The falling rate of profit: how business measures its performance

Submitted by AWL on 19 July, 2011 - 6:24

By Barry Finger

Socialists have been at loggerheads concerning the immediate relevance of the falling rate of profit as an explanatory backdrop to the current crisis. At the extremes are those, such as Andrew Kliman, who have argued that rates of profit in the American economy have fallen since the late 1960s and have never fully rebounded and Michel Husson and Gérard Duménil and Dominique Lévy who have argued that neoliberal policies have so raised the rate of exploitation to have, in effect, neutralized or undermined this as an underlying cause of the current crisis.

I have no intention of intervening directly in the issues raised in that debate. While I come down squarely in Andrew Kliman’s corner as far as the immediate issue is one of using “historical” cost measurements, I question how both sides of the debate handle other uses of National Income and Product Accounts. But on the matter in immediate dispute, the costs that enter into commodities as consumed constant capital are based on an average of historically given prices, of capital goods of various pricing vintages. To employ “replacement” prices as Husson does (and as the NIPA does), blurs how new technology gradually permeates each sector; reducing cost prices by displacing stepwise the existing processes. New averages cost-prices are, so to speak, constantly coming into being, which is why the historical approach better captures a snapshot of that blended process at any moment in time. “Replacement prices” tips the entire calculation replacing average cost prices with that associated with the most recent vintage of embodied technology.

Where I differ, however, is in their treatment of exploitation. Both sides of the debate fail to properly distinguish between productive and unproductive labor in the private sector economy. Of course, this is easier conceptually than practically. The Bureau of Labor Statistics, for instance, distinguishes these categories with respect of manufacturing, mining and construction, broadly defined. And it does so in a manner compatible with Marxist conceptions. But the vast majority of labor power throughout the economy is now no longer expended directly to expand value, but rather takes part in the ancillary processes essential to the reproduction of the system as a whole. The entire capital applied in this way, included the flow of wages consumed in trade and finance (as well as in many services), generally constitute additional costs added to the price of the final product. Such wages are not variable capital for purposes of determining the rate of exploitation. As such the wage share of GDP understates the degree of exploitation and its change over time and tells us nothing about its trajectory. The wages of unproductive workers in the private sector must be considered a special form of circulating constant capital. This is not to argue that unproductive labor power is not exploited. It is important to remember that such work is paid only for that fractional part of the working day needed for its reproduction. It does not, however, transmit new value to output and its wages must be made good from the final sales price.

Insofar as neither side in this debate attempts to integrate wages, both productive and unproductive, into their measurements of the rate of profit, both ends of the debate miss a vital element in the so-called transition to a “service” based economy. For, all other things remaining equal, a rising ratio of nonproductive to productive labor, will always decrease the rate of profit, just as would say an increased consumption of fuel or raw materials, and can also under certain conditions transform what would appear to be an increase in the rate of profit into a falling rate of profit.

Even if profits grow faster than the value of tangible assets (buildings, machines, etc., including the value of the physical capital invested in nonproductive sectors of the economy), they might still grow slower than the sum of tangible assets plus the stock of unproductive wages. Thus we have come to expect a fall in the rate of profit to be associated with a rise in the value composition of capital in productive sectors that exceeds any associated rise in the rate of exploitation. But we might also find a fall in the rate of profit despite a rise in the rate of exploitation that actually exceeds that of the value composition of productive capital - as long as the total growth in nonproductive expenses is sufficiently robust.

Each side of the debate, from the vantage point of the analysis advanced here, are prone to underestimate both the rise in the rate of exploitation and the increase in the total constant capital. Still a capital accumulating upon an relatively, if not absolutely, narrowed base of productive labor power, and applying ever more of its accumulated labor-time to trade, finance and insurance might reasonably be expected to experience secular difficulties in capital self-expansion. Yet the statistical findings often appear less than resoundingly supportive of this proposition.

At least in Marxist circles. Nevertheless if we were to consult US government statistics, the following results can be obtained for the average rate of profit for domestic nonfinancial corporations: 1960-9: 11/1%; 1970-9: 8.3%; 1980-9: 7.4%; 1990-9: 8.3%; 2000-9: 6.6%. This is calculated on net profits after taxes divided by the net stock of physical assets plus inventories valued at current prices. These results therefore suffer from all the frailties discussed above, but nevertheless demonstrate a rather clear downward trend. And if we eliminate the decade of the 1960s---arguably an anomaly in the historical patterns of capitalism, the material seems much less compelling.

