Tendency of the rate of profit to fall
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The tendency of the rate of profit to fall, commonly abbreviated to TRPF, is a hypothesis in economics and political economy, generally accepted in the 19th century, but mostly rejected by mainstream economists today. Economists as diverse as Adam Smith and Stanley Jevons noticed a long-run empirical trend for the return on capital invested in industries to decline, but the theorem was most famously expounded by Karl Marx in chapter 13 of Das Kapital Vol. 3, who called this tendency "the most important law of political economy", and who sought to give a causal explanation for it, in terms of his labour theory of value.
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[edit] 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 Nations, chapter IX)[1]
[edit] Marx's argument
Simply put, Marx argued that technological innovation enabled more efficient means of production. Physical productivity would increase as a result, i.e. a greater output (of use values) would be produced, per unit of capital invested. Simultaneously, however, technological innovations replaced people with machinery, and the organic composition of capital increased. Assuming only labor can produce new additional value, this greater physical output would embody a smaller value and surplus value. The average rate of industrial profit would therefore decline in the longer term. It declined in the long run, Marx argued, paradoxically not because productivity declined, but instead because it increased, with the aid of a bigger investment in equipment.
This was then the general tendency in capitalism, but it was only a tendency, because there were 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 power
- cheapening the elements of constant capital by various means
- the growth and utilization of a relative surplus population (the reserve army of labour)
- foreign trade reducing the cost of industrial inputs and consumer goods.
- the increase in share capital.
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
- 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 capital prevailed.
- military wars or military spending causing capital assets to be inoperative or destroyed, or spurring war production (see permanent arms economy).
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.
[edit] Later Marxist interpretation
Although Marx did not explicitly argue this himself, later Marxists (including Henryk Grossmann and Paul Mattick) have argued that this paradoxical outcome for all the competing enterprise together - an increase in physical output produced, containing a decreasing quantity of labour-value - is the ultimate cause of economic crises, which feature a sharp drop in industrial investments and rising unemployment. Thus, the ultimate cause of economic crises in capitalism is attributed to the overall, 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 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.
There are, however, many more crisis theories in the Marxian tradition, focusing variously on the anarchy of capitalist production, sectoral disproportions, underconsumption, labour-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.
[edit] Criticism of Marx's interpretation of the TRPF
Marx’s interpretation has been the source of intense controversy and - leaving aside numerous attacks on his value theory - has been criticized in two 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 (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).
1) 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.
2) 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).
3) 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.
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.
[edit] 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 Mandel, 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 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 causation. 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 stock 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 havens).
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. 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.
[edit] 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, and asset speculation) increases. Investment in production is only one mode of capital accumulation, not the only one. Thus, even if the growth rate of production stagnates, asset sales may boom.
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.
Critics however reply that Moseley's argument is flawed for several reasons.
- Firstly, it equates new value created in current production of new output, with total gross incomes being distributed in the economy, which is logically and empirically false.
- Secondly, if the income of the unproductive sector is apportioned to S (=surplus value) in the profit ratio S/(C+V), rather than to C (=constant capital) or V (=variable capital), the effect is that every increase in the income of the unproductive sector must increase S, and therefore raise the profit rate, rather than reduce it.
- Thirdly, Moseley applies a definition of unproductive labour which is not only questionable in its own right, but also falsifies Marx's own concept. For example, Moseley defines all managerial and supervisory workers as "unproductive". But that was not Marx's own view at all. Marx wrote:
"The work of supervision and management necessarily arises everywhere when the direct production process takes the form of a socially combined process, and does not appear simply as the isolated labour of separate producers. It has, however, a dual nature. On the one hand, in all labour where many individuals cooperate, the interconnection and unity of the process is necessarily represented in a governing will, and in functions that concern not the detailed work but rather the workplace and its activity as a whole, as with the conductor of an orchestra. This is productive labour that has to be performed in any combined mode of production. On the other hand - and quite apart from the commercial department - this work of supervision necessarily arises in all modes of production that are based on opposition between the worker as direct producer and the proprietor of the means of production. The greater this opposition, the greater the role that this work of supervision plays. It reaches its high point in the slave system." Source: Karl Marx, Das Kapital Vol. 3 (1894), Dietz ed. p. 397. Pelican edition, p. 507 (translation corrected, emphasis added).
In other words, Marx - who never finalised his complete definition of productive labour - was well aware that managerial and supervisory functions were in part technically indispensable and productive, and in part unproductive social control functions - the two being combined in various admixtures. All this is ignored by Moseley, who made no profound study of the division of labour. Yet what definition is used, has large quantitative effects for measurements of the Marxian rate of profit.
[edit] See also
- crises (economic)
- Profitability
- Rate of profit
- Profit margin
- Internal rate of return
- Return on capital
- Capital accumulation
- Diminishing returns
[edit] References
- Karl Marx, Das Kapital Vol. 3
- Theories Combining Keynes, Kondratieff, Marx and Smith: R. L. Norman, Jr.
- Robert Brenner, The Boom and the Bubble - the US in the World Economy. Verso London, New York 2002. (empirical data for the post WWII era)
- James H. Chan-Lee and Helen Sutch, "Profits and rates of return" (an OECD study)[2]
- Steve Cullenberg, The Falling rate of Profit. London: Pluto, 1994. (a review of Marxist arguments)
- Gerard Duménil and Dominique Lévy, The Economics of the Profit Rate: Competition, Crises, and Historical Tendencies in Capitalism. Aldershot, England: Edward Elgar, 1993. (looks at long term empirical trends)
- Alan Freeman: 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 1996 (a mathematical defense of the law)
- Joseph Gillman: The Falling Rate of Profit, London, Dennis Dobson, 1957 (the first attempt to test Marx's hypothesis empirically).
- Shane Mage, The Law of the Falling Tendency of the Rate of Profit; Its Place in the Marxian Theoretical System and Relevance to the US Economy. Phd Thesis, Columbia University, 1963. (a response to Gillman with an elaborate statistical analysis).
- Chris Harman: Explaining the Crisis - a Marxist Reappraisal. London Chicago Sydney, Bookmarks 1999. (a defense of the law)
- Daniel M. Holland (ed.) Measuring profitability and capital costs : an international study. Lexington, Mass. : Lexington Books, c1984. (another study of empirical trends).
- Alfred Kleinknecht, Ernest Mandel and Immanuel Maurice Wallerstein (eds.), New findings in long-wave research. New York, N.Y.: St. Martin's Press, 1992. (links the profitability issue to the Kondratiev waves).
- Fred Moseley, The rate of profit and economic stagnation in the United States economy. Historical Materialism, Volume 1, Number 1, 1997
- Reuben L. Norman Jr., The Internet, Creative Destruction and The Falling Rate of Profit Crisis, February 8, 2000, Paper on how the Internet might precipitate first falling rate crisis and a new 1929 Depression, [ http://www.southerndomains.com/SouthernBanks/p1.htm ]
- Nobuo Okishio, "Technical Change and the Rate of Profit", Kobe University Economic Review, 7, 1961, pp. 85-99. (the famous criticism)
- Anwar Shaikh, The Current Crisis: Causes and Implications (a Solidarity pamphlet)[3] (a succinct modern Marxist interpretation)
- John Weeks, Capital and exploitation, chapter 8 (Princeton University Press, 1980) (careful analysis of the Marxian TRPF in terms of value theory).
