A Marxist Guide to Capitalist Crises
“A Marxist Guide to Capitalist Crises,” an eBook created from the key posts on the Critique of Crisis Theory blog, is currently in production. We’ll be sharing the completed chapters between our regular postings.
Chapter 17: Ricardo and Marx vs. Keynes
Ricardo, unlike Adam Smith, attempted to use the law of labor value consistently. He sensed that this law applied not only to simple commodity production but also to capitalism proper. Ricardo was only partially successful in this, but he was on the right track. He realized that price is a relationship between the commodities whose price is being measured and the money commodity — gold — in which the commodity’s price is reckoned.
According to the Ricardian law of labor value, market prices tend to fluctuate around an axis determined by the relative values of gold and the commodity whose value gold measures. Ricardo realized that a rise or fall in wages would affect the rate of profit but not the overall prices of commodities.
Marx developed Ricardo’s law of labor value further, resolving the contradictions that Ricardo himself was unable to overcome. However, even the Ricardian version of the law of labor value is quite sufficient to refute Keynes’ claim that wages determine prices.
As for Marx, he demonstrated in the first three chapters of Volume I of “Capital” that price must always be measured in terms of the use value of the commodity that serves as the universal equivalent. Assuming gold is the money commodity, exchange value, or what comes to the same thing, price, is always a specific quantity of gold measured in terms of weight.
Value, unlike exchange value, is not mediated by a physical substance such as gold but is a purely social substance — abstract human labor. While gold as a material use value is measured in terms of weight, abstract human labor, though it is a social substance, not a physical substance, also has to be measured in some unit of time.
Unlike Ricardo, Marx, in his mature writings from 1857 onward, made the distinction between labor and labor power. Since labor in the abstract is the very substance of value, labor cannot have value. Labor, therefore, cannot itself be a commodity.
What is a commodity is the worker’s ability to work — that is, labor power. The workers must sell their labor power to the industrial capitalist. When the industrial capitalist buys the labor power from the workers themselves, the capitalist comes into possession of the workers’ ability to work. The industrial capitalist, the boss, then orders the workers to perform work to produce a product that will take the form of a commodity. The workers’ direct labor embodied in the commodity plus the labor embodied in the constant capital used up during the production of the commodity — called indirect labor — is the value of that commodity.
The labor embodied in the commodity produced by the workers is, in turn, divided into two parts. One part, the necessary labor, replaces the value of the worker’s wages. The other part, surplus labor, which under capitalist production takes the form of surplus value, is the labor that workers perform without payment for the capitalists, landowners, and other eaters of surplus value. The industrial capitalists do not get to keep all the surplus value produced by the workers. They are obliged to share it with money capitalists, landowners, the state, and other hangers-on.
The value of labor power
Though labor is not a commodity, labor power is. Like all commodities, it has both a value and an exchange value. The commodity labor power’s price, or the exchange value, is a wage. A wage is a sum of money representing a certain weight of gold that industrial capitalists must use to purchase a certain quantity of labor power measured in some unit of time.
As a use value, labor power is measured in terms of time. The fact that the unit of measure of both labor and labor power is time leads to the common error of equating the two. This confusion creates the illusion that all the work performed by the worker is paid.
With the marginalist economists, including Keynes, this confusion is formalized mathematically by declaring it to be a postulate, a statement that does not have to be proved.
Determination of the value of labor power
In order to work, workers must first live and then produce the next generation of workers. Under the capitalist system, workers must consume the commodities they purchase with the money they receive in exchange for their labor power. As workers consume these commodities, they transfer the value — the amount of abstract human labor needed to produce these commodities under the average prevailing conditions of production — to their own labor power, as well as the developing labor power of their children.
Therefore, the value of the worker’s labor power consists of the value of the commodities that the workers must consume to reproduce their labor power daily, as well as produce the next generation of workers. The value of labor power can change for two reasons. The first reason is a change in the productivity of labor in the industry that produces “wage goods” that the workers must consume to reproduce their labor power and raise the next generation of workers. The second factor is a change in the quantity and quality of use values the workers consume.
