For Marx, the most important tendency of a capitalist economy is the ‘law of the tendential fall in the rate of profit’ (LTFRP). This ‘law’ is often misinterpreted as referring to a permanent fall in the rate of profit, but it actually refers to a tendency that is overcome periodically through crises. Marx argued that during an expansionary phase, there is a tendency for the rate of profit to fall until a crisis point is reached, after which capital values collapse, cheapening prospective investments. This revives profitability and paves the way for a new expansionary phase. Crises, while causing widespread hardship – including bankruptcies, mass unemployment and poverty – play a functional role under capitalism of restoring profitability for those capitalists, now fewer in number, who survive the process.
Marx’s tendency emerges out of the internal logic of capital. But in a fiat-money system, capital itself operates within a broader institutional framework shaped by society itself, especially through representative government. Whereas the logic of capital is determining under a commodity-money or commodity-backed money system, ultimately rendering government and the general community subservient to its imperatives, this need not be the case in a fiat-money system.
As a matter of national accounting, fiscal policy has a direct relationship with realized aggregate profit. Moreover, since the average rate of profit can be expressed as the ratio of aggregate profit to the amount of money capital tied up in production, it follows that fiscal policy is also directly related to the average realized rate of profit. This suggests that Marx’s tendency might be offset through appropriate use of fiscal policy rather than a reliance on socially destructive economic crises. (See Thinking in a Macro Way.)
Fiscal policy also influences the level of private saving. In a closed economy, the budget deficit translates into net private saving, dollar for dollar. Considering the private sector as a whole is currently deep in debt, fiscal policy has an important role to play in restoring private-sector balance sheets.
The purpose of this post is to trace the connections between fiscal policy, the rate of profit and net private saving in a little more detail, and to draw out the basic policy implications.
1. Marx’s Tendency for the Rate of Profit to Fall
If, for simplicity, we abstract from fixed capital, then the average value rate of profit, r, in Marx’s theory is:
r = s/(c + v)
c is constant capital (dollars invested in plant, machinery, raw materials)
v is variable capital (dollars invested in employing labor)
s is surplus value (the dollar value created by labor in excess of v)
So the formula says that the average rate of profit is equal to surplus value (s) divided by the total dollars productively invested by capitalists (c + v). For instance, if capitalists invest $80 in c and $20 in v, resulting in the production of $120 in value and surplus value of $20, the rate of profit is 20/100 = 20%.
For Marx, c (plant, machines, raw materials) represents value produced in a previous production period. In aggregate, these elements of capital only pass on their previously existing value to the total value (and total price) of the new output. In contrast, labor worked in the current period generates new value. In the example provided above, labor added $40 in value during the production period. Labor was paid $20 (i.e. v), which left a surplus (s) for the capitalists of $20.
To avoid confusion, it is important to understand that Marx’s argument applies to value, not physical output or wealth. He is not suggesting that labor is the only source of physical output or wealth. Nature, other animals, and machines all create new physical output and wealth, as does labor. The argument, rather, is that only labor translates into new value. Plant, machinery, and raw materials used up in the production period only pass on their preexisting value (actually, their prices). Nature, on the other hand, does not transfer any value to output. Instead, private property rights give owners of natural resources a legal entitlement to a payment of rent, which comes out of the surplus value created in the production period.
The rate of profit can be rewritten:
r = (s/v)/(c/v + 1)
In this formula, s/v and c/v have special meanings for Marx.
The ratio s/v is the ‘rate of surplus value’ or ‘rate of exploitation’. If workers produce $200 of new value and are paid $100, the rate of surplus value is 100%. It means half the working hours were necessary to pay labor, and so were not appropriated by capitalists as surplus value.
The ratio c/v is the ‘organic composition of capital’.
