The Falling Rate of Profit
Marx’s theory of the law of the tendency of the rate of profit to fall (LTRPF) has been extremely controversial in terms of its validity, interpretation and significance. This chapter outlines Marx’s law and answers some of the criticisms that have been levelled against it. Two misguided interpretations of the LTRPF are often found in the literature. On the one hand, Marx’s contribution is removed to the realm of high philosophy, with the LTRPF taking on the character of an abstract truth, something derived from the logic of capital itself and therefore irrefutable, but also lacking any empirical significance. On the other hand, Marx’s analysis has been treated as if it amounted to a set of empirical propositions that are correct, incorrect or somewhere in between, depending on the analyst’s inclinations and the implications of the chosen model of the economy.
The position adopted here differs from both of these, admittedly parodied, extremes. However, the argument is a complex one, depending upon conceptual rather than algebraic considerations. As a result, the structure of the analysis is summarised first, and this is followed by a more detailed account containing elaboration and justification.
Marx’s LTRPF is based upon the conceptual distinction between the organic and value compositions of capital (OCC and VCC), with the literature rarely distinguishing between the two and generally using the term OCC when referring to the VCC (see Chapter 8). We have shown that the OCC measures the results of accumulation by exclusive reference to the sphere of production, i.e. (surplus) value creation, whilst the VCC measures and reflects the process of accumulation in the sphere of exchange, i.e. (surplus) value realisation, which centres on, but should not be confined to, the problem of sale.
The OCC tends to rise over time because of the adoption of specifically capitalist methods of production, especially the use of machinery, in the context of competition within sectors and the systematic attempt to extract relative surplus value. This tendency of the OCC to increase is the source of the law as such, whilst the formation of the VCC is associated with the counteracting tendencies (CTs) to the LTRPF. The interaction between the law and the CTs is an essential aspect of the process of accumulation. This interaction forms more complex economic phenomena, but only for that stage of development of capitalism for which machine production is predominant. This implies that the LTRPF is not an empirical law in the narrowly predictive sense – it is, rather, an abstract law. It does not give prospective (quantitative) indications about movements in the rate of profit, but it provides the basis on which more complex economic phenomena can be studied (see Chapter 1).
This presentation of Marx’s LTRPF is in stark contrast with the understanding and criticism of it associated with the Japanese economist Nobuo Okishio, which has been taken up by the Sraffian school of economics as well as by some Marxists. Because this approach is limited to what is termed comparative statics (that is comparison of equilibria before and after technical change), it treats the accumulation process as one that necessarily engenders the harmonious integration between production and circulation rather than analysing their contradictory dynamics. Consequently, Okishio’s analysis can be characterised as the dialectical opposite of Marx’s.
The Law as Such and the Counteracting Tendencies
Marx’s treatment of the LTRPF occupies three chapters in the third part of Volume 3 of Capital. The first of these is entitled ‘The Law as Such’, and it contains what appears to be a simple algebraic demonstration of falling profitability in capitalism. Since the rate of profit may, in value terms, be written as r = s ⁄ (c + v) = e ⁄ (OCC + 1), where e is the rate of surplus value (s ⁄ v) and the OCC is c ⁄ v, a fall in r is the direct consequence of a rising OCC, provided there is no rise in e.
This mechanistic interpretation is incorrect, however, and the LTRPF cannot predict empirical movements in the rate of profit for two reasons. First, Marxian laws are not the theoretical expression of empirical regularities. Here, an analogy with the law of gravity might help: this physical law is based upon the idea that bodies mutually attract one another, as in Newton’s apple falling to the earth. But, empirically, the law of gravity can also explain outcomes that appear to contradict it – planets have stable elliptical orbits around the sun, aeroplanes fly and buildings remain upright. Similarly, Marxian laws express the key material forces constituted by capitalist social relations, what Marx calls tendencies. This is why the LTRPF is seemingly oddly named ‘law of the tendency’. Although Marxian laws and tendencies arise from the social relations defining the mode of production, and they are therefore necessary (in other words, they are unavoidable in that type of society), they do not directly determine empirical outcomes. For example, the tendency towards mechanisation and (consequently) the rising OCC does not imply that the profit rate must drop continuously; conversely, fluctuations of the profit rate do not negate the LTRPF. By the same token, the tendency for profit rate equalisation across sectors as a result of profit maximisation and capital mobility does not imply that these rates will actually be equalised at a specific point in the future (it is only in the make-believe world of mainstream economics that this tendency supports an actual equilibrium in which all profit rates are equalised).
