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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.
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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.
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