Today’s lesson on the substantive versus formal approaches to economics is rather simple to grasp despite the way these names may sound.
Learn about these terms and their origin and see some tangible examples of each.
Polanyi and The Great Transformation
The idea of these two differing approaches was first suggested by a guy named Karl Polanyi in his book The Great Transformation, in which he first proposed the concept of substantive and formal approaches to economic systems. It’s important that we remember this name, because he usually pops up when the subject is mentioned or studied.
Working to keep the name Karl Polanyi at the forefront of our minds, let’s describe his theories.
To begin, Polanyi asserted that the word ‘economics’ carries with it two different meanings, hence the two terms, ‘substantive’ and ‘formal.’ With these two terms, he also asserted that the rules used to govern one type cannot be used to judge or explain the other.
With this in mind, let’s start with the formal approach to economics. The formal approach to economics denotes studying the planned-out, rational decisions that a society makes when determining how to use and maximize its resources. For those of us in the West, this is what we think of when we think of economics or sign up for economics classes. It’s the kind of stuff that fills up the nightly news and political debates.
It’s things like the Federal Reserve figuring out a new interest rate or our government trying to decide if we should drill for oil in Alaska. At its core is the idea of scarcity – that there simply just might not be enough resources to go around.Stepping beyond the lands of North America, it’s the government of one country choosing to pool their resources under state control versus another letting the free market determine who owns what. In keeping with this, Polanyi argued that the formal approach to economics is based more on studying preference or benefit than survival. To explain this one, we can use the idea of Americans drilling for oil in Alaska.Oversimplifying this argument, on one side of this debate are people who think we should drill for sure.
It’s their preference. They’d rather drill on American soil than keep funneling money overseas. Conversely, there are those who feel destroying the natural environment of Alaska is too high a price to pay for the benefit of energy independence.
They’d prefer to pay for overseas oil than to disrupt Alaskan soil.Despite where you may fall in this debate, I think most of us could agree that this is an example of making a decision based on preference rather than survival. Since most of us will be able to keep up with our daily needs despite whether or not we drill, at present, this debate falls under what Polanyi would call the study of formal economics.With Polanyi’s formal approach to economics under our belts, let’s turn to the other type he included in his book, The Great Transformation: the substantive approach.
The substantive approach to economics is much broader than the formal approach.
It’s concerned with the study of how people adapt to their natural environments in order to survive. Substantive economics is concerned with what a culture does in order to make a living, and by make a living, we don’t just mean bring home a paycheck. We mean actually make a way to live.
It’s not about preference; it’s about survival.For example, using the substantive approach, an economist would look at a tribal woman of the Amazon gathering vegetation from the forest as economics at work. No, she’s not selling her spoils for paper money or shiny coins, but she is using them to ensure the survival of her family. In the same manner, her husband, who is out hunting game while she gathers, is also participating in their economy. No, he’s not wearing a shirt and a tie, nor is he bringing home a paper check, but he’s ensuring the survival of his family.
To put it in simple terms, hunting and gathering is their economy and, although rare in our modernized world, the economy of several other people groups around the globe. With this example in mind, we can sum up the substantive approach to economics with the idea that it studies how people work to survive within their environments.
In his work The Great Transformation, Karl Polanyi first proposed the concept of substantive and formal approaches to economic systems. In these writings, he asserted that the formal approach to economics indicates the studying of the planned out, rational decisions that a society makes when determining how to use and maximize its resources. Often seen in the modernized world of the West, the formal approach deals more with preference than survival.
Conversely, the substantive approach to economics is much broader. It encompasses the study of how people adapt to their natural environments in order to survive. Unlike the idea of preference, or the Western idea of making a living, it’s the study of how a society actually makes it possible for its members to live.
Find out whether you can complete these goals and tasks after the video lesson ends:
- Recognize the importance of Karl Polanyi’s work, The Great Transformation
- Detail and compare Polanyi’s formal and substantive approaches to economics