Introduction
The general tendency of the profit rate, according to classical economists, is to decline as an economy expands. Here, profit does not refer to the profit of a single business or short-term gains; instead, it represents the long-term average profit of the entire economy. Classical economists argue that while short-term profits may fluctuate due to changes in demand and supply, the average rate of profit will eventually decline. They offer various explanations for this declining profit rate; each rooted in different aspects of economic behavior. Broadly, classical economists believe in the “inverse wage-profit relationship," meaning they see capital and labor as substitutes. As society progresses and the population grows, the increased demand for goods raises wages, which in turn lowers the profit rate for capitalists. Alternatively, as the economy expands, capitalists seek to maximize profits by substituting capital for labor. This over-accumulation of capital relative to labor ultimately leads to a continual decrease in the profit rate. Therefore, the overall growth trajectory of an economy is inherently linked to a declining profit rate.
This paper aims to outline the theories advocated by Adam Smith, David Ricardo, and Karl Marx. How their individual theories of profit support the “theory of the falling rate of profit” and how they have logically demonstrated it as a general tendency of an economy is the main focus of this paper. Additionally, this paper highlights some of the explanations these economists offer for other contemporary theories, using the theory of the falling rate of profit as a reference point. Sections I, II, and III explain the views of Smith, Ricardo, and Marx, respectively. Section IV concludes the paper by comparing these economists' theories of the falling rate of profit.
1. Adam Simt's View
Adam Smith, in his theory of profit, has neither provided a formal definition of profit nor a clear measure of the rate of profit. He has used the interest rate as a substitute for the profit rate. As he has stated:
“the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises. The progress of interest, therefore, may lead us to form some notion of the progress of profit” (p.122, The Wealth of Nations)
According to him, wages and profits in an economy fluctuate so rapidly that it is not possible to calculate the rate of profit at any specific point in time. However, the interest rate can provide some insight into the prevailing profit rate. Adam Smith aimed to explain the fluctuations in an economy's rate of profit. According to him, the rise and fall in profits depend on the stock of capital. He has mentioned:
“The increase of stock, which raises wages, tends to lower profit. When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit” (p.123, The Wealth of Nations)
As an economy grows, the capital stock in any sector increases, leading to competition among capitalists. They start bidding against each other for labor. This ultimately raises wages and lowers the rate of profit. The same logic applies to all sectors of the economy, so the general or average rate of profit tends to decline as the stock of capital increases. In other words, society's growth is linked to a decreasing trend in profit.
He tried to establish empirical evidence to support this theory. Using England's legal interest rate, Smith attempted to identify the general trend in profits in that country. During Henry VIII's reign, the standard interest rate was 10 percent, whereas during Queen Anne's reign it was 5 percent. This indicates a declining trend in profits in England. Based on this evidence, Smith also observed that the country's wealth and wages had increased significantly after Henry VIII. This suggests that as the country progressed, wages increased while profits declined.
Smith has also tried to show that a higher stock of capital is always associated with higher wages and lower profits. In a large town where the stock of capital is greater, competition among capitalists raises wages and lowers the rate of profit. Conversely, in a small village, profits are high because wages are lower. This logic also applies to countries at different stages of development. That means a rich country, with a higher stock of capital, has a lower rate of profit due to higher wages, whereas in a less developed country, profits are very high. But during that period, both wages and profits were higher in North America and West Indian colonies. Smith explained this as the result of an abundance of land relative to capital stock. Since these countries still operated on the most fertile land, profit rates were high there.
However, he has mentioned that the overall profit of a wealthy economy may rise if it discovers new territories and new trade routes. This was the case with Great Britain, where stock profits have not declined since it acquired North America and the West Indies. Similarly, profit could also increase with a reduction in the country's capital stock, since it would lower the wage rate.
