The underlying reality is shown by the circuit of industrial capital set out by Marx in Capital II.
This shows that the circuit begins with a quantity of use values that constitute the productive-capital. These commodities are composed of means of production (constant capital), and means of consumption (variable-capital). These use values must be the starting point, as Marx describes, because without them, production cannot even commence, and nor could workers consume the commodities required for their subsistence. The consequence of this production process is that a whole new load of use values are created. Some of these use values are required to replace, on a like for like basis, the means of production, consumed in production, whilst others go to replace the means of consumption that have been consumed by workers as wages, as well as consumed by capitalists and other exploiters.
Because the use values that go into the production process are not the same as the use values that come out of the production process – for example, cotton, machinery and labour-power go into the production process, but yarn comes out of it – the only way to measure the extent to which the productive-capital has expanded, is to reduce these inputs and outputs to their values, expressed as their money equivalent. Again, this requires that this measurement is done on the basis of current reproduction costs not historic prices, otherwise changes in values would distort the reality, causing capital gains to be confused with profits, and vice versa, not to mention the distorting effects of changes in the value of money, i.e. inflation or deflation.
On this basis, the expansion of capital is equal to the surplus value created by labour in the production process. Even if values change, as a result of changes in social productivity, this method enables us to see the actual expansion of capital. The M at the end of the process is only the transmuted value of the productive-capital that went into it. It is the value required to reproduce this productive-capital, on a like for like basis, as described by Marx in Capital III, Chapter 49. The total value of the output M` is equal to M plus m, where m is equal to the money equivalent of the expansion of the capital, the surplus value created by labour. In conditions of simple reproduction, M, therefore, replaces all of the physical use values that comprised the productive-capital consumed in production, whilst m, represents the additional use values that constitute the means of consumption, of the exploiters, and replace those they consumed during the year, for their own reproduction.
This same reality can be seen in Marx's schema of reproduction, in Capital II, Chapter 20. Here, the concept described earlier of treating Department I as one single producer, so as to see the reality, more clearly, is also used in relation to Department II.
Department I
c 4000 + v 1000 + s 1000 = 6,000
Department II
c 2,000 + v 500 + s 500 = 3,000
So, here, Department I begins the year already with constant capital of 4,000 in the shape of materials. The assumption, here, is that capital turns over once a year. In reality, part of this 4,000 also comprises wear and tear of fixed capital, which turns over at the same rate, as the circulating capital, because it is included in the value of output, and is returned along with it. There must also exist consumption goods required by workers and capitalists, before the year's production can commence, because they cannot live on thin air, waiting for the year's production to be completed.
If we look at Department I, then, the value of its output for the year is 6,000, and this is comprised of 4000 of constant capital transferred directly to output, and 2000 of new value created by labour in processing this constant capital. This new value of 2000 is divided 1,000 to workers, and 1,000 to capitalists. The workers take the 1,000 of wages paid to them, and buy consumption goods from the aforementioned social stock of such commodities. The capitalists use 1000 of money in their hands to buy the consumption goods they require, from Department II capitalists, again from this social stock of consumer goods. When Department I sells means of production to Department II, it gets back, in the value of those goods, both the 1,000 it has paid to its workers in wages, and which those workers have paid to Department II capitalists, along with the 1,000 of its own money that it threw into circulation to buy consumer goods from Department II.
But, when we look at what Department I sells to Department II, it is only a small portion of its total output. Where there is simple reproduction, it only sells means of production to Department II to an amount equal to this new value created by Department I workers, i.e. 2,000. The total value of Department I output is 6,000, but it only sells 2,000 of this output. The other 4,000 it takes directly out of its own production to replace directly, on a like for like basis, the physical means of production it consumed itself in the production process. It thereby, starts the next year again with this stock of means of production, ready to produce again. This 4000, therefore, constitutes a revenue for no one, nor does it form any part of final consumption.
It is bought out of capital not revenue, and it is consumed again productively not personally. It forms a part of Expenditure, only if Expenditure is recognised to occur out of capital as well as out of revenue, which the orthodox interpretation cannot do, because it would directly conflict with Smith's “absurd dogma” that the value of output resolves entirely into revenues. But, it is also clear that this expenditure is not the net investment, out of revenues that Keynes introduces into the analysis either. That represents not this simple replacement of the existing means of production, but only additional accumulation of means of production. Here, there is no accumulation.
