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 3
The Falling Rate of Profit
Is the Falling Rate of Profit the Key to Periodic Economic Crises?
Among Marxists today, the tendency of the rate of profit to fall is perhaps the most popular explanation for capitalism’s cyclical economic crises, with underconsumption a distant second. In its more naive forms, this theory leaves out the question of realizing surplus value altogether.
Supporters of the falling rate of profit school point out that during the boom phase of the industrial cycle, technological progress, competition between industrial capitalists, and — especially — competition between industrial capitalists and the working class combine to force the industrial capitalists to increasingly substitute machines (dead labor, constant capital) for living labor (variable capital). This is all the more true as the boom nears its peak when the conditions are most favorable for the working class in the labor market.
More and more of the surplus value consumed productively by the industrial capitalists is transformed into constant capital, and less and less is transformed into variable capital-labor power. The result is a rise in the organic composition of capital and a fall in the rate of profit.
To make things worse for the industrial capitalists, the forces that tend to counteract the fall in the rate of profit and transform it into a mere tendency are more or less paralyzed during the boom. The strong demand for labor power makes it very difficult, if not impossible, to increase the rate of surplus value. If anything, the rate of surplus value may even fall, as the profit-squeeze/class-struggle school emphasizes.
In addition, the devaluation of the elements of constant capital is essentially neutralized by the strong demand for the commodities that make up constant capital—both constant fixed capital and constant circulating capital. Even if the values of these elements fall, their prices won’t fall as long as demand exceeds supply at existing prices, which will be the case as long as the boom lasts.
As far as the industrial capitalists are concerned, the quantity of constant capital is always measured in terms of price. They neither care nor know what the actual labor value of their constant capital is. And it is not only the monetary value of fixed capital that grows. Booms tend to lead to a rise in the prices of raw and auxiliary materials, which make up the elements of constant circulating capital — for example, the price of oil.
The result is a further rise in the value of constant capital — in terms of prices that, to a certain extent, are independent of the changes in underlying values. As a result of the rise in the organic composition of capital during an economic boom, the falling-rate-of-profit theory holds that the rate of profit on the total social capital begins to fall rapidly. Sooner or later, the rate of profit falls so low that the industrial capitalists can no longer find new fields of investment that yield an adequate rate of profit. The falling-rate-of-profit school holds that the fall in the rate of profit, therefore, leads to an over-accumulation of capital. Industrial capitalists began to slash new investments, and the whole process of capital accumulation soon grinds to a halt.
Instead of making new productive investments, the industrial capitalists either hoard money or engage increasingly in financial speculation, including in the stock and bond markets. As productive investments decline, overproduction of commodities relative to money appears in Department I, the department of production that produces means of production. It then spreads to Department II, the department of production that produces the means of consumption. The crisis now appears to be a crisis of the general overproduction of commodities relative to money. But, according to the falling-rate-of-profit school, it is actually a crisis of the low rate of profit. The rate of profit is too low to maintain the normal process of expanded reproduction of the capitalist economy.
A problem for the falling-rate-of-profit school
Here, I should note a problem with the falling-rate-of-profit school of crisis theory. Most, if not all, capitalist crises since 1825 have tended to begin in the consumer goods sector — Marx’s Department II — especially residential construction. Other durable consumer goods industries, such as the auto industry, which became important during the 20th century, also tend to turn down before the rest of the economy does. Recoveries also tend to begin in the industries that produce items of personal consumption, including residential construction.
The movement of the industries that produce means of production responds to changes in the industries that produce means of consumption with a lag. This is the opposite of what the falling rate of profit, as well as the profit-squeeze/class-struggle schools, would predict.
The crisis of 2007-2009 provides a good example. 1 It began in the U.S. residential construction industry as residential construction in the United States peaked in 2006. As this crisis deepened over the following year, loans for so-called subprime mortgages began to dry up, and home prices began to fall.
