The other element of the value composition of capital is the value of variable-capital. Adam Smith had followed on from the Physiocrats in recognising that surplus value is created in production, but Smith understood that value is labour and surplus value is surplus labour. The individual, independent producer produces a commodity whose value is determined by the labour required for its production. This value is greater than the value required to reproduce the value of the producer's labour (power), and so a surplus value is created, and is already a part of the value of the commodity. Smith also defines the value of the commodity as equal to the labour it commands, meaning that commodity A, commands an equal amount of labour in the form of some other commodity, or in terms of a quantity of labour-service that can be bought with it.
Smith, saw, that, as soon as capital and landed property comes into existence, this seems to break down. A given amount of labour represented by commodity A, in the hands of the capitalist, now commands a greater quantity of labour from the worker, when paid to him as wages. He believes the labour theory of value, thereby, ceases to operate. His mistake was to fail to distinguish between commodities and capital, and between labour and labour-power. What the wage worker sells is not their labour, or a labour service, but their labour-power. What the capitalist owns is not commodities/money, but capital. The value of commodities/money, as capital, is greater than their value as commodities/money, by an amount equal to the average rate of profit. The worker does not sell their commodity – labour-power – below its value, but at its value. However, the value of this commodity is less than the new value the worker creates by the performance of their labour, i.e. by the amount of the surplus value.
Smith saw that the capitalist is able to obtain the surplus value, produced by the labourer, that was previously embodied in the value of the labourer's output, and appropriated by them. He concludes that the reason for this is that labour is plentiful, and capital scarce so that labour is sold below its value, and capital above its value. He further concludes, therefore, that the appropriated profits will be accumulated as additional capital, and those who can will accumulate capital rather than work as wage labourers. The supply of capital will then rise relative to the supply of labour, so that the price of capital (profits) will fall, and the price of labour (wages) will rise, until profits disappear. This is Smith's explanation for the tendency for the rate of profit to fall.
On this basis there would be a natural tendency for wages to rise, and profits to fall. The value composition of capital would, on this basis, also fall, as wages rise as a proportion of the capital advanced. Ricardo, writing at a time when capitalist development was more advanced, was not so sanguine in his view of the prospects for the workers. He saw that, in fact, the population expanded, and the supply of workers rose as the needs of capital for them grew. Basing himself on Malthus' fallacious population theory, Ricardo argued that the supply of labour rises as the population expands, and so Smiths anticipation of rising wages due to a shortage of workers does not materialise. However, Ricardo, says, this expansion of the population means that more food must be produced, and more land must be given over to that, and to the production of additional raw materials required by industry. Like Malthus, he says, agricultural productivity cannot rise as fast as population. More land must be then cultivated, and because Ricardo has a theory of diminishing returns on the land, he believes this must result in less fertile land being cultivated. The result is a higher value of food, and other raw materials.
The higher value of raw materials causes the rate of profit in industry to fall. Higher levels of industrial productivity offset the rise in agricultural prices, so that the prices of industrial products continue to fall, including manufactured wage goods. However, the main component of wages is food, and the rise in food prices is greater than the fall in the price of manufactured wage goods. So, the value of labour-power rises, and its for this reason that Ricardo concludes that wages must rise over time, and this rise in wages then causes profits to fall, as the rate of surplus value falls. A lower rate of industrial profit caused by this squeeze on profits from higher wages, and because of the higher price of raw materials, means that the surplus profit in agriculture rises, i.e. relative to this new lower average industrial rate of profit. So rents rise, and this rise in rents is a further cause of a squeeze on profits.
Where Marx's Law of the Tendency for the Rate of Profit to Fall is based upon changes in the technical composition of capital, rising social productivity, a consequent rising rate of surplus value, and increasing mass of profits, the theories put forward by Smith and Ricardo are based upon changes in the value composition of capital, falling social productivity, rising wages and a squeeze on the mass of profits itself. In effect, they relate to different stages of the long wave cycle. The factors identified by Smith and Ricardo, result in a squeeze on profits, which results from an overproduction of capital. The response to this crisis of overproduction is that capital engages in technological innovation, so as to produce new labour-saving technologies, which creates a relative surplus population, which causes wages to fall and mass of profit to rise; it reduces the value of constant capital, which raises the rate of profit. But, by sharply raising productivity, it reduces the share of labour in total output value, thereby creating the basic conditions for the Law of the Tendency for the Rate of Profit to Fall.
