The Transformation Problem
Exchange Value
Its first necessary to explain what the Transformation Problem is. Marx like the other Classical Economists set out how Exchange Value is determined by the amount of abstract, average, simple labour-time that is socially necessary to produce a commodity. This Labour-time can be divided up as follows. First of all a certain amount of past labour-time has gone into the production of the materials used in producing the commodity. In addition, the machinery used for producing the commodity gives up some of its value - what modern Accountancy calls depreciation - because the act of production also causes it to wear out. The cost of its replacement has to be recovered. But, these expenditures of Labour-time have occurred, they have established the Exchange Value of this material, and of the machines used. It cannot produce any new Exchange Value, only pass on the value it possesses into the new commodity. For this reason Marx calls it Constant Capital (C). It would also include things such as factory buildings as well as ancillary materials such as oil to lubricate machines etc.
The other thing that goes into the production of a new commodity is the labour-power that works up this material using the machines etc. This Labour Power like any other commodity has its Exchange Value determined by the labour-time required for its production. In other words how much time is taken to produce the workers needs for food, clothing and shelter and all of those other cultural and physical needs taken as standard for the particular country and time. However, just as was the case for say a slave in the past or a medieval peasant the worker can work for longer than is required to produce this necessary amount. They can produce a surplus. If a worker produces Exchange Value equivalent to this necessary amount in say 4 hours, and receives that value back in the form of wages, but works for 8 hours, they have produced a surplus Exchange Value equivalent to 4 hours. The new Value they have created is equivalent to 8 hours. Four hours of this is merely transferring the value of their own Labour Power into the commodity in the same manner as the Constant Capital, but the 4 hours of Surplus Value they produce is new value, additional value, Exchange Value that previously did not exist. This quality of labour power to create new Value rather than simply transfer existing value into the commodity is what leads Marx to describe it as Variable Capital (V). Technically, this is incorrect. The worker produces a new USE-Value, but as stated above the Exchange Value of this new Use Value that is required to cover the workers reproduction - called necessary labour-time - is not new Exchange Value. It already exists in the form of the workers Labour-power. The new product produced during this time simply reproduces it. It is technically speaking the new value over and above this, the Surplus Value which can properly be described as Variable. But, Marx wants to show that it is the Labour-power which is the genesis of this new value so his use of the term is understandable. The Surplus Value created by this Labour-power is labelled as (S).
We now have the formulae for the Exchange Value of the product. C + V + S. It is important to understand that this breakdown of that value is not like the way in which orthodox economics determines value from the costs of the factor inputs. The Value of the Commodity is not simply a summation of costs, so much for Constant Capital, so much for wages, so much for profits. These are objective quantities of expenditure of Labour-time. The exchange Value of the Constant Capital IS the amount of labour-time required for the production of the various components. Added to this is the average, socially necessary labour-time required for producing the new product - let us say 8 hours. That gives us the total value of the product. But, that sets the limit within which the distribution of that 8 hours is divided between the Capitalist and the worker. S is not an amount of profit simply added on to the costs of production.
Generalised Exchange
Now, when commodities first began to be produced and generalised exchange begins to take place things are not the same as they are under Capitalism proper. As I have shown in my previous blog in relation to the mistakes of Mandel under peasant or artisanal production, in fact, what we have is not the production of surplus value, but the production of surplus use values, that as a consequence of generalised exchange take on the form of commodities that have Exchange Value. The peasant or artisan is not seeking to maximise profit, because they have no compulsion to accumulate Capital. They merely seek in the case of the peasant to sell those goods excess of their own needs in order to buy those things they cannot produce or themselves, and to pay their taxes etc. The artisan does the same except the whole of their production is to be sold to achieve that result, because they are specialists. This is important.
Capitalism Proper
Under Capitalism proper the Capitalist is forced to maximise profit, because that is the way to accumulate Capital, and the Capitalist has to accumulate Capital, because that is the only way to stay ahead of your competitors. If you fail to do that ultimately you go out of business, and become a worker.
