The Marxist Law of the Tendency of the Rate of Profit to Fall

A numerical illustration

A couple of key concepts distinguishes the Marxist Law of Value from the classical economists’ Labour Theory of Value, i.e. socially necessary labour time and labour power.

Our demonstration of the Marxist Law of the Tendency of the Rate of Profit to Fall is based on the Law of Value, on the origin of the value of commodities and how that value is determined.

The sale of x quantity of commodity Co₁ on the market enables the acquisition with money of y quantity of commodity Co₂. In other words, x of Co₁ is equivalent in value to y of Co₂. But what determines the relative value of these two commodities, Co₁ and Co₂ ? The only common denominator is the average amount of social labour required to reproduce each commodity. Thus, if commodity Co₁ takes 100 hours of human work to produce in total, and commodity Co₂ takes 5 hours to produce, the normal trading ratio of Co₁ and Co₂ will gravitate around a rate of 1:20 (one Co₁ is worth 20 of Co₂). The key point here is that value is determined in the course of the production process and not in the process of circulation. In other words, it is not exchange that determines value, as vulgar economists claim, but human labour. The price of a commodity may oscillate according to short-term fluctuations in supply and demand, but it oscillates around an equilibrium that reflects the commodity’s actual value.

Thus, in Marxist economics price derives from value, just as in physics weight derives from mass. More specifically, the value of commodities, of whatever sort, is determined by the socially necessary labour time crystallized in physical matter in the course of the production process. The concept of socially necessary labour time refers to the quantity required to produce a commodity «in a given state of society, under certain social average conditions or production, with a given social average intensity, and average skill of the labour employed» (Economic Manuscripts, Chapter 6).

Competition means that it is the quantity of socially necessary labour time that regulates the exchange value of commodities, not labour time in general: the example cited by Marx is the hand-loom worker after the introduction of the power-loom: «his product of 20 hours now had no more value than his former product of 10 hours».

What the capitalist pays the worker does not reflect the value that the worker creates in the course of production. Otherwise, no capitalist would ever make any profit. Rather, the capitalist pays the worker for his labour power: to put it crudely, whatever is necessary to ensure that the worker turns up for work the next day. «The maintenance and reproduction of the working-class is, and must ever be, a necessary condition to the reproduction of capital. But the capitalist may safely leave its fulfilment to the labourer’s instincts of self-preservation and of propagation. All the capitalist cares for is to reduce the labourer’s individual consumption as far as possible to what is strictly necessary…» (Capital, Vol. 1 Ch. 23).

The difference between the cost of buying the worker’s labour power, and the value the worker adds to the commodities he produces, is the source of surplus value.

The general formula of a cycle of capital accumulation is M → Co → M^’, with M representing the monetary capital invested, and Co the commodities purchased in order to function as capital.

With a part of M the raw materials to be processed are acquired, to which is added the cost of energy plus a sum set aside to cover wear and tear and the maintenance of the machinery and the premises. This ensemble in Marxist terminology is referred to as Constant Capital (C). Constant because its value remains unchanged during the production process: it is entirely transferred to the value of the end product.

With the remaining part of M the capitalist acquires another commodity, a commodity with very unusual properties: the labour power of workers. During the production process it produces more value than it costs, and capital appropriates the difference. For example, if a working day is 8 hours long, the worker may produce in 4 hours a value equivalent to the wage he receives, and the 4 remaining hours is surplus labour, that is, a surplus value that ends up in the coffers of the capitalist. Marx called the monetary capital expended on the acquisition of labour power Variable Capital (V), variable because during the production process it generates an additional value, or surplus value (P), compared to its cost.

Therefore M expended as capital is transformed into a certain ensemble of commodities, indicated in the formula by Co, divided in its turn into C + V.

In the course of production, a surplus value P is added, and the general formula becomes:

M → Co → (C + V) → (production process) → (C + V + P) → Co’ → M’

Co’ represents all the commodities produced, its value being made up of Co to which is added the surplus value. M’ is the monetary capital taken back from the sale of the final product Co’ after it has been sold on the market. M’ is greater than M and equal to M + P.

In short we have three economic categories: Constant capital C, Variable capital V and Surplus value P. At the beginning we have only C + V but in the end, in the final product, we have C + V + P. The capitalist at the end of the cycle sells his product and, as a rule, re-invests P in order to expand the volume of production, so that from one cycle to the next (M → Co → M’) the value of the capital accrues and there is an unbroken and continuous increase in material production. This at least in the idyllic vision of capitalist production held by the classical economists. David Ricardo (1772-1823) is the last representative of classical economy and his theoretical work is its crowning moment. Classical economy corresponds to the bourgeoisie’s revolutionary phase. Subsequently, with Malthus, bourgeois economy will go on to establish what we Marxists call vulgar economy.

