Adam Smith, David Ricardo and other classical political economists held that the rate of profit—profit as a percentage of the amount of money invested in production—tends to fall in the long run. The fall in the rate of profit was inferred from evidence that interest rates had fallen. Smith justified this inference by arguing that the two rates will tend to move in the same direction.
Karl Marx accepted these economists’ claim that the rate of profit tends to fall over time, but not the theories that they had put forward to account for the fall. He held that their attempts to explain it were “contradictory” and that the fall in the rate of profit had remained an unsolved “mystery” until he offered his own “law of the tendential fall in the rate of profit” (Marx 1991a, 319). Thus, although he was not the first to argue that the rate of profit tends to fall, Marx did take credit for being the first to offer a “law,” or explanatory theoretical principle, that successfully accounts for the falling tendency. He repeatedly stressed that it is “the most important law” of political economy, the solution of the central puzzle around which “the whole of political economy since Adam Smith revolves” (Marx 1973, 748; 1991b, 104; 1991a, 319).
Nevertheless, the law has always been and remains extremely controversial, even among those who identify themselves as Marxists. The same is true of the empirical claim that the rate of profit tends to fall.
The law, which Marx put forward in Part 3 of the third volume of his book Capital, is that “[t]he progressive tendency for the rate of profit to fall is thus simply the expression, peculiar to the capitalist mode of production, of the progressive development of the social productivity of labour” (Marx 1991a, 319, emphasis in original). In other words, rising productivity tends to depress the rate of profit. This conclusion follows in a fairly straightforward manner from the following three points developed earlier in the book:
1 To remain competitive, capitalists must reduce costs of production, and they do so largely by boosting labor productivity (the amount of product per unit of labor performed). The productivity increases are achieved mainly by adopting new technologies that replace workers with machines. Thus, what Marx called the technical composition of capital, the ratio of machines and other means of production to the number of workers employed, tends to rise over time.
2 The amount of new value—and, all else being equal, also the surplus-value—generated by each dollar of capital investment tends to fall as a result. This follows from Marx’s theory that workers’ labor is the exclusive source of new value. When workers are replaced by machines, more of each dollar invested in production is spent on means of production that do not generate new value, and less is spent to hire the workers whose labor does generate it. Thus, the ratio between these two sums of money, which Marx called the value composition of capital, tends to rise along with the rise in the technical composition. (This is a tendency rather than a guaranteed outcome since other factors also affect the value composition.)
3 In the economy as a whole, what is true of value and surplus-value is also true of price and profit. Individual businesses and industries may obtain prices that exceed the amounts of value they produce and thereby obtain more profit than the surplus-value they produce, but Marx’s theory holds that such gains come at the expense of other capitalists. For example, monopoly power allows some businesses to raise their prices and thereby bring in more profit, but this is fully offset by lower prices and profits for the remaining capitalists. The sum of all prices equals the sum of all values, and the sum of all profits equals the sum of all surplus-values. Marx’s law, which pertains to the rate of profit of the economy as a whole, is therefore not affected by discrepancies between surplus-value and profit.
The basic idea behind Marx’s law can thus be expressed in terms of price and profit, without explicit reference to the terminology of his value theory, as follows: when productivity increases, less labor is needed to produce a product, so it can be produced more cheaply. As a result, its price tends to fall. And when prices tend to fall, so do profits and the rate of profit. (Strictly speaking, the price level need not fall; it is sufficient that the rate of inflation falls.)
Marx (1991a, 339) recognized that various “[c]ounteracting influences must be at work, checking and cancelling [durchkreuzen und aufheben] the effect of the general law and giving it simply the character of a tendency.” For example, the value composition of capital can rise more slowly than the technical composition because means of production become cheaper as productivity increases. Or the rate of surplus-value (roughly speaking, the ratio of profit to wages) may rise, and this implies that profit may increase more rapidly than the new value generated in production. When rising productivity leads to lower prices, workers need less money than before to attain the same standard of living. Consequently, as shares of the new value, wages tend to fall and profit tends to rise.
However, Marx argued that this latter counteracting factor can have only a limited effect. The amount of value workers create does not depend on the physical productivity of their labor. The length of the workday thus sets a strict maximum limit to the amount of surplus-value created. If the workforce originally consists of one hundred people, and half of their labor-time—say, four hours—consists of surplus labor (labor for which no equivalent is paid and which therefore creates surplus-value), then the amount of surplus-value created is (the monetary expression of) 4 × 100 = 400 labor-hours. Now, if labor-saving technological change causes the workforce to shrink to forty-nine or fewer workers, the amount of surplus-value created must fall, even if the full eight-hour workday now consists of surplus labor because the workers have been forced to “live on air.” “[T]herefore, the compensation for the reduced number of workers[,] provided by a rise in the level of exploitation of labour[,] has certain limits that cannot be overstepped” (Marx 1991a, 356).
