System Failure: The Falling Rate of Profit and the Economic Crisis

by Andrew Kliman, Jonathan Maunder

Following Marx, Andrew Kliman argues that the economic crisis results from the fundamental logic of capitalism and cannot be solved by pro-growth reform measures. Only a more radical response is adequate to the task.

First published: 17 July, 2012 | Category: Economy, Vision/Strategy

Andrew Kliman is a professor of economics at Pace University and the author, most recently, of The Failure of Capitalist Production: Underlying Causes of the Great Recession. In discussion with Jonathan Maunder he argues that the economic crisis results from the fundamental logic of capitalism and cannot be solved by pro-growth reform measures. Only a more radical response is adequate to the task.

In your book 'The Failure of Capitalist Production' you argue that Karl Marx's theory of the tendency of the rate of profit to fall, which he outlines in volume 3 of 'Capital', is crucial in understanding the current economic crisis. Could you explain this theory for people who may not be familiar with it and why you think it is relevant to the current crisis?

To avoid jargon, I’ll explain Marx’s theory in a somewhat atypical way. Capitalist companies adopt labor-saving technologies that boost productivity. Because the productivity increases lower the cost of producing the companies’ products, the products’ prices also tend to fall, partly because competition between companies drives down the prices and partly because they find it advantageous to cut their prices in order to sell more stuff when their costs of production fall. But the price cutting tends to lower the companies’ average rate of profit.

More precisely, if there’s no change in the relation between profit and wages, and no change in the relation between physical output and the physical capital that is invested––both of which are quite reasonable assumptions––then the rate of profit will fall if prices tend to decline as productivity increases. I say “tend to decline” because nowadays, unlike when Marx wrote, prices typically rise even in the face of rising productivity. But that actually doesn’t matter. As long as prices rise more slowly than they would if productivity didn’t increase, the rate of profit will still fall under these conditions.

Marx argues that the fall in the rate of profit, if and when it materializes, leads to a slowdown in productive investment and economic growth. He also argues that it leads indirectly to financial crises. Companies and investors engage in all manner of speculative activities and shady deals, as they try rather desperately to keep their rates of profit from falling despite the fall in the economy-wide average rate. This risky behavior, along with debt problems stemming from slow economic growth, eventually lead to a debt crisis, a situation in which a large volume of debt can’t be paid back. And this often triggers an economic downturn.

I think this theory is of some help in explaining the 2007-08 financial crisis. It’s of a lot more help in explaining the Great Recession and its aftermath in the U.S., as well as the acute debt crises in several peripheral Eurozone countries and other problems abroad that stem partly from the U.S. downturn. U.S. corporations’ rate of profit suffered a substantial fall, and never recovered in a sustained manner. This led to a persistent slowdown in productive investment––basically, the entire decline in the rate of investment is attributable to the fall in the rate of profit––which in turn led to a marked slowdown in economic growth and mounting debt problems. And the government’s response to all this delayed the outbreak of a major crisis as the cost of further exacerbating the debt problems. To take just one example, the whole rise in U.S. Treasury debt (as a percentage of Gross Domestic Product (GDP)) prior to the crisis is due to a combination of a fall in corporate profits (as a percentage of GDP) and reductions in tax rates on profits that kept the after-tax rate of profit from falling as sharply as did the before-tax rate. So the effects of the fall in the rate of profit were transferred in large part from corporations to the government.

But the real clincher, the thing that convinced me that Marx’s falling-rate-of-profit is needed in order to account for the whole mess, is the fact that it happens to account surprisingly well for why the rate of profit fell. Over the six decades that preceded the financial crisis, there was little long-run change in either the relation between profit and wages or the rate at which money prices rose in relation to commodities’ real values. When you set aside those factors, what’s left is that the rate of profit fell for the reason Marx’s theory singles out: employment grew more slowly than capital was accumulated via investment. The slow growth of employment in relation to capital accumulation accounts for almost all of the fall in the rate of profit over these six decades. That’s remarkable. I never would have thought that the theory would fit the facts so well.

Other writers on the left, such as the Canadian Marxist David McNally, argue that the period since the 1970s has been one of capitalist boom, rather than falling profit rates. How do you respond?

If everything has been so hunky-dory, why is the world economy mired in such a deep and persistent slump? It’s been four and a half years since the Great Recession began in the U.S. and three and a half years since the U.S. government propped up the country’s financial system and quelled the Panic of 2008. A financial crisis can trigger a recession, but if the underlying fundamentals were in good shape, the economy would bounce back rather quickly. In light of the depth and persistence of the slump, we should be very skeptical about claims that the quarter-century or so preceding the financial crisis was a genuine boom period. It would take a lot of strong evidence to shake the initial presumption that these claims are very likely to be wrong. But the evidence simply isn’t there.

