Profits lead the way

It’s been a long time since my last post.  I’ve been snowed under trying to get some papers and articles done.  But anyway, back to the moment!

Are the mature capitalist economies on the road to sustained economic recovery?  It depends on what you mean by sustained and recovery, of course.  The major capitalist economies (i.e what is called the G7) are experiencing some economic growth since the end of Great Recession in mid-2009.  Real gross domestic product (GDP) is rising at about 1-3% a year.  Can this growth be sustained or will these capitalist economies slip back into recession (i.e. a contraction of national output) or at best just crawl along?

The debate between the Keynesians and the Austerians continues.  The Keynesians claim that consumption and employment growth is weak so any reduction in government spending and any reversal of easy money policies (low interest rates and the printing of money) would push the capitalist economy back into slump.   The Austerians claim that the size of the budget deficits and the level of public debt being run up by governments in the major economies are so burdensome that it will restrict economic recovery.  The Keynesians want go on spending; the Austerians want to start cutting.  The strategists of capital in the US have so far adopted the first approach (except for the ‘tea party’ campaigners who wish to reverse it for ideological not economic reasons; while the British have opted for the second strategy.  Who is right?  I would argue that both are right and wrong.  Above all, both approach the question from the wrong angle because they do not recognise the underlying laws of motion of capitalism.

My overall view is that these major capitalist economies are likely to achieve an up phase in growth through to mid-2013 (maybe a bit longer) before entering another economic downturn.  How do I reach that brave forecast, considering that most forecasts by economists turn out to be even worse than weather forecasts?  Well, as I outlined in my book, The Great Recession, I think it is the job of scientists (and economists ought to be social scientists) to analyse empirical data, develop hypotheses and test them against evidence.  And that means making predictions or forecasts that can be tested for the validity of any theory (physical or economic).

So what are the best indicators for how the major capitalist economies are going to go?  GDP is one indicator of recovery but it is backward looking.  GDP rises when consumption and investment rise.  Consumption is driven by employment and wage increases.  In turn, wages are driven by the willingness of employers to invest in more production capacity and take on more staff.  So investment leads consumption into a recession and it leads consumption in the recovery.  That was the case in the Great Recession, which was really a collapse of investment not of consumption – at least initially.  This is something that the Keynesians do not recognise.

But what drives investment?  For Marx and for me it is profitability.  Profits lead the way.  In a capitalist economy, where production is for profit and accumulation of capital depends on its profitability, profits are the best leading indicator of an upcoming slump and/or a recovery.  If profits keep rising , there is more probability that any recovery is sustainable.  From these basic assumptions, we can make a judgement about where the top capitalist economies are heading over the next few years.  The fault of both the Keynesian and Austerian approaches is that both do not look at the key variable for the health of a capitalist economy: profitability and profits.

Before the Great Recession, the rate of profit in the US peaked and began to fall from 2005-6.  We can see the process more closely if we use capitalist categories because they can be measured for each quarter of a year while the data for Marxist categories are only annual.  Using profits to GDP (or profit margins),  US profitability began falling well before the credit crunch started to bite and the Great Recession ensued.  Once the mass of profits began to fall, then the collapse in investment followed.  This reveals the connection between the rate of profit, the mass of profit and capitalist crisis.

If we use the same indicators for looking at the recovery, US profitability and the mass of profits troughed in mid-2009 and began a staggering revival.  Indeed, the profits recovery has never been so quick and large after a recession.  That’s because in this Great Recession, capital values have been reduced more than usual.  Variable capital (to use the Marxist term) or the wage bill has been cut through job losses and the capping of wage rates.  So real incomes for the majority of working households have fallen.  The share of profits in national output has jumped accordingly, or in Marxist terms, the rate of exploitation or surplus value has leapt.  Also with investment slumping, the value of constant capital (the accumulated stock of fixed assets) has dropped.  And fictitious capital in the form of the value of stock plummeted.  So the bottom line in the Marxist equation for profitability, s/c+v, has fallen while the top line has risen.

This is the key to the recovery: not Keynesian boosts to consumption or Austerian cuts to public and private debt levels.  Indeed, during the Great Recession consumption fell only a little, while debt rose even more.  In this recovery, consumption is hardly rising compared to GDP and debt is still high (this applies to the US, the UK, Japan and most of Europe).  In the leading capitalist economies, debt held by households in the form of mortgages, credit cards and loans has fallen only slightly.  Deleveraging, as it is called, still has a long way to go.  In the capitalist corporate sector, there has been no deleveraging at all.  Nevertheless, the recovery is under way because profitability and profits have recovered.