What determines the quantity and quality of these commodities in terms of use values that workers consume to reproduce their labor power? Marx explained that the wage consists of two elements. One is the biological minimum. The biological minimum, in turn, consists of two sub-elements. The first sub-element is the wage portion needed to reproduce the worker’s labor power daily. The second sub-element is the wage portion necessary to reproduce the next generation of workers.
If the wage fell below the level necessary to reproduce the workers’ labor power daily, capitalist production would collapse within days or weeks as the working class starved to death. If the wages were to fall below the level necessary for the workers to produce and raise a new generation of workers, capitalist production would collapse within a decade or so, as there would be no replacements for the workers that would be dying off. The biologically determined minimum sets the limit below which wages can never fall, at least not for very long.
The other element of the wage is the social element. Over generations of class struggle, the workers have managed to add to the biological element an additional element beyond it. This additional element allows the workers, as Marx put it, to participate to some extent in the progress of civilization.
For example, workers do not need radios, TVs, cell phones, personal computers, and so on to live and reproduce their labor power. The apologists for capitalism like to point out that in the past, even the wealthiest people had to go without these and many other commodities that, at least in the imperialist countries, we take for granted today. They then conclude that today, the workers live better than the wealthy did just a few generations ago. Many of these new commodities, such as cell phones, have become necessities within a remarkably short period.
Wages and trade unions
The struggle of the labor unions revolves around this extra wage that is added to the bare biological minimum wage. The capitalists are always pushing wages downward toward the biological minimum. Indeed, in the oppressed capitalist countries, wages are often very close to the biological minimum. On the other hand, labor unions try to defend and, under favorable conditions, increase the extra portion of the wage added to the biologically determined minimum wage.
Wages and prices
Now, what do changes in the level of wages have to do with the prices of commodities? In the last chapter, we saw that Keynes claimed that a rise in money wages would lead to a rise in prices. However, changes in the level of money wages, or real wages for that matter, have only very modest effects on prices. Assuming all else is equal, Keynesian economists notwithstanding, a rise in money wages will not affect the overall cost of living.
Instead, what is affected is the rate of surplus value, or what comes to the same thing, the ratio of unpaid to paid labor. As Ricardo explained, a wage rise will not raise prices but will lower the profit rate. The capitalists and their spokespeople among the professional economists and the mass media oppose wage increases not because they are inflationary but because they lower the rate of the capitalists’ profits.
The total mass of commodities that serve as articles of personal consumption can be divided into two parts, necessaries and luxuries. Necessaries are consumed by both the working class and the capitalist class. For example, whether you are Bill Gates or a worker in a Los Angeles garment factory, you still have to eat, wear clothes, and so on. Luxuries are consumed only by members of the capitalist class. For example, Gulfstream personal jets are purchased and used as items of personal consumption only by the capitalists, indeed only by members of the wealthiest section of the capitalist class, the 1 percent.
However, what commodities consist of necessities or luxuries is not set in stone and can change over time. Here, the struggle of the labor unions under favorable conditions can have a considerable impact. For example, automobiles were luxuries in the first years of the 20th century. If we go back a few years, before the turn of the 20th century, the automobile did not exist. The closest thing was a horse-drawn carriage. However, starting with the introduction of mass production of automobiles during the 1920s, the value and, consequently, the price of automobiles fell considerably. Indeed, they fell so much in value and price that the better-paid workers in the United States could afford to purchase them.
Today, in imperialist countries, automobiles are not luxuries but necessities. Especially in the United States, with its poor public transportation system, many workers would not be able to commute to their workplaces and, therefore, would be unable to sell their labor power without owning an automobile. In most of the world, however, automobiles are still beyond the means of the workers. In these countries, the automobile remains very much a luxury. What commodities represent luxuries and what commodities represent necessaries varies over both time and place.
Suppose in a given country at a given time, the labor unions are strong enough to achieve a general rise in money wages. Then, according to Keynes, this would lead to a rise in marginal prime costs, leading to a general rise in prices. But what, in fact, would happen?
