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Marx’s law of profitability

posted 15 Mar 2010, 15:55 by Admin uk   [ updated 15 Mar 2010, 16:00 ]
Marx’s law of profitability by Michael Roberts

From his book The Great Recession

Nobody argues that the world capitalist economy moves in a straight
upward path. Everybody recognises that it is subject to ‘turbulence’,
booms and slumps, even crises. In these periods of slump or crises,
people’s lives are disrupted, jobs are lost, businesses go bust, families are
made homeless etc.
Can we say why these crises come about? The orthodox bourgeois econo-
mists say they are the result of interference in the market economy by
the state, by monopoly power (mainly trade unions) or as the result of
‘bad’ policies that do not allow capitalists the freedom to make profits
(too high taxes or interest rates etc). There is no inherent fault in the
capitalist mode of production that generates periodic crises in the economy.
Followers of the Marxist economic tradition would disagree. For us, the
capitalist system is not only unjust, unequal and barbarous. It is also shot
through with periodic failure.
The primary reason is that the productive forces that provide prosperity
and a better life are only unleashed under capitalism if there is a profit for
the owners of capital. In other words, the productive forces are privately
owned and turned into ‘capital’, so society only benefits if that capital is
invested in production. If the profit is not there, things and services that
people need are not produced. So profits and the profitability of capital
are key to the health of the capitalist mode of production.
Marx argued that capitalism will suffer periodic crises precisely because
the owners of capital will not be able to generate sufficient profits indefi-
nitely to sustain an untrammelled growth in production and living stand-
ards. For that reason, capitalism may be the most expansive mode of
production seen on the earth so far, but it is also most wasteful, unequal
and crisis-ridden. Human beings can do better.
Why cannot capitalists generate sufficient profits indefinitely so that the
world’s productive forces can expand smoothly forever? Marx argued
that the most important law of the motion of capitalism that explained
periodic crises was the law of the tendency of the rate of profit to fall.
(K Marx, Capital Vol III, Part III, Chapter 13)