If we use the term rate of profit to mean what almost everyone––businesses, investors, Marx––means by it, namely the rate of return on investment, there was no sustained recovery of the rate of profit of U.S. corporations after the recessions of the mid-1970s and early 1980s. If we measure profit as the portion of corporations’ net output that their employees don’t receive, the rate of profit continued to trend downward quite sharply. The data needed to compute the rate of return on investment in other countries aren’t available, but there was a very widespread decline in U.S. multinational corporations’ rate of return on their foreign investment at the same time, which suggests that the global rate of profit probably fell as well. McNally’s claim that the rate of profit rose is based entirely on computations performed by a physicalist economist, Simon Mohun. The problem is that what Mohun and other physicalists mean by rate of profit isn’t a rate of profit in the normal sense––it’s profit as a percentage of what it would cost companies today to replace all of their capital assets––and no one has ever successfully explained why it matters or to what it matters.

But the fall in the rate of profit is far from the only factor. A wide variety of evidence indicates that the economy never fully recovered from the slumps of the 1970s and early 1980s. There’s a glaring contrast between the situation during the quarter-century following World War II, which was a genuine boom phase, and the situation during the quarter-century preceding the latest financial crisis. The rate of investment (capital accumulation) fell and never recovered, debt burdens increased markedly relative to income, growth of GDP, industrial production, employees’ compensation, and public infrastructure investment were all much slower than during the postwar boom, the average duration of unemployment was higher and the problem of workers dropping out of the labor market was more serious, and there were many, many more burst bubbles and banking, debt, and currency crises.

The situation was somewhat obscured by the artificial, temporary expansions and bubbles that were driven by debt financing, and by the fact that there were always pockets of strong growth in the world––Japan, before its bubbles burst around 1990; then the East Asian “Tiger” countries, before the currency crisis of the late 1990s; and most recently, China. But taking the world as a whole, data published by the World Bank indicate that growth of real GDP per person fell drastically, by about one-half, after the postwar boom ended, and never recovered.

Given these facts, why does the narrative of a neoliberal boom persist, even in the face of a protracted slump? I suspect that what’s at work is a confusion between politics and ideology on the one hand, and economic reality on the other, rooted in the belief that politics and ideology drive economic realities. I think a lot of the people who regarded and still regard the period since the 1980s as a genuine boom phase drew this conclusion from the defeats of “Keynesian” economics and social democracy and the political and ideological ascendancy of neoliberalism. Lots of things did indeed change. Nonetheless, the economy never fully recovered. The lesson I draw is that politics and ideology haven’t driven economic reality.

Your book contains a strong critique of Keynesian and 'underconsumptionist' solutions to capitalist crisis. Such approaches, which depend on redistributive measures and state spending to boost the purchasing power of workers and stimulate growth, are dominant on the left in regards to opposing the current austerity measures. Could you outline your critique of this approach and how you see the connection between immediate struggles which might benefit workers and the need to transcend capitalist relations of production?

I definitely support the various efforts taking place around the world to fight austerity, for the practical reason that working people will be able to protect their jobs, homes, incomes, and access to services only by fighting for them, and fighting long and hard. That’s because the economic malaise underlying the push for austerity is real and deep. It’s not a mere pretext that’s being used to justify policies that are actually just attempts to make the rich richer or put forward an ideological agenda.  

In contrast to this practical justification for anti-austerity struggles, there are the theoretical justifications, grounded in what I call “trickle-up economics,” that so many on the left have embraced. We’re told that what’s good for working people is what’s good for the economy. But since we’re dealing with a capitalist economy, this is a very strange notion. Profit is the fuel that powers the capitalist system, but if working people get a bigger slice of the income pie, the slice left over as profit shrinks. It’s already the case that a persistent fall in the rate of profit is a key underlying cause of the current economic instability and malaise. Slicing away profits even further wouldn’t solve these problems; it would make them worse. Working people can definitely improve their situation by fighting for and winning concessions, but these concessions won’t solve the economic problems that capitalism is facing. There’s an inevitable contradiction between what’s good for working people and what’s good for the capitalist economy. The only way to transcend this dilemma is to transcend capitalism.