For Marx, laws and tendencies have to be located analytically in the context of their sources and the (relatively more complex) ways in which these laws and tendencies manifest themselves. For example, tendencies always interact with counter-tendencies in the context of particular historical circumstances, leading to outcomes that are undetermined ex ante but, in principle, understandable ex post (see Chapter 1). In the case of competing capitals, for example, the tendency for their profit rates to be equalised has to be set against the competition between capitals in the same sector, which differentiates their rates of profit, whether this be through accumulation to increase productivity, the payment of lower wages, or whatever (see Chapter 6).
The second reason why the LTRPF does not permit empirical predictions is that any consideration of the organic (rather than value) composition of capital, as is the case in this law, is restricted to changes in production, without any reference to the reflection of those value changes in circulation. This explains why the constant value of e is not an arbitrary assumption, but, rather, an expression of the unchanging values of commodities (including labour power) during production.
Marx’s second chapter, entitled ‘Counteracting Factors’, deals with the CTs. These fall into two categories. There are those that follow directly from the changes in values resulting from the rising OCC. If we write r = s ⁄ (c + v), it follows that anything that reduces c or v, and anything that increases s, tends to increase r. The production of relative surplus value does all of these, because the increase in productivity reduces the value of c and v (whether directly in the wage goods sector or indirectly through its use of lower-valued raw materials), and raises s, through the decline in v (given the real wage). These value changes are synonymous with the formation of the VCC, highlighting the importance of this concept and its difference from the OCC.
Marx also considers CTs of a less systematic variety. For example, he lists the super-exploitation of the workforce, especially the otherwise unemployed and the disorganised (producing absolute surplus value), the cheapening of raw materials and wage goods through foreign trade, and the formation of joint stock companies (which can take a more secure but lower rate of profit on their large-scale activities). This group of CTs does not follow of necessity from capital accumulation or the rising OCC, even though they are likely results of capitalist development. Marx appears to lump them together with the others without separating them analytically. This may be explained by the lack of final preparation of Volume 3 for publication. In addition, Marx’s list of CTs follows closely that of J.S. Mill, suggesting that he had yet to rework this material. However, an important difference between Marx and Mill is that the latter’s treatment of the law follows that of Ricardo, and is based upon the declining productivity of agriculture, rather than, as with Marx, the increasing productivity in industry.
Marx’s treatment of the CTs also makes it appear as though he is dealing with immediate movements in r as a numerical counterweight to the law as such. However, the CTs are necessarily located at a more complex level of analysis than the law, for, as we have seen, they involve the formation of the VCC, which incorporates changes in both production and exchange (whereas the law itself involves only changes in production and the formation of the OCC). Nevertheless, like the law, the CTs should not be seen as factors of empirical weight directly governing the rate of profit, but as embodying those processes of accumulation and restructuring that turn changes in the conditions of production into movements in exchange.
The Internal Contradictions of the Law
In the previous section we have interpreted both the LTRPF and the CTs as capturing relatively abstract processes and relations rather than as predicting immediate movements in the rate of profit. This is the basis on which to examine Marx’s third chapter on the LTRPF, aptly named ‘Development of the Law’s Internal Contradictions’. In this chapter, Marx examines the law and the CTs as a contradictory unity of underlying processes giving rise to more complex empirical phenomena. Even at this relatively concrete stage, Marx is more concerned with the antagonistic coexistence of the law and its CTs than with the prediction of movements in the rate of profit. This is because the law and the CTs cannot be added together algebraically to give a rise or fall in the rate of profit, according to which of the two happens to be the stronger, just as the effects of competition within and between sectors cannot be added up to suggest that profit rates will either diverge towards monopoly or, instead, equalise across all capitals in historical time (see Chapter 6). Rather, Marx is concerned with the contradictions between the production and circulation of (surplus) value as the process of value creation proceeds, on the basis of values that are constantly being disrupted by the accumulation of capital.
That the LTRPF concerns the interaction of abstract tendencies, rather than anticipating an unavoidable decline in the actual profit rates of capitalist firms or economies, is implicitly confirmed by Marx’s analysis of the internal contradictions of the law. There is little or no discussion of movements in the rate of profit in the third part of Volume 3 of Capital, and a much greater concern with the ability of the economy to accumulate the mass of surplus value that it has been able to produce, and that it needs to do so in order to continue to expand. In other words, there is a greater focus on whether accumulation can be sustained than on whether it generates a higher or lower rate of profit. For example, if technical progress reduces the values of constant and variable capital, as it tends to do, this is indicative of the translation of changes in conditions of production into the sphere of exchange, which generates a tendency towards falling profit rates (to the extent that the value of labour power is sustained, and real wages increase in line with accumulation and productivity). In contrast, the formation of joint stock companies, the super-exploitation of the workers, and the opening up of foreign trade are conducive to a continuing accumulation, irrespective of the rate of profit at which they occur.