So, some important relationships arise under Capitalism, between C,V, and S. The Capitalist wants to maximise S, but because C is fixed, can only do so, by squeezing V i.e. the worker. This can be done by increasing the length of the working time of the worker. In the 19th century workers hours were more than doubled compared to the time the average peasant or even day labourer worked in previous centuries. Today, the retirement age is raised to have the same effect over a worker's lifetime. This means of raising S is called ABSOLUTE Surplus Value. The same effect can be obtained by squeezing more out of workers during the same given period. Achieved by speeding up production lines, telling postmen they have to walk faster etc. The other means of raising V is by cutting V. That can be done by reducing the cost of all those things that the worker has to buy. that was why the capitalists wanted to abolish the Corn Laws against the resistance of the Landlords. By cheapening the price of bread the Capitalists could justify cutting wages. This is called RELATIVE Surplus Value. Capitalism's continual improvements in technology and technique, bring about this cheapening of the worker's requirements. In fact, by this means they can not only reduce V in real terms, but it can be accompanied by actual improvements in workers living standards, as cheaper prices for certain goods mean that workers have money left over to buy a wider range of goods. All that is required is that this cheapening is greater than the actual reduction in workers wages. This is what Marx called the "Civilising Mission" of Capitalism, and stands in complete contrast to the Staliinist and Lassallean notion of "absolute immiseration", replicated by others on the Left like the AWL, who proclaim that "Capitalism creates poverty", in complete contradiction to the observable reality.
So, Capitalism is concerned with the ratio of S/V or the rate of exploitation. But, increasingly, because of technological development, and because Capital seeks to increase Relative Surplus Value, C increases at a faster rate than S. For the Capitalist, increasingly he is concerned with the not only how much he can screw his workers, but with how much profit he makes in proportion to the total amount of Capital he has to lay out to achieve it i.e. with S/C+V, the Rate of Profit. This is important, not because like with say a saver who wants to earn the highest rate of interest on their savings they want to increase their spending power, but because it is the index of how much they can increase their business, and thereby out compete their rivals.
But, this is where a difference with those pre-capitalist forms comes about. Not only does the peasant or artisan not produce Surplus Value per se, but even were we to designate the Exchange Value of their Surplus Product as Surplus Value, they would not be concerned with maximising it, because they were not in competition with other peasants or artisans to the extent of needing to expand their operations or die. Moreover, the amount of C used by such producers was quite small. There could be little variation of S/C+V, even could we correctly apply those terms. That is not the case with Capitalism. Capitalists move their Capital to where they can maximise not just the amount of profit, but also the Rate of Profit.
But, when C begins to expand significantly this has consequences. If we take two firms with the same amount of Capital employed, and assuming that the workers in each are exploited to the same degree we will find that the Rate of profit varies depending upon the ratio of C to V - called the Organic Composition of Capital.
C100 V 400 S 400 Rate of profit 400/500 = 80%
C400 V 100 S 100 Rate of profit 100/500 = 20%.
So it can be seen that firms that are more developed and have more C to V, a higher organic composition of Capital, would on the basis of Exchange Values make less Surplus Value, and a lower rate of profit. Now where this happens in a given line of production what happens is that Exchange Values are determined as the average across all firms in that line of production. So, the firm with the higher organic composition of Capital would not sell its commodities at Exchange Values determined by its own costs, but those of the average. It would have a competitive advantage, and would in fact make a higher profit, and rate of profit than the average firms. The firms with a lower organic composition of capital, who would be less competitive would make less profit, and a lower rate of profit. Over time the less efficient firms go out of business, and so more or less the same organic composition of Capital will apply across an industry.
Values Become Prices
But, that is not the case between industries. The degree to which such an equalisation can occur will depend upon the nature of the industry, the degree to which technological developments can be introduced etc. For example, agriculture for a long time remained very poorly capitalised compared to industry. But, if these variations across industries cause differences in the Rate of profit, and if Capitalists will always seek to move their Capital to where it brings the best return, causing profit rates to be averaged over time, how is this average profit to be brought about. Marx resolved this problem, by showing that in establishing an average rate of profit Capital creates market prices that differ from exchange values, such that these prices cause this average rate of profit to be achieved across the whole of Capital. This is the transformation of Values into prices.
