Tendency of the rate of profit to fall
Encyclopedia
The tendency of the rate of profit to fall (TRPF) is a hypothesis
in economics
and political economy
, most famously expounded by Karl Marx
in chapter 13 of Das Kapital
Vol. 3. It was generally accepted in the 19th century. Economists as diverse as Adam Smith
, John Stuart Mill
and Stanley Jevons noticed a long-run empirical trend for the internal rate of return
on capital invested to produce industrial products to decline, and Marx called this tendency "the most important law of political economy" and sought to give a causal
explanation for it, in terms of his labour theory of value.
(factories, machines, land, buildings, raw materials) relative to variable capital (labor) reduced the margin of surplus labor time relative to the total production capital invested (constant capital plus variable capital). Since surplus labor time is, according to Marx, the source of surplus value
, and since the general rate of profit equals total surplus value divided by total capital, then the tendential fall in surplus labor time relative to total production capital owned results in a tendential fall in the rate of profit for newly produced commodities.
Even as investment in constant capital increases productivity (i.e. the margin of surplus labor relative to regular labor, and thus of surplus value relative to variable capital), it reduces the rate of profit (i.e. the ratio of surplus value relative to total capital). The capitalist then responds by investing more in raising productivity or expanding the scale of production, which in turn reduces profits per unit further after a while, and so on and so forth, in a vicious cycle of diminishing returns.
This is then the general tendency in capitalism, but it is only a tendency, because there are also "counteracting factors" operating which had to be studied also. In his draft manuscript (he did not publish it himself), Marx cited six of them:
But there could obviously also be several other factors involved which Marx did not discuss in detail, including for example:
Some of these "countervailing factors" can only temporarily postpone the fall of the rate of profit. Wages, for instance, cannot fall below zero, the turn-over period of capital also cannot fall below zero, and so on. The controversy about the TRPF nowadays concentrates on the point whether cheapening of elements of constant capital could indefinitely counteract the TRPF, and what the effect of increased productivity is on the rate of profit on production capital.
argued that mass longterm unemployment prevalent in 19th and early 20th century were result of long-term effect of labour-saving technological innovations. At a certain point, it is argued, the falling rate of profit stops the total mass of profit in the economy from growing altogether, or at least from growing at a sufficient rate - this results in an over-accumulation (or under consumption) crisis, and consequently a drop in new productive investment, causing an increase in unemployment. In turn, this then leads to a wave of take-overs and mergers to restore profitable production.
However, nearly a century ago, some economists such as Eugen von Bohm-Bawerk
and Ladislaus Bortkiewicz
found Marx's argument mathematically faulty. This gave rise to a controversy about the so-called Transformation problem
. Marx himself pointed out the need to find a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace in Chapter 9 of Capital's draft Volume III, where he also tried to solve it. The essential difficulty was this: given that he derived profit ("surplus value") from direct labour inputs and that the amount of direct labour input varied widely between commodities, how could he explain the tendency towards a uniform rate profit on production capital invested?
This has important implications for Marx's theory of labour exploitation and economic dynamics, namely that there is no inevitability of decline in profit from capital accumulation.
In 20th century, many Marxists have moved away from Marx's labour theory of value and try to provide alternative crisis theories in the Marxian
tradition, focusing variously on the chaos of capitalist production, sectoral disproportions, underconsumption, labor-shortage and population pressures, credit insufficiency and wages squeezing profits. Some theories attribute crises to one single factor (such as the TRPF) while others argue for a multi-causal approach in which a distinction is drawn between the "triggers" of the crisis, its deeper underlying causes, and the concrete manifestation of crises.
Marxist economist Chris Harman
has advanced a reading of Marx that sees economic crisis as being the main effective countervailing factor, but which places limits on its effectiveness as the capitalist system ages and units of capital become larger and more interlinked.
The Japanese economist Nobuo Okishio
(see article on Okishio's theorem
) famously argued "if the newly introduced technique satisfies the cost criterion [i.e. if it reduces unit-costs, given current prices] and the rate of real wage remains constant" then the rate of profit must increase (Okishio, 1961, p. 92). Assuming a constant level of real wages, technical change would lower the production cost per unit, thereby raising the innovator's rate of profit. The price of output would fall, and this would cause the other capitalists’ costs to fall also. The new (equilibrium) rate of profit would therefore have to rise. By implication, the rate of profit could in that case fall, only if real wages rose in response to higher productivity, squeezing profits. (This theory is sometimes called neo-ricardian, because David Ricardo also claimed that a fall in the rate of profit can only be brought about by rising wages.)