The Empirical Implications of the Law
The consideration of the LTRPF as an abstract law does not deny its empirical significance. Marx’s main conclusion in this part of Capital is that the law and the CTs cannot exist side by side in harmony indefinitely, but must at times give rise to crises. This requires careful interpretation, for there is no axiomatic derivation of the necessity of crises, just as there is no axiomatic derivation of a falling rate of profit. Rather, Marx is pointing to the immanent possibility of crises, just as he had done in Capital Volume 2, as a result of the potential disjuncture between sale and purchase on the basis of unchanging values (see Chapter 7). This can be established, as in the Keynesian theory of ineffective demand, without reference to capitalism, other than as a system of supplies and demands co-ordinated by money. But in Capital Volume 1, Marx has established not only that accumulation is an imperative for capitalism, but also that it involves processes of economic and social restructuring that must have both simple and expanded economic reproduction, as established in Volume 2, at its heart. In other words, exchange is neither simply nor primarily a co-ordination of markets, but is the most overt expression of the contradictions of the accumulation of surplus value.
For the LTRPF, a potential source of disjuncture in the circulation of (surplus) value is the accommodation in exchange of both the relative expulsion of labour and the changing values due to the restructuring of capital. These processes are subject to incessant disruption because of technical change throughout the economy. For example, the reduction in values as accumulation proceeds undermines the preservation of capital values, while the expulsion of labour disrupts the balances between supply and demand, the extraction of surplus value, and the reproduction of labour power.
These disturbances demonstrate that the LTRPF and the CTs have a direct connection with observable phenomena, even though they do not involve simple predictions of trends. Instead, they provide a framework for understanding the tensions and displacements due to capital accumulation, supporting the conclusion that the law and the CTs cannot coexist side by side in repose: capitals are devalued even as they are preserved and expanded. These contradictions give rise to crises, booms and cycles of production and exchange. Moreover, the development of the immanent possibility of crisis points to the likelihood of crisis when these processes can no longer be accommodated, especially (but not exclusively) because of disproportions, misguided investment and speculative bubbles. These crises, and the resulting unemployment, concentration and centralisation of capital, and so on, are the ‘predictions’ following from Marx’s analysis of the LTRPF. Corresponding cycles are associated with observable movements in the rate of profit. These movements are not arbitrary, but are based on the abstract tendencies and their contradictions.
This analysis leads to further empirical implications of the LTRPF, for it suggests that crises that owe their origins to developments in the sphere of production will, nevertheless, break in the sphere of circulation, and may do so in surprising ways, depending on the relative strengths and fragilities of the participants in the circulation of capital as a whole. This is one reason why the LTRPF is liable to lead empirically to actual falls in the rate of profit: as the accumulation process falters, the mass of profit realised is set against an unchanging mass of fixed capital, and profitability tends to decline. But this need not be so. If, for example, as a result of economic stagnation or bankruptcies large masses of capital are depreciated or bought up by surviving capitalists at rock-bottom prices, the rate of profit may rise, a factor which often plays an important role in economic recovery.
The previous point illustrates that the falling rate of profit has been something of a fetish in the literature. Often, the focus has been on whether or not theory can produce a fall in the rate of profit, by whatever mechanism, whether this be a rising OCC, VCC or wages (at the expense of profits). Once the rate of profit falls, it is presumed that the economy collapses into crisis because of deficient investment, in turn leading to deficient demand for potential output, as in Keynesian theory. In this perspective, there is a complete separation between the theory that yields the fall in profitability and the results of that fall, i.e. between the cause and the course of the crisis (and, at a further remove, the recovery mechanism – which, in Keynes’s analysis, depends upon a deus ex machina, state deficit spending, and its impact upon capitalist expectations). However, it cannot be presumed that a fall in profitability automatically results in a crisis. There may be a reduced incentive and capacity to accumulate; but some reward is better than none. Continuing accumulation may be necessary to preserve existing (fixed) capital and repay existing debts; and, most importantly, falling profitability is a powerful competitive force. Consequently, as capitalists attempt to restore profitability, they may even accumulate faster than previously!