According to Smith, as an economy grows, the stock of capital increases, and when it reaches an advanced level of development, the rate of profit becomes so low that only wealthy individuals, who invest larger amounts, can survive on it. Small businesses cannot sustain themselves with such low profit rates. Another important point is that although rich countries have lower profit rates, their growth is faster than that of poor countries with higher profit rates. As he mentioned:
“great stock, though with small profits, generally increases faster than a small stock with great profits” (p.129-130, The Wealth of Nations)
2. David Ricardo's View
David Ricardo defines profit as a residual amount that the capitalist receives after paying wages to labor and rent to the landlord. In his theory of profit, he attempts to explain the persistent variation in the overall rate of profit. He has stated,
“Supposing corn and manufactured goods always to sell at the same price, profits would be high or low in proportion as wages were low or high” (p.64, The Principle of Political Economy and Taxation)
Thus, according to him, any change affecting wages can also affect the rate of profit. He has considered the case of raw produce prices or necessities that determine wages in an economy. If the price of raw produce increases, laborers will demand higher wages in both the agricultural and manufacturing sectors. This will lead to higher overall wages, and the profit rate will fall. The increase in raw produce prices will impact the profits of nearly all sectors of the economy, either directly or indirectly. He stated that any rise in the prices of silk or velvet will not affect wages in general since the labor class does not use these products. Only the price of raw produce influences wages and profits.
Here, profit refers to the general long-term profit, not the short-term profit of an individual investment, which may fluctuate with market conditions. According to him, an individual enterprise's profit increase due to higher demand is temporary, since higher profits will attract capital from other businesses, causing the quantity supplied to increase. This will lower the price and, consequently, reduce the profit rate in the long run. This process is associated with the gravitation mechanism.
After defining the inverse wage-profit relationship, meaning higher wages imply lower profit, Ricardo established the general trend of profit in an economy. According to him, as society and the population progress, the demand for food increases. To meet this rising demand, farmers will either cultivate less fertile land or adopt intensive production methods. As a farmer shifts his cultivation from high-quality land to lower-quality land, the crop price increases. This is because the price is always determined based on the marginal land or no-rent land. With rising crop prices, laborers will demand higher wages, reducing profit margins. Consider the following example.
From the table below, it is evident that as the farmer cultivates lower-quality land, the same amount of labor produces less and less output, and prices start increasing, since price is determined by the marginal land. This rise in crop prices will also lead to increased wages. Here, we see that total revenue remains constant, but the farmer's share (profit) decreases as wages increase, and the profit rate also declines. The rate of profit is defined as the ratio of profit to total capital invested. We have assumed labor as constant, even though it produces less as the farmer moves from high- to low-quality land. In other words, the farmer must apply more and more labor to produce the same amount of output, which also reduces the rate of profit.
1. Adam Simt's View
Adam Smith, in his theory of profit, has neither provided a formal definition of profit nor a clear measure of the rate of profit. He has used the interest rate as a substitute for the profit rate. As he has stated:
“the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises. The progress of interest, therefore, may lead us to form some notion of the progress of profit” (p.122, The Wealth of Nations)
According to him, wages and profits in an economy fluctuate so rapidly that it is not possible to calculate the rate of profit at any specific point in time. However, the interest rate can provide some insight into the prevailing profit rate. Adam Smith aimed to explain the fluctuations in an economy's rate of profit. According to him, the rise and fall in profits depend on the stock of capital. He has mentioned:
“The increase of stock, which raises wages, tends to lower profit. When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit” (p.123, The Wealth of Nations)
As an economy grows, the capital stock in any sector increases, leading to competition among capitalists. They start bidding against each other for labor. This ultimately raises wages and lowers the rate of profit. The same logic applies to all sectors of the economy, so the general or average rate of profit tends to decline as the stock of capital increases. In other words, society's growth is linked to a decreasing trend in profit.
He tried to establish empirical evidence to support this theory. Using England's legal interest rate, Smith attempted to identify the general trend in profits in that country. During Henry VIII's reign, the standard interest rate was 10 percent, whereas during Queen Anne's reign it was 5 percent. This indicates a declining trend in profits in England. Based on this evidence, Smith also observed that the country's wealth and wages had increased significantly after Henry VIII. This suggests that as the country progressed, wages increased while profits declined.