Intuitively, Okishio's argument makes sense - after all, why would capitalists invest in more efficient production on a larger scale, unless they thought their profits would increase? Orthodox Marxists have typically responded to this argument in the following basic ways (there are, of course, numerous other arguments, involving more or less complex mathematical models).
Responses 1 and 2 can be interpreted as a prisoner's dilemma
the capitalists are caught in.
Okishio argues in terms of a comparative static analysis
. His starting point is an equilibrium growth path of an economy with a given technique. In a branch of industry a technical improvement is introduced (in a way similar to what Marx described) and then the new equilibrium growth path is established under the assumption that the new better technique is generally adopted by the capitalists of that branch. The result is that even under Marx’s assumptions about technical progress the new equilibrium growth path goes along with a higher rate of profit. However, if one drops the assumption, that a capitalist economy moves from one equilibrium to another, Okishio’s results do not hold anymore.
The "indeterminacy" criticism revolves around the idea that technological change could have many different and contradictory effects. It could reduce costs, or it could increase unemployment; it could be labour-saving, or it could be capital-saving. Therefore, the argument goes, it is impossible to infer definitely that a falling rate of profit must inevitably result from an increase in productivity. Perhaps the law of the tendency of the rate of profit to fall might be true in an abstract model, based on certain assumptions, but in reality no substantive empirical predictions can be made. In addition, profitability itself can be influenced by an enormous array of different factors, going far beyond those which Marx specified. So there are tendencies and counter-tendencies operating simultaneously, and no particular empirical result necessarily follows from them.
("steady state"), that is, input per worker and output per worker grow at the same rate. This means, that capital intensity
remains constant over time. At the same time, in equilibrium, the rate of growth of employment is constant over time. Translated into terms of labor theory of value
, this means that the value composition of capital
does not rise, and the constant rate of growth of employment also indicates in terms of the Labor Theory of Value, that there is no reason for the rate of profit to decline.
In this framework, followers of a tendency of the rate of profit to decline assume, that input per worker is increased by capitalists at a larger rate than output per worker, because
1) either, overcapacities might be built to fend off competition;
2) or, this leads, as an incentive for capitalists, to a larger percentage increase of output per worker than input per worker has been increased beforehand. This results in an alternate movement in which capitalists increase input per worker at a larger percentage than output per worker has risen, which, in the next period, leads to a larger percentage increase of output per worker than that of input per worker before. The rate of growth of employment declines in such a scenario.
, have indeed linked long-term fluctuations in average profitability and interest rates to the Kondratiev waves. There is also some statistical evidence that, as a broad historical trend, average profitability in industry has fallen through the 20th century (see, for instance, Robert Brenner
and the research of Dumenil & Levy for the time after the second world war).
However, there are two basic problems in interpreting the observable evidence available.
Therefore, the debate among economists about the TPRF and its significance remains interminable. At best, Marxian economics
has convincingly argued that profitability is the synthetic, overall indicator of the "economic health" of the capitalist system, and that economic crises are system-immanent, i.e. capitalism is inherently crisis-prone, because of its institutional structure and the way it functions. Thus, capitalist development occurs through inevitable booms and busts. This conclusion is the exact opposite to neo-classical economics, according to which markets, if left alone, will spontaneously move towards equilibrium
and economic harmony. But as regards the exact causes of specific economic crises, the debate continues; it is, of course, not necessarily the case that every economic crisis must have the same basic causes.
, not the only one. Thus, even if the growth rate of production stagnates, asset sales may boom. In advanced capitalist societies such as the United States, constant capital
applied in private sector productive activities represents only about 20-30% of the value of the total physical capital stock, and perhaps 10-12% of total capital assets owned, and therefore it is unlikely that a fall in the industrial rate profit could by itself explain economic crises.