A part of the surplus value produced is reinvested as capital in order to reproduce it on an enlarged scale. The other part is consumed personally by the capitalist and goes towards enriching the various strata of social parasites and whose social weight is far from negligible, namely: those who live off the interest paid on financial capital, the banks, shareholders and financial institutions, and those who live off ground rent. Here, for simplicity’s sake, we will consider that all the surplus value has been reinvested, but if it is only reinvested in part, rather than in full, this doesn’t detract from the validity of the law of the tendency of the rate of profit to fall.

Let us consider a business enterprise which on each working day invests $ 9,000 dollars (or euros, or yuan) in constant capital C, and $ 1,000 in workers’ wages V. Let us suppose that this $ 1,000 in wages corresponds to the value produced in half a day’s work: in 4 hours out of an 8-hour day the labour of the workers produces $ 1,000 value, corresponding to the value of their wages, and in the remaining 4 hours it produces another $ 1,000 value, which this time is entirely surplus value, that is, the yield of the surplus labour with respect to the cost of the labour power which allows the capitalist to rake in a profit.

The value of the final product will therefore be C + V + P, or $ 9,000 + $ 1,000 + $ 1,000 = $ 11,000.

The rate of profit is calculated by dividing the surplus value by the total capital, in this case $ 1,000 / ($ 9,000 + $ 1,000) = 0.1 = 10%, and the rate of surplus value by dividing the surplus value by the variable capital, in this case, $ 1,000 / 1,000 = 1.

By organic composition of capital is meant the ratio of C to V, and it is an indicator of the productivity of labour, of the capacity of labour to set in motion ever bigger production facilities and to transform ever larger quantities of raw materials. In this case the organic composition is $ 9,000 / $ 1,000 = 9.

But our capitalist, exposed to harsh competition, is forced to modernize the productive process by acquiring more efficient machinery. These allow him to double productivity, such that in order to transform $ 9,000 of constant capital, only half of the number or workers are now sufficient. The final cost falls from $ 11,000 to $ 10,000, composed of $ 9,000 C plus $ 500 V plus $ 500 P. Both V and P are halved. The organic composition therefore goes from 9 ($ 9,000 / $ 1,000) to 18 ($ 9,000 / $ 500). The unit production price of the commodities is reduced in the proportion 10/11.

Or else the capitalist could employ the same number of workers and utilize more constant capital. The result is the same, as can be easy verified.

As long as our capitalist is the only one to have introduced this technical innovation, he will not sell his products at their cost price, which is lower, but only at a slight discount with respect to the market price, thus forcing his competitors to sell their products below their value. He therefore obtains a surplus profit while his competitors, on the contrary, derive less profit. We thus we have a transfer of value between capitalists. Our capitalist can even allow himself the luxury of employing new workers to increase production.

However, those of his competitors who haven’t been bankrupted will adopt the new production process. In this way the new productivity radiates throughout the branch of production concerned. The new organic composition of capital becomes the rule and the average amount of labour socially required to transform $ 9,000 of constant capital is halved. On the market, the value of the final product in this branch of industry will therefore no longer be $ 11,000 but $ 10,000. The capitalist will no longer be able to sell his wares above their value but will be compelled to sell them at the new value. The result is a new rate of profit which corresponds to the new organic composition of capital: $ 500 / ($ 9,000 + $ 500) = 5.3%.

The rate of profit has been almost halved! The productivity of labour has doubled at the same time as the rate of profit has fallen. The greater the productivity of labour, the less ‘productive’ capital becomes, and the less profit it produces. As the productivity of labour increases, so the amount of constant capital advanced to obtain the same mass of profit increases as well.

Capital cannot prevent the fall in the rate of profit, but only increase its mass, by enlarging the scale of production, by taking on more workers and by consuming more materials and machinery. In our Case 1, the constant capital that would need to be advanced to obtain the same mass of profit would have to be doubled. The process sees the continual ruin of competitors and an increasing concentration of capital. This leads to the formation of cartels and monopolies. But the fact remains that the more productive social labour becomes and the more social productivity increases, the less productive capital becomes, thus slowing down its relative accumulation. Therefore, growth is actually reduced relative to the production, turnover and capital of the previous year which was determined by the reinvestment of the surplus value, and therefore in proportion to the rate of profit. The accumulation of capital, whose growth tends toward zero, comes ups against this insurmountable obstacle.

