Finance Capital, Hilferding 1910


The Causes of Crises

If one considers the complicated relations of proportionality which must exist in production, despite its anarchic character, one is led to pose the question as to where the responsibility for maintaining these relations lies. Clearly, it is the price mechanism which performs this function, since prices regulate capitalist production, and changes in price determine the expansion or contraction of production, the initiation of a new line of production, etc. This also explains the necessity of an objective law of value as the only possible regulator of the capitalist economy. The disruption of these proportional relations must be explained in terms of a disruption in the specific regulatory mechanism of production, or in other words, in terms of a distortion of the price structure which prevents prices from giving a proper indication of the needs of production. Since such disruptions occur periodically, the distortions of the price structure must also be shown to be periodic.

The capitalist is not primarily concerned with the absolute price level of his product, but with the relation between the market price and the cost price, or in other words, with the level of profit. It is this which determines the branches of production in which he invests his capital. If there is a marked decline in profit, new investment is abandoned, particularly when it is a matter of large-scale investment in fixed capital, because such capital is tied up for a long time and the price of fixed capital is crucial in calculating the rate of profit.

As we already know, the organic composition of capital changes. For technological reasons, constant capital increases more rapidly than does variable capital, fixed capital than circulating capital. The relative reduction of the variable component of capital results in a fall in the rate of profit. A crisis involves a slump in sales. In capitalist society this presupposes a cessation of new capital investment, which in turn presupposes a fall in the rate of profit. This decline in the rate of profit is entailed by the change in the organic composition of capital, which has taken place as a result of the investment of new capital. A crisis is simply the point at which the rate of profit begins to fall. But the crisis is preceded by a long period of prosperity, in which prices and profits are high. How does this turn of fortune in the capitalist world occur, this transition from the blessed state of feverishly intense activity, high profits, and accelerated accumulation, to the hopelessness and despair of a slump in sales, dwindling profits and widespread idleness of capital?

Every industrial cycle begins with an expansion of production, the causes of which vary according to particular historical circumstances but which in general can be attributed to the opening of new markets, the establishment of new branches of production, the introduction of new technology, and the expansion of needs resulting from population growth. As demand increases prices and profits rise in particular branches of production, and they expand their output, which in turn increases the demand for products from those sectors of industry which supply their means of production. New investments of fixed capital, and the replacement of old and technically outmoded equipment, are undertaken on a large scale. The process becomes general as the expansion of each branch of industry creates a demand for the output of other industries. The various sectors of production feed upon each other and industry becomes its own best customer.

Thus the cycle begins with the renewal and growth of fixed capital, which is the main source of the incipient prosperity, and as the expansion continues this new investment is accompanied by the most intensive possible utilization of all the available forces of production.

To the same extent, therefore, that the magnitude of the value and the duration of the fixed capital develop with the evolution of the capitalist mode of production, so does the life of industry and of industrial capital develop in each particular investment into one of many years, say of ten years on average. If the development of fixed capital extends the length of this life on one side, it is on the other side shortened by the continuous revolution of the instruments of production, which likewise increases incessantly with the development of capitalist production. This implies a change in the instruments of production and the necessity of continuous replacement on account of their virtual depreciation long before they are worn out physically. One may assume that this life-cycle, in the essential branches of large-scale industry, now averages ten years. However, it is not a question here of the precise figure. So much at least is evident, that this cycle, extending over several years, through which capital is compelled to pass by its fixed part, furnishes a material basis for the periodical commercial crises in which business goes through successive periods of lassitude, average activity, frantic acceleration, and crisis. It is true that the periods in which capital is invested are different in time and place. But a crisis is always a starting point for a large amount of new investment. Therefore it the point of view of society, more or less of a new material basis for the next cycle of turnover.[1]

But there is another cause of the rise in the rate of profit at the beginning of a period of prosperity, besides the increased demand previously described. Along with, and as a result of, the increase in demand, the turnover period of capital is shortened. The work period for a given output is reduced because the introduction of technical improvements makes it possible to produce more rapidly. For example, the auxiliary workers in mining are reduced to the minimum required to maintain output, machinery is more intensively utilized by speeding up its running time and especially by extending the working day (through the elimination of idle shifts, overtime, hiring of extra workers). Furthermore, the turnover time is shortened when sales go on uninterruptedly, and it is frequently reduced to zero because work is done to order. Many important branches of industry increase their sales in nearby domestic markets relative to sales in distant foreign markets, and this too shortens the circulation time. All these factors bring about a rise in the annual rate of profit, since the productive capital, including the variable capital which produces surplus value, is turned over more rapidly.

