Karl Marx’s writings were among the earliest to analyse what is now called the “business cycle” – the short-term tendency towards boom and bust built into capitalism.
But Marx also talked about long-term tendencies that operate over the course of many such cycles. The most important was his “law of the tendency of the rate of profit to fall”. Marx argued that the total profit available to capitalists depends on, and is limited by, the number of workers they exploit and the level of exploitation.
But in order to try to get more profits than their rivals, individual capitalists also have to invest in ever-greater accumulations of machinery and raw materials.
If the amount of profit is limited but the amount of investment grows, then the return on that investment, the “rate of profit”, will tend to fall over time (see graph below).
If the rate of profit is 50 percent, each capitalist can double the size of their business in two years. If the rate falls to 10 percent, it takes ten years. So a falling rate of profit limits the rate of expansion of capitalism.
There are two important ways in which profit rates can be restored. The first is to increase the exploitation of workers. But there are limits to how long and hard workers can toil. And workers are also required to buy much of the output of the system.
The second factor that can restore profit rates is crisis itself.
For instance, if machines are unsold, capitalists can grab them at a fraction of their old value. Or if one company goes bust, its rival can buy it up on the cheap. This gives a huge boost to profitability for the capitalists that survive.
If the crisis is accompanied by the destruction of vast swathes of the system and mass employment that weakens workers’ organisation – so much the better for those running the system.
From the 1880s to the 1920s profit rates fell by about 40 percent. But a crisis did not emerge immediately. Productive investment fell and wages were held down.
This opened up a gap between the potential output of the system and the much lower level of demand from capitalists and workers.
The gap was plugged through growing levels of unproductive spending. For instance, the stock market and luxury consumption by the rich boomed, and financial expansion allowed growing levels of personal debt.
When this bubble burst at the end of the decade and the underlying problems asserted themselves, the initial responses by states were ineffective. So the “New Deal” in the US boosted the economy for a brief period before it collapsed back into slump in 1937.
Ultimately it was state-driven restructuring in order to wage the Second World War, and the destruction of the war itself, that restored the system’s profitability.
After the war, state involvement in the major economies remained high. The boom of the 1950s and 1960s was the longest in the system’s history.
Pumping vast amounts into weapons production and other “waste” areas slowed down the expansion of productive investment. The rate of profit still fell, but more slowly than would have otherwise been the case.
It was not until the 1970s that serious crises re-emerged. But the recessions of the 1970s and 1980s were not a repeat of the slump of the 1930s.
To understand why, we have to consider another long-term tendency. As capitalism ages, the size of individual companies increases as they reinvest profits and buy up rivals.
By the early 1980s states, now themselves far bigger economic players, were reluctant to allow the collapse of giant firms, which could easily turn a recession into a slump. Governments intervened to prevent this, for example by bailing out large firms.
Profit rates remained relatively low. So capitalists and states with money sought to invest in areas outside production. In particular, they pumped their money into the financial system and other areas of speculation.
This had three implications. First, the expansion of credit allowed workers, especially in the US and Britain, to maintain their level of consumption despite restricted wages.
Second, tapping off profits that would have otherwise flowed into investment further retarded the tendency for profit rates to fall.
Third, the financial explosion helped create bubbles in certain markets – such as shares in Dotcom companies in the 1990s, or more recently property and commodity prices, and derivatives based on these. This created an illusion of profitability as the value of assets held by firms grew – until now.
The current problems are deeper than simply a “credit crunch” or “banking crisis”. It is a crisis of the capitalist system, one that was postponed through changes such as the growth of finance.
It is not inevitable that we will see a slump in the next year or so. The ruling class may just be able to create another bubble or boost demand sufficiently to drive the system forward for a few more years. But it is also possible that they will fail and that the crisis will deepen.
Joseph Choonara’s book, Unravelling Capitalism: A Guide to Marxist Political Economy will be published later this month.