However, the Department I industries such as steel, other metal-producing industries, mining, and energy continued to boom until the fall of 2008. Indeed, companies in these sectors, especially energy, were making the highest profits in the entire history of capitalism through mid-2008. It wasn’t until August 2008 that the crisis in residential construction and auto, as well as related industries, finally spread to the steel, metal, and energy industries.
What causes the upturn in the industrial cycle, according to the falling-rate-of-profit school?
As the boom turns into a slump, workers are laid off, and prices — at least in crises before World War II — begin to fall. Once again, the rate of surplus value begins to rise and thus offsets the fall in the rate of profit brought on by the rise in the organic composition of capital. Under crisis conditions, the labor market once again shifts against the sellers of labor power and back in favor of the buyers of labor power — the capitalists. The prices of the elements of constant capital — both fixed and circulating — fall, lowering the value of the constant capital in terms of money, which reflects the previous declines in labor values.
Perhaps, it is sometimes suggested by the falling-rate-of-profit school, industrial capitalists become somehow “reconciled” to a lower average rate of profit and are willing to accept a lower rate of profit on a larger mass of capital. Recovery begins and gradually builds up to a new boom as expanding industries react to one another. The fall in the rate of profit resumes and ends in a new crisis.
As is the case with the profit-squeeze/class-struggle school, the falling-rate-of-profit school sees the increase in the rate of surplus value achieved by the industrial capitalists during and immediately after the crisis as the key to the recovery. The falling-rate-of-profit school implies that industrial capitalists can keep the expansion going as long as they can increase the rate of surplus value sufficiently to offset the rise in the organic composition of capital.
The industrial capitalists might achieve this through successful union-busting campaigns or by finding new sources of exploitable labor power.
This is exactly what occurred during the closing decades of the 20th century. For example, the People’s Republic of China was opened once again to widespread capitalist foreign investment after the victory of the “reform” faction of Deng Xiaoping in 1978. Then, beginning with the rise to power of Mikhail Gorbachev in 1985 and finishing up under Boris Yeltsin, who rose to power in 1991, came the dismantling of the planned economies of the Soviet Union and Eastern Europe. For the first time since 1917, capital could again exploit workers across almost the entire globe.
Marx on the falling rate of profit and overproduction
Marx wrote in Chapter 15, Volume III of Capital: “The rate of self-expansion of the total capital, or the rate of profit, being the goad of capitalist production (just as self-expansion of capital is its only purpose), its fall checks the formation of new independent capitals and thus appears as a threat to the development of the capitalist production process. It breeds over-production, speculation, crises, and surplus-capital alongside surplus-population.” 2
This passage is often quoted by those who trace the periodic economic crises of capitalism to the tendency of the rate of profit to fall due to the growth in the organic composition of capital. Marx says the fall in the rate of profit “breeds” overproduction and crises. But he doesn’t say that overproduction is identical to a fall in the rate of profit caused by a rise in the organic composition of capital. To Marx, the periodic capitalist economic crises are crises of the generalized overproduction of commodities, not crises of the “low rate of profit.”
How does a fall in the rate of profit “breed” overproduction and crises? Marx does not explain it here. Indeed, if he had, he would have had to dive into crisis theory, which is exactly what he did not want to do at that point in Capital.
But I think we can say this much: The lower the general rate of profit, the greater must be the magnitude of capital, where the fall in the rate of profit is compensated for by the growth in the mass of profit. Large capitals imply huge factories that can very quickly increase production and thus rapidly flood the market, leading to gluts and crises.
Profit and the profit of enterprise
Also, profit proper — as opposed to rent — is the sum of interest plus the profit of enterprise. The industrial capitalists “earn” in addition to the interest appropriated by the money capitalists — all industrial capitalists are also money capitalists, though not all money capitalists (owners of money capital) are industrial capitalists (owners of productive capital) — an additional profit that Marx called the profit of enterprise. The only reason that industrial capitalists take the greater risk of engaging in industrial production as opposed to acting as mere money capitalists is the prospect of appropriating this additional profit. This implies that it isn’t so much the rate of profit as such but the profit of enterprise that is the real motive for the production of surplus value.
