The Law of the Tendency for the Rate of Profit to Fall – Summary

• Marx's Law of the Tendency for the Rate of Profit to Fall differs from that of his predecessors, such as Smith and Ricardo. The latter's laws depend on changes in the value composition of capital, Marx's law on changes in the technical composition, and thereby organic composition of capital.
• Marx's law says that the rate of profit falls when the organic composition of capital rises, or when the rate of turnover of capital falls.
• The rate of profit falls when the organic composition of capital rises, because it is only labour that creates surplus value, so that if labour constitutes a smaller component of output value, then, assuming no change in the rate of surplus value, the proportion of surplus value in output value will also fall, whilst the proportion of output value constituting raw material will rise.
• The basic formula presented by Marx for the rate of profit is s/(c + v). Surplus value, s, divided by the value of constant capital (wear and tear of fixed capital plus raw materials) plus the value of variable-capital (wages). If output value is taken as 100, with c = 50, v 25 and s 25, the rate of profit is 33.3%; if as a result of a change in the technical composition, and thereby organic composition of capital, this becomes c = 60, v = 20 and s = 20, the rate of profit falls to 25%.
• The laws developed by Smith and Ricardo rested upon changes in the value composition of capital, and, particularly, a fall in the rate of surplus value causing the mass of surplus value itself to fall. Marx shows that, with his law, no such fall in the mass of profit is required. In fact, he shows that, because the rise in the organic composition is a function of an increased accumulation of capital, the mass of profit itself also rises. So, if we replace the above percentages with actual numbers, we might have initially, £50 c, £25 v and £25 s, giving 33.3% rate of profit, whilst this may rise to £120 c, £40 v and £40 s, giving a 25% rate of profit, even though the mass of profit rises from £25 to £40.
• Adam Smith correctly identified that value is labour, and so surplus value is surplus labour. He recognised that the value of all commodities, therefore, includes this surplus value. He could not explain, however, why then labour does not obtain the full value it produces, including this surplus value, when it exchanges with capital. He concluded that its because labour is plentiful, and capital is scarce, so that labour is sold below its value, and capital above its value. His law of falling profits is based upon the idea that capital accumulates faster than labour supply, so that eventually wages rise, and profits fall until they disappear.
• Ricardo was not so sanguine in relation to the workers' fate. He argued that the labour supply rises to meet the needs of capital. However, in doing so, it increases demand for food and raw materials. Because, he accepted Malthus' fallacious population theory, he believed agricultural production could not keep pace with population growth. On the basis of his theory of diminishing returns, he argued that  increasingly less fertile land has to be cultivated, causing food prices to rise, which, in turn, causes wages to rise, and so profits to be squeezed. That also causes surplus agricultural profits to rise, so that rents rise, and this rise in rents also squeezes profits. So, both Smith and Ricardo's laws of falling profits are based on a squeeze on profits, and falling social productivity. This is the opposite of Marx's law.
• Marx explains that the laws set out by Smith and Ricardo explain short-run squeezes on profits, which are the cause of crises of overproduction, but they do not explain the long-run law of the tendency for the rate of profit to fall. Capital responds to Smith's labour supply shortage, by introducing new technologies that create a relative surplus population, which then causes wages to fall, and profits to rise. He explains that Ricardo's law of diminishing returns is also only true, at best, in the short run, and that rising social productivity causes food and raw material prices to fall, so that rather than rising, wages fall – even as living standards rise – and profits rise. Instead of the rate of surplus value falling, it rises, and because more capital and labour is employed, the mass of profit also rises.
• It is this rise in social productivity, caused by technological development, prompted by labour shortages, which cause crises of overproduction, which is the basis of Marx's Law of the Tendency for the Rate of Profit to Fall. Marx's law is a consequence of crises of overproduction, and the means by which they are resolved, not a cause of such crises. It means that, unlike the laws of Smith and Ricardo, it is based upon rising productivity not falling productivity, on a rising rate of surplus value, not a falling rate of surplus value, on a rising mass of profits not a squeeze on profits.
• The Crisis of Overproduction of Capital, causes capital to engage in a technological revolution to introduce new labour-saving technologies, so that wages fall, and profits rise, by creating a relative surplus population. This new fixed capital is part of an overall increase in capital accumulation, including the employment of additional labour. The relative surplus population arises not from decreasing the amount of labour employed, but by expanding capital accumulation, and output faster than the demand for labour. The demand for labour rises more slowly than the labour supply/social working-day. More labour is employed absolutely, but less labour is employed relatively.
• The rise in productivity is manifest in the fact that a given mass of labour now processes a greater mass of raw material than previously. This is why the proportion of labour in output value falls, whilst the proportion of raw material in output value rises. It is this which is the basis of Marx's law.
• Moreover, as Marx sets out in Capital III, Chapter 6, although the total mass of fixed capital increases, the value of this fixed capital does not rise proportionately. One new machine replaces several older machines, but its value is less than the value of the machines it replaces. The new machine processes the same quantity of material as all of the old machines it replaces, or more, and its (lower) value is spread across all of this output, so the amount of wear and tear, as a proportion of the output value, also falls, as with labour. The other consequence is that the unit value of output falls e.g. the price of yarn per kg falls, which encourages additional demand for yarn, and so an expansion of the market. This is why the total capital increases, as the market expands. It is also manifest in the creation of new industries, in which the additional mass of profits, and capital released from other spheres, is invested. These new spheres are higher profit industries, and in spheres that grow more quickly. This is also the foundation for the new long wave upswing.
