The profitability of crises

I was recently interviewed on my book, The Long Depression, and on other economic ideas, by José Carlos Díaz Silva from the Economics Department of the National University of Mexico (UNAM) where I have been invited next March 2018 to deliver a series of lectures.

In the first part of this interview, Jose questions me on the basic themes of my book.

JCD: In general terms, how could you explain the recent crisis? Can we link the United States crash in 2008 with the problems that followed in Spain, Greece and Ireland, and the latter with the recent scenario as a unique process of crisis?

MR: In my book, The Great Recession and my subsequent book, The Long Depression, I argue that the global financial crash of 2008 and the ensuing deep global slump in capitalist production were caused by a combination of the falling profitability of productive capital (Marx’s law) and excessive borrowing to speculate in fictitious capital (stocks, bonds and property).  At a certain point, bank lending and mortgages and their ‘diversification’ into mortgage-backed derivatives (bought worldwide) could no longer be funded as profit in productive sectors dropped and incomes fell back.  The great Ponzi scheme of financial speculation then collapsed and revealed the underlying failure of capitalist production.  Investment plunged and took employment, incomes and consumption down with it.

This is the ‘normal’ process of capitalist crisis: profitability falls to a point where profits in total stop rising, then investment collapses and the costs of capital (means of production and labour) are reduced violently.  This particular slump was worse because it was combined with the destruction of fictitious capital that had reached unprecedented levels; and because it was global.  Every major economy and financial sector was affected.  The banking crash and the massive credit squeeze spread to Europe.  The credit crunch hit the property markets of Spain and Ireland; and the excessive over-leveraged property and corporate sectors in Greece.  Greece was brought to its knees because of the previously wild borrowing at cheap rates by Greek corporations especially in property; and the tax evasion and capital flight of those corporates and the rich meant that the Greek government had insufficient revenues to handle a collapse in the economy and meet the demands of its creditors, the French and German banks.

So the Euro crisis was really a crisis of global capitalism.  But it had special features in that the weakest parts of the Euro area were hit hardest because they were dependent on investment from the core (Germany, France etc).  And the Euro leaders were unwilling to subsidise the weaker economies.

JCD: Why is important to build a general theory of capitalist crisis?

MR: If we do not develop general theories then we remain in ignorance at the level of surface appearance.  In the case of crises, every slump in capitalist production may appear to have a different cause.  The 1929 crash was caused by a stock market collapse; the 1974-5 global slump by oil price hikes; the 2008-9 Great Recession by a property crash.  And yet, crises under capitalism occur regularly and repeatedly.  That suggests that there are underlying general causes of crises to be discovered.  Capitalist slumps are not just random events or shocks.

The scientific method is an attempt to draw out laws that explain why things happen and thus be able to understand how, why and when they may happen again.  I reckon that the scientific method applies to economics and political economy just as much as it does to what are called the ‘natural sciences’.  Of course, it is difficult to get accurate scientific results when human behaviour is involved and laboratory experiments are ruled out.  But the power of the aggregate and the multiplicity of data points help.  Trends can be ascertained and even points of reversal.

If we can develop a general theory of crises, then we can test against the evidence to see if it is valid – and even more, we can try and predict the likelihood and timing of the next slump.  Weather forecasting used to be unscientific and just based on the experience of farmers over centuries (not without some validity).  But scientists, applying theory and using more data have improved forecasting so that it is pretty accurate three days ahead and very accurate hours ahead.

Finally, a general theory of crises also reveals that capitalism is a flawed mode of production that can never deliver a harmonious and stable development of the productive forces to meet people’s needs across the globe.  Only its replacement by planned production in common ownership offers that.

JCD: When talking about the pertinence of the falling profit rate as a determinant of the crisis, it is commonly underlined in Marx’s works as the strongest explanation. This is, if Marx himself considered the falling profit rate as the foundation of the main explanation of the crisis, then we should think of it as correct, but if we find some textual evidence, in the Marx’s writings, that shows he abandoned this thesis In his last years of work, then it will be incorrect thinking on the falling rate of profit as the main explanation of the crisis. How fruitful is this way of doing research? Is it possible that waiting for the “Marx approval” is a noxious one for the possibility of constructing a theory of crisis?