If we take the example above:
C100 V 400 S 400
C400 V 100 S 100
Then the total C is 500, V 500, and S 500. The average rate of profit is 500/1000 = 50%. In order to achieve this average the prices received for its products for the first firm have to be reduced, and those of the second increased.
Previously, total Exchange Value of firm 1 was 900, and this has to fall to 750, a reduction of 150, to bring about a rate of profit of 50%.
This surplus value is now transferred to firm 2. The Value of its product was previously 600, and becomes 750 also producing a rate of profit of 50%.
Mandel's Account
All, of the above more or less mirrors Mandel's explanation of this process other than the fact that I do not accept that Surplus Value is produced other than by wage labour, or at least absent wage labour forming a major part of both production and consumption. I also broadly agree with the first part of how Mandel explains the way in which this averaging of the rate of profit arises.
On page 158, he relates how when after the end of the Napoleonic wars the price of coffee in Europe rose steeply, whilst whereas the price of sugar fell as a result of the introduction of beet sugar, sugar producers in Java, Cuba, Haiti, and San Domingo switched over their plantations to coffee. The fall in the supply of sugar caused its price to rise, whilst the increase in the supply of coffee caused its price to fall, and profit rates were once more equalised. This to me is the correct interpretation as to the way in which Capital is allocated to bring about an average rate of profit, and also the way in which Exchange Values give way under pressure of shifts in demand and supply to market prices.
But, Mandel goes on to give a further explanation, which to me is wholly incorrect. First of all he introduces a concept which I think is unnecessary not to say contrived. He argues that because Capital moves to those areas where the Organic Composition of Capital is low it will bring about an increase in that composition, because the increased competition will encourage a greater use of machinery, and more efficient methods. So it will tend to equalise the organic composition of Capital. I think this is largely nonsense. The example he gives of coffee and sugar shows why. Its unlikely that there was any increase in the organic composition of Capital in Coffee production as a result of more Capital being employed there. The fall in price has nothing to do with any such increase in the organic composition of Capital, but is purely and simply a consequence of changes in demand and supply. In reality what we have here is the following. If we begin from a situation where prices are the same as exchange values, and demand and supply are in dynamic equilibrium then supply will respond both to changes in demand, and changes in profitability. If, there arises a change in the organic composition of Capital in one branch of industry this will cause a divergence in rates of profit. Capital will move from where the rate is lowest, and towards where it is highest. But, this means that Supply falls in one and rises in the other. If Supply and demand were previously in balance then this must mean that it is thrown out of equilibrium. There will be an oversupply in one and an undersupply in another. But, oversupply and undersupply are relative terms. Equilibrium means only that the amount suppliers are prepared to supply at a given market price is equal to the amount consumers will demand at that price. Crucial here is supply. The amount producers are prepared to supply is a function of the profit that can be made at the given market price. As at the original Exchange Values profits either above or below average profits were made this meant in effect that at market prices rather than Exchange Values some commodities were being over supplied and others under supplied. Capitalists are not interested in Exchange Values, but market prices, because it is market prices that they are paid. It is these market prices and the resultant money profits they produce which determine how much they are prepared to supply. It is not under Exchange Values that market equilibrium is attained, but under market prices.
Elasticity of Demand
The amount of Capital that has to exit one sphere and enter another is dependent upon another factor known to Marx, what today Economists call the Price Elasticity of Demand, or in other words the extent to which demand changes in response to changes in prices. Speaking in this regaard Marx talks about the steel industry in Sheffield, and the production of cutlery. He remarks that a cut in prices will result in more knives and forks being demanded, but he continues there are only so many knives and forks people need, however cheap they become. If we take an industry where the Organic Composition is high, and where Exchanges Values lead to below average profits then the degree to which prices and profits rise will depend upon this elasticity of demand. Where demand is inelastic this means that demand does not change much as a result of changes in price. So if prices rise by 10%, firms revenues will rise by 10% if demand is perectly inelastic. In contrast where demand is elastic a rise in price will cause demand to fall a lot, so that the revenues firms take in will not increase much, and might even fall, so profits will not rise much. Consequently, where demand is inelastic less Capital will need to leave that sphere than where demand is elastic.