Smith, Ricardo and other classical political economists believed that the falling tendency of the rate of profit would eventually result in a stationary state, or no-growth economy. As opportunities to obtain greater profit diminished, so would capitalists’ willingness to undertake additional productive investment. In contrast, Marx argued that the tendency of the rate of profit to fall produces boom-and-bust cycles. (There seems to be no textual evidence that supports the legend that he claimed that this tendency would cause capitalism to collapse in an automatic or quasi-automatic manner.)
“Permanent crises do not exist,” according to Marx (1989, 128, starred note), because the financial crises and downturns (recessions, depressions) that result indirectly from the fall in the rate of profit cause a portion of the capital-value invested in production to be destroyed by means of bankruptcies, write-offs of bad debt, falling prices of means of production, idled plant and equipment and so on. New owners can therefore acquire businesses cheaply and without assuming all of the previous owners’ debts, which implies that their rate of profit—profit as a percentage of the reduced amount of capital-value they have invested—is greater than the pre-existing rate. Thus, the destruction of capital-value eventually leads to a restoration of the rate of profit and a new phase of capitalist expansion.
In Marx’s view, the fall in the rate of profit is only an indirect cause of financial crises and downturns. He acknowledged that it reduces capitalists’ willingness to invest in production, but argued that the immediate cause of the downturn is a financial crisis, and he attributed these crises to a combination of debts that cannot be repaid and an increase in speculative and fraudulent behavior that occurs when the rate of profit falls. Capitalists take excessive risks or engage in fraud in order to obtain a higher rate of profit than the now-reduced average rate, in part because they need additional profit to repay their debts.
The cycle described above should not be confused with short-term business cycles. Marx accounted for the latter primarily by arguing that wages rise in relation to profit in the expansionary phase of the cycle, which leads to a decline in productive investment, a contraction of economic activity and a fall in wages relative to profits that sets the stage for renewed expansion.
Marx thought that capitalism was once justified, from a long-term historical perspective, because it contributed to human development by greatly increasing our scientific and productive powers. Yet the increases in productivity produce a tendency for the rate of profit to fall, which in turn leads to “bitter contradictions, crises, spasms[––the] violent destruction of capital not by relations external to it, but rather as a condition of its self-preservation” (Marx 1973, 751). He argued that this self-destructive aspect of capitalism is “the most striking form in which advice is given it to be gone and to give room to a higher state of social production” (Ibid.).
Other theories attribute economic downturns and crises to low productivity, sluggish demand, the anarchy of the market, state intervention, high wages, low wages and so forth. Such theories suggest that capitalism’s crisis tendencies can in principle be substantially lessened or eliminated by fixing the specific problem that is making the system perform poorly. Marx’s law is unique in that it suggests that economic crises are inevitable under capitalism, because they are not caused by “relations external to it,” that is, by factors that can be eliminated while keeping the system intact. To do away with these crises, a different socioeconomic system is needed.
One of the main reasons that Marx’s law has always been controversial is this revolutionary implication of his theory of crisis based on the law. In recent years, especially, much of the left chooses to stress the economic successes of capitalism and to argue that the fruits of its success are distributed inequitably. The idea that capitalism is inherently self-limiting and crisis-ridden does not fit together easily with such arguments.
The other main reason that the law is controversial is that it seems counterintuitive to many commentators. It relies heavily on his value theory, but that theory is frequently dismissed, partly because it is supposedly inconsistent or otherwise incorrect and partly because it is supposedly “metaphysical.” The latter objection seems to mean that, because values and surplus-values are not directly observable, arguments based on them are unsafe. Robert Brenner (1998, 11–12, n.1), a Marxist historian, has also famously argued that the law “flies in the face of common-sense” since “it seems intuitively obvious” that the new technologies which individual capitalists adopt in order to raise their own rates of profit must end up raising the economy-wide rate of profit as well. (Marx had argued that the capitalists who innovate produce the fall in the economy-wide rate but shift the consequences onto other capitalists while enhancing the profitability of their own businesses because their costs of production are now lower.) And the so-called Okishio theorem, which will be discussed below, formalizes what seems to be a widespread intuition that increases in productivity must lead to a higher, not lower, rate of profit.
