The Law Of The Tendency For The Rate of Profit To Fall - Part 1

Marx's Law and That Of His Predecessors

The fundamental basis of the Law, as developed by Marx, is straightforward. The rate of profit is the proportion between the surplus value, and the value of the total productive-capital advanced to produce it (assuming a single turnover of capital). If constant capital is designated “c”, variable capital “v”, and the surplus value “s”, then the rate of profit is s/c+v. Because, as any capital grows, the rise in productivity means that the same amount of “v” processes increasing amounts of material, which comprises part of “c”, the ratio of c to v, the organic composition of capital, tends to rise. But, “s” is also a function of “v”. If “c” rises relative to “v”, then it also rises relative to “s”, unless the relation of s to v, the rate of surplus value, “s'” changes, so that “s'” increases. In short, s will tend to fall relative to c+v, so the rate of profit falls. If this tendency for the rate of profit, for any particular capital, to fall, is extended to the total social capital, then there must be a tendency for the average rate of profit of the total social capital also to fall.

This fundamental basis of the law, as described, is straightforward, and yet his predecessors had been unable to uncover it. That is because they had not uncovered the difference between constant and variable capital, as opposed to fixed and circulating capital, and so had not been able to reveal the source of surplus value, and its relation to these component parts of the total advanced capital.

Yet, as Marx points out, the Law of Falling Profits was seen as highly important by those predecessors. The Law of Falling Profits was important for all previous political economy, because it was seen by them as a threat to the existence of capitalism itself. In fact, Marx explains why they were wrong in that view. In Theories of Surplus Value II, Marx writes,

“A distinction must he made here. When Adam Smith explains the fall in the rate of profit from an over-abundance of capital, an accumulation of capital, he is speaking of a permanent effect and this is wrong. As against this, the transitory over-abundance of capital, over-production and crises are something different. Permanent crises do not exist.”

Theories of Surplus Value II, Chapter 17, Footnote 1

They were wrong, because their theories of the falling rate of profit were wrong. The falling rate of profit, for previous political economy, had been the equivalent for capital to what Malthus' theory of population had been for workers. Malthus believed that population must grow faster than the ability to feed it, so real wages would fall as the price of food rose, and workers would starve so as to reduce the population. This same conception is behind Ricardo's theory of falling profits, and Marx comments, in Theories of Surplus Value, that for Ricardo, the falling rate of profit operates as a law of nature. The basis of this law is derived from Ricardo's theory of rent. As capital expands, more workers are employed. The demand for food rises, and because land is limited, less fertile soil is brought into use. The price of food rises, and because food comprises the major part of workers' expenditure, it causes the value of labour-power to rise, even if rises in productivity cause the prices of other wage goods to fall. Wages, must then rise, and as wages rise, profits must fall.

Other economists explained the fall by similar methods, for example, a tendency for the rate of interest to rise, for rent to rise and so on. What all these explanations had in common is that as well as a falling rate of profit, they all involve, at least at some point, a falling mass of profit as well. The rate of profit falls because the mass of profit falls. Marx shows this is fundamentally wrong. In fact, what Marx demonstrates is that not only does the rate of profit tend to fall, despite the mass of profit remaining the same or even rising, but the very process which implies a falling rate of profit itself necessitates a rising mass of profit! 

This is just one of the contradictions at the heart of the process, which Marx unveils. In fact, as Marx outlines, those same processes that create the basis of a falling rate of profit not only necessitate this growing mass of profit, but also equally generate a tendency for the rate of profit itself to rise.

Moreover, there is confusion over exactly what Marx is setting out in the theory, by some who have failed to notice that Marx uses several different definitions of the rate of profit.  The rate of profit that Marx is referring to here is s/c+v, which is the same as the profit margin, which can also be written as p/k, where p is the profit, and k is the cost of production.  This is made clear by Marx in Theories of Surplus Value, Chapter 16, where he writes,

"{Incidentally, when speaking of the law of the falling rate of profit in the course of the development of capitalist production, we mean by profit, the total sum of surplus-value which is seized in the first place by the industrial capitalist, [irrespective of] how he may have to share this later with the money-lending capitalist (in the form of interest) and the landlord (in the form of rent). Thus here the rate of profit is equal to surplus-value divided by the capital outlay."

But, Marx and Engels specifically distinguish between the "capital outlay", and the capital advanced. The capital advanced, is the capital advanced for one turnover period, whereas the capital outlay is the total amount of capital laid-out during the year.  As Engels describes in Capital III, Chapter IV, and as Marx himself refers to in Chapter 13, the rate of profit is calculated on the laid-out capital, whilst the real rate of profit, or annual rate of profit is calculated on the advanced capital.  Two completely different figures and sets of conclusions arise from these different rates of profit, as will be demonstrated.

Forward To Part 2