Its not that Smith and Ricardo's theories are wrong per se, but that they are wrong as an explanation of the long-term tendency for the rate of profit to fall. They are explanations of short run squeezes on profits that result in crises of overproduction. The explanation of the long-run tendency is the measures that capital introduces to overcome the crisis of overproduction.
Marx explains how Smith's argument can apply.
“We have seen that over 20 years, capital increased sevenfold, whereas, even according to the “most extreme” assumption of Malthus, the population can only double itself every twenty-five years. But let us assume that it doubles itself in twenty years, and therefore the working population as well. Taking one year with another, the interest would have to be 30 per cent—three times greater than it is. If one assumes, however, that the rate of exploitation remained unchanged, in 20 years the doubled population would only be able to produce twice as much labour as it did previously (and [the new generation] would be unfit for work during a considerable part of these 20 years, scarcely during half this period would it be able to work, in spite of the employment of children); it would therefore produce only twice as much surplus labour, but not three times as much.”
(Theories of Surplus Value, Chapter 21)
Marx is dealing with the argument of Hodgskin, here, and for interest read profit. In other words, Marx explains, why, as Hodgskin concludes, the mass of absolute surplus value has a limit to its expansion, because not only is the length of the individual working-day limited, but the length of the social working-day is also limited by the scope for population growth. As Marx says,
“Given the necessary means of production, i.e. , a sufficient accumulation of capital, the creation of surplus-value is only limited by the labouring population if the rate of surplus-value, i.e., the intensity of exploitation, is given; and no other limit but the intensity of exploitation if the labouring population is given.”
(Capital III, Chapter 15)
Once the social working-day cannot be expanded, or can only expand more slowly than the rate of expansion of capital, the mass of surplus value must fall relative to the capital advanced. In other words, the rate of profit on the advanced capital must fall. The more capital is advanced, the more the rate of profit must fall, and eventually, the mass of profit itself would fall, because the increasing demand for labour would cause wages to rise, so that the rate of surplus value would fall. There would be an absolute overproduction of capital.
“There would be absolute over-production of capital as soon as additional capital for purposes of capitalist production = 0. The purpose of capitalist production, however, is self-expansion of capital, i.e., appropriation of surplus-labour, production of surplus-value, of profit. As soon as capital would, therefore, have grown in such a ratio to the labouring population that neither the absolute working-time supplied by this population, nor the relative surplus working-time, could be expanded any further (this last would not be feasible at any rate in the case when the demand for labour were so strong that there were a tendency for wages to rise); at a point, therefore, when the increased capital produced just as much, or even less, surplus-value than it did before its increase, there would be absolute over-production of capital; i.e., the increased capital C + ΔC would produce no more, or even less, profit than capital C before its expansion by ΔC. In both cases there would be a steep and sudden fall in the general rate of profit, but this time due to a change in the composition of capital not caused by the development of the productive forces, but rather by a rise in the money-value of the variable capital (because of increased wages) and the corresponding reduction in the proportion of surplus-labour to necessary labour.”
(Capital III, Chapter 15)
In other words, this is a crisis of overproduction caused by a change in the value composition of capital, rising wages, as described by Smith and Ricardo, and not by a change in the technical composition of capital, which is the basis of Marx's Law of the Tendency for the Rate of Profit to Fall. Smith believes that this process must continue until profits disappear, but if that were the case, it would inevitably result in a permanent crisis. Marx notes,
“A distinction must be 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, Chapter 17, Footnote)
Similarly, as Marx describes, Ricardo's theory can explain short-run transitory squeezes on profits, but does not explain the long-term tendency. Malthus' population theory on which Ricardo based himself is wrong. As Anderson showed, agricultural productivity does not fall, there is no law of diminishing returns. It may be the case that agricultural productivity does not grow as fast as industrial productivity, but it still grows, and this growth results in food prices, and raw material prices falling, not rising. So, the basis of Ricardo's argument that food prices rise, causing wages to rise, and that raw material prices rise, so that the industrial rate of profit falls, is wrong, Marx says.
