanyi's analysis is correct, then, in addition to indicating the underlying causes of the present crisis it can also point to a remedy. This would be a move to an economy in which the market is limited only to commodities and the primary elements: land, labour and credit are excluded. For this to take place governments would need to enact their fundamental duty to protect these components from exploitation and thus enable them to fulfill their respective primary economic functions.

This does not require centralized state control. On the contrary, it offers the possibility of truly free market with economically free people having unexploited access to the land and credit that is needed for genuine prosperity. The route to achieve this would be to take the primary factors out of the market system. They need to be ‘de-commoditized’.

How can this be done?

First consider credit. To begin to stop thinking of credit as a commodity and start thinking of it as an essential economic provision requires a fundamental change in attitude. In the developing world this step was taken with the introduction of the micro-financing schemes starting with the Gramene Bank (Yunus 1999). The transformative effect on many thousands of poor people able to take advantage of the scheme has been to begin to lift them out of abject poverty.

In the developed world there is much public confusion and misunderstanding over the way the money and banking system work. As the proportion of money that exists in bank accounts rather than as cash has grown so also has the proportion of the money supply that is produced by the private banks rather than by the government.

On the basis that ‘every advance creates a deposit’ the proportion of the UK money supply that has been privately produced as bank credit has now risen to 97%. The nation’s money supply has become interest bearing bank credit. An essential government function and all the economic privilages that go with it has been gradually and unwittingly handed over to a privately owned cartel.

However, as was demonstrated by the bailouts, the ultimate responsibility for the money supply remains with the government so it is left to pick up the pieces and the taxpayers the bill when these private institutions, through their greed, and incompetence fail.

Credit is essential for economic activity. Where it is directed will prosper and where it is restricted cannot flourish. With the present private banking system and ‘commodity’ model of credit the basis of where it is directed is not how socially or even economically useful the recipient’s purpose is but rather what achieves maximum return at minimum risk for the issuer.

When credit is used for investment in ‘real’ economic activity such as manufacturing then the effect can be real economic growth.

When it is used for the purchase of assets such as real estate in the hope that they will increase in value then the long-term result must be inflation.

Similarly, if credit is issued for consumption, although this may have a short term stimulating effect in the long term it is not likely to produce a sustainable increase in economic activity.

The differing effects on the economy of these different uses of credit are highly significant but it is not in the interests of private banks to recognize them.

Even in this age of electronic money there is good reason to return the function of issuing money to the government and restrict the banks to what most people think they do now – not creating credit but putting their customer’s deposits to good use by investing it in productive enterprise.

With the adoption of the policy of quantitative easing the central banking has recently been openly creating new money but it could be put to much more productive use. Financing much needed infrastructure projects – particularly low carbon energy production - would have a much greater impact on the real economy than its present use of buying back debt.

Under the present conditions with the private banks showing great reluctance to extend credit for productive purpose whilst they rebuild their balance sheets there is a real need for an institution to take on the traditional function of banks and supply credit to the real economy, for the sake of the economy rather than its own gain.

Such is the fundamental importance and therefore high price of land that in our present commoditized arrangements well over two thirds of the credit issued by banks is for mortgages on domestic or commercial property. Redirection of credit away from speculative purchase of assets either directly or through leverage take-overs would be a first step of removing land from the market mechanism.

A further significant step could be achieved in a less direct way as a consequence of reform of the way Government collects its revenue. To appreciate how this could be achieved requires taking a fresh look at what the basis of the value of a plot of land is, particularly in an urban environment where the more valuable land is now found. One sees that it is not the land itself as a piece of earth which is where the value lies but rather with the access to public goods and services, markets, and an environment propitious for business or domestic occupation, that owning that site provides.

In the present system of privatized property all these benefits come free of charge to the owner once he has acquired the plot. The public aspects of these services do have to be paid for by someone. At present it happens indirectly through the system of taxation, mostly levied on labour as income tax but on various other taxes as well.

Perversely, as a community grows and the location is enhanced so the owner receives greater benefits but this enhancement is also reflected in the growing (land component of) property value and increased equity accrues to the private owners as well as the benefits of the location.

This was illustrated quite vividly with the extension of the Jubilee Line in South London in 2000 where an infrastructure development costing £3.5 billion and financed by taxation raised property prices in the locality by an estimated £13.5 billion (Riley 2001). It can also be seen in the way property prices around a good school command a premium.

On this analysis the value of all services and other benefits a particular site receives by virtue of its location can be equated with the rental value of the site (stressing strongly that for any building this is only the site component, not the full market rent for the premises). If the landowners had to actually pay the community back for these services the site-related component of their unearned rental income would be now matched by this expense (Burgess 1993).

