"Profit is so very fluctuating that the person who carries on a particular trade cannot always tell you himself what is the average of his annual profit. It is affected not only by every variation of price in the commodities which he deals in, but by the good or bad fortune both of his rivals and of his customers, and by a thousand other accidents to which goods when carried either by sea or by land, or even when stored in a warehouse, are liable. It varies, therefore, not only from year to year, but from day to day, and almost from hour to hour. To ascertain what is the average profit of all the different trades carried on in a great kingdom must be much more difficult; and to judge of what it may have been formerly, or in remote periods of time, with any degree of precision, must be altogether impossible.
But though it may be impossible to determine, with any degree of precision, what are or were the average profits of stock, either in the present or in ancient times, some notion may be formed of them from the interest of money. It may be laid down as a maxim, that wherever a great deal can be made by the use of money, a great deal will commonly be given for the use of it; and that wherever little can be made by it, less will commonly be given for it. According, therefore, as 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." (The Wealth of Nations, chapter IX)
Simply put, Marx argued that increased investment in and growth of constant capital (factories, machines, land, buildings, raw materials) relative to variable capital (labor) reduced the margin of surplus labor time with respect to total capital (constant capital plus variable capital). Since surplus labor time is, according to Marx, the source of surplus value, and since profit equals surplus value divided by total capital, then the tendential fall in surplus labor time relative to total capital results in a tendential fall in the rate of profit.
Even as investment in constant capital increases productivity (i.e. the margin of surplus labor relative to regular labor, and thus of surplus value relative to variable capital), it reduces profits (i.e. the margin of surplus value relative to total capital). The capitalist then responds by investing more in raising productivity, which in turn reduces profits further, and so on and so forth, in a vicious cycle of diminishing returns.
This tendency, in concert with the other dialectically interrelated crisis factors developed in the course of Marx's overall critique of capital, eventually leads to a catastrophic breakdown in the capital cycle.
This is then the general tendency in capitalism, but it is only a tendency, because there are also "counteracting factors" operating which had to be studied also. In his draft manuscript (he did not publish it himself), Marx cited six of them:
But there could obviously also be several other factors involved which Marx did not discuss in detail, including for example:
Some of these "countervailing factors" can only temporarily postpone the fall of the rate of profit. Wages, for instance, cannot fall below zero, the turn-over period of capital also cannot fall below zero, and so on. The controversy about the TRPF nowadays concentrates on the point whether cheapening of elements of constant capital could indefinitely counteract the TRPF. Marxist economist Chris Harman has advanced a reading of Marx that sees economic crisis as being the main effective countervailing factor, but which places limits on its effectiveness as the capitalist system ages and units of capital become larger and more interlinked.
Although Marx did not explicitly argue this himself, later Marxists (including Henryk Grossmann and Paul Mattick) have argued that this paradoxical outcome for all the competing enterprise together - an increase in physical output produced, containing a decreasing quantity of labour-value - is the ultimate cause of economic crises, which feature a sharp drop in industrial investments and rising unemployment. Thus, the ultimate cause of economic crises in capitalism is attributed to the overall, long-term effect of labour-saving technological innovations. At a certain point, it is argued, the falling rate of profit stops the total mass of profit in the economy from growing altogether, or at least from growing at a sufficient rate - this results in an over-accumulation crisis, and consequently a drop in new productive investment, causing an increase in unemployment. In turn, this then leads to a wave of take-overs and mergers to restore profitable production.
There are, however, many more crisis theories in the Marxian tradition, focusing variously on the chaos of capitalist production, sectoral disproportions, underconsumption, labor-shortage and population pressures, credit insufficiency and wages squeezing profits. Some theories attribute crises to one single factor (such as the TRPF) while others argue for a multi-causal approach in which a distinction is drawn between the "triggers" of the crisis, its deeper underlying causes, and the concrete manifestation of crises.
Marx’s interpretation has been the source of intense controversy and - leaving aside numerous attacks on his value theory - has been criticized in two main ways:
The Japanese economist Nobuo Okishio (see article on Okishio's theorem) famously argued "if the newly introduced technique satisfies the cost criterion [i.e. if it reduces unit-costs, given current prices] and the rate of real wage remains constant" then the rate of profit must increase (Okishio, 1961, p.92). Assuming a constant level of real wages, technical change would lower the production cost per unit, thereby raising the innovator's rate of profit. The price of output would fall, and this would cause the other capitalists’ costs to fall also. The new (equilibrium) rate of profit would therefore have to rise. By implication, the rate of profit could in that case fall, only if real wages rose in response to higher productivity, squeezing profits. (This theory is sometimes called neo-ricardian, because David Ricardo also claimed that a fall in the rate of profit can only be brought about by rising wages.)