MR: Interpreting Marx’s voluminous writings to ascertain what his theory of crises is useful, but only to some extent.  Marx’s contribution must be the foundation of any effective and relevant theory of crises under capitalism, in my view.  But as you say, there can be many interpretations and Marx’s unfinished works lead to ambiguities that can exercise academics and scholars for a lifetime!  So there are severe limits on this type of research.  Even if we were to agree on what Marx’s theory of crises is (or even that he had one – because that is disputed), what if he were just wrong?

Moreover, it is 150 years since Marx developed his analysis of capitalism based on the main example of British capital in the mid-19th century.  The world and capitalism has moved on since then – in particular, it is the US that is now the dominant hegemonic capital, capitalism is now global and controlled even more than before by finance capital.  Thus a theory of crises must take into account these new developments.  Also, we have much more data and information to work on compared to Marx’s limited access.  The task now is not to keep analyzing and re-interpreting Marx, but to stand on his shoulders and raise our understanding.

JCD: If we define the organic composition of capital as the level of the value of the means of production to the value of labor power, does this variable depend on distributional factors or the profit rate? Do you think it is important to take into account the materialized composition of capital and the organic composition of capital?

MR: The organic composition of capital is an important Marxian economic category.  It shows the social relation between human labour and machines as the means of production.  Under capitalism, individual capitalists compete to extract the maximum amount of value (and surplus value after paying for the wages of labour power) from their workforces.  That competitive drive for profit (getting the greater share of the total value produced) pushes capitalists to increase their use of machinery in order to raise the productivity of labour by shedding labour (costs).  So Marx reckoned that a rising organic composition of capital was the long-term tendency of the capitalist mode of production.  Indeed, it was the basis of the law of the tendency of the rate of profit to fall (the law as such).  The organic composition of capital is measured in money but Marx says its mirrors the technical composition of capital (machines measured in hours of labour against the amount of hours worked).  However, the increase in machinery by capitalists to replace labour will raise the productivity of labour and reduce the value of labour power if the costs of reproduction of labour fall.  And it can also reduce the costs of machinery.  So the value composition of capital can fall.  But Marx said that, as a rule, this would only slow the rise in the organic composition of capital, not cause it to fall over the long term.

All the empirical evidence shows that Marx was right.  So the basic assumption of Marx’s law of profitability, that there will be a rising organic composition of capital over time, is realistic and proven.  If there is no change in the rate of exploitation or surplus value of the workforce, then a rising organic composition will lead to a fall in the rate of profit.  However, increased mechanization will usually lead to a rise in the productivity of labour and the rate of surplus value.  This acts a counter-tendency to the rising organic composition of capital and the tendency of the rate of profit to fall.  But the tendency will override the countertendencies over time.

JCD: Is the dynamic between the falling profit rate and its counter tendencies the explanation of the economic cycles? Why is so? Which are the differences with the ideas of the Kondratiev’s long waves and the one of Schumpeter about the cycle?

Yes, in Marx’s theory, it is the dynamic between the rising organic composition of capital and the counter-tendencies of a rising rate of surplus value and a falling value composition of capital.  Marx’s law of profitability means that eventually a fall in the profit rate leads to a fall in the mass of profit or at least a fall in new value created.  This leads to a slump in new investment. Capitalists then look to reduce their costs of capital (labour power and assets). So capital values are devalued (after the bankruptcy and merger of capitals and a large increase in the reserve army of labour) to the point where the mass and rate of profit begins to rise again for the surviving capitalists and then investment resumes, and with it employment and incomes. The whole cycle commences again.