For Marx, falls in the rate of profit can trigger economic crises (for example, industrial bankruptcies can lead to bank failures and a credit crunch), but this offers more a description than a penetrating analysis of the ultimate cause and course of crises. More importantly, it does not demonstrate the organic relationship between the crisis and capital accumulation, except trivially, by implying that an uncoordinated market economy is unable to achieve long-term balanced growth. In contrast, if the LTRPF is understood as the combination of contradictory tendencies operating across production and exchange, crises can be analysed on the basis of the fundamental features of the process of accumulation of capital.
This requires an analysis of value production and its expression in exchange in a much wider context than that presented in the opening chapters of Volume 1 of Capital. There, value is understood as a social relation expressing the equivalence between different types of labour, through the category of abstract labour. In every capitalist economy, there will be different skills and types of labour. Within each sector, there will also be competing firms with different levels of productivity. The profit imperative, capitalist control over the labour process, competition within and between sectors, and commodity equivalence in exchange reduce these labours to the common denominator of value (see Chapters 2 and 3). With accumulation and the competition to reduce commodity values, socially necessary labour time (SNLT) in each sector becomes the centre around which individual labour and accumulation processes revolve.
Recognition of the interaction between the law and the CTs raises difficult problems for value theory, which can be resolved only through an increasingly complex and concrete understanding of value. For example, since accumulation leads to continual reduction in SNLT, the concept of value appears to be at risk, for its quantification is upset as soon as it is established. The only way to address this difficulty is through the recognition that the equivalence between different types of labour is extended to labours of different productivity. We have already illustrated two instances of this process. First, inputs manufactured at different points in time, and with different technologies, are transformed by living labour into new output which, in turn, is often consumed productively as an input in another production process. Consequently, the material equivalence between different types of labour and between labours of different productivity is generally established in production rather than exchange. Second, the OCC is determined on the basis of equivalence grounded on previously established values, whereas the VCC is formed through the emergence of new values determined by the changing production conditions associated with the rising OCC.
This is as much as one can say about the dynamics of the general profit rate at this level of analysis, and no further progress can be made without specifying the nature of the interaction between the law and the CTs. This can be done theoretically, through the analysis of the mechanisms by which value relations are expressed in exchange, or empirically, by specifying the conditions in which accumulation takes place historically. Two important factors in both aspects of the analysis of profitability are the role of finance and the role of fixed capital. In their own ways, both are hugely influential in, and directly affected by, the establishment of value equivalence in exchange as capitals seek to preserve and pass on changing values over an extended period, during which they are liable to be competitively confronted by cheaper substitutes and more productive competitors. These topics cannot be taken up here, but see Chapter 3 and further readings.
The best-known criticism of Marx’s theory of the LTRPF takes as its point of departure a theorem presented and reproduced in mathematical form by the Japanese economist Nobuo Okishio. Briefly and informally, Okishio argues that, given a wider availability of techniques of production, the rate of profit cannot fall unless real wages rise. In other words, a falling rate of profit is contingent upon rising wages, rather than being the result of contradictions internal to the process of capital accumulation, as Marx takes to be the case. In Okishio’s analysis, capitalists will adopt new techniques of production only if these are more profitable than the existing techniques, given the prevailing commodity prices and level of wages. Once these new techniques are generalised, this will result in a new (lower) set of prices and a new rate of profit, equalised across sectors. Prices will change not only in the sectors where there has been innovation, because these lower prices will be passed on to the sectors in which those commodities are used as inputs or as part of the wage. In this case, Okishio’s question is the following: could the capitalists, acting blindly to increase individual profitability by introducing new techniques, paradoxically lead the system to a lower rate of profit? Unsurprisingly, he comes up with a negative answer, unless real wages increase essentially proportionately more than the productivity increase, and concludes that Marx’s analysis of the LTRPF is incorrect.
Okishio’s theorem is an exercise in comparative statics, i.e. it compares one position of economic equilibrium with another, even though comparative statics is inappropriate for the analysis of changes in the rate of profit as a source of crises. In other words, if we move from one position of (static) equilibrium to another, we cannot analyse crises independently of what happens to the rate of profit, since we are only comparing what we take to be one equilibrium with another. Nevertheless, Okishio reaches his conclusion on the assumptions, first, that the economy moves from one position of static equilibrium to another; and second, implicitly, that if the rate of profit falls (because of wage increases that are too large) we have a crisis, but otherwise we do not. Yet it is left unclear why a lower equilibrium profit rate would collapse into a crisis, especially as even a lower rate is preferable to an economic collapse.