Intuitively, Okishio's argument makes sense - after all, why would capitalists invest in more efficient production on a larger scale, unless they thought their profits would increase? Orthodox Marxists have typically responded to this argument in the following basic ways (there are, of course, numerous other arguments, involving more or less complex mathematical models).
Responses 1 and 2 can be interpreted as a prisoner's dilemma the capitalists are caught in.
Okishio argues in terms of a comparative static analysis. His starting point is an equilibrium growth path of an economy with a given technique. In a branch of industry a technical improvement is introduced (in a way similar to what Marx described) and then the new equilibrium growth path is established under the assumption that the new better technique is generally adopted by the capitalists of that branch. The result is that even under Marx’s assumptions about technical progress the new equilibrium growth path goes along with a higher rate of profit. However, if one drops the assumption, that a capitalist economy moves from one equilibrium to another, Okishio’s results do not hold anymore.
The "indeterminacy" criticism revolves around the idea that technological change could have many different and contradictory effects. It could reduce costs, or it could increase unemployment; it could be labour-saving, or it could be capital-saving. Therefore, the argument goes, it is impossible to infer definitely that a falling rate of profit must inevitably result from an increase in productivity. Perhaps the law of the tendency of the rate of profit to fall might be true in an abstract model, based on certain assumptions, but in reality no substantive empirical predictions can be made. In addition, profitability itself can be influenced by an enormous array of different factors, going far beyond those which Marx specified. So there are tendencies and counter-tendencies operating simultaneously, and no particular empirical result necessarily follows from them.
Typically, economic growth is described in the usual growth models (for example Harrod-Domar model) in terms of equilibrium or Steady state, that is, input per worker and output per worker grow at the same rate. This means, that capital intensity remains constant over time. At the same time, in equilibrium, the rate of growth of employment is constant over time. Translated into terms of labor theory of value, this means that the value composition of capital does not rise, and the constant rate of growth of employment also indicates in terms of the Labor Theory of Value, that there is no reason for the rate of profit to decline.
In this framework, followers of a tendency of the rate of profit to decline assume, that input per worker is increased by capitalists at a larger rate than output per worker, because
1) either, overcapacities might be built to fend off competition;
2) or, this leads, as an incentive for capitalists, to a larger percentage increase of output per worker than input per worker has been increased beforehand. This results in an alternate movement in which capitalists increase input per worker at a larger percentage than output per worker has risen, which, in the next period, leads to a larger percentage increase of output per worker than that of input per worker before. The rate of growth of employment declines in such a scenario.
Most economic historians agree that, at the beginning of the big economic depressions or recessions in the history of capitalism (measured by a drop in output), there typically has been a downslide in the observed average returns on capital invested in industries, reducing the incentive to invest, and consequently raising unemployment. Some writers, such as Ernest Mandel, have indeed linked long-term fluctuations in average profitability and interest rates to the Kondratiev waves. There is also some statistical evidence that, as a broad historical trend, average profitability in industry has fallen through the 20th century (see, for instance, Robert Brenner and the research of Dumenil & Levy for the time after the second world war).
However, there are two basic problems in interpreting the observable evidence available.
Therefore, the debate among economists about the TPRF and its significance remains interminable. At best, Marxian economics has convincingly argued that profitability is the synthetic, overall indicator of the "economic health" of the capitalist system, and that economic crises are system-immanent, i.e. capitalism is inherently crisis-prone, because of its institutional structure and the way it functions. Thus, capitalist development occurs through inevitable booms and busts. This conclusion is the exact opposite to neo-classical economics, according to which markets, if left alone, will spontaneously move towards equilibrium and economic harmony. But as regards the exact causes of specific economic crises, the debate continues; it is, of course, not necessarily the case that every economic crisis must have the same basic causes.
Some argue, like Marx, that the TRPF applies only to the sphere of capitalist production. Thus, it is argued, it is eminently possible that while industrial profitability declines, average profitability in activities external to real production (for example, commercial trade, and asset speculation) increases. Investment in production is only one mode of capital accumulation, not the only one. Thus, even if the growth rate of production stagnates, asset sales may boom.
Others claim that for Marx, commercial trade and asset speculation were unproductive sectors, in which no value can be created. Therefore, they argue, all income of these sectors is a deduction of the value created in the productive sectors of the economy. Booms in unproductive sectors may temporarily act as a countervailing factor to the TRPF, but not in the long run. On the contrary, Fred Moseley argues, in the US the rate of profit is lower than it used to be in earlier decades after the second world war, because of a rising share of unproductive labor with respect to productive labor. This is a reason of its own for a falling general rate of profit in distinction to the TRPF. Yet both Moseley's calculations and his definition of unproductive labor have been criticised by other Marxists.