Smith has also tried to show that a higher stock of capital is always associated with higher wages and lower profits. In a large town where the stock of capital is greater, competition among capitalists raises wages and lowers the rate of profit. Conversely, in a small village, profits are high because wages are lower. This logic also applies to countries at different stages of development. That means a rich country, with a higher stock of capital, has a lower rate of profit due to higher wages, whereas in a less developed country, profits are very high. But during that period, both wages and profits were higher in North America and West Indian colonies. Smith explained this as the result of an abundance of land relative to capital stock. Since these countries still operated on the most fertile land, profit rates were high there.
However, he has mentioned that the overall profit of a wealthy economy may rise if it discovers new territories and new trade routes. This was the case with Great Britain, where stock profits have not declined since it acquired North America and the West Indies. Similarly, profit could also increase with a reduction in the country's capital stock, since it would lower the wage rate.
According to Smith, as an economy grows, the stock of capital increases, and when it reaches an advanced level of development, the rate of profit becomes so low that only wealthy individuals, who invest larger amounts, can survive on it. Small businesses cannot sustain themselves with such low profit rates. Another important point is that although rich countries have lower profit rates, their growth is faster than that of poor countries with higher profit rates. As he mentioned:
“great stock, though with small profits, generally increases faster than a small stock with great profits” (p.129-130, The Wealth of Nations)
2. David Ricardo's View
David Ricardo defines profit as a residual amount that the capitalist receives after paying wages to labor and rent to the landlord. In his theory of profit, he attempts to explain the persistent variation in the overall rate of profit. He has stated,
“Supposing corn and manufactured goods always to sell at the same price, profits would be high or low in proportion as wages were low or high” (p.64, The Principle of Political Economy and Taxation)
Thus, according to him, any change affecting wages can also affect the rate of profit. He has considered the case of raw produce prices or necessities that determine wages in an economy. If the price of raw produce increases, laborers will demand higher wages in both the agricultural and manufacturing sectors. This will lead to higher overall wages, and the profit rate will fall. The increase in raw produce prices will impact the profits of nearly all sectors of the economy, either directly or indirectly. He stated that any rise in the prices of silk or velvet will not affect wages in general since the labor class does not use these products. Only the price of raw produce influences wages and profits.
Here, profit refers to the general long-term profit, not the short-term profit of an individual investment, which may fluctuate with market conditions. According to him, an individual enterprise's profit increase due to higher demand is temporary, since higher profits will attract capital from other businesses, causing the quantity supplied to increase. This will lower the price and, consequently, reduce the profit rate in the long run. This process is associated with the gravitation mechanism.
After defining the inverse wage-profit relationship, meaning higher wages imply lower profit, Ricardo established the general trend of profit in an economy. According to him, as society and the population progress, the demand for food increases. To meet this rising demand, farmers will either cultivate less fertile land or adopt intensive production methods. As a farmer shifts his cultivation from high-quality land to lower-quality land, the crop price increases. This is because the price is always determined based on the marginal land or no-rent land. With rising crop prices, laborers will demand higher wages, reducing profit margins. Consider the following example.
From the table below, it is evident that as the farmer cultivates lower-quality land, the same amount of labor produces less and less output, and prices start increasing, since price is determined by the marginal land. This rise in crop prices will also lead to increased wages. Here, we see that total revenue remains constant, but the farmer's share (profit) decreases as wages increase, and the profit rate also declines. The rate of profit is defined as the ratio of profit to total capital invested. We have assumed labor as constant, even though it produces less as the farmer moves from high- to low-quality land. In other words, the farmer must apply more and more labor to produce the same amount of output, which also reduces the rate of profit.