In my view, this profit (ability) cycle, as I call it, is the basis of the so-called business cycle.  But it is not the same as the business cycle.  That is affected by the turnover of capital in productive sectors and in unproductive sectors like housing, also by international trade etc.  The profit cycle from trough to trough can last 30-36 years, while the modern business cycle (Juglar) appears to be 8-10 years.  So, for example, in the period 1946-82, there were several business cycles or slumps (1958, 1970, 1974-5, 1980-2).

The Kondratiev cycle, if it exists, and I am inclined to think so, is much longer term, over 54-72 years (I think it has been getting longer).  The K-cycle is driven by the swings in world commodity prices and probably by the cluster of innovation cycles delineated by Schumpeter – but also by the direction of the profit cycle.  The K-cycle has been getting longer because people are living longer (at least in the major economies), so the generational effect is now four times 18 years, not four times 14 years, if you like.  This affects the length of the innovation cycle of discovery, development, explosion, maturity and stagnation – possibly.  In many ways, these are all hypotheses to be proven. Data points are few.  But I argue in my book, The Long Depression, that the conjunction of the downward phase of the K-cycle, the profit cycle and Juglar cycle only happens once every 60-70 years.  When it does, capitalism has a depression rather than just a ‘normal’ slump.  This was the case in the 1880s, the 1930s and now.

JCD: What are the main difficulties for calculating the profit rate? Is there some way of calculating the circulating capital turnover? If it would be possible to calculate the capital turn over, how different the calculation of the profit rate could be? This can explain the constancy of the materialized composition of capital that some have shown?

MR: The difficulties of measuring the rate of profit from the view of Marxian categories are manifold!  First, we must use official statistics that are not accumulated in the best way to measure Marxian categories.  Indeed, some Marxist economists reckon that trying to measure the rate of profit using official statistics in money is impossible and pointless.  Others reckon that the data are so poor we cannot do it practically.  I do not agree.  It is the job of any scientific analysis to overcome these theoretical and practical difficulties in measurement.  And many Marxist economists are doing just that.

On categories, should we measure the rate of profit of the whole economy, or just the capitalist sector, or just the corporate sector, or just the non-financial corporate sector, or just the ‘productive’ sector?  Should or can we include variable capital and circulating capital in the denominator?  Should we measure gross profit or net profit after depreciation?  Can we measure depreciation correctly?

All these various measures are useful and possible.  The data are available for many major economies and many Marxist scholars have now made such measurements.  And yes, variable capital should and can be included empirically.  And there has been work on measuring the impact of the turnover of capital too.  What increases confidence in this work is that, by and large, whatever measure is used, it shows, for most countries, over time that the rate of profit has been falling.  Of course, not in a straight line because there are periods when the counteracting factors dominate, if only for a while.  And each major slump produces a temporary recovery in profitability.  But these turning points are also broadly at the same time.  All this increases confidence that Marx’s law of profitability is valid and relevant to an explanation of recurrent crises under capitalism and also its eventual demise as a mode of production.

JCD: Which is the correct way of calculating the profit rate: historical cost or current cost? Why is so?

MR: Theoretically, capital accumulation should be seen as temporal.  By that I mean, a capitalist must pay a certain money amount for machinery and raw materials to start production.  Then the workforce is employed to produce a new commodity for sale.  It does not matter if the cost of replacing that machinery in the next production cycle has changed.  The profit for the capitalist should be based on the original (historic) cost of the machinery etc not on its current (replacement) cost.  So the rate of profit properly measured should use historic cost measures.  However, this is a matter of theoretical debate, with some scholars arguing for replacement costs and some arguing for something in between!  What is interesting is that the difference this makes to the measurement of the rate profit is greater or lesser according to the change in prices of the means of production over time.  So in the recent period where inflation has been low, particularly for capital goods, over time, the difference between the rate of profit measured on historic costs versus current costs has narrowed.

JCD: Why is the profit rate not in the core of the recent discussion about the crisis, both in the academic and journalistic field? Is it not paradoxical speaking about capital without underlining the profitability determinants?