Others claim that for Marx, commercial trade and asset speculation were unproductive sectors, in which no value can be created. Therefore, they argue, all income of these sectors is a deduction of the value created in the productive sectors of the economy. Booms in unproductive sectors may temporarily act as a countervailing factor to the TRPF, but not in the long run. On the contrary, Fred Moseley argues, in the US the rate of profit is lower than it used to be in earlier decades after the second world war, because of a rising share of unproductive labor with respect to productive labor
. This is a reason of its own for a falling general rate of profit in distinction to the TRPF. Yet both Moseley's calculations and his definition of unproductive labor have been criticised by other Marxists.
Hypothesis
A hypothesis is a proposed explanation for a phenomenon. The term derives from the Greek, ὑποτιθέναι – hypotithenai meaning "to put under" or "to suppose". For a hypothesis to be put forward as a scientific hypothesis, the scientific method requires that one can test it...
in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
and political economy
Political economy
Political economy originally was the term for studying production, buying, and selling, and their relations with law, custom, and government, as well as with the distribution of national income and wealth, including through the budget process. Political economy originated in moral philosophy...
, most famously expounded by Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...
in chapter 13 of Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...
Vol. 3. It was generally accepted in the 19th century. Economists as diverse as Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
, John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...
and Stanley Jevons noticed a long-run empirical trend for the internal rate of return
Internal rate of return
The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
on capital invested to produce industrial products to decline, and Marx called this tendency "the most important law of political economy" and sought to give a causal
Causality
Causality is the relationship between an event and a second event , where the second event is understood as a consequence of the first....
explanation for it, in terms of his labour theory of value.
Adam Smith's 1776 comment on the rate of profit
"Profit is so very fluctuating that the person who carries on a particular trade cannot always tell you himself what is the average of his annual profit. It is affected not only by every variation of price in the commodities which he deals in, but by the good or bad fortune both of his rivals and of his customers, and by a thousand other accidents to which goods when carried either by sea or by land, or even when stored in a warehouse, are liable. It varies, therefore, not only from year to year, but from day to day, and almost from hour to hour. To ascertain what is the average profit of all the different trades carried on in a great kingdom must be much more difficult; and to judge of what it may have been formerly, or in remote periods of time, with any degree of precision, must be altogether impossible.
But though it may be impossible to determine, with any degree of precision, what are or were the average profits of stock, either in the present or in ancient times, some notion may be formed of them from the interest of money. It may be laid down as a maxim, that wherever a great deal can be made by the use of money, a great deal will commonly be given for the use of it; and that wherever little can be made by it, less will commonly be given for it. According, therefore, as the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises. The progress of interest, therefore, may lead us to form some notion of the progress of profit." (The Wealth of NationsThe Wealth of NationsAn Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...
, chapter IX)http://geolib.com/smith.adam/won1-09.html
Marx's argument
Simply put, Marx argued that increased investment in and growth of constant capitalConstant capital
Constant capital , is a concept created by Karl Marx and used in Marxian political economy. It refers to one of the forms of capital invested in production, which contrasts with variable capital...
(factories, machines, land, buildings, raw materials) relative to variable capital (labor) reduced the margin of surplus labor time relative to the total production capital invested (constant capital plus variable capital). Since surplus labor time is, according to Marx, the source of surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...
, and since the general rate of profit equals total surplus value divided by total capital, then the tendential fall in surplus labor time relative to total production capital owned results in a tendential fall in the rate of profit for newly produced commodities.
Even as investment in constant capital increases productivity (i.e. the margin of surplus labor relative to regular labor, and thus of surplus value relative to variable capital), it reduces the rate of profit (i.e. the ratio of surplus value relative to total capital). The capitalist then responds by investing more in raising productivity or expanding the scale of production, which in turn reduces profits per unit further after a while, and so on and so forth, in a vicious cycle of diminishing returns.
This is then the general tendency in capitalism, but it is only a tendency, because there are also "counteracting factors" operating which had to be studied also. In his draft manuscript (he did not publish it himself), Marx cited six of them:
- more intense exploitation of labour (raising the rate of exploitation)
- reduction of wages below the value of labour powerLabor powerLabour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...
(commonly referred to as the "immiseration thesisImmiseration thesisIn Marxist theory, the immiseration thesis refers to the view that the nature of capitalist production logically requires an ever greater reduction in real wages and worsening of working conditions for the proletariat.-Marx:Concerning the evolution of the worker's living conditions, Marx argued...