Source: Modified from the original text
3. Karl Marx's View
Karl Marx supports the theory of falling profits. He distinguishes between labor and capital by naming them variable capital, “v”, and constant capital, “c”, respectively, and the total of these two is the total capital, “C”. The value of constant capital remains constant throughout the production process, and it is labor that generates additional value. Labor is paid for this act of adding value, but the payment is less than the additional value created. Profit arises from this unpaid part of the total value generated in the production process, called Surplus Value, “S”. The ratio of surplus-value to variable capital (S/v) is called the rate of surplus-value or the degree of labor exploitation. The rate of profit is the ratio of surplus value to total capital (S/C). Thus, Marx has defined the rate of profit by separating it from the concept of the rate of surplus value. From these definitions of the rate of profit and the rate of surplus value, we have;
Here we can see that although the rate of surplus value remains the same, any change in the c/v will lead to a change in profit rate. This ratio of constant capital to variable capital is called the “organic composition” of total capital.
Marx, in chapter XIII of Volume III of Capital, explains that under a constant rate of surplus value, an increasing constant capital (c) results in a decreasing rate of profit. This happens because an increase in constant capital signifies a rise in total capital; with variable capital and the rate of surplus value remaining unchanged, the rate of profit falls. According to him:
“the same rate of surplus-value would express itself under the same degree of labour exploitation in a falling rate of profit, because the material growth of the constant capital implies also a growth albeit not in the same proportion in its value, and consequently in that of the total capital” (p.207, chapter XII; Capital-III)
According to him, this gradual increase in constant capital will occur across all sectors of the economy. Consequently, the average organic composition of capital in the economy will change as constant capital grows relative to variable capital. This results in a decline in the overall profit rate. Marx noted that the law of capitalist production is that development occurs through a decrease in variable capital relative to constant capital. That is, more output is produced by increasing capital relative to labor. This reduction in variable capital relative to constant capital mirrors an increase in the organic composition of capital. In other words, as society advances, labor productivity rises, meaning the same amount of labor can produce more than before, with an increasing amount of constant capital involved. As he stated:
“This continual relative decrease of the variable capital vis--vis the constant, and consequently the total capital, is identical with the progressively higher organic composition of the social capital in its average. It is likewise just another expression for the progressive development of the social productivity of labour, which is demonstrated precisely by the fact that the same number of labourers, in the same time, i.e., with less labour, converts an ever-increasing quantity of raw and auxiliary materials into products, thanks to the growing application of machinery and fixed capital in general”(p.208, chapter XII; Capital-III)
Hence, as an economy grows and the role of capital increases, every commodity contains a lesser amount of labor in it than before. This is the actual tendency of the capitalist mode of production, which is associated with relatively less variable capital or a progressively increasing organic composition of total capital, and, hence, the rate of profit falls. As he mentions:
“But proceeding from the nature of the capitalist mode of production, it is thereby proved a logical necessity that in its development the general average rate of surplus-value, must express itself in a falling general rate of profit” (p.209, chapter XII; Capital-III)
That means the development path of an economy is necessarily associated with a declining rate of profit. Up to this point, he has taken the rate of surplus-value to be constant. However, he has proved that this law also holds even as the rate of surplus-value increases. Consider the following example;(1) 80c+20v=80c+20v+20s, rate of surplus value=100%, rate of profit=20%
(2) 20c+80v=20c+80v+40s, rate of surplus value=50%, rate of profit=40%
Here we can see that the rate of profit is lower in the case of a higher organic composition production process, despite the fact that it has a higher rate of surplus value than that of a low organic composition production process.
Similarly, Marx has asserted that although relative labor is decreasing, this does not mean that the mass of labor, and thereby the mass of surplus value, is not increasing. According to him, it is the relatively lower labour than capital in profits. Consider the following example;
(1) 80c+20v=80c+20v+20s, total capita=100, rate of profit=20%
(2) 200c+40v=200c+40v+40s, total capital=240, rate of profit= 16.6%
Here, it is clear that the relative decline in labor leads to a declining rate of profit, despite an increase in the mass of labor or the mass of surplus value.