As Stephen Cullenberg (1994) usefully points out, there have been two main types of technical objections to Marx’s law (apart from empirical objections), one pertaining to whether technological progress must cause the rate of profit to fall, the other pertaining to whether it can do so. He further notes that the first type of objection predominated until about the mid-1970s while the second has predominated ever since.
The first type of objection, put forward by Joan Robinson (1941, 243–5), Paul Sweezy (1970, 102–4) and others (see, e.g., Heinrich 2013), is that the counteracting factors to the tendency of the rate of profit to fall can always offset, or more than offset, the tendency. For this reason, and because two of these counteracting factors—the cheapening of means of production and reduced wages—are wholly or partly the consequences of the same technological progress that produces the tendency, Marx was not entitled to privilege one effect of technological progress as the “law” and relegate the others to secondary status.
It is important to understand the special sense in which these critics use terms like “can always.” What they mean is that there are hypothetical cases, which do not violate laws of logic or nature or the premises of Marx’s argument, in which the tendency fails to dominate over the counteracting factors. This does not imply that such cases are likely or even plausible. No responsible defender of Marx’s law disputes the idea that the counteracting factors “can always” be stronger in this special sense, but the likelihood and plausibility of such cases are indeed contested. Consider, for example, the argument that, even if the value composition of capital continually rises, the rate of profit can always increase because the rate of surplus-value can always increase more rapidly than the value composition. This is not impossible, strictly speaking, not even in light of Marx’s point that the length of the workday sets a rigid maximum limit to the amount of surplus-value a worker can create. As this maximum limit is approached, however, the extra surplus-value that a worker can create becomes smaller and smaller, which means that the rate of profit can continue to rise only if the increases in the value composition become infinitesimally small.
Defenders of Marx’s law (see Kliman, Freeman, Potts, Gusev and Cooney 2013) also contend that the critics’ argument attacks a strawman, or perhaps some falling-rate-of-profit theory other than Marx’s. His law does not say, much less attempt to prove, that the rate of profit must inevitably fall in the long run. Its purpose is explanatory; it accounts for what Marx and the classical economists regarded as the confirmed fact that the rate of profit does tend to fall. Although he clearly believed that the tendency is stronger than the counteracting factors—the contrary belief is inconsistent with the evidence available to him—his claim to have proven the law is not an assertion that it must inevitably remain stronger. It is an assertion that his value theory, in conjunction with his theory of capitalist accumulation, is able to explain what he regarded as a confirmed fact.
The claim that the rate of profit must inevitably fall in the long run has nevertheless garnered a good deal of support as well as much criticism. Cullenberg’s (1988, 1994) work challenging the falling-rate-of-profit thesis is directed principally against this claim and its supporters, rather than against Marx’s law understood as an explanation of the rate of profit’s tendency to fall. Inspired by Stephen Resnick and Richard Wolff’s overdeterminist perspective, Cullenberg (1988, 41) is suspicious of economic laws (i.e., of statements of supposedly invariant outcomes) and of “modernist” theorists’ typical lack of “attention to the historical specificity and heterogeneity of capitalist enterprises.” He argues against the assumption that all firms share the same basic motivation and calls attention to the fact that technological changes, as well as changes in the efficiency and intensity of labor, affect different firms in different ways. They will thus act differently from one another, and the effects of their actions on the aggregate economy will also differ. As a result, there is no inevitable trend, downward or upward, in the economy-wide rate of profit. Writing from a similar perspective, Norton (2001) has more recently argued against the prevailing belief that Marx argued that capitalist firms are primarily concerned to re-invest their profits rather than to distribute the profits to shareholders or use them in other ways.
The second type of technical objection challenges Marx’s claim that new technologies which replace workers with machines can cause the economy-wide rate of profit to fall even though they increase the rates of profit obtained by firms that introduce these technologies. Arguments of this sort first appeared in 1899, only five years after volume 3 of Capital was published. However, they did not command widespread attention until the latter part of the 1970s, when a paper by Nobuo Okishio (1961), a Japanese Marxist economist, became widely known and extensively discussed in the West. Okishio attempted to provide a formal proof that Marx’s law does not hold true; technologies that raise the innovating firm’s rate of profit cannot cause the economy-wide rate to fall (although it can fall for other reasons). Since the attempted proof was initially regarded as successful, this conclusion became known as “Okishio’s theorem.” Okishio restricted his attention to cases without fixed capital (means of production that last more than one period), but John Roemer (1981, 108–9) later deduced the same conclusion from a model in which fixed capital is employed.
