Wednesday, 10 July 2013

The Rates of Profit, Interest and Inflation - Part 4

Source: Doug Henwood.  

The Rate Of Profit (3)

The Organic Composition Of Capital

In Part 3, I showed that estimates of the rate of profit are wrong because they do not include a major element of capital, i.e. the circulating constant capital. Often they are just estimates of the rate of surplus value, at best they are estimates of surplus value measured against the variable capital, and fixed capital. As a consequence, although they overstate the rate of profit, they understate the rise in the rate of profit over the last 30 years arising from the significant reduction in value (and in some cases physical quantities) of constant capital used in production.

The reduction in the value of this constant capital arises from a number of factors. Some of that has been mentioned in relation to the “Moral Depreciation” of the fixed capital. If we look back at the 1980's slump, it was the start of the Long Wave Winter Phase. During that period, global growth slows to below its average level, so the demand for inputs of various kinds, including materials falls. However, in the preceding boom phases of the Long Wave, particularly in the Spring Phase, high levels of demand for materials pushes up primary product prices. We have seen exactly the same thing in the current boom, as prices for materials, foodstuffs etc. rose sharply after 1999.

The following Chart illustrates the situation with copper.

Historical Copper Prices - Copper Price History Chart
Copper is significant, for the simple reason that it is sometimes called Dr. Copper, the metal with a PhD. In Economics, because it is such a good measure of economic activity. In almost any area you can think of from electrical production to construction, copper is required as an input. If the demand for copper is rising then economic activity is rising. A look back, however, shows that during the last Long Wave Boom – 1949-1974 – Copper showed a similar pattern, reaching similar highs in the 1960's.

Trends In Copper

A comment in the above, demonstrates why during the Long Wave downturn, the price of copper declined, and why during the current boom it has risen sharply.

“As a result of booming demand, operating profits in the copper industry have grown dramatically – operating margins up from 8% in 2001 to 38% in 2005. So why does copper supply not increase faster, as the industry clearly has plenty of cash to invest? To answer this question, we need to look at the basic economics behind investment decisions in the copper industry. Much of the added value in production of copper arises in the mining stage: only 25% of added value is in smelting / refining but the rest is in extraction and processing of copper ore. Thus the key supply constraint is the limited number of mines. When copper demand was lower, there was a surplus of production capacity and additional supply could be added simply by increasing throughput from existing mines. But supply cannot be increased indefinitely without additional copper production capacity, i.e. new mines. Despite the prevailing very high level of copper prices, copper supply from mines has not risen as fast as might be expected.

Copper Industry Investors Look at Long Term Prices

The economic theory is that when prices rise due to higher demand, supply will increase as it becomes possible to operate marginally economic mines at a profit due to the higher prices. The problem in practice is that copper is supplied from facilities that require huge investment in the mine and supporting infrastructure, and a major investment decision is required. A short-term rise in copper prices – even when sustained over several months - does not necessarily change industry investors’ perceptions of the long-term copper price. Mining companies will not invest in a project unless their expectations of long-term prices are at a level where the project becomes attractive.”

This is precisely the kind of phenomena of how and why firms build cash hoards when they are making large profits that Marx describes in Volume II of Capital. It also demonstrates why there is no mechanistic reason that capital, which is making large profits, and enjoying high prices for its commodities, necessarily is compelled to immediately invest those profits to accumulate. For a copper mine, the process from the initial prospecting, to completion and opening of the mine takes seven years. For the mine to reach its optimal operating level requires several years longer than that. In short, it can be around 12-13 years, before the effects of a Long Wave Boom, in producing levels of demand that cause prices and profits to rise, result in the necessary increase in supply. By the same token, a look at the movement from its previous peak (2004 $) of $3 per lb. to its trough in the late 90's of around $0.75 per lb. shows what happens when that increased supply comes on stream, and then faces a slowing demand, as the boom ends.

But, one reason these rapidly rising prices of inputs during the Spring Phase of the boom do not bring it to a halt, is precisely that during the Winter Phase, capital has been developing all of the new means of producing more efficiently that raise productivity. It is not just a rise in productivity of labour, resulting in an increase in relative surplus value that occurs, but much greater efficiency in the use of materials, energy etc. Oil provides a good example.