A rise in money wages will increase the purchasing power of the working class. But the rise in the purchasing power of the workers will be offset by a fall in the purchasing power of the capitalists. This is why the capitalists are so bitterly opposed to any proposals to increase money wages. The rising purchasing power of the workers will increase demand for consumer necessities like food, clothing, cell phones, and TVs. Certain articles that were considered luxuries in the past might even enter into the consumption of the working class, allowing the working class to take part in “the progress of civilization.”
Even if that happens, it is safe to say that there will be no increase in the demand for personal Gulfstream jets. Instead, higher wages will mean that the demand for Gulfstreams will fall since the capitalist class will have less purchasing power than before. But won’t the rise in the purchasing power of the working class drive up the prices of the necessities that enter into the consumption of the working class? That might happen. Perhaps the prices of food, essential medicines, and other necessities would rise.
But as economists have understood since Adam Smith’s days, the profit rate in different industries tends to equalize. Capital, in its constant search for the highest profit possible, flows from sectors where the rate of profit is below average to sectors where the rate of profit is above average.
Immediately after the rise in wages, the rate of profit in the industries that produce necessities will be above the now lower average rate of profit, while those industries that produce luxuries, such as Gulfstreams, will find that their rate of profit is now below the new lower average rate of profit. The rate of profit will fall in all branches of industry, but it will fall much more in industries that produce commodities such as Gulfstreams than in the food and basic clothing industries, for example.
Capital will therefore start to flow out of industries that produce commodities consumed by the capitalists into industries that produce commodities for the workers. As this process unfolds, prices of necessities will fall while the prices of commodities such as Gulfstreams will rise. Soon, the rate of profit will be more or less equal once again. However, the new average rate of profit will be lower than before the rise in wages.
Second, more of the total labor time of society will be devoted than before to producing commodities for the workers and less to producing commodities such as Gulfstreams for the capitalists. There will be a greater chance that a given group of workers will be producing commodities for their fellow workers and less chance that these workers will be producing commodities for their capitalist exploiters.
This does not mean that prices will be the same as before. This is because commodities tend to sell at prices that do not exactly express their values but rather at prices that equalize the rate of profit among the various branches of industry, called by Marx prices of production. In more labor-intensive branches of production, or, to use Marxist terminology, in those branches of industry that have a lower than average organic composition of capital, prices will rise as wages rise and fall as wages fall because these branches of industry spend more on their “labor costs” than the average for industry as a whole.
Conversely, industries with a higher than average organic composition of capital, what the economists call “capital-intensive industries,” are less affected by a rise in wages. Immediately after a rise in wages, the rate of profit in industries with an above-average organic composition of capital, though they will suffer some decline in their profit rates, will now exceed the now lower average rate of profit in industry as a whole. Capital will flow into these industries from the “labor-intensive” industries. Therefore, the prices of commodities produced by these industries, in direct contradiction to the claims of Keynes, will fall as wages rise. This effect is one of Ricardo’s great economic discoveries.
Here, I should make a few qualifications. First, I assume that the rise and fall in money wages are “across the board.” If the workers win a rise in wages in just one industry that fails to inspire a rise in wages in other industries, this may cause a price rise for the commodity produced by that particular industry. This is because profits will fall in the face of rising “labor costs” in that industry, causing the industry’s rate of profit to fall below the average for industry as a whole.
All other things remaining equal, a wage rise will cause an outflow of capital from that industry. Even in this case, however, the rise in prices in one industry would lead to a slight fall in the prices of commodities produced in all other industries as capital flows out of the industry that has experienced a rise in wages into all the other industries that have not. So, in this case, too, there would be no general rise in prices.
The same is true on an international scale. It is well known that wages in Asia, excluding Japan, are a tiny fraction of wages in the United States, Western Europe, and Japan. That is why we have seen a flow of capital out of industries in the United States and Western Europe toward Asia in recent years. Industry had developed at a feverish rate in many Asian countries, while there was little expansion of industrial production in the United States and Western Europe. Indeed, in these countries, that trend for a generation now has been toward “de-industrialization.”