And that is beginning to drive up investment.  Those capitalist corporations that survived the Great Recession (that is most) are now flush with cash that they have accumulated by laying off labour and stopping investment.  They have held back from investing (a ‘strike of capital’) while allowing the taxpayer to hand over large lumps of free cash through zero interest rate loans and cuts in corporate taxes.  But now they are beginning to reinvest.  If profits continue to grow, investment will gather pace.  Then employment will start to rise.  We see that now in the US and the UK.  In both, public sector employment in falling and private sector employment is rising.

As long as profits keep rising and profitability stays up, investment will rise and drive up employment, which will eventually provide  a rise in household incomes that will allow more consumption and the recovery becomes ‘sustainable’ .  There will be no slip back into what we used to call a ‘double-dip recession’  (see my previous post on this, No double-dip, 29 October 2010).

But this ‘sustainable’ recovery is likely to be shorter and weaker than in previous ones, in my view.  That’s because there is a cycle of profitability that I have identified for the US as lasting about 32-36 years.  Currently, this cycle is in its downward phase and has been since 1997.  The 1997 level of profitability has not been surpassed even after the credit-fuelled boom leading up to 2006-7.  Profitability has recovered from its recession trough in 2009, but it won’t get back to 1997 levels or even that of 2006.  So investment growth will be weaker and slower.  In the graph below, VROP means the Marxist or value rate of profit and OCC means the organic composition of capital, Marx’s measure of capital accumulation.  When capital accumulates, it eventually drives down the rate of profit.  This is a cyclical process that takes 16-18 years in each direction.

One reason that profitability won’t get back to 1997 levels is that capitalism still has a huge layer of ‘dead capital’ that it needs to clear.  This is machinery and plant that is old and unproductive; this is labour that does not have the right skills; and it is also fictitious capital (debt) that needs to be paid down to restore profitability. So US capitalism (and the other G7 economies to varying degrees) need to have the ‘cleansing ‘ experience of another slump before too long, in order to start afresh with companies unburdened with debt and unproductive assets.  That means another recession will be on the horizon, probably from about 2014 onwards.  In the meantime, the recovery from 2009 could continue for another few years.

9 thoughts on “Profits lead the way

  1. From Proctor & Gamble’s earnings report today (4-28):

    “We’re taking a holistic approach to the commodity cost increases we’re facing. First, we’re turning up the dial on our productivity and cost savings initiatives. As I mentioned earlier, for the first 3 quarters this fiscal year, we’ve generated an average of 150 basis points of cost savings per quarter…”

    P&G indicated also that it will be raising prices for a number of its products in early June. The increases are due to increasing cost of production, itself due to increasing costs for materials (“commodity cost increases”). Price increases are necessary to maintain profit margins. A number of other corporations have indicated increasing cost of production, most recently Ford in its earnings report.

    To offset the increased cost of production P&G must not only raise prices but it will also need, as indicated above, to reduce its work force. The later is necessary since there are limits to price increases when the economy is limping along and consumer demand is relatively weak.

    In general, the leap in corporate profits came at the expense of layoffs. To sustain profits will necessitate more layoffs. This will result in reduced consumer demand combined which will feedback into heightened overproduction.

    Samsung Electronics, the world’s largest chip maker reports today that it’s first-quarter profit fell by almost a third, due to declining demand. Corporate re-investments in computer upgrades has largely runs its course. These investments were made possible by reducing cost of production, i.e., laying off workers.

    Granted, other multinational corporations such as Federal Express reported strong demand, though mostly contained in Asia. Yet price inflation and increasing wages in China, combined with a real estate bubble (which has now falling out of the sky in Bejing), along with misallocation of capital directed to overproduction of infrastructure and commercial real estate, presents real problems for the China, which is attempting to reduce speculative inflows — just as is Brazil is. India is also experiencing very high inflation. My point in very briefly mentioning these conditions in Asian countries, Brazil and India is to support a view that any potential for a US recession must be analyzed in a global context. Analyzing the US in a vacuum is far from sufficient.

  2. The magic lies in “That’s because there is a cycle of profitability that I have identified for the US as lasting about 32-36 years.” I don’t accept that as valid forecasting. In particular, US capital does less and less manufacturing itself, and is tending to rely on “intellectual property” and other more virtual endeavours. In addition, the internet is continually enabling improvements in productivity; this is relatively new, historically.

