Is the Declining Rate of Profit thesis salvageable?

A shift from value to monetary analysis better shines a light on capitalism's contradictions, but even then it's hard to find any hard laws

One of the central points of Karl Marx’ third volume of Capital is the Law of the tendency of the rate of profit to fall (LTRPF). The contradictory dynamic of capitalism is that each new wave of investment takes as its means the “unconditional development” of the social productivity of labour, for the purpose of a more limited self-expansion of capital. In essence, each capitalist acts narrowly for himself to maintain or expand his position in a market, but by doing so increases the capital-to-labour ratio, driving down prices and ultimately undercutting himself.

The mechanism is that capital does not produce above its own value, while labour-power does. As the ratio of capital to labour (or constant to variable capital) increases, the rate of profit falls because only the latter yields surplus value which can convert to profit

Every individual product, considered by itself, contains a smaller quantity of labour than it did on a lower level of production, where the capital invested in wages occupies a far greater place compared to the capital invested in means of production. […] The immediate result of this is that the rate of surplus-value, at the same, or even a rising, degree of labour exploitation, is represented by a continually falling general rate of profit.

There is a certain elegance to the LTRPF. It hinges on the microeconomic considerations of volume one and value and links to the macroeconomic anlayses of cyclical creation and destruction as well as a long-term forecast of capitalism’s demise. It makes capitalism’s historical mission – unfettered expansion of the means of production– the cause of its own downfall. And yet it’s that same foundation on value theory that reveals its weakness, and empirical support for its existence is lacking. The question is whether the LTRPF should be salvaged, thereby making capitalist breakdown a matter of necessity, or should we instead look to Marx’ other theories of monetary realisation, which makes breakdown a mere tendency.

Faulty Foundations

In my previous post I contend that it’s a mistake to privilege labour, one of the factors of production, as solely surplus-yielding. From a more physicalist lens, it is difficult to see how labour directly materially produces the net product, although such a restrictive view ends up treating manufacturing as ‘sterile.’ With a more social lens, it’s possible to see that labour employed in wage-industries work to reproduce themselves and then produce a net above that.

But why isn't capital value-generating? Especially in the case of specialised machine equipment, capital-goods increase the productivity of labour. It begs the question why at least some of that extra production isn’t attributed to the equipment. In the 21st century we have factories virtually entirely staffed by robots, sometimes themselves manufactured by robots, requiring us to look very far in the production chain history to find the original labour-intensive human input. Marx’ theory rests on the notion that the value these machines impart is only transferred from that original human labour.

To illustrate, imagine instead of value we talk about energy. Now energy would be a poor substitute in the main analysis, because all conversions of energy in production would lead to loss or entropy, not surplus, and we would be back to the physicalist problem of only land, Nature or in this case the Sun being the source of surplus (in the Economic sphere). But if we take Marx’s approach and assume that the energy expended by labour is socially but not literally embodied in an output, simply because it represents the cost of that input in energy (or food) terms, then we can also compare with the energy expended machines. What we would see is that the machine-aided production is far in excess of the human labour initially expended to produce that machine, largely because the machine is continually powered by raw materials i.e coal or oil.

Sure, a hypothetical society that’s fully roboticised may struggle to generate profit due to lack of wages. That, however, is a realisation problem, a matter of whether the expenditure exists to provide incomes in excess of costs. In absolute physical terms or value equivalents, robots can produce in excess of their needs or "capital-power," and the extent to which other capital-goods do this is lesser but still positive. A rise in capital-to-labour then cannot tell us whether the rate of surplus value increases, decreases or stays the same.

Distinguishing Constant and Variable capital without reference to value generation

An expansion of productive capacity because of rising productivity could lead to a deflation of consumer goods, undermining revenues and potentially profits. The case of the Long Depression from the 1870s to the 1890s, proceeding directly after the proliferation of new technologies (mass steel production, the telegraph etc.) and investments in the Second Industrial revolution is one such example. But falling prices need not cut into profits if costs fall proportionally, assuming a fixed markup. If the rising ratio of capital to labour might mean higher costs though, but again if we assume a constant markup shouldn’t profit stay stable?

If we consider fixed and variable costs as separate, then we can observe business behaviour in competitive pricing and how it entails tracking variable costs more closely. This is because variable costs scale with production, while fixed costs represent longer-term investments into structures, business and sometimes contracts that expand over several production cycles. While variable costs include raw materials, the predominant operating cost of most firms is labour, meaning there is a high degree of symmetry between constant/variable capital and fixed/variable costs.

