The Conversion of Profit into Average Profit
(This post is part of an ongoing project: a close reading of volume 3 of Kapital, one post per chapter. I hope that others who are tackling this book for the first time might find my summaries and thoughts useful. I also hope that others might leave their own thoughts, criticisms, help, etc. here so that this blog might become a good collective resource for those brave souls who take on Vol. 3.)
Chapter 8. Different Compositions of Capitals in Different Branches of Production and Resulting Differences in Rates of Profit
From the title the concept seems clear. The composition of capital is short for the “organic composition of capital” or “value composition of capital” which is the ratio of constant to variable capital. If a firm devotes more investment to constant capital than variable capital it should have a lower profit rate than one which hires lots of workers and no machines.
Marx begins by explaining that he will make the assumption in this chapter that the rate of surplus value is uniform throughout the economy. This could just be a theoretical abstraction for the purpose of examining different value compositions of capital. But instead Marx goes further and argues that he is justified in this simplification by a real trend in the economy toward a uniform rate of surplus value. Yes he says that different levels of skill make it harder to see this, referring us to the distinction between simple and complex labor in Vol. 1, but that the forces of capital tend to press evenly upon all labor everywhere, reducing it to a common ratio of surplus labor to wages. Of course there are obstacles to this process everywhere, but the tendency of capital is to slowly, over time, remove these barriers and create a uniform rate of exploitation. (I was surprised to see him refer to Adam Smith here. If anyone can explain this Smith reference more I’d be much obliged.)
This reasoning is common in many of Marx’s arguments. The idea that capital has inherent tendencies, inherent within the basic form of capital itself is similar to the idea of value. In the same way that, to the extent that markets penetrate the social relations of society, we can make observations about the way in which the law of value breaks down barriers, monopolies, etc. to establish socially necessary labor time, we can also observe capital, to the extent that it dominates production relations, slowly imposing its internal logic around the heterogeneous and uneven world around it.
The next important distinction to make is between mass of profit and rate of profit. In all our previous analysis of profit rates it might be easy to forget that a lower profit rate doesn’t mean less surplus value is being produced. It just means that producing this surplus value is more expensive. The mass of surplus value in society can grow at the same time that profit rates are falling. In fact this is the prediction of the falling rate of profit. That belongs to part 3 of the book but this distinction will also be important in this part because Marx will be distinguishing between the aggregate mass of surplus value created by the whole economy and the amount of surplus value each individual capitalist can claim as their own profit.
In Part 1 we often compared the organic composition or turnover times of one firm against another. But in reality such glaring differences in organic composition or turnover are more likely to exist between different industries. The same process of competition which tends to even out differences in the rate of surplus value also evens out differences in organic composition and turnover within each industry. But between different sectors of the economy these differences are still quite drastic. The service sector employs a lot of people and does not have big expenses in machines and fixed capital. It therefore naturally has a lower organic composition than the automobile industry which employs a lot more constant capital relative to variable. From here on, when Marx talks of the organic or value composition of a sector/sphere/industry he is talking about the average organic composition. Individual firms may fluctuate above or below this average, but competition pulls them back toward it. The average itself may change over time, but pulling stragglers along with it. The same logic goes for discussions of turnover time.
Marx then goes on to define three terms which sometimes cause some trouble for readers: technical composition, value composition and organic composition of capital. Many writers who write about Kapital complain that Marx uses these terms too interchangeably and that he changes his definitions of them. Sometimes this is used to claim that his thinking about them changed over time and even that perhaps his understanding of them was incomplete. A lot of writers stick with organic composition for the most part though David Harvey prefers value composition in his book Limits to Capital. (critique that term of Harvey’s which attempts to show the way in which value composition is embodied in physical forms….)
This, tripartite distinction has a dialectical basis. It is similar to Marx’s distinction between use-value, exchange-value and value. It’s theoretical basis is the idea that in a market social relations become reified in the physical form of commodities. These commodities have all sorts of technical features: smell, taste, particular uses, etc. But they also are the means of coordinating a social labor process. Thus they also have the quality of having a price. Price is abstract. It is not related to any physical-material-technical quality. Price is the mechanism for measuring and apportioning social labor. Thus value is manifest in exchange value and exchange value is attached to particular, concrete use-values.
Similarly the process of production has basic technical features depending on the given level of productivity. No matter how the labor is coordinated (markets, feudalism, socialism, parecon, etc.) the material aspects of the labor process determine the ratio of people to machines to raw materials. This is the technical composition of capital. It is purely a description of use-values which abstracts from the amount of money paid for the different elements of production. The technical composition measures numbers of people, numbers of machines, numbers of bolts, barrels of oil, etc.
But all of these people, machines, bolts and barrels have a price. This price is the mechanism by which social labor is apportioned. This price determines how much a capitalist can afford to spend on each item, and how much to charge for the final product. Thus the value composition of capital measures the values of each element of production. A number of people becomes wage expenses. A number of machines becomes fixed capital expenses.
The technical and value compositions have an inner relation. The technical composition determines the proportions that are needed to produce a given level of output. The value-composition determines how much each element costs and how much can be invested in production. Both elements are always changing. Changes in productivity might mean less workers are needed when more machines are bought. Changes in the value of raw materials (caused by changes in the technical composition elsewhere) mean that the technical composition can be changed without changing the amount of money invested. These feedback effects require a third term that distinguishes between changes in value due to changes in the technical composition in the firm and changes in value due to changes in value of the elements of capital caused by changes in productivity elsewhere. This is the organic composition of capital. It ties the material world of use-value to the social world of value. It stands with one foot in each world, reflecting their interaction effects. Organic composition refers to changes in the value-composition which are caused by changes in the technical composition, as opposed to changes caused by alterations of the value of raw materials, labor, etc. If a firm decides to build more machines so that it can increase output with the same number of workers this is a rise in the organic composition. If a firm finds cheaper raw materials which allow it to buy the same amount of constant capital for less money this is a change in the value composition.