    How much improvement in productivity we get and whether it’ll pull us out of this slump is the big question. I’m not optimistic.

  3. True enough, the rate of profit has turned up. But I believe that deleveraging is continuing and that consumption fell dramatically during the great recession but quickly rebounded after the mid-2009 output recovery. Increased consumption seemed to be the response to the deflation which began in earnest in late 2009. As prices fell, consumption increased also driven by the weak stimulus efforts by the Federal Government.

    There certainly seems to be much empirical evidence for the FROP school. For example, one economist asserts;

    In summary, policies of budget deficits and monetary accommodation deployed by the US government, which are popularly but inaccurately referred to as ‘Keynesian’, may well have contributed to the relative shallowness of the decline in US consumption during the Great Recession. They are, however, insufficient to prevent the fall in fixed investment and therefore the long term slowing of the US economy.

    Consumption is still near 70% of GDP and the fall in fixed investment was much greater than the fall in consumption of durables which remained high as prices fell due to overproduction and excess inventories particularly for automobiles. This could suggest that the fall in the rate of profit played a great role in the decline in fixed investment despite some strong consumption trends.

    But it must also be acknowledged that overcapacity played a major role in the drop off in fixed investment until 2010 when it began to turn up dramatically along with the mass (and rate) of profit. Much of the increased consumption that occured along side investment declines was probably of excess inventories. Overcapacity depresses investment as much as a fall in the rate of profit which likely follows rather than preceeds overcapacity. A fall in consumption probably predates both, though consumption recovered quickly probably due to fiscal stimulus and deflationary trends for overproduced durables. But overcapacity during the Great Recession was probably the highest since the Great Depression. The Fed provides these figures for overcapacity;

    In 2008/09, during the height of the recession, total capacity utilization in the US economy hit a low of about 67% and 64% in manufacturing alone. In 2010, capacity utilization began to turn up slightly to about 72% on average which is still the lowest in the entire post-WWII era. In March of this year, capacity utilization peaked at 77% which is still significantly below the 80% average for 1972-2010. The average in the late 1980s and mid to late 1990s was around 85% during the business cycle upswings in each decade. It is entirely plausible that overcapacity is depressing investment. Corporations don’t add capacity when 25% to 35% remains unused (and this is accounting for a significant decline in overall capacity to begin with!

    It is well known that wages have been stagnant and many economists believe this has contributed to stagnation overall and a fall in profit rates. One analysis posits;

    Excessive Corporate Profit From Low Wages Leads to Overcapacity

    This new rule of globalized trade is designed to produce short-term maximization of corporate profit for an export sector. But in the post industrial finance economy, the export sectors in low-wage economies are largely owned or financed by cross-border international capital. This type of international trade incurs inevitable long-term stagnation in the domestic economies of all trading nations because the low wages paid by international capital lead to insufficient aggregate domestic consumer demand. Stagnant wages everywhere in turn reduce aggregate global purchasing power needed for the expansion of international trade. It is a clear case of imbalanced economic sub-optimization.

    Low wages and consumption seem to have led to overcapacity and a decline in output, employment, profits, and investment. This adds up to a recession. I cannot see what would cause a fall in profit rates other than a fall in demand due to low wages and a deleveraging of household debt. I personally don’t get the whole capital composition/socially necessary labor time reduction analysis. Perhaps you can help. I tend to think of capitalist crisis as a realization problem due to overproduction and overcapacity.

  4. some where else you mentioned that this period of downturn is due to end of life of the means of production. IMHO, this is wrong. EOL is historical specific. while in previous periods, it was close to reality, the EOL nowadays, since it based around IT equipment is, more like 5 years. 2nd point is, that youv’e too few samples to conclude with any accuracy from.
    3rd point is, that these cyclonic predictions ignores the structural changes in the organisation of capital; in this sense, these predictions are a-historical. and 4th, as already mentioned by others, by concentrating on the US economic cycle, you are ignoring the global implications. that is, growth of profitability not necessarily leads to increase in invsments. take the UK latest minuscule growth for example, it was accompanied by downturn in investments. in the UK it is quite clear why – because of the currency value, that is, profitability is virtual.

  5. Both Steve and Ron make very important points from different angles. Many of Steve’s arguments in favour of effective demand or the realisation of capital accumulation I have dealt with in my book, The Great Recession, as have many others, including Marx.

