Crisis Theories: Falling Rate of Profit

I mentioned earlier that the insufficient surplus value family of crisis theories can be divided into two sub-families: the profit squeeze school and the falling rate of profit school.

The profit squeeze school sees the cause of crises as rooted in the fall in the rate of surplus value that develops as the demand for labor power rises during a boom, creating more favorable opportunities for the workers to struggle against capitalist exploitation. The fall in the rate of exploitation eventually reduces the rate of profit so much that a crisis results.

But there is another version of the insufficient surplus value school. This school traces the cause of crises to the fall in the rate of profit brought on by the rise in the organic composition of capital. This is the famous law of the tendency of the rate of profit to fall.

These crisis theories are not mutually exclusive, because boom conditions not only put downward pressure on the rate of surplus value but at the same time encourage a growth in the organic composition of capital. The lower the rate of surplus value, the more the industrial capitalists will attempt to economize on labor power, or what comes to exactly the same thing, the more they will substitute constant capital—or dead labor—for variable capital—or living labor.

I will devote the rest of this post entirely to the law of the tendency of the rate of profit to fall. Marx described this law as the most important law of political economy. It has implications not only for crisis theory but for the breakdown controversy as well.

The capitalist mode of production is a system of production not for use but for profit. Yet the very laws of capitalist development lead to a fall in the rate of profit. The more the system develops, the more it undermines its own driving force. Doesn’t this prove that the capitalist mode of production must sooner or later come to an end? I will examine the various “breakdown” theories (1) in future posts.

Marx was not the only economist who held that as capitalism developed the rate of profit would tend to decline. (2) Adam Smith and David Ricardo, as well as the founders of modern marginalist bourgeois economics and John Maynard Keynes, all held that the tendency of the rate of profit was downward. (3)

Marx’s approach unique

But Marx’s approach to the tendency of the rate of profit to fall was unique. It is rooted in his distinction between constant capital, which merely conserves its existing value—hence the term constant capital—and variable capital, which not only reproduces its existing value but produces surplus value, the sole source of profits and rents including interest and all the secondary incomes that derive from them.

Classical bourgeois political economy was unable to solve the problem of the falling tendency of the rate of profit, because it fell victim to Adam Smith’s mistake of reducing constant capital to variable capital “in the final analysis,” which I examined in earlier posts. For example, when Ricardo analyzed the rate of profit, he was really examining in Marxist terms the rate of surplus value.

Suppose C represents the value of the total industrial constant capital, both the portion that is used up and needs to be replaced—reproduced in a given production cycle—and that portion which is not. (4) Suppose V represents the total variable capital consumed by the industrial capitalists, while S represents the total surplus value. For the sake of simplification, assume that the turnover period of V is one year. (5) Assume also that the rate of surplus value is 100 percent—that is, half the workday the workers are reproducing the value of their wages; the rest of the workday they work unpaid for the bosses producing surplus value.

A given rate of surplus value can, therefore, express itself in many—indeed an infinity of—annual rates of profit. With a 100 percent rate of surplus value, the greater the value of C, the lower will be the rate of profit. Conversely, the lower the value of C, the higher the rate of profit to the limit of 100 percent if the value of C were to fall to zero—which of course is impossible.

Since C will rise relative to V with the development of the productive powers of labor, the rate of profit will decline, all else remaining equal. All else in the real world, however, is never equal. For example, since a rise in C relative to V reflects a rise in the productivity of labor, the industrial capitalists will be able increase the rate of surplus value as productivity of labor increases without lowering the real wages of the workers. Indeed, the ratio of unpaid labor (surplus value) to paid labor (wages) can rise even as real wages rise if the productivity of labor rises fast enough. Therefore, the rate of surplus value and the rate of profit can trend in opposite directions. (6)

Indeed, Marx believed that this is what would happen as capitalism develops. The rate of—and even more the mass of—surplus value would rise. Without a growing mass of surplus value, the continued existence of capitalist production is impossible. Outside of crisis years and their immediate aftermath, the capitalist class generally realizes a greater total profit in a given year than any previous year. This is reflected in the secular rise in stock market prices over time. (7)

For the sake of simplification, I will assume that all commodities produced in a given year fully realize their labor values on the market. The annual rate of profit on productive capital is R = S/(C + (V / T)), where R equals the total rate of profit, S the total mass of surplus value produced in a given year, C the total constant capital in existence, V the total variable capital, and T the number of turnovers of variable capital in a given year.