After explaining the theory of falling profit, Marx discusses some contemporary theories using this concept. He states that since the law of falling profit applies at various stages of economic development, it also explains differences in profit rates among countries at different levels of development. This means that a developed country with a higher organic composition faces a lower profit rate than an underdeveloped country with a lower organic composition. However, this may not hold if labor in the underdeveloped country is less productive than in the developed one or if there are differences in working hours between the two countries. Lower productivity means less surplus value is generated, which can lead to a lower rate of profit. Conversely, fewer working hours of higher intensity can result in a higher surplus value.
Classical economists believe that, despite a decreasing rate of profit, aggregate profit increases over time, which seems contradictory. According to Marx, the accumulation of capital or the increased productivity of labor leads to overpopulation of workers because a small number of workers can produce the same amount of output with high constant capital. That means every increase in constant capital is accompanied by an excess of exploitable variable capital, or working population. Thus, there is no constraint on the growth of constant capital. With advances in the production process, the amount of constant capital increases, ultimately resulting in higher total profit. This is the nature of capitalist production, which is associated with a relatively declining variable capital, leading to overpopulation and facilitating capital expansion and profit increases, albeit at a decreasing rate. According to Marx, this dual effect—i.e., a falling rate of profit with an ever-increasing mass of profit—characterizes the system.
It is only possible if the rate of growth of total capital is higher than the rate at which profit falls. Consider the following example;
(1)80c+20v=80c+20v+20s, rate of surplus value=100%,rate of profit=2
(2)200c+40v=200c+40v+40s, total capital= 240(+140%), rate of profit= 16.6%(-17%) (3)800c+100v=800c+100v+100s, total capital=900 (+270%), rate of profit=11.1%,(-33.1%)
In the first stage of production, with a total capital of 100 and a profit rate of 20%, the total profit is 20. As the economy grows and adopts more capital-intensive or labor-substituting technology, the total profit increases to 40. Similarly, in the third stage, this profit level rises to 100. Despite a fall in the profit rate, the total profit increases because, at each stage of development, the growth rate of total capital exceeds the rate at which profit decreases. In the second stage, total capital grows by 140%, while the profit rate falls by 17%. Likewise, in the third stage, the growth rate of total capital remains higher than the rate of profit decline. Therefore, the rate of increase in total capital must outpace the fall in profit for the capitalist to achieve a higher total profit. Finally, Marx noted that counteracting forces slow the decline in the rate of profit. These include increased exploitation, wage suppression below the value of labor-power, cheaper elements of constant capital, relative overpopulation, and foreign trade.
Conclusion
From the above discussion, it is clear that classical economists, mainly Adam Smith, David Ricardo, and Karl Marx, supported the theory of a falling rate of profit. However, each provided a different explanation and cause for the same theory. Because these theories are based on different but important economic relations, it is difficult to determine which one is superior. Smith noted that increasing competition among capitalists raises wages and lowers the overall rate of profit. He described England's growth path as being associated with a falling rate of profit. His theory, supported by empirical evidence, uniquely establishes the economic relationship.
On the other hand, Ricardo used the basic theory of decreasing land productivity to establish the theory of a falling rate of profit. According to him, economic growth increases the demand for food, and to meet this increased demand, farmers will start cultivating lower-quality land. This will raise the prices of raw products and increase wages in all spheres of production, which ultimately decreases the rate of profit.
One common point between Smith and Ricardo is that their theories of the falling rate of profit are based on the inverse wage-profit relationship. The increase in the wage rate is the ultimate cause of the fall in the profit rate. Both of them have indicated that societal growth will raise laborers' wages, although, according to Smith, this will happen through the mechanism of competition and, according to Ricardo, through the mechanism of falling land productivity.