Global oil consumption rose from 63 million barrels per day in 1980, to 85 million barrels per day in 2006. That is an increase of 35%. But, between 1980 and 2012, Global GDP increased from $18.8 Trillion to $71.8 Trillion (1990 dollars). That is an increase of 282%! Even allowing for the 6 years difference in periods that means that global GDP rose by around seven times the increase in oil consumption. That is also despite the huge growth in the number of cars in places like China, which is now the biggest car market in the world. The reason that oil consumption has increased by only a fraction of the increase in global economic growth is because huge advances have been made in the efficiency of oil use. That is why in the 1970's a four fold increase in oil prices sparked a global slump, but from the late 90's a ten fold increase in the price of oil has not.

But, this revolution in the way oil is used is merely one example, of a process that has occurred across the global economy. On the one hand, an inability to increase supply quickly has pushed prices of primary materials higher, on the other this transformation of usage has meant that unit costs have fallen. As I have pointed out elsewhere - The Tendency For The Rate Of Profit To Rise – it is not just that there has been this revolution in the way materials are used. As always happens, in order to reduce costs, capital finds cheaper, better alternative materials to use. It replaced cotton and other natural materials, in the past, with synthetic materials like nylon, polyester etc. for example.  About ten years ago, I became convinced of the Peak Oil Thesis, but I have never accepted the Malthusian conclusions that some draw from it.  Capital uses science and technology to use oil more efficiently, and via things such as fracking, is able to extract more of it.  I will come back to the consequences of this for the rate of profit later.

But, today, the revolution in technology and in the patterns of production and consumption that it has partly brought about, has itself changed the whole structure of demand for constant capital. As I point out in the post linked to above,

The materials that go into modern devices are a fraction
of those that went into their predecessors, especially as
these new devices frequently replace a number of different
pieces of equipment.  The main components of value in them
is not constant capital, but the highly complex labour
required for design, software and hardware development etc.
“Similarly, if we look at other items of consumption we find that in fact the materials used are negligible. A mobile phone, a PC, an LCD TV, the various services we use such as cinema, theatre etc. In fact a mobile phone probably uses far less materials than did the old type of land line, the LCD certainly less than a CRT screen. Again the largest component in the value of these products is not the Capital or material used in the production, but the intellectual labour that went into their development etc. Look at the huge amounts now spent on Computer games, yet a CD or DVD takes very few material resources to produce, very little in the way of Constant Capital. But it does take the labour of skilled games programmers. Or music. When I was first collecting records 40 years ago to amass 1,000 records consumed a fair amount of vinyl. Now 20 times that amount can be stored on a tiny stick, instead of the cost of transporting all the vinyl etc to record shops the music can be downloaded all over the world instantaneously over the Internet.”

I was talking to my son today about this. He works in media production, and he was saying he and his friends were looking, at the weekend, at the production costs of various blockbuster films compared with their takings. With this in mind, I asked him about how those huge budgets were made up. A good portion of the budget of “Avengers Assemble” he said was probably just made up of Robert Downey Jnr.'s wages. Certainly, looking at the vast array of products that consumers now spend their budgets on these kinds of products, alongside the huge growth in service production, mean that not only is the value of constant capital falling, not only is the quantity, of constant capital, required, for an increasing proportion, of current production, falling, but also the other side to that is that the proportion of highly complex labour to constant capital is rising. In other words, there are very strong forces tending towards a lowering of the organic composition of capital, and thereby setting in place a tendency for the rate of profit to rise.  The other film we discussed was "Avatar", where the same principle applies, but here the main value added is from the hihgly complex labour provided by computer programmers developing the software for the CGI, and the animators who use it.

I pointed this out in a response to Paul Cockshott some time ago – Reply To Paul Cockshott.

I gave the following example.

Imagine an economy with two Departments - one Department produces all of the material consumption goods the other produces entertainment. I am leaving aside the production of Producer Goods for the sake of simplicity, and because it is irrelevant for the purpose of demonstration. 10 million people work in Department I, working a total of 10 billion hours of simple labour-time. 90% of the output of the Department is exchanged internally amongst its workers and capitalists, leaving 10% to be traded with Department II - that is 1 billion hours of output. In Department II 1 million people work a total of 1 billion hours of simple labour which they trade with Department I for consumption goods. These 1 million people are employed in 10,000 music halls around the country, 100 people working in each.