This raises the much more interesting question of the movement between the two equilibria. By examining this process, it is apparent that, far from interpreting Marx’s LTRPF, the approach associated with Okishio is its opposite. For, in Okishio’s approach, an individual capitalist initially adopts a more advantageous technique of production through superior access to finance or technology and, at the initial prices, this capitalist obtains a higher profit rate. This approach contrasts sharply with Marx’s analysis of the rising OCC. For Marx, as was shown above, the tendency for falling profitability is due to the evaluation of inputs and outputs at old values, which holds for capital as a whole.
Consider now, in the context of Okishio’s theorem, the consequences of the generalisation of the new technique to all capitals in the sector, and the formation of new equilibrium prices and profit rate. It can be shown mathematically that the short-term profit rate of the innovating capitalist is greater than the new long-term ‘equilibrium’ rate (after the diffusion of the technical change) which, in turn, is greater than the ‘original equilibrium’ rate of profit (before the technical change). This implies that the capitalist who has acquired an advantage through technical innovation finds that this advantage is eroded as the innovation becomes generalised. That is, the reduction of prices through the introduction of the new technique eventually reduces the rate of profit of the innovating capitalist. Therefore, for Okishio, price formation out of technical change acts for the individual innovating capitalist as a pressure reducing the rate of profit towards the (new and higher than before) average. In contrast, for Marx, the process of price (and VCC) formation resulting from technical change is a counteracting tendency to the falling profitability for capital as a whole, since it leads to a reduction in the value of constant and variable capital.
Now put the two processes together, introducing new technology and generalising it across other producers to form new prices. For Okishio, these processes are immediate empirical equilibrium phenomena. They do not interact with one another to give more complex and concrete outcomes; instead, they are simply added together algebraically to show a rise in profitability for the economy as a whole from one equilibrium to the next. Moreover, the two disequilibrium processes cancel each other out as processes of change and leave the system in harmonious equilibrium. Because of this, the Okishio approach cannot distinguish between the VCC and the OCC. Instead, it relies exclusively upon an equilibrium notion of the VCC which, nevertheless, is given the name organic composition. By contrast, for Marx, the law and the CTs are abstract tendencies whose interaction is not some algebraic sum, but a crisis-ridden path of accumulation which can be understood but not always anticipated.
Okishio’s result is powerful only in the limited sense that the rate of profit can fall if wages rise sufficiently (by more than enough to outweigh the impact of productivity increases on profitability). However, the rate of profit can fall for other reasons unrelated to the movements in wages; for example, if the economy suffers an adverse external shock (a deterioration in terms of trade, say, due to higher import prices), a financial crisis (currently germane in light of stagnant wages in the last three decades or even longer) or any loss of business confidence. This suggests that we have to locate the impact of wages as (at most) a proximate influence on profitability as well as accumulation (recalling that Okishio-type analyses are entirely static). For wages, in Marx, are a consequence of the process of accumulation and not some sort of independent influence. Specifically, even though higher wages could precipitate a crisis, capital accumulation can also prosper with rising real wages, because they lead to higher levels of consumption and sales. In contrast, if real wages remain the same in spite of technical progress, there is a reduction in the value of labour power and an increase in the rate of surplus value. These are CTs for Marx. That they exist, as a result of accumulation, does not guarantee the absence of crisis. Whereas these outcomes are always possible in the context of Marx’s analysis of the LTRPF and the CTs, they are precluded by Okishio’s narrow interest in the profit–wage trade-off.
The current global financial meltdown demonstrates how falling profitability and crisis can result irrespective of, or even despite, stagnant real wages (see Chapter 14). So, Okishio’s theorem at best can only be rescued by accepting that it does not apply in these circumstances. By contrast, Marx’s LTRPF and CTs do apply, are different in method, scope and content, and are not invalidated by Okishio. For they target the contradictions (and the possibility of crisis) inherent in the accumulation and circulation of capital as a whole, for which rising real wages is but one part that needs to be appropriately located analytically, as opposed to being taken as an exogenous and independent factor.
Issues around the LTRPF have been covered in the text. Marx develops his analysis in Marx (1981a, pt.3). The exposition in this book draws upon Ben Fine (1982, ch.8 and, especially, 1992a) and Ben Fine and Laurence Harris (1979, ch.4). For similar interpretations, see Duncan Foley (1986, ch.8), Geert Reuten (1997), Roman Rosdolsky (1977, ch.26) and John Weeks (1982a). Nobuo Okishio’s (1961) critique of Marx has attracted enormous attention – see, for example, Research in Political Economy (vol.18, 2000); but see also Okishio’s (2000) acknowledgement of the limitations in his original paper (including proposed changes, which fail, however, to address the problems identified in this chapter). For a broader review of the LTRPF in Marx, see Reuten and Thomas (2011).