The shortening of turnover time also means that the industrialist has to advance a smaller amount of money capital in relation to his productive capital. In the first place, better use is made of the available productive capital without any greater outlay of money capital, or at least without a correspondingly greater outlay, as a result of shortening the period of work required by accelerating the tempo of machine operations, and in general by using more intensively the available elements of production. Second, the circulation time is reduced, and along with it the amount of capital which the capitalist must keep on hand during the period of circulation, in addition to the capital that is actually functioning in production. In this way the capital used only for purposes of circulation, unproductive capital, is diminished in relation to the profit-producing capital which functions in production. At the same time the contraction of the circulation period and the accelerated turnover reduce the amount of capital which is lying idle in the form of commodity stocks, which represents an unproductive expense. Thus the annual rate of surplus value and profit rises, the latter particularly sharply because of the reduction in the amount of capital devoted to circulation. At the same time the total sum of surplus value increases and along with it the opportunities for accumulation.

Industrial prosperity simply means, therefore, improved conditions for the valorization of capital. But the very conditions which at first make for prosperity contain within themselves potentialities which gradually worsen the conditions for valorization, until finally a point is reached where new capital investment ceases and there is an evident slump in sales.

For example, if the growth of demand in the first phase of the industrial cycle involves a rise in the rate of profit, this rise nevertheless occurs in circumstances which prepare the way for a later fall. During the period of prosperity there is a large amount of new capital investment, reflecting the latest advances in technology. As we know, however, technical improvements are expressed in a higher organic composition of capital, and this involves a decline in the rate of profit, a deterioration of the conditions for the valorization of capital. The rate of profit declines for two reasons: first, because the variable capital diminishes as a proportion of total capital, so that the same rate of surplus value represents a lower rate of profit; and second, because the larger the amount of fixed capital in relation to circulating capital the longer is the turnover period for capital, and this too involves a decline in the rate of profit.

There are other circumstances which extend the turnover time. At the peak of prosperity labour time per unit of output may increase as a result of a shortage of labour, especially skilled labour, to say nothing of wage disputes which are usually more widespread during such periods. There may also be disruptions of the work process, resulting from an overintensive utilization of the constant capital; for instance, through excessive speeding up of machines which may also be damaged by the employment of inexperienced workers, or by the neglect of repairs and maintenance in order to take full advantage of the brief period of industrial boom. As the cycle continues, turnover time increases again. Once domestic demand has been met, more distant foreign markets have to be sought, and the marketing of commodities and their reconversion into money takes a longer time. All these factors bring about a fall in the rate of profit in the second phase of prosperity.

There are also other factors to be considered. During prosperity the demand for labour power increases and its price rises. This involves a reduction in the rate of surplus value and hence in the rate of profit. Furthermore, the rate of interest rises gradually above its normal level for reasons which will be discussed later, and as a result the rate of entrepreneurial profit falls. Of course, the profit of bank capital is thereby increased (a consideration which is usually overlooked). Yet, during a period such as this, the banks are no longer in a position to make their funds available for the expansion of production. In the first place, speculation in both commodities and securities is in full spate and makes increasing demands on the supply of credit. Second, as we shall see presently, the circulation credit which producers extend to each other becomes inadequate to meet the increased demands, and here too the banks must help out. The banks will therefore tend to retain their profit in liquid form, as money, and this impedes its conversion into productive capital, and hence any real accumulation and expansion of the reproduction process. At the same time, this involves a disruption of the process of production, since as a result of the obstacles to the reconversion of the money capital which the banks have attracted by the higher rate of interest and have retained in money form, a part of the productive capital intended for expanded reproduction remains unsaleable. Thus the decline in entrepreneurial profit means increasingly unfavourable conditions for realization, and a lower level of accumulation for the whole capitalist class.

A crisis begins at the moment when the tendencies toward a falling rate of profit, described above, prevail over the tendencies which have brought about increases in prices and profits, as a result of rising demand. Two questions suggest themselves at this point. First, how do these tendencies, which presage the end of prosperity, assert themselves in and through capitalist competition? Second, why does this occur in the form of a crisis, suddenly rather than gradually? The latter question is less important, for it is the alternation of prosperity and depression which is crucial for the wavelike character of the business cycle, and the suddenness of the change is a secondary matter.

