Okishio's theorem

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Okishio's theorem states that, if a firm raises its rate of profit by introducing a new technique of production, in which less labour is needed on one side, but more means of production on the other side, that this also for the economy as a whole leads to a higher rate of profit, if this new technique of production has spread through the whole branch - under the assumption, that real wages or the commodity basket workers get for their labour power has not been enlarged but remained constant.

This theorem contradicts Marx's law of the tendency of the rate of profit to fall. Marx had claimed that the new general rate of profit, after the new technique has spread throughout the branch where it has been introduced, would be lower than before. In modern words, the capitalists would be caught in a rationality trap or prisoner's dilemma, what is from the point of view of a single capitalist rational turns out to be irrational for the system as a whole, for the collective of all capitalists.

1 The Sraffa model
2 Introduction of technical progress
3 Result
4 Marxist responses
5 The model in physical terms
6 Quotes
7 References
8 Literature

[edit] The Sraffa model

The argument of Nobuo Okishio, a Japanese economist, is based on a Sraffa-model. The economy consists of two departments I und II, where I is the investments goods department (means of production) and II is the consumption goods department, where the consumption goods for workers are produced. The coefficients of production tell, how much of the several inputs is necessary to produce one unit of output of a given commodity ("production of commodities by means of commodities"). In the model below two outputs exist $x 1$ , the quantity of investment goods, and $x 2$ , the quantity of consumption goods.

The coefficients of production are defined as:

$a 11$ : quantity of investment goods necessary to produce one unit of investment goods.
$a 21$ : quantity of hours of labour necessary to produce one unit of investment goods.
$a 12$ : quantity of investment goods necessary to produce one unit of consumption goods.
$a 22$ : quantity of hours of labour necessary to produce one unit of consumption goods.

The worker receives a wage at a certain wage rate w (per unit of labour), which is defined by a certain quantity of consumption goods.

Thus:

$w \cdot a_{21}$ : quantity of consumption goods necessary to produce one unit of investment goods.
$w \cdot a_{22}$ : quantity of consumption goods necessary to produce one unit of consumption goods.

This table describes the economy:

	Input $x 1$	Input $x 2$	Output
Department I	$a_{11} \cdot x_1$	$a_{21} \cdot w \cdot x_1$	$x 1$
Department II	$a_{12} \cdot x_2$	$a_{22} \cdot w \cdot x_2$	$x 2$

This is equivalent to the following equations:

$(a_{11} \cdot x_1 \cdot p_1 + a_{21} \cdot w \cdot x_1 \cdot p_2) \cdot (1+r) = x_1 \cdot p_1$
$(a_{12} \cdot x_2 \cdot p_1 + a_{22} \cdot w \cdot x_2 \cdot p_2) \cdot (1+r) = x_2 \cdot p_2$

$p 1$ : price of investment good $x 1$
$p 2$ : price of consumption good $x 2$
$r$ : General rate of profit. Due to the tendency, described by Marx, of rates of profits to equalise between branches (here departments) a general rate of profit for the economy as a whole will be created.

In department I expenses for investment goods or for constant capital are:

$a_{11} \cdot x_1 \cdot p_1$ and for variable capital:
$a_{21} \cdot w \cdot x_1 \cdot p_2$ .

In Department II expenses for constant capital are:

$a_{12} \cdot x_2 \cdot p_1$ and for variable capital:
$a_{22} \cdot w \cdot x_2 \cdot p_2$ .

(The constant and variable capital of the economy as a whole is a weighted sum of these capitals of the two departments. See below for the relative magnitudes of the two departments which serve as weights for summing up constant and variable capitals.)

Now the following assumptions are made:

$p 2 = 1$ : The consumption good $x 2$ is to be the Numéraire, the price of the consumption good $p 2$ is therefore set equal to 1.
The real wage is assumed to be $w = 2 \cdot p_2 = 2$ .
Finally, the system of equations is normalised by setting the outputs $x 1$ und $x 2$ equal to 1, respectively.

Okishio, following some Marxist tradition, assumes a constant real wage rate equal to the value of labour power, that is the wage rate must allow to buy a basket of consumption goods necessary for workers to reproduce their labour power. So, in this example it is assumed that workers get two pieces of consumption goods per hour of labour in order to reproduce their labour power.

