Profits call the tune

It’s time to return to my favourite topic – Marx’s law on profitability and economic crises.  I have been preparing a paper on the idea of a world rate of profit for the upcoming joint conference of the Association of Heterodox Economists (AHE), the International Initiative for Promoting Political Economy(IIPPE), the World Association of Political Economy (WAPE) and the Association Francaise D’Economie Politique (AFEP), taking place in Paris in early July.  But more on that in a future post.

In reading up for that paper, I revisited a paper by Deepankur Basu and Rama Vasudevan (B-V) called Technology, distribution and the rate of profit in the US economy: understanding the current crisis (see deepankar_basu_ramaa_vasudevan_technology_distribution_and_the_rate_of_profit_in_the_us_countdown).  In this, B-V measure the rate of profit a la Marx in all ways possible, from what I call the whole economy, the corporate sector only, just the non-financial corporate sector and using gross operating surplus, before and after taxes, with and without inventories, based on replacement or historic cost measures of fixed assets.  I could go on: you name it and B-V try to measure it.

Their main conclusions are that the US rate of profit declined from the mid-1960s to the early 1980s and then rose on most measures until recently.  Nothing surprising there – that merely confirms what most others (including my own empirical research) have found.  B-V did not find a rise after 1982, if capital stock was measured in historic costs, confirming Andrew Kliman’s analysis (see my posts, Andrew Kliman and the failure of capitalist production, 8 December 2011 and The rate of profit, the devil in the detail, 15 January 2012).

But there is a more controversial conclusion:“the current crisis was not preceded by a long period of declining profitability, as was in evidence during the ‘structural crisis’ of the late 1970s; the fall in the rate of profit during the current crisis coincides with a short-run downward movement associated with fluctuations of the rate of profit at business cycle frequencies”.  What does all that mean?  It means that B-V follow the view of Gerard Dumenil and Dominique Levy (D-L) that each post-war capitalist crisis had a different cause: the one in the 1970s was due to a fall in the rate of profit (structural); but the Great Recession was not (see my post on this, The crisis of neo-liberalism and Gerard Dumenil, 3 March 2011, ).

But are they right?  When I look at their results, by whatever measures, the rise in the rate of profit after 1982 appears to have peaked in 1997 (confirming my own analysis).  That peak is not surpassed in the following years (except on some measures).  That suggests to me that Marx’s law of profitability is just as relevant to the Great Recession, as it was in the so-called ‘structural crisis’ of the late 1970s, and was not just part of some short-run business cycle.  Indeed, it is strange that Basu reaches this conclusion because in earlier paper with Panayiotos Manolakos (, they applied econometric analysis to the US economy between 1948-07 and found that there was a tendency for the rate of profit to fall – with the rate profit declining at about 0.3% a year.  B-M conclude that “this finding establishes the relationship between the inexorable mechanisation of capitalist production and the tendency of the rate of profit to fall.”

Now B-V go onto to decompose the movement in the US rate of profit.  By that I mean they try to isolate the factors causing the movement in the rate of profit.  Marx identified these as basically changes in the organic composition of capital (the value of constant capital – machinery, plant etc relative to the value of variable capital – the cost of labour employed) and the rate of surplus value (the value over and above that paid to the labour force and appropriated by the capitalists).  Marx’s law of profitability ‘as such’ is that there is a long-term tendency for organic composition of capital to rise faster than any rise in the rate of exploitation of the workforce.  Thus the rate of profit falls.  However, there are periods when counteracting factors to the law ‘as such’ can dominate.  These factors are a faster rising rate of surplus value or a cheapening of the cost of machinery and technology so that it can lower the organic composition of capital.  Then the rate of profit can rise – for a while.

B-V isolate these counteracting factors and find that, in the period after 1982 when the rate of profit rose (on most measures), constant capital was cheapened through new technology and falling computer prices.  At the same time, the rate of surplus value rose.  Thus the counteracting factors dominated over the law ‘as such’ and the rate of profit rose.  However, in the first decade of this century, the organic composition of capital resumed its upward rise as the effects of hi-tech, internet and other innovations wore off.   Indeed, according to B-V, the cost of mechanisation rose six times faster after 2000 than in the previous two decades.  So the downward pressure on the rate of profit was resumed despite a still rising rate of surplus value or exploitation.  As B-V put it: “It was capitalism’s dynamic drive to accumulate and innovate that led to the potential erosion of profitability.”  There seems a perfectly reasonable explanation of the Great Recession as coming about after a change in the rate of profit from 1997 onwards and a rise in the organic composition of capital.  So there is no reason for B-V to argue that the “current crisis cannot be viewed a crisis of profitability”.