MR: The reason that profitability is not considered in any discussion of crises is both ideological and theoretical.  Mainstream economics has no real theory of crises anyway: crises are just chance, random events or shocks to harmonious growth under capitalism; or they are the result of the interference in competition and markets by governments, or central banks; or they are result of monopoly or financial recklessness or greed.  Mainstream economics also denies any role or concept of profit in its marginalist theories of production and demand.  This is deliberate: there is no place for a theory of profit based on the exploitation of labour power (Marx’s value theory).  Diminishing returns on utility and productivity lead to no profit at the point of equilibrium.  Also heterodox/Keynesian theories also deny the role of profit, as they are also based on marginalism and (im)perfect competition.  Crises are therefore the result of a ‘lack of effective demand’ caused by an ‘irrational’ change in expectations (‘animal spirits’).  It has nothing to do with the profitability of capital, apparently – or more precisely the exploitation of labour.  And yet capitalism is a system of production for profit in competition.  So why is profit not a determinant in investment and production?  It is an ideological refusal to accept that.  Instead apparently, everybody gets their fair share according to their (marginal) contribution.  The mainstream finds no explanation of crises as a result; and the Keynesians look to ‘demand’ not profit as the driver of crises.

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8 Responses to “The profitability of crises”

  1. Peter Wright Says:

    Michael
    I fear that attempts to “model” capitalism are doomed to failure. Human institutions change and, as a former economic modeller, I found that the very existence of a forecast, if acted upon, can change the result. Human responses are not a factor in weather forecasting but they are very much so in the modelling capitalism while data in economic modelling is a lot noisier than in weather forecasting. I would settle for some rules of thumb, e.g., debt, investment and profitability matter and can be, at least roughly, quantified.

    • Edgar Says:

      “Human responses are not a factor in weather forecasting”

      Well they are if we factor in human responses to global warming. In the long term the actions taken in response to the forecast can affect the forecast.

      “I would settle for some rules of thumb”

      You can’t really settle for these without building an understanding of the system. You don’t actually need a model to tell you profitability matters under capitalism, it is a self evident fact. You don’t need a rule of thumb for this either, as any child knows the truth of this. The question isn’t does profit matter but what determines profit and its trends and what are the affects of this movement. Having a rule of thumb for whether profit matters under capitalism is like asking for a rule of thumb about whether oxygen is important for humans, the question needs to be different if related. Building a model is about building the framework, the key categories or dimensions to use a modern term. Unless these dimensions fundamentally change you can model a system based on various assumptions or holding various variables, then asking questions around this. The economic questions are not about will it be raining tomorrow at 8 o’clock, they are not this precise. Economic forecasting is about trends, determining patterns.

      The degree to which human action affects this modelling depends on how you see the human influence, are human beings just actors in this system, passive elements being controlled by greater forces, or do humans fundamentally give the system its character. This depends on the specific questions being looked at.

      “I found that the very existence of a forecast, if acted upon, can change the result.”

      This is sort of the point of a forecast when you really think about it, what would be the point in forecasting if no response was expected? If I am told it is going to rain I take a brolly out with me, if I am told it is going to be sunny I may wear sun cream.

      But I suspect from a Marxist point of view the economic forecasts you were looking at were pointless, irrelevant and trivial.

  2. Charles A. Says:

    A crucial question for an interview of you is: Crises have recurred throughout the 200-plus years of industrial capitalism. Karl Marx, in addition to providing the value theory tools to explain why, also suggested that a mode of production reaches a phase when it can go no further in some economic sense. Then begins the era of revolution. How do you distinguish between a deep depression, or the bottom of a Kondratiev cycle if such things exist, and the arrival of that phase? (My answer is in The Hollow Colossus, but this is your platform.)

  3. Rudy Says:

    Yes, and while that, the number os millionaries (holding financial assets, excluding their primary residence, with a value greater than US$1 million) is now 15.36 million. They, together, have a US$ 58.7 trillion fortune
    https://www.worldwealthreport.com/reports/wealth

  4. Boffy Says:

    “If there is no change in the rate of exploitation or surplus value of the workforce, then a rising organic composition will lead to a fall in the rate of profit.”