Suppose the rate of profit is 25 percent and the rate of interest is 5 percent. Then, the profit of enterprise is 20 percent. But if the rate of profit were to fall to, say, 7 percent, without a fall in the rate of interest, the profit of enterprise will be only 2 percent. And if the general rate of profit falls to 5 percent, while the rate of interest remains at 5 percent, the profit of enterprise falls to zero. The motive to produce surplus value disappears, and the industrial capitalists begin to turn increasingly into money capitalists.
This point is often overlooked by Marxists, though John Maynard Keynes was highly aware of it. Indeed, it is central to his General Theory of Employment, Interest, and Money, first published in 1936. This book forms the foundation of Keynesian economics.
Before we explore this question, we will first have to examine what exactly determines the division between interest and profit. In my opinion, no crisis theory can be anywhere near complete if it does not explain this division.
Unfortunately, this question has traditionally been ignored by Marxists. It obviously has implications for the “financialization” phenomena that has developed since the 1970s, which drew the attention of Paul Sweezy 3 in the final years of his life. However, the examination of this question belongs to a future chapter and cannot be dealt with here.
Bill Jefferies’ fruitful mistake
Bourgeois economists like to sneer that Marxists have predicted 100 of the last 10 recessions. Marxists can answer that bourgeois economists, with very few exceptions, have predicted exactly zero of the last 10 recessions. This shows that even the most superficial “vulgar” Marxism is superior to present-day “orthodox” marginalist bourgeois economics.
Bourgeois economists, whether Keynesians or neo-liberals, claim that capitalism would be crisis-free if only the right policies were followed. For example, after every recession, the bourgeois economists generally “explain” that if only the Federal Reserve System — or other central banks — hadn’t “tightened” so much, or if the Wall Street bankers hadn’t been so “greedy” or “reckless,” or if only there had been more regulation, there would have been no crisis. The bourgeois economists then praise the bankers, the corporations, the governments, and the central banks for following correct policies that will avoid the mistakes of the past — until the next crisis arrives, catching our (bourgeois) economists by surprise once again.
Marxists, on the other hand, especially during periods of extreme reaction that dominated world politics from 1978-1979, 4 hoped that an economic crisis would radicalize the workers and lead to a new era of upsurge for the workers’ movement. They scan the horizon for signs of an approaching economic crisis, much like Marx and Engels did in the 1850s. Frequently, Marxists predict the approach of a crisis long before it actually arrives — though, in the end, the crisis always comes.
To his credit, the British Marxist Bill Jefferies 5 rose above this often superficial “crisis mongering” based more on wishful thinking than on a scientific analysis of the capitalist system and its crises. When the first stage of the global economic crisis of 2007-09 began in August 2007 with the initial credit market freeze-up centered around the market for subprime mortgages in the United States, the question was posed: Is the world on the brink of a new major worldwide capitalist economic crisis?
Most Marxists answered in the affirmative, while bourgeois economists claimed that world capitalism would “probably” escape with only a “slowdown” or, at worst, a mild recession with a new expansion beginning in the second half of 2008 would remain largely confined to the United States.
When the crisis began, Jefferies, basing himself on the view that it is fluctuations in the production of surplus value and in the rate of profit calculated in terms of values not prices, that determine the alteration of boom and crisis, expressed the view that a major worldwide recession would not occur. Any downturn that grew out of the U.S. subprime mortgage crisis and the resulting credit market disturbances, Jefferies predicted, would be a minor one and would soon give way to a renewed vigorous capitalist expansion.
Jefferies reasoned that the last few decades have seen huge defeats for the working class worldwide. As a result of these reactionary developments, vast numbers of workers, especially in the People’s Republic of China, but also in the former Soviet Union and Eastern Europe, that were outside the sphere of capitalist exploitation have now been transformed into surplus-value producers, both for the emerging native capitalists of these regions and Western and Japanese corporations.
