Marx’s law of the tendency of the rate of profit to fall

Marx’s law of the tendency of the rate of profit to fall is therefore at the center of Kliman’s analysis. This would explain why before he wrote the current book he devoted a separate volume to refuting the “neo-Ricardian” claim that Marx’s law of the tendency of the rate of profit to fall was invalid. Kliman’s current book on crises can therefore be seen as Volume II of a single work.

Let’s briefly review Marx’s law of the tendency of the rate of profit to fall. Marx called it the most important law of political economy. In Volume III of “Capital,” Marx showed that assuming the rate of surplus value—the ratio between paid and unpaid labor—remains unchanged, the rate of profit will fall as the organic composition of capital rises. Marx assumed that workers work half of the work day for themselves—reproducing the value of their labor power—and the other half free of charge producing surplus value for the capitalists.

Marx showed that a rate of surplus value of 100 percent can express itself in many different rates of profit depending on what Marx called the organic composition of capital. The organic composition of capital is the ratio of what Marx called constant capital, which includes all the productive capital except for the purchased labor power of the workers. The purchased labor power of the workers is the variable capital that actually produces the surplus value.

Marx made several assumptions for reasons of simplification—not because he believed that this was true in reality: that all commodities find buyers (there are no realization problems), the rate of turnover of (variable) capital is fixed, and all commodities sell at their prices of production. The sum total of the prices of production is assumed to be identical to the sum total of their direct prices. The rate of profit measured in terms of value—or what comes to exactly the same thing, in terms of embodied abstract human labor—is assumed to be identical to the rate of profit in terms of prices of production.

Marx demonstrated that assuming the ratio of constant capital to the variable capital rises—every other variable remaining unchanged—the rate of profit will decline. Marx then explored various forces that counteract the fall in the rate of profit. The most important of these are a rise in the rate of surplus value and the cheapening of the elements of constant capital—auxiliary and raw materials plus fixed capital such as buildings and machines. These and other offsetting factors transform the law of the falling rate of profit into the law of the tendency of the rate of profit to fall.

However, the lowering of the value of constant capital due to a fall in the labor value of the constant capital—called moral depreciation by Marx—is a double-edged sword. To the extent that the constant capital experiences a moral depreciation, a portion of the value of the constant capital will not be transferred to the final commodity product but is destroyed. These losses must be taken into account when calculating the actual rate of profit.

Marx separated these contradictory effects by assuming that after the organic composition has risen, it then stops rising. He shows that once the organic composition has risen and all the transitional effectsbrought on by the moral depreciation of capital have been fully absorbed—assuming that the rate of surplus value is still 100 percent—the rate of profit will be lower than before. It is important to realize that Marx is assuming a constant rate of surplus value—or value of the commodity labor power—and not a constant real wage like the authors of the neo-Ricardian Okishio’s theorem do.

The naive falling rate of profit crisis theory

The most naive form of the falling rate of profit crisis theory is that the rate of profit progressively falls within each industrial cycle as the organic composition of capital rises until the rate of profit has fallen so low that the capitalists cut back their rate of investment, since the low rate of profit no longer justifies the risk and bother of investing in new factories and equipment and hiring more workers. The period leading up to a crisis, according to the supporters of the naive falling rate of profit school, is therefore not a period of the overproduction of commodities but rather a period of falling rates of profit.

Eventually, as the rate of profit keeps falling, there are fewer fields of investment that yield the minimum rate of profit that the capitalists are willing to accept. Hence, there is an overaccumlation of capital relative to the fields of available investment that yield the minimal acceptable rate of profit. Once investment starts to fall, an overproduction of commodities does appear, but according to the naive falling rate of profit school this overproduction of commodities is the result, not the cause, of the crisis.

Kliman does not hold to the naive version of the theory. He notes that the rate of profit actually rose just before the crisis of 2007-09 broke out, for example, something it should not have done according to the naive falling rate of profit theory. What Kliman believes happens is that as the rate of profit falls within a particular industrial cycle, the economy becomes more vulnerable to crisis. More and more businesses are operating at the edge, making barely enough profit to survive. These growing difficulties are papered over by the growing inflation of credit.

But the inflation of credit can only go so far. Eventually, the bubble bursts and the crisis is on. The immediate cause of the crisis, therefore, is a crisis in the credit system. Of course, the chain of payments, like any chain, will break at its weakest link. In the crisis of 2007-09, the weakest link was in the area of residential mortgage credit.

But according to Kliman, the crisis of the credit system was not the real cause of the crisis, nor was the overproduction of commodities the real cause. The real cause of the crisis was the relentless fall in the rate of profit brought on by the rise in the organic composition of capital during the preceding boom.

This, by the way, if I understand him correctly, is why Kliman does not believe the rate of profit has actually fallen over the history of capitalism. If it had, capitalism, according to his logic, would have never fully recovered from its very first crisis. If we apply Kliman’s falling rate of profit theory to the first modern capitalist crisis—the crisis of 1825—in the period preceding that crisis, the rate of profit was already so low that capitalism could barely function.

As a result, in 1825 all it took were some problems involving gold drains and the credit system to trigger capitalism’s first modern economic crisis. If the rate of profit had drifted even lower in the coming decades, capitalism would have effectively been crippled. But as Kliman demonstrates, capitalism continued to develop with great vigor—despite its periodic crises—in the years after 1825, only showing signs of getting bogged down from the 1970s onward. Therefore, Kliman quite logically draws the conclusion that there is no actual lasting downward movement of the rate of profit—at least before the 1970s.