A technique of production is defined according to Sraffa by its coefficients of production. For a technique, for example, might be numerically specified by the following coefficients of production:

$a 11 = 0,8$ : quantity of investment goods necessary to produce one unit of investment goods.
$a 21 = 0,1$ : quantity of working hours necessary to produce one unit of investment goods.
$a 12 = 0,4$ : quantity of investment goods necessary to produce one unit of consumption goods.
$a 22 = 0,1$ : quantity of working hours necessary to produce one unit of consumption goods.

From this an equilibrium growth path can be computed. The price for the investment goods is computed as (not shown here): $p 1 = 1,78$ , and the profit rate is: $r = 0{,}0961 = 9{,}61 \%$ . The equilibrium system of equations then is:

$(0{,}8 \cdot 1 \cdot 1{,}78 + 0{,}1 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}0961) = 1 \cdot 1{,}78$
$(0{,}4 \cdot 1 \cdot 1{,}78 + 0{,}1 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}0961) = 1 \cdot 1$

[edit] Introduction of technical progress

A single firm of department I is supposed to use the same technique of production as the department as a whole. So, the technique of production of this firm is described by the following:

$(a_{11} \cdot x_1 \cdot p_1 + a_{21} \cdot w \cdot x_1 \cdot p_2) \cdot (1+r) = x_1 \cdot p_1$

$= (0{,}8 \cdot 1 \cdot 1{,}78 + 0{,}1 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}0961) = 1 \cdot 1{,}78$

Now this firm introduces technical progress by introducing a technique, in which less working hours are needed to produce one unit of output, the respective production coefficient is reduced, say, by half from $a 21 = 0,1$ to $a 21 = 0,05$ . This already increases the technical composition of capital, because to produce one unit of output (investment goods) only half as much of working hours are needed, while as much as before of investment goods are needed. In addition to this, it is assumed that the labour saving technique goes hand in hand with a higher productive consumption of investment goods, so that the respective production coefficient is increased from, say, $a 11 = 0,8$ to $a 11 = 0,85$ .

This firm, after having adopted the new technique of production is now described by the following equation, keeping in mind that at first prices and the wage rate remain the same as long as only this one firm has changed its technique of production:

$= (0{,}85 \cdot 1 \cdot 1{,}78 + 0{,}05 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}1036) = 1 \cdot 1{,}78$

So this firm has increased its rate of profit from $r = 9{,}61 \%$ to $10{,}36 \%$ . This accords with Marx`s argument that firms introduce new techniques only if this raises the rate of profit.

Karl Marx, volume III of Capital, chapter 15: "No capitalist ever voluntarily introduces a new method of production, no matter how much more productive it may be, and how much it may increase the rate of surplus-value, so long as it reduces the rate of profit."

Marx expected, however, that if the new technique will have spread through the whole branch, that if it has been adopted by the other firms of the branch, the new equilibrium rate of profit not only for the pioneering firm will be again somewhat lower, but for the branch and the economy as a whole. The traditional reasoning is that only "living labour" can produce value, whereas constant capital, the expenses for investment goods, do not create value. The value of constant capital is only transferred to the final products. Because the new technique is labour saving on the one hand, outlays for investment goods have been increased on the other, the rate of profit must finally be lower.

Let us assume, the new technique spreads through all of department I. Computing the new equilibrium rate of growth and the new price $p 2$ gives under the assumption that a new general rate of profit is established:

$(0{,}85 \cdot 1 \cdot 1{,}77 + 0{,}05 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}1030) = 1 \cdot 1{,}77$
$(0{,}4 \cdot 1 \cdot 1{,}77 + 0{,}1 \cdot 2 \cdot 1 \cdot 1) \cdot (1+0{,}1030) = 1 \cdot 1$

If the new technique is generally adopted inside department I, the new equilibrium general rate of profit is somewhat lower than the profit rate, the pioneering firm had at the beginning ( $10{,}36 \%$ ), but it is still higher than the old prevailing general rate of profit: $10{,}30 \%$ larger than $9{,}61 \%$ .

[edit] Result

Nobuo Okishio proved this generally, which can be interpreted as a refutation of Marx's law of the tendency of the rate of profit to fall. This proof has also been confirmed, if the model is extended to include not only circulating capital but also fixed capital. The introduction of labour saving techniques does not lead to falling, but to increasing rates of profit.

[edit] Marxist responses

1) Some Marxists simply dropped the law of the tendency of the rate of profit to fall, claiming that there are enough other reasons to criticise capitalism, that the tendency for crises can be established without the law, so that it is not an essential feature of Marx's economic theory.

Others would say that the law helps to explain the recurrent cycle of crises, but cannot be used as a tool to explain the long term developments of the capitalist economy.