What if surplus value increases?

The only way of countering the fall in the rate of profit, momentarily, is to increase the rate of surplus value.

We have seen that an increase in the productivity of labour reduces the value of the commodities produced. When the increase in the productivity of labour spreads to the sectors involved in producing goods for the maintenance and reproduction of labour power, the value of labour power itself is reduced, because less social labour time is required to produce what is required.

If in the 19^th century half a day’s labour was enough to meet a worker’s needs, nowadays the time required has certainly gone down to an hour, or perhaps even less. The rate of surplus value, that is the P / V ratio, has gone up as a consequence. So from 1 in our Case 1 considered earlier, $ 1,000 / 1,000 or 4/4 hours, now, if 1 hour a day is enough to offset the requirements of labour power, the rate of surplus value has risen to 7 / 1 = 7. This increase in the rate of surplus value, which increases P, counteracts the fall in the rate of profit, despite the reduction in time worked, which has gone down from 12 hours a day in the 19^th century to around 8 hours today.

And yet the effect of the increase in the absolute surplus value, with the lengthening the working day, or of the relative surplus value, with the increase in its intensity, which has physical limits, cannot arrest the tendency of the rate of profit to fall in the long term.

Let us look again at the figures in Case 2: $ 9,000 C + $ 500 V + $ 500 P. If we now suppose (Case 3) that the rate of surplus value rises from 1 to 10, with all else remaining the same, we have: $ 9,000 C + $ 90V + $ 900 P. There has been a steep decline in the wage bill but profits have gone up. The organic composition also increases from 18 to 100. Temporarily the rate of profit has risen from 5.3% ($ 500 / $ 9,500) to 9.9% ($ 900 / $ 9,090).

But for as long as the historically inevitable growth of fixed capital and the corresponding rise in its depreciation and maintenance quotas, continue, so will decline the rate of profit. If C is increased to $ 10,000 (Case 4) the rate of profit immediately drops to 8.9%, ($ 900 / $ 10,090). Whatever the increase, even if enhanced by increased levels of exploitation of the working class, the progressive barrenness of capital cannot be reversed.

In the wonderful third part of Volume Three of Capital, Marx writes: «It has already been shown, moreover, and this forms the real secret of the tendential fall in the rate of profit, that the procedures for producing relative surplus value are based, by and large, either on transforming as much as possible of a given amount of labour into surplus value or on spending as little as possible labour in general in relation to the capital advanced; so that the same reasons that permit the level of exploitation of labour to increase make it impossible to exploit as much labour as before with the same total capital. These are the counter-acting tendencies which, while they act to bring about a rise in the rate of surplus value, simultaneously lead to a fall in the mass of surplus value produced by a given capital, hence a fall in the rate of profit» (Chapter 14, Penguin Edition).

What is more, the reduction in the social value of labour, caused by the increase in labour’s productivity, also contributes to the reduction in the rate of profit: the serpent bites its own tail.

Thus, whatever measures the capitalists take to ‘rationalize’ production, such as closing non-profitable businesses, reducing costs by out-sourcing, reducing staffing levels by increasing productivity, etc., even if they result in an initial increase in the rate of profit due to reduced production costs, in the end they are bound to lead, once all such measures have become generalized, to a further reduction in the rate of profit.

At the same time capital has an interest in reducing the price of labour power, cutting wages that is. Rising unemployment and the large-scale importation of cheap labour serve to exert a downward pressure on wages. Increasing job insecurity and impoverishment of the labour force are thus inseparable from capitalism. In Japan 30% of the labour force is already impoverished and working part-time. In Germany the figure is 20%, In France the rate was 15% in 2010 and is now approaching 20%. Capitalism equals insecurity and improvidence: in the end all long-term contracts will be eliminated, and a lack of job security will become the norm. Spain, Greece and Portugal are already showing the rest of Europe what it can expect.

Today we can add to all this a decrease in the employers’ responsibilities for pensions and health benefits and the incessant changes to employment legislation to make it more ‘flexible’ and compliant with the requirements of Capital, i.e., making it possible to lower wages and sack staff without incurring penalties or costs. Already in Great Britain so-called ‘zero-hour’ contracts are fast becoming the norm.

As capitalism gets older and more decrepit, its true nature and essential mechanisms, as laid bare by Marx, will become increasingly evident. Its centralized, ‘globalized’, militaristic, exploitative, and crisis-ridden characteristics will become more and more accentuated, until finally it is destroyed, by the communist revolution.