Karl Marx Cyclically Recurring Fluctuations

One model of economic fluctuation suggested by Marx is a recurring cycle. Impressed by the dramatic growth of the textile industry in England, he hypothe­sized that a burst of technological change could generate a business cycle. A technological burst will produce increased capital accumulation and an increased demand for labor. The size of the reserve army will fall, wages will rise, surplus value will fall, the rate of surplus value will fall, and the rate of profit will decrease. The falling rate of profit will result in decreased capital accumulation as the economy spirals downward into depression. But depression, according to Marx, contains elements that will sooner or later generate a new expansion in economic activity. As total output falls, the size of the reserve army of the unemployed is enlarged. The competitive pressure of this unemployed labor will bring down wages and thus provide greater profit opportunities. These larger profits will stimulate more capital accumulation, and economic activity will increase as the upward stage of the cycle begins. Marx suggested that another self-corrective aspect of depressions was their destruction of capital values. Because profit is a money calculation, businesses that were not profitable because of the inflated value of their capital assets carried over from the prosperity phase of the cycle become profitable as asset values are lowered during the depression. A cycle started by a technological burst may generate further cycles in the future as capital equipment wears out. If all plants and equipment were replaced evenly over time, there would be a constant level of investment to replace worn-out capital goods. A replacement cycle can be generated, however, when the capital goods put into place during the technological burst suddenly require immediate replacement.

Disproportionality Crises

Once an economy moves from the barter stage to a high degree of labor specialization and the use of money and markets, there may be difficulty in coordinating the levels of output of its various sectors. Under capitalism the market mechanism performs this function, but Marx questioned the ability of the market to reallocate resources smoothly. Suppose there is an increase in the demand for the products of industry A and a decrease in demand for the commodities produced in industry B. In a smoothly functioning capitalist economy, prices and profits in industry A would increase, and prices and profits in industry B would decline. In reaction to these changing profits, capitalists would move resources from the Contracting to the expanding industry. The excess supply or overproduction of industry B would thus be of short duration and would have no perceptible influence on the general level of economic activity. Overproduction in one industry, what Ricardo called a partial glut, would not spread to the rest of the eco
nomy and cause a general decline in economic activity, or a depression.

Marx contended that supply and demand will not always mesh this perfectly in an economy's various submarkets and that the entire process of resource reallocation therefore will not work as smoothly as in the classical model. His theory is that the unemployment created in industry B as demand decreased could spread to the rest of the economy and result in a general decline in economic activity, a view that is directly opposed to the orientation of the orthodox classical theorists. Classical theory looks to the market to solve problems of resource allocation. It stresses equilibrium, maintaining that positions of disequilibrium are of short duration and that a smooth transition occurs between equilibria. Marx assumed disharmony in the system and looked for basic contradictions in the workings of market forces. Orthodox theory has not paid much attention to Marx's disproportionality crises theory, arguing that an individual industry is so small relative to the entire economy that the spread of overproduction from one industry to produce a general decline is unlikely. They also argue that the mobility of resources is much greater than Marx admitted. Overproduction in a major industry such as automobiles, however, might conceivably spread to the rest of the economy.

The Falling Rate of Profit and Business Crises

The two Marxian theories of business crises that we have examined so far, cyclically recurring fluctuations and disproportionality crises, explicitly reject Say's Law. Marx integrated his law of the falling rate of profit into these two theories. Thus, his theories that depressions result when technology fails to develop smoothly, that disproportionality crises will occur because overproduc­tion in one industry can adversely affect the rest of the economy, and that the rate of profit will steadily decline, are all facets of a single integrated view that capitalism will fail to provide stable levels of economic activity at a full utilization of resources

Marx had another explanation for depressions —or crises, as he called them— that is unusual in that it accepts Say's Law. He said that even if we make all the necessary assumptions so that Say's Law holds, capitalism will still fail because of inherent contradictions that will bring about business crises. In the Marxian model, a capitalist economy clearly depends on the behavior of the capitalist, whose reactions to changing rates of profits and changing expectations of profits are a central part of the explanation of business crises. Marx used his law of the long-run, continual fall in the rate of profits to explain short-run fluctuations in economic activity, asserting that in their search for greater profits, the capitalists increase capital spending and thereby cause the rate of profit to fall. The capitalists will periodically react to this fall in profit rates by reducing investment spending, causing fluctuations in economic activity, which will engender crises. Thus, Marx deduced crises even in a model that accepts Say's Law.

Business Crises: A Summary

Marx's explanation of the source and nature of the business cycle is intertwined with his broader analysis of capitalism and is incompletely developed. He did not take any one theory and develop its full meaning and implications. This has resulted in a good deal of controversy among Marxists themselves and among historians of economic thought as to the nature and significance of Marx's contributions to business-cycle theory. Although the relative importance of Marx's various theories of crises is disputed by historians of economic thought, there is general agreement that he did offer three distinct explanations of fluctuations in business activity: the falling rate of profit, the uneven introduction of new technology, and disproportionalities that develop in one sector of the economy and spread to cause a decrease in the general level of economic activity. Marx's writing also contains some even vaguer hints of an underconsumptionist explanation of economic fluctuations, but these are never pursued.

Although Marx did not fully develop his theories of business crises, he clearly argued that periodic fluctuations in economic activity were a fundamental part of a capitalist economy and one more manifestation of the basic contradictions in capitalism that would lead to its ultimate destruction. It is also important to recognize that he saw these periodic fluctuations as inherent in the system, because they are based on the activities of the capitalists as they search for profits and react to changes in the rate of profits. Whatever'Marx's theories of business crises may lack in internal consistency, there can be no doubt that his view of capitalism as basically unstable and subject to periodic fluctuations in economic activity because of internal contradictions represents an important insight into capitalism as an economic system. Nevertheless, the Marxian vision of capitalism as inherently unstable was largely ignored by orthodox economic theory until the 1930s.