Groucho Marxism

The tendency of the rate of profit to fall, henceforth TRPF, is a theory according to which the rate of profit – the ratio of the profit to the amount of invested capital – decreases over time. The hypothesis is usually attributed to Marx, but economists as diverse as Adam Smith, John Stuart Mill, David Ricardo, and William Stanley Jevons referred explicitly to the TRPF as an empirical phenomenon that demanded further theoretical explanation, although they differed on the reasons why the TRPF should necessarily occur. The TRPF is usually considered a cornerstone of Marxism. But what does it actually tell us, why is it sometimes thought of as controversial, and why should we care?! These are the questions I will attempt to answer in this blog post.

First, what exactly do we mean by the ‘rate of profit’? Marx defined the rate of profit by r = s/(v+c), where s is surplus value, v is variable capital, and c is constant capital. Surplus value is usually taken as synonymous with profit, but they are not quite the same: surplus value refers to revenue minus labour costs, whereas profit refers to revenue minus total costs. Thus, surplus value will always be greater than or equal to profits. Variable capital refers to labour costs, and constant capital refers to money invested in production, including money invested in fixed assets and raw materials plus any other non-labour expenses. Marx then defined the ‘rate of exploitation’ by e =  s/v, and the ‘organic composition of capital’ by o = c/v. Using these definitions, the rate of profit can be written as r = e/(1+o).

So if that’s the rate of profit then why should we expect it to fall? The explanation is actually quite straightforward. The central idea that Marx had was that overall technological progress has a ‘labour-saving bias’, and that the overall long-term effect of saving labour time in producing commodities with the aid of more and more machinery had to be a falling rate of profit. This is obvious from the definition: over time, constant capital has a tendency to increase, and as constant capital appears in the denominator of the formula for the rate of profit, it is inevitable that the rate of profit will go down. However, Marx maintained that this decrease was only a tendency and that there are also counteracting factors operating which can temporarily cause an increase in the rate of profit.

I think this is one reason why the TPRF is sometimes considered controversial: critics accuse Marx of making his theory unfalsifiable by introducing his counteracting factors. But all Marx was really saying was that we cannot expect the rate of profit to fall in a completely straight line, and that there are bound to be ups and downs and fluctuations along the way. This seems entirely reasonable for a hypothesis in the social sciences. It is not realistic to expect to see a definitive pattern in economic data, as anyone who has ever tried to analyse such data will tell you. But what does the data actually show? A bit of internet searching shows that the rate of profit has indeed fallen across many different countries over the last 100-150 years, exactly as Marx predicted. (Have a look for yourself if you don’t believe me.)

So we have determined what the TRPF is, and that it is a real phenomenon. The relevance of the TRPF is that it is a core component of Marx’s crisis theory, which posits that the inherent tendency for the rate of profit to fall is the fundamental reason for capitalism’s cyclical booms and busts. The key idea here is that capitalists use the rate of profit as an indicator of how well things are going, so when the rate of profit begins to fall, they are less likely to invest in new equipment and this pullback in investment slows down the economy. However, it will also prevent the rate of profit from decreasing so quickly (or at all), which in turn will encourage capitalists to invest more, leading to a boom. This boom leads to an increase in the amount of constant capital which reduces the rate of profit – and on it goes.

This is another reason why the TRPF is considered controversial. There are many competing views about what causes capitalism’s booms and busts and not everybody agrees with Marx that the TRPF is to blame, even if they accept that it is a real phenomenon. However, in 2015 the economist Esteban Maito published some empirical work on the TRPF which seems to back up Marx’s hypothesis. Maito provides data on the rate of profit across 14 countries over the last 150 years. Not only does he demonstrate that the rate of profit has decreased in those countries over that time, but his data also show some interesting trends. We can see the rate of profit decrease more sharply in the periods immediately prior to the crashes of 1929 and 2008, as well as before and during the ‘stagflation’ era of the 1970s.

Of course, eyeballing some graphs doesn’t prove anything, and more rigorous tests would need to be done to validate the hypothesis that the TRPF is the primary cause of capitalism’s booms and busts. But it suggests that Marx may have been on the right lines, which is all the more remarkable when you consider that he made this hypothesis over 150 years ago, before any of the crises mentioned above had actually occurred.