These extreme differences in wages, which were unknown in the days of Marx, allowed the industrial capitalists operating in Asia to charge considerably lower prices and still realize the overall global average rate of profit.
However, these lower prices are offset by a rise in the prices of commodities still produced in the United States, Western Europe, and Japan by industries with a very high organic composition of capital. So again, the general price level remains unaffected when looking at the world market.
The only way that the general price level could be affected by changes in wages would be if such a change affects the “price” of the commodity that serves as money. As I have explained in earlier chapters, the “price” of the money commodity is simply all price lists read backward.
For example, if the wages were to rise in all countries and the average organic composition of capital in the gold mining and refining industry was lower than the global industrial average, the “price” of the money commodity — price lists read backward — would rise. Or, what comes to the same thing, a rise in wages in the gold industry would lower the general global price level, assuming that the gold values of the currencies remain unchanged.
How apartheid helped the ‘free world’ win the Cold War
While we are on this subject, we should examine the effect of artificially low wages in the gold mining industry after World War II on global commodity prices. Under the prevailing Bretton Woods international monetary system — which collapsed between 1968 and 1971 — currencies, unlike today, were still more or less stable against gold. South Africa, which in those days was ruled by the ultra-racist regime of apartheid, was the world’s largest gold producer.
Under apartheid, normal labor union activity was impossible for the African workers who mined and refined the gold. Assuming that gold was selling at its “price” of production, this would mean that the rate of profit in the gold industry would be well above the average rate prevailing on the world market.
As the post-Depression, post-World War II boom gradually raised prices on the world market, the rate of profit began to decline in the South African gold industry. But since the rate of profit was abnormally high in that industry due to the extremely low wages under apartheid, it took a long time for the rate of profit to fall to the point where the production of gold began to decline.
Indeed, gold production did not begin to level off until the mid-1960s and did not start to drop until 1971. Therefore, the extremely low level of wages of African gold miners made possible by apartheid, along with the devaluation of the dollar against gold by U.S. President Franklin Roosevelt in 1933-34, explains why dollar prices in the United States and the world were so much higher in the post-World II years than they were in the years before World War II — though in dollar terms, they were still much lower than prices today.
Higher money wages, therefore, had absolutely nothing to do with the “high cost of living,” though the higher cost of living did lead to higher money wages in terms of devalued currencies rose in reaction to the rise in the cost of living. Indeed, if money wages had not risen after World War II, real wages would have fallen to starvation levels or even below the biologically determined minimum wage.
The high level of gold production that prevailed after World War II and the consequent expansion of the world market that the newly produced gold made possible meant that the boom phase dominated the early postwar industrial cycles. And as I showed in earlier chapters, one of the effects of booms is to raise the general level of commodity prices. Therefore, higher money wages were an effect, not a cause, of a rise in the cost of living. In contrast, the extremely low wages of the South African gold miners did contribute to the high and rising price levels that prevailed under the post-World War II Bretton Woods international monetary system.
What really does cause inflation?
Ricardo and Marx proved scientifically that rising wages, whether by “rising wages” we refer to money or real wages, do not cause inflation. The effect of higher wages, all other things remaining equal, is to lower the rate of profit. So, if rising money wages do not cause inflation, what does cause inflation? Several factors can cause a general rise in commodity prices.
Price increases caused by booms
First, as we saw in the chapters on an “ideal” industrial cycle, during the industrial cycle’s boom phase, the demand for commodities at the existing price levels tends to exceed the supply. Therefore, prices must rise so that supply and demand can again be equalized.
However, these higher price levels are temporary. As soon as the industrial cycle turns down, supply will exceed demand at the existing price levels. As a result, prices again drop to their values and below their values. Indeed, one of the main functions of crises is to keep market prices in line with values in the long run. Therefore, changes in the phases of the industrial cycle cannot explain the almost continuous rise in prices that we have seen since 1933. At most, booms partially explain the rise in prices between 1945 and 1968, when industrial cycles were dominated by their boom phases.