2) Others argued that Marx's law holds if one assumes a constant ‘’wage share’’ instead of a constant real wage ‘’rate’’. Then, the prisoner's dilemma works like this: The first firm to introduce technical progress by increasing its outlay for constant capital achieves an extra profit. But as soon as this new technique has spread through the branch and all firms have increased their outlays for constant capital also, workers adjust wages in proportion to the higher productivity of labour. The outlays for constant capital having increased, wages having been increased now also, this means that for all firms the rate of profit is lower.

However, Marx does not know the law of a constant wage share. Mathematically the rate of profit could always be stabilised by decreasing the wage share. In our example, for instance, the rise of the rate of profit goes hand in hand with a decrease of the wage share from $58{,}6 \%$ to $41{,}9 \%$ , see computations below.

3) The third response , finally, was to reject the whole framework of the Sraffa-models, especially the comparative static method^[1]. In a capitalist economy entrepreneurs do not wait until the economy has reached a new equilibrium path but the introduction of new production techniques is an ongoing process. Marx’s law is valid if an ever larger portion of production is invested per working place instead of in new additional working places. Such an ongoing process cannot be described by the comparative static method of the Sraffa models.

[edit] The model in physical terms

[edit] The dual system of equations

Up to now it was sufficient to describe only monetary variables. In order to expand the analysis to compute for instance the value of constant capital c, variable capital v und surplus value (or profit) s for the economy as whole or to compute the ratios between these magnitudes like rate of surplus value s/v or value composition of capital, it is necessary to know the relative size of one department with respect to the other. If both departments I (investment goods) and II (consumption goods) are to grow continuously in equilibrium there must be a certain proportion of size between these two departments. This proportion can be found by modelling continuous growth on the physical (or material) level in opposition to the monetary level.

In the equations above a general, for all branches, equal rate of profit was computed given

certain technical conditions described by input-output coefficients
a real wage defined by a certain basket of consumption goods to be consumed per hour of labour $x 2$

whereby a price had to be arbitrarily determined as numéraire. In this case the price $p 2$ for the consumption good $x 2$ was set equal to 1 (numéraire) and the price for the investment good $x 1$ was then computed. Thus, in money terms, the conditions for steady growth were established.

[edit] The general equations

To establish this steady growth also in terms of the material level, the following must hold:

$(a_{11} \cdot x_1 + K \cdot a_{12} \cdot x_2) \cdot (1+g) = x_1$
$(a_{21} \cdot w \cdot x_1 + K \cdot a_{22} \cdot w \cdot x_2) \cdot (1+g) = K \cdot x_2$

Thus, an additional magnitude K must be determined, which describes the relative size of the two branches I and II whereby I has a weight of 1 and department II has the weight of K.

If it is assumed that total profits are used for investment in order to produce more in the next period of production on the given technical level, then the rate of profit r is equal to the rate of growth g.

[edit] Numerical examples

In the first numerical example with rate of profit $r = 9,61 \%$ we have:

$(0{,}8 \cdot 1 + 0{,}2808 \cdot 0{,}4 \cdot 1) \cdot (1+0{,}0961) = 1$
$(0{,}1 \cdot 2 \cdot 1 + 0{,}2808 \cdot 0{,}1 \cdot 2 \cdot 1) \cdot (1+0{,}0961) = 0{,}2808 \cdot 1$

The weight of department II is $K = 0,2808$ .

For the second numerical example with rate of profit $r = 10,30 \%$ we get:

$(0{,}85 \cdot 1 + 0{,}14154 \cdot 0{,}4 \cdot 1) \cdot (1+0{,}1030) = 1$
$(0{,}1 \cdot 2 \cdot 1 + 0{,}14154 \cdot 0{,}05 \cdot 2 \cdot 1) \cdot (1+0{,}1030) = 0{,}14154 \cdot 1$

Now, the weight of department II is $K = 0,14154$ . The rates of growth g are equal to the rates of profit r, respectively.

For the two numerical examples, respectively, in the first equation on the left hand side is the input of $x 1$ and in the second equation on the left hand side is the amount of input of $x 2$ . On the right hand side of the first equations of the two numerical examples, respectively, is the output of one unit of $x 1$ and in the second equation of each example is the output of K units of $x 2$ .

The input of $x 1$ multiplied by the price $p 1$ gives the monetary value of constant capital c. Multiplication of input $x 2$ with the set price $p 2 = 1$ gives the monetary value of variable capital v. One unit of output $x 1$ and K units of output $x 2$ multiplied by their prices $p 1$ and $p 2$ respectively gives total sales of the economy c + v + s.