Of course, each capitalist business, large or small, earns a different amount
of profits. And each earns a different rate of profit, as measured by the
amount of profits produced in, say a year, against the amount of money
capital that the capitalist owner had to put into the business.
Marx argued that the only way to understand the forces at work in a
whole economy was to aggregate all the profits and capital in all the
businesses and come up with an average rate of profit. He then said that,
if this average rate of profit dropped so low as to cause the capitalists to
stop investing further in production, the economy would go into crisis.
There would be what modern economists call a ‘recession’ or ‘slump’,
with all that entails for jobs and living standards for the mass of working
people and their dependents.
What could make the average rate of profit in the capitalist economy fall
to such a low level, and for that matter what would make it rise? Marx
starts from the fundamental fact that nothing is created without human
beings spending time making or delivering it. Under capitalism, however,
that labour time has been appropriated by the owners of capital (namely
those that own and control the plant and equipment, raw materials and
the money to buy them). Production depends on workers, but production
does not happen without the say-so of the owners of capital. They own
the means of production.
Thus, the labour time of the workers is turned into a certain value that the
owners of capital measure against the costs of employing their workers
and the cost of setting up the businesses and supplying the necessary raw
materials and services.
Only if the workers expend labour time is there any production and any
profit. The workers get paid a certain amount for their time. The capitalists
own and control the product of their labour and sell it in the market.
The difference between the revenues of those sales and cost of employ-
ing the workforce is what Marx called the surplus-value that the own-
ers of capital had appropriated over and above the value of the production
paid to the workers for their time.
From the capitalists’point of view, the capital invested in paying the work-
ers is variable, in that the workers add more value. Marx called that
variable capital. But the capitalists also have the costs of setting up and
running the businesses. Factories, offices and supplies cannot add any
production value in themselves. But they still have to be paid for. From
the capitalist viewpoint, this is constant capital.
In any one period, the capitalists put up money for variable capital
(workforce) and constant capital (plant and machinery etc). At the end
of the production period, they sell the production in the market and re-
ceive revenues to cover their original money capital and more. The rate
of profit is thus the surplus value (s) created by the workers divided by
the sum of the cost of variable (v) and constant capital (c), or (s/c+v).
Marx argued that over a whole economy, there was tendency for that
rate of profit to fall. And indeed, after a period of time, it would fall,
causing an economic crisis.
Why is there a tendency for the rate of profit to fall? The reason is
inherent in the capitalist mode of production. Capitalism is a system of
production where individual owners of capital (or limited companies with
lots of small owners or shareholders) compete in the market place to sell
their goods at a profit. So there is an inherent drive to keep costs down
relative to likely sales revenues.
Assuming, for the moment, that the price that a business is going to get
for its product or service is fixed by the market, then each business can
raise (or just maintain) profits either by lowering the costs of employing
the workforce or by lowering the costs of raw materials and offices etc.
The latter costs are usually fixed or out of the control of the individual
capitalist, so the big drive is to lower labour costs.
Capitalists can do this by reducing the workforce to the minimum re-
quired to make the business function. Or they can make an existing
workforce work harder or longer. These measures will either raise the
absolute size of surplus value created by the workforce or its relative
value compared to the costs of employing the workforce (the rate of
surplus value), or both.
In the modern capitalist world, the most effective way of raising the rate
of surplus value is to introduce new technology that can either reduce the
number of workers needed or increase how much they produce in the
same period of time, or both. The rate of surplus value will rise and, other
things being equal, so will profits and the rate of profit.
But other things are not equal. New technology means more money
capital must be invested in machinery. Most important, Marx said, the
amount of capital devoted to machinery and technology will rise relative
to the amount of capital invested in the workforce. So there will be a
tendency for the value of constant capital (c) to rise relative to variable
capital (v). Marx called this ratio: the organic composition of capital,
or c/v.
If the organic composition of capital (c/v) rises, then, unless the rate of
surplus value (s/v) rises as fast or faster, the rate of profit (s/c+v) will
fall. Marx argued that under capitalism, the forces of competition and the
drive for profit will mean that the organic composition of capital will rise.
If it is rising, it is because capitalists are cutting back on labour and substi-
tuting machinery. More technology may well raise the productivity of the
workforce, but a smaller workforce will reduce the amount of value pro-
duced, as only workers expending labour time can add value. Thus rela-
tively more spent on technology and relatively less on labour will tend to
reduce the amount of value produced for each unit of money capital in-
vested. There is a tendency for the rate of profit to fall.
However, Marx identified a whole number of ‘countervailing tendencies’
that could mean either the organic composition of capital would not rise
or the rate of profit would still rise even if it did — for a while
(K. Marx, Capital Vol 1I1, Part III, Chapter 14)

And that last point is key. The countervailing tendencies were just that. The
tendency for the organic composition of capital would exert itself and so
would the tendency for the rate of profit to fall. Eventually, such would
be the effect on the average rate of profit and the mass of profits in the
economy, that it would push many capitalists into bankruptcy and others
to stop producing (as much). There would be an economic crisis.
Of course, this is where it all gets controversial, especially among Marx-
ist economists themselves! The first big argument is that many econo-
mists who consider themselves Marxists reckon that Marx made such
important theoretical errors in his explanation of the law of the tendency
of the rate of profit to fall that it just does not hold up.
The second big argument against Marx’s rate of profit theory is that it is
just not empirically correct. The average rate of profit has not fallen over
time and, even more significant, the organic composition of capital has
not risen to explain it. Marx is just plain wrong, they say.
So with Marx wrong both theoretically and empirically, his explanation of
economic crisis falls to the ground. The critics say we should look else-
where for an explanation of economic crisis. Many fall back on the
inadequate theories of the orthodox bourgeois economists or alternatively
try to work out a bastardised Marxist version that does not rely on Marx’s
rate of profit theory.
I hope to try and answer these critics and defend Marx’s theory of prof-
itability and crisis both theoretically and empirically. The aim is not just to
defend Marx, but also to show that his profit theory is both relevant and
crucial to understanding through what stage world capitalism is currently
The graph in the next chapter shows the movement in the average rate of
profit and the organic composition of capital in the US since 1945. The
US is the biggest and most important capitalist economy. As such, it
provides the best indicator of the laws of motion of capitalism, just as
Marx found Britain was in the 19th century.
And this graph provides strong empirical confirmation of Marx’s analysis
of the capitalist economy and his explanation of the nature of capitalist
crises. From it, we can draw some startling conclusions, as the next
chapter will try to show.