Price increases caused by a fall in the value of the money
Commodity prices as a whole will rise if the value of the money commodity falls relative to the values of other commodities. For example, when gold and silver were discovered in the Americas during the 16th century, the opening up of these rich new mines lowered the value of gold and silver relative to most other commodities. This caused prices measured in terms of these precious metals to rise.
This phenomenon was observed again after the discovery of gold in California and Australia between 1848 and 1851. The previous falling trend in prices was reversed, and prices continued to rise until 1873. The introduction during the 1890s of the cyanide process in gold refining, which enables gold to be extracted from very poor ores, combined with the discovery of rich new gold fields in Alaska and the Yukon, considerably lowered the value of gold. This set off a significant rise in world commodity prices that began in 1896 and continued until 1913.
Price increases caused by wars
Wars, particularly world wars that curtail the production of civilian commodities, both articles of personal consumption and capital goods, lead to sharp rises in prices. This was observed, for example, during the world war that followed the French Revolution of 1789-93, as well as during World War I and World War II. However, once the war ends and normal “peacetime” patterns of production resume, prices inflated by war, all other things remaining equal, will drop sharply. This was observed in Ricardo’s time after the end of the world war that followed the French Revolution and again after World War I and World War II.
Price increases caused by currency devaluations
Nominal prices, as opposed to prices in terms of fixed weights of gold (or, in the past, silver), will rise if the amount of precious metal represented by the unit of currency is reduced. In the days before the rise of the international gold standard, governments often reduced the gold or silver content of their coinage. Or they might define the currency unit — the pound sterling, for example — as a lesser amount of precious metal. This was a common practice in the pre-Gold Standard days of mercantilism.
Today, a rise in the “price of gold” in terms of a given currency accomplishes the same thing, as I explained in the chapters dealing with money. For example, the devaluation of the U.S. dollar by 40 percent between 1933 and 1934 set off a long period of rising prices in the U.S.
A far more violent inflation occurred in the 1970s, when the U.S. Federal Reserve System, following the advice of Keynesian economists, refused to curtail the growth rate of its token money in the face of declining gold production. Instead, in a failed attempt to maintain the post-World War II prosperity, the Fed moved to overcome the effects of the global “shortage” of gold by attempting to replace gold with its token money. This caused the U.S. dollar to lose about 90 percent of its gold value in a decade.
The 2007-09 Great Recession refutes marginalism and its Keynesian variant
During the sharp economic crisis of 2007-09, known as the “Great Recession,” the cost of living in the U.S. dropped only slightly, according to official government statistics. Most of the fall was due to a gasoline price drop.
In the days before the Great Depression, a far milder recession would have led to a much greater fall in the cost of living. Indeed, real wages before 1933 would generally rise during economic downturns. In the last chapter, we saw how Keynes, just like the more “orthodox” marginalists, blamed the tendency of real hourly wages to rise during periods of falling prices for cyclical unemployment. The rise in real wages on an hourly basis partially compensated workers for the reduction in the hours of work during economic downturns.
Remember, according to marginalist theory, workers get back in wages all the value they produce. The workers do not, according to the marginalists, produce surplus value. If the marginalists hold, the general price level drops for any reason and money wages do not drop as fast as other prices, the workers get what amounts to a general wage increase in real terms. Unless the value produced by the workers increases, the marginalists claim, the workers will now be paid more than the value they are producing. Labor will be exploiting the capitalists!
On this much, both the traditional marginalists — Keynes’s classical economists — and the Keynes of the “General Theory” agree. The capitalists, unwilling to pay the workers wages more value than they are producing, respond by laying off workers. According to the marginalists, including Keynes, this explains the rise in unemployment during recessions.