The 2000 of means of production that Department I sells to Department II, is what appears in the GDP data as “intermediate production”. For Department II, it certainly appears as constant capital, and physically it is, but it is clear from Marx's explanation, here, that, in value terms, it comprises not one penny of constant capital. So, believing that this “intermediate production” constitutes the c in c + v + s, in relation to the national output, is entirely fallacious, as Marx describes. This “intermediate production” is equal only to Department I revenues, i.e. to the new value created by Department I workers. In Capital II, and in Theories of Surplus Value, Chapter 3, Marx illustrates this fallacy by showing what happens where vertical integration occurs.
Suppose we take the case of bread again. We can leave out other constant capital. If the farmer adds £100 in value from labour, they sell grain to the miller for £100. For the miller this grain is constant capital. They add £100 by their own labour, and so sell £200 of flour to the baker. This flour for them is constant capital, and they add £100 by their own labour, creating bread with a value of £300. But, now, assume the farmer also turns the grain into flour, and then bakes it into bread. Now, they do not sell grain to themselves as miller, nor do they sell flour to themselves as baker. All of the value of the bread is seen to be simply the result of their labour.
Indeed, its this idea that what is constant capital for one is simply revenue for another is precisely what led Adam Smith into his error, and formulation of his “absurd dogma”, because, as seen earlier, what is missing, here, is the fact that the farmer did not produce the grain from thin air, just with their labour, but also required seed to begin with, i.e. constant capital. The value of the bread is equal to revenues, with no element of constant capital, comprising its value, and it can be consumed entirely out of revenues. But, it does not constitute the total value of output, because that includes the value of the seed used by the farmer to produce the grain, only a portion of which is used to turn into flour, and then into bread, the other portion having been taken out directly to replace the consumed seed.
If we look at Department II, it again begins the year with a quantity of productive-capital. It cannot wait until the end of the year, for Department I to sell it means of production, nor can its workers live on air during the year. So, likewise, it begins with 2000 of constant capital, and there must exist a further stock of consumer goods to the value of 1,000 to cover the wages of its workers, and the consumption of Department II capitalists. The value of its output is 3000, comprised of 2,000 of constant capital whose value is transmuted directly to final output, and 1,000 of new value created by Department II workers, which is divided into 500 wages and 500 surplus value.
In this economy, therefore, the total output value is 6000 in Department I, and 3000 in Department II = 9,000. Yet, if we were to look at the GDP figure for this economy, it would show a figure of only 3,000 the value of final output, as produced by Department II, i.e. as Marx says, only the value of the consumption fund. This value of 3000 complies with all of the requirements of Smith's absurd dogma that the value of output resolves into revenues, and with Say's Law, therefore, that supply creates its own demand, the incomes generated by that final output, including the incomes generated in the production of “intermediate production” are exactly equal to, and so able to create the required expenditure needed to consume all of that final output.
Yet, it is clearly a fiction, for the simple reason that the actual value of national output here is 9,000 not 3,000. The 3,000 of final output can certainly be bought by the 3,000 of incomes generated. On this basis National Income equals National Expenditure, equals the value of National Output, or GDP. And, yet, the truth is, here, that this figure for national output only represents a third of the actual value of national output. Nor is this a matter of using some different metric such as Gross Output, which adds up the value of output at each stage, rather than just the added value. That amounts to simply double counting the intermediate production. The answer is that the difference is bought out of capital not revenue.
If we start with Department I, then the 4,000 of its constant capital consumed in production, produces a revenue for no one. It cannot be bought out of revenue, but is instead bought out capital. In other words, Department I replaces its consumed constant capital directly out of its own production, in the same way that a farmer replaces their seed, or a coal miner replaces their consumed coal. If we take, Department II, it does not replace the 2,000 of consumed constant capital out of its revenues, which amount only to 1,000, but again out of capital. The value of its output is 3,000, and of this 2,000 is the transmuted value of the constant capital it consumed in production. Its revenues are only 1,000, and these buy 1,000 of its output, equal to the new vale added in Department II. The other 2,000 comprises the value of the constant capital, and it recovers this by exchanging this other 2,000 of its output with Department I that requires these means of consumption.
Looking at the economy as a whole, then, as Marx describes, it divides into two parts capital and revenue. In this economy the total value of output is 9,000. But, total revenues, National Income/Expenditure/GDP is only 3,000. The other 6,000 is capital. Of this 4,000 is capital spending in Department I, and 2,000 in Department II. But, this is not net capital investment, i.e. capital accumulation. It is only the direct replacement of consumed means of production out of capital.
If we wanted to also take into consideration net capital investment, then we would have to consider what occurs with expanded reproduction.
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