At the end of their paper, B-V attach the results of previous work by D-L (see Stages in the development of US capitalism: trends in profitability and technology since the civil war), who measured the US rate of profit right back to 1870, when we can first talk about the US becoming a modern capitalist economy and soon to be the leader.  Using various sources before official data became available from 1925 (see The US economy since the civil war: sources and construction of the series,, D-L use the ‘whole economy’ measure for their estimates, which I prefer as I think it covers the whole movement of value in an economy.  D-L apparently concluded from their analysis of the data that the Great Depression cannot have been caused by Marx’s law of profitability, because there was no rising organic composition of capital before 1929.  Well, I’ve looked at their data (see graph below, making a reciprocal of the productivity of capital ) and it seems to me that the productivity of capital starts falling (i.e. a rising organic composition) from 1924 onwards and this also coincides with a peaking in the rate of profit.  After 1924, they fall in unison, while the rate of surplus value is steady (not shown).  So for five years before the start of the Great Depression the US rate of profit was falling.

And by the way, D and L’s data also confirm that the US rate of profit peaked in 1997 and has not been surpassed since. Indeed, if we use D-L’s data, we can discern, as I have done on many occasions with my own data, two periods: first the neo-liberal period of 1982-97 when the rate of profit rose and the organic composition of capital fell, although interestingly, the share of profit did not change much.  Then the period after 1997 when the rate of profit started falling (although not by much) while the organic composition of capital rose, exactly according to Marx’s law ‘as such’.  The rate of profit did not fall much up to the point of the Great Recession because the share of profit rose to a record high!  So huge exploitation of the workforce compensated somewhat for the rising organic composition of capital.  D-L’s data confirm exactly what my own data show (see my book, The Great Recession, chapter six (developed in 2006) and various papers).  And yet B-V and D-L argue that Marx’s law of profitability is not relevant to the current crisis.

I updated D-L’s data to 2011.  I find that the data confirm a previous estimate that I made for 2011 (see my post, Why is the US recovery so weak? – look at profitability, 3 April 2012).  Despite the very high mass of profit that has been generated since the economic recovery began, the rate of profit stopped rising in 2011.  That’s a sign that the US capitalist economy will not achieve any significant sustainable growth over the next year so so.  The rate remains below the peak of 1997.  But the rate is clearly higher than in was in the late 1970s and early 1980s at its trough.  That can be explained by one counteracting factor, namely the record high rate of surplus value in recent years.  But it also suggests that there is still a long way down to go for US capitalism before it reaches the bottom of the current down phase.

This brings me to a really excellent paper by Jose A Tapia Granados entitled Does investment call the tune?  Empirical evidence and endogenous theories of the business cycle, to be found in Research in Political Economy, May 2012, 

Tapia’s paper is in two parts: the first part is a discussion of the various theories of economic crisis to be found from Keynes, Kalecki and Minsky and from Marx.  The second part is an empirical analysis to try and show who is right.  I love that approach.  First let’s analyse the theoretical arguments and then let’s look at the evidence.  That’s what I try to do in my papers.  Tapia does it so much better than me.

As he puts it: “a major issue is whether there exists a key variable or variables that exerts a major influence on the economy and serves as the major determinant of its dynamic condition of expansion or contraction”.  Exactly: if we cannot scientifically find a key cause of crisis, we shall remain in the dark.  As we have seen above, despite evidence, many Marxist economists find no common underlying cause of capitalist crises – each crisis has a different one apparently.

Tapia shows exactly where the Keynes-Kalecki explanation differs from the Marxist one.  As I have argued in recent posts (see Keynes, Kalecki and the profits equation, 13 June 2012) and to quote Tapia; “for the whole Keynesian school, investment is the key variable explaining macroeconomic dynamics and leading the cycle.”  Tapia shows, as I have done, that for the Keynesians, investment depends on the psychology of investors, which changes for no apparent reason into a loss of faith in expected profits.  Yes, profits do appear in Keynes-Kalecki analysis, but “in Kalecki, the determination is from investment to profits and in the relation there is little room, if any, for reverse causation.”  Indeed, by relying on investor psychology (“animal spirits”) as an explanation of the dynamics of the capitalist economy, Keynesians don’t really have an endogenous theory of crisis.  Crises happen because of unexplained things taking place outside the economic process.

And yet, as Tapia points out, when empirical work is done on the causes of ‘business cycles’ or booms and slumps in capitalist economies, all the mainstream economics researchers (Matthews, Wesley Mitchell, Tinbergen) conclude that the movement in investment is driven by movements in profitability.  But Keynes and the Keynesians ignored the evidence and continued with the mantra that “it is investment that calls the tune” , to use the phrase of Hyman Minsky.  This is the direct opposite of Marx’s view that ‘profits call the tune’.