The formula shows that as c/v rises (due to technical progress that tends to shed labor per investment dollar over the expansionary phase), the rate of profit, r, falls, holding other factors constant. Capitalists can partially offset this tendency by wringing more value out of labor per dollar invested in variable capital. That is, they can try to increase the rate of surplus value, s/v. They can do this by increasing s through technical innovation (an increase in relative surplus value) and enforcing more intensive work and a longer working day (an increase in absolute surplus value), as well as through reductions in v (by restricting employment and wage growth). However, Marx argued that these countervailing tendencies cannot offset the rise in the organic composition of capital indefinitely. First, increases in absolute surplus value are limited by the number of working hours in the production cycle; e.g. a day only contains 24 hours, placing an absolute limit on the working day. Second, increases in relative surplus value are mainly achieved through greater investment in c, and so raise the organic composition of capital, c/v, at the same time as s/v. Third, restricting wage and employment growth, which restricts the growth in v, not only raises s/v, but also c/v.
So during an expansionary phase, Marx argues that c/v rises and r falls over time. Capitalists offset this tendency as much as possible through attempts to increase s/v, but these efforts can’t fully compensate for the rise in c/v. The solution within capitalism is for a crisis to bring about a collapse in capital values (and prices). This dramatically reduces c, and hence c/v, and causes a dramatic rise in the rate of profit, r. The system is then ready for a new expansionary phase.
Marx’s argument that the countervailing factors cannot offset the tendency for the rate of profit to fall is amenable to empirical testing. In what I consider to be an important new study, Andrew Kliman argues that the rate of profit in the US has behaved in the way Marx theorized over the post-war period. (The study can be obtained here.) On the basis of his empirical analysis, Kliman argues that the failure of the rate of profit to revive sufficiently after successive post-war crises (due to insufficient capital destruction) has been the underlying reason for the unsustainability of successive recoveries from crises, especially since the 1970s, consistent with Marx’s theory.
From Kliman’s perspective, governments have been intent on preventing massive destruction of capital at the onset of each post-war crisis. The reason for this is simple. Although the destruction of capital results in a dramatic rise in profitability, it is devastating both for weak capitals and for the general population. In the face of such a social upheaval, the legitimacy of capitalism itself comes into question, and the risk (to capital) of social revolution rises.
From an MMT perspective, fiscal policy offers an alternative means of restoring profitability. Low profitability can be viewed as the result of insufficient capital destruction, if the focus is on cost, but it can also be regarded as the result of insufficient aggregate demand, if the focus is on revenue. From the latter standpoint, a failure of the rate of profit to revive sufficiently to underpin sustainable growth can be attributed to the fiscal austerity of the neo-liberal era during which governments failed to maintain demand at levels consistent with a high rate of profit and sustainable growth. More on this later.
2. Private Debt and the Private-Sector Desire to Net Save
Marx’s theory, and Kliman’s study, suggest that the increasing tendency toward speculative rather than productive investment is due to the drying up of profitable productive investments. The result has been relatively weak growth in GDP (compared with the immediate post-war period), and a consequent recourse to more and more speculation as financial capital seeks higher returns, creating a level of private debt that is unsustainable in relation to real-value creation (or GDP growth). Attempts to prop up the rate of profit through attacks on real wages and living conditions have at the same time resulted in a marked increase in inequality, providing further impetus toward private debt.
The economy has reached a point where many private firms and households need to save in order to pay back debt. For this to be possible, the government must enable the private sector’s efforts to net save. That is the lesson of one of the accounting identities that modern monetary theory (MMT) stresses. For a closed economy:
Budget Deficit = Net Private Saving
In a closed economy, the private sector can only increase its net saving if the government increases its budget deficit.
For an open economy:
Government Deficit = Non-government Surplus
=> Budget Deficit = Private Net Saving – Net Exports
In an open economy with a trade deficit (like the US), a budget deficit is even more necessary if the private sector wishes to net save.