    The problem being that the rise in the rate of surplus value, and of the rise in the organic composition of capital, are as Marx says two sides of the same coin, as the rising rate of surplus value means rising productivity, which means a given quantity of labour processes a greater quantity of material!

    Secondly, that Marx makes clear that his Law of a Falling Rate of Profit, as opposed to that of Smith, Malthus or Ricardo, is based upon a rising rate of surplus value!

    Smith argued that capital was in shorter supply than labour, and so capital was able to appropriate some or all of the surplus value, as a result of the price of capital relative to labour. But, he thought that capital accumulates faster than growth of population, so that this excess supply of labour disappears, and so profit is competed away. Marx says that Smith thought that this competing away of profit, so that the labourers obtained the full fruit of their labour was a good thing. However, he recognised that if profit disappeared it would cause a permanent crisis for capital. Its in that context that Marx wrote,

    “A distinction must he made here. When Adam Smith explains the fall in the rate of profit from an over-abundance of capital, an accumulation of capital, he is speaking of a permanent effect and this is wrong. As against this, the transitory over-abundance of capital, over-production and crises are something different. Permanent crises do not exist.”

    However, this fall in the rate of profit caused by such a profits squeeze, as at times labour becomes in short supply, when capital expands extensively, and the growth in productivity slows, does occur periodically. It is synonymous as Smith et al recognised with a fall in the rate of surplus value causing a falling the rate of profit. It is the kind of profits squeeze leading to overproduction that Marx describes in Capital III, Chapter 15, in Chapter 6, and again in dealing with Ricardo in Theories of Surplus Value Chapter 17 and 18. It is the opposite of Marx’s theory of the Law of Falling profits.

    Malthus adopted a mercantilist theory of profit as a surcharge added on to the value of commodities, and in which he defines the value of commodities not by the labour-time they required for production, but by labour defined as wages. He recognised that profit cannot then be realised in exchanges between capitalists, and that the workers cannot buy back all of their output, so he argues that it is necessary for someone in society to consume without selling, to only spend money. Enter the landlords, clergy and other parasitic elements for whom Malthus is the apologist. He argues that they must obtain rent etc. so that they can consume the surplus product, allowing capital to realise its profits, and be given an incentive to accumulate. He argues that if capital simply uses its profits to accumulate then the population will expand faster than agriculture can meet its needs so that workers will starve to reduce the population.

    Marx says that Ricardo correctly did not buy Smith’s fairytale view by which capital would expand faster than the workforce, causing wages to eat away profits. Instead, Ricardo argues that the workforce will always expand fast enough to meet the needs of capital because as wages rise, workers marry earlier, and have more children etc. Rather then for Ricardo, the problem is that as the workforce expands, and as the demand for agricultural products expands, in order to meet this demand agriculture has to move to less fertile land.

    The result then is that as agricultural productivity falls, the price of food rises, and the price of other agricultural products rises. As agricultural prices rise, Ricardo says, rents rise. Revolutions in technology, periodically cause the prices of other wage goods to fall, but not enough to offset the rise in the value of labour-power caused by higher food prices. Wages therefore, have to rise, and this rise in wages causes the rate of surplus value, and ultimately the mass of surplus value to fall causing the rate of profit to fall. The rise in rent, as agricultural prices rise, also means that profit is squeezed by rent taking a larger chunk of it. It was this inevitable long term squeeze of profits caused by rising wages and rising rents that Marex says, caused Ricardo to fear the inevitability of some ultimate collapse.

    But, the whole point of Marx’s explanation of the tendency for the rate of profit to fall, was to show that all of these catastrophist theories are wrong!