We know that the output of Department II is equal to the traded output of Department I because both outputs exchange for each other and is equal to 1 billion hours. Whenever, then the output of Department II exchanges entirely for the traded output of Department I we know that to be the case, and we can calculate the value of Department II's output from it, provided that we assume that the labour employed in Department I is entirely simple labour.

Now the population falls by 900,000 people. All of them were employed in Department II. However, rather than being employed in 10,000 music halls around the country they are now by the magic of technological development all employed in a single TV Company that is able to replicate the output of those 10,000 music halls. The output of these remaining 100,000 people in Department II exchanges entirely for the entire traded output of Department I, whose value we know to be equal to 1 billion hours. We know then that the value of the output of these 100,000 people in Department II is also equal to 1 billion hours or else this trade could not occur.

What then do we have. We have a fall in population of 900,000 people. Yet we have the total output value of the economy remaining constant 10 billion hours from Department I, 1 billion from Department II. We also have the output of Department II remaining constant despite employment in Department II falling to a tenth its previous level. The basis of this is that the labour employed in Department II is no longer simple labour, it is complex labour each unit of it being the equivalent of ten units of simple labour.

By the same token, wages paid to this complex labour, with a constant rate of surplus value, will be ten times more than that paid to simple labour. This means that not only has output remained constant with a falling population, but average wages will have risen - because wages paid per person in Department I remain constant whilst, wages paid in Department II will have risen tenfold.

This, of course, assumes that the organic composition of capital in Department II has remained constant, i.e. all of the constant capital used in TV production amounts to exactly that previously used by 10,000 Music Halls. I would suggest, however, that this constraint is unrealistic. It is an unrealistic constraint to place on Marx in respect of a rising organic composition of capital leading to a tendency for a falling rate of profit, because empirical evidence showed that industrial production DID and does necessitate such a rising organic composition. I would suggest it is an unrealistic constraint for the scenario I am depicting of modern technological production, and the expansion of high value service production leading to a falling organic composition of Capital and tendency for the rate of profit to rise, because empirical observation DOES show on an extended scale the same kind of transformation given in the example above.

To give another example, take Manchester United. If we use current prices, let's say back in 1980, the product of one hour of abstract labour had a value of £100. On a Saturday, Manchester United's eleven players play for 2 hours to a crowd of 40,000, each paying £50, meaning the product of them is £2 million, or approximately £200,000 per player, giving £100,000 per hour. So each player's labour, as complex labour, is equivalent to 1000 hours of abstract labour.

Today, the game is sold, via the Internet and satellite, to 1 billion people each paying £1 each. Half the revenue is taken by the various providers of services, leaving £500 million for MU. So, now the product of an hour's labour is £25 million, per player, which means that it is the equivalent of 250,000 hours of abstract labour. If there is a 100% rate of surplus value, then each player would get the equivalent of £12.5 million, and produce the same amount of surplus value. On a Saturday they would produce the equivalent surplus value as 5,000 workers working a 50 hour week!

In the early 1980's, I wrote that exactly this change in the structure of production and consumption was occurring, away from manufacturing production, where a high organic composition of capital necessarily develops, to an increase amount of production and consumption of service commodities, where it does not – Imperialism and The New International Division Of Labour. Back then, Services accounted for 57.2% of the UK economy. Today, they account for 78.2%. Back then industry accounted for 40%, today it accounts for just 21%. By nature, service industry tends to have a lower organic composition of capital, though neo-fordism is revolutionising that too. But, many of the areas of that production, are themselves based on high-value production, using very complex, high value labour. It is not just in Britain, where this transformation has taken place, and even in many rapidly developing economies, services already form a large part, often the majority of the economy.

Of course, this is like most things under capitalism a contradictory process itself. For example, to go back to the film industry, the porn industry has been a multi-billion dollar business. But, as I wrote a while ago, it has found itself getting screwed – Porn Free. That is because, thousands of people across the globe have been making their own porn, and uploading it to the net. Nobody will pay for porn when they can get it for free. But, even here the point is that this development has only been possible, because the cost of constant capital itself has been massively reduced by the factors described earlier. A decent film camera will set you back £20,000, but if the image quality isn't vital, then you can do the filming on a DVC costing a few hundred pounds, or even just your mobile phone, or digital camera.

But, there are more instances of the opposite movement, and as things like gene technology begin to develop a whole series of new high value products that trend will continue. In later parts, I will, however, argue that it will continue under different conditions than those of the last 20 years.

Back To Part 3

Forward To Part 5

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