Therefore, rising productivity may see a decline in operating costs and assuming constant markup, consumer prices as well. However on the firm’s cash flow statement, separate from the income statement which considers profit/loss, we see the fixed costs of investment and the financing costs usually associated with paying down the interest on those initial capital outlays. Competition drives firms to invest more, increased fixed costs, but it may punish them if they try to cover that cost in the price. This is because while revenues must cover short-term costs, a firm that extends its time horizons on fixed costs and financing will be able to keeps its prices as close to variable costs as possible, beating out the firm that doesn’t. This ‘coercive competition¹’ can lead to a squeeze of cash-flow or liquidity, even a negative statement. Even absent of this, the profit rate is calculated as a return on investment, so mechanically declines so long as investment costs disproportionately rise even on growing absolute profits.

Data and the counterveiling (co)tendency

In the neatly named Astonishingly Poor Empirics of the Tendency of the Rate of Profit to Fall, YouTuber UnlearningEconomics demonstrates the lack of rigour in contemporary Marxians' attempt to demonstrate the LTRPF. The most pressing issue is taking a time-series of data without controlling for third variables and simply ‘eyeballing it.’ So long as a trend looks like it’s falling, that’s suitable evidence for the law, and wherever the trend is not falling, that’s assumed to be on account of the counterveiling forces Marx’ discussed in Volume III.

Consider the profit squeeze of the 70s. Since data from this period trends downward, LTRPF proponents are happy to take it as evidence for the law, assuming the counterveiling forces are absent. But here is a case where one of the forces, the increased exploitation of labour, appears in the reverse, i.e the increasing wage share of income. Economists Stephen Marglin and Amit Bhaduri suggested this fall of the profit rate² was due to the fall in the profit-share (which is the inverse of the wage share), and data from the US up to 1979 reinforces this correlation³. This doesn’t rule out alternate regimes, where an increase in the wage-share leads to an increase in the profit rate, what Marglin and Bhaduri term a wage-led or ‘stagnationist’ regime. Far from a law of inexorable decline in the profit rate, this would instead require a careful a posteriori analysis of whether a given economy is wage-led or profit-led during a given period.

Another counterveiling force to the LTRPF is the relative cheapening of capital. One mechanism through which capital becomes cheaper is through foreign trade, as an importing nation gets access to capital produced elsewhere if it is too expensive to make domestically. But Marx also acknowledges that the same dynamic that cheapens consumer goods also cheapens capital-goods.

In short, the same development which increases the mass of the constant capital in relation to the variable reduces the value of its elements as a result of the increased productivity of labour, and therefore prevents the value of constant capital, although it continually increases, from increasing at the same rate as its material volume, i.e., the material volume of the means of production set in motion by the same amount of labour-power.

In which case it is not an exogenous counterveiling force, but should be considered a potential co-tendency, something he is too quick to dismiss. In fact, data tends to show that the relative prices of capital equipment falls over time (although structures tend to rise, since construction lags behind in productivity compared to manufacturing)⁴.

Business Cycle and Crisis

Orthodox Marxian theory suggests that LTRPF leads to both short term crisis and long term stagnation. Falling profitability leads to a crisis, but the relative cheapening of capital or new exploitation of workers restores profitability and begins a new boom. As said, the relative cost of capital is crucial for both the short and long of it. Rising productivity in manufacturing should at the very least lead to cheaper equipment, but at the same time, investment prices are more volatile than consumer prices. This makes sense consider that consumers have to smooth spending i.e a drop in income cannot mean they stop buying basic food, and they are likely to save some extra income if it rises, and similarly small shifts in prices won’t dramatically affect the quantity purchased. Investors however are sensitive to financing conditions such as interest rates, and are especially sensitive to shifts in the price of goods. What this means is that during a boom, investors will buy up stock until the price runs hot, since it is better to buy cheap now than wait until later. The distance between consumer and investment prices shortens, leading to some of the cash-flow issues mentioned earlier.

It’s these financial and liquidity issues rather than the mere lower profit rate itself which tends to cause an acute crisis. As Marxian James Crotty highlights, Marx recognises this and shifts his analysis from the more mechanical rising composition equation to issues of realisation and increasingly fragile debt commitments in the M-C-M’ monetary circuit⁵. The composition of capital and realisation problems are meant to form a cohesive whole, but once the realisation analysis is added, the question of effective demand becomes critical and the analyses of later writers such as Keynes, Kalecki and Minsky become warranted. A LTRPF style theory can help explain some depressions like the aforementioned 1870s, but becomes less relevant for a credit-crunch led crisis such as 2008.

Stagnation in the long-run

On the longer side though, stagnation and overcapacity in the early 20th century can be attributed to a saturation of capital. In JM Keynes’ analysis, capital only becomes capital if it is expected to yield an income, which in the final analysis comes down to some sort of consumption. When capital is scarce relative to market demand for products, it is able to yield a higher profit rate than when it is abundant. The expansion of capital relative to consumption drives down the rate of profit as each capital-good must compete for its share of the income stream. Following Michal Kalecki’s profit equation (profits = investment expenditure - workers saving), in a situation where each successive year investment expenditures stay the same but the capital stock expands, necessarily the profit-per-capital-good would decline.