    Marx says,illustrating that it is rising productivity and a rising rate of surplus value, manifest in the greater quantity of material processed by any given quantity of labour, that stands behind the law,

    “The progressive tendency of the general rate of profit to fall is, therefore, just an expression peculiar to the capitalist mode of production of the progressive development of the social productivity of labour. This does not mean to say that the rate of profit may not fall temporarily for other reasons. But proceeding from the nature of the capitalist mode of production, it is thereby proved logical necessity that in its development the general average rate of surplus-value must express itself in a falling general rate of profit. Since the mass of the employed living labour is continually on the decline as compared to the mass of materialised labour set in motion by it, i.e., to the productively consumed means of production, it follows that the portion of living labour, unpaid and congealed in surplus-value, must also be continually on the decrease compared to the amount of value represented by the invested total capital. Since the ratio of the mass of surplus-value to the value of the invested total capital forms the rate of profit, this rate must constantly fall.”

    It requires no more than a passing remark at this point to indicate that, given a certain labouring population, the mass of surplus-value, hence the absolute mass of profit, must grow if the rate of surplus-value increases, be it through a lengthening or intensification of the working-day, or through a drop in the value of wages due to an increase in the productiveness of labour, and that it must do so in spite of the relative decrease of variable capital in respect to constant.

    The same development of the productiveness of social labour, the same laws which express themselves in a relative decrease of variable as compared to total capital, and in the thereby facilitated accumulation, while this accumulation in its turn becomes a starting-point for the further development of the productiveness and for a further relative decrease of variable capital — this same development manifests itself, aside from temporary fluctuations, in a progressive increase of the total employed labour-power and a progressive increase of the absolute mass of surplus-value, and hence of profit.” (ibid p 219-20)

    “Thus, the same development of the social productiveness of labour expresses itself with the progress of capitalist production on the one hand in a tendency of the rate of profit to fall progressively and, on the other, in a progressive growth of the absolute mass of the appropriated surplus-value, or profit; so that on the whole a relative decrease of variable capital and profit is accompanied by an absolute increase of both. This two-fold effect, as we have seen, can express itself only in a growth of the total capital at a pace more rapid than that at which the rate of profit falls.” (ibid p 223)

    One of the reasons that Smith was wrong, Marx shows is that, when labour does become periodically in short supply, pushing up wages and reducing the rate of surplus value – squeezing profits – not only does that cause a slow down in accumulation, so that the demand for labour declines relatively, but it prompts capital to seek out new labour saving technologies. In Value, price and profit, Marx gives the example of the period from 1849-59 in that regard.

    So, capital not only acts to determine the demand for labour, but also its supply, because by introducing these labour-saving technologies, it creates a relative surplus population, so that wages are pushed back down again. Its the fact that such labour-saving technology introduced during periods of intensive rather than extensive accumulation, replaces labour that its during such periods that Marx’s Law of the Falling Rate of Profit really comes into play, because its during such periods that productivity and the rate of surplus value is really ramped up, that the growth of c, in the shape of a greater mass of material relative to labour is processed.

    The Smithian, Malthusian, Ricardian theory of a falling rate of profit is a cause of crises because it implies not just a falling rate of profit, but a falling rate of surplus value, and falling mass of profit. But, marx’s theory of a falling rate of profit comes in as the solution to such crises, as it requires it requires and brings about a rise in the rate of surplus value, a rise in the mass of profit, an increase in the relative surplus population, a depreciation of the fixed capital stock, and thereby creates the conditions for a new more rapid growth of accumulation.

  5. Mehmet Says:

    Michael, in every article of yours you insist on the same claim, that is “it is not demand, but the fall of the rate of profit is the cause of crisis”.

    But you are wrong!

    The fact that Keynasian economists see lack of demand as the main reason of the crises does not mean that when you say the opposite you’ll be a better marxist.

    Here’s how Lenin resumes your (and Keynasian economists’) mistake:

    “The difference is that the petty-bourgeois economists considered this connection between production and consumption to be a direct one, that they thought production follows consumption. Marx showed that this connection is an indirect one, that it only makes itself felt in the final analysis, because in capitalist society consumption follows production. But the connection nevertheless exists, even if it is indirect; consumption must, in the final analysis, follow production, and, if the productive forces are driving towards an unlimited growth of production, while consumption is restricted by the proletarian condition of the masses of the people, there is undoubtedly a contradiction present.”

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