These developments have affected not only the workers in the former Soviet Union, Eastern Europe, and China but also workers throughout the world. Everywhere, the trade unions have been weakened, and the workers’ political parties have been pushed back. Both the rate of surplus value and the number of workers who are available for exploitation by private capital have greatly increased.
Jefferies explained that these developments have been a powerful offset to the long-term tendency of the rate of profit to fall, and it’s hard to disagree with him there. With this huge increase in the quantity of cheap labor power, the industrial capitalists have far less incentive to replace living labor with machinery, which slows down if it does not reverse the rise in the organic composition of capital. These events are indeed a powerful example of Marx’s “counteracting influences” that turn the law of the falling rate of profit into the tendency of the rate of profit to fall.
Based on this rise in the rate of profit in terms of values, Jefferies predicted that a major new economic crisis — or series of crises — would not occur until a combination of the growing demand for labor power combined with a recovery of the workers’ movements from the disastrous defeats at the end of the 20th century again puts downward pressure on the rate of surplus value. This will, in turn, stimulate a renewed growth in the organic composition of capital. Then and only then will a renewed fall in the rate of profit lead once again to a new era of crises and revolutionary opportunities. But with the workers’ movement still reeling in 2007, it would take, Jefferies assumed, several more decades before major economic crises would again be possible.
We now know that Jefferies was wrong about the crisis of 2007-09. Far from being a minor crisis, it turned out to be — in its impact on industrial production and employment, its universal sweep and effect on world trade — the worst crisis since 1929-33. And again, contrary to Jefferies’ forecast, the recovery from this crisis proved to be painfully slow. But exactly where was the flaw in Jefferies’ logic? Jefferies’ mistaken economic forecast points to what I believe to be the greatest weakness of the falling-rate-of-profit crisis theory, as well as the profit-squeeze/class-struggle theories.
While underconsumption theory looks only at the problem of realizing surplus value, the insufficient surplus value theories look only at the problem of producing surplus value. If the crisis problem could be reduced to the problem of producing surplus value, I believe Jefferies’ economic prediction would have proven correct.
Jefferies was, of course, correct in noting that the rate of profit is the driving force of capitalist production. But he forgot that produced surplus value is not yet profit. Before surplus value can become profit, it must be realized in money form. If the surplus value is not realized in the form of money, as the underconsumption schools point out, there is no profit, no matter how much surplus value is produced. This is what I believe Jefferies overlooked.
As Jefferies explained, the possibilities open to the industrial capitalists of producing surplus value vastly increased during the years leading up to the 2007-09 debacle. But what about the realization of the great mass of surplus value that was being produced in the lead-up to the events of 2007-09?
To the industrial capitalists, it is not the rate of profit in terms of values but the rate of profit in terms of prices — or what comes to the same thing, in terms of money — that matters. We know from the law of the labor value of commodities that prices are determined by values — but only in the final analysis. Marx had pointed out already in his early book The Poverty of Philosophy when he wrote that prices tend to equal values only by constantly not equaling them.
The process by which prices are ultimately brought into line with values is a complex one, and we will have to examine this closely as our investigation proceeds. Jefferies’ failure to grasp the relationship between value and price was, in my opinion, the root of his mistaken economic forecast.
Underconsumptionists and followers of the “Monthly Review School,” 6 such as Monthly Review‘s editor John Bellamy Foster, share my opinion on this point. But as we saw in an earlier chapter, there are also big problems with underconsumptionist theories. Perhaps something other than “underconsumption” — the inability of the workers to buy back the entire mass of commodities they produce — lies behind the problem of realizing the value and surplus value contained in commodities produced under capitalism.