This scenario can also be thought of as a feature of rising capital/labour ratios, but for monetary reasons not value generation. If wages remain stagnant, then capitalists purchase the productive power of labour at a low cost. This means that full employment can be reached for the purpose of profit-making, but rates of capacity utilisation can remain low. Coercive competition also leads to a vicious cycle of labour-saving investment, price wars and assaults on labour, exacerbating excess capacity. If however wages rise, excess capacity declines and the rate of profit can increase; although ala Bhaduri & Marglin, only if the sensitivity of investment to the profit share is lower than the sensitivity of consumption demand to the wage share. Consequently, if capitalist spending must rise (to pay wages), and capacity utilisation also rises, income flows to capital stock will also rise and increase the relative scarcity of capital again, even at an elevated capital/labour ratio. One main limit on this is the scale of worker saving, which tends to rise as incomes grows.

Hidden within this, there is still a tendency towards profit stagnation, although whether it is inexorable is unclear. In a developing economic with scarce capital, even relative to minimal wages, capital is likely to yield a high rate of return on investment because labour supply is perfectly elastic and wages do not pose a significant threat to profit. Labour is so elastic because of large ‘reserve armies of labour’ (also known as infinite supplies of labour) that can be drawn from, including landless peasants, informal workers and the unemployed. Increasing capital stock employs workers, and a country is considered developed when the primary cause of unemployment is no longer structural (lack of capital) but cyclical (lack of investment demand). Rising capital/labour ratios mean autonomous demand, luxury spending, exports or whatever else are no longer sufficient to purchase the potential output of excess capacity, nor to generate income streams for a more abundant capital stock. Hence the economy becomes ‘wage-led’ in the sense that a rising wage share will raise capacity utilisation more than it increases the cost of production. Yet at the same time those costs do rise, even possibly off-setting the cheapening of capital equipment, meaning that the rate of profit, while higher than stagnation level, will be capped to a certain degree.

A Theory Salvaged?

Is there a law for the tendency of the rate of profit to fall? There likely isn’t. What is true is that capitalist development invariably leads to a rising of capital to labour, taking a society from an economy of abundant but unemployed labour and scarce capital leading to potentially high rates of profit, to one of mostly employed labour with abundant capital and a tendency towards excess capacity, depressing profits. The effect of rising capital is the unconditional development of the social productivity of labour, which relatively cheapens manufactures leading to a cotendency of consumer prices to fall against wages in relative terms, and capital equipment prices to fall relative to consumer prices — even if the mass of capital-good purchased grows. This however is unlikely to be uniform, leading to fluctuations which squeeze cash flows at the end of the boom, or lead to prolonged deflationary crisis in the absence of expansionary forces.

The ambiguity of wages in a capitalist system is crucial to understanding late-stage stagnation. Low wages in an early economy allows for a higher profit share without depressing overall demand which can come from other sources, but in a mature economy boosting the wage-share and long-term consumption patterns is vital to absorb the excess capacity (although boosting exports, government deficits or capitalist consumption may also have the same effect, to varying degrees of success). This however raises the cost of production and puts a ceiling on how far profits could rise again.

There is however no reason for surplus value to decline, no matter how construed, since there is no way to establish that only labour is a living factor of production. The conversion of value into profit can only exist in a monetary circuit, or what Marx terms the scheme of reproduction, and in the sense that he turns from the analysis of value to the analysis of realisation, he perfected his system and paved the way for later writers such as Keynes, Kalecki, Bhaduri and Marglin.

It is by understanding monetary features of capitalism that we can understand how its unconditional development of productive forces undermines its limited aim of self-expansion.

1. As opposed to corespective competition. James Crotty discusses both in Capitalism, Macroeconomics and Reality (2017)

2. Profit Squeeze and Keynesian Theory (1989)

3. Specifically, T. E Weisskopf in Marxian crisis theory and the rate of profit in the post-war U.S. economy (1979) argues all declines in profitability from 1949 to 1979 are attributable to the rising share of wages, although he distinguishes between ‘defensive’ and ‘offensive’ wage gains.

4. “For decades real investment in machinery and equipment has outpaced real GDP growth in many emerging market and developing economies. Since 1970, the real investment rate in machinery and equipment has tripled, rising from about 2 to 6 percent of real GDP. This capital deepening coincided with a steep decline in the price of capital goods relative to the price of consumption” in Lian et al. The Price of Capital Goods: A Driver of Investment Under Threat (2019)

5. J. Crotty The Centrality of Money, Credit and Financial Intermediation in Marx’s Crisis Theory: An Interpretation of Marx’s Methodology (1985)