That said, the omission of the entire financial sector still gives a distorted picture of the entire period. For during that time, the financial sector came to claim almost 40% of total profits at its pre-collapse peak. And many, if not most, large firms specializing in production also germinated financial offshoots to finance purchases of their products. Conversely many financial institutions acquired holdings in manufacturing and other commodity generating sectors. Official statistics are at pains to disentangle these mixed enterprises and isolate only nonfinancial activities. Yet the problem remains. Marxists are not clear how the rate of profit should be calculated for a sector whose product consists of claims to future surplus value. Most of the capital here never interacts directly with productive labor. It also seems pointless to calculate a rate of return based on the value of physical structures---buildings, office equipment, computers and software when such balance sheets are composed basically of liquid and near liquid assets.

And yet this is key. Capital is a social relationship in which value takes the general form of money in the process of self-expansion. Marx derived the falling rate of profit directly from the contradictory nature of value-creation, by the need to constantly raise productivity by investing in capital augmenting technological improvements. These raise the value composition of capital and diminish the labor power base upon which new value is generated. But the process of social reproduction requires ever more specialization. This means spinning off ever more distinct sectors needed to harvest idle balances and keep them actively engaged so that capital is not needlessly tied up in inventories buildups or non-interest bearing demand deposits. But this also multiplies the claims on future profits. And, insofar as the manipulation of monetary instruments enlarges claims without directly expanding productive capacity, the tendency to produce assets in excess of profits should only compound the problems identified by Marx in the generation of value.

It is therefore not surprising that the world of finance, which specializes in activating what would otherwise remain as dormant capital, has generated a proper general measurement for rates of profit. These are perfectly applicable to both the financial and nonfinancial sectors and come far closer to expressing a more integrated gauge of capital’s ability to propagate earnings than comparisons with “physical stocks” of capital and inventory. The most general form of this measurement of profitability is the rate of return on assets (ROA). This involves examining the balance sheet of corporations and comparing profits (sometimes calculated before deductions are made for interest and taxes) also called, somewhat confusingly, net income with the total amount of fixed and current assets (measured at historical prices) at the corporation’s command. Fixed assets consist of structures, equipment and machinery which are depreciable. Current assets are cash accounts and instruments, including inventories, which can be converted into cash at short notice, within a business’s fiscal year.

When profitability is examined from this vantage point a much clearer picture emerges of the underlying fragility of the American economy. This has been done by the authors of the so-called “Shift Index” produced by Deloitte LLP and has received broad attention in the business press including the Harvard Business Review. This comprehensive review which includes all corporate sectors found that “US companies’ return on assets (ROA) have progressively dropped 75 percent from their 1965 levels despite rising labor productivity”, a doubling of labor productivity to be more precise. That is, for all the efficiencies gained in managing capital, in squeezing labor, in becoming leaner and stripped down---of massively raising the rate of exploitation--- firms are experiencing ever lower returns to their balance sheets. The Shift Index explains this decline rather lamely by heightened competition among firms. But we might better consider this “heightened competition” more a result of a falling rate of profit than its cause.

Exhibit 6 from the report, reproduced below, presents a stark overall view of the perilous decline in total corporate profitability. Note that the decline in absolute terms demonstrates that corporate returns have been hovering through the past decade in a range that is just barely positive. This contrasts starkly with the picture usually painted of in Marxist studies based of robust profits (and growing profitability) just prior to the economic meltdown. (See Exhibit 6.)

We also see these results in deaggregated from. The following is a reproduction of the rate of return on assets in the technology sector. (See Exhibit 58.)

This sector, it should be noted, exhibited some of the most robust gains in labor productivity, at almost three times the growth in the economy as a whole (2010 Shift Index, p 183.), yet could not escape the general trend. (See Exhibit 57.)

A disaggregated review of the banking and securities industries actually demonstrates a very slight improvement in trendline banking performance until the last decade, but was otherwise incapable of making much of an impact on the larger economic performances. (See Exhibit 11).

A word by way of a conclusion. Most capitalist crises of significance are crises of profit shortfalls. It is true that there are crises of proportional dislocations caused say by weather or natural resource limitations. But these are rather short lasting due to the adaptability of modern capitalism. The larger problem resides in the very nature of value creation from which all the various claims on surplus labor arise. The American economy has grown in recent decades in spurts associated with financial bubbles and punctuated by their deflation despite continuous improvements throughout the economy in labor productivity. Capital has simply been unable to accumulate faster than the decline in profitability. This is the forty year backdrop to the Great Recession.

Yet Marxists are paradoxically among the last to grasp what is painfully apparent to the business community and reflected in its literature.

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