The above diagrams illustrate this. In Fig 1 to the left we see that from an original position of equilibrium represented by the intersection of SS and DD the price is P, and the quantity demanded and supplied is Q. If we assume that the price has to rise to P1 in order that average profits are achieved then this results in a new equilibrium point at S1S1 DD. At this equilibrium level Supply has to shrink all the way back to Q1. This is because demand is elastic, and as price rises demand falls back sharply as shown by the shallowness of the demand curve DD. By comparison if we draw in a demand curve showing relatively inelastic demand the difference is marked. Fig. 2 to the right shows that now a price rise from P to P1 results in a new equilibrium level at the intersection of S2S2 and D1D1. But now the equilibrium level is achieved with demand and supply only falling back to Q2.
It is apparent then that in industries or for products where price elasticity of demand is higher more Capital will have to be withdrawn (because the level of Supply is a direct function of the Capital employed) in order for an equilibrium level to be achieved that produces average profit.
Socially Necessary?
Keen to show that an average rate of profit exists across the whole of Capital short of the need for this equalisation of the organic composition of Capital, Mandel comes up with what I think is a thoroughly contorted argument. He says that because Exchange Value is based upon socially necessary labour any industry where the Organic composition of Capital is lower than the average is in effect wasting labour-power. Whilst, this argument holds WITHIN a given industry, it is ludicrous to apply it across industries. In what way is it sensible to say, for example, that agriculture is wasting labour, because it has a lower organic composition of Capital than Steel-making? It isn't. Socially necessary means socially necessary given the available techniques, and technology at that particular time. It makes no sense to say that labour is being wasted in agriculture or some other industry because it is not using machinery that does not exist!!!
Its undoubtedly the case that over time increases in demand leading to high prices that attract new Capital will encourage new ways of producing more efficiently. This has nothing directly to do with the fact that there are variations in the organic composition of Capital, and the lower prices are caused by the increased supply not some kind of punishing by consumers of suppliers that don't use enough Constant Capital!! Generally, this works backwards from the consumer to the producers of Constant Capital. But, it is not necessary to argue that the movement in prices is a result of producing below some imaginary socially necessary labour-time that would be the case if non-existent machines did already exist.
There are a number of examples which demonstrate the point. When the price of wool rose, largely due to increased trade bringing about an increased demand for woollen garments, Capital moved into the farming of sheep. This didn't to any significant degree entail an increase nin the organic composition of Capital in sheep farming. It did involve a greater volume of Capital leading to an increased supply of sheep, and consequently lower prices. As the price of wool fell as more wool became available, and as weaving became more profitable Capital moved into weaving, new machines were developed, but now not enough wool could be spun. Prices for woollen thread rose causing Capital to move into spinning. New spinning machines were developed.
The Average Rate of Profit and Mysticism
Mandel is led to these arguments because he sees an average rate of profit as being a feature of Capitalism. It is the average rate of profit itself that MUST be applied to all Capital that then determines prices. This is clearly not true WITHIN industries. Some firms that are more efficient earn higher rates of profit, others lower rates of profit than the average. But, it is not true ACROSS industries either. At any one time some industries will have higher rates of profit than others. It is possible as with almost anything else to take the total profits, and divide them by the total Capital to arrive at an Average Rate of Profit, but in and of itself that is meaningless. To argue as Mandel does that this average can be applied to determine prices is bordering on the mystical. Moreover, the argument Mandel uses here contradicts the correct argument he commenced his exposition with. Indeed to a certain degree it removes the transformation problem altogether. If prices are magically formed in the way that Mandel suggests by the application of the average rate of profit, so that in some way unexplained consumers reduce teh prices they are prepared to pay for goods produed by industries with a low organic composition of capital, and vice versa then the resultant average raate of profit resulting from these prices will give no reason for Capital to move frm one sphere to another! He removes the very mechanism by which the average rate of profit is formed. The real average that Marx is concerned with is the average that arises via competition, and the movement of Capital from those areas where the Rate is low to those where it is high, which of itself through the working of supply and demand brings about changes in market prices, and averages out the rate of profit. But, Capital does not flow easily from one area to another, there are necessary frictions, and so the averaging of the rate of profit can never in reality be achieved. Even besides the continual changes in technology, of the composition of Capital and so on, the average rate of profit is always a moving target which can never be reached. Modern Capitalism achieves it as best it can not in he sphere of production, but in the sphere of fictional Capital, through the instantaneous revaluation of Capital values on the world's Stock Exchanges.