In contrast to Smith and Ricardo, Marx has defined the rate of profit by distinguishing it from the rate of surplus-value. He has explained that the relative decline in labor or the substitution of more and more capital for labor, which increases the “organic composition” of total capital, leads to a fall in the rate of profit and is a general trend associated with the capitalist mode of production. Marx's theory of the falling rate of profit holds that the relative decline in variable capital is driven by the introduction of labor-saving technology. An important point to note is that Ricardo argues that technological changes that reduce labor costs can increase the rate of profit, whereas Marx argues that labor-saving technology will further decrease the rate of profit through the surplus-value effect.
Another important distinction among Smith, Ricardo, and Marx lies in their approaches to the theory of falling profits. Smith described it empirically; Ricardo used natural phenomena such as “decreasing land productivity”; and Marx attempted to describe it in a somewhat scientific manner using the concept of surplus value. Despite these differences and criticisms, we can conclude that these theories of the falling rate of profits are logically strong within their respective analytical and assumed spectra.
References
(1) Marx Karl; “Capital, Volume-III”,Second Impression-Foreign Language Publishing House.
(2) Ricardo David;“The Principle of Political Economy and Taxation”, J.M. DENT Publication.
(3) Smith Adam;“Wealth of nations”, Bantam Edition.
By
Dr. Akash Kumar Baikar
Assistant Professor of Economics
SBSS, MRIIRS (Faridabad)
According to Ricardo, the natural tendency of profit is to fall as the economy and population grow. This happens because, to meet the increased demand for food, farmers shift to inferior quality land or adopt intensive production methods. In both cases, declining land productivity raises the prices of raw products, which in turn raises wages across various sectors of business, leading to a general fall in the rate of profit. If this trend continues, there will come a time when profit reaches zero. However, Ricardo argued that such a situation will never occur because investors will stop investing well before that point. The rate of profit falls in the long run, but this tendency can be checked. He has also mentioned:
“this tendency, this gravitation as it were of profits, is happily checked at repeated intervals by the improvements in machinery connected with the production of necessaries, as well as by discoveries in the science of agriculture” (p.71, The Principle of Political Economy and Taxation)
That means technological innovations and improvements in production methods can temporarily boost the rate of profit. Another point that Ricardo emphasizes is that the total profit can increase even as the rate of profit decreases. He also explains the differences in profit rates between the two countries. In a large, closed economy with poor land, a moderate accumulation of capital causes a greater decrease in the rate of profit, whereas in a small, open economy with fertile land, a large accumulation of capital may result in less reduction in profit.
Thus, Ricardo supports the “Theory of Falling Rate of Profit” and concludes his chapter on profit with the following statement:
“i have endeavored to show, first, that a rise of wages would not raise the price of commodities, but would invariably lower profits; and secondly, that if the prices of all commodities could be raised, still the effect on profits would be the same; and that in fact the value of medium only in which prices and profits are estimated would be lowered” (p.76, The Principle of political economy and Taxation)
3. Karl Marx's View
Karl Marx supports the theory of falling profits. He distinguishes between labor and capital by naming them variable capital, “v”, and constant capital, “c”, respectively, and the total of these two is the total capital, “C”. The value of constant capital remains constant throughout the production process, and it is labor that generates additional value. Labor is paid for this act of adding value, but the payment is less than the additional value created. Profit arises from this unpaid part of the total value generated in the production process, called Surplus Value, “S”. The ratio of surplus-value to variable capital (S/v) is called the rate of surplus-value or the degree of labor exploitation. The rate of profit is the ratio of surplus value to total capital (S/C). Thus, Marx has defined the rate of profit by separating it from the concept of the rate of surplus value. From these definitions of the rate of profit and the rate of surplus value, we have;
Here we can see that although the rate of surplus value remains the same, any change in the c/v will lead to a change in profit rate. This ratio of constant capital to variable capital is called the “organic composition” of total capital.