• The rise in social productivity, causes the value of all wage goods, including food, to fall, contrary to Ricardo's expectation. That causes the rate of surplus value to rise. With the mass of labour employed increased, and the rate of surplus value higher, this brings about a rise in the mass of surplus value. Marx's law depends on this increase being proportionately less than the increase in the total value of raw material processed by that labour.
• In Theories of Surplus Value, Chapter 23, Marx sets out why higher social productivity also causes the unit value of raw materials to fall. However, he says that they do not fall immediately – because, for example, crops require a year to grow before harvesting – and their unit value does not fall as fast as the unit value of fixed capital, and other manufactured commodities. So, the increase in the mass of raw material processed results still in the value of raw materials, as a proportion of total output value, rising, which is the basis of his law of the tendency for the rate of profit to fall.
• However, in Chapter 23, Marx says of this tendency, that it is “far smaller than it is said to be.” And, he concludes that although the fall in the unit value of raw materials does not compensate for the increase in its mass, “The cheapening of raw materials, and of auxiliary materials; etc., checks but does not cancel the growth in the value of this part of capital. It checks it to the degree that it brings about a fall in profit.”
• The reason for this is that there are other “countervailing factors” that also flow from the rise in social productivity that creates the tendency for the rate of profit to fall. The rise in productivity reduces the value of fixed capital, which reduces the value of wear and tear as a proportion of output value; it also reduces the value of wage goods, which increases the rate of surplus value.
• But, Marx's definition of the rate of profit itself evolves from this initial basic definition, which is really a definition of the profit margin, and assumes that the capital turns over only once in a year.
• The other determinant of the rate of profit – actually the annual rate of profit as Marx later defines it – is the rate of turnover of capital. For any given organic composition of capital, the rate of profit is higher, the faster the capital turns over. That is because, as Marx sets out in Capital II, a higher rate of turnover means that the annual rate of surplus value rises. If the rate of surplus value is 100%, a variable-capital of £100 produces £100 of surplus value, if the capital turns over once in a year. But, if the capital turns over ten times, £100 of variable-capital produces £1,000 of surplus value, so that the annual rate of surplus value is 1,000%.
• The higher the rate of turnover, the higher the annual rate of surplus value, and so also the higher the annual rate of profit. The same factors that cause a rise in social productivity that are the basis of the Law of the Tendency for the Rate of Profit to Fall, also cause a rise in the rate of turnover of capital, both by shortening the production time, and the circulation time. They thereby bring about a rise in the annual rate of profit.
• It is the annual rate of profit that is the determinant of the average annual rate of profit, which determines prices of production. Price of production is cost of production (c + v) plus average profit.
• The rate of profit/profit margin is calculated as s/(c + v), but the annual rate of profit is calculated as the annual profit divided by the total capital advanced for one turnover, or s/C. In the first calculation, only the value of wear and tear of fixed capital is included, but in the second, the full value of fixed capital is taken into account.
  • Rate of Profit/Profit Margin with £10,000 fixed capital depreciating at 10% p.a., £10,000 raw material, £5,000 wages, £4,000 profit = 25%.
  • Annual Rate of Profit
    • Assuming circulating capital turns over once = 16%
    • Assuming capital turns over ten times, so profit equals £40,000 = 160%.
  • For any given average annual rate of profit, the rate of profit/profit margin will fall, as the rate of turnover rises. For example, if the average annual rate of profit is 100%, on the above basis, the average profit is £25,000.
    • If the capital turns over 10 times a year, the cost of production is £1,000 wear and tear, £100,000 raw materials, £50,000 materials = 16.6%.
    • If the capital turns over 20 times, it is £1,000 wear and tear, £200,000 materials £100,000 wages = 8.3%.
    • But, the annual rate of profit would remain 100%.
• The fact that new technologies create new industries, where capital released from older sectors, plus the increased mass of surplus value can be invested, also acts to raise the average rate of profit. These new industries have lower than average organic compositions, so that initially, their annual rate of profit is higher than average. This higher figure draws up the average rate of profit. Given that these new industries grow more rapidly, and so form an increasing component of the total social capital, the more they pull the average rate of profit upwards.
• Marx's arguments about why organic raw material values could not be reduced in the same proportions as manufactured commodities, proved wrong. Large scale capital investment in agriculture and in mineral extraction, along with technological developments to reduce waste, and utilise materials more effectively, as well as to produce cheap synthetic materials, massively reduced the prices of primary products.
• More significantly, Marx's law, which depends on this increasing mass of raw materials as a proportion of output value, is only relevant in economies where manufacturing forms the majority of output value. In modern economies, manufacturing accounts for less than 20% of new value and surplus value production. Around 80% of new value and surplus value production is in service industry, where this processing of raw materials plays little or no part. It uses materials only as auxiliary materials, whose consumption does not rise in proportion to output value. Consequently, the basis of Marx's law no longer applies to the majority of the modern economy.
• The law still applies in the major role that Marx described for it. That is that it remains the basis for the calculation of average profits, and thereby for the calculation of prices of production. It continues, thereby, to be the basis for the allocation of capital across the economy.