This much at least is clear: if price rises during prosperity were general and uniform they would remain purely nominal. If the prices of all commodities were to rise by 10 per cent or 100 per cent, their exchange relationship would remain unchanged.[2] The rise in prices would then have no effect upon production; there would be no redistribution of capital among the various branches of production and no change in the proportional relations. If production is carried on in the proper proportions (as was shown in the schema presented earlier) these relations need not change and no disruption need occur. It is different, however, if the character of price changes is such as to exclude uniformity. The changed price structure may then bring about changes in the proportional relations among the various branches of production; for the changes in prices and profits crucially affect the allocation of capital among these different branches. This possibility becomes a reality once it is evident that the rise in prices must necessarily be accompanied by a shift in the distribution of capital. And indeed, the existence of factors which, prevent prices from rising uniformly can easily be shown.

Leaving aside revolutions in technology and considering only the ordinary, constant technical improvements, we may say that the greatest change in the organic composition of capital, which is responsible, in the last analysis, for the fall in the rate of profit, will occur where the use of machinery and of fixed capital in general is greatest. For the larger the amount of machinery, scientific knowledge, etc., that is already employed, the greater will be the opportunity for further rationalization of production, improved techniques, and more scientific methods. Hence the tendencies toward a higher organic composition of capital become even stronger. The higher organic composition of capital, however, is only the economic expression of increased productivity, which means a lower price for the same quantity of commodities. Newly invested capital, therefore, obtains an extra profit, and capital will flow into such spheres of investment. At this point a disruptive factor supervenes. The larger the extra profit to be made from these new investments the more capital flows into these spheres. This movement can only be corrected when the new products of these sectors of industry come on to the market, and oversupply depresses prices.[3] In the meantime, however, the demand of such industries will also have driven up the prices of products in other sectors, which will now attract capital, though on a smaller scale because, owing to their lower level of technological, development, the extra profit is smaller. A further consequence is that the price rise is relatively greater in the latter sectors, since they have not increased their capital to the same extent. In the first sector of production the extra profit is considerable, in the second less so, but this situation is gradually equalized by a reduction in the extra profit through the inflow of capital in the first case, and by price increases as a result of a relatively smaller inflow of capital in the second.

With the development of capitalist production the sum of fixed capital grows, and along with it an increasing differentiation among the various industries with respect to the quantity of fixed capital they employ. The larger the amount of fixed capital, however, the longer is the period of time required to install new plant, and hence the greater the difference between various branches of industry in the time required to expand production. The longer it takes to invest in new plant the more difficult it is to adapt to the needs of consumption; and the longer supply lags behind demand the more strongly do prices rise and the more widespread does the pressure to accumulate capital become in such industries.

The larger the mass of fixed capital, the longer does it take for the changes to become effective and productivity to increase. Until that happens, however, supply will continue to lag behind demand. It takes much longer to increase the number of blast furnaces, sink new coal shafts, and complete new railways, than it does to expand textile or paper production. Thus, while a higher organic composition of capital intensifies the causes which must bring about, in the long run, a fall in the rate of profit, these sectors are able, nevertheless, because of the changed conditions of competition resulting from the slower growth of supply in relation to demand, to raise their prices more sharply than other branches of production. Not only do their profits not diminish ; on the contrary, the change in organic composition is accompanied by rising prices and profits, and indeed there is a general tendency for prices to rise more steeply where the organic composition of capital is most highly developed. Since capital flows into those sectors which have the highest profit, the new capital which is being accumulated will be largely diverted into them, and this will continue until the new investments have been completed and the stronger competition from new plants makes itself felt. There is thus a tendency toward overinvestment and overaccumulation of capital in the sectors with the highest organic composition in comparison with those which have a lower organic composition. This disproportion becomes apparent when the products of the first sector reach the market. The sale of these new products is impeded because production in those sectors with a lower organic composition has not increased equally, or at the same speed, but more rapidly though less intensively. This explains why crises are most severe in those branches of production which are technologically most advanced; for example, in the textile (cotton) industry at an earlier time, and subsequently in heavy industry. In general, a crisis is most severe where the turnover of capital is most prolonged and technical improvements and innovations are most advanced, and hence, for the most part, where the organic composition is highest.