I should note that the above formula deals only with productive capital. In addition to productive capital, there is also commodity capital, the commodities that the industrial capitalists have produced but have not yet sold, and money capital, capital in the form of money. Therefore, the rate of profit on the total capital of the capitalist class, which includes not only productive capital but commodity capital and money capital, will be lower than indicated by the formula.

The division between constant and variable capital is only meaningful when we deal with productive capital. It has no meaning in regard to either commodity capital or money capital. A consequence of this is that the smaller the portion of the total capital that consists of either commodity capital or money capital, the higher will be the rate of profit on the total capital that includes both commodity and money capital as well as productive capital. Therefore, the industrial capitalists try to minimize the portion of their capital that consists of commodity capital—inventories—on one side, and money capital, on the other.

Tendency of the rate of profit to decline

Marx spoke of the law of the tendency of the rate of profit to decline, rather than the law of the falling rate of profit. There are various forces that counteract the fall in the rate of profit. I don’t have space to explore all of them, but I will mention the most important.

I have already explained one. The rise in the productivity of labor tends to lead to a rise in the rate of surplus value that counteracts the fall in the rate of profit. Second, as the productivity of labor rises, the elements—the commodities—that make up the constant capital, also fall in value, which in turn works in the direction of lowering the value of C, thereby counteracting the rise in the organic composition of capital.

Indeed, one of the functions of crises is to to lower the prices of the elements of constant capital—reflecting a fall in the value of constant capital that has already occurred due to a rise in the productivity of labor. The contraction of the constant capital in terms of prices, along with the rise in the rate of surplus value made possible by the mass unemployment created by a crisis, makes possible a renewed rise in the rate of profit. (8)

Also note the term T in our formula for the annual rate of profit on productive capital. T represents the turnover of variable capital. If the turnover of variable capital can be increased, for example due to improved transportation, faster ships and railroads, or the construction of canals that shorten ship routes, such as the Panama and Suez canals, (9) the turnover of capital, including variable capital, is increased, thereby counteracting the tendency of the rate of profit to fall.

I should also mention the discovery of new markets, or the expansion of old ones, that increase the pace of sales. Such an increase in sales also increases the turnover of capital, including variable capital. The value of T will thereby be increased, which will counteract the tendency of the rise in the relative value of C to lower the rate of profit.

As Marx explained, due to the workings of these counteracting tendencies, the fall in the rate of profit manifests itself only over very long periods of time and should not be confused with short-term fluctuations in the rate of profit caused by changes in the phases of the industrial cycle. For this reason, the secular fall in the rate of profit should be measured across industrial cycles rather than within them.

Let’s take a closer look at constant capital. It consists partly of fixed capital (machines, buildings and so on), which transfers its value little by little to the commodities that are produced with its help. Take, for example, a machine tool. The transfer of the machine tool’s value is complete only when the wear and tear on the machine has progressed to the point that it can no longer function as a use value, when it has become in a sense a non-machine. This might take 10 years.

Another form of depreciation of fixed constant capital is what Marx called moral depreciation, what is sometimes called functional depreciation. Let’s assume a better machine—a machine, for example, that can replace more living labor—can now be produced for the same price. Or, alternatively, a machine identical to the existing machines of the given type can now be produced at a lower price due to a rise in the productivity of labor in the machine-building industry.

In both these cases, the existing machines will represent less value—less abstract human labor—and this will represent a loss for the industrial capitalists that are using the existing machinery. Such devaluations of the existing fixed capital before it has the opportunity to transfer its total value to the commodities it helps produce is an important source of crisis. It should also be noted that the moral depreciation of existing fixed capital by reducing the value of existing constant capital is also a force that counteracts the fall in the rate of profit. Therefore, the devaluation of the existing constant capital that counteracts the long-term decline in the rate of profit across industrial cycles is a force for the formation of crises within each industrial cycle.

The other part of constant capital is constant circulating capital. This can be divided into raw materials and auxiliary materials. Raw materials enter the commodities that are produced by the industrial capitalists directly—for example, textiles used to produce garments. Electricity used to run sewing machines in a garment factory is an example of an auxiliary material. Unlike the raw materials such as textiles, the electricity does not actually enter the body of the commodities, but just like raw materials, it transfers its value to the commodities it helps to produce. As raw and auxiliary materials are used up in production, their values are transferred all at once into the value of the commodity product.

