Karl Marx Falling Rate of Profit Profits

Karl Marx Falling Rate of Profit

One of the important contradictions between the forces and relations of produc­tion that Marx said would lead ultimately to the destruction of capitalism is the falling rate of profit. Here he followed the classical tradition of Smith, Ricardo, and Mill, who had all predicted that the rate of profit would fall over time.

Marx maintained that competition in commodity and labor markets would lead to a fall in profits in the following way: There is a strong drive, according to Marx, for the capitalist to accumulate capital. Capital accumulation means that more capital will bid for labor, forcing up wages and reducing the size of the reserve army of the unemployed, and the rate of profit will fall. Capitalists will react to these rising wages and falling profits by substituting machinery for labor—that is, by increasing the quantity of capital in the economy, which will push profit rates even lower. Marx was suggesting that each individual capitalist, in reacting to rising wages and falling profits, will take actions that will effectively reduce still further the rate of profit in the economy.

Competition in commodity markets will also result in a continuous decrease in the rate of profit because the capitalist will keep trying to reduce the costs of production in order to sell final output at lower prices. These competitive forces lead the capitalist to search for new, lower-cost methods of production that will reduce the labor time necessary to produce a given commodity. These new, more efficient production techniques almost always involve an increase in capital, and this will result in a falling rate of profit. Marx concluded, therefore, that competition in labor and commodity markets necessarily leads to an increase in capital, which in turn will result in a falling rate of profit.

The issue is more complicated than this, however, because increases in the quantity of capital in the economy produce two opposing forces affecting the rate of profit. Increases in the quantity of capital, other things being equal, result in a falling rate of profit because the added capital has reduced productivity—the principle of diminishing returns. However, increases in the quantity of capital will usually incorporate new technology, which reduces costs and thereby increases the rate of profit. In short, other things are not equal, and whether the rate of profit falls over time depends on the rate of change in capital accumulation as compared to the rate of change in technological improvement. The outcome of these opposing forces cannot be determined theoretically—it is an empirical question.

It must be concluded, therefore, even keeping within the structure of the Marxian model, that what course the rate of profit takes over time will depend on the relative rates of increase in these two forces: diminishing returns and technological improvements. Marx posited a constantly declining rate of profit, although his model affords no theoretical grounds for doing so. Marx, Smith, Ricardo, and J. S. Mill all reach the conclusion that the rate of profit would fall for essentially the same reason: that diminishing returns would offset techno­logical improvements.

The crucial unknown element in predicting changes in the rate of profit, however, is one that is difficult to predict—the rate of technological develop­ment. Will technological development take place in the future at a rate suffi­cient to offset diminishing returns from capital accumulation? This question is difficult to answer, largely because economists have no theory that satisfactorily explains the rate of technological development. In the absence of such a theory, economists have been inclined to underestimate the expected future rate of technological development. That is why Smith, Ricardo, and J. S. Mill all concluded that the rate of profit will decrease over the long run. It is why Malthus concluded that population tends to increase at a faster rate than the supply of food.