(1) The system of paper money in the form of the dollar standard that was in effect during the crisis of 2007-09 exaggerated this effect. During the first phase of the crisis, which lasted from August 2007 to July 2008, many capitalists expected that the U.S. Federal Reserve System would respond to the crisis by rapidly increasing the quantity of U.S. dollar-denominated token money.
The industrial capitalists — industrial corporations — fearing that their cash reserves were about to be sharply devalued, moved to increase their investments in constant capital before prices of the commodities that make up constant capital soared. This abrupt increase in the demand for and the prices of the means of production occurred just as the demand for items of personal consumption produced by Department II was falling dramatically in the case of houses.
However, contrary to widespread expectations fearing a new 1970s-style “Great Inflation,” the U.S. Federal Reserve Board did not significantly increase the quantity of U.S. dollar-denominated monetary tokens before September 2008. As the realization that “the Fed” was not increasing the quantity of its dollar monetary tokens starting in August 2008, industrial investment began to implode as fears of runaway inflation abruptly gave way to fears of deflation and depression. The “mild recession” affecting only Department II was transformed into the “Great Recession” that hit Department I with devastating effect.
Then, in September, a full-scale financial panic erupted, beginning with the bankruptcy of the Lehman Brothers investment bank. The Fed responded by more than doubling the quantity of its dollar-denominated monetary tokens within a few months, beginning the era of “quantitative easing.” However, the crisis increased the demand for the U.S. dollar as a means of payment and means of hoarding. The tendency for crises to break out in Department II and then spread to Department I — especially in credit-sensitive areas such as residential construction has been observed, if to a lesser degree, under the gold standard as well. This is a problem for the falling-rate-of-profit theory of crisis, which would predict the opposite. (back)
(2) Capital Vol. III Part III, The Law of the Tendency of the Rate of Profit to Fall. Chapter 15. Exposition of the Internal Contradictions of the Law https://www.marxists.org/archive/marx/works/1894-c3/ch15.htm (back)
(3) Paul Sweezy (1910-2004) was a Marxist economist, political activist, publisher, and founding editor of Monthly Review, a socialist magazine. (back)
(4) The year 1978 saw the rise to power of Deng Xiaoping, which represented a sharp turn to the right in the politics of post-revolutionary China. The following year saw the electoral victory of the British Conservative Party under the extreme right-wing Margaret Thatcher, who defeated the more moderate “Tory Wets” to become the leader of the Conservatives in 1975. In 1980, Ronald Reagan was elected President of the U.S., defeating the “moderate” Democratic U.S. President Jimmy Carter. Five years later, Mikhail Gorbachev was elected the General Secretary of the Central Committee of the Communist Party of the Soviet Union.
The cumulative effect of the rise to power of such right-wing leaders not only represented a sharp shift to the right in their respective countries but in world politics as a whole. This shift to the right reflected a change for the worse in the balance of forces between the capitalist class and the working class that occurred after the end of the post-World War II economic boom that occurred between 1968 and 1973. (back)
(5) Bill Jefferies was the leader of a small British Marxist group that has since dissolved. Between 2006 and 2013, they put out a Permanent Revolution magazine. Back issues can be found at the website https://www.marxists.org/history/etol/newspape/permanent-revolution-group/index.htm (back)
(6) The “Monthly Review School” refers to a school of economic thought associated with the U.S. socialist magazine Monthly Review, which has been published monthly since 1949. It was founded by the renowned U.S. Marxist economist Paul Sweezy. Other writers associated with the Monthly Review School include Paul Baran, Samir Amin, Harry Magdoff, Harry Braverman, and Monthly Review’s current editor, John Bellamy Foster. In addition to Marx, the school was heavily influenced by John Maynard Keynes and Michal Kalecki and was sometimes referred to as “Keynesian-Marxist.” For an assessment, see “The Monthly Review School” at https://critiqueofcrisistheory.wordpress.com/responses-to-readers-austrian-economics-versus-marxism/the-monthly-review-school/ (back)
A Critique of Crisis Theory 