Perhaps the most important economic prediction of Karl Marx’s theory of capitalism is that the rate of profit would tend to decline over time as a result of what contemporary economics would call technological change. According to Marx’s theory, the rate of profit varies directly with the rate of surplus value and inversely with the composition of capital. Marx argued that both the composition of capital and the rate of surplus would increase as a result of the capitalists’ tendency to accumulate capital, a tendency rooted in the desire to increase short-run profits by replacing wage-earners with labor-saving capital, hence offsetting effects of the rate of profit.

But how does this happen? The answer lies in what happens to the rate of surplus value, which we will examine more closely. The way Marx measures value is labor time, so surplus value is the accumulated product of the unpaid labor time of the producers. The fact that there can be any unpaid labor time is rooted in the fact that labor-power has the power to produce more than is necessary to reproduce itself. From this fact about labor is where Marx thought profits came from. Hence, in bourgeois society, surplus value is acquired by the capitalist in the form of profit: the capitalist owns the means of production as private property, so the proletariat have no choice but to sell their labor-power to the capitalists in order to live. The capitalist then owns not only the means of production, and the workers’ labor-power which he has bought to use in production, but he owns the product as well. After paying wages, the capitalist then becomes the owner of the surplus value, which, all the necessary Marxian conditions having been met, is above the value of the workers’ labor-power.

Now, the “organic composition of capital” is the ratio of the value of the materials and fixed costs (constant capital) embodied in production of a commodity to the value of the labor-power (variable capital) used in making it. This is an important concept, as we shall see.

By variable capital Marx meant that proportion of capital which is invested in wages, in the purchase of labor-power. He calls this capital “variable” because it is this proportion of capital which, if it is used wisely may produce a new, surplus value in the course of the labor process, above the necessary labor time which constitutes the value of labor power.

The constant capital refers to that proportion of capital invested in the materials and components purchased but then embodied in the product when it is sold, and the materials, tools, machinery etc., which are used up, bit by bit in the course of production, and which for all intents in purposes are the same as the materials materially incorporated into the products. These materials must be renewed when they are used up or obsolete.

If a certain quantity of constant capital, c, and variable capital, v, are invested in a productive process, then at the end of a cycle of reproduction these values will have renewed themselves, but in addition, if the labor power of the employees has used to at least the social average of usefulness, there will a surplus-value, s.

This can be expressed this symbolically as:

c + v → c + v + s.

(iii)

On the basis of this conception, the rate of profit for the individual capitalist who got into the game of profiteering by investing (c + v) at the beginning of the cycle of reproduction, and made a profit of s, the rate of profit is s/(c + v). This rate of profit is the ratio which affects the individual unit of capital, as opposed to the rate of surplus value, s/v, which characterizes the proportion of value expropriated by the capitalist class as a whole.

In all societies in which there is a division of labor, there is a social surplus; what is different about bourgeois society is that surplus value takes the form of capital, and surplus value is in fact the essence of production in capitalism. Only productive work, that is, work which creates surplus value, is supported. All “unproductive labor” is eliminated.

Thus, it is now clear that the rate of surplus value expresses the proportion of unpaid labor that workers submit to the capitalist (s) over to the necessary labor time, v, that the workers spend reproducing their own needs, and is paid as wages, or variable capital.

The organic composition of capital, c/v, measures the difference between the rate of surplus value, s/v, and the rate of profit, s/(c + v) – the higher the organic composition of capital, i.e., the more capital-intensive the industry, the lower the rate of profit. We can now see how it is that Marx characterized the process of the decreasing rate of profit as tantamount to an increasing organic composition of capital.

Based on this Marxian analysis, it is also evident that a general rate of profit and a general rate of surplus value may coexist in a given society, despite the fact that the two measures appear incompatible, since the rate of surplus value reflects the proportion of the total social product appropriated by the capitalist class, and the rate of profit reflects the proportion of any given product appropriated by an individual capitalist producer. However, Marx further argued that the composition of capital would increase at a faster rate than the surplus value, so that the net effect would be a decline in the rate of profit.

It seems, however, that the rate of the longrun rate of profit in capitalist society has a tendency to increase. Why would capitalists increase the organic composition of capital if they knew it would bring down their profits? Further, it would appear that the capitalist would want to increase the surplus value. This objection may be only partly true. The capitalists may increase the amount of surplus value extracted from the working class by two means: (1) extending the working day as long as possible, and (2) by cutting wages.

However, as each capitalist employs less labor and spends more on machinery and materials to produce the same value, the rate of surplus value decreases. Further, since employing workers is the only source of profit, Marx believed that the rate of profit would fall. Attempts by individual capitalists to increase their profits by introducing machinery or speeding-up production by technique fail as soon as their competitors copy the new technique and restore their market share. The end effect of these improvements in production may be to increase the productivity of labor, but unless the rate of surplus value is increased proportionately, the rate of profit will actually fall.

Marx’s conclusions, however, were not tentative. Marx believed that this process was an inevitable historic tendency for the rate of profit to fall, having resulted from the growing technology and complexity of the labor process, and the growing productivity of labor. Each capitalist employs less labor and spends more on machinery and materials to produce the same value. Since employing workers is the only source of profit, Marx believed that the rate of profit would eventually fall. This conjures up all the pessimism associated with the Ricardian stationary state, and, by means of revolution, all the optimism associated with a Millian stationary state.