The Concentration and Centralisation of Capital
One final point. Mandel links this argumeent with the concentration and centralisation of Capital, which is an undeniable feature of Capitalism. But, Mandel has in my mind too mechanical a view of this. Its true that Marx talked about this centralisation and concentration of Capital, and the necessary drive towards Monopoly. But Marx not only said that Competition breeds Monopoly, he also said that Monopoly breeds competition. I think that Marx's centralisation and concentration of Capital really refers to that centralisation and concentration in the hands of a few Capitalists.
For example, the Dow Jones Index is an index of the US's 30 biggest companies. Not one single company that was in that index at the beginning of the twentieth century is in it today. Meanwhile companies that did not even exist 10, 20 or 30 years ago today make up some of the biggest companies. So it is clear that the argument about the centralisation and concentration of Capital caannot be used mechanically to argue that some given set of very large companies must dominate the economy. In any one industry it is inevitably true that the largest companies tend to dominate - though again not absolutely as the demise of GM and Ford proves (not though to be replaed by new small companies but by other very large companies like Toyota, VW etc.) - but over time, new industries develop that repalce the old. These new industries are almost inevitably dominated by small not large companies, but these small companies grow rapidly to become large companies. Contrary, to Mandel's assertion, it is usually these new, small dynamic companies that have the highest rates of profit, not the old large companies. It is precisely, this higher rate of profit of these small companies that enables them to grow rapidly.
And again contrary, to Mandel's argument in relation to the organic composition of capital these companies usually have a very low organic composition of Capital. When Bill Gates, Steve Ballmer, and Paul allen started Microsoft they did so with a very small amount of Constant Capital. It amounted to little more than use of Bill Gates parents garage. They did have a large amount of Variable Capitalin the form of their respective skills - even if initially those skills were not remunerated in high salaries. But, it was not the existing giant of he Computer industry - IBM - that was to be the dominant player in the following years, but this tiny start up, which made huge profits, and a very high rate of profit. Nor is that experience untypical. It can be applied to almost any new industry you care to mention.
It is the basic idea behind the Harvard Business School Model of the product Life Cycle. New products are generally developed in developed economies where consumers are more likely to be early uptakers. But, also new products rely on innovation and development. They tend to have a high level of skilled labour in their research and development. Small production runs mean that this labour component tends to be a high proportion compared to any capital used in production. It is only as the product becomes established and demand rises that larger production runs enable a profitable implementation of new production techniques, and eventually as the product becomes mature to the introduction of new machinery, mass production etc. and unskilled labour. As the model shows this is a large part of the explanation of the way multintionals are able to utilise cheap labour economies for the production of commodities in that phase of the product cycle.
What is clear is that although large companies come and go as new industries develop and old ones decline, the ownership of Capital itself becomes more centralised and concentrated in the hands of fewer and fewer people. To get into the wealthiest 1% in he US you need a Net Worth of just $3 million. Most of the peeople in this top 1% are not really Capitalists. The large majority are people who are over 50 years old, nearly all of their wealth is in the form of their home, and their pension fund. In short it is not in the form of productive wealth over which they have direct control. They are basically middle class people, who have had a decent income and been able to buy a nice house, and save for their retirement. By contrast, Bill Gates has a personal net worth of around $40 billion, or more than 10,000 times that of most of these people. The real ownership of productive wealth in the US is probably concentrated in the hands of not the top 1%, but the top tenth of 1%, or even less than that. In other words in the hands of around 250,000 people. Very few of these people with that extent of wealth will find themselves being cast down into teh ranks of the middle class let alone the proletariat. 1% interest a year on $40 billion would give you an annual income of $400 million!!! But, the entrance every so often of the odd Bill Gates into this exclusive club can hardly change its nature as a stable ruling class. Even 10 Bill Gates every decade hardly changes the nature of a group of 250,000.
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