On the Falling Tendency of the Rate of Profit

A (very) brief explanation for those not familiar with this issue…
Based on an unfinished exercise by the late Ronald Meek

(if you have read about this before and just want to go to a demo, skip to the very end…)

 

Even if this is a very controversial law – it has always been the subject of polemics and different interpretations – the law of the falling tendency of the rate of profit seems to explain the inherent logic of the capitalist system and its bumpy historical development. This law expresses the contradiction between, on the one hand, the processes of accumulation and its technological progress (spured by the profit motive) and, on the other, the consequent increases in productivity and related relative reduction in employment opportunities for those that have to sell (or lease…) their available work-force.

On the other hand, the manifestation of the law of the falling tendency of the rate of profit expresses itself at the deepest level of economic reality: the level of values. To use a metaphor, the analytical level of values is equivalent to a geological layer upon which is based the «geography» of prices. In this sense, any «earthquake» defined in terms of values, always ends up being reflected in crisis and visible phenomena in monetary terms, such as prices, overproduction of goods and services, lack of purchasing power, monetary movements, inflation and unemployment. These phenomena vary from country to country, both according to geography and to institutional arrangements.

In the «geological» level of values, we then consider the set of relations between constant capital (one that corresponds to stored-up labor from previous cycles (such as technologies, machinery, materials, buildings and other structures …) and variable capital (that which corresponds to the payment of goods and services necessary for the reproduction of the labor-force);

The sum of constant capital and variable capital becomes the total capital invested (both at the level of a single company, a sector of activity or the economic system as a whole. All this is measured in terms of «average number hours of socially necessary labor» (to reproduce whatever it is, in a sense, «from scratch»).

From the relationship between constant capital and variable capital results the concept of «organic composition of capital». At the geological level, this variable capital (the total labor that is spent in production) is supposed to add new value during the process of production. This value that has been added is the one and only source of profit (latu sensu). When these profits are «converted» into price terms, they are the sole source from which «entrepreneurial» profit, taxes, rents and interest will be paid.

In the rudimentary model that is presented here, the rate of «gross profit» (at the «geological» level…) is then expressed as a fraction where the numerator is the value added in each annual cycle and the denominator is the sum of Constant capital and Variable capital. Through an elementary mathematical manipulation (dividing both terms of the fraction by the amount of variable capital) we then obtain an equation somewhat more complex in that the «rate of profit» is equal to «the rate of value added» divided by the sum of the «organic composition of capital» plus one.

In this rudimentary model what is proposed is simply this:

- The system is continuously subjected to a process of accumulation which is achieved at a certain rate. This is called «Flow Back Rate» (the proportion of the product that flows back into the system as new capital…).

- As a result of that flow back rate, there is an impact on both types of Capital with related improvements in productivity of both Constant and Variable capital. This leads to changes in the proportions of Constant and Variable capital in the investment decisions for each cycle (or iteration) of the model.

This seems to correspond to the overall logical principles underlying the historical reality of the capitalist system, at the «geological» level of economic activity.

At this stage of model development, the number of average hours worked by the working population as well as the rate of value added (also known as «exploitation rate»…) is assumed as constant.

What the experimenter can do then is to «assess» the impact of a higher or lower rate of reflux and its impacts in the proportion of constant capital and variable capital.

As can be seen the rate of profit always starts by increasing (as per the «Okishio Theorem»…) rise but eventually comes to stagnate and to decline.

RECENT DYNAMICS OF THE CAPITALIST SYSTEM

AN ANALYTICAL SKELETON IN 20 PARAGRAPHS…

1. By virtue of its intrinsic logic, in particular the mechanism of competition, the system has to grow and accumulate… Accumulate and grow.

2. The engine and carrot of this intrinsic logic of the functioning of the system (what makes entrepreneurs, top executive managers and «investors» run…) is the obtaining of PROFIT.

3. In the control of the functioning of the system, the mechanism that works like an «accelerator», a «brake» and as a «gear box», is the indicator of the rate of profit. This happens in different ways, according to the phases of the evolutionary process of the system. It turns out that there is no driver and that the evolution of rate of profit goes through periods of growth, slowdown, stagnation and decline.

4. Meanwhile… the global amount of corporate profits is supposed to be divided beteween RENTs (payable to “rentiers or «landlords”), INTEREST (payable to ‘banks’ or owners of ‘financial capital’ and TAXES (payable to the State in exchange for the provision of services essential to the functioning of any economy (infrastructures… public sanitation… justice… security …)

5. When the RATE of profit begins to fall, unless they manage to obtain a brutal reduction in overall unit labour costs (including through delocalizations to «greener pastures»…). business owners executives and their executive managers begin a frantic search for other outlets for the surplus funds accumulated, as well as for the not yet visible output of potential reproductive investment. In other words, «investment opportunities»…

6. Thus, in that situation, when the RATE of profit begins to fall, in order to keep the mass of profits intact, owners of capital will also seek to reduce transfers to «rentiers», «banks» and the «State»…

7. As the owners of Capital (through its owners and managers) combines (interchanges…) easily with «rentiers» and «banks», the «costs» of this reduction in transfers will always and eventually be left to the Res Publica, ie the STATE.