The crisis itself depresses prices and profits below their normal level, that is, below the price of production and the average rate of profit respectively. Production contracts and the weaker concerns fail, leaving the field to those which can achieve an average profit even at the lower prices. But the average profit is now at a different level. It no longer reflects the organic composition which existed at the start of the industrial cycle, but the changed, higher organic composition of capital.

Conversely, the industries with a smaller amount of fixed capital are able to adapt more quickly to the requirements of consumption, price rises are more limited (leaving aside fluctuations in the prices of raw materials) and there is less pressure to accumulate capital. This is another reason for the emergence of disproportionality, through the concentration of new investment-seeking capital upon those branches of production with the most rapid and extreme price increases, and at the same time a reason for the fact that, in general, the effects of crises are more severe the more extensive the fixed capital, and most severe in those branches of production where the amount of fixed capital is greatest.

It should be added here that the larger the quantity of capital required at any given time by the level of technology in a particular branch of production, the more difficult it becomes to effect a precise quantitative adaptation of increased production to the increased consumption. It is technically irrational and hence uneconomic to increase steel production by making a new investment in a small steel works. The technological imperative here dictates the scale of expansion without any regard for whether such expansion corresponds with the needs of consumption. Expansion in the heavy industries, once all the available productive forces are fully utilized (and variations in the possibility of utilization are an important factor in making adjustments to minor fluctuations in demand) can only occur on a large scale, in sudden spurts, not on the modest scale characteristic of the early period of capitalism. The light industries are far more adaptable in this respect, and hence their price increases in the interim period are smaller.

In addition to these disproportions in the price structure which result from the diversity of organic composition there are others which arise from natural conditions. We have seen that there is a tendency to over-accumulation in those sectors which have a higher organic composition of capital. These sectors are not only large consumers of raw materials, but also supply raw materials and semi-manufactured goods (iron, coal) to other industries. Disruptions of proportionality may also occur here.

We have seen in Volume II that once the commodities have been converted into money, sold, a certain portion of this money must be reconverted into the material elements of constant capital, and this in proportion to the technical nature of any given sphere of production. In this respect, the most important element in all lines - aside from wages, or variable capital - is the raw material, including the auxiliary substances, which are particularly important in all lines of production that do not use any raw materials in the strict meaning of the term; for instance, in mining and extractive industries in general. . . . If the price of raw materials rises, it may be impossible to make it good fully out of the price of the commodities after deducting the wages. Violent fluctuations of price, therefore, cause interruptions, great collisions, or even catastrophes in the process of reproduction. It is especially the products of agriculture, raw materials taken from organic nature, which are subject to such fluctuations of value in consequence of changing yields, etc., leaving aside altogether the question of the credit system. . . . A second element, which is mentioned at this point only for the sake of completeness, since competition and the credit system are still outside the scope of our analysis, is this: it is in the nature of things that vegetable and animal substances which are dependent on certain laws of time for their growth and production, cannot be suddenly augmented in the same degree as, for instance, machines and other fixed capital or coal, ore, etc., whose augmentation, assuming the natural requirements to be present, can be accomplished in a very short time in an industrial country. It is therefore possible, and under a developed system of capitalist production even inevitable, that the production and augmentation of that portion of constant capital which consists of fixed capital, machinery, etc., should run ahead of that portion which consists of organic raw materials, so that the demand for these last materials grows more rapidly than their supply, and their price rises in consequence. The rise in prices carries with it the following results: (1) a shipping of raw materials from great distances, seeing that the rising price covers greater freight rates; (2) an increase in their production which, however, for natural reasons will not be felt until the following year; (3) the use of various hitherto unused substitutes and a better economizing of waste. If this rise in prices begins to exert a marked influence on production and supply, the turning point has generally arrived at which, on account of the protracted rise in the price of the raw material and of all commodities in which it is an element, demand falls so that a reaction in the price of raw material takes place. Aside from convulsions due to the depreciation of capital in various forms, this reaction is also accompanied by other circumstances which will be mentioned shortly.