") - cheapening the elements of constant capitalConstant capitalConstant capital , is a concept created by Karl Marx and used in Marxian political economy. It refers to one of the forms of capital invested in production, which contrasts with variable capital...
by various means - the growth and utilization of a relative surplus population (the reserve army of labourReserve army of labourReserve army of labour is a concept in Karl Marx's critique of political economy. It refers basically to the unemployed in capitalist society. It is synonymous with "industrial reserve army" or "relative surplus population", except that the unemployed can be defined as those actually looking for...
) - foreign trade reducing the cost of industrial inputs and consumer goods
- the increase in share capital which devolves part of the costs of using capital on others.
But there could obviously also be several other factors involved which Marx did not discuss in detail, including for example:
- reductions in the turnover-time of industrial capital generally (e.g. an increase (technology or management driven) in the productivity of fixed capital investment)
- accelerated depreciation and faster throughput
- the level of price inflation for different types of goods and services
- capital investment into previously non-capitalist production, where a lower organic composition of capitalOrganic composition of capitalThe organic composition of capital is a concept created by Karl Marx in his critique of political economy and used in Marxian economics as a theoretical alternative to neo-classical concepts of factors of production, production functions, capital productivity and capital-output ratios. Marx first...
prevailed - military wars or military spending causing capital assets to be inoperative or destroyed, or spurring war production (see permanent arms economy)
- demographic factors http://newschool.edu/gf/econ/bulletin-board/Spring07_cottrell.pdf
- consolidationof mature industries into an oligarchy of survivors. Mature industries do not attract new capital because of low returns. Also, mature companies with large amounts of capital invested and brand recognition create barriers to entry against new competitors. See also: Economic stagnation#Secular stagnation theory
Some of these "countervailing factors" can only temporarily postpone the fall of the rate of profit. Wages, for instance, cannot fall below zero, the turn-over period of capital also cannot fall below zero, and so on. The controversy about the TRPF nowadays concentrates on the point whether cheapening of elements of constant capital could indefinitely counteract the TRPF, and what the effect of increased productivity is on the rate of profit on production capital.
Quote from Marx on the TRPF
Later Marxist interpretation
Henryk Grossmann and Paul MattickPaul Mattick
Paul Mattick Sr. was a Marxist political writer and social revolutionary, whose thought can be placed within the council communist and left communist traditions...
argued that mass longterm unemployment prevalent in 19th and early 20th century were result of long-term effect of labour-saving technological innovations. At a certain point, it is argued, the falling rate of profit stops the total mass of profit in the economy from growing altogether, or at least from growing at a sufficient rate - this results in an over-accumulation (or under consumption) crisis, and consequently a drop in new productive investment, causing an increase in unemployment. In turn, this then leads to a wave of take-overs and mergers to restore profitable production.
However, nearly a century ago, some economists such as Eugen von Bohm-Bawerk
Eugen von Böhm-Bawerk
Eugen Ritter von Böhm-Bawerk was an Austrian economist who made important contributions to the development of the Austrian School of economics.-Biography:...
and Ladislaus Bortkiewicz
Ladislaus Bortkiewicz
Ladislaus Josephovich Bortkiewicz , August 7, 1868 – July 15, 1931) was a Russian economist and statistician of Polish descent, who lived most of his professional life in Germany, where he taught at Strassburg University and Berlin University...
found Marx's argument mathematically faulty. This gave rise to a controversy about the so-called Transformation problem
Transformation problem
In 20th century discussions of Karl Marx's economics the transformation problem is the problem of finding a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace...
. Marx himself pointed out the need to find a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace in Chapter 9 of Capital's draft Volume III, where he also tried to solve it. The essential difficulty was this: given that he derived profit ("surplus value") from direct labour inputs and that the amount of direct labour input varied widely between commodities, how could he explain the tendency towards a uniform rate profit on production capital invested?
This has important implications for Marx's theory of labour exploitation and economic dynamics, namely that there is no inevitability of decline in profit from capital accumulation.
In 20th century, many Marxists have moved away from Marx's labour theory of value and try to provide alternative crisis theories in the Marxian
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...
tradition, focusing variously on the chaos of capitalist production, sectoral disproportions, underconsumption, labor-shortage and population pressures, credit insufficiency and wages squeezing profits. Some theories attribute crises to one single factor (such as the TRPF) while others argue for a multi-causal approach in which a distinction is drawn between the "triggers" of the crisis, its deeper underlying causes, and the concrete manifestation of crises.