Once it became widely known, discussion of Okishio’s theorem largely eclipsed the debate over whether the counteracting factors offset the tendency of the rate of profit to fall. This probably occurred because arguments that the rate of profit might not fall do not discredit Marx’s theory as effectively as the argument that it cannot fall for the reasons he stated.
Initially, a wide variety of counterarguments were offered in attempts to circumvent Okishio’s theorem. For example, it was shown that the rate of profit can fall if an increase in real (i.e., physical) wages accompanies the technological innovation (ironically, this was one of the main things that Okishio himself wished to show); and if cutthroat competition compels firms to adopt new technologies that are suboptimal when considered in the abstract; and if there are joint products, two or more products produced by a single production process; and if new techniques become prematurely obsolete. However, none of these contributions vindicated Marx’s claim that the rate of profit can fall because productivity increases. Nor did they disprove the alleged theorem; they obtained results that differed from Okishio’s only because they altered one or another of his assumptions.
More recently, however, the main criticism of the alleged theorem has come from proponents of the temporal single-system interpretation (TSSI) of Marx’s value theory. They stress that Okishio and Roemer failed to prove that “the” rate of profit cannot fall for the reasons Marx claimed; the rate of profit that cannot fall is conceptually different from the rate to which his law refers. They also claim to have proven that Marx’s rate can fall under conditions in which the alleged theorem says it cannot, and that it falls because productivity increases.
Specifically, TSSI authors argue that Marx’s rate of profit is profit as a percentage of the amount of money that has actually been invested in production (net of depreciation). This is very close, if not identical, to the standard meaning of the term rate of profit. However, the proponents of Okishio’s theorem mean something quite different by the term: profit as a percentage of the replacement cost (or current cost) of a business’s means of production, the amount of money that would currently be needed to replace them. If prices of means of production fall—because, for instance, productivity increases—the amount of money that is currently needed to replace the means of production now in use falls in relation to the amount of money that was actually invested to acquire them in the past. The denominator of Okishio’s rate of profit therefore falls in relation to the denominator of Marx’s rate, and this causes Okishio’s rate to rise in relation to Marx’s rate. Consequently, technological innovations that must result in an increase in Okishio’s rate can indeed cause Marx’s rate of profit to fall and, proponents of the TSSI claim, they can do so because productivity increases.
At first, the TSSI critique was basically ignored or dismissed. Somewhat later, Duncan Foley (1999), David Laibman (2000) and others challenged it by offering algebraic examples in which Marx’s rate of profit does not fall. Proponents of the TSSI countered that the point of these examples is unclear, since Okishio’s theorem “asserts that no viable technical change lowers the profit rate. Even one counterexample is sufficient to refute the theorem. We have provided not one, but many, such counterexamples” (Freeman and Kliman 2000, 247).
Foley (2000) and Laibman (2000) ultimately acknowledged, even if only implicitly, that Marx’s rate of profit can fall under conditions in which the alleged theorem says that “the” rate of profit cannot fall. However, they continued to argue that the theorem is true, on the grounds that it was always meant to be a theorem on the replacement-cost rate of profit rather than Marx’s rate. Kliman and Freeman (2000, 290) responded by quoting from Okishio’s paper: “[our] conclusions are negative to [the] Marxian Gesetz des tendenziellen Falls der Profitrate [law of the tendential fall in the profit rate].”
Critics of Marx’s law and the TSSI defense have also argued that Okishio’s theorem is true, even if the rate of profit employed in the proof of the theorem is not Marx’s, because it is “a mathematical theorem and does not contain any logical flaws. One can object to its assumptions as being inappropriate or not the same as Marx’s assumptions. … But the theorem is logically sound” (Robin Hahnel, quoted in Kliman 2012a, 106–7). Kliman (2014, 658, n.21) has replied that the theorem is logically invalid because it is guilty of equivocation, using the same term in different senses within the same argument. (For example, the following argument is logically invalid because the term “man” is used in two different senses: “Man is the only rational animal. No woman is a man. Therefore, no woman is rational.”) The “rate of profit” employed in the mathematics is the replacement-cost rate, while Okishio’s conclusions refer to the rate of profit to which the “Marxian Gesetz” pertains. Thus, “the theorem cannot possibly do damage to Marx’s law. As a theorem on Marx’s law, it does no damage because it is false. As a disinterested exercise in applied mathematics, it does no damage because it is not a theorem on Marx’s law” (Ibid.).