Now, I’ve said that profits would take a hit if income were redistributed downward, but underconsumptionist theory says the opposite: profits would actually rise, because spending on goods and services would rise. Poorer people spend almost all of their income on goods and services, while richer people use a big chunk of their incomes to buy bonds, stocks, and other so forth, which aren’t goods and services. That much is true; downward redistribution would boost consumption spending. The more naïve underconsumptionist authors act as if this proves their case, but it simply doesn’t. It ignores another important component of spending on goods and services, businesses’ productive investment––spending on equipment, construction of factories and office buildings, and so forth. Productive investment is paid for out of profits and borrowed funds. But downward redistribution of income would reduce profit, and it would also reduce the amount of funds businesses could borrow, because rich people would be sinking less money into bonds and savings accounts. So productive investment spending would decline. If it declined by as much as consumption spending rose, the redistribution wouldn’t cause an increase in total spending on goods and services. And the fall in investment spending would retard future growth of income and spending.

The more sophisticated underconsumptionists realize that they need to show that downward redistribution of income would boost total spending, not just consumption spending. They argue that investment spending is ultimately limited by the level of consumption spending. So the rise in consumption spending would indeed boost total spending, by making possible a greater volume of investment spending. But this conclusion depends crucially on the argument that investment spending is ultimately limited by consumption spending, and I show in my book that this argument is fatally flawed. It rests on an elementary logical error, and the statistical evidence indicates clearly that investment spending has grown far more rapidly than consumption spending in the long run. For instance, in the 75-year period between 1933 and 2008, productive investment spending by U.S. businesses increased almost five times as rapidly as did personal consumption spending.

Frankly, the “Keynesian” solutions that you seem to be referring to––those based on the notion that deficit spending is like a spark that can turn the economy into a perpetual motion machine––aren’t anything like the Keynesian economics I ever learned. I don’t know where this notion comes from and I see no justification for it. It’s true that in Keynesian economics, there’s a concept of a multiplier effect: the government may be able to boost GDP by somewhat more than it increases its budget deficit. But one radically misunderstands this concept if one thinks it means that a temporary increase in the deficit will permanently boost the rate of GDP growth and thereby pay for itself. Some Keynesian economists do advocate massive deficit spending, but as a short-term measure, not as a long-term solution. 

Furthermore, even as a short-term measure, there are limits to what deficit spending can do. The U.S. Treasury has been borrowing like crazy since Lehman Brothers collapsed. Its total debt has increased by 64%. That’s an extra $6.2 trillion in borrowing, $20,000 per person in less than four years. And yet we’re mired in a situation in the U.S. in which, if we don’t count the extra people working only part-time who want full-time jobs, the percentage of the population that’s employed is still more than 10% below its pre-recession peak. It’s just not realistic to imagine that this problem can be eliminated by massive government borrowing. The ratio of Treasury debt to GDP has jumped by about one-half since Lehman collapsed; it’s already reached 100%.

If the government were to try to eliminate the unemployment problem, even temporarily, by means of massive borrowing, the interest rates it would have to pay would almost certainly skyrocket to unsustainable levels. And once the artificial stimulus ended, we’d be back where we were. If it isn’t profitable for companies to create the extra jobs in the absence of such stimulus now, it also won’t be profitable in the absence of such stimulus later.

In your analysis economic crisis is a recurring product of deep structural contradictions which are inherent to capitalism. This implies the need for revolutionary change rather than reform. How do you see such a revolutionary process occurring?

The key factor is that working people’s well-being is deteriorating and in danger of deteriorating much further. They’re worried and disgusted by that. And they’re disgusted at the great lengths to which policymakers have gone in order to try to save the present system, while doing so little to help them, and even trying to save the system at their expense. So we’ve had a big wave of revolts all around the world, not only in the economically developed countries, but also throughout the Arab world. Deteriorating well-being and the worry and disgust it engenders aren’t the only things behind “Arab Spring” by any means, but they’re important elements. And they were important elements behind the Occupy movement, even though those who dominated the movement chose to downplay them while playing up corporate power, greed, and inequality.

The wave of revolts has given the lie to the notion that regular people lack the “consciousness” to understand their own interests. So it’s also given the lie to the notion that raising their “consciousness” is a crucial component of the revolutionary process. Of course, there’s a serious lack of access to certain kinds of information and certain explanations of how the economic and political systems function and malfunction, and a serious lack of access of to certain ideas about what needs to be changed, but these are entirely different matters. Those on the left who complain about “false consciousness” are referring to people’s supposed unwillingness to receive and understand the information, explanations, and ideas––they are supposedly “not ready”––rather than just their lack of access. As a result, many people and groups on the left have themselves become part of the problem. Because they think that people are not ready for the needed information, explanations, and ideas, they don’t help provide them, but instead put forward a lot of superficial stuff that’s supposedly more palatable.