Subtracting from total sales the value of constant capital plus variable capital (c+v) gives profits s.

Now the value composition of capital c/v, the rate of surplus value s/v, and the „wage share“ v/(s+v) can be computed.

With the first example the wage share is $58,6 \%$ and with the second example $41,9 \%$ . The rates of surplus value are, respectively, 0,706 and 1,389. The value composition of capital c/v is in the first example 6,34 and in the second 12,49. According to the formula

            Rate of profit

for the two numerical examples rates of profit can be computed, giving $9{,}61 \%$ and $10{,}30 \%$ , respectively. These are the same rates of profit as were computed directly in monetary terms.

[edit] Comparative static analysis

The problem with these examples is that they are based on Comparative statics. The comparison is between different economies each on an equilibrium growth path. Models of dis-equilibrium lead to other results. If capitalists raise the technical composition of capital because thereby the rate of profit is raised, this might lead to an ongoing process in which the economy has not enough time to reach a new equlilibrium growth path. There is a continuing process of increasing the technical composition of capital to the detriment of job creation resulting at least on the labour market in stagnation. The law of the tendency of the rate of profit to fall nowadays usually is interpreted in terms of disequilibrium analysis, not the least in reaction to the Okishio critique.

[edit] A mathematical counter example

The following numerical example shows that individual profit maximising rationality can go hand in hand with decreasing employment (first with a decreasing rate of growth of employment, then with an absolute decrease in employment). A slow down in employment is to be interpreted as a falling rate of profit for the economy as a whole.

For simplicity it is assumed that every product, whether for individual consumption or for investment, has a price of 1 Euro. The wage rate for one unit of labour L is 1 Euro or one consumption good at a price of 1 Euro.

In period 1, 100 € are invested in the form of variable capital L, and another 100 € in the form of constant capital K. Output Y is assumed to be 206 €.

The technical composition of capital (TCC) K/L then is 1,0, labour productivity is Y/L, that is 2,06. All output is sold at a total price of 206 Euros, all income of 206 Euros is expended in the next period to be invested in either labour L or capital C.

In the next period TCC will be raised by 5 % (growth factor 1,05). It is assumed that this is rational from the individual point of view of a single capitalist. To estabalish this rationality on an individual basis it is assumed that by raising TCC by 5 %, labour productivity is not raised only by 5 %, but by twice 5 %, that is 10,3 % (growth factor 1,05 times 1,05 = 1,103). Otherwise the capitalist would get a higher rate of profit by sticking with the old technique of production leaving TCC constant.

By this scenario it is garuanteed that Marx’s remark in volume III of Das Kapital holds true that "no capitalist ever voluntarily introduces a new method of production, … so long as it reduces the rate of profit."

If an increase in TCC was profitable for the capitalists because they thus have achieved a higher rate of profit, they will continue to try to raise the TCC in future periods. It is now assumed that they manage to raise the TCC not only as much as labour productivity has risen (10,3 %), but by additional 5 %, that is in total 15,8 % (growth factor 1,05 times 1,05 times 1,05 = 1,158).

If this goes on, at first employment increases, however, at a decreasing rate. In period 15 finally employment reaches it maximum and from then onwards TCC can only be further increased if at the same time employment is reduced.

In purely numerical terms the development can go on. However, the decline in overall employment is equivalent to an overall decline in the rate of profit in value terms and must lead to a change of nature of the capitalist economy.

[edit] Table

L: labour input
C: Consumption goods, C=L, if wage is 1.
K: capital input
Y: Output
K/L: technical composition of capital TCC
Y/L: labour productivity
G( …): rate of growth in %

The wage of a worker is C/L or consumption goods per worker employed. As initial values an output Y of 206 in period 1 is assumed which is divided in 100,5 goods of consumption to be consumed in the next period, which the workers pay for with their wages of 100,5 Euros, and in K = 105,5 investment goods, which are productively consumed as means of production. And so on, from period to period.