    Ron’s points are difficult to answer in a short space and require a proper rebuttal that I shall try later. In the meantime, 1) IT equipment may have a depreciation life of 3-5 years but the bulk of capital accumulation is in structures and their life is much longer. The average of this is 16-18 years. 2) yes, the samples are small – capitalism has only been around 500 years and capitalism as a dominant mode of production only about 200 years. But in my book I do develop the cycle going back that far. 3) I agree, the cycle is not structural or historical but the booms and slumps of capitalism are the way capitalism ‘breathes’ and profitabilty lies at the basis of this. The social structure of capitalism will change as capitalist react to crises 4) the US is the most important capitalist economy still and so the movement of profits and investment there remain key. Whay happens in the UK is very much a reaction to global capitalism.

  6. Mr. Roberts,

    You seem to base much of your argument on the faulty methodologies so often used in calculating the rate of profit. Profit is calculated in various ways depending upon whether we are talking about operating profit (operating revenues minus operating costs); total profit including interest;economic profits (revenues exceed opportunity costs of total input costs); rate of return on fixed investment;total operating costs as a share of total revenue; overall rate of return on all investment, fixed and variable. You seem to see much of the argument against what I call the Declining Rate of Profit (DROP) thesis being based on unrealistic under valuation of fixed capital, specifically structures which depreciate over the course of decades instead of just years. Thus, according to your argument, consistently under valued assets in the profit calculation give a false impression of higher profits, or rate of return on fixed capital investment, than actually exist for most industries. This is quite a reasonable argument. But do differences in the various methods of calculation make enough difference to judge the additional profit rate decline in your preferred method, as a significant cause of overall stagnation.

    And of course, we are still left with the issue of causation; do falling profit rates choke up investment causing recession, unemployment and low effective demand? Or does declining effective demand due to income concentration, which occurs during every successive contraction in the business cycle, leading to shorter and weaker upturns due to demand shock ultimately constraining GDP and profit rate growth? I suspect the answer to this important question isn’t determined by methods of profit calculation no matter how thorough or unreliable. But perhaps it is also a question for an entirely different discussion.

  7. Is the Economic Crisis Over?

    I would like to recommend the latest entry from the Critique of Crisis Theory blog by Sam Williams. In it he analyses the current stage of the industrial cycle and asks, “Is the Economic Crisis Over?” (See

    I hope that reading this blog post will encourage people to look more closely at the entire series, which has taken the form of a developing book on crisis theory.

    The first blog chapter explains the biggest challenge the author faced — the fact that Marx did not leave a completed crisis theory. It was certainly the plan when Marx began Capital, but in the end only one volume was completed before his death and volumes two and three only took partial steps to a completed theory.

    However, based on all of Marx’s writings, Sam believes the answer can be clarified. The solution he believes involves reaffirming Marx and Engels’ views that periodic crises are the inevitable result of a clash between the powerful forces that drive capitalist expansion of production and the laws that govern the expansion of the market. In the words of Engels in Anti-Duhring: “The extension of the markets cannot keep pace with the extension of production. The collision becomes inevitable, and as this cannot produce any real solution so long as it does not break in pieces the capitalist mode of production, the collisions become periodic. Capitalist production has begotten another ‘vicious circle’.” Why this is the case is the subject of the blog.

    To answer this question the blog author believes it is necessary to build on the most important economic discoveries of Marx in Capital, including Marx’s perfected labour theory of value. In the process he critiques both the “underconsumptionist” and “tendency of the rate of profit to fall” schools for their one-sided approach to understanding crises. The first ignores the problems associated with the production of surplus value and the second the problems associated with its realization.

    At the same time both schools have tended to ignore the role of the money commodity gold as the universal equivalent. Sam argues that the money commodity continues to be an integral part of the operation of the law of value in capitalist society with or without the gold standard for state-issued paper currencies, which in reality continue to represent gold in circulation. Taking into account this role is critical to understanding why capitalist crises of generalized overproduction periodically occur, according to Sam.

    He takes up bourgeois critics of or alternatives to Marx including detailed critiques of Ricardo and the theory of “comparative advantage”, Say’s Law, marginalism, the Austrian school and Keynes. He looks at the concrete history of capitalism and the question of “long waves” including whether there is a material basis to their existence.

    After the main blog series was finished Sam took up questions and suggestions for discussion. I had my own “debate” over the question of productive and unproductive labour. And finally he discusses what the historical limits are to the continued existence of capitalism.

    There is much to interest and challenge the reader.

    Even if you don’t agree with everything that is written it does challenge and stimulate new ways at looking at the questions under debate — which are ultimately questions vital for the future of humanity.

    Mike Treen

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