Constant and variable capital

Variable capital is the labor power purchased from the workers by the industrial capitalists. Like raw and auxiliary materials, labor power is circulating capital. Unlike constant capital, which conserves its value by transferring it to the commodities it helps to produce, variable capital replaces its value with a new value and produces an additional value, a surplus value.

Taking the social capital as a whole, it is only changes in the turnover period of the variable capital that affects the rate of profit. However, this is hidden from both the industrial capitalists and our modern bourgeois economists by the equalization of the rate of profit and the transformation of values into prices of production. This gives rise to the illusion that it is the rate of turnover of the entire capital that affects the general rate of profit. Once we strip away the vale of prices of production and deal directly with values, we see that the rate of profit on constant capital is zero. And no matter how many times you multiply zero by itself, you get exactly zero. Therefore, no increase in the turnover of the constant capital, or any element thereof that does not result in an increase in the turnover of the variable capital, can increase the rate of profit on the total social capital.

For the industrial capitalist—assuming that the amount of labor necessary to produce the elements of the capital remains unchanged—the constant capital preserves its value—assuming everything goes well—and the variable capital produces additional value. When the productive worker consumes wage goods, the value of the commodities that make up the wage goods is transformed through the biological process into labor power, the ability to work. When the labor power is consumed by the industrial capitalist, the value of labor power is not transferred to the commodities it produces like is the case with constant capital.

Instead, the worker replaces the value of the commodities she consumes in order to reproduce her labor power and produces an additional value, or surplus value, beyond it. This is the specific use value of the commodity labor power to the industrial capitalist. Under a system of commodity-slave production such as prevailed in the pre-Civil War southern United States, the worker herself was fixed capital. In contrast, under the capitalist “free labor system,” labor power is circulating capital, since like raw and auxiliary materials it is consumed all at once by the industrial capitalists rather than little by little as is the case with machinery, pipes and buildings, which represent fixed capital. Therefore, labor power is both a part of circulating capital and uniquely makes up variable capital. Unlike under chattel slavery, the boss buys the worker’s ability to work but not the worker herself.

The composition of capital versus the organic composition of capital

The ratio between constant and variable capital is the composition of capital. Suppose the working class succeeds through the class struggle in reducing the rate of surplus value. The value of variable capital will increase. Therefore, the ratio of constant to variable capital will decline. Similarly, if the capitalists succeed in driving the value of labor power down, the ratio of constant capital to variable will rise. This will represent an increase in the composition of capital.

Such a rise in the composition of capital will lead to a rise in the rate of profit, while the converse will lead to a drop in the rate of profit. Therefore, a change in the composition of capital brought about by a change in the rate of surplus value will, all else remaining equal, bring about a change in the rate of profit in the opposite direction to a change in the composition of capital brought about by a change in the value of the constant capital.

Because of these opposite effects on the rate of profit, Marx distinguished between (1) changes in the composition of capital brought about by changes in the rate of surplus value and (2) changes in the composition of capital caused by changes in the value of constant capital. He referred only to the latter changes as changes in the organic composition of capital. It is the changes in the organic composition of capital that are responsible for the tendency of the rate of profit to fall.

A note on raw and auxiliary materials and the organic composition of capital

Before the current crisis led to a collapse in the demand and price of oil, there was much concern in capitalist circles that the era of cheap oil was coming to an end. These concerns may well revive when the worldwide industrial cycle now in a deep downward phase again turns upward. Contrary to some claims, the world is far from running out of fossil fuel, since even the most conservative estimates don’t project a peak in coal production for centuries to come. (10)

The fear, rather, is that the energy that enters into virtually all branches of production as an auxiliary material will rise in value due to either more expensive carbon fuels as the richest mines and oil fields are depleted, or if the threat of global warming forces the state to restrict the production of carbon-based fuels and expand the use of more expensive non-carbon fuels.

Alternative energy sources such as solar or nuclear energy, given current technology, are considerably more expensive than the energy extracted from carbon-based fuels. Therefore, the capitalists are worried that though the world is not running out of energy it might be running out of cheap energy. A rise in energy prices that reflects a real upward movement of the value of energy, as opposed to merely temporary conjunctural shifts in supply and demand, will, all other things remaining equal, represent a considerable rise in the organic composition of capital and thus would lower the rate of profit. It is not enough for the industrial capitalists to have access to raw and auxiliary materials, they want access to cheap raw and auxiliary material.

As Marx himself noted, the depletion of raw materials—mines, oil wells, and so on—works in the direction of increasing the value of constant capital and therefore works in the direction of lowering the rate of profit.