Tapia considers the evidence on these conflicting views using the US economy.  He shows that over 251 quarters of US economic activity from 1947, the movement in profits was much more volatile that movement in wages or even investment.  Most important, “corporate profits stop growing, stagnate and then start falling a few quarters before a recession”.  Profits then lead investment and employment out of each recession.  In the long expansion of the 1990s, profits started declining long before investment did (profits fell back in 1997 while investment went on growing until 2000, when a crisis ensued).  “In all these cases, profits peaks several quarters before the recession, while investment peaks almost immediately before the recession.”  Using regression analysis, Tapia finds that pre-tax profits can explain 44% of all movement in investment, while there is no evidence that investment can explain any movement in profits.  This confirms my own empirical analysis of the Great Recession where I show that profits fell for several quarters before the US economy went into a nose dive (see my book, The Great Recession, chapter 24, written in 2007).

Thus the process of capitalist boom and slump can be summed up in this way.  If the rate of profit is rising, this will lead to faster capitalist accumulation, employment and incomes.  However, that cannot continue as Marx’s law of profitability will apply.   Counteracting factors can reverse the effects of the law as such for a while, for even a decade or more, but eventually the rate of profit will start to fall.  When the rate falls sufficiently to cause a fall in the absolute mass of profit, an economic crisis will follow within a few quarters.  That slump will not end until profitability is sufficiently restored through the destruction of capital values (bankruptcies, banking collapses, closure of plant, laying off of labour, writing off of debt etc).  Then investment will follow.  So it is profits that call the tune.

The current recovery from the Great Recession has been so weak and has festered into a long depression like the 1880s and 1890s because of the huge build up of capital (real and fictitious) previously.  The ‘deleveraging’ of this dead capital will take a long time – indeed the major capitalist economies are only halfway through that process.  I shall visit the question of debt and deleveraging in a future post.

7 thoughts on “Profits call the tune

  1. Dear Sir,
    I read an article from and here is the quote
    from Deutsche Bank’s Jim Reid

    “Our shorter business cycle theory (or return to normal length ones at least) first discussed two years ago was based around what we saw as a future lack of policy flexibility from the monetary and fiscal side. It feels like Europe has proved us right but that the US has the ability to disprove the universal nature of our theory. If this US cycle is of completely average length as seen using the last 158 years of history (33 cycles) then the next recession should start by the end of August. The average expansion has been 39 months over the period. One way the US can disprove us over the next 6-12 months is if they find a way of maintaining what are record peace time budget deficits thus showing that they retain fiscal flexibility where virtual every other country has had this reduced. Perhaps much depends on the election, the next budget ceiling point and crucially the Fiscal cliff debate.”

    What do you think?

    Thank you

    1. Reid is talking about the four-year Kitchin trade cycle. If the last trough was mid-2009, then the next trough would be in mid-2013. Reid has reduced that cycle to to 39 months, so the trough comes this August, according to him. We already have a slowdown in the US economy to justify this trough. My high frequency data do not suggest the Kitchin trough will mean an outright recession this year (it does not always mean a recession). My best bet for the next recession is maybe next year or 2014. But don’t hold me to that! For more on various cycles, see my book, The Great Recession.

  2. Very nice. My investigation concurs with the ROP peaking in 1997-1998, and that in the “recovery” after the 2001-2003 recession the ROP did not exceed that level.

    In the 2004-2007 recovery, profitability did increase from its recession levels based on maintaining wages below their 2000 level and rigid controls on capital expenditures. As the recovery increased, that control is relaxed and the peak in the ROP for this period in 2006 coincides with a increases in capital spending, increases which continue into 2007.

  3. Keeping real wages below levels reached in 1964 helped the capitalist class with the problem of a falling rate of profit. Working class consciousness about the nature of the wage system was never put on the political agenda by the radical liberals who call themselves ‘the left’. To be made, profits depend on sales and if the marketplace has insufficient funds/wages to sop up the commodities, the wage system sputters and spits and the ruling class wonders where to put all the unemployed it doesn’t already have in prison or the military.

  4. Except the marketplace always has “insufficient wages to sop up the commodities.” The basis of surplus value is that the wage only covers the cost of the reproduction of labor and is not the value equivalent for the entire labor time commanded by capital. Don’t think the predicament of capital is ever one of “insufficient– pick one– wage/demand/consumption” since insufficient wage/demand/consumption is, at core, the very heart of profit.

  5. An excellent ongoing discussion of the decline in return on assets in the American economy, and much neglected by Marxists, can be found in Deloitte’s Shift Index studies. These studies have followed 20,000 publicly traded firms between 1965 and 2010 to yield a comprehensive measure of profitability. All iterations (2009. 2010, 2011) are accessible on the web. It shows that the rate of return on assets (not simply “fixed capital”) has been in dramatic decline for the past 45 years. It moreover demonstrates this decline both with and without integrating the banking sector. However, once the banking sector is included, which now accounts for 60% of total assets (30% in 1965), the decline is even more pronounced.
    More specifically, this comprehensive review found that “US companies’ return on assets (ROA) have progressively dropped 75 percent from their 1965 levels despite rising labor productivity”, a near doubling of labor productivity to be more precise.


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