It may well be the case that, in the short-run, a spike in demand for food and raw material prices causes the prices of these things to rise. When the new long wave uptrend began in 1999, raw material prices spiked much higher. A doubling of the global working class, compared to the 1980's, and corresponding rise in living standards, also caused a sharp rise in demand for food, which caused food prices to rise sharply. The spike in raw material prices was the consequence of new technologies, introduced in the previous period, which meant that, as economic activity picked up, it resulted in a sudden increase in demand for materials. The same higher productivity meant that producers could more easily cope with the price spike, because their end prices were much lower. But, the rise in material prices still results in a lower rate of profit, and the potential for profits to be squeezed, as producers absorb some of the increase in raw material prices, so as to not suffer a fall in demand. 
The rise in food prices results from the increase in the total number of workers, and from the increase in their living standards, as wage workers rather than subsistence peasants. The factors outlined by Ricardo apply, because, in the short-run, supply can only be increased from existing mines, farms and so on, some of which are exhausted. Prices rise not only because demand outstrips supply, but because, to increase supply, workers have to be paid overtime, less fertile land is cultivated, and so on, so short-run marginal costs rise. The market value of the output rises. The result was both rising wages, as well as food riots in a number of countries, as food supplies failed to increase adequately. 
However, this short-run price spike was only ephemeral. Large scale investment in new mines, quarries and farms brought about an increase in supply of food and raw materials. Once the investment in those facilities, as well as in associated infrastructure was in place, the higher level of productivity in these new facilities also brought about a fall in the market value of foodstuffs and raw materials, which caused a sharp fall in their market prices, which was witnessed in 2014. The price of oil which peaked in 2007 at $150 a barrel, fell in 2014 to just £26 a barrel, the price of a litre of milk fell to less than a litre of water, and so on.
The rise in the value composition of capital, as these price spikes occur can lead to disruption and crises, as the rate of profit falls, and the mass of profit is squeeze, because end producers cannot pass on all of the price rise in their end prices.
“It is, in the nature of things that vegetable and animal substances whose growth and production are subject to certain organic laws and bound up with definite natural time periods, cannot be suddenly augmented in the same degree as, for instance, machines and other fixed capital, or coal, ore, etc., whose reproduction can, provided the natural conditions do not change, be rapidly accomplished in an industrially developed country. It is therefore quite possible, and under a developed system of capitalist production even inevitable, that the production and increase of the portion of constant capital consisting of fixed capital, machinery, etc., should considerably outstrip the portion consisting of organic raw materials, so that demand for the latter grows more rapidly than their supply, causing their price to rise. Rising prices actually cause 1) these raw materials to be shipped from greater distances, since the mounting prices suffice to cover greater freight rates; 2) an increase in their production, which circumstance, however, will probably not, for natural reasons, multiply the quantity of products until the following year; 3) the use of various previously unused substitutes and greater utilisation of waste.”
(Capital III, Chapter 6)
Moreover, once a technological revolution has occurred, and new technologies have been introduced, the following period sees these technologies replacing previous machines and fixed capital, and then being rolled out more extensively. As the new uptrend of the long wave gets underway, it is this extensive accumulation that becomes characteristic, using up plentiful supplies of labour. Its eventually, on this basis, that the limits on increasing absolute surplus value begin to be reached. Moreover, any increases in the price of wage goods are then more likely to provoke demands for higher wages to compensate, and which capital is more likely to concede, in order to avoid loss of production, or losing workers to other employers. Its on this basis that rising wages begin to cause a squeeze on profits as described by Glyn and Sutcliffe and others, in relation to the 1960's and 70's.
This is not a consequence of Marx's Law of the Tendency for the Rate of Profit to Fall, but simply of the functioning of the long wave cycle. Whether Marx's law exists or not, it would be the case that, at such points of the cycle, existing supplies of labour would begin to be used up, and used up more quickly the more productivity growth slows. It would mean that the growth of absolute surplus value would hit its limits, as the expansion of the social working-day, slows down or stops. That would mean that capital is inevitably overproduced, as additional capital brings forward no additional absolute surplus value. But, the same fact, as Marx describes in Capital III, Chapter 15, means that this shortage of labour would cause wages to rise, so that the rate of surplus value is also, thereby reduced, squeezing profits. It brings about a crisis of overproduction of capital. Its in relation to that that capital engages in a new round of technological innovation. Only on that basis does it create new labour-saving technologies that create a relative surplus population, which causes wages, and the value of labour-power to fall. That is why such crises of overproduction have a cyclical nature.
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