It is already evident from the foregoing that the greater the development of capitalist production, the greater the means of suddenly and permanently increasing that portion of the constant capital which consists of machinery, etc., and the more rapidly accumulation takes place (as it does particularly in times of prosperity), the greater is the relative overproduction of machinery and other fixed capital, the more frequent the relative underproduction of vegetable and animal raw materials, and the more pronounced the above-mentioned rise in their prices and the subsequent reaction. And the convulsions increase correspondingly in frequency in so far as they are due to the violent price fluctuations of one of the main elements in the process of reproduction.[4]

The closer we approach our own time in the history of production, so much more regularly do we find, especially in the essential branches of industry, the ever recurring alternation between relative appreciation and the resulting subsequent depreciation of raw ma terials obtained from organic nature.[5]

These disruptions are complemented by others which arise from the manner in which fixed capital is reproduced. We have seen that in simple reproduction, the fixed capital which has been consumed must equal that which is to be newly invested. In fact, this condition is never strictly fulfilled, and to compensate for the discrepancy there must always be available on one side a surplus of elements of fixed capital, a stock of commodities, which represents, on the other side, a reserve of money capital. A certain amount of reserve stock, and a certain amount of hoarding, is a condition of reproduction, which would otherwise always come to a standstill at some point. The elasticity of capital itself also helps to smooth out minor fluctuations and makes possible the satisfaction of particularly urgent needs by speeding up production, overtime working, etc. The feverish harnessing of all the powers of production diminishes the stock of commodities on one side and of money on the other (both relatively and absolutely) and thus eliminates a factor which in normal times helps to compensate any imbalances. This reduction in the money capital reserve becomes absolute on the eve of the crisis, because on one side the industrialist capitalists' demand for money reaches a peak at such a time, and on the other side the demand for money as a means of payment rises rapidly, as the rate at which capital flows back begins to slow down, and along with it the supply of commercial credit. Any further decline in sales cannot now be met by drawing upon reserve money capital and hence leads to bankruptcy.

Proportionality may also be disrupted by a change in the relation between production and consumption. In times of prosperity both prices and profits rise. The rise in commodity prices must necessarily be greater than that in wages, or there would be no increase in profit. Consequently, the share of the entrepreneurial class in the new production increases more rapidly than does that of the workers. In absolute terms there is an increase in consumption, since the entrepreneurs, like the workers, will consume more. But accumulation increases still more rapidly, for this is a period in which the drive to accumulate capital is especially strong, and there is always an interval before luxury consumption begins to grow. The demand for luxury goods is in any case very elastic and easily accommodates itself to the drive toward accumulation. Thus there is a redeployment of profit ; a relatively larger part of it is accumulated, a relatively smaller part is devoted to consumption. This means that consumption does not keep pace with the increase in production. It should also be borne in mind that a certain part of consumption remains unchanged since it is based upon fixed salaries, or upon incomes which are not derived directly from production. Such income strata are only affected indirectly by fluctuations in production.

Thus, disproportional relations arise in the course of the business cycle from disturbances in the price structure. All the factors mentioned above involve deviations of market prices from production prices, and hence disruptions in the regulation of production, which depends for its extent and direction upon the structure of prices. It is clear that such disturbances must eventually lead to a slump in sales. They are also accompanied and mediated by various phenomena in the credit system, which we must now analyse.


[1]Capital, vol. II, p. 211 [MECW 36, p ].

[2]At first sight a period of prosperity seems to be characterized by general and uniform price rises and a period of depression by a similar fall in prices. This is the reason why the cause of crises has been sought so long and so persistently in changes in the value of money. The superstitious faith in the quantity theory of money draws its strongest support from this view.

[3]'Undoubtedly, the economic development of mining and the iron industry has been much too rapid in the Lorraine-Luxembourg area. The effects of this were particularly noticeable because the new concerns came into operation at a late stage, and for a long time, during the period of peak prosperity, helped to increase demand. But the new plants went into production at the end of 1899 and in the spring of 1900, when the high point of development had already passed, so that they merely increased the supply . . . . When they ceased to be consumers, and now appeared on the market with their own output, productive capacity increased enormously and overproduction became inevitable.' `Die Störungen im deutschen Wirtschaftsleben wärend der Jahre 1900 ff.' in Montan- und Eisenindustrie, vol. 2, p. 48.

[4]Capital, vol. III, pp. 139-41 [MECW 37, p 119-120].

[5]ibid., p. 143 [ibid, p122].