Laibman (1999, 223), Gérard Duménil and Dominique Lévy (2011a, 37), Deok-Min Kim (2012, 255, 260) and others have argued that the trend in Marx’s rate of profit is of little importance. What really matters is the trend in Okishio’s replacement-cost rate of profit, since the latter, they contend, is the expected rate of profit that governs investment decisions. This claim has been challenged by proponents of the TSSI (see Kliman and Freeman 2000, 287–8) and by Christian Lager (1998). As Okishio (2001, 497) himself noted, the replacement-cost rate will coincide with the expected rate of profit only “if prices and wages at [time] t + 1 are expected to be the same as at [time] t.” The replacement-cost and expected rates of profit are both based on current investment costs, but the replacement-cost rate compares these costs to profits based on current prices while the expected rate of profit compares them to profits based on expected future prices. The two rates will differ whenever prices are expected to change. (Although Marx’s law pertains to the actually realized rate of profit, not the expected rate, it too compares investment costs based on one set of prices to profits based on prices of a later time.)
In the wake of the recent Great Recession, there has been a substantial increase in research that estimates trends in rates of profit. These investigations neither confirm nor refute Marx’s law. Since the law is a particular explanation of why the rate of profit supposedly tends to fall, a falling rate does not, by itself, tend to confirm the law. Conversely, the law is consistent with a rising rate of profit in some countries and during some spans of time, at least, so a rising rate does not, by itself, tend to disconfirm the law. Another difficulty is that some data that would be needed to conduct an appropriate and direct test of the law, particularly data for the world economy as a whole, are unavailable.
Some empirical studies have decomposed movements in rates of profit into those associated with changes in the rate of surplus-value and those associated with changes in the value composition of capital, but since these variables themselves have multiple potential causes, this does not provide a satisfactory causal explanation of movements in the rate of profit. Very few studies have attempted to isolate the actual causes of changes in rates of profit. (See, however, Kliman 2012a, 133–8 where causes of U.S. corporations’ rate of profit between 1947 and 2007 are investigated and the argument is made that Marx’s law “fits the facts.”)
Measurement of movements in rates of profit is nonetheless potentially important in order to understand why the Great Recession and its prolonged aftermath occurred. Some authors argue that there was a “slight upward trend” (Duménil and Lévy 2011b, 60) to U.S. corporations’ rate of profit from the early 1980s onward, as a result of neoliberalism and financialization. They thus reject the idea that falling profitability is among the causes of the recession. Other authors (e.g. Kliman 2012a, Freeman 2012) argue that the rate of profit either failed to recover in a sustained manner from the recessions of the mid-1970s and early 1980s, or continued to trend downward, and suggest that the fall in the rate of profit is one of the indirect causes of the recession and its aftermath. (No one argues that it was a direct cause, since no one contends that the rate of profit fell during the bubble that preceded the recession.)
This is actually a conceptual controversy rather than an empirical one. The facts are not seriously in dispute. Instead, the key issue involved in the debate between the TSSI’s supporters and opponents over the logical validity of Okishio’s theorem has resurfaced here in a different context. Once again, what one group calls “the rate of profit” is the replacement-cost rate. It rose. The other group uses the term “rate of profit” to refer to profit as a percentage of the actual amount of money that was invested in production (the capital stock’s historical cost). It either continued to fall or failed to recover in a sustained manner (depending on the measure of profit considered). The trajectories of “hybrid” rates of profit, which value capital investment at historical cost but use replacement-cost depreciation data to compute profit (see Basu and Vasudevan 2013), lie in between these extremes.
What would be needed to resolve the dispute over the trend in “the” rate of profit during the last several decades is sustained discussion of the meaning and significance of the quite different measures that are called “the rate of profit.” Does a certain measure actually help to answer a particular question? If so, how? Such discussion has not (yet) taken place. Duménil and Lévy (2011a, 37, 37 n.36) have dismissed TSSI authors’ concept of the rate of profit as “[f]iddling with definitions.” Kliman (2012b, 294) has responded that Duménil, Lévy and others have “fail[ed] to disclose the full meaning, and meaninglessness, of what they define as ‘the rate of profit.’”
This controversy has spilled over into the political realm. Most trade unions and electoral and non-electoral groups on the left have a redistributionist orientation and/or regard neoliberalism and financialization as a new phase of capitalism and are hostile to explanations of the Great Recession that appeal to a fall in the rate of profit or Marx’s law. Their websites frequently carry writings by and highlight the research conducted by those who argue that the rate of profit rebounded under neoliberalism. Parties belonging to the Committee for a Workers International, a Trotskyist organization, recently suspended two members who contend that a falling rate of profit is among the causes of the recession.
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