Marxist economist Chris Harman
Chris Harman
Chris Harman was a British journalist and political activist, and a member of the Central Committee of the Socialist Workers Party...
has advanced a reading of Marx that sees economic crisis as being the main effective countervailing factor, but which places limits on its effectiveness as the capitalist system ages and units of capital become larger and more interlinked.
Criticisms
Marx’s interpretation has been the source of intense controversy and has been criticized in different main ways:- Firstly, it is argued that, by raising productivity, labour-saving technologies increase the average industrial rate of profit.
- Secondly, how exactly the average rate of industrial profit will evolve, is uncertain and unpredictable.
The Japanese economist Nobuo Okishio
Nobuo Okishio
was a Japanese Marxian economist and emeritus professor of Kobe University. In 1979, He was elected President of Japan Association of Economics and Econometrics, which is now Japanese Economic Association....
(see article on Okishio's theorem
Okishio's theorem
Okishio's theorem is a mathematical theorem formulated by Japanese economist Nobuo Okishio. It has had a major impact on debates about Marx's theory of value...
) famously argued "if the newly introduced technique satisfies the cost criterion [i.e. if it reduces unit-costs, given current prices] and the rate of real wage remains constant" then the rate of profit must increase (Okishio, 1961, p. 92). Assuming a constant level of real wages, technical change would lower the production cost per unit, thereby raising the innovator's rate of profit. The price of output would fall, and this would cause the other capitalists’ costs to fall also. The new (equilibrium) rate of profit would therefore have to rise. By implication, the rate of profit could in that case fall, only if real wages rose in response to higher productivity, squeezing profits. (This theory is sometimes called neo-ricardian, because David Ricardo also claimed that a fall in the rate of profit can only be brought about by rising wages.)
Intuitively, Okishio's argument makes sense - after all, why would capitalists invest in more efficient production on a larger scale, unless they thought their profits would increase? Orthodox Marxists have typically responded to this argument in the following basic ways (there are, of course, numerous other arguments, involving more or less complex mathematical models).
- Capitalists operating in a competitive environment may not have any choice about investing in new technologies, to keep or expand their market share, even if doing so raises the pressure for all of them to spend an ever larger share of their income on newest technology thus reducing the available surplus to finance expansion of employment.
- It may be that in the heyday of a technological breakthrough, profits will indeed initially increase, but as the new technologies are widely applied by all enterprises, the overall end-result will be that average rate of return on capital falls for all of them. (This however is exactly what Okishio's equilibrium model seeks to refute).
- A slight reduction in profit rates on capital invested due to more expensive productive equipment may not seem such a problem to business anyhow, if it is compensated for by an increase in profit volume (profit margins) through increased sales and market shares. The yield on capital might decline somewhat in percentage terms, while total net income from capital employed increases.
- Arguments such as Okishio's are based on a fundamental misunderstanding of the TRPF and a confusion of rate of profit with surplus value. Marx himself acknowledged that productivity increases even as the rate of profit decreases, and that these two tendencies necessarily go hand in hand with each other. However, the decrease in production cost per unit brought about by investment in constant capital translates not to an increase in the rate of profit, but rather to an increase in surplus value—it increases the surplus labor time relative to variable capital. But meanwhile the constant capital has expanded relative to variable capital (as a result of the capitalist's investment in productivity), meaning that surplus value, even though it has expanded relative to variable capital, shrinks relative to total capital. Since the rate of profit is defined as
( 
being surplus value and 
being Total Capital, i.e. constant capital plus variable capital), the rate of profit therefore tends to fall.
Responses 1 and 2 can be interpreted as a prisoner's dilemma
Prisoner's dilemma
The prisoner’s dilemma is a canonical example of a game, analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so. It was originally framed by Merrill Flood and Melvin Dresher working at RAND in 1950. Albert W...
the capitalists are caught in.
Okishio argues in terms of a comparative static analysis
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....