Therefore, according to marginalist theory, as long as the cost of living remains unchanged as it did during the 2007-09 Great Recession, there should have been no employment contraction or rise in unemployment. However, in defiance of all versions of marginalist theory, employment fell sharply, and unemployment soared during the “Great Recession.” In the United States, four years after the beginning of the “Great Recession,” total employment was still far from returning to its pre-crisis levels, though the cost of living is not lower, nor are real wages higher than they were on the eve of the crisis in 2007.
The 2007-09 “Great Recession” provides only one illustration of the failure of the marginalist theory of wages and employment in this regard. An even more extreme refutation of the Keynes-marginalist theory of wages and employment is provided by the stagflation-era recessions of 1969-70, 1974-75, and 1979-82. During these recessions, the cost of living rose sharply. As a result of the inflation, real wages dropped on an hourly basis. The workers’ standard of living was doubly squeezed. They were hit by inflation, falling real wages, recession through reduced hours of work, and a considerable rise in unemployment.
According to the marginalist-Keynesian theory, falling real wages should have ensured “full employment.” Therefore, every recession since the 1950s, whether mild, moderate, or severe, has refuted the Keynes-marginalist theory of wages and employment.
In the natural sciences, if only one observation contradicts a theory, it is considered enough to refute it. If the same standard prevailed in economics, the entire marginalist theory of value in all its forms would have been abandoned long ago. The fact that marginalism is still taught — including in its Keynesian form — in the universities shows that present-day bourgeois economics is not a science but is simply a cover for the class interests of the ruling, exploiting capitalist class.
How to react and how not to react to currency devaluations — two examples from history
Almost as soon as he assumed office in 1933 at the bottom of the Great Depression, Franklin Roosevelt began to tamper with the U.S. currency system. He ordered the Reconstruction Finance Corporation to buy gold on the open market at higher and higher dollar prices. During 1933 and 1934, the Roosevelt administration pushed the dollar price of gold from the $20.67 that had prevailed since 1879 to $35. This amounted to a 40% devaluation of the dollar against gold.
This was a move by the New Deal to raise dollar prices, supposedly to help indebted farmers who were an important part of the base of the Democratic Party. Prices began to soar, and industrial production also began to rise rapidly as industrial and commercial capitalists began to buy commodities with the expectation that their prices would soon rise. This “expectation” on the part of the capitalists — entirely rational in the face of Roosevelt’s deliberate reduction in the gold value of the currency — quickly became a reality, and prices started to rise sharply.
U.S. workers, whose money wages and living standards had already been battered by the first three and a half years of the Depression, responded with a wave of strikes demanding union recognition and wage increases to compensate for the inflation caused by Roosevelt’s deliberate devaluation of the dollar. Within a few years, industrial unions organized basic industry for the first time in U.S. history, and the CIO was born.
The rise in wages neutralized the effects of the fall in the dollar’s value on the standard of living of U.S. workers. Perhaps Roosevelt halted his devaluation of the dollar in 1934 because of the resistance it provoked in the form of strikes and union-organizing drives. Therefore, indirectly, the push for higher money wages by the workers may have halted further inflation at that time.
This is in sharp contrast with what happened in the 1970s. During 1968-71, the U.S. government broke its promise to keep the dollar at 1/35th of an ounce of gold, and the dollar price of gold began to soar. It rose from $35 an ounce in 1970 to $875 at the peak during the winter of 1980. In terms of U.S. dollars, the price of gold never fell below $250 again.
Unfortunately, the AFL-CIO unions, listening to Keynesian economic advisers, practiced wage restraint, the exact opposite of what happened in 1933-34 during the Roosevelt devaluation. As a result, unlike after 1933, the workers’ real wages were devastated. And in direct contradiction with Keynes’s marginalist analysis of employment, the unemployment rate also soared.
Since the unions largely failed in their most elementary role to defend their members’ standard of living, they became increasingly discredited. So far from launching new unionization campaigns — with few exceptions — as they did in the 1930s, the unions retreated across the board. This opened the whole era of political reaction and counterrevolution that was to dominate world politics for the remainder of the 20th century.
A Critique of Crisis Theory 