It is sometimes pointed out that Marx’s use of organic composition and value compositions is inconsistent. Marx apparently started developing these terms later in his writing of Kapital. Their appearance in volume 1 did not occur until the 3rd edition. David Harvey, in his book “Limits to Capital”, quotes a passage from Marx’s “Theories of Surplus Value” in which the relation between value composition and organic composition seems to conflict with the definition given in Kapital. People also complain that Marx uses the two terms quite interchangeably in Volume 3 which blurs the distinction. From the definition I give above it seems like organic composition describes internal changes to the firms composition while value composition describes the feedback effects of productivity on other firms yet Marx will use organic composition to describe the economy as a whole as well. As we read through Vol. 3 we’ll have to pay attention to how this term is used to see if we can make sense of this distinction.
It is obvious that the distinction will be important to our discussion of the falling rate of profit. There is a reason that a rising organic composition is associated with the FRP. The FRP argues that changes in the ratio of machines to workers, the technical composition, alters the value composition. This is what the organic composition seeks to explain. If the value composition was rising because of increased prices of raw materials this would not be related to the FRP argument.
Harvey makes the distinction that the organic composition makes more sense in relation to the individual firm’s value composition changing due to changes in the technical composition. He reserves organic composition for individual firms and uses value composition for referring to the entire economy. But this is Harvey’s own distinction. Marx uses organic composition most of the time.
…………. moving on
What does variable capital measure? It is the sum of money spent on wages. That lets us understand the value composition. But those wages correspond to a given mass of workers. This mass of workers is part of the technical composition. The value created by this mass of workers is greater than their wages, than variable capital, than their contribution to the value composition. We don’t necessarily know what this value is unless the rate exploitation is given. If we know the rate of exploitation then we can look at the value of the variable capital and both know how many workers are represented and how much surplus value they will produce for capital. For our purposes we are assuming that surplus value is the same for all firms. This allows us to see what changes come about from changes in the organic composition or changes in the prices of the elements of capital.
Marx shows, through some examples, that different technical compositions of capital will result in different profit rates. Firms with a lot of workers and little constant capital expenses (low organic composition) create more surplus relative to cost-price. Firms with lots of machines and few workers (high organic composition) create less surplus relative to cost price. The same is also true if the value composition is changing due to the cost of constant capital or variable capital changing.
Here comes the crucial point/problem. The labor theory of value predicts that lower organic compositions must create more surplus value than firms with higher organic compositions. If this were not the case, if in the real world we saw profit accruing to firms with no relation to the ratio of variable to constant capital, then this would seem to question whether exploited labor is really the source of profit. “If this were not so, then value and surplus-value would be something else than materialised labour. Since capitals in different spheres of production viewed in percentages — or as capitals of equal magnitude — are divided differently into variable and constant capital, setting in motion unequal quantities of living labour and producing different surplus-values, and therefore profits, it follows that the rate of profit, which consists precisely of the ratio of surplus-value to total capital in per cent, must also differ.” The profit rate must vary if the organic/value compositions vary!
But, of course, profit rates in a capitalist society tend toward average profit rates even as their organic/value compositions diverge. Why? Higher profit rates attract investment in that industry. More investments raises supply which lowers prices so that supply and demand balance. This brings down profits to an average level. The opposite happens with low profit rates. Of course this is a theoretical abstraction. In a real economy profit rates are always shifting as firms compete. But in the long run, an average level of profits is established. Does this mean that the labor theory of value is wrong? Let us find out.
The phenomenon of average profits is a phenomena in which the magnitude of profit corresponds to the magnitude of capital invested, or cost price. If I invest $100 in my firm, and the average profit rate is 20%, then I will make $20 in profit. If invest $1000 dollars my profit will be $200. It doesn’t matter if 1% or 99% of this capital is invested in labor. I get the same profit either way. This would make it appear that profit comes from capital itself and not from labor. But it is in this world of appearance where Marx always shows his strength. Of course capital is self-expanding. Capital does create value. But it does so because it incorporates the body of the laborer into capital. The worker breathes life into capital. But in doing so he breathes life into an antagonism.
…And we are not quite up to the chapter on average profits yet anyway. There are a few pages left to go in which Marx discusses other things which should vary profit rates.
Differences in surplus value alter the profit rate. Of course, in this chapter we are assuming that surplus value is the same across the economy. But Marx takes this opportunity to point out that differences in the rate of surplus value between countries is usually what causes different profit rates in different countries.
Marx reminds us that changes in turnover time create changes in profit rates as we saw in chapter 4. The ratio of fixed to circulating capital does not effect the profit rate unless this ratio also involves a change in the organic composition of capital or a change in turnover time.
In concluding Marx says, as timpani rumble in the background, that up until now we have assumed that prices equal values, and that profit equals surplus value. But if these two things are the case then we would have unequal rates of profit across the economy. “…differences in the average rate of profit in the various branches of industry do not exist in reality, and could not exist without abolishing the entire system of capitalist production. It would seem, therefore, that here the theory of value is incompatible with the actual process, incompatible with the real phenomena of production, and that for this reason any attempt to understand these phenomena should be given up.”
We are about to solve this riddle, but it will involve relaxing some of the previous assumptions of the model as we introduce the relation of capitalists in competition into the picture.