The ramification would be that no unearned income would any longer accrue from merely having property in land. It would become particularly disadvantageous to hold land out of use in the hope of making speculative gain since the service expenses would still have to be met but without any corresponding income.

The only reason for having property in land would be to actively make the best use of any advantages a given location offered. The best sites, would be available at a premium, but with the payments now going to the suppliers of the services, i.e. the community as represented by either local or central government. For the enterprising, marginal sites would be available at very low cost.

Here is the second step of reform, the charging for public services by location using land rentals as a means of evaluating the overall value. The overall effect of this would be to de-commoditize land. It would no longer be worthwhile to treat it as a good that can be bought and sold. It would remain a valuable primary factor of production, which would have to be put to good use for it to be retained.

A similar system could be applied to natural resources. The extractor would be paid the costs of extraction including normal profits. (The value of this could be decided by auction as recently happened in Iraq). The resource rental, the difference between the extraction costs and the market value of the resource would then fall to the local community. This could provide a much-needed source of public revenue for many developing countries.

An additional advantage of using land and resource rents as a major source of Government revenue is that the burden of taxation could be taken away from labour and enterprise.

Setting the economy free

The combined effect of de-commoditized credit directed towards productive economic activity, de-commoditized land freed from speculative valuation and the burden of taxation removed from production would have a huge impact on the conditions for engaging in economic activity and hence on the ‘labour market’. With the possibility of self-employment and associated meaningful work so much more accessible there would be a shift in bargaining power from the employer to the employee. A viable alternative to ‘wage slavery’ would be much more realistic. The possibility could also arise of full employment.

More and more of the workforce could begin using their working life as a means of utilizing their innate talents rather than just earning enough to keep body and soul together.

From this follows the possibility of a general uplift in society. There would be the opportunity for a move away from cheap, low quality manufactured goods that the circumstances of the debt-based economy forced upon us, back towards the production of quality goods that actually provide the purchaser with some lasting satisfaction. This shift would also have positive effects for the environment. In the long term longer-lasting quality goods require fewer raw materials taken from nature and less pollution. The freeing up of the labour market would encourage a general increase in the quality of service offered including the rejuvenation of a maintenance industry. The incentive could be for quality rather than quantity.

For example the new labour and land tenure arrangements would make quality domestic food production much more viable. With credit sensibly directed there would be the possibility of bringing low carbon energy production into play.

In addition, and of the greatest importance, is the effect these changes have on our social welfare. The removal of the special privileges accruing to the effective monopolies on land and credit in combination with greater opportunities for productive employment would directly address the underlying causes of the inequalities in wealth and income we see in both developing and developed economies. This in turn would bring about a considerable reduction in the gap between the richest and poorest with the consequent wide-ranging social benefits that are now recognized to accrue to more equal societies.

Polanyi’s insight offers an analysis that is both simple and deep. The aim here has been to no more than sketch out how it could provide a basis for the transformation of the economy towards something that is more stable, more just and less damaging for the environment; one that continues to embrace the extraordinary technical achievements of the age whilst at the same time offering the opportunity for a much greater proportion of humanity to find fulfillment and satisfaction through their everyday work; one in which the rewards obtained for honest endeavour are preferred to those achieved through exploitation.


Bezemer, Dirk (2009) No-one Saw This Coming: Understanding Financial Crisis Through Accounting Models, Munich Personal PePEc Archive.

Burgess, Ronald (1993) Public Revenue without Taxation, Shepheard-Walwyn, London.

Hosking, Patrick (2009), quoting Lord Turner of Ecchinswell: FSA chairman says City is too big, Times, August 27.

Mazor, Joseph (2009) A Liberal Theory of Natural Resource Property Rights, PhD thesis for Harvard University.

Polanyi, Karl (1944) The Great Transformation: the political and economic origins of our times Beacon Press, Boston, Ma.

Riley, Don (2001) Taken for a Ride: Trains, Taxpayers and the Treasury, Centre for Political Studies, London.

Spratt, S., Simms, A., Neitzart, E. & Ryan-Collins, J. (2009) The Great Transition, New Economics Foundation, London.

Werner, Richard (2005) A New Paradigm in Economics, Palgrave.

Wilkinson, Richard & Pickett, Kate (2009) The Spirit Level: Why More Equal Societies Almost Always Do Better, Allen Lane.

Yunus, Muhammad with Jolis, Alan (1999) Banker to the Poor. The autobiography of Muhammad Yunus founder of the Grameen Bank, Aurum Press LW.