8. From this «dodging» to bear the burden of that reduction in the overall average rate of profit, has resulted the systematic demand from «business» for a widespread and systematic reduction in corporate tax rates and those tax rates that are applicable to the higher echelons of personal income tax rates (owners and executives of Capital); from progressive tax system to regressive tax systems. That demand has led to generalised tax competition among states.

9. Meanwhile… Through the normative activities of the IBSA («International Accouting Standards Board» – a private entity sponsored by the largest international accounting and auditing firms), large corporations have searched for, and achieved, the manipulation, adjustments and control in the standards of international business accounting, to facilitate the opacity in their declaration of global income, rather than a transparent «country-by-country» statement of accounts.

10. At about the same time… Auditing firms managed to obtain flexibility of standards and legal framework of the audit activity by obtaining (starting with the Isle of Jersey in 1997) the passing of new laws of Limited Liability Partnerships which provided for limited an individual responsibility of individual auditors, instead of the previous law of joint and unlimited liability on audit firms. This caused a general slackening of auditing practices and encouraged malpractices in the management of many large corporations.

11. The liberalization of movements of financial capital and the creation of the financial market called the «Euromarket» (not to be confused with the «euro») has enabled an «exit option» out of any State regulations. The «eurodollar» is an hybrid new currency that corresponds to bank accounts designated in US dollars, that are placed in banks outside the U.S.. As a result these accounts are out of the reach of control or regulation of any State authority and also free from the conventional standards of prudent “fractional banking” (in very simple terms, «the requirement for an approximate 10% ratio between the total amounts of deposits and the total amounts of loans»).

12. Meanwhile, from the incessant and continued productivity gains in society as a whole, come to result a natural corporate tendency for a «systemic relative reduction of wages» and a concomitant growth in «systemic unemployment»… This in turn reduces the purchasing power for the bountifull amount of goods and services that are being produced

13. Thus, if the system reduces the purchasing power, there arises a systemic need for the facilitation of access to credit. As noted by Financial Times: «Debt, is capitalism dirty litke secret» (Ben Funnell – June 30 2009).

14.As a result of the falling rate of profit (points 3, 4 and specially point 13) there results a DOUBLE BIFURCATION in interest rates: according to the «entities» and the «end use of credit». In the case of interest rates charged by the central banks those interest rates come close to zero (to make credit cheaper to businesses and so encouraging business to borrow and invest …). In the case of interest rates charged by commercial banks (consumer credit) rates are free to rise and fall depending on the play of «supply» and «demand» in conjunction with the banks’ need to sell credit.

15. Relaxation of usury laws (which restricted or limited the interest rates on consumer credit …) and a decision by the U.S. Supreme Court has allowed banks (and their credit card companies) to «export» higher interest rates from some States to other States. From about 8% to about 24% now… This practice (of easy but expensive credit…) came naturally and logically to be generalized to the whole world. 1978 decision on Marquette National Bank of Minneapolis versus First of Omaha Service Corp. (439 U.S. 299)

16. Despite the increase in consumer interest rates, and through multiple promotional campaigns, in the style of «buy now and pay later» there came about an exponential increase in consumption on credit by households. As a result there was also an exponential increase in the overall private debt.

17. Meanwhile, tax competition between national States would eventually lead to a generalized reduction of corporate tax rates and a reduction of marginal tax rates (whereby the rich are paying relatively less…). From thence the result could only have been a growing increase in budget deficits and public debt.

18. Meanwhile, the ineffectiveness of reducing interest rates as an incentive to reproductive investment has become notorious. As already noted by various scholars of the Keynesian approach, «you cannot push a cart with a rope». Whereby the «rope» is the monetary policy and the «cart» is the productive economy of goods and services.

19. In the particular case of the Eurozone and taking advantage of the specific status of the ECB, Member States are required to fund themselves by going to commercial banks rather then, as in the old days, having recourse to the issue of national currency with each national central bank. As a result of this, commercial banks in Europe have taken to «refill» themselves with the ECB and then profit from the financing of «public debt» of each European state…

20. Considering the following systemic features that are now prevailing in the world economy, namely:

20.1 – Systemic growth of unemployment resulting from overall productivity gains

20.2 – Fiscal competition amongst sovereign States

20.3 – Lower taxation for the largest corporations and the very rich

20.4 – Lax or reduced supervision of banking activities

20.5 – Free (or uncontrolled) creation of virtual money

20.6 – Free (or uncontrolled) movement of financial capitals accross borders

20.7 – Relaxation of usury laws and exponential growth of consumer credit

If the operation of the system is to continue without a «pilot cum driver», the only natural and logical result that must come from all this, is a recessionary spiral and a natural tendency to instability, chaos and the possibility of «wars» and the continued growth of social anomie…