Marx, in chapter XIII of Volume III of Capital, explains that under a constant rate of surplus value, an increasing constant capital (c) results in a decreasing rate of profit. This happens because an increase in constant capital signifies a rise in total capital; with variable capital and the rate of surplus value remaining unchanged, the rate of profit falls. According to him:
“the same rate of surplus-value would express itself under the same degree of labour exploitation in a falling rate of profit, because the material growth of the constant capital implies also a growth albeit not in the same proportion in its value, and consequently in that of the total capital” (p.207, chapter XII; Capital-III)
According to him, this gradual increase in constant capital will occur across all sectors of the economy. Consequently, the average organic composition of capital in the economy will change as constant capital grows relative to variable capital. This results in a decline in the overall profit rate. Marx noted that the law of capitalist production is that development occurs through a decrease in variable capital relative to constant capital. That is, more output is produced by increasing capital relative to labor. This reduction in variable capital relative to constant capital mirrors an increase in the organic composition of capital. In other words, as society advances, labor productivity rises, meaning the same amount of labor can produce more than before, with an increasing amount of constant capital involved. As he stated:
“This continual relative decrease of the variable capital vis--vis the constant, and consequently the total capital, is identical with the progressively higher organic composition of the social capital in its average. It is likewise just another expression for the progressive development of the social productivity of labour, which is demonstrated precisely by the fact that the same number of labourers, in the same time, i.e., with less labour, converts an ever-increasing quantity of raw and auxiliary materials into products, thanks to the growing application of machinery and fixed capital in general”(p.208, chapter XII; Capital-III)
Hence, as an economy grows and the role of capital increases, every commodity contains a lesser amount of labor in it than before. This is the actual tendency of the capitalist mode of production, which is associated with relatively less variable capital or a progressively increasing organic composition of total capital, and, hence, the rate of profit falls. As he mentions:
“But proceeding from the nature of the capitalist mode of production, it is thereby proved a logical necessity that in its development the general average rate of surplus-value, must express itself in a falling general rate of profit” (p.209, chapter XII; Capital-III)
That means the development path of an economy is necessarily associated with a declining rate of profit. Up to this point, he has taken the rate of surplus-value to be constant. However, he has proved that this law also holds even as the rate of surplus-value increases. Consider the following example;(1) 80c+20v=80c+20v+20s, rate of surplus value=100%, rate of profit=20%
(2) 20c+80v=20c+80v+40s, rate of surplus value=50%, rate of profit=40%
Here we can see that the rate of profit is lower in the case of a higher organic composition production process, despite the fact that it has a higher rate of surplus value than that of a low organic composition production process.
Similarly, Marx has asserted that although relative labor is decreasing, this does not mean that the mass of labor, and thereby the mass of surplus value, is not increasing. According to him, it is the relatively lower labour than capital in profits. Consider the following example;
(1) 80c+20v=80c+20v+20s, total capita=100, rate of profit=20%
(2) 200c+40v=200c+40v+40s, total capital=240, rate of profit= 16.6%
Here, it is clear that the relative decline in labor leads to a declining rate of profit, despite an increase in the mass of labor or the mass of surplus value.
After explaining the theory of falling profit, Marx discusses some contemporary theories using this concept. He states that since the law of falling profit applies at various stages of economic development, it also explains differences in profit rates among countries at different levels of development. This means that a developed country with a higher organic composition faces a lower profit rate than an underdeveloped country with a lower organic composition. However, this may not hold if labor in the underdeveloped country is less productive than in the developed one or if there are differences in working hours between the two countries. Lower productivity means less surplus value is generated, which can lead to a lower rate of profit. Conversely, fewer working hours of higher intensity can result in a higher surplus value.
Classical economists believe that, despite a decreasing rate of profit, aggregate profit increases over time, which seems contradictory. According to Marx, the accumulation of capital or the increased productivity of labor leads to overpopulation of workers because a small number of workers can produce the same amount of output with high constant capital. That means every increase in constant capital is accompanied by an excess of exploitable variable capital, or working population. Thus, there is no constraint on the growth of constant capital. With advances in the production process, the amount of constant capital increases, ultimately resulting in higher total profit. This is the nature of capitalist production, which is associated with a relatively declining variable capital, leading to overpopulation and facilitating capital expansion and profit increases, albeit at a decreasing rate. According to Marx, this dual effect—i.e., a falling rate of profit with an ever-increasing mass of profit—characterizes the system.