The worst thing the US government could do right now is to try to reduce the budget deficit. Not only is it likely to fail in its immediate objective (by causing plummeting demand, output, income and tax revenues), but it will also defeat the private-sector attempt to net save and pay off debt. If firms attempt to save to pay off debt, and households attempt to save to pay off debt, there are only two remaining avenues for maintaining the level of aggregate demand: government spending and exports. Deficit expenditure, to the extent that it weakens the dollar, will somewhat help exports. But the impact of improved exports is likely to be small compared to the impact of sustained and large deficit expenditures (because other countries may also try to prop up their exports through competitive devaluations, protectionism, etc). Expansionary deficit spending is the only policy that can enable the private sector to pay off its debt. Of course, an alternative is for the private debt to be written off. It is likely that such an action would meet with stiff resistance from powerful sections of capital, to say the least, but that does not mean it is impossible.
The main political obstacle to sustained, highly expansionary government expenditure is an unfounded fear of government debt. The fear is unfounded in countries where the government is the monopoly issuer of its own fiat currency. There is no funding constraint on a sovereign government. There is a real resource constraint. There are also political constraints. But there is no financial constraint. There is no need to issue public debt at all to fund government expenditure. The reasons public debt is in fact issued, in practice, are: (i) as a method of interest-rate targeting (but this could be achieved in other ways); (ii) as an ideologically motivated constraint on government (a desire by private-sector interests to restrict the role of government); (iii) as a propaganda mechanism to imply government faces a budget constraint similar to a private household (which creates a misguided fear of government debt and gives the impression social needs are not being met because of legitimate affordability issues, even when large reserves of labor and other resources are clearly available).
Relating back to Marx’s profit-rate tendency, sustained deficit expenditure not only provides a means to address the private-debt problem but also helps to revive the economy-wide average rate of profit. At the aggregate level, Marx maintained that total profit equals total surplus value, total price equals total value, and the average rate of profit equals the average rate of surplus value. It is therefore permissible to consider the effect of deficit expenditure in price rather than value terms. If it is further assumed that all surplus value is realized in exchange, the impact of fiscal policy on profitability can be considered in terms of Kalecki’s profit equation:
P = CP + I + BD + NX – SW
In this identity, P is aggregate profit, CP is capitalist consumption, I is private gross investment, BD is the budget deficit, NX is net exports and SW is worker saving. The profit identity shows that aggregate profit is the sum of capitalist expenditures (CP + I), government net expenditure (BD) and net exports (NX) minus worker saving (SW). Clearly, the budget deficit adds to aggregate profit, except to the extent that some of the proceeds of government net expenditure are saved by workers or leak to imports. For the global economy as a whole, net exports sum to zero. If, following Marx and Kalecki, workers in aggregate are assumed not to save, the sum of national budget deficits adds to aggregate global profit. The reason for this is that government expenditure, whether it initially goes to workers or capitalists, ultimately ends up in the hands of capitalists, since workers, in aggregate, spend the wages they earn on consumption items.
For a national economy, the average rate of profit, r, in price terms can be expressed:
r = P/K = (CP + I + BD + NX – SW)/K
where K is the dollar amount of fixed capital investment tied up in production. Since, under conditions of unemployment and excess capacity, the budget deficit will add to the numerator of the profit expression without adding to the costs of fixed capital investment K in the denominator, the budget deficit boosts the average rate of profit and improves investment prospects for the private sector. If, in contrast, the government imposes cutbacks and austerity, this squeezes the private sector, impacting negatively both on net private saving and the average rate of profit.
Of course, whether a focus on capitalist profitability is the appropriate use of fiscal policy is a political question. For some, it may be preferable to allow private markets to be subjected to the full (or partial) force of Marx’s profit-rate tendency while handling the social ramifications in other ways (e.g. by providing a job guarantee outside the regular economy, or a basic income guarantee, or a system of welfare and benefit payments, and by maintaining a public sector of some size that need not be subject to profit imperatives, etc.). For others (I include myself in this group), it may be preferable to do away with capital altogether and opt for an alternative social system. Nevertheless, the point remains that a mixed economy in which fiscal policy is used to maintain profitability consistent with sustainable capitalist growth is a viable social alternative provided the government is the monopoly issuer of its own flexible exchange-rate fiat currency.