The widespread acceptance on the left of Margaret Thatcher’s TINA doctrine, “there is no alternative” to capitalism, has also become part of the problem. It’s amazing that in the midst of the worst economic crisis since the Great Depression––in the fall of 2008 when mainstream pundits were saying that capitalism was a failed system––most of the left refrained from drawing the same conclusion, at least publicly, and some even denied that the system was in serious crisis. But it makes sense in a way. If greater equality within the existing system is the best realistic alternative, you want to say that the wealth is there to spread around and the system can afford to spread it around, even at a moment of acute crisis in which a big chunk of the wealth is being destroyed.

The rapidity with which the revolts have spread from place to place and the degree to which they have organized themselves were remarkable. And they’ve erupted rather quickly, more quickly than during the Great Depression. The wave of sit-down strikes that re-created the labor movement in the U.S. didn’t come until seven years into the Depression. So I think that the latest wave of revolts also seriously calls into question the notion that the process of social change has to be a gradual, step-by-step one, in which movements start with demands for immediate reforms and move in stages to more and more radical demands, and in which a gradual process of organization- and movement-building is crucial. This notion has everything to do with the concern over “false consciousness.” If people lack the consciousness they need, they have to be moved step by step like pieces on a game board, or they have to acquire the needed consciousness step by step as they move around the game board.

It’s true that there hasn’t yet been a widespread explicit demand for revolutionary change, in the sense of an anti-capitalist social revolution, but the worry and disgust over deteriorating well-being is pretty total. And already in 2009, a nationwide poll in the U.S. conducted by a respected Republican pollster found support for capitalism was only marginally greater than support for socialism among low-income people and young adults. Only 37 percent of respondents under 30 favored capitalism, while almost as many, 33 percent, favored socialism. Respondents whose income was less than $20,000 favored capitalism by only a 35 percent to 27 percent margin. The poll didn’t define “capitalism” or “socialism,” so we don’t know what the people who expressed a preference for “socialism” meant. But one thing is clear: the TINA doctrine is no longer all-dominating.

In any case, what’s important isn’t whether revolutionary change is explicitly demanded at a certain moment. The things that are important are what people want, whether what they want can be granted within the existing system, and whether, if it can’t, they’ll resign themselves to that fact or try to move beyond the existing system. We’ll see, but I’m hopeful, much more hopeful than I was before the economic crisis and the fightback against it.

Of course, lots of things can derail the process of total social transformation. One is that aspirations for a total change can be channeled down wrong directions, including fascism. This may seem alarmist, but it happened in the Great Depression, though not principally within the working class, and fascism and anti-Semitism are again on the rise, for instance in Germany, France, the Netherlands, Hungary, and Greece. If the left isn’t offering an alternative to mainstream efforts to manage the economic crisis, and it isn’t, there’s a void that only the far-right will fill.

Another thing that can derail the process is the one that dominated the thought of Raya Dunayevskaya, the founder of the philosophy of Marxist-Humanism. The destruction of the old society, and the creation of a new one that really transcends capitalism and makes freedom universal, are two different things. The transformation of the Russian Revolution into a state-capitalist monstrosity made that clear. So she stressed that the revolutionary process needs to have what she called a dual rhythm; the process of creating the new society has to take place in tandem with the destruction of the old one. And she stressed that, in order for this to happen, we need Marx’s philosophy of “revolution in permanence”––a philosophy of unceasing revolution against all obstacles, regardless of the guises in which they appear, until the moment is finally reached in which a classless, non-racist, non-sexist, genuinely human and free society is achieved.

I think we need to reclaim and further develop all this. One way in which we need to do so is to show that an emancipatory alternative to capitalism is a real historical possibility. The widespread belief that it isn’t makes movements hold back and refrain from developing a perspective of total transformation. Why put your life on the line for something that’s impossible? So I think the foremost task of revolutionary thought today is to work out exactly what must be changed in order to have a modern society that isn’t governed by the economic laws that govern capitalism, one that isn’t actually capitalism in sheep’s clothing, and one that’s economically viable, so that it doesn’t revert back to capitalism, collapse, or lead to something even worse like warlordism.

We don’t have to start from scratch; Marx left us a lot of guidance on this and a few others have recently done some good work on this issue. It’s important for working people and social movements to be involved in the process. Indeed, I think they have to take the lead in making sure that that this work continues and becomes a top priority, since intellectuals on the left have largely embraced the TINA doctrine. But working people and social movements can’t shoulder all of the responsibility here. A lot of sustained attention and hard labor are needed to answer the question of “exactly what must be changed?”; answers won’t arise spontaneously or as by-products of activism. It’s not a matter of providing “consciousness” to people who lack it, but of responding productively to people’s conscious desire to know whether and how “Another World is Possible.” 

Jonathan Maunder is on the editorial board of International Socialism - a quarterly journal of socialist theory

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