In the next post, I will deal with the theory that it is the tendency of the rate of profit to fall that is the basic cause of the periodic crises of capitalist production such as the one we are passing through at present.

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1 There isn’t one but two breakdown theories. One, associated with Henryk Grossman and Paul Mattick, is based on the fall in the rate of profit bought on by the growth in the organic composition of capital. A second, proposed by Rosa Luxemburg, is based on the alleged inability of the industrial capitalists to realize their surplus value in a pure capitalist society consisting only of capitalists and workers, where all independent commodity producers have disappeared.

2 The fall in the rate of profit is often confused with a fall in the rate of interest. Marx divided profit into two fractions, both of which are pocketed by the industrial and commercial capitalists. These capitalists “earn” interest on their capital plus an additional profit, what Marx called the profit of enterprise. The money capitalists appropriate interest alone. Marx believed that the tendency of both the total rate of profit (interest plus profit of enterprise), as well as the rate of interest as such was downward. In addition to interest, there is another portion of the surplus value that takes the form of ground rent. Marx also believed that the tendency of the ratio between the sum of profit and rent—the total surplus value—relative to the total mass of capital was downward.

3 Modern marginalist bourgeois economics holds that when the economy is in equilibrium, capital will “earn” only interest. However, if capital earned only interest, there would be no motive to actually produce surplus value. The industrial capitalists would turn into money capitalists and progressively abandon industrial production. A situation where the industrial capitalists (and commercial capitalists) earned only interest would not be an equilibrium but a highly abnormal situation that could not be sustained. In the long run, the industrial capitalists (and commercial capitalists) must realize a profit of enterprise above and beyond the rate of interest if capitalist production is to continue.

4 Constant capital consists of both fixed and circulating capital. The circulating constant capital transfers its entire value to the commodities it helps produce in each turnover cycle. The fixed capital, however, transfers only a portion of its value in a given turnover cycle. The total value of a commodity is often expressed as c + v + s. Here, c represents only the portion of constant capital that actually transfers its value to the commodity. But in analyzing the rate of profit on the total capital, it is necessary to add as well the portion of the constant capital C that does not actually transfer its value in a given production cycle.

5 This is a reasonable assumption for capital invested in agriculture if one crop is raised in a given year, but not for most other industries, where there are usually many annual turnovers of variable capital over a year.

6 According to the pro-capitalist economists, real wages can only rise when the productivity of labor rises. In reality, if real wages rise in line with the growth in the productivity of labor—assuming that the rise in the productivity of labor in the wage-goods industries exactly matches the average rise in the productivity of labor—this means the rate of surplus value, or what comes to exactly the same thing, the rate of exploitation, remains unchanged. However, real wages can rise faster than productivity. In that case, the rate of surplus value will fall and so will the rate of profit, all else remaining equal. It is equally possible—which in fact tends to be the case—for labor productivity to grow faster than the rise—if any—in real wages. In this case, the rate of surplus value will rise.

7 Investment advisors often urge that their clients weigh their portfolios heavily toward stocks, pointing to the secular rise in stock market prices. They are counting on the mass of surplus value squeezed out of the global working class continuing to grow in the future as it has in the past. This growth in the mass of surplus value can occur even if the rate of profit falls due to a rise in the organic composition of capital.

8 The industrial capitalists can only measure the value of their total capital, as well as their profits, in terms of money, not values—quantities of abstract human labor measured in terms of time—which can never be directly known under capitalist production.

9 One of the reasons for the stubborn support of the United States for apartheid Israel is the need to guard the Suez Canal, and thus the rate of turnover of variable capital on a global basis. If ships had to go around the Horn of Africa as they did in the days before the Suez Canal was constructed, the rate of turnover of variable capital would fall. As a result, the general rate of profit on global capital would decline.

10 The use of carbon-rich fossil fuels is, of course, the major driving force behind global warming. Industrial—and other—capitalists are concerned only about profits, not the environment, unless the disruption of the environment is so severe that it brings into question the possibility of making profits. This could indeed well occur if global warming continues unchecked. If the capitalist state is forced to intervene and limit the use of fossil fuels in order to safeguard the very possibility of profit making, the capitalists fear that the cost of energy—a crucial component of circulating constant capital—will rise. If that occurs, the organic composition of capital will rise, and all else remaining equal, the rate of profit will fall. This is one of the reasons why business circles have been so resistant to the notion of global warming caused by the burning of fossil fuels.

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