Period	L (=C)	K	Y	K/L	Y/l	G(K/L)	G(Y/L)
	€	€	€		€	%	%
1	100,0	100,0	206,0	1,0	2,1
2	100,5	105,5	228,2	1,1	2,3	5,0	10,3
3	103,0	125,2	284,4	1,2	2,8	15,8	21,6
4	111,5	172,9	412,3	1,6	3,7	27,6	34,0
5	129,6	282,8	708,1	2,2	5,5	40,7	47,7
6	161,4	546,7	1 437,3	3,4	8,9	55,1	62,9
7	211,6	1 225,7	3 383,5	5,8	16,0	71,0	79,6
8	283,8	3 099,7	8 984,9	10,9	31,7	88,6	89,0
9	379,0	8 605,9	26 192,4	22,7	69,1	107,9	118,3
10	493,8	25 698,6	82 125,9	52,0	166,3	129,2	140,7
11	619,8	81 506,1	273 495,6	131,5	441,3	152,7	165,3
12	744,5	272 751,1	960 983,9	366,4	1 290,8	178,6	192,5
13	853,2	960 130,6	3 551 968,7	1 125,3	4 162,9	207,2	222,5
14	931,9	3 551 036,8	13 793 779,6	3 810,6	14 802,0	238,6	255,6
15	969,5	13 792 810,1	56 256 170,2	14 226,6	58 025,7	273,3	292,0
16	960,7	56 255 209,6	240 918 113,2	58 558,8	250 783,5	311,6	332,2
17	906,6	240 917 206,7	1 083 337 619,5	265 742,2	1 194 968,8	353,8	376,5

The table shows that output Y and input of K grow at an increasing rate, whereas, however, input of labour L increases only up to period 15 and then must decline.

[edit] Discussion

Crucial for this outcome is, that entrepreneurs raise the TCC of their firms more than labour productivity has been raised a period before. This is rational from a single entrepreneur’s point of view, if this increase in TCC goes hand in hand with a higher increase in labour productivity (individual rationality). In the table this is the case, as in each period (in each line) the increase of labour productivity is larger than the increase of TCC. Rationality at the individual level is thus insured. However, the increase of the TCC is always larger than the increase of labour productivity, which was achieved a period before (one line above). From this follows a collective irrationality in the sense that this regime must finally lead to shrinking employment (rationality trap).

The assumption that an increase of labour productivity is followed by a larger increase in TCC the next period might seem arbitrary. But if an increase of TCC goes hand in hand with a larger increase in labour productivity, there is an incentive for firms to increase TCC as much as possible. It is arbitrary to assume that capitalists are not able to raise TCC by a higher percentage than labour productivity was raised. In fact, main stream growth models usually assume arbitrarily that TCC cannot be raised more than labour productivity. In the technical progress function of Nicholas Kaldor, for instance, there is an equilibrium point at which labour productivity and TCC grow at the same rate. This assumption is necessary in order to get a "well-behaved" function to be able to argue for an equilibrium growth path free of disturbances.

[edit] Quotes

Considered abstractly the rate of profit may remain the same, even though the price of the individual commodity may fall as a result of greater productiveness of labour and a simultaneous increase in the number of this cheaper commodity … The rate of profit could even rise if a rise in the rate of surplus-value were accompanied by a substantial reduction in the value of the elements of constant, and particularly of fixed, capital. But in reality, as we have seen, the rate of profit will fall in the long run. Karl Marx, Capital III, chapter 13. The last sentence is, however, not from Karl Marx but from Friedrich Engels.

No capitalist ever voluntarily introduces a new method of production, no matter how much more productive it may be, and how much it may increase the rate of surplus-value, so long as it reduces the rate of profit. Yet every such new method of production cheapens the commodities. Hence, the capitalist sells them originally above their prices of production, or, perhaps, above their value. He pockets the difference between their costs of production and the market-prices of the same commodities produced at higher costs of production. He can do this, because the average labour-time required socially for the production of these latter commodities is higher than the labour-time required for the new methods of production. His method of production stands above the social average. But competition makes it general and subject to the general law. There follows a fall in the rate of profit — perhaps first in this sphere of production, and eventually it achieves a balance with the rest — which is, therefore, wholly independent of the will of the capitalist ‘'Karl Marx, Capital volume III, chapter 15.

[edit] References

^ THE OKISHIO THEOREM: AN OBITUARY

[edit] Literature

Duncan K. Foley: Understanding Capital: Marx's Economic Theory. Harvard University Press 1986. ISDN 0674920880
Alan Freeman (1996): Price, value and profit - a continuous, general, treatment in: Freeman, Alan und Carchedi, Guglielmo (Hrsg.) "Marx and non-equilibrium economics". Edward Elgar, Cheltenham, UK, Brookfield, US
Nobuo Okishio, "Technical Change and the Rate of Profit", Kobe University Economic Review, 7, 1961, pp. 85-99.

Sraffa, Piero: Production of Commodities by Means of Commodities: Prelude to a critique of economic theory, 1960.

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Categories: History of economic thought | Marxist theory