. His starting point is an equilibrium growth path of an economy with a given technique. In a branch of industry a technical improvement is introduced (in a way similar to what Marx described) and then the new equilibrium growth path is established under the assumption that the new better technique is generally adopted by the capitalists of that branch. The result is that even under Marx’s assumptions about technical progress the new equilibrium growth path goes along with a higher rate of profit. However, if one drops the assumption, that a capitalist economy moves from one equilibrium to another, Okishio’s results do not hold anymore.
The "indeterminacy" criticism revolves around the idea that technological change could have many different and contradictory effects. It could reduce costs, or it could increase unemployment; it could be labour-saving, or it could be capital-saving. Therefore, the argument goes, it is impossible to infer definitely that a falling rate of profit must inevitably result from an increase in productivity. Perhaps the law of the tendency of the rate of profit to fall might be true in an abstract model, based on certain assumptions, but in reality no substantive empirical predictions can be made. In addition, profitability itself can be influenced by an enormous array of different factors, going far beyond those which Marx specified. So there are tendencies and counter-tendencies operating simultaneously, and no particular empirical result necessarily follows from them.
In terms of mainstream economics
Typically, economic growth is described in the usual growth models (for example Harrod–Domar model) in terms of equilibriumEconomic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
("steady state"), that is, input per worker and output per worker grow at the same rate. This means, that capital intensity
Capital intensity
Capital intensity is the term in economics for the amount of fixed or real capital present in relation to other factors of production, especially labor...
remains constant over time. At the same time, in equilibrium, the rate of growth of employment is constant over time. Translated into terms of labor theory of value
Labor theory of value
The labor theories of value are heterodox economic theories of value which argue that the value of a commodity is related to the labor needed to produce or obtain that commodity. The concept is most often associated with Marxian economics...
, this means that the value composition of capital
Organic composition of capital
The organic composition of capital is a concept created by Karl Marx in his critique of political economy and used in Marxian economics as a theoretical alternative to neo-classical concepts of factors of production, production functions, capital productivity and capital-output ratios. Marx first...
does not rise, and the constant rate of growth of employment also indicates in terms of the Labor Theory of Value, that there is no reason for the rate of profit to decline.
In this framework, followers of a tendency of the rate of profit to decline assume, that input per worker is increased by capitalists at a larger rate than output per worker, because
1) either, overcapacities might be built to fend off competition;
2) or, this leads, as an incentive for capitalists, to a larger percentage increase of output per worker than input per worker has been increased beforehand. This results in an alternate movement in which capitalists increase input per worker at a larger percentage than output per worker has risen, which, in the next period, leads to a larger percentage increase of output per worker than that of input per worker before. The rate of growth of employment declines in such a scenario.
Empirical evidence
Most economic historians agree that, at the beginning of the big economic depressions or recessions in the history of capitalism (measured by a drop in output), there typically has been a downslide in the observed average returns on capital invested in industries, reducing the incentive to invest, and consequently raising unemployment. Some writers, such as Ernest MandelErnest Mandel
Ernest Ezra Mandel, also known by various pseudonyms such as Ernest Germain, Pierre Gousset, Henri Vallin, Walter , was a revolutionary Marxist theorist.-Life:...
, have indeed linked long-term fluctuations in average profitability and interest rates to the Kondratiev waves. There is also some statistical evidence that, as a broad historical trend, average profitability in industry has fallen through the 20th century (see, for instance, Robert Brenner
Robert Brenner
Robert P. Brenner is a professor of history and director of the Center for Social Theory and Comparative History at UCLA, editor of the socialist journal Against the Current, and editorial committee member of New Left Review...
and the research of Dumenil & Levy for the time after the second world war).
However, there are two basic problems in interpreting the observable evidence available.
- Firstly, correlation does not imply causationCorrelation does not imply causation"Correlation does not imply causation" is a phrase used in science and statistics to emphasize that correlation between two variables does not automatically imply that one causes the other "Correlation does not imply causation" (related to "ignoring a common cause" and questionable cause) is a...
. Just because a fall in profitability is observed, this does not prove any particular causal theory about why it has fallen; at most it can empirically corroborate a theory ("it fits with the known facts"). Any such theory remains an interpretation, which may be more or less plausible in the light of the facts.