It is only possible if the rate of growth of total capital is higher than the rate at which profit falls. Consider the following example;
(1)80c+20v=80c+20v+20s, rate of surplus value=100%,rate of profit=2
(2)200c+40v=200c+40v+40s, total capital= 240(+140%), rate of profit= 16.6%(-17%) (3)800c+100v=800c+100v+100s, total capital=900 (+270%), rate of profit=11.1%,(-33.1%)
In the first stage of production, with a total capital of 100 and a profit rate of 20%, the total profit is 20. As the economy grows and adopts more capital-intensive or labor-substituting technology, the total profit increases to 40. Similarly, in the third stage, this profit level rises to 100. Despite a fall in the profit rate, the total profit increases because, at each stage of development, the growth rate of total capital exceeds the rate at which profit decreases. In the second stage, total capital grows by 140%, while the profit rate falls by 17%. Likewise, in the third stage, the growth rate of total capital remains higher than the rate of profit decline. Therefore, the rate of increase in total capital must outpace the fall in profit for the capitalist to achieve a higher total profit. Finally, Marx noted that counteracting forces slow the decline in the rate of profit. These include increased exploitation, wage suppression below the value of labor-power, cheaper elements of constant capital, relative overpopulation, and foreign trade.
Conclusion
From the above discussion, it is clear that classical economists, mainly Adam Smith, David Ricardo, and Karl Marx, supported the theory of a falling rate of profit. However, each provided a different explanation and cause for the same theory. Because these theories are based on different but important economic relations, it is difficult to determine which one is superior. Smith noted that increasing competition among capitalists raises wages and lowers the overall rate of profit. He described England's growth path as being associated with a falling rate of profit. His theory, supported by empirical evidence, uniquely establishes the economic relationship.
On the other hand, Ricardo used the basic theory of decreasing land productivity to establish the theory of a falling rate of profit. According to him, economic growth increases the demand for food, and to meet this increased demand, farmers will start cultivating lower-quality land. This will raise the prices of raw products and increase wages in all spheres of production, which ultimately decreases the rate of profit.
One common point between Smith and Ricardo is that their theories of the falling rate of profit are based on the inverse wage-profit relationship. The increase in the wage rate is the ultimate cause of the fall in the profit rate. Both of them have indicated that societal growth will raise laborers' wages, although, according to Smith, this will happen through the mechanism of competition and, according to Ricardo, through the mechanism of falling land productivity.
In contrast to Smith and Ricardo, Marx has defined the rate of profit by distinguishing it from the rate of surplus-value. He has explained that the relative decline in labor or the substitution of more and more capital for labor, which increases the “organic composition” of total capital, leads to a fall in the rate of profit and is a general trend associated with the capitalist mode of production. Marx's theory of the falling rate of profit holds that the relative decline in variable capital is driven by the introduction of labor-saving technology. An important point to note is that Ricardo argues that technological changes that reduce labor costs can increase the rate of profit, whereas Marx argues that labor-saving technology will further decrease the rate of profit through the surplus-value effect.
Another important distinction among Smith, Ricardo, and Marx lies in their approaches to the theory of falling profits. Smith described it empirically; Ricardo used natural phenomena such as “decreasing land productivity”; and Marx attempted to describe it in a somewhat scientific manner using the concept of surplus value. Despite these differences and criticisms, we can conclude that these theories of the falling rate of profits are logically strong within their respective analytical and assumed spectra.
References
(1) Marx Karl; “Capital, Volume-III”,Second Impression-Foreign Language Publishing House.
(2) Ricardo David;“The Principle of Political Economy and Taxation”, J.M. DENT Publication.
(3) Smith Adam;“Wealth of nations”, Bantam Edition.
By
Dr. Akash Kumar Baikar
Assistant Professor of Economics
SBSS, MRIIRS (Faridabad)