- Secondly, the statistical evidence (beyond anecdotal evidence from business reports) is itself problematic, because the measures of average profitability available are not neutral, but themselves rely on many assumptions. They are in a sense ""stylized facts". It is wellknown to statisticians that it is almost impossible to measure the value of the capital stockStock and flowEconomics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...
accurately, and insofar as profit totals are derived from gross product measures, they may include or exclude profit components at variance from tax data or company reports; profits may also be overstated or understated with various accounting "tricks". This is particularly true in the age of multinationals, which often make profits appear here and disappear there to avoid or evade tax (for example in tax havenTax havenA tax haven is a state or a country or territory where certain taxes are levied at a low rate or not at all while offering due process, good governance and a low corruption rate....
s). An additional complication is that if corporate officers pay themselves enormous salaries, this is accounted for as a salary "cost" and not as an element of gross profit. All Marxist analyses up till now have simply assumed that Marx's value productValue productThe value product is an economic concept formulated by Karl Marx in his critique of political economy during the 1860s, and used in Marxian social accounting theory for capitalist economies...
is equal to "net value added" in national accounts. The official valuation principles, computations and definitions used to obtain a measure of value-added have never been challenged; at most a few small adjustments have been made to the official aggregates.
Therefore, the debate among economists about the TPRF and its significance remains interminable. At best, Marxian economics
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...
has convincingly argued that profitability is the synthetic, overall indicator of the "economic health" of the capitalist system, and that economic crises are system-immanent, i.e. capitalism is inherently crisis-prone, because of its institutional structure and the way it functions. Thus, capitalist development occurs through inevitable booms and busts. This conclusion is the exact opposite to neo-classical economics, according to which markets, if left alone, will spontaneously move towards equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
and economic harmony. But as regards the exact causes of specific economic crises, the debate continues; it is, of course, not necessarily the case that every economic crisis must have the same basic causes.
Further controversy
Some argue, like Marx, that the TRPF applies only to the sphere of capitalist production. Thus, it is argued, it is eminently possible that while industrial profitability declines, average profitability in activities external to real production (for example, commercial trade, capital gains and asset speculation) increases. Investment in production is only one mode of capital accumulationCapital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
, not the only one. Thus, even if the growth rate of production stagnates, asset sales may boom. In advanced capitalist societies such as the United States, constant capital
Constant capital
Constant capital , is a concept created by Karl Marx and used in Marxian political economy. It refers to one of the forms of capital invested in production, which contrasts with variable capital...
applied in private sector productive activities represents only about 20-30% of the value of the total physical capital stock, and perhaps 10-12% of total capital assets owned, and therefore it is unlikely that a fall in the industrial rate profit could by itself explain economic crises.
Others claim that for Marx, commercial trade and asset speculation were unproductive sectors, in which no value can be created. Therefore, they argue, all income of these sectors is a deduction of the value created in the productive sectors of the economy. Booms in unproductive sectors may temporarily act as a countervailing factor to the TRPF, but not in the long run. On the contrary, Fred Moseley argues, in the US the rate of profit is lower than it used to be in earlier decades after the second world war, because of a rising share of unproductive labor with respect to productive labor
Productive and unproductive labour
Productive and unproductive labour were concepts used in classical political economy mainly in the 18th and 19th century, which survive today to some extent in modern management discussions, economic sociology and Marxist or Marxian economic analysis...
. This is a reason of its own for a falling general rate of profit in distinction to the TRPF. Yet both Moseley's calculations and his definition of unproductive labor have been criticised by other Marxists.
See also
- Marginal utilityMarginal utilityIn economics, the marginal utility of a good or service is the utility gained from an increase in the consumption of that good or service...
- Crisis theoryCrisis theoryCrisis theory is generally associated with Marxian economics. In this context crisis refers to what is called, even currently and outside Marxian theory in many European countries a "conjuncture" or especially sharp bust cycle of the regular boom and bust pattern of what Marxists term "chaotic"...
- crises (economic)
- Profit (accounting)Profit (accounting)In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
- Rate of profitRate of profitIn economics and finance, the profit rate is the relative profitability of an investment project, of a capitalist enterprise, or of the capitalist economy as a whole...
- Profit marginProfit marginProfit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.Net profit Margin = x100...
- Internal rate of returnInternal rate of returnThe internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
- Return on capital
- Capital accumulationCapital accumulationThe accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
- Diminishing returnsDiminishing returnsIn economics, diminishing returns is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.The law of diminishing returns In economics, diminishing returns (also...